UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10
HORIZON TELCOM, INC.
(Exact name of Registrant as specified in its charter)
OHIO 31-1449037
State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
68 East Main Street
Chillicothe, Ohio 45601-0480
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (740) 772-8200
Securities to be registered pursuant to
Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- ------------------- ---------------------
None None
Securities to be registered pursuant to
Section 12(g) of the Act:
CLASS A COMMON STOCK, without par value
(Title of Class)
CLASS B COMMON STOCK, without par value
(Title of Class)
HORIZON TELCOM, INC.
AND CONSOLIDATED SUBSIDIARIES
FORM 10
TABLE OF CONTENTS
Item Page No.
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ITEM 1. Business...............................................................................................2
ITEM 2. Financial Information.................................................................................52
ITEM 3. Properties............................................................................................65
ITEM 4. Security Ownership Of Certain Beneficial Owners And Management........................................65
ITEM 5. Directors And Executive Officers Of The Company.......................................................67
ITEM 6. Executive Compensation................................................................................69
ITEM 7. Certain Relationships And Related Transactions........................................................73
ITEM 8. Legal Proceedings.....................................................................................76
ITEM 9. Market Price of and Dividends on Common Equity and Related Stockholder Matters........................76
ITEM 10. Recent Sales of Unregistered Securities...............................................................76
ITEM 11. Description of Registrant's Securities to Be Registered..............................................78
ITEM 12. Indemnification of Officers and Directors.............................................................82
ITEM 13. Financial Statements And Supplementary Data...........................................................84
ITEM 14. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure.................116
ITEM 15. Financial Statements and Exhibits....................................................................116
Forward Looking Statements
This report contains certain "forward-looking statements," as defined in
Section 21E of the Securities Exchange Act of 1934, that are based on the
beliefs of our management, as well as assumptions made by, and information
currently available to, our management. We have based these forward-looking
statements on our current expectations and projections about future events and
trends affecting the financial condition of our business. These forward-looking
statements are subject to risks, uncertainties and assumptions about us, several
of which are identified below at "Item 1. Business-Risk Factors," and which
include, among other things:
o changes in industry conditions created by the federal
Telecommunications Act of 1996 and related state and federal
legislation and regulations,
o recovery of the substantial costs which will result from the
implementation and expansion of our new businesses,
o retention of our existing customer base and our ability to attract new
customers,
o rapid changes in technology, and
o actions of our competitors.
These forward-looking statements are principally contained in the following
sections of this report:
o Item 1. Business; and
o Item 2. Financial Information - Management's Discussion and Analysis
of Financial Condition and Results of Operations.
1
In addition, in those and other portions of this report, the words and
phrases such as "expects," "estimates," "intends," "plans," "believes,"
"projection," "will continue" and "is anticipated" are intended to identify
forward-looking statements.
These forward-looking statements may differ materially from actual results
because they involve estimates, assumptions and uncertainties. In making these
forward-looking statements, we claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995. We undertake no obligation to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
All forward-looking statements should be viewed with caution.
ITEM 1. Business
GENERAL
Horizon Telcom, Inc. (Horizon Telcom or the Company) is a holding company.
Through its operating subsidiaries, Horizon Telcom is a facilities-based
telecommunications carrier that provides (i) local and long distance telephone,
Internet and data services to residential and business customers located
primarily in Ohio, and (ii) digital wireless service to customers in Ohio,
Indiana, Kentucky, Maryland, New Jersey, New York, North Carolina, Pennsylvania,
Tennessee, Virginia and West Virginia. Unless otherwise specified, all
references to "we," "us" or "our" refer to Horizon Telcom and its consolidated
subsidiaries.
We began operations in 1895 as The Home Telephone Company. In 1929 this
company changed its name to The Chillicothe Telephone Company (CTC). After a
reorganization in 1996, we became a holding company and CTC became a
wholly-owned subsidiary. CTC continues to operate as an incumbent local exchange
carrier (ILEC) covering approximately 800 square miles in Ross, Pickaway, Pike,
Jackson, Hocking and Vinton Counties, Ohio. In addition to local telephone
service, CTC sells key systems and other telephone equipment to businesses,
offers Internet access through digital subscriber line (DSL) technology and
offers very high bit rate digital subscriber line (VDSL) services to residences
as an alternative to cable television services.
Our majority-owned subsidiary, Horizon PCS, Inc. (HPCS), is in the digital
wireless personal communications industry. It is now one of the largest Sprint
PCS affiliates based on the exclusive right to market Sprint PCS products and
services to a total population of over 10.2 million in portions of twelve
contiguous states. A Sprint PCS affiliate is an entity that has agreed to act as
Sprint PCS' exclusive agent to market its services in a particular area. Our
markets are located between Sprint PCS' Chicago, New York and Raleigh/Durham
markets and connect or are adjacent to 15 major Sprint PCS markets that have a
total population of over 59 million. As a Sprint PCS affiliate, we market
digital personal communications services, or PCS, under the Sprint and Sprint
PCS brand names. We offer the same national pricing plans and use the same sales
and marketing strategies and national distribution channels as Sprint PCS.
Through our wholly-owned subsidiary, United Communications, Inc. (United),
we offer Internet and data services and resell long distance services. The
Internet and data services are provided under the "bright.net" brand through
United's contractual arrangement with Comnet, a consortium of small Ohio
telephone companies. United provides long distance services through a reselling
arrangement with a primary long distance carrier. Prior to December 1, 2000,
United also operated a paging business. On December 1, 2000, United sold the
assets of its paging business to an unrelated third party for $100,000.
We also own 100% of Horizon Services, Inc. (Services), which provides
administrative services to our other subsidiaries. These administrative services
generally include such functions as insurance, billing services, accounting
services, computer access and other customer relations, and human resources.
2
The following chart illustrates our corporate structure:
[graph omitted]
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(1) The ownership percentage for HPCS excludes options granted under its 2000
Stock Option Plan, warrants issued to the initial purchasers of HPCS'
senior discount notes and shares subject to Sprint PCS warrants.
(2) This percentage includes the 48% of Bright PCS which HPCS owns indirectly
through Horizon Personal Communications.
3
The operations of CTC and HPCS are our primary business segments. Landline
telephone services accounted for approximately 48%, 70%, and 78% of our
operating revenues, respectively, in 2000, 1999, and 1998. Landline telephone
services accounted for $11.3, $12.3, and $12.8 million operating profit for
2000, 1999, and 1998, respectively. HPCS (wireless communication services)
accounted for approximately 39%, 9%, and 2% of our operating revenues, and most
of our operating (loss) of $(39.6), $(11.8), and $(7.8) million, respectively,
for 2000, 1999, and 1998. We expect that landline telephone services and HPCS
services will account for more than 93% of our revenue, operating earnings and
losses in 2001.
Horizon Telcom, Inc. is incorporated under the laws of Ohio and was
organized in 1996 pursuant to the corporate reorganization of CTC into a holding
company structure. Our principal executive offices are located at 68 East Main
Street, Chillicothe, Ohio 45601-0480 (telephone number: (740) 772-8200)).
Certain business, financial and competitive information about our
operations is discussed below. For certain other information regarding our
business segments, see the Note entitled "Segment Information" in the Notes to
Consolidated Financial Statements at Item 13 below, which information is
incorporated herein by reference.
ILEC SERVICES
General
CTC offers integrated telecommunications services as an ILEC to customers
served by more than 37,800 access lines in Ross, Pickaway, Pike, Jackson,
Hocking and Vinton Counties, Ohio. Our ILEC network facilities include nearly
223 fiber miles, serving ten exchanges in a host-remote switch architecture.
The number of access lines increased from 36,832 on December 31, 1999 to
37,824 on December 31, 2000. The following table details access line growth over
the past three years:
YEARS ENDED DECEMBER 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
ACCESS LINES
Residential............................................................ 28,820 28,580 27,811
Business............................................................... 9,004 8,252 8,743
---------- ---------- ----------
TOTAL ILEC............................................................. 37,824 36,832 36,554
========== ========== ==========
PERCENTAGE OF TOTAL
Residential............................................................ 76% 78% 76%
Business............................................................... 24% 22% 24%
Customer satisfaction remains a top priority, and our efforts are directed
accordingly. Since we are a small ILEC serving its home town, it is important to
our business strategy that our employees concentrate on customer service, and
training and orientation programs emphasize that concern.
Our ILEC sales team is structured to provide maximum flexibility for our
customers. Residential customers may personally meet with a sales and service
representative in our business office or can alternatively take advantage of the
convenience of calling into our centralized customer care center. Our sales team
provides "one-stop" shopping; each residential customer service representative
is trained in all residential applications, including Internet and data
services, and digital wireless services, and telephone equipment, and will
additionally address any follow-up sales and billing concerns.
Business customers are served by a specialized group trained to manage the
specialized products and services unique to business customers. Customers with
less complex needs are supported by a specialized telephone customer care group,
4
which develops solutions and schedules service installations. Major business
customers are assigned dedicated account executives that are familiar with their
complex applications and service requirements.
A centralized operations service center coordinates provisioning and
maintenance for all ILEC customers. In addition to receiving maintenance
requests, this center dispatches field personnel and monitors the status of all
service orders and maintenance requests. To ensure continued customer
satisfaction, the center is measured against targeted time intervals and the
ability to meet customer commitment dates.
CTC operates a class 4/5 Siemens EWSD digital host central office and nine
remote switches serving population clusters throughout Ross County, Ohio. CTC
also has an extensive fiber optic fed electronic concentrator network. This
SONET based network, now serving approximately one-third of the 37,800 access
line base, presently covers approximately 223 miles. The vendors providing SONET
equipment include Alcatel and Fujitsu. The electronic concentrator vendors
include Alcatel, AFC and Next Level Communications. CTC has deployed ISDN, ADSL
and VDSL high speed Internet access service, which brings broadband service
capability to approximately 75% of the subscriber base. We continue to upgrade
our distribution network by moving fiber and electronics closer to the customer
through the use of remote switching units. The customer care service center
operations are supported by a Martin and Associates service order,
trouble-ticketing, billing and collection system and an NEC private branch
exchange with automated call distribution capabilities. At the heart of our
network is a network operations center that identifies problems as they occur
and diagnoses potential network problems before customers are impacted.
CTC recently began offering VDSL service under the name "Horizon View." The
first customer was connected on August 15, 2000. This quality digital video
service competes with cable and satellite television providers. It also provides
high-speed always-on Internet access and a voice path for regular telephone
service. In April 2001, we celebrated our 1000th Horizon View customer.
In addition to local telephone service, CTC sells key systems and other
telephone equipment to businesses.
Regulation of Our ILEC Business
Our ILEC is subject to extensive regulation by various federal, state and
local governmental bodies. Federal laws and regulations, and, specifically, the
Telecommunications Act of 1996 (the Telecom Act), have sought to open the local
service market to competition.
The Telecom Act has imposed somewhat burdensome obligations upon ILECs that
are not exempted as "rural telephone companies." These obligations include the
duty to negotiate interconnection agreements with competing local service
providers and to obtain state commission approval of such agreements, the
obligation to interconnect with competing local carriers at any technically
feasible point, the duty to provide nondiscriminatory access to unbundled
network elements (e.g., loops and subloops, local switching, interoffice
transport facilities, signaling networks and operations support systems) at
regulated prices, the duty to furnish local competitors with local services at
wholesale rates for resale purposes, and the obligation to allow local
competitors to collocate their equipment in ILEC central offices. Our ILEC takes
the position that it is a "rural telephone company" within the meaning
established by the Telecom Act, and is therefore presently exempt from these
ILEC obligations. It will retain this exemption unless and until the Public
Utilities Commission of Ohio terminates it at the request of a competing local
carrier.
The Telecom Act has also imposed obligations upon all local exchange
carriers (ILECs and competitive local exchange carriers, or CLECs). These
obligations include the payment of reciprocal compensation for the transport and
termination of local calls, the provision of local number portability and
dialing parity, and the affording of access by competing local carriers to
poles, ducts, conduits and rights-of-way. Small carriers may request suspension
or modification by their state commission of some or all of these requirements,
but such suspensions or modifications are extremely difficult to obtain. Our
ILEC has not sought or obtained suspension or modification of any of these local
exchange carrier obligations.
5
As a general matter, federal regulation increases our ILEC's business risks
and may have a substantial impact on our ILEC's future operating results. The
Federal Communications Commission (FCC) regulates two significant sources of our
ILECs revenues - namely, interstate access charges and federal universal service
support. The FCC currently has several proceedings pending that could materially
change both the mechanisms for determining interstate access charges and federal
universal service support, and the dollar revenues received by our ILEC from
these sources. For example, the FCC is presently considering an interstate
access charge reform proposal submitted by the Multi-Association Group (MAG)
comprised of four national telephone trade associations. If adopted as
submitted, the MAG Plan would increase the monthly federal subscriber line
charges paid by our ILEC's business and residential customers, reduce the
per-minute access charges paid by our ILEC's interexchange carrier customers,
and establish residual funding mechanisms that could be taken from our ILEC by
competitors. The MAG Plan has received substantial opposition from interexchange
carriers, state commissions, and consumer groups, and may be rejected or adopted
in significantly modified form by the FCC.
The FCC is also presently considering a recommendation by the Rural Task
Force (RTF) for reform of the federal universal service support mechanism
presently applicable to our ILEC. The RTF recommendation would retain the
embedded cost mechanism presently used to determine and distribute federal
high-cost loop support to rural telephone companies. It would also recalculate
and modify the indexed cap that presently limits federal high-cost loop support,
establish a new mechanism that would enable rural telephone companies to obtain
some universal service support for exchanges that they acquire and upgrade, and
permit rural telephone companies facing potential competition to disaggregate
their study areas to discourage competitors from entering rural population
centers in order to seize disproportionate amounts of the universal service
support received by rural ILECs. The RTF Recommendation received less opposition
than the MAG Plan, and could be acted upon by the FCC during the first half of
2001.
Our ILEC is required to contribute to the federal universal service
program. States also have similar assessment mechanisms. At the present time it
is not possible to predict the extent of our ILEC's total federal and state
universal service assessments or the amount of dollars it will receive from
federal and state universal service funds.
The FCC and the Federal Bureau of Investigation (FBI) are responsible for
the implementation of the Communications Assistance for Law Enforcement Act
(CALEA). This legislation obligates our ILEC to upgrade its switching facilities
to give it the capabilities and capacity to install and operate wiretaps, pen
registers and similar surveillance activities in response to properly authorized
requests from federal, state and local law enforcement. The CALEA statute and
regulations also impose security and administrative obligations and risks upon
carriers such as our ILEC. Some of the more expensive and risky potential CALEA
obligations - for example, those related to the interception of packet-switched
communications - are still subject to litigation before the FCC and the courts.
Federal statutes and FCC rules and proceedings regarding the slamming of
local and long distance customers, the use of Customer Proprietary Network
Information (CPNI) and the conservation of telephone number resources can affect
the costs and risks of doing business of our ILEC and other local exchange
carriers.
State laws and regulations require us to comply with Ohio pricing
regulations, file periodic reports, pay various fees and comply with rules
governing quality of service, consumer protection and similar matters. Local
regulations require us to obtain municipal franchises and to comply with various
building codes and business license requirements.
CTC continues to provide local exchange service through traditional rate
base, rate of return regulation. The Public Utilities Commission of Ohio has
proposed alternative rate regulation and, when the regulation is finalized, CTC
will have the right to elect this form of regulation. Generally, under the
proposed regulations, we would have greater flexibility to decrease prices, but
would have to petition the Public Utilities Commission of Ohio to increase
rates. We have not decided whether to elect the alternative rate regulation.
6
Competition
Several factors have resulted in rapid change and increased competition in
the local telephone market over the past 15 years, including:
o growing customer demand for alternative products and services,
o technological advances in transmitting voice, data and video,
o development of fiber optics and digital electronic technology,
o a decline in the level of access charges paid by interexchange
carriers to local telephone companies to access their local networks,
and
o legislation and regulations designed to promote competition.
To date, we have not faced competition for local telephone service in our
ILEC service territory from any CLECs. It is possible, however, that we will
face such competition in the future. We believe that Adelphia Cable is preparing
to upgrade its cable television plant to be in a position to provide local
service, and is already offering long distance telephone services as a reseller.
No potential competitor has asked us to enter into interconnection agreements or
collocation agreements to connect their network with our network. If competition
develops, we may face pressure to match the pricing and service offerings of
these competitors.
LONG DISTANCE, INTERNET AND NETWORK SERVICES
Our wholly-owned subsidiary, United Communications, offers long distance
service, Internet and data services and network consulting services to
customers.
Long Distance Service
The long distance market has become significantly more competitive since
1984, when AT&T was required to divest its local telephone system. Since that
time, new competitors have entered the market and prices have declined,
resulting in increased consumer demand and significant market growth. Increased
competition has also led to increased consolidation among long distance service
providers. Major long distance competitors include AT&T, Sprint and MCI
WorldCom, Inc. Furthermore, Verizon obtained approval to provide long distance
services in New York and Massachusetts, and SBC Communications, Inc. has
obtained approval in Texas, Kansas and Oklahoma. These competitors benefit from
established market share and from established trade names through nationwide
advertising. Internet-protocol telephony, a potential competitor for low cost
telephone service, is also developing.
United began offering long distance services as a reseller in 1996 and now
provides that service to approximately 5,050 access lines. We expect to continue
to offer a competitively priced service to those customers who are looking for a
local supplier of long distance services.
Internet Access Service
United provides Internet and data services through our affiliation with
Comnet. Comnet is a consortium of independent local exchange carriers in Ohio.
We have the right to market and sell Internet and data services using the
"bright.net" brand in 27 counties in southern Ohio, including our ILEC service
territory. We act as the gateway for the services and rely on the Internet
backbone of Comnet and its contractual relationships with other backhaul
providers. As of December 31, 2000, we had 17,239 subscribers to this service.
We offer a variety of dial-up and dedicated access solutions which provide
access to the Internet. We also offer a full range of customer premise equipment
required to connect to the Internet. Our access services include:
7
o Dial-up Access. Our dial-up services provide access to the Internet
through ordinary telephone lines at speeds of up to 56 Kbps and
through digital ISDN lines at speeds of up to 128 Kbps.
o Dedicated Access. We offer a broad line of high-speed dedicated access
utilizing frame relay and dedicated circuits, which provide business
customers with direct access to a full range of Internet applications.
o DSL Access. We began to offer several ILEC customers high-speed
Internet access service using ADSL technology in the first quarter of
2000. ADSL technology permits high speed digital transmission over the
existing copper wiring of regular telephone lines. Our ADSL service is
available at speeds up to 768 Kbps. Our ADSL services are designed for
residential users and small-to-medium sized businesses to provide high
quality Internet access at speeds faster than an integrated services
digital network (ISDN) and at flat-rate prices that are lower than
traditional dedicated access charges. As the local exchange carriers
in other areas of southern Ohio begin offering DSL technology, we will
offer DSL in the rest of our bright.net service territory.
We offer a variety of value-added services, including Web hosting, Web
design, collocation, virtual private networks or intranets, remote access and
security solutions, and video conferencing.
We provide software solutions that enable companies to conduct electronic
commerce. We offer electronic data interchange/extraNet solutions consisting of
software and services that are designed to help businesses connect to their
suppliers and customers. We also provide Internet commerce software to allow
businesses to build Web applications for commerce-enabled Web sites, intranets
and extranets. Common features of this software include the ability to build
electronic catalogs to conduct transactions and to integrate with business
systems, including purchasing, accounting and inventory systems.
Account executives sell Internet and data services directly to business
customers in our service areas. Our technical support staff is available 24
hours a day, seven days a week. Our technicians design, order, configure,
install and maintain all of our equipment to suit the customer's needs. We have
a customer care group dedicated to Internet and data services.
In general, Internet and data services are not regulated at the federal
level. An important regulatory issue currently pending before both the FCC and
federal courts is how Internet traffic will be classified and treated for
purposes of interstate access charges and reciprocal compensation related to
local traffic. Internet service providers currently obtain access services from
local exchange carriers without having to pay the access charges that
interexchange carriers pay for equivalent service. This special exemption may be
withdrawn at any time, in which case Internet services could be subject to
access charges. As we provide Internet services directly to the ILECs' networks,
a change in the treatment of Internet traffic for purposes of reciprocal
compensation would likely have little effect on our operations.
The Internet and data services market is extremely competitive, highly
fragmented and has grown dramatically in recent years. The market is
characterized by the absence of significant barriers to entry and the rapid
growth in Internet usage among customers. Sources of competition are:
o access and content providers, such as AOL, the Microsoft Network and
Prodigy;
o local, regional and national Internet service providers, such as
PSINet and EarthLink;
o the Internet services of regional, national and international
telecommunications companies, such as AT&T, BellSouth, and MCI
WorldCom;
o online services offered by incumbent cable providers, such as Time
Warner; and
o DSL providers, such as COVAD.
8
The recent merger of AOL/Time Warner creates further, formidable
competitive threats in the Internet and data services markets. The merging
companies announced plans to leverage their combined assets and resources
post-merger to offer a wide variety of Internet and data-related services.
Network Consulting
Our computer solutions division offers network consulting services to
businesses in our ILEC service territory.
DIGITAL WIRELESS SERVICES
The information set forth under this heading describes the business of our
subsidiary Horizon PCS, Inc., a Delaware corporation. Horizon Telcom owns 92.0%
of the outstanding class B common stock of HPCS, representing 56.5% of all
classes of capital stock on a fully diluted basis, and 81.5% of the total voting
power of all classes of capital stock of HPCS on a fully diluted basis.
References under this heading to "we," "us" and "our" are to HPCS.
Overview
We are one of the largest Sprint PCS affiliates based on our exclusive
right to market Sprint PCS products and services to a total population of over
10.2 million in portions of twelve contiguous states. Our markets are located
between Sprint PCS' Chicago, New York and Raleigh/Durham markets and connect or
are adjacent to 15 major Sprint PCS markets that have a total population of over
59 million. As a Sprint PCS affiliate, we market digital personal communications
services, or PCS, under the Sprint and Sprint PCS brand names.
We became one of the five charter Sprint PCS affiliates in June 1998, when
we were awarded our initial seven markets in Ohio, West Virginia and Kentucky
with a total population of approximately 1.6 million. Since our initial
territory grant, we have substantially expanded the size of our territory, as
follows:
o in August 1999, Sprint PCS granted us additional markets in Virginia,
West Virginia, Kentucky, Maryland, North Carolina and Tennessee with a
total population of approximately 3.3 million;
o in May 2000, Sprint PCS granted us additional markets in Pennsylvania,
New York, Ohio and New Jersey with a total population of approximately
2.9 million; we also agreed to grant Sprint PCS warrants to purchase
2,510,460 shares of our class A common stock, as further described in
"The Sprint PCS Agreements"; and
o in June 2000, we completed the acquisition of Bright PCS, a Sprint PCS
affiliate, adding markets in Indiana, Ohio and Michigan with a total
population of approximately 2.4 million.
Our territory includes significant market coverage in Indiana, Ohio,
Pennsylvania, Tennessee, Virginia and West Virginia and selected markets in
Kentucky, Maryland, Michigan, New Jersey, New York and North Carolina. Our
markets are adjacent to or connect a number of major markets owned and operated
by Sprint PCS, including Buffalo, Chicago, Cincinnati, Cleveland, Columbus,
Detroit, Indianapolis, Knoxville, Lexington, New York, Philadelphia, Pittsburgh,
Raleigh/Durham, Richmond and Washington, DC. In addition, our territory contains
more than 2,600 heavily traveled interstate miles, including over 460 miles of
Interstate 80, a major east-west artery connecting New York to Chicago, and
numerous other federal and major state highways. Our territory is also home to
more than 60 four-year colleges and universities with a student population of
over 240,000, as well as a number of smaller colleges and universities.
Sprint PCS
Sprint PCS, a wholly-owned subsidiary of Sprint, operates the only 100%
digital, 100% PCS wireless network in the United States. The digital technology
that Sprint PCS uses is code division multiple access technology, referred to as
9
CDMA. Sprint PCS has licenses to provide PCS service nationwide. Sprint PCS
operates its PCS network in major metropolitan markets throughout the United
States and has entered into agreements with affiliates, such as HPCS, to build
out and manage networks in smaller metropolitan areas and along major highways.
Statements in this document regarding Sprint Corporation or Sprint PCS are
derived from information contained in the periodic reports and other documents
filed with the Securities and Exchange Commission by Sprint and Sprint PCS, or
press releases issued by Sprint and Sprint PCS.
Business Strategy
We believe that the following elements of our business strategy will enable
us to rapidly complete our network, distinguish our wireless service offerings
from those of our competitors and compete successfully in the wireless
communications marketplace.
Taking Full Advantage of the Benefits of our Affiliation with Sprint PCS.
Our long-term strategic affiliation with Sprint PCS provides us with many
business, operational and marketing advantages including the following:
Exclusive Provider Of Sprint PCS Products And Services. We have the
exclusive right to use the Sprint and Sprint PCS brand names for the sale of
Sprint PCS products and services in our territory. We provide these products and
services exclusively under the Sprint and Sprint PCS brand names.
Sprint PCS Licenses And Long-Term Commitments. We have the exclusive right
to use Sprint PCS' licensed spectrum to provide Sprint PCS products and services
in our territory. Sprint PCS has funded the purchase of the licenses covering
our territory at a cost of approximately $57.0 million and has incurred
additional expenses for microwave clearing. As a Sprint PCS affiliate, we did
not have to fund the acquisition of these licenses, thereby reducing our
start-up costs. The Sprint PCS agreements are for a total of 50 years, including
an initial term of 20 years and three 10-year renewal terms. These agreements
will automatically renew for the renewal period unless at least two years prior
to the commencement of any renewal period either party notifies the other party
that it does not wish to renew the agreement.
Sprint PCS' Nationwide Digital PCS Network. As of December 31, 2000, Sprint
PCS, together with its affiliates, operated PCS systems providing service in
metropolitan markets within the United States containing nearly 223 million
people nationwide, including all of the 50 largest metropolitan markets. Our
network operates with Sprint PCS' national network and will extend Sprint PCS'
coverage into our markets, which we believe is important to Sprint PCS' national
strategy. We believe our ability to provide our customers with access to Sprint
PCS' nationwide network represents a competitive advantage over other national
and regional providers of wireless services.
Established And Available Distribution Channels. We benefit from immediate
access to major national retailers under Sprint PCS' existing sales and
distribution agreements and other national sales and distribution channels,
including:
o a sales and distribution agreement with RadioShack, which provides us
with access to approximately 170 stores in our territory on an
exclusive basis for PCS;
o the sales and distribution agreements with other major national
third-party retailers such as Best Buy, Circuit City and Office Depot,
which collectively provide us with access to approximately 304
additional retail outlets in our territory;
o Sprint PCS' national inbound telemarketing sales force;
o Sprint PCS' national accounts sales team; and
o Sprint PCS' electronic commerce sales platform.
10
Sprint PCS' National Brand Name Recognition And National Advertising
Support. We benefit from the strength and the reputation of the Sprint and
Sprint PCS brands. Sprint PCS' national advertising campaigns and developed
marketing programs are provided to us at little or no additional cost under our
Sprint PCS agreements. We offer the same strategic pricing plans, promotional
campaigns and handset and accessory promotions as Sprint PCS, and have the
ability to add pricing plans and marketing promotions that target local market
needs.
Better Equipment Availability And Pricing. We are able to acquire our
network equipment, handsets and accessories more quickly and at a significantly
lower cost than we would without our strategic relationship with Sprint PCS. We
purchase our network equipment, handsets and accessories under Sprint PCS'
vendor arrangements that provide for volume discounts. These discounts
significantly reduce the overall capital required to build our network and
significantly reduce our costs of handsets and accessories.
Sprint PCS Wireless Web. Our network will support and market the Sprint PCS
Wireless Web. The Sprint PCS Wireless Web allows customers with data capable or
Web-browser enabled handsets to connect to the Internet and browse specially
designed text-based Web sites, including AOL, Yahoo!, Amazon.com, Bloomberg.com,
CNN Interactive, MapQuest.com, Fox Sports, Ameritrade, InfoSpace.com and
Weather.com. For more information on the Sprint PCS Wireless Web, see "--
Products and Services -- Access to the Sprint PCS Wireless Web."
Sprint PCS' Extensive Research And Development. We benefit from Sprint PCS'
extensive research and development effort, which provides us with ongoing access
to new technological products and enhanced service features without significant
research and development expenditures of our own. We have prompt access to any
developments produced by Sprint PCS for use in our network.
Sprint PCS' Back Office Services. When we initially launched our
independent PCS operations, we provided our own back office services, such as
customer services and billing services. In May 2000, we amended the Sprint PCS
agreements so that Sprint PCS will provide these back office services to us. All
new markets we launch are under our back office arrangement with Sprint PCS. We
anticipate that we will complete conversion of our existing customers to these
services by the end of 2001. We expect the cost of these services will be at or
below the cost of providing the services ourselves, due to anticipated rate
reductions and Sprint PCS' ability to economically manage the support of new
services. We also believe this arrangement will allow us to more quickly roll
out new Sprint PCS products and services in our markets.
Rapidly Completing The Build-Out And Launch Of Our Network. We plan to
offer coverage to 6.9 million residents, or approximately 68% of our covered
population, by February 28, 2002. We have successfully developed several key
relationships which allow us to efficiently launch our markets. For building the
portion of the Sprint PCS network located within our territory, which we refer
to as our build-out, in our Bright PCS markets and for fill-in coverage in our
initial markets, we rely on our build-to-suit arrangements with SBA Towers,
Inc., a wholly-owned subsidiary of SBA Communications Corporation, which we
refer to as SBA. These arrangements allow us to minimize capital costs and take
advantage of SBA's expertise in quickly completing the site acquisition process.
For markets with a high concentration of existing towers or zoning challenges,
we employ a co-location strategy. For our Virginia and West Virginia markets, we
use our network services agreement with the West Virginia PCS Alliance and the
Virginia PCS Alliance, which we refer to as the Alliances, to provide us with
the use of and access to key components of their network in most of our markets
in Virginia and West Virginia thereby increasing our coverage to our markets
with a total population of 3.3 million. For our new markets in Pennsylvania, New
York, Ohio and New Jersey, we purchased network assets currently under
construction from Sprint PCS, enabling us to launch these markets much earlier
than if we had to complete the entire build-out of these markets independently.
Deploying A High-Capacity Network. We have built an all-digital PCS network
that we believe is state-of-the-art and high-quality. Our strategy is to provide
service to the largest communities in our markets and the interstates and
primary roads connecting these communities to one another and to the adjacent
major markets owned and operated by Sprint PCS. We believe that our network
design, together with the use of digital CDMA technology, will allow our network
to handle more customers with fewer dropped calls and better clarity than our
competitors. In addition, our network will have sufficient capacity to provide
services beyond traditional voice transmissions.
11
Executing An Integrated Local Marketing Strategy. Our marketing strategy is
to take full advantage of Sprint's and Sprint PCS' nationwide presence and brand
names while at the same time establishing a strong local presence in each of our
markets. We emphasize the improved clarity and quality, enhanced features and
favorable pricing of Sprint PCS products and services and replicate the
marketing strategies that have resulted in Sprint PCS becoming the fastest
growing wireless service providers in the country. In addition, on the local
level, we are or soon will be:
o establishing 40 Sprint PCS stores within our territory;
o establishing local third-party sales and distribution relationships on
an as-needed basis;
o directing our media efforts at the community level by advertising in
local publications and radio;
o sponsoring local and regional events; and
o using the local telephone offices of Sprint and the former owners of
Bright PCS which are located in our markets to offer our products and
services.
Continuing To Explore Opportunities To Expand Our Territory And Provide
Complementary Products And Services. Since the initial grant of our markets, we
have significantly expanded the geographic scope of our territory through three
separate transactions. We expect to continually evaluate ways to strategically
expand our territory. Similarly, we expect to consider offering complementary
products and services. Any transaction we undertake to expand our territory may
require additional financing and would involve a number of risks, as discussed
at "Business-Risk Factors."
Exploiting Our Potential For Significant Roaming Revenue. We receive Sprint
PCS roaming revenue from Sprint PCS subscribers based outside our territory who
roam on our network. Our territory is adjacent to or connects 15 major markets
owned and operated by Sprint PCS, including Buffalo, Chicago, Cincinnati,
Cleveland, Columbus, Detroit, Indianapolis, Knoxville, Lexington, New York,
Philadelphia, Pittsburgh, Raleigh/ Durham, Richmond and Washington, D.C. These
markets include five of the ten largest metropolitan areas in the United States,
which have a total population of approximately 59 million residents. Our
territory also contains more than 2,600 interstate miles.
Support From Our Fully Financed Business Plan. We believe that our existing
cash and available borrowings under our new senior secured credit facility will
be adequate to fund our PCS network build-out, tax payments, anticipated
operating losses and working capital requirements until we achieve positive
earnings before interest, taxes, depreciation and amortization, which we expect
to achieve in the third quarter of 2003.
Markets
Our territory covers 54 markets in parts of Indiana, Kentucky, Maryland,
Michigan, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee,
Virginia, and West Virginia. Sprint PCS has launched service in 15 major
metropolitan areas that are adjacent to our markets and have a combined total
population of approximately 59 million. We believe that connecting or being
adjacent to existing Sprint PCS markets is important to Sprint PCS' strategy to
provide seamless, nationwide PCS service.
12
The following chart identifies our markets:
Sprint PCS MhZ of Estimated Total
Market Grant (1) Spectrum Population(2)
------ ---------- -------- ---------------
Charleston, WV 1st 20 492,700
Huntington, WV 1st 20 369,700
Zanesville, OH 1st 20 187,200
Parkersburg, WV 1st 20 182,000
Athens, OH 1st 20 132,100
Chillicothe, OH 1st 35(4) 104,700
Portsmouth, OH 1st 20 93,800
Roanoke, VA 2nd 10 645,200
Charlottesville, VA 2nd 30 218,600
Clarksburg, WV 2nd 30 195,600
Danville, VA 2nd 10 168,600
Lynchburg, VA 2nd 10 160,100
Morgantown, WV 2nd 30 107,800
Staunton, VA 2nd 10 107,600
Martinsville, VA 2nd 10 90,400
Fairmont, WV 2nd 30 56,800
Kingsport (Tri-Cities), TN 2nd 20 689,100
Cincinnati, OH (Partial) (3) 2nd 10 127,400
Erie, PA 3rd 10 280,200
Sharon, PA 3rd 10 122,300
Ashtabula, OH 3rd 10 103,500
Meadville, PA 3rd 10 90,000
Fort Wayne, IN Bright 10 689,200
South Bend, IN Bright 10 348,800
Elkhart, IN Bright 10 256,900
Lima, OH Bright 30 251,800
Kokomo, IN Bright 30 186,000
Benton Harbor, MI Bright 10 160,100
Findlay, OH Bright 30 152,900
Michigan City, IN (Partial) (3) Bright 10 109,900
Marion, IN Bright 30 108,600
Dayton, OH (Partial) (3) Bright 10 41,065
Toledo, OH (Partial) (3) Bright 30 30,066
Kalamazoo, MI (Partial) (3) Bright 30 20,009
Battle Creek, MI (Partial) (3) Bright 30 8,980
Beckley, WV 2nd 20 169,500
Knoxville, TN (Partial) (3) 3rd 10 54,201
Jamestown, NY 3rd 30 180,100
Scranton, PA 3rd 30 664,700
Olean, NY 3rd 30 240,200
Sunbury, PA 3rd 30 194,300
Williamsport, PA 3rd 30 161,200
New York, NY (Partial) (3) 3rd 30 169,673
Pottsville, PA 3rd 30 151,000
State College, PA 3rd 30 134,900
Stroudsburg, PA 3rd 30 128,100
Du Bois, PA 3rd 30 127,900
Oil City, PA 3rd 30 104,500
Allentown, PA (Partial) (3) 3rd 30 59,094
Williamson, WV 2nd 20 183,900
Bluefield, WV 2nd 20 176,200
Cumberland, MD 2nd 10 159,000
Logan, WV 2nd 10 40,900
Canton, OH (Partial) (3) 2nd 10 36,215
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--------------------
(1) Indicates the grant from Sprint PCS in which we received our
respective markets. "Bright" indicates markets granted to Bright PCS
in October 1999. The following summarizes our other grants:
1st: July 1998
2nd: August 1999
3rd: May 2000
(2) Estimated total population is based on January 1, 1999 estimates
compiled by Rand McNally Commercial Atlas & Marketing Guide, 2000
Edition.
(3) The estimated total population in these markets represents the
population of the counties within the market granted to us in the
Sprint PCS agreements, not the total population of that market.
(4) Includes 15 MHz of spectrum owned directly by us.
Network Build-Out Plan
Overview. Our network build-out strategy is to provide service to the
largest communities in our markets and to cover interstates and primary roads
connecting these communities to each other, and to the adjacent major markets
owned and operated by Sprint PCS. We believe that our schedule for completing
the build-out is achievable based on our prior experience in network build-out,
the digital PCS technology we will use to build our PCS network and the
established standards of Sprint PCS.
Our markets have a total population of approximately 10.2 million and, as
of December 31, 2000, we covered approximately 5.1 million residents or 50% of
the total population. When complete, the build-out of our 54 markets will
consist of approximately 1,300 sites. We plan to cover approximately 6.9 million
residents or 68% by February 28, 2002. The following details the current status
of each of our market grants.
First HPCS Grant (June 1998). By January 1999 we covered approximately
887,000 residents, or 57% of the total population of our initial seven markets.
We are currently extending the coverage in these markets along connecting
highways and to smaller communities. We also expect the Alliances to fill in
coverage in the two initial markets that are being served under our network
services agreement. As of December 31, 2000, we covered approximately 913,000
residents, or 58% of the total population of our initial seven markets, and we
plan to cover approximately 985,000 residents, or 63% by September 30, 2001.
Second HPCS Grant (August 1999). In August 1999, Sprint PCS granted us 17
additional markets in Virginia, West Virginia, Tennessee, Maryland, Kentucky and
Ohio with a total population of approximately 3.3 million. Within two months of
this second grant, we launched service in nine of these markets, providing
coverage to 1.0 million residents, or 31% of the total population in these
markets through our network services agreement with the Alliances.
In August 2000, we launched service in our Kingsport, Tennessee market,
which has a total population of 689,000. We plan to cover approximately 488,000
residents, or 71% of the total population in this market. By September 30, 2001,
we will launch two additional markets, and the five remaining markets received
in the second grant will be launched by February 28, 2002, at which time we plan
to cover approximately 2.0 million residents, or 61% of the total population in
these 17 markets.
Bright PCS Grant (October 1999). In September 2000 we launched service in
our Bright PCS markets and now offer service in all of the Bright PCS markets,
covering approximately 2.0 million residents, or 85% of the total population of
these 13 markets.
14
Third HPCS Grant (May 2000). In May 2000, Sprint PCS granted us 17
additional markets in Pennsylvania, New York, Ohio and New Jersey with a total
population of approximately 2.9 million. In conjunction with the grant, we
agreed to purchase from Sprint PCS 154 sites in various stages of construction.
We have completed our engineering design for these markets and the build-out is
expected to consist of approximately 438 sites, including the 154 that were
purchased from Sprint PCS. We have site lease options for 151 of the 438 site
locations. Of these 438 sites, 257 have been approved for construction, 152 have
received zoning approval, 130 leases have been executed, 105 building permits
have been approved, construction has begun on 94 sites and 84 sites are
complete.
The 29 sites that were operational at December 31, 2000 are located in the
Erie, Jamestown, Sharon, Ashtabula and Meadville markets, which have a total
population of approximately 776,000.
The remaining sites being purchased from Sprint PCS are located in the
Scranton, Pottsville, Stroudsburg, New York and Allentown markets, which have a
total population of approximately 1.2 million. We will assume responsibility for
construction in these markets as clusters of sites are transferred to us. We
expect to launch service in these markets early in the third quarter of 2001.
The remaining markets to be launched are Williamsport, Sunbury, State
College, Oil City, Olean and Du Bois, which have a total population of
approximately 963,000. We expect to launch service in these markets by the end
of the third quarter of 2001. At that time, we plan to cover approximately 1.9
million residents, or 65% of the total population of the 17 markets received in
our third grant.
Network Build-Out Elements
As part of our network build-out strategy, we entered into outsourcing
relationships with the third parties to described below to assist us in building
out our network. We believe that these relationships result in a more timely,
efficient and cost effective build-out process.
Radio Frequency Design. We have engaged an outside design firm to provide
radio frequency design, engineering and optimization services for our markets.
This firm assists us in determining the required number of cell sites to operate
the network and identifies the general geographic areas in which each of the
required cell sites will be located.
Site Acquisition, Project Management And Construction. We use a combination
of build-to-suit and co-location opportunities in the design and construction of
our network. Build-to-suit arrangements are contractual relationships whereby a
tower company constructs and owns a cell tower at a location which we approve
and leases the cell tower to us for use in our network. Co-location is an
arrangement whereby a wireless service provider, like us, is allowed to use
another party's cell tower as part of its network. Generally we prefer
build-to-suit opportunities because of the favorable development fees and
leasing terms associated with our arrangement with SBA. Under our build-to-suit
agreement, SBA acquires the site, builds the tower and leases it to us. We
consider this arrangement to be preferable to building our own towers.
In situations where we determine that build-to-suit is not appropriate, we
use a co-location strategy. For sites where co-location leases are utilized,
zoning, permitting and surveying approvals and licenses have already been
secured, which minimizes our start-up costs and accelerates access to the
markets.
We expect that approximately 1,230 sites will be required to achieve our
planned coverage of the residents in our territory, including those provided to
us through our network services agreement. Of those sites, we believe that
approximately 345 will be build-to-suit towers.
Microwave Relocation. At the time of the FCC's auction of PCS licenses,
other third parties were using portions of the same frequency bandwidths for the
operation of microwave facilities. The FCC has procedures for PCS licensees to
relocate these existing microwave paths, generally at the PCS licensee's
expense. Sprint PCS relocates the microwave paths that use frequencies owned by
Sprint PCS, and is analyzing these relocations as we continue the build-out of
our network. Sprint PCS is also paying for a portion of the relocation costs.
15
Sprint PCS has completed necessary relocation for all microwave paths in all of
our markets that are operational or scheduled to be operational before March 31,
2001. We estimate our future costs associated with relocation to be
approximately $3.0 million.
Switching. We currently use one switching center in Chillicothe, Ohio to
provide services to our network. We also utilize the Alliances' two switching
centers under our network services agreement, and intend to use a Sprint PCS
switching center on an interim basis to more rapidly launch our markets in
western Pennsylvania. A switching center serves several purposes, including
routing calls, managing call handoff, managing access to the public telephone
network and providing access to voice mail. We believe the capacity of these
switching centers is adequate to accommodate our planned growth until 2001. We
plan to install additional switching centers prior to that time.
Interconnection. Our network connects to the public telephone network
through local exchange carriers. Through our Sprint PCS agreements, we benefit
from Sprint PCS-negotiated interconnection agreements with local exchange
carriers.
Long Distance And Back Haul. We use Sprint and other third party providers
for long distance services and for back haul services. Back haul services are
the telecommunications services which other carriers provide to carry our voice
traffic from our cell towers to our switching facilities. When we use Sprint, we
receive the same preferred rates made available to Sprint PCS.
Network Monitoring. We currently operate our own network monitoring system
for continuous network monitoring. For markets launched after July 31, 2000, we
use Sprint PCS' Network Operations Control Center for continuous network
monitoring. We began converting our existing markets to Sprint PCS' Network
Operation Control Center beginning in the third quarter of 2000.
SBA Agreement
Prior to August 1999, Horizon Telcom owned the cell site towers we used in
our network. In August 1999, Horizon Telcom sold to SBA the towers we used in
our network, and we subsequently entered into a long-term lease arrangement with
SBA. We now pay a fixed amount per month, per cell site, to SBA for the right to
use their towers in our markets. This fixed fee is subject to an annual
percentage increase for each site beginning on the third anniversary of the date
we began using the site. We believe that the rates we pay under this agreement
are generally more favorable than average co-location rates available in our
markets.
In August 1999, we also entered into a build-to-suit agreement with SBA.
Under this agreement, SBA acquires and develops the sites and installs the
towers at locations approved by us. We receive a site development fee from SBA
for tower sites which SBA constructs on our behalf. We have agreed to lease
space on a number of existing SBA towers for which we pay a fixed amount per
month, per cell site. For some of the leases, we receive a one-year rent
abatement on these sites. Rent expense for the leases which include abatement
will be recognized on a straight-line basis over the life of the lease.
Motorola Product Supply Agreement
In December 1999, we entered into a product supply agreement with Motorola
for the purchase of the telecommunications products and services for our
network. Motorola also provides installation services for our network equipment.
We intend to use Motorola equipment for the build out of our new markets in
Pennsylvania, New York, Ohio and New Jersey and the Bright PCS markets. Since
entering the Sprint PCS agreements in June 1998, we have benefited from Sprint
PCS' volume pricing arrangements with Motorola on our equipment purchases and
expect to continue to benefit going forward.
Alliances Network Services Agreement
The Alliances are two related independent PCS providers offering service
under the NTELOS brand name. The Alliances' network is managed by CFW
Communications. In August 1999, we entered into a network services agreement
16
with the Alliances for 16 of our markets in Virginia and West Virginia. Under
this agreement, we are entitled to use the Alliances' wireless network and
equipment to provide services to our customers in these markets. The Alliances
are required to maintain their network to Sprint PCS technical standards. We pay
the Alliances a per minute of use charge for use of their network whenever
Sprint PCS subscribers use their network.
We believe this arrangement eliminates or defers capital costs, and reduces
network expenses while permitting a faster launch of service and preserving our
capital for other uses. In addition, this arrangement gives us access to
additional spectrum in markets where Sprint PCS has limited bandwidth and
reduces our risk of technological obsolescence in these markets.
As of December 31, 2000, the Alliances had deployed 393 cell sites within
our markets in West Virginia and Virginia and had complied with their
contractual build-out requirements to date. The Alliances have also committed to
build out the Bluefield, Virginia market by September 30, 2001. If the Alliances
fail to build out this market by this date, we have at least 12 additional
months to complete the build-out under our Sprint PCS agreements. The Alliances
provided coverage to 56% of the total population of 3.3 million in the markets
covered by our network services agreement as of December 31, 2000, and expect to
provide coverage to 61% by February 2002.
The three remaining markets, which the Alliances have not yet committed to
build out, are the Williamson and Logan, West Virginia and Cumberland, Maryland
markets. We have the option to either allow the Alliances to build out these
markets, or to build them ourselves. Under the terms of our Sprint PCS
agreements, these markets must be built out by February 2002.
In the event we terminate our agreement with the Alliances because of the
Alliances' breach of the agreement, we have the right to continue to use the
Alliances' network for up to 36 months after the termination at rates which
reflect a significant discount from the standard pricing terms under our
agreement. This is intended to enable us to continue to provide services to our
customers while we build out our own network. In addition, under all
circumstances, we have the right to overbuild the Alliances' markets, on a
market-by-market basis, at any time for any reason.
Products And Services
We will offer established Sprint PCS products and services throughout our
territory. Our products and services mirror the service offerings of Sprint PCS
and are designed to integrate seamlessly with the Sprint PCS nationwide network.
Sprint PCS Wireless Services currently serve the majority of the nation's
metropolitan areas, including more than 4,000 cities and communities, providing
customers with affordable, reliable 100% digital, 100% PCS services. The Sprint
PCS service package we offer includes the following:
100% Digital Wireless Mobility. Our primary service is wireless mobility
coverage. Our PCS network is part of the largest 100% digital, 100% PCS network
in the nation. We offer customers in our territory simple, affordable Sprint PCS
Free and Clear pricing plans. These plans include free long distance and
wireless airtime minutes for use throughout the Sprint PCS network at no
additional charge. Our basic wireless service includes voice mail, caller ID,
enhanced call waiting, three-way calling, call forwarding, distinctive ringing
and call blocking.
Nationwide Service. Our customers are able to use Sprint PCS services in
our markets and seamlessly throughout the Sprint PCS network.
Dual-band/dual-mode handsets allow roaming on wireless networks where Sprint PCS
is not available and with which Sprint PCS has roaming agreements. These
handsets are designed to operate on analog and digital cellular networks, as
well as on Sprint PCS' digital PCS networks.
Advanced Handsets. CDMA handsets weighing approximately five to seven
ounces offer up to three to five days of standby time and approximately two to
four hours of talk time. We also offer dual-band/dual- mode handsets that allow
customers to make and receive calls on both PCS and cellular frequency bands and
both digital or analog technology. All handsets are equipped with preprogrammed
features such as speed dial and last number redial, and are sold under the
Sprint and Sprint PCS brand names.
17
Extended Battery Life. CDMA handsets offer significantly extended battery
life relative to earlier technologies, providing up to three to five days of
standby battery life. Handsets operating on a digital system are capable of
saving battery life while turned on but not in use, improving efficiency and
extending the handset's use.
Improved Voice Quality. We believe the Sprint PCS CDMA technology offers
significantly improved voice quality compared to existing analog and TDMA
networks, more powerful error correction, less susceptibility to call fading and
enhanced interference rejection, all of which result in fewer dropped calls. See
"-- CDMA Technology" for a discussion of the reasons CDMA technology offers
improved voice quality.
Privacy And Security. Sprint PCS provides secure voice transmissions
encoded into a digital format to prevent eavesdropping and unauthorized cloning
of subscriber identification numbers.
Easy Activation. Customers can purchase a Sprint PCS handset off the shelf
at a retail location and activate their service by calling customer service,
which can program the handset over the air. We believe over-the-air activation
will reduce the training requirements for salespersons at the retail locations.
Customer Care. When we initially launched our independent PCS operations,
we provided our own "back office" services, such as customer services and
billing services. In May 2000, we amended our Sprint PCS agreements so that
Sprint PCS will provide the back office services to us. We anticipate that our
existing customers will be transitioned to these services by the end of 2001. By
using Sprint PCS' established back office services, we believe that our
operating costs will be reduced. By using Sprint PCS' services, we expect to
more rapidly implement new products and services offered by Sprint PCS. Sprint
PCS offers customer care 24 hours a day, seven days a week.
Access To The Sprint PCS Wireless Web. We will soon be able to support and
market the Sprint PCS Wireless Web throughout our network. The Sprint PCS
Wireless Web allows subscribers with data-capable handsets to connect their
portable computers or personal digital assistants to the Internet. Sprint PCS
subscribers with data-capable handsets also have the ability to receive periodic
information updates such as stock prices, airline schedules, sports scores and
weather reports directly on their handsets. Sprint PCS subscribers with
Web-browser enabled handsets have the ability to connect to and browse specially
designed text-based Internet sites on an interactive basis. Sprint PCS has
agreements with Internet providers including AOL, Yahoo!, Amazon.com,
Bloomberg.com, CNN Interactive, MapQuest.com, Fox Sports, Ameritrade,
InfoSpace.com and Weather.com to provide services for the Sprint PCS Wireless
Web. Sprint PCS offers Sprint PCS Wireless Web as an add-on to existing Sprint
PCS' Free and Clear pricing plans. We began offering wireless Web service in
most of our markets in the fourth quarter of 2000.
Other Services. In addition to these services, we may also offer wireless
local loop services in our territory. Wireless local loop refers to the use of a
wireless network to provide a substitute for the portion of traditional
telephone companies' networks which extends from homes and businesses to the
traditional telephone companies' switching facilities. We also believe that new
features and services will be developed on the Sprint PCS nationwide network to
take advantage of CDMA technology. As a leading wireless provider, Sprint PCS
conducts ongoing research and development to produce innovative services that
give Sprint PCS a competitive advantage. We intend to offer a portfolio of
products and services developed by Sprint PCS to accommodate the growth in, and
the unique requirements of, high-speed data traffic and demand for video
services. We plan to provide, when available, a number of applications for
wireless data services including facsimile, Internet access, wireless local area
networks and point-of-sale terminal connections.
Marketing Strategy
Our marketing and sales strategy uses Sprint PCS' strategies and developed
national distribution channels that have helped Sprint PCS generate rapid
customer growth. We plan to enhance Sprint PCS' strategies with strategies
tailored to our specific territory.
Use Of Sprint PCS' Brand Equity And Marketing. We will feature exclusively
and prominently the nationally recognized Sprint and Sprint PCS brand names in
our marketing effort. From the customers' point of view, they will use our PCS
18
network and the Sprint PCS national network seamlessly as a unified national
network. We will build on Sprint PCS' national distribution channels and
advertising programs.
Pricing. We believe that our use of the Sprint PCS pricing strategy will
offer customers in our territory simple, easy-to-understand service plans.
Sprint PCS' consumer pricing plans are typically structured with what we believe
to be competitive monthly recurring charges and large local calling areas,
service features such as voicemail, enhanced caller ID, call waiting and
three-way calling and what we believe to be competitive per-minute rates. Lower
per-minute rates relative to analog cellular providers are possible in part
because the CDMA system that both we and Sprint PCS employ has greater capacity
than current analog cellular systems, which we believe will enable us to market
high usage customer plans at lower prices.
Local Focus. Our local focus enables us to supplement Sprint PCS' marketing
strategies with our own strategies tailored to each of our specific markets.
These include attracting local businesses to enhance our distribution and using
local radio and newspaper advertising to sell our products and services in each
of our launched markets. We have established a local sales force to execute our
marketing strategy through company-owned Sprint PCS stores, and also employ a
direct sales force targeted to business sales. In addition, Sprint PCS' existing
agreements with national retailers provide us with immediate access to over 481
retail locations in our territory. We also expect the former owners of Bright
PCS to offer Sprint PCS products in their local telephone offices in
northwestern Ohio. Sprint-owned local exchange carriers provide local telephone
service to approximately 20% of the total population in our territory, which
will provide us with an additional distribution channel through which we can
market to an established base of Sprint customers. Some of the Sprint local
exchange markets have a store for Sprint customers to pay their bills, which we
expect to use to sell Sprint PCS products and services.
Advertising And Promotions. Sprint PCS uses national as well as regional
television, radio, print, outdoor and other advertising campaigns to promote its
products. We benefit from this national advertising in our territory at no
additional cost to us.
Sponsorships. Sprint PCS is a sponsor of numerous selected, broad-based
national and regional events. These sponsorships provide Sprint PCS with brand
name and product recognition in high profile events, provide a forum for sales
and promotional events and enhance our promotional efforts in our territory.
Bundling Of Services. We intend to take advantage of the complete array of
communications services offered by bundling Sprint PCS services with other
Sprint products, such as long distance and Internet access.
Sales And Distribution
Our sales and distribution plan mirrors Sprint PCS' multiple channel sales
and distribution plan. Key elements of our sales and distribution plan consist
of the following:
Sprint Store Within A RadioShack Store. Sprint has an exclusive arrangement
with RadioShack to install a "store within a store," making Sprint PCS the
exclusive brand of PCS sold through RadioShack stores. RadioShack has
approximately 170 stores in our territory.
Other National And Regional Third Party Retail Stores. We also will benefit
from the distribution agreements established by Sprint PCS with other national
and regional retailers which currently include Best Buy, Circuit City, Office
Depot, The Good Guys, Dillards, The Sharper Image, Montgomery Ward, OfficeMax,
Ritz Camera, Staples, Cord Camera, The Wiz and certain May Company department
stores. At present, these retailers operate approximately 304 retail stores in
our territory. We also believe that we benefit from stores located in major
Sprint PCS markets near our markets because residents of our territory who buy
PCS handsets at those stores become our subscribers.
Sprint PCS Stores. We currently own and operate 16 Sprint PCS stores. We
plan to have a total of 40 Sprint PCS stores in our territory by the end of
2003. These stores will be located in larger markets within our territory, which
we believe provides us with strong local presence and a high degree of
visibility. Following the Sprint PCS model, these stores will be designed to
facilitate retail sales, bill collection and customer service.
19
Local Telephone Stores. We also plan to offer Sprint PCS products and
services through the Sprint Local Telephone Division retail centers in our
service area and through at least thirteen local telephone service centers of
the former owners of Bright PCS and their affiliates located in our markets. We
also expect former Bright PCS members and local Sprint service providers to
offer Sprint PCS products and services.
National Accounts And Direct Selling. We participate in Sprint PCS'
national accounts program. Sprint PCS has a national accounts team which focuses
on the corporate headquarters of Fortune 500 companies. Once a representative
reaches an agreement with the corporate headquarters, we service the offices of
that corporation located in our territory. Our direct sales force will target
the employees of these corporations in our territory and cultivate other local
business clients. At present, we employ 26 direct sales representatives, and
plan to hire approximately 29 more over the next 24 months.
Inbound Telemarketing. Sprint PCS provides inbound telemarketing sales when
customers call from our territory. As the exclusive provider of Sprint PCS
products and services in our market, we use the national Sprint 1-800-480-4PCS
number campaigns that generate call-in leads. These leads are then handled by
Sprint PCS' inbound telemarketing group.
Electronic Commerce. Sprint PCS launched an Internet site in December 1998
which contains information on Sprint PCS products and services. A visitor to
Sprint PCS' Internet site can order and pay for a handset and select a rate
plan. Customers visiting the site can review the status of their account,
including the number of minutes used in the current billing cycle. Customers in
our territory who purchase products and services over the Sprint PCS Internet
site will become our customers.
CDMA Technology
Sprint PCS' Nationwide Network And Its Affiliates' Networks All Use Digital
Cdma Technology. CDMA technology is fundamental to accomplishing our business
objective of providing high-volume, high-quality airtime at a low cost. We
believe that CDMA provides important system performance benefits.
Voice Quality. We believe that CDMA systems offer less interference, more
powerful error correction and less susceptibility to fading than analog systems.
Using enhanced voice coding techniques, CDMA systems achieve voice quality that
is comparable to that of the typical wireline telephone. This CDMA voice coding
technology also filters out annoying background noise more effectively than
existing wireline, analog cellular or other digital PCS phones.
Capacity. CDMA technology allows a greater number of calls within one
specific frequency and reuses the entire frequency spectrum in each cell. CDMA
systems provide capacity gains of up to seven times over current analog systems
and up to three times greater than TDMA and GSM systems. In the first half of
2000, Sprint PCS began to deploy a new voice coding technology for CDMA networks
which is expected to increase the capacity of the system by approximately 100%.
This new voice coding standard, referred to as Enhanced Variable Rate Coding,
will allow the network to support additional capacity while maintaining the high
level of voice quality associated with digital networks. We expect to begin
using the Enhanced Variable Rate Coding technology in our PCS network to
increase its capacity. Additional capacity improvements are expected for CDMA
networks over the next two years as new third generation standards are approved
and implemented that will allow for high-speed data and an even greater increase
in the voice traffic capacity.
CDMA technology is designed to provide flexible or "soft" capacity that
permits networks like ours to temporarily increase the number of telephone calls
that can be handled within a cell. When capacity limitations in analog, TDMA and
GSM systems are reached, additional callers in a given cell must be given a busy
signal. Using CDMA technology, networks like ours can allow a small reduction in
voice quality to provide temporary increases in capacity. This reduces blocked
calls and increases the probability of a successful cell-to-cell hand-off.
Soft Hand-Off. As a subscriber travels from one cell site to another cell
site, the call must be "handed off" to the second site. CDMA systems transfer
calls throughout the network using a technique referred to as a soft hand-off,
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which connects a mobile customer's call with a new cell site while maintaining a
connection with the cell site currently in use. CDMA networks monitor the
quality of the transmission received by both cell sites simultaneously to select
a better transmission path and to ensure that the network does not disconnect
the call in one cell until it is clearly established in a new one. As a result,
fewer calls are dropped compared to analog, TDMA and GSM networks which use a
"hard hand-off" and disconnect the call from the current cell site as it
connects with a new one.
Integrated Services. CDMA systems permit us to offer advanced features,
including voice mail, caller ID, enhanced call waiting, three-way calling, call
forwarding and paging and text-messaging. These advanced features may also be
offered by companies utilizing competing technologies.
Privacy And Security. One of the benefits of CDMA technology is that it
combines a constantly changing coding scheme with a low power signal to enhance
security and privacy. Vendors are currently developing additional encryption
capabilities which we believe will further enhance overall network security.
Frequency Planning. Frequency planning is the process used to analyze and
test alternative patterns of frequency use within a wireless network to minimize
interference between one call and another call and to maximize capacity.
Currently, cellular service providers spend considerable money and time on
frequency planning. Because TDMA and GSM based systems have frequency reuse
constraints similar to present analog systems, frequency reuse planning for TDMA
and GSM based systems is expected to be comparable to planning for the current
analog systems. With CDMA technology, however, the same group of frequencies can
be reused in every cell, substantially reducing the need for costly frequency
reuse patterning and constant frequency plan management.
Battery Life. Due to their greater efficiency in power consumption, CDMA
handsets will provide up to three to five days of standby time and approximately
two to four hours of talk time availability. We believe this generally exceeds
the battery life of handsets using alternative digital or analog technologies.
Benefits Of Other Technologies. While CDMA has the benefits discussed
above, TDMA networks are generally less expensive when overlaying existing
analog systems. In addition, the GSM technology standard, unlike CDMA, supports
a more robust interoperability standard which more easily allows a network
operator to use equipment from several different vendors in the same network.
This, along with the fact that the GSM technology is currently more widely
deployed throughout the world than CDMA, provides economies of scale for handset
and equipment purchases. A standards process is also underway which will allow
wireless handsets to support analog, TDMA and GSM technologies in a single unit.
Currently, there are no plans to have CDMA handsets that support either the TDMA
or GSM technologies.
Third Generation Technology. In addition, wireless carriers are seeking to
implement a new "third generation," or "3G," technology throughout the industry.
The 3G technology is intended to increase networks' capacity for voice calls and
enable better transmission of high-speed data. To date, this technology has not
been deployed on a commercial basis.
Competition
Given the broad geographic coverage of our territory, the competition that
we face from other wireless providers is fragmented. We compete, to varying
degrees, with regional and national cellular, PCS and other wireless service
providers, although today no competing provider offers complete coverage of our
territory. Currently, we believe that our strongest competition is from cellular
providers, many of which have been operating in our markets and building their
customer base for a number of years. We believe however, that our competition
from other PCS providers is limited. Many are in the preliminary stages of
building their networks and customer bases and currently offer less consistent
coverage than the cellular providers.
Our largest single cellular competitor is Verizon Wireless, which offers
service in markets covering 60% of our planned covered residents. However,
Verizon is a newly formed company, and we believe it lacks the well established
national brand name and fully integrated service platform that we enjoy as a
Sprint PCS affiliate. Furthermore, Verizon does not hold licenses for 40% of our
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territory. In addition, we believe that a significant portion of Verizon's
network in our markets is analog. While the recently formed national cellular
alliance between BellSouth and SBC, now called Cingular, competes with us in
some markets, those markets represent only 9% of our planned covered residents.
AT&T, which has licenses to provide service to all markets in our territory,
currently provides service to only 27% of our planned covered residents. ALLTEL,
a large regional provider and our most significant competitor to date, competes
with us in markets representing 41% of our planned covered residents. Small
regional cellular providers, such as US Cellular and Dobson Cellular, which
offers service under the Cellular One brand, also operate in our territory,
though none competes with us in markets representing more than 25% of our
planned covered residents.
Our primary PCS competition is from PCS providers whose coverage is
regional. VoiceStream is the largest, and offers service in markets covering 36%
of our planned covered residents. The Alliances, which offer service under the
NTELOS brand, provide service in markets covering 30% of our planned covered
residents. SunCom, an AT&T affiliate, currently offers service in markets
covering 22% of our planned covered residents. As a Sprint PCS affiliate, we
believe we are positioned to successfully compete with all of these PCS
providers due to the strength of the Sprint PCS brand name, distribution
channels, and CDMA network. More importantly, we will be the first PCS provider
to market in 32 of our 54 markets, representing over 43% of our planned covered
residents and the first or second PCS provider to market in 49 of our 54
markets, representing 82% of our planned covered residents.
Nextel, together with Nextel Partners, which we believe has licenses to
offer service in the vast majority of our markets, currently offers service to
only 34% of our planned covered residents. Nextel's coverage in many of these
markets is focused primarily on highway coverage as opposed to community
coverage.
The following table lists the primary operational competitors known to us
within our various geographic areas:
GEOGRAPHIC AREA PRIMARY OPERATING COMPETITORS TYPE OF SERVICE
- --------------- ----------------------------- ---------------
Ohio markets................................ ALLTEL Cellular
AT&T Cellular
Verizon Wireless Cellular
Nextel ESMR
Indiana markets............................. Centennial Cellular
Century Cellular
Verizon Wireless Cellular
VoiceStream PCS
Nextel EMSR
Pennsylvania and New York markets........... AT&T Cellular
Verizon Wireless Cellular
VoiceStream PCS
Nextel PCS
Virginia and West Virginia markets.......... ALLTEL Cellular
AT&T Cellular
Verizon Wireless Cellular
NTELOS PCS
Suncom PCS
Tennessee markets........................... ALLTEL Cellular
Verizon Wireless Cellular
Cingular PCS
Suncom PCS
Nextel ESMR
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Most of these primary competitors offer a wireless service that is
generally comparable to our PCS service. However, we believe that most do not
offer the full range of products, services and features that we offer. For
instance, we believe that Verizon, Cingular, AT&T, ALLTEL and most regional
cellular providers do not offer 100% digital technology. Similarly, Cingular,
ALLTEL, and regional cellular providers do not offer nationwide service. In
addition, many of our competitors do not offer full wireless Internet
connectivity in all of our markets. We began offering wireless Internet
connectivity in most of our markets in the fourth quarter of 2000. Some
additional competitors may also begin to offer wireless Internet connectivity in
some of our markets in 2001.
Our ability to compete effectively with these other providers will depend
on a number of factors, including the continued success of CDMA technology in
providing better call clarity and quality as compared to analog cellular
systems, Sprint PCS' competitive pricing with various options suiting individual
customer's calling needs, the continued expansion and improvement of the Sprint
PCS nationwide network, our extensive direct and indirect sales channels, our
centralized Sprint PCS customer care systems, and our selection of handset
options.
Some of our competitors have access to more licensed spectrum than the 10
or 20MHz licensed to Sprint PCS in some of our markets. Some of our competitors
also have established infrastructures, marketing programs and brand names. Some
of our competitors may be able to offer coverage in areas not served by our
network, or, because of their calling volumes or their affiliations with, or
ownership of, other wireless providers, may be able to offer roaming rates that
are lower than those offered by Sprint PCS. PCS operators compete with us in
providing some or all of the services available through the Sprint PCS network
and may provide services that we do not. Additionally, we expect that existing
cellular providers will continue to upgrade their systems to provide digital
wireless communication services competitive with Sprint PCS.
We also face limited competition from "resellers" which provide wireless
service to customers but do not hold FCC licenses or own facilities. Instead,
the reseller buys blocks of wireless telephone numbers and capacity from a
licensed carrier and resells service through its own distribution network to the
public. Thus, a reseller is both a customer of a wireless licensee's services
and also a competitor of that and other licensees. The FCC requires all cellular
and PCS licensees to permit resale of carrier service to resellers. Although
Sprint PCS is required to resell PCS in our markets, currently there is no
reseller of Sprint PCS in our markets. Any reseller of Sprint PCS in our markets
would be required to pay us for the use of our capacity and their use of the
Sprint PCS service marks in our markets would be restricted to describing their
handsets as operational on the Sprint PCS network
In addition, we compete with paging, dispatch and other mobile
telecommunications companies in our markets. Potential users of PCS systems may
find their communications needs satisfied by other current and developing
technologies. One or two-way paging or beeper services that feature voice
messaging and data display as well as tone-only service may be adequate for
potential customers who do not need immediate two-way voice communications.
In the future, we expect to face increased competition from entities
providing similar services using other communications technologies, including
satellite-based telecommunications and wireless cable systems. While few of
these technologies and services are currently operational, others are being
developed or may be developed in the future.
Over the past several years the FCC has auctioned and will continue to
auction large amounts of wireless spectrum that could be used to compete with
Sprint PCS service. Based upon increased competition, we anticipate that market
prices for two-way wireless services generally will decline in the future. We
will compete to attract and retain customers principally on the basis of:
o the strength of the Sprint and Sprint PCS brand names, services and
features;
o the location of our markets;
o the size of our territory;
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o national network coverage and reliability;
o customer care; and
o pricing.
Intellectual Property
"Sprint," the Sprint diamond design logo, "Sprint PCS," "Sprint Personal
Communications Services," "The Clear Alternative to Cellular" and "Experience
the Clear Alternative to Cellular Today" are service marks registered with the
United States Patent and Trademark Office. These service marks are owned by
Sprint. Pursuant to the trademark and service mark license agreements, we have
the right to use, royalty-free, the Sprint and Sprint PCS brand names and the
Sprint diamond design logo and other service marks of Sprint in connection with
marketing, offering and providing licensed services to end-users and resellers,
solely within our territory.
Except in limited instances, Sprint PCS has agreed not to grant to any
other person a right or license to provide or resell, or act as agent for any
person offering, licensed services under the licensed marks in our market areas
except as to Sprint PCS' marketing to national accounts and the limited right of
resellers of Sprint PCS to inform their customers of handset operation on the
Sprint PCS network. In all other instances, Sprint PCS reserves for itself and
its affiliates the right to use the licensed marks in providing its services,
subject to its exclusivity obligations described above, whether within or
without our territory.
The trademark license agreements contain numerous restrictions with respect
to the use and modification of any of the licensed marks. See "The Sprint PCS
Agreements -- The Trademark and Service Mark License Agreements."
This document includes product names, trade names and trademarks of other
companies. We do not have any rights with respect to these product names, trade
names and trademarks.
The Sprint PCS Agreements
The following is a summary of the material terms and provisions of the
Sprint PCS agreements. The summary applies to the Sprint PCS agreements for
Horizon's wholly-owned subsidiaries, Horizon Personal Communications and Bright
PCS, except where otherwise indicated. We have filed the Sprint PCS agreements
as exhibits to the registration statement of which this is a part and urge you
to review them carefully.
Overview Of Sprint PCS Relationship And Agreements. Under the Sprint PCS
agreements, we exclusively market PCS services under the Sprint and Sprint PCS
brand names in our markets. The Sprint PCS agreements require us to interface
with the Sprint PCS wireless network by building our network to operate on PCS
frequencies licensed to Sprint PCS in the 1900 MHz range. The Sprint PCS
agreements also give us access to Sprint PCS' equipment discounts, roaming
revenue from Sprint PCS customers traveling into our territory, and various
other back office services. The Sprint PCS agreements provide strategic
advantages, including avoiding the need to fund up-front spectrum acquisition
costs and the costs of maintaining billing and other customer services
infrastructure. The Sprint PCS agreements have initial terms of 20 years with
three 10-year renewals which would lengthen the contracts to a total of 50
years. The Sprint PCS agreements will automatically renew for each additional
10-year term unless we or Sprint PCS provide the other with two years' prior
written notice to terminate the Sprint PCS agreements.
We have eight major agreements with Sprint and Sprint PCS (collectively,
the "Sprint PCS agreements"), consisting of one of each of the following for
Horizon Personal Communications and one for Bright PCS:
o the management agreement;
o the services agreement;
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o the trademark and service mark license agreement with Sprint; and
o the trademark and service mark license agreement with Sprint PCS.
The Management Agreement. Under our Sprint PCS agreements, we have agreed
to:
o construct and manage a network in our territory in compliance with
Sprint PCS' PCS licenses and the terms of the management agreement;
o distribute, during the term of the management agreement, Sprint PCS
products and services;
o conduct advertising and promotion activities in our territory; and
o manage that portion of Sprint PCS' customer base assigned to our
territory.
Sprint PCS will monitor our network operations and has unconditional access
to our network.
Exclusivity. We are designated as the only person or entity that can manage
or operate a PCS network for Sprint PCS in our territory. Sprint PCS is
permitted under our agreement to make national sales to companies in our
territory, and as required by the FCC, to permit resale of the Sprint PCS
products and services in our territory. We accrue the financial benefits of
either of these activities.
Network Build-Out: The management agreement specifies the terms of the
Sprint PCS affiliation, including the required network build-out plan. We have
agreed to operate our network to provide for a seamless handoff of a call
initiated in our territory to a neighboring Sprint PCS network.
Under our Sprint PCS agreements for Horizon Personal Communications, Sprint
PCS can decide to expand the coverage requirements of our territory by providing
us with written notice. We have 90 days after receiving notice from Sprint PCS
to determine whether we will build out the proposed area. If we decline to
exercise our right to build out the proposed area, Sprint PCS may construct the
new area itself or allow a Sprint PCS affiliate or other manager to construct
the new area.
Under our Sprint PCS agreements for Bright PCS, Sprint PCS can decide to
expand the coverage requirements of our Bright PCS territory by providing us
with written notice, provided that Sprint PCS may not give us notice until
October 12, 2001, which is the second anniversary of the signing of our Sprint
PCS agreement. If we decline or fail to comply with Sprint PCS' expanded
coverage requirements, Sprint PCS will have the right to terminate our Sprint
PCS agreement for our Bright PCS markets. We believe it is unlikely that Sprint
PCS will request additional coverage beyond the 85% coverage we plan to achieve
for these markets. There is no cross default provision between our Sprint PCS
agreement for Horizon Personal Communications and the Sprint PCS agreements for
Bright PCS.
Our Sprint PCS management agreements require us to complete specified
portions of our markets by specified dates. Future build-out dates are
summarized below:
Population To
Covered Requirement Estimated Total Population Be Covered
October 2001 2,369,867 811,730
February 2002 535,078 147,365
Products And Services. The management agreement identifies the products and
services that we can offer in our territory. These services include Sprint PCS
consumer and business products and services available as of the date of the
agreements, or as modified by Sprint PCS. We are allowed to sell wireless
25
products and services that are not Sprint PCS products and services if those
additional products and services do not otherwise violate the terms of the
agreement, cause distribution channel conflicts, materially impede the
development of the Sprint PCS network, cause consumer confusion with Sprint PCS'
products and services or violate the trademark lease agreements. We may
cross-sell services such as Internet access, customer premise equipment, and
prepaid phone cards with Sprint, Sprint PCS and other Sprint PCS affiliates. If
we decide to use third parties to provide these services, we must give Sprint
PCS an opportunity to provide the services on the same terms and conditions. We
cannot offer wireless local loop services specifically designed for the
competitive local exchange market in areas where Sprint owns the local exchange
carrier unless we name the Sprint owned local exchange carrier as the exclusive
distributor or Sprint PCS approves the terms and conditions. Subject to
agreements existing before we became a Sprint PCS affiliate, we are required to
use Sprint's long distance service which we can buy at wholesale rates.
National Sales Programs. We will participate in the Sprint PCS sales
programs for national sales to customers, and will pay the expenses and receive
the compensation from national accounts located in our territory.
Service Pricing. We must offer Sprint PCS subscriber pricing plans
designated for regional or national offerings, including Sprint PCS' Free and
Clear plans. We are permitted to establish our own local price plans for Sprint
PCS' products and services offered only in our territory, subject to the terms
of the agreement, consistency with Sprint PCS' regional and national pricing
plans, regulatory requirements, capability and cost of implementing rate plans
in Sprint PCS systems and Sprint PCS' approval.
Fees. We are entitled to receive from Sprint PCS an amount equal to 92% of
collected revenues under the Sprint PCS agreements. Collected revenues include
revenue from Sprint PCS subscribers based in our territory, excluding outbound
roaming, and inbound non-Sprint PCS roaming. Except in the case of taxes, we are
entitled to 100% of the following revenues that are not considered collected
revenues:
o outbound non-Sprint PCS roaming revenue;
o inbound and outbound Sprint PCS roaming fees;
o proceeds from the sales of handsets and accessories through our
distribution channels;
o proceeds from sales not in the ordinary course of business; and
o amounts collected with respect to taxes.
Roaming. Although many Sprint PCS subscribers purchase bundled pricing
plans that allow roaming anywhere on the Sprint PCS' and affiliates' network
without incremental roaming charges, we earn roaming revenues from every minute
that a Sprint PCS subscriber not based in our territory and any non-Sprint
subscriber uses our network. We earn revenues from Sprint PCS based on an
established per-minute rate for Sprint PCS' or its affiliates' subscribers
roaming in our territory. Similarly, we pay for every minute our own subscribers
use the Sprint PCS nationwide network outside our territory. The analog roaming
rate onto a non-Sprint PCS provider's network is set under Sprint PCS'
third-party roaming agreements.
Advertising And Promotions. Sprint PCS is responsible for all national
advertising and promotion of the Sprint PCS products and services. We are
responsible for advertising and promotion in our territory, including the pro
rata cost of any promotion or advertising done by any third-party retailers in
our territory pursuant to a national cooperative advertising agreement with
Sprint.
Program Requirements. We must comply with Sprint PCS' program requirements
for technical standards, customer service standards, national and regional
distribution and national accounts programs to the extent that Sprint PCS meets
these requirements. Sprint PCS can adjust the program requirements from time to
time. We have the right to appeal to Sprint PCS' management adjustments which
could cause an unreasonable increase in cost to us if the adjustment: (1) causes
us to incur a cost exceeding 5% of the sum of our equity plus our outstanding
long-term debt, or (2) causes our long term operating expenses to increase by
more than 5% (10% for Bright PCS) on a net present value basis. If Sprint PCS
denies our appeal, we must then comply with the program adjustment, or Sprint
26
PCS has the right to exercise the termination rights described below. There is
no cross default provision between the Sprint PCS agreements for Horizon
Personal Communications and the Sprint PCS agreements for Bright PCS.
Non-Competition. We may not offer Sprint PCS products and services outside
our territory without the prior written approval of Sprint PCS. Within our
territory we may offer, market or promote telecommunications products and
services only under the Sprint PCS brands, our own brand, brands of related
parties of ours or other products and services approved under the management
agreement, except that no brand of a significant competitor of Sprint PCS or its
related parties may be used for those products and services. To the extent we
have or obtain licenses to provide PCS services outside our territory, we may
not use the spectrum to offer Sprint PCS products and services without prior
written consent from Sprint PCS.
Inability To Use Non-Sprint PCS Brands. We may not market, promote,
advertise, distribute, lease or sell any of the Sprint PCS products and services
on a non-branded, "private label" basis or under any brand, trademark or trade
name other than the Sprint PCS brand, except for sales to resellers or as
otherwise permitted under the trademark and service mark license agreements.
Termination Of Management Agreement. The management agreement can be
terminated as a result of:
o termination of Sprint PCS' PCS licenses;
o an uncured breach under the management agreement;
o bankruptcy of a party to the management agreement;
o the management agreement not complying with any applicable law in any
material respect;
o the termination of either of the trademark and service mark license
agreements; or
o our failure to obtain the financing necessary for the build-out of our
network and for our working capital needs.
The termination or non-renewal of either of the management agreements
triggers our rights and those of Sprint PCS, as described below.
If we have the right to terminate the management agreement because of an
event of termination caused by a Sprint PCS breach under the management
agreement, we may generally:
o require Sprint PCS to purchase all of our operating assets used in
connection with our network for an amount equal to at least 80% of our
Entire Business Value as defined below;
o if Sprint PCS is the licensee for 20MHz or more of the spectrum on the
date the management agreement was executed, require Sprint PCS to sell
to us, subject to governmental approval, up to 10MHz of licensed
spectrum for an amount equal to the greater of (1) the original cost
to Sprint PCS of the license plus any microwave relocation costs paid
by Sprint PCS or (2) 9% of our Entire Business Value; or
o sue Sprint PCS for damages or submit the matter to arbitration and
thereby not terminate the management agreement.
If Sprint PCS has the right to terminate the management agreement because
of an event of termination caused by us, Sprint PCS may generally:
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o require us to sell our operating assets to Sprint PCS for an amount
equal to 72% of our Entire Business Value;
o require us to purchase, subject to governmental approval, up to 10MHz
of licensed spectrum for an amount equal to the greater of (1) the
original cost to Sprint PCS of the license plus any microwave
relocation costs paid by Sprint or (2) 10% of our Entire Business
Value;
o take any action as Sprint PCS deems necessary to cure our breach of
the management agreement, including assuming responsibility for and
operating our network; or
o sue us for damages or submit the matter to arbitration and thereby not
terminate the management agreement.
Non-Renewal. If Sprint PCS gives us timely notice that it does not intend
to renew the management agreement, we may:
o require Sprint PCS to purchase all of our operating assets used in
connection with our network for an amount equal to 80% of our Entire
Business Value; or
o if Sprint PCS is the licensee for 20MHz or more of the spectrum on the
date the management agreement was executed, require Sprint PCS to sell
to us, subject to governmental approval, up to 10MHz of licensed
spectrum for an amount equal to the greater of (1) the original cost
to Sprint PCS of the license plus any microwave relocation costs paid
by Sprint PCS or (2) 10% of our Entire Business Value.
If we give Sprint PCS timely notice of non-renewal, or we both give notice
of non-renewal, or the management agreement can be terminated for failure to
comply with legal requirements or regulatory considerations, Sprint PCS may:
o purchase all of our operating assets for an amount equal to 80% of our
Entire Business Value; or
o require us to purchase, subject to governmental approval, the licensed
spectrum for an amount equal to the greater of (1) the original cost
to Sprint PCS of the license plus any microwave relocation costs paid
by Sprint PCS or (2) 10% of our Entire Business Value.
Determination Of Entire Business Value. If the Entire Business Value is to
be determined, we and Sprint PCS will each select one independent appraiser and
the two appraisers will select a third appraiser. The three appraisers will
determine the Entire Business Value on a going concern basis using the following
guidelines:
o the Entire Business Value is based on the price a willing buyer would
pay a willing seller for the entire on-going business;
o then-current customary means of valuing a wireless telecommunications
business will be used;
o the business is conducted under the Sprint and Sprint PCS brands and
the Sprint PCS agreements;
o that we own the spectrum and frequencies presently owned by Sprint PCS
that we use and are subject to the Sprint PCS agreements; and
o the valuation will not include any value for businesses not directly
related to the Sprint PCS products and services, and these businesses
will not be included in the sale.
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Insurance. We are required to obtain and maintain workers' compensation
insurance, commercial general liability insurance, business automobile
insurance, umbrella excess liability insurance and "all risk" property insurance
with financially reputable insurers.
Indemnification. We have agreed to indemnify Sprint PCS and its directors,
employees and agents, and related parties of Sprint PCS and their directors,
employees and agents against any and all claims against any of these parties
arising from our violation of any law, a breach by us of any representation,
warranty or covenant contained in the management agreement or any other
agreement between us and Sprint PCS, our ownership of the operating assets or
the actions or the failure to act of anyone who is employed or hired by us in
the performance of any work under this agreement, except we will not indemnify
Sprint PCS for any claims arising solely from their negligence or willful
misconduct. Sprint PCS has agreed to indemnify us and our directors, employees
and agents against all claims against any of these parties arising from Sprint
PCS' violation of any law, from Sprint PCS' breach of any representation,
warranty or covenant contained in this agreement or any other agreement between
Sprint PCS and us, or the actions or the failure to act of anyone who is
employed or hired by Sprint PCS in the performance of any work under this
agreement except Sprint PCS will not indemnify us for any claims arising solely
from our negligence or willful misconduct.
Sprint PCS Warrants. In connection with Sprint PCS' grant to us of our new
markets in Pennsylvania, New York, Ohio and New Jersey, HPCS agreed to grant to
Sprint PCS warrants to acquire shares of its class A common stock at the earlier
of (i) the date on which the Company closes an initial public offering (IPO), or
(ii) July 31, 2003. These warrants become exercisable on January 1, 2003 in the
case of an IPO. If these warrants are granted on July 31, 2003, they will be
immediately exercisable. Under the terms of the warrant agreement, in the case
of an IPO, Sprint PCS is entitled to receive 2,510,460 shares, which number
shall be no more than 4.2% and no less than 3.0% of the HPCS equity securities
outstanding immediately after the offering. The number of shares subject to the
warrants will be adjusted, if necessary, to reflect these limits. The exercise
price will be equal to the initial public offering price per share. If there has
not been an IPO on or before July 31, 2003, the number of shares of common stock
subject to the warrant will represent 3.0% of the "Private Valuation" of HPCS
(as determined by the appraisal process set forth in the agreement) and the
exercise price will be the lower of the per share private valuation as of July
31, 2003, or the price per share of the most recent negotiated private
placement, if any, of HPCS' equity securities within the last twelve months. In
either case, the exercise price is subject to anti-dilution adjustments after
the issuance of the warrant. Sprint PCS will have registration rights for the
shares subject to the warrants.
The Services Agreements. The services agreements outline back office
services provided by Sprint PCS and available to us at established rates. Sprint
PCS can change any or all of the service rates one time in each twelve month
period. Some of the available services include: billing, customer care,
activation, credit checks, handset logistics, home locator record, voice mail,
prepaid services, directory assistance, operator services, roaming fees, roaming
clearinghouse fees, interconnect fees and inter-service area fees. Sprint PCS
offers three packages of available services. Each package identifies which
services must be purchased from Sprint PCS and which may be purchased from a
vendor or provided in-house. Essentially, services such as billing, activation
and customer care must either all be purchased from Sprint PCS or we may provide
those services ourselves. When we signed our original Sprint PCS agreements, we
elected to provide billing, activation and customer care services on our own. In
connection with the May 2000 grant by Sprint PCS of additional markets to us, we
agreed to change our arrangement under the services agreement, so that Sprint
PCS will provide activation, billing and customer care. For our Bright PCS
markets and our new markets in Pennsylvania, New York and New Jersey, we intend
to launch these markets using Sprint PCS billing and customer care services.
Sprint PCS may contract with third parties to provide expertise and services
identical or similar to those to be made available or provided to us. We have
agreed not to use the services received under the services agreement in
connection with any other business or outside our territory. We may discontinue
use of any service upon three months' prior written notice. Sprint PCS may
discontinue a service provided that Sprint PCS provides us with nine months'
prior notice.
We have agreed with Sprint PCS to indemnify each other as well as officers,
directors, employees and other related parties and their officers, directors and
employees for violations of law or the services agreement except for any
liabilities resulting from the indemnitee's negligence or willful misconduct.
The services agreement also provides that no party to the agreement will be
liable to the other party for special, indirect, incidental, exemplary,
consequential or punitive damages, or loss of profits arising from the
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relationship of the parties or the conduct of business under, or breach of, the
services agreement except as may otherwise be required by the indemnification
provisions. The services agreement automatically terminates upon termination of
the management agreement and neither party may terminate the services agreement
for any reason other than the termination of the management agreement.
The Trademark And Service Mark License Agreements. We have
non-transferable, royalty-free licenses to use the Sprint and Sprint PCS brand
names and "diamond" symbol, and several other U.S. trademarks and service marks
such as "The Clear Alternative to Cellular" and "Clear Across the Nation" on
Sprint PCS products and services. We believe that the Sprint and Sprint PCS
brand names and symbols enjoy a very high degree of awareness, providing us an
immediate benefit in the marketplace. Our use of the licensed marks is subject
to our adherence to quality standards determined by Sprint and Sprint PCS and
use of the licensed marks in a manner which would not reflect adversely on the
image of quality symbolized by the licensed marks. We have agreed to promptly
notify Sprint and Sprint PCS of any infringement of any of the licensed marks
within our territory of which we become aware and to provide assistance to
Sprint and Sprint PCS in connection with Sprint's and Sprint PCS' enforcement of
their respective rights. We have agreed with Sprint and Sprint PCS to indemnify
each other for losses incurred in connection with a material breach of the
trademark license agreements. In addition, we have agreed to indemnify Sprint
and Sprint PCS from any loss suffered by reason of our use of the licensed marks
or marketing, promotion, advertisement, distribution, lease or sale of any
Sprint or Sprint PCS products and services other than losses arising solely out
of our use of the licensed marks in compliance with the contractual guidelines.
Sprint and Sprint PCS can terminate the trademark and service mark license
agreements if we file for bankruptcy, materially breach the agreement or our
management agreement is terminated. We can terminate the trademark and service
mark license agreements upon Sprint's or Sprint PCS' abandonment of the licensed
marks or if Sprint or Sprint PCS files for bankruptcy, or the management
agreement is terminated.
Consent And Agreement For The Benefit Of The Holders Of The Senior Secured
Credit Facility. Sprint PCS entered into a consent and agreement for the benefit
of the holders of the indebtedness under the senior secured credit facility.
This agreement was acknowledged by us, and modified Sprint PCS' rights and
remedies under our Sprint PCS agreements, for the benefit of the existing and
future holders of indebtedness under our senior secured credit facility and any
refinancing of the senior secured credit facility, which was a condition to the
funding of any amounts under our senior secured credit facility.
The senior secured consent principally provides for the following:
o Sprint PCS' consent to the pledge of substantially all of our assets,
including our rights in the Sprint PCS agreements;
o Sprint PCS' consent to the pledge of all our equity interests in
Horizon Personal Communications, Inc. and the pledge by Horizon
Personal Communications, Inc. of all of its equity interests in each
of its subsidiaries;
o for redirection of payments due to us under our Sprint PCS agreements
to the administrative agent during the continuation of our default
under our senior secured credit facility;
o for Sprint PCS to maintain 10 MHz of PCS spectrum in all of our
markets until our senior secured credit facility is satisfied or our
operating assets are sold after our default under our senior secured
credit facility;
o for Sprint PCS and the administrative agent to provide each other with
notices of default by us under the Sprint PCS agreements and the
senior secured credit facility, respectively; and
o the ability to appoint interim replacements, including Sprint PCS or a
designee of the administrative agent, to operate our portion of the
Sprint PCS network under the Sprint PCS agreements after an
acceleration of or event of default under our senior secured credit
facility or an event of termination under the Sprint PCS agreements.
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Sprint PCS' right to purchase on acceleration of amounts outstanding under
our senior secured credit facility. Subject to the requirements of applicable
law, so long as our senior secured credit facility remains outstanding, Sprint
PCS has the right to purchase our operating assets or pledged equity of our
operating subsidiaries, upon its receipt of notice of an acceleration of our
senior secured credit facility upon the following terms:
o Sprint PCS elects to make such a purchase of our operating assets
within a specified period;
o the purchase price of our operating assets is the greater of an amount
equal to 72% of our "entire business value" or the amount we owe under
our senior secured credit facility;
o if Sprint PCS has given notice of its intention to exercise the
purchase right for our operating assets, then the administrative agent
is prohibited from enforcing its security interest for a time period
after the acceleration or until Sprint PCS rescinds its intention to
purchase; and
o if we receive a written offer within a time period after acceleration
that is acceptable to us to purchase our operating assets or pledged
equity of our operating subsidiaries after the acceleration, then
Sprint PCS has the right to purchase our operating assets or pledged
equity of our operating subsidiaries on terms at least as favorable to
us as the offer we receive.
Sale of operating assets to third parties. If Sprint PCS does not purchase
our operating assets after an acceleration of the obligations under our senior
secured credit facility, then the administrative agent will be able to sell the
operating assets, subject to the requirements of applicable law, including the
law relating to foreclosures of security interests. The administrative agent
will have two options:
o to sell the assets to an entity that meets the requirements to be our
successor under the Sprint PCS agreements; or
o to sell the assets to any other third-party (including competitors of
Sprint PCS), principally subject to the condition that Sprint PCS does
not have to accept the third-party as a Sprint PCS affiliate and may
terminate our Sprint PCS agreements.
Regulation Of The Wireless Telecommunications Industry
The FCC regulates the licensing, construction, operation, acquisition and
interconnection arrangements of wireless telecommunications systems in the
United States.
The FCC has adopted, or is in the process of adopting, a series of rules,
regulations and policies to, among other things:
o grant or deny licenses for PCS frequencies;
o grant or deny PCS license renewals;
o rule on assignments and/or transfers of control of PCS licenses;
o govern the interconnection of PCS networks with the networks of other
wireless and wireline carriers;
o possibly facilitate the offering of a "calling party pays" service
which would require that a party who calls a subscriber would pay for
the call;
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o establish access and universal service funding provisions in an effort
to raise funds to help defray the cost of providing telecommunications
services to rural and other high-cost areas;
o possibly permit commercial mobile radio service spectrum to be used
for transmission of programming material targeted to a limited
audience;
o impose fines and forfeitures for violations of any of the FCC's rules;
and
o regulate the technical standards of PCS networks.
The FCC currently prohibits a single entity from having a combined
attributable interest of 20% or greater in broadband PCS, cellular, and
specialized mobile radio service licenses totaling more than 45 MHz in any urban
areas or 55 MHz in rural areas. Interests held by passive institutional
investors, small companies and rural telephone companies are not usually deemed
attributable for purposes of this prohibition if these interests do not exceed
40%.
Transfers And Assignments Of PCS Licenses. The FCC must give prior approval
to the assignment of, or transfers involving, substantial changes in ownership
or control of a PCS license. Non-controlling interests in an entity that holds a
PCS license or operates PCS networks generally may be bought or sold without
prior FCC approval. In addition, a recent FCC order requires only
post-consummation notification of certain pro forma assignments or transfers of
control.
Conditions Of PCS Licenses. All PCS licenses are granted for ten-year terms
conditioned upon timely compliance with the FCC's build-out requirements.
Pursuant to the FCC's build-out requirements, all 30 MHz broadband PCS licensees
must construct facilities that offer coverage to one-third of the population
within five years and to two-thirds of the population within ten years, and all
ten MHz broadband PCS licensees must construct facilities that offer coverage to
at least one-quarter of the population within five years or make a showing of
"substantial service" within that five-year period. Rule violations could result
in license revocations. The FCC also requires licensees to maintain a certain
degree of control over their licenses. The Sprint PCS agreements reflect an
arrangement that the parties believe meets the FCC requirements for licensee
control of licensed spectrum. If the FCC were to determine that our agreements
with Sprint PCS need to be modified to increase the level of licensee control,
the Sprint PCS agreements may be modified to cure any purported deficiency
regarding licensee control of the licensed spectrum.
PCS License Renewal. PCS licensees can renew their licenses for additional
ten-year terms. PCS renewal applications are not subject to auctions. However,
under the FCC's rules, third parties may oppose renewal applications and/or file
competing applications. If one or more competing applications are filed, a
renewal application will be subject to a comparative renewal hearing. The FCC's
rules afford PCS renewal applicants involved in comparative renewal hearings
with a "renewal expectancy." The renewal expectancy is the most important
comparative factor in a comparative renewal hearing and is applicable if the PCS
renewal applicant has: (1) provided "substantial service" during its license
term; and (2) substantially complied with all applicable laws and FCC rules and
policies. The FCC's rules define "substantial service" in this context as
service that is sound, favorable and substantially above the level of mediocre
service that might minimally warrant renewal.
Interconnection. The FCC has the authority to order interconnection between
commercial mobile radio providers and any other common carrier. The FCC has
ordered traditional telephone companies to provide compensation to commercial
mobile radio providers for the termination of traffic. Using these new rules, we
will negotiate interconnection agreements for the Sprint PCS network in our
market area with the major regional Bell operating companies, GTE, Sprint and
several smaller independent local exchange carriers. Interconnection agreements
are negotiated on a state-wide basis. If an agreement cannot be reached, parties
to interconnection negotiations can submit outstanding disputes to state
authorities for arbitration. Negotiated interconnection agreements are subject
to state approval. On July 18, 2000, the FCC adopted an order denying requests
for mandatory interconnection between resellers' switches and commercial mobile
radio providers' networks, and declining to impose general interconnection
obligations between these networks.
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Other FCC Requirements. In June 1996, the FCC adopted rules that prohibit
broadband PCS providers from unreasonably restricting or disallowing resale of
their services or unreasonably discriminating against resellers. Resale
obligations will automatically expire on November 24, 2002. The FCC recently
decided that these prohibitions apply to services and not to equipment such as
handsets, whether alone or in bundled packages.
The FCC also adopted rules in June 1996 that require local exchange and
most commercial mobile radio carriers, to program their networks to allow
customers to change service providers without changing telephone numbers, which
is referred to as service provider number portability. The FCC currently
requires most commercial mobile radio carriers to implement nationwide roaming.
Most commercial mobile radio carriers are required to implement nationwide
roaming by November 24, 2002 as well. The FCC currently requires most commercial
mobile radio providers to be able to deliver calls from their networks to
numbers anywhere in the country, and to contribute to the Local Number
Portability Fund.
The FCC has adopted rules permitting broadband PCS and other commercial
mobile radio providers to provide wireless local loop and other fixed services
that would directly compete with the wireline services of local telephone
companies. In June 1996, the FCC adopted rules requiring broadband PCS and other
commercial mobile radio providers to implement enhanced emergency 911
capabilities within 18 months after the effective date of the FCC's rules. Full
compliance with these rules must occur by October 1, 2001.
On June 10, 1999, the FCC initiated a regulatory proceeding (the
competitive networks proceeding) seeking comment from the public on a number of
issues related to competitive access to multiple-tenant buildings, including the
following:
o the FCC's tentative conclusion that the Communications Act of 1934, as
amended, requires utilities to permit telecommunications carriers
access to rooftop and other rights-of-way in multiple tenant buildings
under just, reasonable and nondiscriminatory rates, terms and
conditions; and
o whether building owners that make access available to a
telecommunications carrier should be required to make access available
to all other telecommunications carriers on a nondiscriminatory basis,
and whether the FCC has the authority to impose such a requirement.
On October 25, 2000, the FCC issued an order that addressed certain of the
issues in the competitive networks proceeding. Notably, the FCC:
o prohibits carriers from entering into contracts that restrict owners
of commercial office buildings from permitting access from competing
carriers;
o clarifies the FCC's rules governing control of in-building wiring;
o concludes that utilities that own conduits or rights-of-way within a
building must give non-discretionary access thereto; and
o concludes that parties with a direct or indirect ownership or
leasehold interest in property, including building tenants, should
have the ability to place antennas one meter or less in diameter used
to receive or transmit any fixed wireless service in certain areas.
This proceeding could affect the availability and pricing of sites for our
antennae and those of our competitors.
Communications Assistance For Law Enforcement Act. The Communications
Assistance for Law Enforcement Act was enacted in 1994 to preserve electronic
surveillance capabilities by law enforcement officials in the face of rapidly
changing telecommunications technology. The Communications Assistance Act
requires telecommunications carriers, including us, to modify their equipment,
facilities, and services to allow for authorized electronic surveillance based
on either industry or FCC standards. In 1997, industry standard-setting
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organizations developed interim standards for wireline, cellular and broadband
PCS carriers to comply with the Communications Assistance Act. In August 1999,
the FCC supplemented the interim industry standards with additional standards.
For interim industry standards, the deadline for compliance was June 30, 2000,
which has since been extended to June 30, 2001, and for the additional standards
established by the FCC, the deadline is September 30, 2001. In August 2000, the
District of Columbia Circuit Court remanded the FCC's Communications Assistance
Act requirements, which has resulted in some uncertainty as to the program.
Although we will be able to offer traditional electronic surveillance
capabilities to law enforcement agencies, we may not meet the compliance
deadlines of either June 30, 2001 or September 30, 2001, due to required
hardware changes that have not yet been developed and implemented by switch
manufacturers. We may be granted extensions for compliance, or we may be subject
to penalties if we fail to comply, including being assessed fines or having
conditions put on our licenses.
Other Federal Regulations. Wireless systems must comply with FCC and FAA
regulations regarding the siting, lighting and construction of transmitter
towers and antennas. In addition, FCC environmental regulations may cause some
cell site locations to become subject to regulation under the National
Environmental Policy Act. The FCC is required to implement this Act by requiring
carriers to meet land use and radio frequency standards.
Review Of Universal Service Requirements. The FCC and the states are
required to establish a universal service program to ensure that affordable,
quality telecommunications services are available to all Americans. Sprint PCS
is required to contribute to the federal universal service program as well as
existing state programs. The FCC has determined that Sprint PCS' contribution to
the federal universal service program is a variable percentage of "end-user
telecommunications revenues." Although many states are likely to adopt a similar
assessment methodology, the states are free to calculate telecommunications
service provider contributions in any manner they choose as long as the process
is not inconsistent with the FCC's rules. At the present time it is not possible
to predict the extent of the Sprint PCS total federal and state universal
service assessments or its ability to recover from the universal service fund.
Wireless Facilities Siting. States and localities are not permitted to
regulate the placement of wireless facilities so as to prohibit the provision of
wireless services or to discriminate among providers of these services. In
addition, so long as a wireless system complies with the FCC's rules, states and
localities are prohibited from using radio frequency health effects as a basis
to regulate the placement, construction or operation of wireless facilities. The
FCC is considering numerous requests for preemption of local actions affecting
wireless facilities siting.
State Regulation Of Wireless Service. Section 332 of the Communications Act
preempts states from regulating the rates and entry of commercial mobile radio
providers, like us. However, states may petition the FCC to regulate these
providers and the FCC may grant a state's petition if the state demonstrates
that (1) market conditions fail to protect subscribers from unjust and
unreasonable rates or rates that are unjustly or unreasonably discriminatory, or
(2) when commercial mobile radio is a replacement for landline telephone service
within the state. To date, the FCC has granted no petition of this type. To the
extent we provide fixed wireless service, we may be subject to additional state
regulation.
Legislative And Regulatory Developments. The telecommunications industry is
subject to federal, state and local regulation. The application of these
regulations to our business segments is discussed above. A more general
description is set forth below.
Federal Regulations. The FCC regulates interstate and international
telecommunications services, which includes using local telephone facilities to
originate and terminate interstate and international calls. The
Telecommunications Act is intended to promote competitive development of new
service offerings, to expand public availability of telecommunications services
and to streamline regulation of the industry. Implementation of its legislative
objectives is the task of the FCC, state public utilities commissions and a
federal-state joint board. The Telecom Act makes all state and local barriers to
competitive entry unlawful, whether they are direct or indirect. The Telecom Act
directs the FCC to hold notice and comment proceedings and to preempt all
inconsistent state and local laws and regulations. Among the numerous pending
FCC proceedings are its Implementation of the Local Competition Provisions of
the Telecom Act proceeding (CC Docket No. 96-98), its Deployment of Wireline
Services Offering Advanced Telecommunications Capability proceeding (CC Docket
No. 98-147), and at least four proceedings relating to universal service and
access charge reform (CC Docket Nos. 94-1, 96-45, 96-262, 99-249).
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In addition to opening up local exchange markets, the Telecom Act contains
provisions for:
o updating and expanding telecommunications service guarantees;
o removing certain restrictions relating to former AT&T operating
companies (the Regional Bell Operating Companies) resulting from the
federal court antitrust consent decree issued in 1984;
o the entry of telephone companies into video services;
o the entry of cable television operators into other telecommunications
industries;
o changes in the rules for ownership of broadcasting and cable
television operations; and
o changes in the regulations governing cable television.
Each state retains the power to impose "competitively neutral" requirements
that are both consistent with the Telecom Act's universal service provision and
necessary for universal service, public safety and welfare, continued service
quality and consumer rights. Although a state may not impose requirements that
effectively function as barriers to entry or create a competitive disadvantage,
the scope of state authority to maintain existing or adopt new requirements
under this section is not clear. In addition, before it preempts a state or
local requirement as violating the entry barrier prohibition, the FCC must hold
a notice and comment proceeding.
The FCC must forbear from applying any statutory or regulatory provision
that is not necessary to keep telecommunications rates and terms reasonable or
to protect consumers. A state may not apply a statutory or regulatory provision
that the FCC decides to forbear from applying. In addition, the FCC must review
its telecommunications regulations every two years and repeal or modify any that
it deems to be no longer in the public interest.
Although certain interpretive issues under the Telecom Act have not yet
been resolved, it is apparent that the requirements of the Telecom Act have led
to increased competition among providers of local telecommunications services
and have simplified the process of switching from incumbent local exchange
carrier services to those offered by competitive access providers and
competitive local exchange carriers.
The FCC regulates wireless services through its Wireless Telecommunications
Bureau. Providers of wireless mobile radio services are considered "common
carriers" and are subject to the obligations of such carriers, except where
specifically exempted by the FCC. As a result, our wireless operations and
business plans may be impacted by FCC regulatory activity. For example, the FCC
has concluded that commercial mobile radio service providers are entitled to
enter into reciprocal compensation arrangements with local exchange carriers.
The FCC has declined at this time to classify commercial mobile radio service
providers themselves as local exchange carriers subject to the obligations of
the Telecom Act, but could do so at some point in the future. Other regulatory
issues currently facing wireless carriers include issues relating to telephone
number administration. Because they are common carriers, wireless carriers are
subject to FCC and state actions regarding exhaustion, conservation or expansion
of telephone numbers and area codes. Programs to conserve or expand telephone
number and area code resources may possibly have a disproportionate impact on
wireless carriers because such carriers may not have a large reserve of spare
numbers, as wireline carriers may have, and so-called "area code overlay"
programs are sometimes imposed on wireless carriers alone, which forces their
customers to dial more digits for most local calls than wireline callers in the
same area. Within the past year, the FCC has issued an order asserting
jurisdiction over nearly all telephone numbering issues.
A cellular licensee must apply for FCC authority to use additional
frequencies to modify the technical parameters of existing licenses, to expand
its service territory and to provide new services. In addition to regulation by
the FCC, cellular systems are subject to certain Federal Aviation Administration
(FAA) tower height regulations with respect to the siting and construction of
35
cellular transmitter towers and antennas. The FCC also has a rulemaking
proceeding pending to update the guidelines and methods it uses for evaluating
acceptable levels of radio frequency emissions from radio equipment, including
cellular telephones, which could result in more restrictive standards for such
devices.
State And Local Regulation. We are also regulated by the Public Utilities
Commission of Ohio, which we also refer to as the PUCO, because we provide
intrastate telephone services within Ohio. As a result, we must comply with Ohio
pricing regulations, file periodic reports, pay various fees and comply with
rules governing quality of service, consumer protection and similar matters. The
rules and regulations are designed primarily to promote the public's interest in
receiving quality telephone service at reasonable prices. Our networks are
subject to numerous local regulations such as requirements for franchises,
building codes and licensing. Such regulations vary on a city by city and county
by county basis.
EMPLOYEES
At December 31, 2000, we had approximately 655 employees. Of these, 137 are
represented by a union. We consider relations with our employees to be good.
RISK FACTORS
You should carefully consider the risks described below in evaluating our
businesses.
Risks Related To Our ILEC, Long Distance And Internet Businesses
We may not be able to compete effectively.
We face, or will face, significant competition in the markets in which we
currently provide ILEC, long distance, data and Internet services. Many of our
competitors are substantially larger and have greater financial, technical and
marketing resources than we do. In particular, larger competitors have certain
advantages over us, which could cause us to lose customers and impede our
ability to attract new customers, including:
o long-standing relationships and greater name recognition with
customers;
o financial, technical, marketing, personnel and other resources
substantially greater than ours;
o more capital to deploy services; and
o potential to lower prices of competitive services.
These factors place us at a disadvantage when we respond to our
competitors' pricing strategies, technological advances and other initiatives.
Additionally, our competitors may develop services that are superior to ours or
that achieve greater market acceptance.
We face competition from other current and potential market entrants,
including:
o domestic and international long distance providers seeking to enter,
re-enter or expand entry into our local communications marketplace;
o other domestic and international competitive communications providers,
resellers, cable television companies and electric utilities; and
o providers of broadband and Internet services.
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A continuing trend toward combinations and strategic alliances in the
communications industry could give rise to significant new competitors. This
could cause us to lose customers and impede our ability to attract new
customers.
We may not be able to successfully integrate new technologies or respond
effectively to customer requirements.
The communications industry is subject to rapid and significant changes in
technology, frequent new service introductions and evolving industry standards.
We cannot predict the effect of these changes on us or our industry.
Technological developments may reduce the competitiveness of our networks and
require unbudgeted upgrades or the procurement of additional products that could
be expensive and time consuming. If we fail to adapt successfully to
technological changes or obsolescence or fail to obtain access to important new
technologies, we could lose customers and be limited in our ability to attract
new customers.
A system failure could cause delays or interruptions of service, which
could cause us to lose customers.
To be successful, we will need to provide our customers reliable service
over our network. Some of the risks to our network and infrastructure include:
o physical damage to access lines;
o power surges or outages;
o capacity limitations;
o software defects;
o lack of redundancy; and
o disruptions beyond our control.
Disruptions may cause interruptions in service or reduced capacity for
customers, either of which could cause us to lose customers.
If our back office and customer care systems are unable to meet the needs
of our customers, we may lose customers.
Sophisticated back office processes and information management systems are
vital to our anticipated growth and our ability to achieve operating
efficiencies. We are dependent on third-party vendors for billing, provisioning
and customer support systems. We cannot assure you that these systems will
perform as expected as we increase our number of customers. If they fail to
perform as expected, we could lose customers. The following could prevent our
back office and customer care systems from meeting the needs of our customers:
o failure of third-party vendors to deliver products and services in a
timely manner at acceptable costs;
o our failure to identify key information and processing needs;
o our failure to integrate products or services effectively;
o our failure to upgrade systems as necessary; or
o our failure to attract and retain qualified systems support personnel.
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Furthermore, as our suppliers revise and upgrade their hardware, software
and equipment technology, we could encounter difficulties in integrating this
new technology into our business or find that such new hardware, software and
technology is not appropriate for our business. In addition, our right to use
such hardware, software and technology depends upon license agreements with
third party vendors. Vendors may cancel or elect not to renew some of these
agreements, which may adversely affect our business.
The market for our data and Internet services is rapidly evolving and we
cannot predict whether the market for our services will continue to grow.
An element of our strategy is to deliver data and Internet services. The
market for data and Internet services is rapidly evolving. We cannot assure you
that growth in demand for these services will occur as expected. A number of
critical issues concerning commercial viability of these services, including
security, reliability, ease and cost of access and quality of service, may
remain unresolved and may negatively affect our growth. To be successful, we
must develop and market our services in a rapidly changing competitive
marketplace. Therefore, there is a risk that the data and Internet services we
decide to offer will become obsolete before they can be profitably sold. If the
market for these services grows more slowly than we anticipate or becomes
saturated with competitors, our business may be adversely affected.
We Are Subject to Significant Regulatory Risks.
We are subject to significant regulation that could change in a manner
adverse to us.
We operate in a heavily regulated industry, and the majority of our
revenues generally have been supported by regulations, including in the form of
support for the provision of telephone services in rural areas. Laws and
regulations applicable to us and our competitors may be, and have been,
challenged in the courts, and could be changed by Congress or regulators at any
time. In addition, any of the following have the potential to have a significant
impact on us:
Risk of loss or reduction of network access charge revenues. Approximately
50% of our revenues in 2000 came from network access charges, which are paid to
us by intrastate carriers and interstate long distance carriers for originating
and terminating calls in the regions we serve. The amount of access charge
revenues that we receive is calculated based on guidelines set by federal and
state regulatory bodies, and such guidelines could change at any time. The FCC
continues to reform the federal access charge system. States often mirror these
federal rules in establishing intrastate access charges. It is unknown at this
time how changes to the FCC's access charge regime will affect us. Federal
policies being implemented by the FCC strongly favor access charge reform, and
our revenues from this source could be at risk. Regulatory developments of this
type could adversely affect our business.
Risk of loss or reduction of Universal Service Support. We receive
Universal Service Support Fund, or USSF, revenues to support the high cost of
our operations in rural markets. Such support payments represented 5% of
revenues in 2000. If CTC were unable to receive support from the Universal
Service Support Fund, which we also refer to as the USSF, or if such support was
reduced, CTC would be unable to operate as profitably as before such reduction.
In addition, potential competitors generally cannot, under current laws,
receive the same universal service support enjoyed by CTC. CTC therefore enjoys
a significant competitive advantage, which could, however, be removed by
regulators at any time. The Telecom Act provides that competitors could obtain
the same support as we do if the Public Utilities Commission of Ohio determines
that granting such support to competitors would be in the public interest. If
such universal service support were to become available to potential
competitors, we might not be able to compete as effectively or otherwise
continue to operate as profitably in our CTC markets. Any shift in universal
service regulation could, therefore, have an adverse effect on our business.
The method for calculating the amount of such support could change in 2001.
It is unclear whether the chosen methodology will accurately reflect the costs
incurred by CTC, and whether it will provide for the same amount of universal
service support that CTC enjoyed in the past. The outcome of any of these
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proceedings or other legislative or regulatory changes could affect the amount
of universal service support that we receive, and could have an adverse effect
on our business.
Risk of loss of protected status under interconnection rules. CTC takes the
position that it does not have to comply with the Telecom Act's more burdensome
requirements governing the rights of competitors to interconnect to our
traditional telephone companies' networks due to our status as a rural telephone
company. If state regulators decide that it is in the public's interest to
impose these interconnection requirements on us, more competitors could enter
our traditional telephone markets than are currently expected and we could incur
additional administrative and regulatory expenses as a result of such newly
imposed interconnection requirements.
Risks posed by costs of regulatory compliance. Regulations create
significant compliance costs for us. Our subsidiary that provides intrastate
services is also generally subject to certification, tariff filing and other
ongoing regulatory requirements by state regulators. Challenges to these tariffs
by regulators or third parties could cause us to incur substantial legal and
administrative expenses.
Regulatory changes in the telecommunications industry involve
uncertainties, and the resolution of these uncertainties could adversely affect
our business by facilitating greater competition against us, reducing potential
revenues or raising our costs.
The Telecom Act provides for significant changes in the telecommunications
industry, including the local telecommunications and long distance industries.
This federal statute and the related regulations remain subject to judicial
review and additional rulemakings of the FCC, thus making it difficult to
predict what effect the legislation will have on us, our operations and our
competitors. Several regulatory and judicial proceedings have recently
concluded, are underway or may soon be commenced, that address issues affecting
our operations and those of our competitors, which may cause significant changes
to our industry. We cannot predict the outcome of these developments, nor can we
assure that these changes will not have a material adverse effect on us.
We May Face Potential Conflicts Of Interest With HPCS Which May Adversely
Affect Horizon Telcom's Business And The Value of Its Common Stock.
Conflicts of interest may arise between us and HPCS, in areas relating to
past, ongoing and future relationships, including:
o corporate opportunities;
o tax and intellectual property matters; and
o potential acquisitions.
Horizon Telcom controls approximately 81.5% of the voting power of HPCS'
shares on a fully diluted basis. Any conflicts that may arise between us and
HPCS or any loss of corporate opportunity to us that may otherwise be available
to us may impact our financial condition or results of operations because these
conflicts of interest or losses of corporate opportunities could result in a
loss of potential profits or customers. Although Horizon Telcom will be able to
control the outcome of most conflicts upon which HPCS stockholders could vote
and because Horizon Telcom will have the voting power to control the HPCS board
of directors, conflicts nevertheless may not be resolved in favor of Horizon
Telcom. The directors of HPCS, including those nominated by Horizon Telcom, have
fiduciary duties to all of HPCS' shareholders, which may prevent them from
taking actions which would be advisable if HPCS was wholly owned by Horizon
Telcom.
Present And Future Transactions With HPCS May Be On Terms Which Are Not As
Favorable As Could Be Obtained From Third Parties.
In the past, we have entered into transactions with HPCS including the
leasing of towers by HPCS from us and the advancing of cash by us to finance
HPCS' operations. In addition, under our former tax sharing agreement with HPCS,
39
we used HPCS' net operating losses to offset our taxes. Under this agreement, we
paid HPCS the amount of our tax savings from our net operating losses used for
this purpose. In addition, a subsidiary of Horizon Telcom provides
administrative services to HPCS including finance functions, billing and
collections, accounting services, computer access, customer relations and human
resources. Although these transactions were and may be on terms that we believe
are fair, third-parties or the marketplace may not perceive them to be fair.
Risks Particular To HPCS, Our Wireless Digital Communications Business
The information set forth under this heading describes risk factors
relating to the business of our majority-owned subsidiary HPCS. References under
this heading to "we," "us" and "our" are to HPCS.
We Have Not Had Any Profitable Years In The Past Five Years And We May Not
Achieve Or Sustain Operating Profitability Or Positive Cash Flow From Operating
Activities.
At HPCS, we expect to incur significant operating losses and to generate
significant negative cash flow from operating activities until 2003 while we
continue to construct our network and grow our customer base. We have already
incurred a total of approximately $76.9 million in net losses through December
31, 2000. Our operating profitability will depend upon many factors, including
our ability to market our services, achieve our projected market penetration and
manage customer turnover rates. If we do not achieve and maintain operating
profitability and positive cash flow from operating activities on a timely
basis, we may not be able to meet our debt service requirements, and Horizon
Telcom could lose all or part of its investment in HPCS.
If We Do Not Successfully Manage our Anticipated Rapid Growth, We May Fail
To Complete The Build-Out Of Our Network, Sprint PCS May Terminate The Sprint
PCS Agreements, And We Would No Longer Be Able To Offer Sprint PCS Products And
Services From Which We Generate Substantially All Our Revenues.
Our long-term affiliation agreements with Sprint PCS, which we refer to as
the Sprint PCS agreements, require us to build out and operate the portion of
the Sprint PCS network located in our territory, in accordance with Sprint PCS'
technical and coverage requirements. The agreements also require that we provide
minimum network coverage to the total population within each of the markets
which make up our territory by specified dates.
As of June 30, 2000, we had not yet met the minimum covered population
requirements under the Sprint PCS agreements for Roanoke, Fairmont,
Martinsville, Lynchburg, Staunton-Waynesboro, and Danville, Virginia. Sprint PCS
has agreed that the shortfalls were not material and agreed in writing that if
we met our build-out requirement by December 31, 2000, we would not be in breach
of our management agreement. We extended our coverage to meet the build-out
requirements in these markets by December 31, 2000.
In addition, we did not launch all of our Bright PCS markets by the date
set forth in the Sprint PCS agreements. We were unable to obtain the required
backhaul from local exchange carriers by that date, despite using commercially
reasonable efforts. Sprint PCS agreed in writing that we are in compliance with
the build-out requirements in these markets. We have subsequently obtained the
required backhaul services and launched these markets.
Under the terms of our Sprint PCS agreements, we are required to provide
additional coverage in specified markets by the following dates:
Population To Be
Covered Requirement Estimated Total Population Covered
October 2001 2,369,867 811,730
February 2002 535,078 147,365
Portions of the Scranton, Pottsville, Stroudsburg and Allentown,
Pennsylvania, Knoxville, Tennessee, and New York City area markets were required
to be completed by December 31, 2000. As of April 30, 2001, these markets have
not been completed as required. To cure these shortfalls, we must increase our
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coverage in these markets by an additional covered population of approximately
135,000. Although Sprint PCS is aware of these shortfalls, they have not sent a
notice of default, which would begin a cure period. We believe that if there is
a default, we can cure these shortfalls within the applicable cure period.
Assuming we cure within this timeframe as expected, we would not be subject to
any penalties. We are presently considering a proposal from Sprint PCS that
would, among other things, extend the deadlines for building out several of our
markets. As of the date of this registration statement, we are in compliance
with the build-out requirements in all of our markets except these markets.
By the third quarter of 2001, we are required by our Sprint PCS agreements
to provide aggregate coverage of 65% in the markets granted to us in the third
grant. We will require additional expenditures of significant funds for the
continued development, construction, testing, deployment and operation of our
network. These activities are expected to place significant demands on our
managerial, operational and financial resources.
We Have Substantial Debt Which We May Not Be Able To Service And Which May
Result In Our Lenders Controlling HPCS' Assets In An Event Of Default.
As of December 31, 2000, our total debt outstanding was $185.3 million,
$50.0 million of which was due under our senior secured credit facility and
$135.3 million of which was due under our senior discount notes (total debt
outstanding of $155.2 million less a $19.9 million unrecognized discount
associated with the warrants issued in connection with our senior discount notes
offering).
Our substantial debt will have a number of important consequences for our
operations and our investors, including the following:
o we have to dedicate a substantial portion of any cash flow from
operations to the payment of interest on, and principal of, our debt,
which will reduce funds available for other purposes;
o we may not have sufficient funds to pay interest on, and principal of,
our debt;
o we may not be able to obtain additional financing for currently
unanticipated capital requirements, capital expenditures, working
capital requirements and other corporate purposes;
o some borrowings likely will be at variable rates of interest, which
will result in higher interest expense in the event of increases in
market interest rates; and
o due to the liens on substantially all of our assets and the pledges of
equity ownership of our subsidiaries that secure our senior debt, our
lenders may control our assets upon a default.
If We Fail To Pay Our Debt, Our Lenders May Sell Our Loans To Sprint PCS
Giving Sprint PCS The Rights Of A Creditor To Foreclose On Our Assets.
If the lenders accelerate the amounts due under our new senior secured
credit facility, Sprint PCS has the right to purchase our obligations under this
facility and become a senior lender. To the extent Sprint PCS purchases these
obligations, Sprint PCS' interests as a creditor could conflict with ours.
Sprint PCS' rights as a senior lender would enable it to exercise rights with
respect to our assets and Sprint PCS' continuing relationship in a manner not
otherwise permitted under the Sprint PCS agreements.
If Sprint PCS Terminates The Sprint PCS Agreements, The Buy-Out Provisions
Of Those Agreements May Diminish The Valuation Of Our Company.
Provisions of the Sprint PCS agreements could affect the valuation of HPCS,
and decrease our ability to raise additional capital. If Sprint PCS terminates
these agreements, Sprint PCS may purchase our operating assets or capital stock
for 80% of the entire business value. If the termination is due to our breach of
the Sprint PCS agreements, the percent is reduced to 72% instead of 80%. Under
41
our Sprint PCS agreements, the entire business value is generally the fair
market value of our wireless business valued on a going concern basis as
determined by an independent appraiser. In addition, Sprint PCS must approve any
change of control of our ownership and consent to any assignment of the Sprint
PCS agreements. Sprint PCS also has a right of first refusal if we decide to
sell our operating assets in our Bright PCS markets. We are also subject to a
number of restrictions on the transfer of our business including a prohibition
on selling our company or our operating assets to a number of identified and as
yet to be identified competitors of Sprint PCS or Sprint. These and other
restrictions in the Sprint PCS agreements may limit the marketability of and
reduce the value a buyer may be willing to pay for our company or its business
and may operate to reduce the entire business value of our company.
The Termination Of Our Strategic Affiliation With Sprint PCS Or Sprint PCS'
Failure To Perform Its Obligations Under The Sprint PCS Agreements Would
Severely Restrict Our Ability To Conduct Our Business.
Because we own only a single license to operate a wireless PCS network of
our own, our ability to offer Sprint PCS products and services on our network is
dependent on the Sprint PCS agreements remaining in effect and not being
terminated. Sprint PCS may terminate the Sprint PCS agreements for breach of any
material terms. We also depend on Sprint PCS' ability to perform its obligations
under the Sprint PCS agreements. The termination of the Sprint PCS agreements or
the failure of Sprint PCS to perform its obligations under the Sprint PCS
agreements would severely restrict our ability to conduct the wireless digital
communications business.
If Sprint PCS Does Not Complete The Construction Of Its Nationwide PCS
Network, We May Not Be Able To Attract And Retain Customers, Which Would
Adversely Affect Our Revenues.
Sprint PCS' network may not provide nationwide coverage to the same extent
as its competitors, which could adversely affect our ability to attract and
retain customers. Sprint PCS is creating a nationwide PCS network through its
own construction efforts and those of its affiliates. Today, neither Sprint PCS
nor any other PCS provider offers service in every area of the United States.
Sprint PCS has entered into, and anticipates entering into, affiliation
agreements similar to ours with companies in other territories pursuant to its
nationwide PCS build-out strategy. Our business and results of operations depend
on Sprint PCS' national network and, to a lesser extent, on the networks of its
other affiliates. Sprint PCS and its affiliate program are subject, to varying
degrees, to the economic, administrative, logistical, regulatory and other risks
described in this registration statement. Sprint PCS' and its other affiliates'
PCS operations may not be successful.
The Inability To Maintain Our Back Office Systems Or To Successfully
Convert Over To And Use Sprint PCS' Back Office Services And Third Party
Vendors' Back Office Systems Could Disrupt Our Business.
In some of our markets, we presently provide our own back office services,
such as customer activation, support and billing. As our business has expanded
our internal support systems have been subject to increased demand. This
increases the risk that our information systems, business processes and related
support functions, especially those related to prompt activation of service upon
receipt of the customer order, customer service and accounts receivable
collection could prove inadequate or inefficient. We recently completed a review
of our internal systems and processes and implemented many of the improvements
to our process recommended from the review. However, there can be no assurance
that the improvements we have implemented will be sufficient. If our systems
become unable to timely and efficiently meet demands for service, this could
decrease subscriber growth, and delay or otherwise impede billing and collection
of amounts owed, which would adversely affect our revenues.
Furthermore, we have engaged Sprint PCS to provide back office systems. We
began the transition to Sprint PCS back office services in September 2000. We
expect that these services will be transitioned to Sprint PCS by the end of
2001. The process of transitioning our own back office services to Sprint PCS
could be accompanied by unanticipated errors, delays or expenses, which could
adversely affect our ability to service our customers, add new customers, or
complete the transition. Once the transition is complete, our operations could
be disrupted if Sprint PCS is unable to maintain and expand its back office
services, or to efficiently outsource those services and systems through third
party vendors. The rapid expansion of Sprint PCS' business will continue to pose
a significant challenge to its internal support systems. Additionally, Sprint
PCS has relied on third-party vendors for a significant number of important
functions and components of its internal support systems and may continue to
rely on these vendors in the future. We depend on Sprint PCS' willingness to
continue to offer these services to us and to provide these services at
42
competitive costs. The Sprint PCS agreements provide that, upon nine months'
prior written notice, Sprint PCS may elect to terminate any of these services.
If Sprint PCS terminates a service for which we have not developed a
cost-effective alternative, our operating costs may increase beyond our
expectations and restrict our ability to operate successfully.
We Depend On Other Telecommunications Companies For Some Services Which, If
Delayed, Could Delay Our Planned Network Build-Out And Delay Our Expected
Increases In Customers And Revenues.
We depend on other telecommunications companies to provide facilities and
transport to interconnect portions of our network and to connect our network
with the landline telephone system. American Electric Power, Ameritech, AT&T,
Verizon and GTE are our primary suppliers of facilities and transport. Without
these services, we could not offer Sprint PCS services to our customers in some
areas. From time to time, we have experienced delays in obtaining facilities and
transport from these companies, and in obtaining local telephone numbers for use
by our customers, which are sometimes in short supply, and we may continue to
experience delays and interruptions in the future. Delays in obtaining
facilities and transport could delay our build-out plans and our business may
suffer. Delays could also result in a breach of our Sprint PCS agreements,
subjecting these agreements to potential termination by Sprint PCS.
If We Do Not Meet All Of The Conditions Under The HPCS Senior Secured
Credit Facility, We May Not Be Able To Draw Down All Of The Funds Under The
Facility And, As A Result, We May Not Be Able To Complete The Build-Out Of Our
Network, Which May Result In The Termination Of The Sprint PCS Agreements.
Our senior secured credit facility provides for aggregate borrowings of
$250.0 million of which $50.0 million was borrowed on September 26, 2000.
Availability of future borrowings will be subject to customary credit conditions
at each funding date, including the following:
o the absence of any default or event of default;
o the continuing accuracy of all representations and warranties; and
o no material adverse change.
If we do not meet these conditions at each funding date, our senior secured
lenders may choose not to lend any or all of the remaining amounts, and if other
sources of funds are not available, we may not be in a position to complete the
build-out of our network. If we do not have sufficient funds to complete our
network build-out, we may be in breach of the Sprint PCS agreements and in
default under our senior secured credit facility.
Our Indebtedness Places Restrictions On Us Which Limit Our Operating
Flexibility.
The indenture governing our senior discount notes and the senior secured
credit agreement both impose material operating and financial restrictions on
us. These restrictions, subject to ordinary course of business exceptions, may
limit our ability to engage in some transactions, including the following:
o designated types of mergers or consolidations;
o paying dividends or other distributions to our stockholders;
o making investments;
o selling assets;
o repurchasing our common stock;
o changing lines of business;
43
o borrowing additional money; and
o transactions with affiliates.
These restrictions could limit our ability to obtain debt financing,
repurchase stock, refinance or pay principal or interest on our outstanding
debt, consummate acquisitions for cash or debt or react to changes in our
operating environment.
An event of default under the senior secured credit facility may prohibit
us and the guarantors of our senior discount notes from paying the senior
discount notes or the guarantees of the senior discount notes.
The Terms Of The Convertible Preferred Stock May Affect Our Financial
Results.
If we do not complete an initial public offering of common stock that
yields gross proceeds of at least $65.0 million with a per share price for the
HPCS common stock that exceeds $10.29 or consummate a business combination with
another Sprint PCS affiliate that meets specified criteria, our convertible
preferred stock will not convert into common stock. The terms of the convertible
preferred stock give the holders of the preferred stock the following principal
rights:
o to initially designate two members of our board of directors, subject
to reduction based on future percentage ownership;
o to approve or disapprove fundamental corporate actions and
transactions;
o to receive dividends in the form of additional shares of our
convertible preferred stock, which may increase and accelerate upon a
change in control; and
o to require us to redeem the convertible preferred stock.
If we become subject to the repurchase right or change of control
redemption requirements under the convertible preferred stock while our senior
debt or senior discount notes are outstanding, we will be required to seek the
consent of the holders of our senior debt and the holders of the senior discount
notes to repurchase or redeem the convertible preferred stock, or attempt to
refinance the debt and the senior discount notes. If we fail to obtain these
consents, there will be an event of default under the terms governing our senior
debt. In addition, if we do not repurchase or redeem the convertible preferred
stock and the holders of the convertible preferred stock obtain a judgment
against us, any judgment in excess of $5.0 million would constitute an event of
default under the indenture governing the senior discount notes.
If We Breach Our Agreement With SBA, Or It Otherwise Terminates Its
Agreement With Us, Our Right To Provide Wireless Service From Some Of Our Cell
Sites Will Be Lost.
We lease cell sites from SBA. We rely on our contract with SBA to provide
us with access to most of our cell sites and to the towers located on these
sites. If SBA were to lose its underlying rights to these sites, our ability to
provide wireless service from these sites would end, subject to our right to
cure defaults by SBA. If SBA terminates our agreement as a result of our breach,
we will lose our right to provide wireless services from most of our current
cell sites.
We May Have Difficulty In Obtaining Infrastructure Equipment And Handsets,
Which Are At Times In Short Supply, Which Could Result In Delays In Our Network
Build-Out, Disruption Of Service Or Loss Of Customers.
If we cannot acquire the equipment required to build our network in a
timely manner, we may be unable to provide wireless communications services
comparable to those of our competitors or to meet the requirements of the Sprint
PCS agreements. The demand for the equipment required to construct our network
is considerable, and manufacturers of this equipment could have substantial
44
order backlogs. Accordingly, the lead time for the delivery of this equipment
may be longer than anticipated. In addition, the demand for specific types of
handsets is strong and the manufacturers of those handsets may have to
distribute their limited supply of products among their numerous customers. Some
of our competitors purchase large quantities of communications equipment and may
have established relationships with the manufacturers of this equipment.
Consequently, they may receive priority in the delivery of this equipment. If we
do not obtain equipment or handsets in a timely manner, we could suffer delays
in the build-out of our network, disruptions in service and a reduction in
customers.
If The Alliances Fail To Provide Their Network To Us In Their Markets, Or
If Our Network Services Agreement With The Alliances Is Otherwise Terminated, We
Will Lose The Ability To Use The Alliances' Networks.
Under our network services agreement, the Alliances provide us with the use
of and access to key components of their network in most of our markets in
Virginia and West Virginia. We directly compete with the Alliances in some of
our other markets where we don't use their network. If the Alliances fail to
maintain the standards for their network as set forth in our network services
agreement with them or otherwise fail to provide their network for our use, our
ability to provide wireless services in these markets may be adversely affected,
and we may not be able to provide seamless service for our customers. If we
breach our obligations to the Alliances, or if the Alliances otherwise terminate
the network services agreement, we will lose our right to use the Alliances'
network to provide service in these markets. In that event, it is likely that we
will be required to build our own network in those markets and incur the costs
associated with doing so.
Sprint PCS' Vendor Discounts May Be Discontinued, Which Could Increase Our
Equipment Costs And Require More Capital Than We Project To Build Out Our
Network.
We intend to continue to purchase our infrastructure equipment under Sprint
PCS' vendor agreements that include significant volume discounts. If Sprint PCS
were unable to continue to obtain vendor discounts for its affiliates, the loss
of vendor discounts could increase our equipment costs for our new markets.
The Failure Of Our Vendors, Consultants And Contractors To Perform Their
Obligations May Delay Construction Of Our Network Which May Lead To A Breach Of
The Sprint PCS Agreements.
We have retained vendors, consultants and contractors to assist in the
design and engineering of our systems, construct cell sites, switch facilities
and towers, lease cell sites and deploy our network systems, and we will
continue to significantly depend upon them in order to fulfill our build-out
obligations. The failure by any of our vendors, consultants or contractors to
fulfill their contractual obligations to us could materially delay construction
of the remaining portion of our network and may cause us to breach our build-out
commitments to Sprint PCS.
Conflicts With Sprint PCS May Not Be Resolved In Our Favor Which Could
Restrict Our Ability To Manage Our Business And Provide Sprint PCS Products And
Services, Adversely Affect Our Relationships With Our Customers, Increase Our
Expenses And Decrease Our Revenues.
Under the Sprint PCS agreements, Sprint PCS has a substantial amount of
control over the conduct of our business. Conflicts between us may arise, and as
Sprint PCS owes us no duties except as set forth in the Sprint PCS agreements,
these conflicts may not be resolved in our favor. The conflicts and their
resolution may harm our business. For example:
o Sprint PCS could price its national plans based on its own objectives
and could set price levels that may not be economically sufficient for
our business;
o Sprint PCS could decide not to renew the Sprint PCS agreements on the
following renewal dates, which would not be in our best interest or
that of our stockholders:
45
o the Sprint PCS agreements for Horizon Personal Communications
will come up for renewal on June 8, 2018;
o the Sprint PCS agreements for Bright PCS will come up for renewal
on October 13, 2019;
o Sprint PCS could increase the prices we pay for our back office
services;
o Subject to limitations under the Sprint PCS agreements, Sprint PCS may
alter its network and technical requirements or request that we
build-out additional areas within our markets, which could result in
increased equipment and build-out costs or in Sprint PCS building out
that area itself or assigning it to another affiliate; and
o Sprint or Sprint PCS could make decisions which could adversely affect
the Sprint and Sprint PCS brand names, products or services.
We May Not Be Able To Compete With Larger, More Established Wireless
Providers Who Have Resources To Competitively Price Their Products And Services,
Which Could Impair Our Ability To Attract And Retain Customers.
Our ability to compete will depend in part on our ability to anticipate and
respond to various competitive factors affecting the telecommunications
industry, including new services that may be introduced, changes in consumer
preferences, demographic trends, economic conditions and discount pricing
strategies by competitors. In each market, we compete with two cellular
providers which have had their infrastructure in place and have been operational
for a number of years. They have significantly greater financial and technical
resources than we do, could offer attractive pricing options and may have a
wider variety of handset options. We expect that existing cellular providers
will continue to upgrade their systems and provide expanded, digital services to
compete with the Sprint PCS products and services that we offer. Many of these
wireless providers generally require their customers to enter into long-term
contracts, which may make it more difficult for us to attract customers away
from them. Sprint PCS generally does not require its customers to enter into
long-term contracts, which may make it easier for other wireless providers to
attract Sprint PCS customers away from Sprint PCS. We will also compete with
several PCS providers and other existing communications companies in our
markets, and expect to compete with new entrants as the FCC licenses additional
spectrum to mobile services providers. A number of our cellular, PCS and other
wireless competitors have access to more licensed spectrum than the amount
licensed to Sprint PCS in most of our territory and therefore will be able to
provide greater network call volume capacity than our network to the extent that
network usage begins to reach or exceed the capacity of our licensed spectrum.
Our inability to accommodate increases in call volume could result in more
dropped or disconnected calls. In addition, any competitive difficulties that
Sprint PCS may experience could also harm our competitive position and success.
For further information on the Sprint PCS licensed spectrum in our markets, see
"Business - Digital Wireless Communications Services - Markets."
There Is No Uniform Signal Transmission Technology And If We Decide To Use
Other Technologies In The Future, This Decision Could Substantially Increase Our
Equipment Expenditures To Replace The Technology Used On Our Network.
The wireless telecommunications industry is experiencing evolving industry
standards. We have employed code division multiple access, known as CDMA
technology, which is the digital wireless communications technology selected by
Sprint PCS for its network. CDMA is a relatively new technology and may not
provide the advantages expected by us and by Sprint PCS. In addition to CDMA,
there are two other principal signal transmission technologies, time division
multiple access, or TDMA, and global systems for mobile communications, or GSM.
These three signal transmission technologies are not compatible with each other.
If one of these technologies or another technology becomes the preferred
industry standard, we may be at a competitive disadvantage and competitive
pressures may require Sprint PCS to change its digital technology which, in
turn, may require us to make changes at substantially increased costs.
46
We May Not Receive As Much Sprint PCS Roaming Revenue As We Anticipate And
Our Non-Sprint PCS Roaming Revenue Is Likely To Be Low.
We are paid a fee from Sprint PCS or a Sprint PCS affiliate for every
minute that a Sprint PCS subscriber based outside of our territory uses our
network. Similarly, we pay a fee to Sprint PCS or a Sprint PCS affiliate for
every minute that our customers use the Sprint PCS network outside our
territory. Our customers may use the Sprint PCS network outside our territory
more frequently than we anticipate, and Sprint PCS subscribers based outside our
territory may use our network less frequently than we anticipate. The current
fee for each Sprint PCS roaming minute used is expected to be changed from $0.20
per minute to $0.15 per minute on June 1, 2001, $0.12 per minute on October 1,
2001, and to "a fair and reasonable return," expected to be approximately $0.10
per minute, in 2002, and for the remainder of the term of the PCS agreements.
This change has not yet been documented, and may not represent the final
arrangements. As a result, we may receive less Sprint PCS roaming revenue than
we anticipate or we may have to pay more Sprint PCS roaming fees than we
anticipate. Furthermore, we do not expect to receive substantial non-Sprint PCS
roaming revenue.
If Sprint PCS Customers Are Not Able To Roam Instantaneously Or Efficiently
Onto Other Wireless Networks, We May Suffer A Reduction In Our Revenues And
Number Of Customers.
The Sprint PCS network operates at a different frequency and uses or may
use a different signal transmission technology than many analog cellular and
other digital systems. To access another provider's analog cellular, TDMA or GSM
digital system when outside the territory served by the Sprint PCS network, a
Sprint PCS customer is required to utilize a dual-band/dual-mode handset
compatible with that provider's system. Generally, because dual-band/dual-mode
handsets incorporate two radios rather than one, they are more expensive, larger
and heavier than single-band/single-mode handsets. The Sprint PCS network does
not allow for call hand-off between the Sprint PCS network and another wireless
network, so a customer must end a call in progress on the Sprint PCS network and
initiate a new call when outside the territory served by the Sprint PCS network.
In addition, the quality of the service provided by a network provider during a
roaming call may not approximate the quality of the service provided by Sprint
PCS. The price of a roaming call may not be competitive with prices of other
wireless companies for roaming calls, and Sprint PCS customers may not be able
to use Sprint PCS advanced features, such as voicemail notification, while
roaming.
Parts Of Our Territories Have Limited Licensed Spectrum, And This May
Affect The Quality Of Our Service, Which Could Impair Our Ability To Attract Or
Retain Customers.
In the majority of our markets, Sprint PCS has licenses covering 20 or 30
MHz of spectrum. However, Sprint PCS has licenses covering only 10 MHz in parts
of our territory covering approximately 3.8 million residents out of a total
population of over 10.2 million residents, including our Fort Wayne and South
Bend, Indiana, markets. In the future, as our customers in those areas increase
in number, this limited licensed spectrum may not be able to accommodate
increases in call volume and may lead to increased dropped calls and may limit
our ability to offer enhanced services.
Non-Renewal Or Revocation By The FCC Of The Sprint PCS Licenses Would
Significantly Harm Our Business Because We Would No Longer Have The Right To
Offer Wireless Service Through Our Network.
We are dependent on Sprint PCS' licenses, which are subject to renewal and
revocation by the FCC. Sprint PCS' licenses in many of our territories will
expire as early as 2005 but may be renewed for additional ten year terms. There
may be opposition to renewal of Sprint PCS' licenses upon their expiration and
the Sprint PCS licenses may not be renewed. The FCC has adopted specific
standards to apply to PCS license renewals. For example, if Sprint PCS does not
demonstrate to the FCC that Sprint PCS has met the five-year construction
requirements for each of its PCS licenses, it can lose those licenses. Failure
to comply with these standards in our territory could cause revocation or
forfeiture of the Sprint PCS licenses for our territory or the imposition of
fines on Sprint PCS by the FCC.
47
The Loss Of Our Officers And Skilled Employees That We Depend Upon To
Operate Our Business Could Reduce Our Ability To Offer Sprint PCS Products And
Services.
The loss of one or more key officers could impair our ability to offer
Sprint PCS products and services. Our business is managed by a small number of
executive officers. We believe that our future success will also depend in large
part on our ability to attract and retain highly qualified technical and
management personnel. We believe that there is and will continue to be intense
competition for qualified personnel in the PCS equipment and services industry
as the PCS market continues to develop. We may not be successful in retaining
our key personnel or in attracting and retaining other highly qualified
technical and management personnel. We have not obtained life insurance covering
any of our officers.
We May Need More Capital Than We Currently Project To Complete The
Build-Out Of Our Network And A Delay Or Failure To Obtain Additional Capital
Could Adversely Affect Our Revenues.
The completion of our network build-out will require substantial capital.
Additional funds would be required in the event of:
o significant departures from our current business plan;
o unforeseen delays, cost overruns, unanticipated expenses; or
o regulatory, engineering design and other technological changes.
Due to our highly leveraged capital structure, additional financing may not
be available or, if available, may not be obtained on a timely basis and on
terms acceptable to us or within limitations permitted under our existing debt
covenants. Failure to obtain additional financing, should the need for it
develop, could result in the delay or abandonment of our development and
expansion plans, and we may be unable to fund our ongoing operations.
Unauthorized Use Of Our Network And Other Types Of Fraud Could Disrupt Our
Business And Increase Our Costs.
We will likely incur costs associated with the unauthorized use of our
network, including administrative and capital costs associated with detecting,
monitoring and reducing the incidence of fraud. Fraud impacts interconnection
costs, capacity costs, administrative costs, fraud prevention costs and payments
to other carriers for unbillable fraudulent roaming. Although we believe that we
have a plan in place to implement appropriate controls to minimize the effect to
us of fraudulent usage, we cannot assure you that we will be successful.
Expanding Our Territory May Have A Material Adverse Effect On Our Business
And Reduce The Market Value Of Our Common Stock.
As part of our business strategy, we may expand our territory through the
grant of additional markets from Sprint PCS or through acquisitions of other
Sprint PCS affiliates. We will evaluate strategic acquisitions and alliances
principally relating to our current operations. These transactions may require
the approval of Sprint PCS and commonly involve a number of risks, including:
o difficulty assimilating acquired operations and personnel;
o diversion of management attention;
o disruption of ongoing business;
o inability to retain key personnel;
48
o inability to successfully incorporate acquired assets and rights into
our service offerings;
o inability to maintain uniform standards, controls, procedures and
policies; and
o impairment of relationships with employees, customers or vendors.
Failure to overcome these risks or any other problems encountered in these
transactions could have a material adverse effect on our business. In connection
with these transactions, we may also issue additional equity securities, incur
additional debt or incur significant amortization expenses related to goodwill
and other intangible assets.
If The Sprint PCS Agreements Do Not Comply With FCC Requirements, Sprint
PCS May Terminate The Sprint PCS Agreements, Which Could Result In Our Inability
To Provide Service.
The FCC requires that licensees like Sprint PCS maintain control of their
licensed spectrum and not delegate control to third-party operators or managers
like us. Although the Sprint PCS agreements reflect an arrangement that the
parties believe meets the FCC requirements for licensee control of licensed
spectrum, we cannot assure you that the FCC will agree with us. If the FCC were
to determine that the Sprint PCS agreements need to be modified to increase the
level of licensee control, we have agreed with Sprint PCS to use our best
efforts to modify the Sprint PCS agreements to comply with applicable law. If we
cannot agree with Sprint PCS to modify the Sprint PCS agreements, they may be
terminated. If the Sprint PCS agreements are terminated, we would no longer be a
part of the Sprint PCS network and we would have extreme difficulty in
conducting our business.
The Sprint PCS Agreements And Our HPCS Certificate Of Incorporation Include
Provisions That May Discourage, Delay And Restrict Any Sale Of HPCS' Operating
Assets Or Common Stock To The Possible Detriment Of Horizon Telcom.
The Sprint PCS agreements restrict our ability to sell our operating assets
and common stock. Generally, Sprint PCS must approve a change of control of our
ownership and consent to any assignment of the Sprint PCS agreements. The Sprint
PCS agreements also give Sprint PCS a right of first refusal if we decide to
sell the operating assets of our Bright PCS markets to a third party. In
addition, provisions of our certificate of incorporation could also operate to
discourage, delay or make more difficult a change in control of our company. For
example, our HPCS certificate of incorporation provides for:
o two classes of common stock, with our class B common stock having ten
votes per share;
o the issuance of preferred stock without stockholder approval; and
o a classified board, with each board member serving a three-year term.
The restrictions in the Sprint PCS agreements and the provisions of our
HPCS certificate of incorporation could discourage any sale of HPCS' operating
assets or common stock. This could have a material adverse effect on the value
of Horizon Telcom common stock.
HPCS will Not Be Able To Receive The Tax Benefit Of Future Losses Until
HPCS Begins To Generate Taxable Income.
From our inception until September 2000, we were included in the
consolidated federal income tax return of Horizon Telcom. Under the tax-sharing
agreement with Horizon Telcom, Horizon Telcom filed a consolidated tax return
and paid HPCS an amount equal to the tax savings realized by Horizon Telcom as a
result of our taxable operating losses being used to offset consolidated taxable
income. As a result of the sale of convertible preferred stock in September
2000, we are no longer included in Horizon Telcom's consolidated tax return and,
as a result, will no longer be able to recognize any tax benefits from HPCS'
49
operating losses until HPCS starts to generate taxable income. In addition, as a
result of this change in our tax status, we recognized a tax liability of
approximately $7.6 million. This liability was paid by HPCS.
We May Experience A High Rate Of Customer Turnover Which Would Increase Our
Costs Of Operations And Reduce Our Revenue And Prospects For Growth.
Our strategy to minimize customer turnover, commonly known as churn, may
not be successful. Our average monthly churn for 2000 was less than 2.6%. As a
result of customer turnover, we lose the revenue attributable to these customers
and increase the costs of establishing and growing our customer base. The PCS
industry has experienced a higher rate of customer turnover as compared to
cellular industry averages. The rate of customer turnover is affected by the
following factors, several of which are not within our ability to address:
o extent of network coverage;
o reliability issues such as blocked calls, dropped calls and handset
problems;
o non-use of phones;
o change of employment;
o the decision not to require our customers to sign contracts, unlike
most cellular providers that do require contracts;
o a lack of affordability;
o price competition;
o customer care concerns; and
o other competitive factors.
A high rate of customer turnover could adversely affect our competitive
position, results of operations and our costs of, or losses incurred in,
obtaining new customers, especially because we subsidize some of the cost of
initial purchases of handsets by our customers.
Because The Wireless Industry Has Experienced Higher Customer Additions And
Handset Sales In The Fourth Calendar Quarter As Compared To The Other Three
Calendar Quarters, A Failure By Us To Acquire Significantly More Customers In
This Quarter Could Have A Disproportionate Negative Effect On Our Results Of
Operations.
The wireless industry is historically dependent on fourth calendar quarter
results. Our overall results of operations could be significantly reduced if we
have a worse than expected fourth calendar quarter for any reason, including the
following:
o our inability to match or beat pricing plans offered by competitors;
o our failure to adequately promote Sprint PCS' products, services and
pricing plans;
o our inability to obtain an adequate supply or selection of handsets;
o a downturn in the economy of some or all of the markets in our
territory; or
o a poor holiday shopping season.
50
Wireless Providers Offering Services Based On Lower Cost Structures Or
Alternative Technologies And Current Uncertainties In The Wireless Market May
Reduce Demand For PCS.
Other wireless providers enjoy economies of scale that can result in a
lower cost structure for providing wireless services. Rapid technological
changes and improvements in the telecommunications market could lower other
wireless providers' cost structures in the future. These factors could reduce
demand for PCS because of competitors' ability to provide wireless services at a
lower price. There is also uncertainty as to the extent of customer demand as
well as the extent to which airtime and monthly recurring charges may continue
to decline. As a result, our future prospects, those of our industry, and the
success of PCS and other competitive services, remain uncertain.
Technological advances and industry changes could cause the technology used
on our network to become obsolete. We may not be able to respond to these
changes and implement new technology on a timely basis, or at an acceptable
cost.
The wireless telecommunications industry is experiencing significant
technological change, as evidenced by the increasing pace of digital upgrades in
existing analog wireless systems, evolving industry standards, ongoing
improvements in the capacity and quality of digital technology, shorter
development cycles for new products and enhancements and changes in end-user
requirements and preferences.
If we are unable to keep pace with these technological changes or changes
in the telecommunications market based on the effects of consolidation from the
Telecom Act or from the uncertainty of future government regulation, the
technology used on our network or our current business strategy may become
obsolete. In addition, wireless carriers are seeking to implement a new "third
generation," or "3G," technology throughout the industry. To date, this
technology has not been deployed on a commercial basis. If wireless carriers
adopt the 3G technology, we could come under competitive pressure to convert our
network. In addition, if Sprint adopts the 3G technology, it could require us to
convert our network after a specified phase-in period. The implementation of the
3G technology for our network could create significant costs. There can be no
assurance that we can implement the new 3G technology successfully on a
cost-effective basis. See "Business -- CDMA Technology."
Regulation By Government Agencies May Increase Our Costs Of Providing
Service Or Require Us To Change Our Services, Which Could Impair Our Financial
Performance.
The licensing, construction, use, operation, sale and interconnection
arrangements of wireless telecommunications systems are regulated to varying
degrees by the FCC, the FAA, and, depending on the jurisdiction, state and local
regulatory agencies and legislative bodies. Adverse decisions regarding these
regulatory requirements could negatively impact our operations and our cost of
doing business.
Use Of Hand-Held Phones May Pose Health Risks, Which Could Result In The
Reduced Use Of Our Services Or Liability For Personal Injury Claims.
Media reports have suggested that radio frequency emissions from wireless
handsets may be linked to various health problems, including cancer, and may
interfere with various electronic medical devices, including hearing aids and
pacemakers. Concerns over radio frequency emissions may discourage use of
wireless handsets or expose us to potential litigation. Any resulting decrease
in demand for our services, or costs of litigation and damage awards, could
impair our ability to profitably operate our business.
51
ITEM 2. Financial Information
Selected Financial Data
The following table sets forth our selected historical consolidated
financial data. We derived the data as of and for the five years ended December
31, 2000, 1999, 1998, 1997 and 1996 from our audited consolidated financial
statements and related notes. This data should be read in conjunction with our
audited consolidated financial statements and related notes for the years ended
December 31, 2000, 1999 and 1998 included at Item 13 of this Form 10, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" below.
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Operating Revenues $ 71,512,472 $ 48,270,381 $ 41,169,845 $ 37,140,688 $ 38,081,788
Operating Income (Loss) (37,142,923) (4,504,463) 2,038,267 3,372,840 4,720,357
Net Income (Loss) (37,181,562) (4,481,098) (1,207,083) 1,853,184 9,356,782
Earnings (Loss) Per Share of
Common Stock (1) (107.39) (11.23) (3.03) 4.65 23.46 (2)
Cash Dividends on Common
Stock 1,793,038 1,815,014 1,815,014 1,815,014 1,815,014
Dividends Per Share On Common
Stock (1) 4.60 4.55 4.55 4.55 4.55
DECEMBER 31,
----------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Property, Plant and Equipment 170,960,204 111,297,730 112,026,207 85,048,600 67,222,082
Total Assets 466,065,379 101,713,365 106,102,379 107,433,495 79,244,261
Long Term Debt 205,283,104 45,557,965 53,180,442 26,711,248 20,315,618
Convertible Preferred Stock of
Subsidiary - book value 134,421,881 -- -- -- --
Total Access Lines 37,824 36,832 36,554 34,918 33,546
Total HPCS Subscribers 66,447 13,749 2,091 346 NA
Total bright.net Subscribers 17,239 14,544 11,760 7,022 NA
Capital Expenditures 101,491,729 17,799,773 15,984,218 39,794,525 9,295,251
- ----------------
(1) Earnings (loss) and dividends per share have been adjusted to reflect
the change in number of shares caused by the three-for-one stock split
in the form of a stock dividend.
(2) Includes $16.55 Gain on Sale of SmarTView.
52
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
This discussion reflects the operations of Horizon Telcom, Inc. and its
subsidiaries, The Chillicothe Telephone Company (CTC), Horizon PCS, Inc. (HPCS),
Horizon Services, Inc. (Services), and United Communications, Inc. (United).
This discussion and analysis should be read in conjunction with the consolidated
financial statements and the related notes.
Horizon Telcom operates primarily within two operating segments: landline
telephone services and personal communications services. See Note 3 of "Notes to
Consolidated Financial Statements" for additional financial information
regarding Horizon Telcom's operating segments.
At December 31, 2000, CTC serviced 37,824 access lines in Chillicothe, Ohio
and the surrounding area. United provided Internet service to 17,239 customers
through its bright.net Internet service.
At December 31, 2000, HPCS had launched service in 38 markets covering
approximately 4.9 million residents, or approximately 48% of the total
population in its territory, and had 66,447 customers. We expect to launch all
of our markets and be offering service to approximately 6.9 million residents,
or 68% of the total population in our territory, by the end of 2001, at which
time our planned network build-out will be substantially complete.
Sprint PCS has invested approximately $57.0 million to purchase the PCS
licenses in our territory and has incurred additional expenses for microwave
clearing. Under the Sprint PCS agreements, we manage our network on Sprint PCS'
licensed spectrum and have the right to use the Sprint and Sprint PCS brand
names.
HISTORY AND BACKGROUND
Horizon Telcom is a holding company which, in addition to its 92% (56.5% on
a fully diluted basis) ownership interest in Horizon PCS, owns 100% of CTC, a
local telephone company in service for 105 years. Horizon Telcom also owns 100%
of Horizon Services, which provides administrative services to Horizon PCS and
other Horizon Telcom affiliates, and 100% of United, a separate long distance
and Internet services business. Prior to providing PCS service, one of the HPCS
subsidiaries operated a DirecTV affiliate. We sold that business in 1996. We
also launched a successful Internet services business in 1995, which we
transferred from HPCS to United in April 2000.
Horizon Telcom is a facilities-based telecommunications carrier that
provides a variety of voice and data services to commercial, residential/small
business and local market segments. Horizon Telcom provides landline telephone
service, VDSL cable television service, and Internet access services to the
southern Ohio region, principally in and surrounding Chillicothe, Ohio. Horizon
Telcom also provides PCS operations to a twelve-state region in the Midwest,
including Ohio, Indiana, Virginia, and West Virginia, as an affiliate of Sprint
PCS.
CTC began operations in 1895 as The Home Telephone Company. In 1929 this
company changed its name to The Chillicothe Telephone Company. After a
reorganization in 1996, CTC became a wholly-owned subsidiary of us. CTC
continues to operate as an ILEC in a territory covering approximately 800 square
miles in Ross, Pickaway, Pike, Jackson, Hocking and Vinton Counties, Ohio. In
addition to local telephone service, CTC sells key systems and other telephone
equipment to businesses, offers Internet access through digital subscriber line
(DSL) technology and offers video digital subscriber line (VDSL) services to
residences as an alternative to cable television services.
53
The following are key milestones in HPCS' business:
o In November 1996, we acquired PCS licenses in the FCC's C Block
auction giving us the right to provide service to five markets in
Ohio, West Virginia and Kentucky with a total population of
approximately 1.0 million.
o In June 1998, we returned all of our FCC licenses except for a portion
of the license covering our Chillicothe, Ohio market, and agreed to
become one of five charter Sprint PCS affiliates. Our initial grant of
markets from Sprint PCS consisted of seven markets in Ohio, West
Virginia and Kentucky with a total population of approximately 1.6
million. This grant included the five markets for which we originally
held licenses. We continued to use Horizon Personal Communications as
the primary brand for marketing our PCS service.
o In August 1999, Sprint PCS granted us 17 additional markets in
Virginia, West Virginia, Tennessee, Maryland, Kentucky and Ohio with a
total population of approximately 3.3 million. In conjunction with
this second grant, we also entered into a network services agreement
with the West Virginia PCS Alliance and Virginia PCS Alliance, which
we refer to as the Alliances. The Alliances are two related
independent PCS providers offering services under the NTELOS brand,
and whose network is managed by CFW Communications. Under this
agreement, we obtained the right to use their wireless network to
provide Sprint PCS services to our customers in most of these new
markets.
o In September 1999, Horizon Telcom, sold its interest in the towers it
owned to SBA for $15.7 million and invested the net proceeds in HPCS.
Prior to the sale, HPCS had been leasing the towers from Horizon
Telcom. HPCS now leases those towers from SBA. HPCS also has a
build-to-suit agreement with SBA for the construction of new towers as
part of the network build-out. HPCS receives site development fees and
reduced lease rates for specified towers constructed by SBA and leased
by HPCS as an anchor tenant of SBA.
o In September 1999, an HPCS subsidiary became one of the founders of
Bright PCS, receiving a 26% equity stake in exchange for approximately
$3.1 million. Bright PCS became the exclusive Sprint PCS affiliate for
13 markets in Indiana, Ohio and Michigan, with a total population of
approximately 2.4 million. We launched service in substantially all of
the Bright PCS markets in October 2000.
o In December 1999, we completed a two-month transition from a
co-branded marketing strategy to marketing and selling all of our
products and services exclusively under the "Sprint PCS" brand name,
which gave us full access to Sprint PCS' major national retailers.
Since that transition, we have experienced an accelerated growth in
our customer base.
o In May 2000, Sprint PCS granted us an additional 17 markets in
Pennsylvania, New York, Ohio and New Jersey with a total population of
approximately 2.9 million. In September 2000, we substantially
completed the purchase from Sprint PCS of the assets related to our
new markets.
o In June 2000, we acquired the remaining 74% of Bright PCS equity that
we did not already own. As consideration, we exchanged 4.7 million
shares of HPCS' class B common stock equal to 8% of its outstanding
shares of all classes of its common stock prior to this offering, and
31,912 shares of Horizon Telcom common stock equal to 8% of the
outstanding shares of Horizon Telcom, which HPCS acquired in February
2000.
o On September 26, 2000, an investor group led by Apollo Management
purchased $126.5 million of HPCS convertible preferred stock in a
private placement. Concurrently, holders of HPCS' $14.1 million
short-term convertible note (including accrued interest of $1.1
million) converted it into the same convertible preferred stock
purchased by the investor group. Concurrently, HPCS received $149.7
million from the issuance of $295.0 million of senior discount notes
due 2010 and $50.0 million of term loans from its $225.0 million
senior secured credit facility (later increased to a $250.0 million
facility).
54
RESULTS OF OPERATIONS
The landline telephone services operating segment consists of basic local
and long-distance service and network access services.
Basic local exchange and intralata long-distance service revenue consists
of flat rate services and measured services billed to customers utilizing CTC's
telephone network. Long distance interlata/interstate revenue consists of
message services that terminate beyond the basic service area of the originating
wire center.
Network access revenue consists of revenue derived from the provision of
exchange access services to an interexchange carrier or to an end user beyond
the exchange carrier's network.
The personal communications service operating segment consists primarily of
PCS subscriber revenues, Sprint PCS roaming revenues, non-Sprint PCS roaming
revenues and PCS equipment sales. PCS subscriber revenues consist primarily of
monthly service fees and other charges billed to our customers for Sprint PCS
service in our territory under a variety of service plans. Roaming revenues
consist of Sprint PCS roaming and travel and non-Sprint PCS roaming and travel.
We receive Sprint PCS roaming revenues at a per minute rate from Sprint PCS or
another Sprint PCS affiliate when Sprint PCS subscribers based outside of our
territory use our portion of the Sprint PCS network. Non-Sprint PCS roaming
revenues include payments from wireless service providers, other than Sprint
PCS, when those providers' subscribers roam on our network.
We record 100% of PCS subscriber revenues from our customers, Sprint PCS
roaming revenues from Sprint PCS subscribers based outside our markets and
non-Sprint PCS roaming revenues. Sprint PCS retains 8% of all collected service
revenue as a management fee. Collected service revenues include PCS subscriber
revenues and non-Sprint PCS roaming revenues, but exclude Sprint PCS roaming
revenues and revenues from sales of equipment. We report the amounts retained by
Sprint PCS as selling, general and administrative expenses.
PCS equipment sales consist of digital handsets and accessories sold to our
customers. Certain of our equipment sales are made through independent
distributors under agreements allowing rights of return on merchandise unsold by
the distributors. We defer recognition of such sales until the merchandise is
sold by the distributors.
Other revenues include Internet access services, equipment systems sales,
information services and paging services.
Internet access revenues for our bright.net services are monthly service
fees and other charges billed to our bright.net customers. Service fees
primarily consist of monthly recurring charges billed to customers.
Equipment system sales, information services, paging and other revenues
consist of sales made by CTC to various businesses or other residential
customers for equipment used on the telephone system. Each year a telephone
directory is published which provides a source of revenue from yellow page
advertising. Revenue also consists of operator services, local directory
assistance, and paging services, the latter provided by United until its
divestiture of that business in December, 2000.
55
The following table sets forth a breakdown of operating revenues by
segment.
YEARS ENDED DECEMBER 31,
(Dollars in thousands, except PCS ARPU)
2000 1999 1998
--------------------- ---------------------- ---------------------
AMOUNT % AMOUNT % AMOUNT %
-------------- ------ --------------- ------ ------------- -------
Landline telephone services $ 34,061 48% $ 33,947 70% $ 32,075 78%
Personal communication equipment and
services 27,764 39% 4,516 9% 765 2%
Other revenues 9,687 13% 9,807 21% 8,330 20%
-------------- -------------- -------------
Total revenues $ 71,512 $ 48,270 $ 41,170
============== ============== =============
PCS ARPU (including roaming) (1) $ 75 $ 64 $ 46
PCS ARPU (excluding roaming) (1) 51 55 44
- ---------------
(1) ARPU, average revenue per unit, is an industry term that measures total
PCS service revenues per month from our subscribers divided by the
average number of digital subscriber units for that month. ARPU,
including roaming, is ARPU with Sprint PCS roaming and travel and
non-Sprint PCS roaming and travel. ARPU excluding roaming excludes
Sprint PCS roaming and travel and non-Sprint PCS roaming and travel.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Operating Revenues
Landline Telephone Services
Basic local and long-distance service revenue increased from $16.4 million
in 1999 to $16.8 million in 2000, an increase of $0.4 million or 2%. This
increase was primarily driven by the increase in the number of access lines,
from 36,832 at December 31, 1999 to 37,824 at December 31, 2000, as well as
increased enhanced services.
Network access revenues were essentially flat to the comparable prior year
period, decreasing from $17.5 million in 1999 to $17.3 million in 2000, a $0.2
million decrease or 1%. This decrease is attributable to a decrease in access
rates.
Personal Communication Equipment and Services
PCS service revenues for the year ended December 31, 2000 were $24.7
million, compared to $3.9 million for the year ended December 31, 1999, an
increase of $20.8 million. The growth in revenues is the result of the growth in
our customer base as well as an increase in travel and roaming revenue.
Subscriber revenues increased $13.0 million for the year ended 2000. We had
66,447 customers at December 31, 2000, compared to 13,749 at December 31, 1999.
We believe our customer base has grown because we have launched additional
markets, increased our sales force and are now marketing under the Sprint PCS
brand rather than our own.
Travel and roaming revenues increased $7.8 million in 2000 compared to
1999. This increase primarily resulted from the launch of portions of our
network covering two heavily traveled interstate highways in western Virginia in
the fourth quarter of 1999, as well as our launch of our northwest Ohio and
northern Indiana markets in the fourth quarter of 2000. We expect continued
increases in Sprint PCS roaming revenues attributable to volume as we complete
the remainder of our network build-out, including completing other portions of
our network covering additional heavily traveled highways. These volume-based
increases in roaming revenues may be offset in large measure over the next two
years by the expected reduction in the per minute Sprint PCS roaming rate.
56
PCS ARPU excluding roaming and travel decreased from the year ended
December 31, 1999 to the year ended December 31, 2000 primarily as a result of
the change in the mix of the packages our subscribers have selected. Our
subscribers have selected packages with lower monthly recurring charges made
available to our subscribers as a result of our seasonal promotions. The
decrease caused by the change in the mix of packages was partially offset by the
increase in the charges to our subscribers for minute sensitive usage (long
distance and overage) and the growth in our Sprint PCS roaming revenues. PCS
ARPU including roaming and travel increased in the year ended December 31, 1999
as compared to the same period in 2000, as a result of the increase in travel
revenue from customers other than our own on our network. We expect PCS ARPU
including roaming to decrease due to the expected reduction in the Sprint PCS
roaming rate.
PCS equipment revenues consist of handsets and accessories sold to
customers. Equipment revenues for the year ended December 31, 2000 were $3.0
million, compared to $600,000 for the year ended December 31, 1999, an increase
of $2.4 million. The increase in equipment revenues is the result of our
increase in customers.
Other Revenues
Internet access services increased from $3.1 million in 1999 to $3.4
million in 2000, an increase of $0.3 million or 9%. The number of bright.net
customers increased by 2,695, from 14,544 at December 31, 1999 to 17,239 at
December 31, 2000, accounting for the increase in revenue.
Other revenue decreased from 1999 to 2000 from $6.7 million to $6.3
million, a $0.4 million decrease or 6%. CTC business system sales decreased
approximately $0.3 million due to four large account sales in 1999 that did not
recur in 2000. In addition, CTC's maintenance contract revenue decreased by
approximately $0.1 million during 2000. Management expects the sale of its
paging business to have a minimal impact on revenues and earnings.
Operating Expenses
Cost of goods sold. Cost of goods sold primarily includes the costs of
handsets and accessories sold to customers. Cost of goods sold also includes, to
a lesser extent, the cost of business system sales incurred by CTC. Cost of
goods sold for the year ended December 31, 2000 was $10.5 million, compared to
$3.5 million for the year ended December 31, 1999, an increase of $7.0 million.
The increase in the cost of goods sold is the result of the growth in our
wireless customers (13,749 customers at December 31, 1999 compared to 66,447 at
December 31, 2000), partially offset by the decreasing unit cost of the
handsets. For competitive and marketing reasons, we have sold handsets to our
customers below our cost and expect to continue to sell handsets at a price
below our cost for the foreseeable future.
CTC experienced reduced revenue for business system sales, resulting in a
lower cost of goods sold. This resulted in a reduction to 2000 cost of goods
sold of $0.3 million. The increase in PCS handset cost of goods sold accounted
for $7.3 million of the total cost of goods sold increase. This was partially
offset by the reduction in cost of goods sold for the CTC business system sales.
Cost of services. Cost of services for CTC and United includes the support,
switching, access, and circuitry expenses utilized for maintaining telephone
service. Cost of services also includes expenses related to the startup and
installation of CTC's VDSL television service and United's computer solutions
consulting business. Cost of services for HPCS includes site rent, utilities,
maintenance, engineering and network personnel, interconnection expenses, Sprint
PCS roaming fees, non-Sprint roaming fees, and other expenses related to
operations. HPCS pays Sprint PCS roaming fees to Sprint PCS when HPCS' customers
use Sprint PCS' network outside of our territory. HPCS pays non-Sprint PCS
roaming fees to other wireless service providers when our customers use their
networks. Also included in cost of services are costs incurred under HPCS'
network services agreement with the Alliances. HPCS pays the Alliances a per
minute use charge whenever our customers or Sprint PCS subscribers use their
network.
Under HPCS' build-to-suit agreement with SBA, HPCS receives site
development fees for towers SBA constructs and leases to HPCS. Each site
development fee received is recorded as a deferred credit and is amortized over
57
the term of the lease, thereby effectively reducing our tower lease expense.
During 2000, HPCS recorded $320,000 as a reduction to lease expense. As of
December 31, 2000, HPCS has received but not recognized site development fees
totaling $6.9 million.
Cost of services for the year ended December 31, 2000 was $35.3 million,
compared to $15.1 million for the year ended December 31, 1999, an increase of
$20.2 million. CTC and United cost of services increased $3.6 million from the
year ended December 31, 1999 to the year ended December 31, 2000. This increase
was a result of increased telephone and network costs of $0.7 million,
additional expenses at United related to startup services for its consulting
business, including Web design, of $0.6 million, VDSL expenses of $0.8 million
resulting from the installation and startup of the VDSL product, $0.5 million
from increased access line fees for bright.net Internet service, and other
miscellaneous expenses, including operator service fees, maintenance and labor,
regular telephone installation, and other expenses, which increased in aggregate
by $1.0 million for the year ended 2000.
HPCS' increase ($16.6 million) in cost of services reflects the increase in
roaming fees of $5.8 million, an increase in costs incurred under our network
services agreement with the Alliances of $6.7 million, $1.5 million of
additional costs for rent expense for the additional towers leased and $2.6
million of network operational and payroll expenses. Cost of services for HPCS
has declined as a percentage of revenues, and we believe that these costs will
continue to decline as a percentage of revenues.
Selling, general and administrative expenses. Selling, general and
administrative expenses consist of sales and marketing expenses and general and
administrative costs. Sales and marketing expenses relate to salaries and
commissions paid to our sales representatives and sales support personnel,
commissions paid to national and local third party distribution channels,
operating costs associated with our retail stores, costs associated with
distribution channels, handset subsidies on units sold by third parties for
which we do not record revenue, and marketing and advertising programs. General
and administrative costs relate to corporate personnel, including executives and
customer care. The 8% of collected service revenues retained by Sprint PCS is
included in selling, general and administrative costs.
In May 2000, HPCS agreed to begin purchasing certain back office services,
including customer activation, billing and customer care, directly from Sprint
PCS. Previously, we provided these services ourselves. We will purchase these
services from Sprint PCS at rates which reflect Sprint PCS' economies of scale.
We expect that the total cost of these services will be at or below the total
cost of providing the services ourselves due to anticipated rate reductions and
Sprint PCS' ability to economically manage the support of new services. We also
believe this arrangement will allow us to more quickly roll out new Sprint PCS
products and services in our markets. During the third quarter of 2000, we
launched new markets using Sprint PCS back office services. We also began to
transition our existing customers to Sprint PCS' back office services in the
third quarter of 2000. The transition to Sprint PCS' back office services should
be completed by the end of 2001. At December 31, 2000, more than half of our
customers were serviced via Sprint PCS back office services.
Selling, general and administrative expenses rose to $49.0 million for the
year ended December 31, 2000, compared to $24.6 million for the same period in
1999, an increase of $24.4 million. CTC and United incurred a decrease in
selling, general and administrative expenses of $0.3 million for the year ended
December 31, 2000 compared to the same period in the prior year. This decrease
was a result of less consulting fees in 2000 versus 1999, as well as lower
allocations of Horizon Services expenses to CTC.
HPCS' increase was $24.7 million, while the decrease at CTC and United was
$0.3 million. The HPCS increase reflects the 8% fee paid to Sprint PCS on our
increased collected service revenues (an increase of $1.2 million), the costs of
servicing an increased coverage area including 16 storefronts at December 31,
2000 compared to 3 at December 31, 1999 and the related marketing of the
increased service area (increase of $7.6 million), additional customer support
personnel and associated activities (an increase of $1.8 million), commissions
paid to national and local third party distribution channels (an increase of
$2.8 million), increased subsidy paid to third party vendors for handsets sold
(an increase of $4.0 million) increased headcount and professional services at
Horizon Services needed to support our growth (an increase of $3.6 million), the
increase in building and maintenance expenses ($1.4 million), the increase in
consulting, legal and bank fees ($900,000), Sprint PCS support charges
58
($900,000), and an increase in management payroll and benefits at Horizon Telcom
needed to support our growth (increase of $500,000). We expect selling, general
and administrative expenses to increase in the aggregate as we expand our
coverage and add customers, but to decrease as a percentage of revenues.
Non-cash compensation expense. For the years ended December 31, 2000 and
1999, we recorded stock-based compensation expense of $852,718 and $2,671,
respectively, for certain stock options granted in November 1999. Stock-based
compensation expense will continue to be recognized through the conclusion of
the vesting period for these options in 2005. The annual non-cash compensation
expense expected to be recognized is approximately $441,000 in 2001, $413,000 in
2002, $389,000 in 2003, $193,000 in 2004, and $71,000 in 2005.
Depreciation and amortization expense. Depreciation and amortization
expenses increased by $3.5 million to a total of $13.1 million in 2000. The
increase reflects the continuing construction of our PCS network as well as
capital additions for VDSL and other telephone services. Because our acquisition
of Bright PCS was accounted for as a purchase transaction, amortization will
increase as a result of amortizing the intangible assets. Our sale of towers to
SBA reduced the amount of depreciation expense, but that decrease is more than
offset by the overall increase in our depreciable assets.
At September 30, 2000, HPCS recorded an intangible asset of $13.4 million
for the value of warrants we agreed to grant to Sprint. These warrants will be
amortized over the remaining term of the Sprint PCS management agreement,
resulting in $752,000 of amortization expense per year. Amortization expense for
the year ended December 31, 2000 was approximately $188,000.
Gain on exchange of stock. HPCS transferred 40% of its Horizon Telcom stock
to the former members of Bright PCS as part of the consideration for the
acquisition of Bright PCS. This transaction resulted in a gain of $10.5 million.
In addition, in September 2000, 10% of the 12% of the stock of Horizon Telcom
was distributed to the shareholders in the form of a dividend. To the extent
that the dividend was paid to shareholders other than Horizon Telcom, a non-cash
gain of $1.0 million was recognized.
Subsidiaries preferred stock dividend. HPCS convertible preferred stock
pays a stock dividend at the rate of 7.5% per annum, payable semi-annually
commencing April 30. For the year ended December 31, 2000, we recorded the
accrual of a stock dividend payable in additional stock of $2.8 million. If HPCS
completes an initial public offering or an approved merger transaction by April
30, 2001, a portion of the stock dividend will be cancelled.
Minority interest in loss. As part of the acquisition of Bright Personal
Communication Services, LLC (BPCS), the former members of BPCS have a 7.974%
ownership in HPCS, excluding the impact of the possible conversion of
convertible preferred stock and exercise of options and warrants. Horizon Telcom
accounts for this ownership by recording the portion of net income (loss)
attributable to the minority shareholders as minority interest in earnings
(loss) in the accompanying consolidated statement of operations. For the year
ended December 31, 2000, approximately $2.3 million of the net loss for the year
was allocated to for the minority interest. As of December 31, 2000, the
minority interest in HPCS was approximately $0.9 million. Horizon Telcom will
continue to allocate a portion of net losses to minority interest until minority
interest is reduced to zero. There would be no further allocations to minority
interests until such time as HPCS becomes profitable and any unallocated losses
to minority interests are offset with income in future periods.
Interest income and other, net. Interest income and other in 2000 was $4.7
million and consisted primarily of interest income of approximately $4.2 million
and other miscellaneous income of approximately $500,000. Interest income was
generated from cash proceeds from HPCS' private equity sales, senior
subordinated discount notes and drawings under the senior secured credit
facility, all completed on September 26, 2000. The proceeds were invested in
short-term accounts waiting to be deployed. As capital expenditures are made to
complete the build-out of our network, decreasing cash balances may result in
lower daily interest income in the future.
Interest expense, net. Aggregate interest expense for the year ended
December 31, 2000 was $12.2 million, compared to $3.6 million in 1999, and
consisted of interest on debt. The increase in interest expense is the result of
our additional debt outstanding during the year ended December 31, 2000 compared
to the same period in 1999.
59
CTC's line of credit resulted in additional interest expense of $0.1
million in 2000. CTC's line of credit accrues interest on the outstanding
balance at a fluctuating rate tied to the LIBOR rate (8.3% as of December 31,
2000) and is due and payable monthly. The outstanding balance at December 31,
2000 was $12.8 million. We expect our interest expense to increase in the future
as we borrow under our senior credit facility to fund our network build out and
operating losses.
HPCS incurred approximately $2.0 million from the senior secured credit
facility entered into in September, 2000. Interest on the HPCS senior credit
facility accrues at LIBOR plus a specified margin (approximately 10.6% at
December 31, 2000). HPCS accrues interest at a rate of 14% per annum on our
senior subordinated discount notes through October 1, 2005 and will pay interest
semi-annually in cash thereafter. Non-cash interest expense also included the
amortized amount of deferred financing fees related to the HPCS senior secured
credit facility, the HPCS senior subordinated discount notes, and the accretion
of HPCS warrants related to the HPCS senior subordinated discount notes. Total
non-cash interest expense for the year ended December 31, 2000 was $6.5 million
compared to $4,700 for the same period in 1999. In addition, the $13.0 million
short-term convertible note issued to obtain funds used to purchase common stock
of Horizon Telcom resulted in an increase in interest expense of $1.1 million.
This convertible note was converted into HPCS preferred stock in September 2000.
Income tax (expense) benefit. We recorded an income tax expense from
continuing operations of $3.2 million for the year. This expense was primarily a
result of the recognition by us of an excess loss account on the deconsolidation
of HPCS from the Horizon Telcom affiliated group, reduced by the benefit of the
carryback net operating losses and an increase in the valuation allowance. A
valuation allowance of $2.6 million was recorded in 2000 to the extent that
HPCS' deferred tax assets exceeded its deferred tax liabilities at December 31,
2000.
We generated a tax of $4.3 million on a stock dividend of 10% of Horizon
Telcom stock held by HPCS to Horizon Telcom. The tax on the stock dividend was
charged directly to equity and not recorded as an income tax expense.
Until September 26, 2000 HPCS was included in the consolidated federal
income tax return of Horizon Telcom. HPCS provided for federal income taxes on a
pro-rata basis, consistent with a consolidated tax-sharing agreement. As a
result of the sale of the convertible preferred stock on September 26, 2000,
HPCS will not be able to participate in the tax sharing agreement nor will
Horizon Telcom be able to recognize any net operating loss benefits from HPCS.
Loss before extraordinary items. Our loss before extraordinary items for
the year ended December 31, 2000 was $36.7 million compared to $4.5 million for
the year ended December 31, 1999. The increase in our loss reflects the
continued expenses related to launching HPCS' markets and building our customer
base partially offset by the $11.6 million gain on exchange of stock.
Extraordinary loss. As a result of the September 26, 2000 financings
described earlier, we retired long term debt payable to financial institutions.
As a result of this debt extinguishment, we expensed the unamortized portion of
the related financing costs as well as fees associated with the debt
extinguishments. These fees and expenses amounted to $748,000 and are shown on
the statement of operations net of a tax benefit of $262,000.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Operating Revenues
Basic local and long-distance service revenue was essentially flat at $16.4
million in 1999 and 1998. The number of access lines remained steady, from
36,554 at December 31, 1998 to 36,832 at December 31, 1999.
Network access revenues increased from $15.6 million in 1998 to $17.5
million in 1999, an increase of $1.9 million or 12%. This increase was primarily
attributable to increased long distance usage, which results in increased
revenue from interexchange carriers for using CTC's network. In addition,
increased local telephone network costs incurred by CTC resulted in increased
support revenues from the Universal Service Fund.
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Internet access services increased from $2.1 million in 1998 to $3.1
million in 1999, an increase of $1.0 million or 48%. The number of bright.net
customers increased by 2,784, from 11,760 at December 31, 1998 to 14,544 at
December 31, 1999, accounting for the increase in revenue. In addition, in 1998,
service discounts were offered as enticements to add subscribers, resulting in
lower revenue in 1998.
Other revenue increased from 1998 to 1999 from $6.3 million to $6.7
million, a $0.4 million increase or 6%. CTC business system sales increased
approximately $0.4 million due to four large account sales in 1999 that did not
occur in 1998.
PCS service revenues for the year ended December 31, 1999 were $3.9 million
compared to $456,000 for the year ended December 31, 1998, an increase of $3.5
million. The growth in revenues is the result of the growth in our customer base
as well as an increase in travel and roaming revenue. We had 13,749 customers at
December 31, 1999, compared to 2,091 at December 31, 1998, resulting in an
increase in revenue of $2.8 million. We have experienced increased growth in our
customer base at the end of 1999 as a result of full branding with Sprint PCS in
October 1999 and as a result of utilization of Sprint PCS' national third-party
distribution channels. Roaming revenues increased $624,000 in 1999 compared to
1998. This was the first year we recognized significant roaming revenue. This
increase primarily resulted from the launch of portions of our network covering
two heavily traveled interstate highways in western Virginia.
PCS ARPU also increased from the year ended December 31, 1998 to the year
ended December 31, 1999. In 1998 we had substantial promotions for our
subscribers, which were phased out in 1999. In addition, in 1999 we experienced
a significant growth in the charges to our customers for minute sensitive usage
(long distance and overage).
PCS equipment revenues for the year ended December 31, 1999 were $600,000
compared to $309,000 for the year ended December 31, 1998, an increase of
$291,000. The increase in equipment revenues is the result of our increase in
customers.
Operating Expenses
Cost of goods sold. Cost of goods sold primarily includes the costs of
handsets and accessories sold to customers. Cost of goods sold also includes, to
a lesser extent, the cost of business system sales incurred by CTC. Cost of
goods sold for the year ended December 31, 1999 was $3.5 million compared to
$1.7 million for the year ended December 31, 1998, an increase of $1.8 million.
The increase in the cost of goods sold is primarily the result of the growth in
our customer base at HPCS, accounting for $1.4 million of the increase. For
competitive and marketing reasons, we have sold handsets to our customers below
our cost and expect to continue to sell handsets at a price below our cost for
the foreseeable future. The remaining $0.4 million increase in cost of goods
sold is a result of the increased equipment system sales at CTC.
Cost of services. Cost of services for the year ended December 31, 1999 was
$15.1 million, compared to $11.4 million for the year ended December 31, 1998,
an increase of $3.7 million. HPCS' increase ($3.1 million) reflects the increase
in network costs to service the growing customer base. CTC and United's cost of
services increased $0.6 million from the year ended December 31, 1998 to the
year ended December 31, 1999. This increase was a result of increased telephone
and network costs to service the telephone customers as well as increased access
line fees for the growing number of bright.net Internet service customers.
Selling, general and administrative expenses. Selling, general and
administrative expenses rose to $24.6 million for the year ended December 31,
1999, compared to $18.0 million for the same period in 1998, an increase of $6.6
million. CTC and United incurred an increase of $2.1 million for the year ended
December 31, 1999 compared to the same period in the prior year. This increase
was a result of additional marketing expenses, increased customer service
representatives, additional computer related expenses and information technology
consulting .
HPCS' increase reflects the 8% fee paid to Sprint PCS on our increased
collected service revenues (an increase of $130,000), the costs of additional
sales and marketing personnel and associated activities (an increase of $1.7
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million), additional customer support personnel (an increase of $602,000) and
increased headcount and professional services at Horizon Services needed to
support our growth (an increase of $536,000).
Non-cash compensation expense. For the year ended December 31, 1999, we
recorded stock-based compensation expense of $2,671 associated with certain
stock options granted in November 1999.
Depreciation and amortization. Depreciation and amortization increased by
$1.6 million to a total of $9.6 million for the year ended December 31, 1999.
The increase reflects the continuing construction of our PCS network and
increased capital expenditures related to the telephone network infrastructure.
Gain on sale of PCS assets. During 1999, in connection with entering the
network services agreement with the Alliances, we sold certain PCS ancillary and
base station equipment to the Alliances. The sale resulted in a gain of
approximately $1.4 million, representing the excess of cash proceeds over the
historical net book value of the assets sold.
Interest income and other, net. Interest income and other for the years
ended December 31, 1999 and 1998 of $75,000 and $30,000, respectively, consists
primarily of interest income.
Interest expense, net. Interest expense for the year ended December 31,
1999 was $3.6 million compared to $2.4 million for the year ended December 31,
1998, and consisted of interest on debt in excess of the amount capitalized for
the purpose of the network build-out. The increase in interest expense is the
result of increased borrowings on the RTFC financing to finance the build out of
our network.
Income tax benefit. For the year ended December 31, 1999, we recorded an
income tax benefit of $2.2 million. A valuation allowance of $238,000 was
recorded in 1999 for the amount of the deferred tax assets that exceeded the
deferred tax liabilities at December 31, 1999.
Loss before extraordinary items. Our loss before extraordinary items for
the year ended December 31, 1999 was $4.5 million compared to $1.2 million for
the year ended December 31, 1998. The increase in our loss reflects the
continued expenses relative to launching our PCS markets and building our PCS
customer base.
LIQUIDITY AND CAPITAL RESOURCES
Overview
In 1996, Horizon Telcom was formed as part of a reorganization of CTC and
several of its affiliates. Since that time, Horizon Telcom has met its needs for
capital primarily by borrowing, by selling selected businesses and assets, and
by funds generated from operations. In 2000, Horizon Telcom also formed HPCS, to
which it transferred its subsidiary Horizon Personal Communications. In June
2000, HPCS acquired the remaining 74% of Bright PCS. HPCS also entered into
several major financing transactions in September 2000.
The net cash used in operating activities of $480,000 for the year ended
December 31, 2000 was the result of Horizon Telcom's $37.2 million net loss
being offset by increases in accounts payable of $10.5 million, increases in
accrued liabilities of $22.1 million and an increase in deferred income of $6.9
million.
Net cash used in investing activities was $96.8 million for the year ended
December 31, 2000. Our capital expenditures were $17.8 million in 1999 and
$101.5 million in 2000. This reflects the continuing build out of our PCS
network as well as the deployment of capital necessary to offer VDSL service.
Other investing activities were related to the cash acquired in the acquisition
of Bright PCS of $4.9 million.
Net cash provided by financing activities for the year ended December 31,
2000 was $285.5 million consisting primarily of borrowings under senior discount
notes of HPCS ($149.7 million), HPCS' senior secured credit facility ($50.0
million), the sale of HPCS convertible preferred stock ($126.5 million), less
related fees, and borrowings of $12.8 million under CTC's line of credit. During
the year ended December 31, 2000, HPCS borrowed $13.0 million in the form of a
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short-term convertible note to purchase 19.78% of the outstanding capital stock
of Horizon Telcom. The $13.0 million short-term convertible note, including
accrued interest, was converted into shares of HPCS preferred stock on September
26, 2000. Horizon Telcom paid $1.8 million in dividends during 2000.
During 2000, CTC entered into an agreement with a bank for a line-of-credit
that provides maximum borrowings of $15.0 million, payable on demand. The line
was extended in March 2001 to provide for maximum borrowings of $30.0 million.
On September 26, 2000, an investor group purchased $126.5 million of HPCS'
convertible preferred stock in a private placement. Concurrent with the closing,
holders of HPCS' $14.1 million short-term convertible note (including accrued
interest of $1.1 million) converted it into the same convertible preferred stock
purchased by the investor group. On September 26, 2000, HPCS received $149.7
million from the issuance of $295 million of Senior Discount Notes due 2010.
Also on September 26, 2000, HPCS received $50.0 million as part of a $225.0
million senior secured credit facility. The amount of the senior secured credit
facility was increased to $250.0 million in November, 2000.
For 2001, we anticipate our funding needs will be approximately $195.0
million, of which $138.0 million will be used for capital expenditures, and the
remainder will be used to fund working capital and operating losses. The terms
of their respective credit agreements prohibit or severely restrict the ability
of CTC and HPCS to provide funds to their affiliates in the event the affiliate
experiences a shortfall. However, we anticipate that our cash and borrowings
under existing financing agreements will be adequate to fund our capital
expenditures, anticipated operating losses and working capital requirements over
the next twelve months. The actual funds required to build-out the network and
to fund operating losses, working capital needs and other capital needs may vary
materially from our estimates and additional funds may be required because of an
expansion of our territory, unforeseen delays, cost overruns, unanticipated
expenses, regulatory changes, engineering design changes and required
technological upgrades and other technological risks. If we are unable to obtain
any necessary additional funding and we are unable to complete our network
build-out, this may result in a termination of HPCS' Sprint PCS agreement. We
will no longer be able to offer Sprint PCS products and services. Additionally,
Sprint PCS may purchase HPCS' operating assets or capital stock for 72% of the
entire business value.
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging
Activities, as amended in June 2000 by Statement of Financial Accounting
Standards No. 138 (SFAS 138), Accounting for Certain Derivative Instruments and
Certain Hedging Activities, which requires companies to recognize all
derivatives as either assets or liabilities in the balance sheet and measure
such instruments at fair value. As amended by Statement of Financial Accounting
Standards No. 137 (SFAS 137), Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133, the
provisions of SFAS 133 required adoption to all fiscal quarters of all fiscal
years beginning after June 15, 2000. The adoption did not have a material effect
on Horizon Telcom's consolidated results of operations, financial position, or
cash flows.
On December 3, 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB
101"), "Revenue Recognition in Financial Statements" which required adoption
during the first quarter of fiscal 2000. The adoption did not have a material
effect on Horizon Telcom's consolidated results of operations.
FORWARD-LOOKING STATEMENTS
The foregoing discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ significantly and
materially from the results anticipated in these forward-looking statements.
Risks and uncertainties that may affect our business include the risk that (i)
we may not be able to compete effectively; (ii) we may not be able to
63
successfully integrate new technologies or respond effectively to customer
requirements; (iii) system failure could cause delays or interruptions in
service; (iv) our back office and customer care systems may be unable to meet
the needs of our customers; (v) the market for our services may not continue to
grow; (vi) our business is subject to significant regulatory risks; (vii)
Horizon PCS has not had any profitable years in the past five years and may not
achieve or sustain operating profitability or positive cash flow from operating
activities; (viii) Sprint PCS may terminate the Sprint PCS agreements; (ix)
Horizon PCS has substantial debt which it may not be able to service, resulting
in a default; (x) we may not be able to manage our anticipated rapid growth;
(xi) Sprint PCS may have difficulty obtaining infrastructure equipment or
handsets; (xii) the Alliances may fail to provide their network to HPCS
affecting our service to markets in Virginia and West Virginia; (xiii) HPCS may
not receive as much Sprint PCS roaming revenue as anticipated; (xiv) we may need
more capital than we currently project; and (xv) use of hand-held PCS phones may
pose health risks. See "Item 1. Business-Risk Factors" for further information.
64
ITEM 3. Properties
Management believes that its property, plant and equipment are adequate for
its business at CTC, United and Services, although additional property, plant
and equipment is being added. United is building a new 22,000 square foot
operations and training facility, which is due to be completed in the summer of
2001. Our properties consist of land, buildings, central office equipment,
exchange and toll switches, data transmission equipment, underground conduits
and cable, aerial cable, poles, wires, telephone instruments and other
equipment. Our principal operations are conducted in a group of buildings we own
on East Main Street, Chillicothe, Ohio. These headquarters buildings have
approximately 40,000 square feet of floor space.
CTC occupies several properties and buildings comprising approximately
51,000 square feet in the aggregate, used for telephone switches, warehouse and
office space. CTC installed new plant record, mapping and billing software in
2000. CTC also maintains over 100 vehicles used in servicing customers and
maintaining the telephone infrastructure for residential customers and business
services. In addition, CTC has easements it uses in deploying its wireline
network.
HPCS' properties consist of network assets used in the deployment of
wireless services, which are mainly switching equipment, base stations and
ancillary equipment placed at tower sites. At December 31, 2000 HPCS leased over
300 tower sites for deployment of its network assets. HPCS leases 16 retail
store sites for sale of wireless handsets and related services. HPCS also leases
warehouse and office space from CTC. In addition, HPCS owns more than 60
vehicles used mainly in its retail and network build-out operations. HPCS
continues its network build-out, which is expected to be substantially complete
by the end of the third quarter of 2001.
ITEM 4. Security Ownership Of Certain Beneficial Owners And Management
The following table sets forth information regarding the beneficial
ownership of our voting securities, as of March 31, 2001 by:
o each person who, to our knowledge, is the beneficial owner of 5% or
more of a class of our outstanding common stock;
o each of our directors;
o each of the executive officers; and
o all executive officers and directors as a group.
Beneficial ownership is determined in accordance with Rule 13d-3 of the
Securities Exchange Act. A person is deemed to be the beneficial owner of any
shares of common stock if that person has or shares voting power or investment
power with respect to the common stock, or has the right to acquire beneficial
ownership at any time within 60 days of the date of the table. "Voting power" is
the power to vote or direct the voting of shares and "investment power" is the
power to dispose or direct the disposition of shares.
65
CLASS A COMMON STOCK (1) CLASS B COMMON STOCK (1)
------------------------------------- -------------------------------------
Name and Address (2) Number Percent Number Percent
- -------------------- ------ ------- ------ -------
Robert McKell 2,079 2.1% 4,463 1.5%
Thomas McKell (3) 7,638 7.7% 20,620 6.9%
Peter M. Holland 290 * 875 *
Jack E. Thompson (4) 423 * 1,311 *
William A. McKell (5) 1,274 1.3% 3,800 1.3%
Phoebe H. McKell (6) 2,625 2.6% 7,912 2.6%
Joseph S. McKell (7) 8,993 9.0% 26,979 9.0%
David McKell (8) 9,294 9.3% 27,882 9.3%
Helen M. Sproat (9) 6,135 6.2% 17,735 5.9%
John E. Herrnstein (10) 105 * 352 *
Joseph G. Kear 230 * 727 *
All Executive Officers and Directors 39,086 39.2% 112,656 37.6%
as a Group (11 persons) (10)
- ---------------------
* Less than one percent.
(1) Holders of class A common stock are entitled to one vote per share. Holders
of class B common stock do not have voting rights, except as otherwise
required by law.
(2) The address for Horizon Telcom, Inc. and each executive officer and
director is 68 E. Main Street, Chillicothe, Ohio 45601-0480.
(3) Includes 6,623 shares of class A common stock and 17,575 shares of class B
common stock held by a trust. Mr. McKell shares voting and investment power
over these shares. A separate trust owns 1,015 shares of class A common
stock and 3,045 shares of class B common stock. Mr. McKell's wife shares
voting and investment power over these shares. Mr. McKell disclaims
beneficial ownership of the shares owned by his wife.
(4) Includes 213 shares of class A common stock and 639 shares of class B
common stock owned by Mr. Thompson's spouse. Mr. Thompson disclaims
beneficial ownership of these shares.
(5) Includes 400 shares of class A common stock and 1,200 shares of class B
common stock held by Mr. McKell's spouse and their children. Mr. McKell
disclaims beneficial ownership of those shares.
(6) Includes 80 shares of class A common stock and 240 shares of class B common
stock held by Ms. McKell's spouse. Ms. McKell disclaims beneficial
ownership of these shares.
(7) Includes 415 shares of class A common stock and 1,245 shares of class B
common stock owned by Dr. McKell's spouse. Dr. McKell disclaims beneficial
ownership of these shares.
(8) These shares are owned by a Trust. Mr. McKell shares voting and investment
powers over these shares. Mr. McKell disclaims beneficial ownership of
these shares.
(9) Includes 385 shares of class A common stock and 115 shares of class B
common stock held by Ms. Sproat's spouse. Ms. Sproat disclaims beneficial
ownership of these shares.
(10) Includes 37 shares of class B common stock issuable upon exercise of stock
options that are presently exercisable or exercisable within 60 days of the
date hereof.
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ITEM 5. Directors And Executive Officers Of The Company
DIRECTORS AND EXECUTIVE OFFICERS
The following are our directors and executive officers as of the date
hereof.
NAME AGE POSITION
- ---- --- --------
Robert McKell 77 Chairman of the Board, Director
Thomas McKell 65 President, Director; President of CTC
Peter M. Holland 35 Vice President of Finance and Treasurer;
Chief Financial Officer of HPCS
Jack E. Thompson 67 Secretary, Director
William A. McKell 40 Chairman of the Board, President and Chief
Executive Officer of HPCS
Phoebe H. McKell 54 President of Horizon Services
Joseph S. McKell 75 Director
David McKell 73 Director
Helen M. Sproat 68 Director
John E. Herrnstein 63 Director
Joseph G. Kear 77 Director
ROBERT MCKELL has served as Chairman of the Board of Directors of Horizon
Telcom since its inception in 1996 and of CTC since 1988. Mr. McKell has 54
years of telecommunications experience.
THOMAS MCKELL has served as the President and a Director of Horizon Telcom
since its inception in 1996 and of CTC since 1988. Mr. McKell has 45 years of
telecommunications experience.
PETER M. HOLLAND has served as Vice President of Finance and Treasurer of
Horizon Telcom since November 1999. He has also served as the Chief Financial
Officer of HPCS since its inception in April 2000 and has served as the Chief
Financial Officer and a director of Horizon Telcom's other subsidiaries since
November 1999. Mr. Holland has nearly 13 years of telecommunications experience.
From May 1996 to December 1999, Mr. Holland was a principal and owner of The
Pinnacle Group, which provides consulting services to independent wireless and
wireline companies, including HPCS. Prior to joining Pinnacle in May 1996, Mr.
Holland was a manager in Nextel Communications Business Development and
Corporate Strategy groups. Mr. Holland started his career in telecommunications
with Ernst & Young's telecommunications consulting group and is a Certified
Public Accountant.
JACK E. THOMPSON has been Secretary and Director of Horizon Telcom since
its inception in 1996 and of CTC since May 1982. He served as chief financial
officer of Horizon Telcom from its inception to May 2000, and was treasurer of
CTC from May 1982 until May 2000. Mr. Thompson has 34 years of
telecommunications experience.
WILLIAM A. MCKELL has served as Chairman of the Board, President and Chief
Executive Officer of HPCS since its inception in April 2000 and has served as
President, Chief Executive Officer and Chairman of the Board of Horizon Personal
Communications since May 1996 and as President of Bright PCS since its formation
in September 1999. Mr. McKell has 13 years of telecommunications experience. Mr.
McKell served as Vice President of Network Services from January 1996 to April
1996 and Director of Network Services from August 1994 to December 1995 for CTC.
PHOEBE H. MCKELL has served as the President of Horizon Services since its
inception in 1996. Ms. McKell has 22 years of telecommunications experience.
From 1989 to 1996, she was Director of Administration for CTC.
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JOSEPH S. MCKELL has been a director of Horizon Telcom since its inception
in 1996 and a director of CTC since 1983. Mr. McKell, a physician, has practiced
medicine in Chillicothe, Ohio for more than forty years.
DAVID MCKELL has been a director of Horizon Telcom since its inception in
1996 and a director of CTC for 35 years. He is now retired.
HELEN M. SPROAT has been a director of Horizon Telcom since its inception
in 1996 and a director of CTC since (1988). She has owned and managed Hidden
Hill Gallery, Springboro, Ohio, for more than five years.
JOHN E. HERRNSTEIN has been a director of Horizon Telcom since its
inception in 1996, and a director of Chillicothe Telcom since 1981. He has been
a registered representative and financial consultant for AG Edwards & Sons, Inc.
a securities brokerage firm for more than five years.
JOSEPH G. KEAR has been a director of Horizon Telcom since its inception in
1996, and of CTC for 35 years. Mr. Kear, an attorney, has practiced law in
Chillicothe, Ohio for the past 52 years. He is now a partner at Kear-Motes law
firm, a firm which was organized in January 2001. Prior to that time, he
practiced law as a sole practitioner.
Robert McKell, Thomas McKell, David McKell and Joseph McKell are brothers.
Helen Sproat is their sister. Phoebe McKell is the daughter of Robert McKell.
William McKell is the son of Thomas McKell.
BOARD OF DIRECTORS
There are presently eight members of the board of directors. Following
election, directors serve for a term of one year, or until their successors have
been elected and qualified, and are compensated at the discretion of the board
of directors. Executive officers are ordinarily elected annually and serve at
the discretion of the board of directors.
DIRECTOR COMPENSATION
Directors who are not otherwise employed by Horizon Telcom or its
subsidiaries receive $2,200 per quarter as director compensation. Robert McKell,
Thomas McKell, and Jack Thompson receive $50 per quarter.
BOARD COMMITTEES
There are no committees of the Board of Directors at present.
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ITEM 6. Executive Compensation
EXECUTIVE COMPENSATION
The following table presents summary information with respect to the
compensation paid to our Chief Executive Officer and each of our other executive
officers whose salary and bonus exceeded $100,000 during the year ended December
31, 2000:
Annual Compensation Long-Term Compensation
--------------------------- Securities Underlying All Other
Name and Principal Position Salary ($) Bonus ($) Options (#) Compensation ($)
- --------------------------- ---------- --------- ---------------------- ----------------
Thomas McKell
President; President of CTC 207,312 -- -- 8,789 (1)
William A. McKell
Chairman of the Board, President
and Chief Executive Officer of
HPCS 154,167 26,815 -- 12,497 (2)
Peter M. Holland
Vice President of Finance and
Treasurer, Chief Financial
Officer; Chief Financial Officer
of HPCS 150,000 20,625 -- 11,971 (3)
Jack E. Thompson
Vice President, Finance, and
Secretary (5) 154,807 -- -- 10,676 (4)
Phoebe McKell
President of Horizon Services 117,856 -- -- 8,202 (6)
- ------------------------
(1) Includes a yearly car allowance of $7,189 and a 401(k) contribution of
$1,600.
(2) Includes a yearly car allowance of $7,784 and a 401(k) contribution of
$4,713.
(3) Includes yearly car allowance of $7,578 and a 401(k) contribution of
$4,393.
(4) Includes yearly car allowance of $9,076 and a 401(k) contribution of
$1,600.
(5) During 2001, Mr. Thompson elected to work part-time, for a reduced salary.
(6) Includes yearly car allowance of $6,960 and a 401(k) contribution of
$1,242.
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None of the named executive officers received stock options from Horizon
Telcom or HPCS in 2000.
The following table sets forth information concerning the number and value
of unexercised options held by each of our named executive officers on December
31, 2000. There was no public market for our common stock as of December 31,
2000. Accordingly, the fair market value on December 31, 2000 is based on an
average assumed value of $100.00 per share for Horizon Telcom stock and $5.39
per share for HPCS stock. This valuation at December 31, 2000 does not
necessarily represent the actual value of our stock at December 31, 2000.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR AND OPTION/SAR VALUES
Number of Securities Underlying Value of Unexercised
Shares Unexercised Options at Year End In-The-Money Options at Year
Acquired Value (#) End ($) (1)
on Realized ---------------------------------- --------------------------------
Exercise ($) Exercisable / Unexercisable Exercisable / Unexercisable
---------- --------- --------------- -------------- ------------- ---------------
Thomas McKell -- -- -- -- -- / --
William A. McKell -- -- 371,263* / 1,242,923* 1,956,256* / 6,549,206*
Peter M. Holland -- -- 371,263* 1,242,923* 1,956,256* / 6,549,206*
Jack Thompson 37 1,480 .5 / 112.5 20 / 4,500
Phoebe McKell 37 1,480 .5 112.5 20 / 4,500
- --------------
* These options represent options to purchase HPCS class A common stock.
(1) Based on an assumed value of $100.00 per share for Horizon Telcom stock and
$5.39 per share for HPCS stock.
EMPLOYMENT AGREEMENTS
HPCS entered into employment agreements with William McKell and Peter
Holland, its Chief Executive Officer and Chief Financial Officer, respectively.
The employment agreements provide for an annual base salary of $200,000 to Mr.
McKell and $175,000 to Mr. Holland. In addition to their base salary, Mr. McKell
and Mr. Holland are eligible to receive an annual bonus up to 40% of their base
salary. In addition, Mr. McKell and Mr. Holland are eligible to participate in
all of HPCS' employee benefit plans and policies.
The employment agreements provide that Mr. McKell or Mr. Holland's
employment may be terminated with or without cause, as defined in the agreement.
If either Mr. McKell or Mr. Holland is terminated without cause, he is entitled
to receive 24 months base salary, the vesting of all of his stock options on the
date of termination, and 24 months of health and dental benefits. Under the
employment agreements, both Mr. McKell and Mr. Holland have agreed to a
restriction on their present and future employment. They have agreed not to
compete in the business of wireless telecommunications either directly or
indirectly within our markets while employed by us and for a period of twelve
months after termination of employment.
HORIZON TELCOM 1999 STOCK OPTION PLAN
The 1999 Stock Option Plan has been adopted by our board of directors and
stockholders. The option plan permits the granting of both incentive stock
options and nonqualified stock options to employees. The aggregate number of
shares of common stock that may be issued pursuant to options granted under the
option plan is 10,000 shares, including both shares of class A common stock and
shares of class B common stock, subject to adjustments in the event of certain
changes in the outstanding shares of common stock. In 1999, we granted options
to purchase 950 shares of class B common stock at an exercise price of $60.00
per share. No additional options were granted in 2000.
70
The option plan will be administered by our board of directors or by a
compensation committee appointed by our board of directors, which will be
authorized, subject to the provisions of the option plan, to grant options and
establish rules and regulations as it deems necessary for the proper
administration of the option plan and to make whatever determinations and
interpretations it deems necessary or advisable.
An incentive option may not have an exercise price less than the fair
market value of the common stock on the date of grant or an exercise period that
exceeds ten years from the date of grant. In the case of option holders that own
more than 10% of Horizon Telcom's stock, the exercise price for an incentive
option cannot be less than 110% of the fair market value of the common stock on
the date of grant and the exercise period cannot exceed five years from the date
of grant. Incentive options are also subject to other limitations which allow
the option holder to qualify for favorable tax treatment. Nonqualified options
may have an exercise price of less than, equal to or greater than the fair
market value of the underlying common stock on the date of grant but are limited
to an exercise period of no longer than ten years.
The board of directors or the compensation committee will determine the
persons to whom options will be granted and the terms, provisions, limitations
and performance requirements of each option granted, and the exercise price of
an option.
An option will not be not transferable except by will or by the laws of
descent or distribution or unless determined otherwise by our board of directors
or the compensation committee.
The plan provides that all stock issued under the plan will be subject to a
right of first refusal in favor of Horizon Telcom. Under the right of first
refusal, each holder of stock issued under the plan must offer the stock to
Horizon Telcom prior to selling it to a third party. If Horizon Telcom declines
to purchase the stock, the stockholder may sell the stock to the third party,
but the stock will remain subject to the Horizon Telcom right of first refusal.
The right of first refusal shall cease to apply upon the completion of an
underwritten initial public offering of Horizon Telcom's capital stock
registered under the Securities Act of 1933, as amended.
The plan contains provisions that give the compensation committee or our
board of directors or the acquiring entity's board of directors discretion to
take specified actions if Horizon Telcom is acquired, unless the individual
option grants provide otherwise. Those actions can include the authorization to
purchase option grants from plan participants, or make adjustments or
modifications to outstanding options granted to protect and maintain the rights
and interests of the plan participants or, upon notice to optionees, require
that all options must be exercised within a specified number of days and
thereafter the option will terminate. The board may provide for acceleration of
options upon the occurrence of events specified in the option agreement. To
date, all individual option grants have provided that the options will
accelerate and become fully exercisable upon an acquisition of Horizon Telcom.
HPCS 2000 STOCK OPTION PLAN
The HPCS Stock Option Plan has been adopted by HPCS' board of directors and
stockholders. That option plan permits the granting of both incentive stock
options and nonqualified stock options to employees. The aggregate number of
shares of common stock that may be issued pursuant to options granted under the
option plan is 7,500,000 shares of HPCS class A common stock and 4,196,884
shares of HPCS class B common stock, subject to adjustments in the event of
certain changes in the outstanding shares of common stock. On December 1, 1999,
HPCS' subsidiary, Horizon Personal Communications, granted options to purchase
3,588,000 shares of its class B common stock with an exercise price of $0.1414
per share to 13 individuals under its 1999 Stock Option Plan. After HPCS was
incorporated, it issued options to replace those initial options, on the same
economic terms adjusted for the fact that Horizon Personal Communications was a
subsidiary. After taking into account the adjustment, HPCS issued 4,196,884
substituted options at an exercise price of $0.1209. In November 2000, HPCS
granted options to purchase an additional 116,970 shares at an exercise price of
$5.88 per share.
The HPCS option plan is administered by our board of directors or a
compensation committee appointed by its board of directors, which will be
authorized, subject to the provisions of the option plan, to grant options and
71
establish rules and regulations as it deems necessary for the proper
administration of the option plan and to make whatever determinations and
interpretations it deems necessary or advisable.
An incentive option may not have an exercise price less than the fair
market value of the common stock on the date of grant or an exercise period that
exceeds ten years from the date of grant. In the case of option holders that own
more than 10% of HPCS' stock, the exercise price for an incentive option cannot
be less than 110% of the fair market value of the common stock on the date of
grant and the exercise period cannot exceed five years from the date of grant.
Incentive options are also subject to other limitations which allow the option
holder to qualify for favorable tax treatment. Nonqualified options may have an
exercise price of less than, equal to or greater than the fair market value of
the underlying common stock on the date of grant but are limited to an exercise
period of no loner than ten years. However, we will not grant non-qualified
options with an exercise price less than 85% of fair market value of the common
stock on the date of the grant.
An option will not be not transferable except by will or by the laws of
descent or distribution or unless determined otherwise by our board of directors
or the compensation committee.
Unless previously exercised, a vested option granted under the HPCS option
plan will terminate automatically:
o twelve months after the employee's termination of employment by reason of
disability or death; and
o three months after an employee's termination of employment for reasons
other than disability or death.
The plan contains provisions that give the HPCS compensation committee or
board of directors of the acquiring entity's board of directors discretion to
take specified actions if HPCS is acquired, unless the individual option grants
provide otherwise. Those actions can include the authorization to purchase
option grants from plan participants, or make adjustments or modifications to
outstanding options granted to protect and maintain the rights and interests of
the plan participant or accelerate the vesting of outstanding options. To date,
all individual option grants have provided that the options will accelerate and
become fully exercisable upon an acquisition of HPCS.
The HPCS board of directors has adopted a policy to the effect that, for at
least one year from March 27, 2001, 3,000,000 of the shares authorized to be
issued under the plan are subject to the condition that they must either be
issued to non-promoter employees (as defined in the North American Securities
Administration Association's statement of policy on options and warrants) or at
an exercise price no less than $5.88 per share. The HPCS board also has
undertaken not to grant options (other than under the HPCS 2000 Stock Option
Plan) with a term of longer than 5 years until the class A common stock is
listed on either the New York Stock Exchange, the American Stock Exchange, or
the Nasdaq National Market.
PENSION PLAN
Pension Plan Table
This table shows the estimated annual benefits payable upon retirement at
age 65 in the September 1, 2000 plan year under The Chillicothe Telephone
Company Salaried Employees' Pension Plan and Trust Agreement, a non-contributory
qualified defined benefit plan. Benefits from the plan are payable upon
retirement in monthly installments for the life of the participant.
72
----------------------------------------------------------------------------------------------
Years of Service
----------------------------------------------------------------------------------------------
Remuneration 15 20 25 30 35
$125,000 18,750 25,000 31,250 37,500 43,750
150,000 22,500 30,000 37,500 45,000 52,500
175,000 25,500 34,000 42,500 51,000 59,500
200,000 25,500 34,000 42,500 51,000 59,500
225,000 25,500 34,000 42,500 51,000 59,500
250,000 25,500 34,000 42,500 51,000 59,500
300,000 25,500 34,000 42,500 51,000 59,500
400,000 25,500 34,000 42,500 51,000 59,500
450,000 25,500 34,000 42,500 51,000 59,500
500,000 25,500 34,000 42,500 51,000 59,500
The remuneration shown above is the annual equivalent of an average of
monthly rates of pay. The benefits shown above are based on the sum of the
highest five consecutive monthly rates of pay in effect on each July 1 during
the final ten plan years divided by five. The benefit stated in the table will
not be reduced by Social Security or other amounts received by a participant.
The benefits in the table would be paid in the form of a joint and 50% survivor
annuity.
For the September 1, 2000 plan year, the July 1, 2000 monthly rate of pay
is limited to $14,167, which is equivalent to an annual pay of $170,000.
Compensation in excess of this amount will not be taken into account for benefit
calculation purposes. Along these lines, years of benefit service in excess of
40 years will not be taken into account for benefit calculation purposes.
The pension plan was amended on November 11, 2000. This amendment increased
the minimum benefit from $32.00 per month times years of benefit service to
$35.00 per month times years of benefit service. This minimum does not apply for
any of the benefits listed in the table above.
The number of years of credited service certain executive officers have
accrued under the pension plan as of the most recent fiscal year end are:
Name Years of Service
Thomas McKell 44.5
William A. McKell 13.3
Jack E. Thompson 32.7
Phoebe McKell 22.3
Thomas McKell is an active employee, but he is currently eligible to
retire. Mr. Thompson is retired and receives retirement benefits under the
pension plan. HPCS employees do not now participate in this plan, although
several current employees of HPCS who formerly were employees eligible to
participate, including William McKell, have vested pension benefits under this
plan.
ITEM 7. Certain Relationships And Related Transactions
SERVICE AGREEMENTS WITH HORIZON TELCOM SUBSIDIARIES
Horizon Personal Communications and Bright PCS, wholly-owned subsidiaries
of our majority-owned subsidiary HPCS, have entered into service agreements with
Horizon Services, Inc. and a separate services agreement with United
Communications, Inc. Horizon Services and United Communications are both
wholly-owned subsidiaries of Horizon Telcom.
73
Under the agreement with Horizon Services, Horizon Services provides
services to Horizon Personal Communications and Bright PCS including insurance
functions, billing services, accounting services, computer access and other
customer relations, human resources, and other administrative services that
Horizon Personal Communications and Bright PCS would otherwise be required to
undertake on their own. These agreements have a term of three years, with the
right to renew the agreement for additional one-year terms each year thereafter.
HPCS has the right to terminate each agreement during its term by providing 90
days written notice to Horizon Services. Horizon Services may terminate the
agreement prior to its expiration date only in the event that HPCS breaches its
obligations under the services agreement and the breach is not cured within 90
days after HPCS receives written notice of breach from Horizon Services. Horizon
Services is entitled to the following compensation from Horizon Personal
Communications for services provided:
o direct labor charges at cost; and
o expenses and costs which are directly attributable to the activities
covered by the agreement on a direct allocation basis.
The agreement provides that Horizon Services' obligations do not relieve
Horizon Personal Communications of any of its rights and obligations to their
customers and to regulatory authorities having jurisdiction over them.
Additionally, Horizon Services, upon request, is required to provide Horizon
Personal Communications with access to Horizon Services' records with respect to
the provision of services, and Horizon Services is also required to provide
regular reports to Horizon Personal Communications, as it may request. Horizon
Services received compensation from Horizon Personal Communications of
approximately $330,000 in 1998, $960,000 in 1999, and $4.4 million in 2000. The
amount due to Horizon Services for these services as of December 31, 1999 was
$499,000. As of December 31, 2000, Horizon Personal Communications had a prepaid
balance with Horizon Services of $10,000 for these services. Horizon Services
also provides administrative services to Bright PCS.
Horizon Personal Communications, a subsidiary of HPCS, also has a services
agreement with United Communications, Inc., a wholly-owned subsidiary of Horizon
Telcom. Under the services agreement, Horizon Personal Communications provides
services to United Communications including customer activation and
deactivation, customer care support and other administrative services that
United Communications would otherwise be required to undertake on its own. This
arrangement has a term of one year, with the right to renew the agreement for
additional terms of three months thereafter. Either party has the right to
terminate the agreement during its term by providing 30 days written notice to
the other party. Horizon Personal Communications is entitled to the following
compensation from United Communications for services provided:
o direct labor charges at cost; and
o expenses and costs which are directly attributable to the activities
covered by the agreement on a direct allocations basis.
In addition, United Communications must pay Horizon Personal Communications
$4,000 each month of the term of the services agreement. Horizon Personal
Communications, upon request, is required to provide United Communications with
access to Horizon Personal Communications' records with respect to the provision
of services, and Horizon Personal Communications must provide regular reports to
United Communications, as it may request.
CONSULTING AGREEMENT
Peter M. Holland, the Chief Financial Officer of HPCS, was a principal and
50% owner of The Pinnacle Group which provided strategic, business planning and
regulatory consulting services to Horizon personal Communications. Pinnacle
received consulting fees of approximately $204,000 in 1998 and $267,000 in 1999.
74
Mr. Holland joined HPCS in November 1999 and terminated his relationship with
Pinnacle. HPCS believes that the consulting fees paid to Pinnacle were on terms
no less favorable to HPCS than would have been obtained from a non-affiliate.
SALE OF ASSETS TO AFFILIATE
On April 1, 2000, HPCS transferred the assets and contractual rights that
made up its Internet, long distance and other businesses unrelated to the
wireless operations to United Communications, a subsidiary of Horizon Telcom,
for a purchase price of approximately $708,000. United Communications paid the
purchase price by delivering a promissory note with an interest rate equal to
the applicable federal rate, which was 6.0%. Subsequent to year-end, this note
was sold by HPCS to Services.
OFFICE LEASE
HPCS leases its principal office space, the space for one of its retail
locations and the space for certain equipment from The Chillicothe Telephone
Company, a wholly owned subsidiary of Horizon Telcom. The monthly rental
payments under the lease are $10,000. Prior to signing the lease agreement in
May 2000, HPCS rented the office space from The Chillicothe Telephone Company
under a month-to-month rental arrangement. Under this lease, HPCS paid The
Chillicothe Telephone Company $22,300, $22,300 and $97,500 in 1998, 1999, and
2000, respectively. We believe that the lease was made on terms no less
favorable to HPCS than would have been obtained from a non-affiliated third
party. The lease term expires in May 2005. HPCS has the option to renew the
lease for an additional two year period. It is the expectation of management
that the lease will be renewed.
LEASE OF CELL SITES
Prior to October 1999, HPCS leased most of its cell sites from Horizon
Telcom. In 1998 and 1999, HPCS paid $1.3 million and $2.0 million, respectively,
to Horizon Telcom under this lease. The lease was terminated in October 1999
when the leased assets were sold by Horizon Telcom to SBA Communications.
STOCK GRANT
In 2001, HPCS distributed the remaining 2% of the Horizon Telcom stock that
it owned to a group of its officers and key employees in the form of a bonus.
Recipients included William McKell, who received 259 shares of class A common
stock and 750 shares of class B common stock, and Peter Holland, who received
259 shares of class A common stock and 750 shares of class B common stock. None
of the other named executive officers of Horizon Telcom received stock grants.
TAX SHARING AGREEMENT
In 1997, Horizon Telcom entered into a tax-sharing agreement with its
subsidiaries, including Horizon Personal Communications (now a subsidiary of
HPCS). This agreement provides that Horizon Telcom and its subsidiaries will
file a consolidated tax return as long as they are eligible to do so, and that
subsidiaries will be paid for the amount of their taxable net operating losses
used by Horizon Telcom to offset taxable income.
Due to the sale by HPCS of convertible preferred stock in September 2000,
HPCS will no longer be included in the consolidated tax return of Horizon
Telcom. This change in its tax status is referred to as a tax deconsolidation.
The tax-sharing agreement provides that Horizon Telcom will indemnify HPCS to
the extent of any aggregate tax liability in excess of $11.5 million related to
the tax deconsolidation and the dividend of the Horizon Telcom stock. For the
year ended December 31, 2000, HPCS paid $5.2 million to Horizon Telcom for
taxes. As of December 31, 2000 HPCS had a payable to Horizon Telcom of
approximately $340,000 for federal income taxes attributable primarily to the
tax liability for the tax deconsolidation and the dividend of the Horizon Telcom
stock offset by the utilization of net operating losses.
75
PAYABLE TO HORIZON TELCOM
At December 31, 1999, HPCS had a payable to Horizon Telcom relating to cash
advances received from Horizon Telcom's line of credit and the associated
interest. The cash advances related to this payable were used to finance
operations. The outstanding balance as of December 31, 1999 was $4.4 million. In
June 2000, this balance was repaid by HPCS with proceeds from a new financing
from an unrelated lender.
ITEM 8. Legal Proceedings
We currently and from time to time are involved in litigation incidental to
the conduct of our business, but we are not a party to any lawsuit which, in our
opinion, is likely to have a material adverse effect on us.
ITEM 9. Market Price of and Dividends on Common Equity and Related Stockholder
Matters
To date, both our class A common stock and our Class B Nonvoting Common
Stock have traded principally in local transactions without the benefit of an
established public trading market, or an organized system for reporting prices
paid.
We paid the following cash dividends per share during the past two calendar
years:
DIVIDENDS*
Year Ended December 31, 1999
First Quarter................................... $1.14
Second Quarter.................................. $1.14
Third Quarter................................... $1.14
Fourth Quarter.................................. $1.14
Total....................................... $4.55
Year Ended December 31, 2000
First Quarter................................... $1.15
Second Quarter.................................. $1.15
Third Quarter................................... $1.15
Fourth Quarter.................................. $1.15
Total....................................... $4.60
-------------
*Dividends are adjusted to reflect the stock split in 2000.
Dividends are paid only as and when declared by our board of directors, in
its sole discretion, based on our financial condition, results of operations,
market conditions and such other factors as it may deem appropriate.
There were 348 holders of record of our class A common stock as of April 9,
2001. There were 684 holders of record of our class B common stock as of April
9, 2001. This number does not include beneficial owners of Common Stock whose
shares are held in the name of various dealers, depositories, banks, brokers or
other fiduciaries.
ITEM 10. Recent Sales of Unregistered Securities
(1) On November 17, 1999, the Registrant granted stock options to purchase
a total of 950 shares of the class B common stock of the Registrant at an
exercise price of $60.00 per share.
(2) On June 27, 2000, in connection with the acquisition of Bright PCS,
HPCS issued an aggregate of 4,678,800 shares of its class B common stock and
distributed 31,912 shares of Horizon Telcom common stock (7,978 shares of class
A common stock and 23,934 shares of class B common stock) to the former
76
non-Horizon members of Bright PCS in return for the contribution by the former
members of approximately 70% of their ownership interest in Bright PCS.
(3) On June 27, 2000, HPCS granted incentive stock options to purchase
3,874,047 shares of HPCS' class B common stock at an exercise price of $0.1209
per share, and nonqualified options to purchase 322,837 shares of its class B
common stock, at an exercise price of $0.1209 per share. These options were
granted in replacement of stock options which had been granted by Horizon
Personal Communications, Inc. on November 16, 1999, prior to the incorporation
of HPCS as a holding company for Horizon Personal Communications, Inc. and
Bright PCS.
(4) In connection with Sprint PCS' grant of HPCS' new markets on May 19,
2000, HPCS agreed to grant a warrant to Sprint PCS to acquire 2,510,460 shares
of HPCS' class A common stock at an exercise price equal to the initial public
offering price per share. The warrant will expire on the 3rd anniversary of the
completion of this offering.
(5) On February 15, 2000, HPCS borrowed $13 million from First Union
Investors, Inc. in connection with HPCS' purchase of shares of common stock of
Horizon Telcom. In connection with the loan transaction, HPCS and First Union
Investors, Inc., agreed that, upon the completion of an initial public offering,
the outstanding principal amount, and accrued interest thereon, under the note
to First Union Investors, Inc. would be converted into shares of HPCS' class A
common stock at a conversion price equal to the initial public offering price
per share. The note was converted by First Union on September 26, 2000.
(6) On September 8, 2000, HPCS effected a 1.1697 for 1 stock dividend of
its issued and outstanding class B common stock and made corresponding
adjustments to the outstanding options and warrants.
(7) On September 26, 2000, HPCS issued 26,087,237 shares of its convertible
preferred stock at a weighted average purchase price of $5.39 per share
(consisting of 10,252,239 shares of Series A Preferred Stock at $5.88 per share
and 15,834,998 shares of Series A-1 Preferred Stock at $5.07 per share). The
purchasers of the preferred stock and the amount purchased are listed in the
table below.
NAME OF PURCHASER NUMBER OF SHARES
Series A Series A-1
--------- ----------
Apollo Investment Fund IV, L.P................................ 7,854,719 12,132,161
Apollo Overseas Partners IV, L.P.............................. 436,097 673,582
Ares Leveraged Investment Fund, L.P........................... 467,687 722,375
Ares Leveraged Investment Fund II, L.P........................ 467,687 722,375
First Union Capital Partners, L.P............................. 1,026,049 1,584,505
(8) On September 26, 2000, HPCS issued 295,000 units (Units) consisting of
$295,000,000 principal amount of 14% Senior Discount Notes due 2010 and warrants
to purchase 3,805,500 shares of class A common stock at an exercise price of
$5.88 per share. The initial purchasers of the Units and the amount purchased
are listed in the table below.
INITIAL PURCHASERS NUMBER OF UNITS
Donaldson, Lufkin & Jenrette Securities Corporation ................... 206,500
First Union Securities, Inc............................................ 88,500
---------------------------
Total................................................ 295,000
===========================
(9)Three persons holding options to acquire Horizon Telcom class B common
stock each exercised the vested portions of the options (37 shares each at $60
per share). One option was exercised in July 2000, and the other two were
exercised in August 2000. Each optionee was an executive officer or director.
See Item 6.
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(10) In February 2001, HPCS decided to distribute a total of 7,249 shares
of Horizon Telcom common stock (1,819 shares of class A common stock and 5,430
shares of class B common stock) to a group of HPCS' officers and employees in
the form of a bonus.
Exemption from the registration provisions of the Securities Act for the
transaction described in paragraphs 6 and 10 above was claimed on the basis that
such transactions did not constitute an "offer," "offer to sell," "sale," or
"offer to buy" under Section 5 of the Securities Act. Exemption from the
registration provisions of the Securities Act for the other transactions
described above was claimed under Section 4(2) of the Securities Act and the
rules and regulations promulgated thereunder on the basis that such transactions
did not involve any public offering, the purchasers were sophisticated with
access to the kind of information registration would provide and that such
purchasers acquired such securities without a view towards distribution thereof.
In addition, exemption from the registration provisions of the Securities Act
for the transactions described in paragraphs 1 and 9 was claimed under Section
3(b) of the Securities Act on the basis that such securities were sold pursuant
to a written compensatory benefit plan or pursuant to a written contract
relating to compensation and not for capital raising purposes under Rule 701 of
the Securities Act, and exemption from the registration provisions of the
Securities Act for the transactions described in paragraphs 7 and 8 above was
claimed under Rule 144A of the Securities Act.
ITEM 11. Description of Registrant's Securities to Be Registered
GENERAL
The authorized capital stock of Horizon Telcom consists of 200,000 shares
of class A common stock, without par value, and 500,000 shares of class B common
stock, without par value. As of December 31, 2000, there were 99,726 shares of
class A common stock and 299,301 shares of class B common stock issued and
outstanding. The following description summarizes the material terms of our
capital stock. Your rights as a shareholder of Horizon Telcom will be governed
by the provisions of our Articles of Incorporation and Code of Regulations and
by the provisions of Ohio law, including the Ohio General Corporation Law (OGCL)
and other provisions contained in the Ohio Revised Code.
COMMON STOCK
The common stock will be entitled to share in any dividends that the Board
of Directors, in its discretion, validly declares from funds legally available.
In the event of liquidation, each outstanding share of common stock entitles its
holder to participate ratably in the assets remaining after payment of
liabilities. There are no redemption or sinking fund provisions with regard to
Horizon Telcom common stock. All outstanding shares of common stock will be
fully paid, validly issued and nonassessable. Except with respect to voting
rights and preemptive rights as described below, the shares of class A common
stock and the shares of class B common stock shall have identical terms and
shall be deemed a single class of capital stock for all purposes. The following
terms apply with respect to voting and preemptive rights of the class A common
stock and the class B common stock.
Class A Common Stock
Class A common stock is entitled to one vote for each share held of record
on all matters submitted to a vote of shareholders. Holders of class A common
stock have the right to cumulate votes in the election of directors upon
fulfillment of the conditions prescribed in Section 1701.55 of the Ohio Revised
Code. That Section provides for cumulative rights if notice in writing is given
by any shareholder to the president, a vice-president, or the secretary of a
corporation, not less than forty-eight hours before the time fixed for holding a
meeting of the shareholders for the purpose of electing directors if notice of
the meeting has been given at least ten days before the meeting, and, if the ten
days' notice has not been given, not less than twenty-four hours before such
meeting time, that he desires that the voting at such election shall be
cumulative, provided that an announcement of the giving of such notice is made
upon the convening of the meeting by the chairman or secretary or by or on
behalf of the shareholder giving such notice. If the cumulative rights apply,
each shareholder has the right to cumulate the voting power he possesses and to
give one candidate as many votes as the number of directors to be elected
multiplied by the number of his votes equals, or to distribute his votes on the
same principle among two or more candidates, as he sees fit.
78
Holders of class A common stock have preemptive rights to purchase class A
common stock but have no preemptive or other rights to subscribe for or purchase
additional shares of any other class of stock or any other securities of Horizon
Telcom. Under Section 1701.15 of the OCGL, if Horizon Telcom offers or sells any
class A common stock, current holders of class A common stock have the right,
during a reasonable time and on reasonable terms fixed by the directors, to
purchase the offered shares in proportion to their respective holdings of shares
of the same class, at a price fixed as provided under the OCGL, unless the
shares offered or sold are in any of the following categories:
(1) Treasury shares;
(2) Issued as a share dividend or distribution;
(3) Issued or agreed to be issued for considerations other than money;
(4) Issued or agreed to be issued upon exercise of options granted and
authorized in accordance with Section 1701.16 of the Revised Code;
(5) Issued or agreed to be issued upon conversion of convertible shares
authorized in the articles, or upon exercise of conversion rights
conferred and authorized in accordance with Section 1701.22 of the
Revised Code;
(6) Offered to shareholders in satisfaction of their pre-emptive rights
and not purchased by such shareholders, and thereupon issued or agreed
to be issued for a consideration not less than that at which the
shares were so offered to such shareholders, less reasonable expenses,
compensation, or discount paid or allowed for the sale, underwriting,
or purchase of the shares, unless by the affirmative vote or written
order of the holders of two-thirds of the shares otherwise entitled to
the pre-emptive rights, the pre-emptive rights are restored as to any
of the shares not previously issued or agreed to be issued;
(7) Released from pre-emptive rights by the affirmative vote or written
consent of the holders of two-thirds of the shares entitled to the
pre-emptive rights. Any such vote or consent shall be entered in the
records of the corporation and shall be binding on all shareholders
and their transferees for the time specified in the vote or consent up
to but not exceeding one year, and shall protect all persons who
within the time acquire the shares or options on or conversion or
other rights with respect to the shares so released;
(8) Released from pre-emptive rights by the affirmative vote or written
consent of the holders of a majority of the shares entitled to the
pre-emptive rights, for offering and sale, or the grant of options
with respect thereto, to any or all employees of the corporation or of
subsidiary corporations or to a trustee on their behalf, under a plan
adopted or to be adopted by the directors for that purpose.
The vote of holders of a majority of all outstanding shares of class A
common stock is required to amend the company's Articles and to approve mergers,
reorganizations and similar transactions.
Class B Common Stock
The holders of shares of class B common stock do not have any voting
rights, except as required by law. No holder of shares of class B common stock
shall, as such holder, have any preemptive or preferential right to purchase or
subscribe to any shares of any class of Horizon Telcom, whether now or hereafter
authorized, whether unissued or in the treasury, or to purchase any obligations
convertible into shares of any class of Horizon Telcom, which at any time may be
proposed to be issued by Horizon Telcom or subjected to rights or options to
purchase granted by Horizon Telcom.
79
CERTAIN PROVISIONS OF OHIO LAW
Section 1701.59 of the Ohio Revised Code provides, with certain limited
exceptions, that a director shall be held liable in damages for any action he
takes or fails to take as a director only if it is proved by clear and
convincing evidence that the director's action or failure to act involved an act
or omission undertaken with deliberate intent to cause injury to the corporation
or with reckless disregard for its best interest. In addition, Section 1701.59
of the Ohio Revised Code provides that a director of an Ohio corporation, in
determining what the director reasonably believes to be in the best interests of
the corporation, shall consider the interests of the corporation's shareholders
and may consider, in the director's discretion, any of the following: (i) the
interests of the corporation's employees, suppliers, creditors and customers;
(ii) the economy of the State of Ohio and the nation; (iii) community and
societal considerations; and (iv) the long-term as well as short-term interests
of the corporation and its shareholders, including the possibility that these
interests may be best served by the continued independence of the corporation.
The Ohio Revised Code also authorizes Ohio corporations to indemnify
officers and directors from liability if the officer or director acted in good
faith and in a manner reasonably believed by the officer or director to be in or
not opposed to the best interests of the corporation, and, with respect to any
criminal actions, if the officer or director had no reason to believe his action
was unlawful. In the case of an action by or on behalf of a corporation,
indemnification may not be made (i) if the person seeking indemnification is
adjudged liable for negligence or misconduct, unless the court in which such
action was brought determines such person is fairly and reasonably entitled to
indemnification or (ii) if liability asserted against such person concerns
certain unlawful distributions. The indemnification provisions of the Ohio
Revised Code require indemnification if a director or officer has been
successful on the merits or otherwise in defense of any action, suit or
proceeding that he was a party to by reason of the fact that he is or was a
director or officer of the corporation. The indemnification authorized under
Ohio law is not exclusive and is in addition to any other rights granted to
officers and directors under the articles of incorporation or code of
regulations of the corporation or any agreement between officers and director
and the corporation. A corporation may purchase and maintain insurance or
furnish similar protection on behalf of any officer or director against any
liability asserted against the officer or director and incurred by the officer
or director in his capacity, or arising out of the status, as an officer or
director, whether or not the corporation would have the power to indemnify the
officer or director against such liability under the Ohio Revised Code.
Section 1707.041 of the Ohio Revised Code regulates control bids for
corporations in Ohio having certain concentrations of Ohio shareholders and
permits the Ohio Division of Securities to suspend a control bid if certain
information is not provided to offerees. A control bid includes the purchase or
offer to purchase any equity security of the Company from a resident of Ohio if,
after the purchase of that security, the offeror would be directly or indirectly
the beneficial owner of more than 10% of any class of issued and outstanding
equity securities of the Company. Section 1707.043 of the Ohio Revised Code, the
so-called "green mail disgorgement" statute, provides an Ohio corporation, or in
certain circumstances the shareholders of an Ohio corporation, the right to
recover profits realized under certain circumstances by persons who dispose of
securities of a corporation within 18 months of proposing to acquire such
corporation.
Chapter 1704 of the Ohio Revised Code may be viewed as having an
anti-takeover effect. This statute, in general, prohibits an "issuing public
corporation," the definition of which will include Horizon Telcom, from entering
into a "Chapter 1704 Transaction" with the beneficial owner of 10% or more of
the outstanding shares of the corporation (an "interested shareholder") for at
least three years after the date on which the interested shareholder attains a
10% ownership, unless the board of directors of the corporation approves, prior
to the person becoming an interested shareholder, either the transaction or the
acquisition of shares resulting in a 10% ownership position.
A "Chapter 1704 Transaction" includes, among other things, a merger or
consolidation with, a sale of substantial assets to, or the receipt of a loan,
guaranty or other financial benefit which is not proportionately received by all
shareholders, from the interested shareholder. After the three-year period, a
Chapter 1704 Transaction with the interested shareholder is permitted only if
either the transaction is approved by the holders of at least two-thirds of the
voting power of the corporation (or such different proportion as is required by
the corporation's articles of incorporation), including a majority of the shares
not owned by the interested shareholder, or the business combination results in
80
the shareholders other than the interested shareholder receiving a prescribed
"fair price" for their shares. One significant effect of Chapter 1704 is to
encourage a person to negotiate with the board of directors of a corporation
prior to becoming an interested shareholder.
In addition, Section 1707.043 of the Ohio Revised Code requires a person or
entity that makes a proposal to acquire the control of a corporation to repay to
that corporation any profits made from trades in the corporation's stock within
18 months after making the control proposal.
Section 1701.831 of the OGCL, Ohio's "Control Share Acquisition Statute,"
requires shareholder approval of any proposed "control share acquisition" of an
Ohio corporation. A "control share acquisition" is the acquisition, directly or
indirectly, by any person of shares of a corporation that, when added to all
other shares of the corporation that may be voted, directly or indirectly, by
the acquiring person, would entitle such person to exercise or direct the
exercise of
(a) 20% or more, but less than 33 1/3%, of the voting power of the
corporation in the election of directors, or
(b) 33 1/3% or more, but less than a majority, of such voting power, or
(c) a majority or more of such voting power.
The control share acquisition must be approved in advance by the holders of
a majority of the outstanding voting shares represented at a meeting at which a
quorum is present and by the holders of a majority of the portion of the
outstanding voting shares represented at the meeting excluding the voting shares
owned by the acquiring shareholder and certain "interested shares," including
shares owned by officers elected or appointed by the directors of the
corporation and by directors of the corporation who are also employees of the
corporation.
The purpose of the Control Share Acquisition Statute is to give
shareholders of Ohio corporations a reasonable opportunity to express their
views on a proposed shift in control, thereby reducing the coercion inherent in
an unfriendly takeover. The provisions of the Control Share Acquisition Statute
are intended to give shareholders of Horizon Telcom assurance that they will
have adequate time to evaluate the proposal of an acquiring person, that they
will be permitted to vote on the issue of authorizing the acquiring person's
purchase program to go forward in the same manner and with the same proxy
information that would be available to them if a proposed merger of the company
were before them and, most importantly, that the interests of all shareholders
will be taken into account and the probability will be increased that they will
be treated equally regarding the price to be offered for their common shares if
the proposal is approved.
The Control Share Acquisition Statute applies not only to traditional
offers but also to open market purchases, privately negotiated transactions and
original issuances by an Ohio corporation, whether friendly or unfriendly. The
procedural requirements of the Control Share Acquisition Statute could render
approval of any control share acquisition difficult in that the transaction must
be authorized at a special meeting of shareholders, at which a quorum is
present, by the affirmative vote of the majority of the voting power represented
and by a majority of the portion of that voting power excluding interested
shares. Any corporate defense against persons seeking to acquire control may
have the effect of discouraging or preventing offers which some shareholders
might find financially attractive.
Although we believe that these provisions are in Horizon Telcom's best
interests, you should be aware that the provisions could be disadvantageous to
you because the overall effect of these statutes may be to render more difficult
or discourage the removal of incumbent management or the assumption of effective
control by other persons. It is possible that the foregoing provisions will
discourage other persons from making a tender offer for or acquisition of
substantial amounts of the Company's common shares, or may delay changes in
control or management of the Company.
81
TRANSFER AGENT AND REGISTRAR
The registrar and transfer agent for Horizon Telcom common stock will be
selected prior to effectiveness of the registration statement.
ITEM 12. Indemnification of Officers and Directors
HORIZON TELCOM
The regulations of Horizon Telcom provide for indemnification of officers
and directors, as described below:
Actions Not by the Company. Horizon Telcom shall 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
Company, by reason of the fact that he is or was a director or officer of
Horizon Telcom or is or was serving at the request of Horizon Telcom as a
director, officer, partner, or trustee of another corporation, domestic or
foreign, nonprofit or for profit, partnership, joint venture, trust or other
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
Company, and with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. The termination of any
action, suit or proceeding by judgment, order, settlement, conviction, or upon a
plea of nolo contendere or its equivalent, shall not, of itself create a
presumption that the person did not act in good faith and in a manner which he
reasonably believed to be in or not opposed to the best interests of the
Company, and with respect to any criminal action or proceeding, he had
reasonable cause to believe that his conduct was unlawful.
Actions by the Company. Horizon Telcom shall 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 Horizon Telcom to procure a
judgment in its favor by reason of the fact that he is or was a director or
officer of the Company, or is or was serving at the request of Horizon Telcom as
a director, officer, partner, or trustee of another corporation, domestic or
foreign, nonprofit or for profit, partnership, joint venture, trust, or other
enterprise 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 in good faith and in a manner he reasonably believed to be in
or not opposed to the best interests of the Company, except that no
indemnification shall be made in respect of any claim, issue, or matter as to
which such person shall have been adjudged to be liable for negligence or
misconduct in the performance of his duty to Horizon Telcom unless, and only to
the extent that, the court of common pleas, or the court in which such action or
suit was brought, shall determine upon application that, despite the
adjudication of liability, but in view of all the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such expenses as
the court of common pleas or such other court shall deem proper.
Indemnification for Expenses. To the extent that a person indemnified by
right or at the option of Horizon Telcom under the above bylaw provisions has
been successful on the merits or otherwise in defense of any action, suit or
proceeding referred to in said sections, or in 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.
Determination of Indemnification. Any indemnification under these bylaw
provisions, unless ordered by a court, shall be made by Horizon Telcom only as
authorized in the specific case upon a determination that indemnification of the
indemnified person is proper in the circumstances because he has met the
applicable standard of conduct set forth in the bylaws. Such determination shall
be made (a) by a majority vote of a quorum consisting of directors of Horizon
Telcom who were not and are not parties to or threatened with any such action,
suit, or proceeding, or (b) if such a quorum is not obtainable or if a majority
vote of a quorum of disinterested directors so directs, in a written opinion by
independent legal counsel, other than an attorney or a firm having associated
with it an attorney who has been retained by or who has performed services for
Horizon Telcom or any person to be indemnified, within the past five years, or
(c) by the shareholders, or (d) by the court of common pleas or the court in
82
which such action, suit, or proceeding was brought. Any determination made by
the disinterested directors under clause (a) or by independent legal counsel
under clause (b) shall be promptly communicated to the person who threatened or
brought the action or suit by or in the right of the Company, and within ten
days after receipt of such notification, such person shall have the right to
petition the court of common pleas or the court in which such action or suit was
brought to review the reasonableness of such determination.
Advances of Expenses. Expenses, including attorneys' fees, incurred in
defending any action, suit, or proceeding referred to in the above bylaw
provisions may be paid by Horizon Telcom in advance of the final disposition of
such action, suit, or proceeding as authorized by the board of directors in the
specific case upon receipt of an undertaking by or on behalf of the indemnified
person to repay such amount, unless it shall ultimately be determined that he is
entitled to be indemnified by Horizon Telcom as authorized in the above bylaw
provisions. No holder shall have the right to question such expenses paid so
long as the board of directors has authorized such payment and the
aforementioned undertaking has been received by the Company; provided that the
restriction contained in this sentence shall not be construed to restrict a
shareholder's right to question the reasonableness of the ultimate determination
of indemnification as described above under "--Determination of
Indemnification."
Indemnification Not Exclusive. The indemnification provided by the bylaws
shall not be deemed exclusive of any other rights to which those seeking
indemnification may be entitled under the articles, or any agreement, vote of
shareholders or disinterested directors, statute (as now existing or as
hereafter enacted or amended), or otherwise, both as to action in his official
capacity and as to action in another capacity while holding such office and
shall continue as to a person who has ceased to be a director, officer, partner,
trustee, or other indemnified capacity and shall inure to the benefit of the
heirs, executors, and administrators of such a person.
Insurance. Horizon Telcom is authorized under the bylaws to purchase and
maintain insurance on behalf of any person who is or was a director, officer,
trustee, employee, or agent of the Company, or is or was serving at the request
of Horizon Telcom as a director, officer, partner, trustee, employee, or agent
of another corporation, domestic or foreign, nonprofit or for profit,
partnership, joint venture, trust, or other enterprise against any liability
asserted against him and incurred by him in any such capacity, or arising out of
his status as such, whether or not Horizon Telcom has the obligation or power to
indemnify him against such liability under the bylaws. Horizon Telcom has
purchased such insurance covering the officers and directors.
Definitions. As used in the bylaws, references to "Company" includes all
constituent corporations in a consolidation or merger and the new or surviving
corporation, so that any person who is or was a director or officer of such a
constituent corporation, or is or was serving at the request of such constituent
corporation as a director, officer, partner, trustee, or other indemnified
capacity of another corporation, domestic or foreign, nonprofit or for profit,
partnership, joint venture, trust, or other enterprise, shall stand in the same
position under this section with respect to the new or surviving corporation as
he would if he had served the new or surviving corporation in the same capacity.
HPCS
HPCS' certificate of incorporation limits the liability of HPCS directors
to the maximum extent permitted by Delaware law. HPCS' certificate of
incorporation provides that HPCS shall indemnify our directors and executive
officers and may indemnify its other officers and employees and agents and other
agents to the fullest extent permitted by law. HPCS' certificate of
incorporation also permits it to secure insurance on behalf of any officer,
director, employee or other agent for any liability arising out of actions in
his or her official capacity.
HPCS intends to enter into agreements to indemnify its directors and
officers in addition to indemnification provided for in its certificate of
incorporation. These agreements will indemnify its directors and officers for
certain expenses, including attorneys' fees, judgments, fines and settlement
amounts incurred by any of these persons in any action or proceeding, including
any action by HPCS or in its right, arising out of that person's services as a
director or officers of HPCS, any subsidiary of HPCS, or any other company or
enterprise to which the person provides services at HPCS' request. In addition,
HPCS has directors' and officers' insurance providing indemnification for
83
certain of its directors, officers and employees for these types of liabilities.
HPCS believes that these provisions, agreements and insurance are necessary to
attract and retain qualified directors and officers.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of HPCS where indemnification will be
required or permitted. We are not aware of any threatened litigation or
proceeding that might result in a claim for indemnification.
ITEM 13. Financial Statements And Supplementary Data
Our consolidated financial statements, the financial statement schedules
required to be filed with this report and the report of independent public
accountants are set forth on pages 85 through 115 below.
84
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Financial Statements As of
December 31, 2000 and 1999
And For Each of the Three Years in the Period Ended
December 31, 2000
Together With Auditors' Report
85
Report of Independent Public Accountants
To the Board of Directors and Stockholders of Horizon Telcom, INC. AND
SUBSIDIARIES:
We have audited the accompanying consolidated balance sheets of HORIZON TELCOM,
INC. (an Ohio corporation) AND SUBSIDIARIES as of December 31, 2000 and 1999,
and the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2000. 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 auditing standards generally accepted
in the United States. 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 Horizon Telcom, INC.
and Subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule on page 115 is presented for purposes
of complying with the Securities and Exchange Commission's rules and is not part
of the basic financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
/s/ ARTHUR ANDERSEN LLP
Columbus, Ohio,
February 16, 2001
86
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As Of December 31, 2000 and 1999
- --------------------------------------------------------------------------------
2000 1999
------------------ ------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 192,011,997 $ 3,790,455
Accounts receivables - subscriber, less allowance for doubtful accounts of
$1,826,000 in 2000 and $911,000 in 1999 4,527,098 1,242,100
Accounts receivable - interexchange carriers and access charge pools, less
allowance for doubtful accounts of $65,000 in 2000 and $67,000 in 1999 3,475,340 2,744,140
Receivables - other 3,327,190 1,414,864
Inventories 6,756,789 4,070,078
Taxes applicable to future years 1,441,811 1,449,127
Prepayments, investments and other 6,349,176 571,516
------------------ ------------------
Total current assets 217,889,401 15,282,280
------------------ ------------------
DEFERRED CHARGES AND OTHER ASSETS:
Unamortized debt expense 14,292,486 233,299
Prepaid pension costs 4,033,370 3,612,753
Intangibles, net 52,879,934 -
Investments 387,169 4,542,813
Other assets 1,041,280 930,385
------------------ ------------------
Total deferred charges and other assets 72,634,239 9,319,250
------------------ ------------------
PROPERTY, PLANT AND EQUIPMENT:
In service 170,960,204 111,297,730
Less - accumulated depreciation (49,027,055) (38,429,223)
------------------ ------------------
Property, plant and equipment in service, net 121,933,149 72,868,507
Construction work in progress 53,608,590 4,243,328
------------------ ------------------
Total property, plant and equipment 175,541,739 77,111,835
------------------ ------------------
Total assets $ 466,065,379 $ 101,713,365
================== ==================
(Continued on next page)
87
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Continued)
As Of December 31, 2000 and 1999
- --------------------------------------------------------------------------------
2000 1999
------------------ ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Lines of credit $ 12,767,338 $ 4,300,000
Current maturities of long-term debt 2,000,000 -
Notes payable - 1,032,000
Accounts payable 13,323,743 1,460,304
Accounts payable - interexchange carriers and access charge pools 1,763,271 1,012,355
Payable to Sprint 4,959,128 -
Accrued taxes 2,960,489 3,211,630
Accrued vacation and payroll 1,788,137 1,098,139
Other accrued liabilities 25,292,702 4,472,833
------------------ ------------------
Total current liabilities 64,854,808 16,587,261
------------------ ------------------
LONG-TERM DEBT AND OTHER LIABILITIES:
Deferred Federal income taxes, net 3,295,462 3,557,248
Deferred income 10,844,378 3,721,837
Postretirement benefit obligation 4,717,774 4,221,902
Notes payable 185,283,104 23,557,965
Senior notes 20,000,000 22,000,000
Other liabilities 264,138 373,400
------------------ ------------------
Total long-term debt and other liabilities 224,404,856 57,432,352
------------------ ------------------
MINORITY INTEREST 983,883 -
CONVERTIBLE PREFERRED STOCK 134,421,881 -
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock - class A, no par value, 200,000 shares authorized, 99,726 shares
issued, stated at $4.25 per share 423,836 423,836
Common stock - class B, no par value, 500,000 shares authorized, 299,301 and
299,178 shares issued in 2000 and 1999, respectively, stated at $4.25 per
share 1,272,029 1,271,506
Additional Paid-in Capital 64,862,430 2,311,801
Deferred compensation (1,503,889) (2,177,897)
Retained earnings (deficit) (17,029,493) 25,864,506
Treasury stock - 43,947 shares at cost (6,624,962) -
----------------- -----------------
Total stockholders' equity 41,399,951 27,693,752
------------------ ------------------
Total liabilities and stockholders' equity $ 466,065,379 $ 101,713,365
================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
88
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31, 2000, 1999 and 1998
- --------------------------------------------------------------------------------
2000 1999 1998
------------------ ------------------ ------------------
OPERATING REVENUES:
Basic local and long-distance service $ 16,785,027 $ 16,438,381 $ 16,447,056
Network access 17,275,754 17,508,729 15,627,492
Internet access services 3,356,337 3,073,729 2,063,445
Equipment systems sales, information services, and paging
services and other revenues 6,330,956 6,733,059 6,266,601
Personal Communications Services revenue 24,728,376 3,916,032 456,318
PCS equipment sales 3,036,022 600,451 308,933
------------------ ------------------ ------------------
Total operating revenues 71,512,472 48,270,381 41,169,845
------------------ ------------------ ------------------
OPERATING EXPENSES:
Cost of goods sold 10,472,130 3,472,649 1,707,309
Cost of services 35,290,010 15,129,651 11,360,391
Selling, general and administrative 48,982,950 24,580,463 18,040,307
Non-cash compensation expense 852,718 2,671 -
Depreciation and amortization 13,057,587 9,589,410 8,023,571
------------------ ------------------ ------------------
Total operating expenses 108,655,395 52,774,844 39,131,578
------------------ ------------------ ------------------
OPERATING INCOME (LOSS) (37,142,923) (4,504,463) 2,038,267
------------------ ------------------ ------------------
NONOPERATING INCOME (EXPENSE):
Loss on disposition of Personal Communication Licenses - - (1,716,535)
Gain on sale of PCS assets - 1,387,718 -
Gain on exchange of stock 11,550,866 - -
Subsidiaries preferred stock dividends (2,782,048) - -
Minority interest in loss 2,301,344 - -
Interest income and other, net 4,734,949 75,091 30,230
------------------ ------------------ ------------------
Total nonoperating income (expense) 15,805,111 1,462,809 (1,686,305)
------------------ ------------------ ------------------
INCOME (LOSS) BEFORE INTEREST EXPENSE (21,337,812) (3,041,654) 351,962
INTEREST EXPENSE 12,193,821 3,598,275 2,359,049
------------------ ------------------ ------------------
LOSS BEFORE INCOME TAX (EXPENSE) BENEFIT (33,531,633) (6,639,929) (2,007,087)
INCOME TAX (EXPENSE) BENEFIT (3,163,606) 2,158,831 800,004
------------------ ------------------ ------------------
LOSS BEFORE EXTRAORDINARY ITEMS (36,695,239) (4,481,098) (1,207,083)
EXTRAORDINARY LOSS, NET OF TAX (486,323) - -
------------------ ------------------ ------------------
NET LOSS $ (37,181,562) $ (4,481,098) $ (1,207,083)
================== ================== ==================
Basic and diluted loss per share before extraordinary item $ (105.98) $ (11.23) $ (3.03)
Basic and diluted loss per share from extraordinary item (1.41) - -
------------------ ------------------ ------------------
Basic and diluted loss per share $ (107.39) $ (11.23) $ (3.03)
================== ================== ==================
Weighted average shares outstanding 346,237 398,904 398,904
================== ================== ==================
The accompanying notes are an integral part of these consolidated financial
statements.
89
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2000, 1999 and 1998
- --------------------------------------------------------------------------------
class A class B Additional Deferred Retained Total
common common Treasury Paid-in Stock Earnings Stockholders'
stock stock Stock Capital Compensation (Deficit) Equity
----------- ------------ ------------ -------------- -------------- -------------- --------------
Balance, December 31, 1997 $ 423,836 $ 1,271,506 $ - $ 131,233 $ - $ 35,182,715 $ 37,009,290
Dividends - - - - - (1,815,014) (1,815,014)
Net loss - - - - - (1,207,083) (1,207,083)
----------- ------------ ------------ -------------- -------------- -------------- --------------
Balance, December 31, 1998 423,836 1,271,506 - 131,233 - 32,160,618 33,987,193
Dividends - - - - - (1,815,014) (1,815,014)
Deferred stock compensation - - - 2,180,568 (2,180,568) - -
Stock option compensation
expense - - - - 2,671 - 2,671
Net loss - - - - - (4,481,098) (4,481,098)
----------- ------------ ------------ -------------- -------------- -------------- --------------
Balance, December 31, 1999 423,836 1,271,506 - 2,311,801 (2,177,897) 25,864,506 27,693,752
Acquisition of treasury
stock - - (11,835,000) - - - (11,835,000)
Acquisition of BPCS - - 4,786,800 33,999,532 - - 38,786,332
Issuance of warrants - - - 33,600,647 - - 33,600,647
Stock issuance costs - - - (234,464) - - (234,464)
Stock option compensation
expense - - - 178,710 674,008 - 852,718
Exercise of stock options - 523 - 6,857 - - 7,380
Stock dividends paid - - 473,100 - - (1,529,072) (1,055,972)
Tax on dividend - - - - - (4,256,818) (4,256,818)
Dividends paid - - - - - (1,793,038) (1,793,038)
Stock dividends received - - (49,862) - - - (49,862)
Minority interest
adjustment - - - (5,000,653) - 1,866,491 (3,134,162)
Net loss - - - - - (37,181,562) (37,181,562)
----------- ------------ ------------ -------------- -------------- -------------- --------------
Balance, December 31, 2000 $ 423,836 $ 1,272,029 $(6,624,962) $ 64,862,430 $ (1,503,889) $ (17,029,493) $ 41,399,951
=========== ============ ============ ============== ============== ============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
90
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2000, 1999 and 1998
- --------------------------------------------------------------------------------
2000 1999 1998
------------------ ------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (37,181,562) $ (4,481,098) $ (1,207,083)
------------------ ------------------ ------------------
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities, net of effect of acquisition:
Depreciation and amortization 13,057,587 9,589,410 8,038,493
Deferred Federal income taxes (261,786) (1,216,364) 102,931
Deferred investment tax credits (69,635) (82,036) (98,402)
Extraordinary loss 486,323 - -
Non-cash compensation expense 852,718 2,671 -
Non-cash interest expense 5,635,498 - -
Non-cash gain on exchange of stock (11,550,866) - -
Loss on disposition of Personal Communications Licenses - - 1,716,535
(Gain) loss on disposal of fixed assets 21,277 (5,206,286) 114,907
Non-cash preferred stock dividend of subsidiary 2,782,048 - -
Minority interest in subsidiary (2,301,344) - -
Uncollectable operating revenues 2,487,170 1,136,099 348,562
(Increase) decrease in certain assets:
Accounts receivable (8,387,769) (261,645) (1,693,444)
Inventories (2,707,991) (271,432) (916,297)
Prepaid pension costs (420,617) (720,765) (726,556)
Prepayments, investments and other (2,864,492) (154,586) 122,963
Increase (decrease) in certain liabilities:
Accounts payable 10,529,126 (605,579) (8,753,598)
Deferred income 6,911,554 3,721,837 -
Other accrued liabilities 22,145,267 3,934,096 39,183
Postretirement benefit obligation 495,872 737,838 813,054
Change in other assets and liabilities, net (138,290) (21,231) 359,992
------------------ ------------------ ------------------
Total adjustments 36,701,650 10,582,027 (531,677)
------------------ ------------------ ------------------
Net cash provided by (used in) operating activities (479,912) 6,100,929 (1,738,760)
------------------ ------------------ ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net (101,491,729) (17,799,773) (15,984,218)
Proceeds from sale of fixed assets 834,000 20,450,000 -
Net cash acquired in acquisition of BPCS (Note 2) 4,926,803 - -
Investment in joint venture (1,032,000) (2,068,000) -
------------------ ------------------ ------------------
Net cash provided by (used in) investing activities $ (96,762,926) $ 582,227 $ (15,984,218)
------------------ ------------------ ------------------
(Continued on next page)
91
HORIZON TELCOM, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
For the Years Ended December 31, 2000, 1999 and 1998
- --------------------------------------------------------------------------------
2000 1999 1998
------------------ ------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Notes and term loans payable - borrowings, net of
repayments $ 185,321,607 $ (5,641,354) $ 17,953,712
Exercise of stock options 7,380 - -
Issuance of preferred stock 126,500,000 - -
Deferred financing fees (15,410,327) - -
Stock issuance costs (9,161,242) - -
Dividends paid (1,793,038) (1,815,014) (1,815,014)
------------------ ------------------ ------------------
Net cash (used in) provided by financing activities 285,464,380 (7,456,368) 16,138,698
------------------ ------------------ ------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 188,221,542 (773,212) (1,584,280)
CASH AND CASH EQUIVALENTS, beginning of year 3,790,455 4,563,667 6,147,947
------------------ ------------------ ------------------
CASH AND CASH EQUIVALENTS, end of year $ 192,011,997 $ 3,790,455 $ 4,563,667
================== ================== ==================
Cash paid during the year for:
Interest, net of amounts capitalized $ 4,330,600 $ 3,569,284 $ 3,569,284
Income taxes 9,078,515 3,278,100 3,278,100
NONCASH TRANSACTIONS:
The purchase of the Company's common stock (Note 13) was financed through a
$13,000,000, one year, unsecured 13% senior subordinated promissory note to a
third party lender. The lender converted 100% of the outstanding principal and
interest into HPCS' convertible preferred stock valued at $14,066,611 (Note 11).
The proceeds from the issuance of the discount notes have been allocated to
long-term debt and the value of the warrants ($20,245,000 or $5.32 per share)
has been allocated to additional paid-in capital (Note 8).
HPCS agreed to grant to Sprint PCS warrants to acquire 2,510,460 shares of HPCS'
class A common stock, valued at $13,356,000, in exchange for the right to
service PCS markets in additional areas (Note 14).
During 2000, 1999 and 1998, the Company incurred approximately $1,718,000,
$118,900 and $731,000, respectively, of additional debt related to the purchase
of Rural Telephone Finance Cooperative subordinated capital certificates (Note
5).
During 1999, HPCS had outstanding notes payable totaling $1,032,000 related to
the investment in joint venture.
During 1998, the Company returned the majority of its personal communications
licenses to the FCC which eliminated the associated debt of approximately
$10,116,000.
The accompanying notes are an integral part of these consolidated financial
statements.
92
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies
Business Organization and Principles of Consolidation
The accompanying consolidated financial statements reflect the operations
of Horizon Telcom, Inc. (the Company) and its subsidiaries, The Chillicothe
Telephone Company (CTC), Horizon PCS, Inc. (HPCS), Horizon Services, Inc.
(Services), and United Communications, Inc. (United). All material
intercompany transactions and balances have been eliminated in
consolidation.
On April 26, 2000, Horizon Telcom, Inc. formed HPCS, Inc. On June 27, 2000,
Horizon Telcom, Inc. transferred 100% ownership of Horizon Personal
Communications, Inc. (HPC) to HPCS in exchange for 53,806,200 shares of
stock of HPCS. This transfer was accounted for as a reorganization of
companies under common control in a manner similar to a
pooling-of-interests in the consolidated financial statements. HPC will
continue to exist and conduct business as a wholly-owned subsidiary of
HPCS.
The Company is a facilities-based telecommunications carrier that provides
a variety of voice and data services to commercial, residential/small
business and local market segments. The Company provides landline telephone
service, VDSL television service, and Internet access services to the
southern Ohio region, principally in and surrounding Chillicothe, Ohio. The
Company also provides PCS operations to a twelve state region in the
Midwest, including Ohio, Indiana, Virginia, and West Virginia, as an
affiliate of Sprint PCS (Note 4).
Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, demand deposits, money
market accounts, and investments in commercial paper with original
maturities of three months or less.
Inventories
Inventories consist of equipment held for resale, materials and supplies
and installation-related work in progress held by CTC and HPCS. CTC
inventories include the cost (determined by the first-in, first-out method)
of equipment to be used in the installation of telephone systems, as well
as costs related to direct sales orders in process. HPCS inventories
consist of handsets and related accessories which are carried at the lower
of cost (determined by the weighted average method) or market (replacement
cost).
93
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Inventories consist of the following for the years ended December 31, 2000
and 1999:
2000 1999
---------------- ----------------
Equipment held for resale $ 3,968,704 $ 2,358,518
Materials, supplies and work in progress 2,788,085 1,711,560
---------------- ----------------
Total inventories $ 6,756,789 $ 4,070,078
================ ================
Property, Plant and Equipment
Property, plant and equipment is stated at original cost. Included in the
cost of construction for the Company are items such as direct
payroll-related benefits and interest capitalized during construction.
Property, plant and equipment consists of the following for the years ended
December 31, 2000 and 1999:
2000 1999
----------------- -----------------
Land and building $ 11,324,343 $ 9,689,921
Network assets 128,213,234 80,972,128
Computer and telecommunications equipment 22,577,446 15,494,383
Furniture and office equipment 4,277,098 2,005,648
Vehicles 4,568,083 3,135,650
----------------- -----------------
Total property, plant and equipment in service 170,960,204 111,297,730
Less- accumulated depreciation (49,027,055) (38,429,223)
----------------- -----------------
Property, plant and equipment, net $ 121,933,149 $ 72,868,507
================= =================
During 1999, the Company sold certain PCS equipment, including ancillary
equipment and base stations, to an external third party. The sale resulted
in a gain of approximately $1,388,000, which is included in the Company's
consolidated statement of operations.
Depreciation
CTC provides for depreciation under the straight-line method using rates
based on the estimated service lives of the various classes of property.
The provisions were equivalent to an annual rate of approximately 7.1% and
6.9% of the average depreciable property cost for 2000 and 1999,
respectively.
In 1996, the Public Utilities Commission of Ohio (PUCO) approved CTC's
application to increase annual depreciation rates and to amortize an
estimated depreciation reserve deficiency of approximately $4,600,000 over
a five year period beginning January 1, 1996. Amortization of the
depreciation reserve deficiency was approximately $740,000, $798,000 and
$732,000 during 2000, 1999 and 1998, respectively. This deficiency was
fully amortized as of December 31, 2000.
In 1998, CTC retired its 1210 digital switch upon completion of the
conversion to a new EWSD digital switch. In 1998, the PUCO approved the
Company's application to amortize the remaining undepreciated cost of the
1210 digital switch of approximately $1,344,000 over a five year period
beginning April 1, 1998. Amortization of the switch was approximately
$269,000, $267,000 and $208,000 in 2000, 1999 and 1998, respectively. The
remaining unamortized balance was approximately $598,000 and $867,000 as of
December 31, 2000 and 1999, respectively, and is included in other assets
on the accompanying consolidated balance sheet.
94
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
HPCS, Services and United provide for depreciation and amortization under
the straight-line method based on the estimated service lives of the
various classes of property. Estimated useful lives are as follows:
Years
-----------
Network assets 5-15
Furniture and office equipment 5
Computer equipment 3-5
Vehicles 5
Debt Issuance Costs
In connection with the issuance of long-term debt discussed in Note 8, the
Company has incurred a total of $14,331,000 in deferred financing costs in
2000. These debt issuance costs are amortized using the effective interest
method over the term of the underlying obligation, ranging from eight to
ten years. For the years ended December 31, 2000, 1999 and 1998, $726,000,
$23,000 and $20,000 of amortization on debt issuance costs were included in
interest expense.
Revenue Recognition
CTC is an independent local exchange carrier that provides local telephone
service within ten local exchanges, servicing approximately 37,800
customers.
CTC follows an access charge system as ordered by the FCC and the PUCO in
1984. The access charge methodology provides a means whereby local exchange
carriers, including CTC, provide their customers access to the facilities
of the long-distance carriers and charge long-distance carriers for
interconnection to local facilities.
The PUCO issued an Opinion and Order effective January 1, 1988 for
reporting intraLATA toll revenues. This methodology is defined as the
Originating Responsibility Plan with a Secondary Carrier Option (ORP-SCO).
This plan calls for one or more primary carriers in each LATA with other
local exchange carriers acting as secondary carriers. The secondary
carriers provide the primary carrier with access to local facilities and
are compensated based upon applicable intraLATA access charge tariffs. CTC
is a primary carrier. IntraLATA toll revenue is reflected in basic and
long-distance service revenue on the accompanying consolidated statements
of operations.
CTC recognizes revenue for billing and collection services performed on
behalf of certain interexchange carriers. CTC also recognizes advertising
revenues from its telephone directory. These items are recorded in other
revenues on the accompanying consolidated statements of operations.
CTC recognizes revenues on the completed contract basis for the
installation of telecommunication and other related equipment. Maintenance
revenues are recognized over the life of the contract, and recorded as
equipment systems sales.
HPCS is a non-regulated entity that provides wireless personal
communications services (Note 4). HPCS sells handsets and accessories which
are recorded at the time of the sale as equipment revenue. After the
handset has been purchased, the subscriber purchases a service package
which is recognized monthly as service is provided and is included as
95
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Personal Communications Service revenue. Roaming revenue is recorded when
Sprint PCS subscribers, other Sprint PCS affiliate subscribers and
non-Sprint PCS subscribers roam onto HPCS' network.
HPCS began charging activation fees in 2000. The accounting policy for the
recognition of activation fee revenue is to record the revenue over the
periods such revenue is earned in accordance with the current
interpretations of SEC Staff Accounting Bulletin No. 101 (SAB 101), Revenue
Recognition in Financial Statements. Accordingly, activation fee revenue
and direct customer activation expense has been deferred and will be
recorded over the average life for those customers (36 months) that are
assessed an activation fee. As of December 31, 2000, the Company has
recognized approximately $47,000 of activation fee revenue and has deferred
$393,000 of activation fee revenue and direct customer activation expense.
An affiliation fee of 8% of collected personal communications service
revenues from Sprint PCS subscribers based in the Company's territory,
excluding outbound roaming, and from non-Sprint PCS subscribers who roam
onto the Company's network, is accrued as services are provided and
remitted to Sprint PCS and recorded as cost of service. Revenues generated
from the sale of handsets and accessories, inbound and outbound Sprint PCS
roaming fees, and from roaming services provided to Sprint PCS customers
who are not based in the Company's territory are not subject to the 8%
affiliation fee.
Certain of the personal communications equipment sales are made through
independent distributors under agreements allowing the right of return on
merchandise not sold by the distributors. The Company defers recognition of
such sales until the merchandise is sold by the distributors.
United is an FCC licensed radio common carrier that provides primarily
Internet access services and wireless transmission service relating to
mobile telephones and analog and digital paging services in the state of
Ohio, as well as reselling long-distance services. Revenues on equipment
sales are recognized at the time of sale. Revenues for the Internet and
paging service are recognized monthly as service is rendered. In December
2000, United sold the assets of its paging business to an unrelated third
party and recognized a loss of approximately $230,000.
Minority Interest
As part of the acquisition of Bright Personal Communication Services, LLC
(BPCS) (Note 2), the former members of BPCS have a 7.974% ownership in
HPCS. The Company accounts for this ownership by recording the portion of
net income (loss) attributable to the minority shareholders ($2,301,344
loss in 2000) as minority interest in earnings (loss) in the accompanying
consolidated statement of operations. Minority interest in the underlying
equity of HPCS is $983,883 as of December 31, 2000.
Advertising Costs
Costs related to advertising and other promotional expenditures are
expensed as incurred. Advertising costs totaled approximately $4,645,000,
$1,207,000 and $636,000 for the years ended December 31, 2000, 1999, and
1998, respectively.
Stock Based Compensation
The Company accounts for compensation cost associated with its stock
compensation plans for employees in accordance with APB Opinion No. 25,
Accounting for Stock Issued to Employees. The Company applies SFAS No. 123,
Accounting for Stock Based Compensation and related interpretations, for
options granted to non-employees.
96
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Federal Income Taxes
The Company accounts for income taxes pursuant to the requirements of SFAS
No. 109, Accounting for Income Taxes. Under SFAS No. 109, deferred tax
assets and liabilities are determined based on differences between the
financial reporting and tax basis of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when
the differences are expected to reverse. Deferred tax assets and
liabilities are adjusted for future changes in tax rates.
Investment tax credits have been deferred and are being amortized over the
estimated service lives of the related property.
Concentration of Credit Risk
The Company maintains cash and cash equivalents in an account with a
financial institution in excess of the amount insured by the Federal
Deposit Insurance Corporation. The financial institution is one of the
largest banks in the United States and management does not believe there is
significant credit risk associated with deposits in excess of federally
insured amounts.
Further, the Company maintains accounts with nationally recognized
investment managers. Such deposits are not insured by the Federal Deposit
Insurance Corporation. Management does not believe there is significant
credit risk associated with these uninsured deposits.
Other financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of accounts receivable. The
risk is limited due to the large number of customers comprising the
Company's customer base.
Deferred Income
During 2000, HPCS received approximately $7,200,000 of site bonuses from
SBA, which constructs towers leased by HPCS. HPCS has entered into ten year
leases of these towers and therefore recognizes the site bonus over the
life of the respective lease. The amortization of the site bonus is
recorded as a reduction to lease expense. For the year ended December 31,
2000, HPCS had reduced lease expense by approximately $320,000 related to
amortization of the site bonus.
In October 1999, the Company sold all of its towers, including both
in-service property and construction work in progress, to an external third
party. The towers were then leased back by HPCS (Note 16). The gain on the
sale of the towers was $3,817,269. Since this transaction is classified as
a sale-leaseback, the gain was deferred and is being recognized over the
ten-year term of the operating lease. Amortization of the gain recognized
during 2000 and 1999 totaled approximately $381,000 and $95,000,
respectively, and is offsetting the related lease expense.
Net Loss per Share
The Company computes net loss per common share in accordance with SFAS No.
128, Earnings per Share and SEC Staff Accounting Bulletin No. 98. Basic and
diluted loss per share is computed by dividing loss, for each period, by
the weighted-average outstanding common shares. No conversion of common
stock equivalents (stock options granted by the Company, Note 15) has been
assumed in the calculations since the effect would be antidilutive. As a
result, the number of weighted-average outstanding common shares as well as
the amount of net loss per share are the same for basic and diluted net
loss per share calculations for all periods presented. As further discussed
97
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
in Notes 11, 14 and 15, HPCS has issued stock options, stock purchase
warrants and convertible preferred stock, which may impact minority
interest and the related earnings or loss of the Company.
Issued Accounting Pronouncements
On July 8, 1999, the Financial Accounting Standards Board (FASB) issued
SFAS No. 137, Deferral of the Effective Date of SFAS 133. SFAS No. 137
defers the effective date of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting
for Certain Derivative Instruments and Certain Hedging Activities, to all
fiscal quarters of all fiscal years beginning after June 15, 2000. The
adoption did not have a material effect on the Company's consolidated
results of operations, financial position, or cash flows.
Reclassifications
Certain prior year amounts have been reclassified to conform with the 2000
presentation.
(2) Acquisitions
During 1999 HPCS entered into a joint venture agreement through the
purchase of 25.6% of Bright Personal Communications Services, LLC (BPCS).
The investment was accounted for under the equity method. The joint venture
was established in October 1999 to provide personal communications services
in Ohio, Indiana, and Michigan.
On June 27, 2000, HPCS acquired the remaining 74.4% of BPCS in exchange for
approximately 8% of HPCS' class B common stock (4,678,800 shares valued at
approximately $34,000,000) and approximately 40% of the Horizon Telcom,
Inc. common stock owned by HPCS (31,912 shares valued at $15,300,000) (Note
13).
This acquisition was treated as a purchase for accounting purposes. The
consolidated statement of operations includes the results of BPCS from June
28, 2000.
In conjunction with this transaction, HPCS also acquired the BPCS
management agreement with Sprint PCS and, with it, the right to operate
using Sprint PCS licenses in BPCS' markets. HPCS has recognized an
intangible asset totaling $33,000,000 related to this licensing agreement
which will be amortized over 20 years, the initial term of the underlying
management agreement. Amortization commenced in June 2000. Amortization
expense for the year ended December 31, 2000 is $867,672.
The purchase price, as preliminarily allocated, exceeds the fair market
value of the net assets acquired by approximately $7,778,000. The resulting
goodwill will be amortized on a straight-line basis over 20 years.
Amortization commenced in June 2000. Amortization expense for the year
ended December 31, 2000 is $197,685.
The preliminary purchase price allocation of the fair value of assets
acquired and liabilities assumed is summarized below:
Working capital $ 2,072,000
Property and equipment 6,328,000
Sprint PCS licenses 33,000,000
Goodwill 7,777,752
Other assets 122,000
98
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
The following unaudited pro forma summary presents the net revenues, net
loss and loss per share from the combination of the Company and BPCS, as if
the acquisition had occurred at the beginning of the 2000 and 1999 fiscal
years. The pro forma information is provided for information purposes only.
It is based on historical information and does not necessarily reflect the
actual results that would have occurred nor is it necessarily indicative of
the future results of operations of the combined enterprise:
Year Ended December 31,
--------------------------------------
2000 1999
----------------- ----------------
Net revenue $ 71,007,355 $ 48,197,380
Net loss (37,624,343) (4,603,448)
Basic and diluted per share (108.67) (11.54)
Prior to acquisition, BPCS had not commenced revenue-generating operations
and was paying a management fee to its investor, HPCS. The management fee
recognized by HPCS in the period prior to the acquisition date is included
in net revenue. In the pro forma disclosure above, this management fee
revenue is fully eliminated.
(3) Segment Information
The Company adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 requires companies to
define and report financial and descriptive information about its operating
segments. The Company is organized based on the services it offers. Under
this organizational structure, the Company operates in two business
segments: landline telephone services and wireless personal communications
services.
The Company evaluates the performance of the segments based on operating
earnings before the allocation of administrative expenses. Information
about interest income and expense, and income taxes is not provided on a
segment level. The accounting policies of the segments are the same as
described in the summary of significant accounting policies. Corporate
assets represent assets maintained by services for the benefit of all
segments.
The following table includes revenue, operating earnings, capital
expenditures and depreciation and amortization expense for the fiscal years
ended December 31, 2000, 1999 and 1998 and assets as of December 31, 2000
and 1999 for each segment and reconciling items necessary to total to
amounts reported in the financial statements:
Net Revenues
-------------------------------------------------------
2000 1999 1998
---------------- ---------------- ---------------
Landline telephone services $ 34,060,781 $ 33,947,110 $ 32,074,548
Personal communications services 27,764,398 4,516,483 765,251
Other 9,687,293 9,806,788 8,330,046
---------------- ---------------- ---------------
Total net revenue $ 71,512,472 $ 48,270,381 $ 41,169,845
================ ================ ===============
99
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Operating Earnings (Loss)
--------------------------------------------------------
2000 1999 1998
---------------- ---------------- ----------------
Landline telephone services $ 11,339,372 $ 12,258,313 $ 12,829,046
Personal communications services (39,558,604) (11,811,014) (7,810,179)
Other 725,860 2,298,116 2,359,765
Unallocated administrative expenses (9,649,551) (7,249,878) (5,340,365)
---------------- ---------------- ----------------
Total operating earnings (loss) $ (37,142,923) $ (4,504,463) $ 2,038,267
================ ================ ================
Depreciation and Amortization
--------------------------------------------------------
2000 1999 1998
---------------- ---------------- ----------------
Landline telephone services $ 6,313,846 $ 6,046,874 $ 5,634,296
Personal communications services 6,134,458 2,532,982 1,686,089
Other 609,283 1,009,554 703,186
---------------- ---------------- ----------------
Total depreciation and amortization $ 13,057,587 $ 9,589,410 $ 8,023,571
================ ================ ===============
Capital Expenditures
--------------------------------------------------------
2000 1999 1998
---------------- ---------------- ----------------
Landline telephone services $ 14,032,169 $ 8,803,298 $ 6,904,271
Personal communications services 83,562,958 8,640,456 8,397,182
Other 3,896,602 356,019 682,765
---------------- ---------------- ----------------
Total capital expenditures $ 101,491,729 $ 17,799,773 $ 15,984,218
================ ================ ================
Assets
-----------------------------------
2000 1999
---------------- ----------------
Landline telephone services $ 70,991,973 $ 62,432,630
Personal communications services 385,060,550 32,878,756
Other 4,711,189 1,804,237
Corporate 5,301,667 4,597,742
---------------- ----------------
Total assets $ 466,065,379 $ 101,713,365
================ ================
(4) Personal Communications Services (PCS)
In October 1996, the FCC conditionally granted HPCS licenses to provide
personal communications services in various parts of Ohio, West Virginia
and Kentucky (a total of five licenses). The FCC financed the licenses.
According to FCC rules, the licenses were conditional upon the full and
timely payment of the licenses cost. The licenses were subject to a
requirement that HPCS constructs and operates facilities that offer
coverage to a defined population within the relevant license areas within a
defined period. HPCS began the engineering and design phase in 1996 and
began the construction of the personal communications network in early
1997. HPCS began providing digital, wireless personal communications
services in August 1997.
In 1997, the FCC offered four options to certain PCS license holders to
change the payment terms of the FCC financed debt. These options were:
continuing with the current installment plan (status quo); return half of
100
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
the spectrum from any or all of the licenses in exchange for a
proportionate reduction in debt (disaggregation); turning in all licenses
in exchange for total debt forgiveness (amnesty); or prepay for as many
licenses as HPCS can afford at face value while returning other licenses in
exchange for debt forgiveness (prepayment).
During 1998, HPCS elected to return all of the spectrum from four licenses
and half of the spectrum from the fifth license. As a result of returning
the spectrum to the FCC, HPCS recognized a loss of approximately
$1,700,000. The loss primarily represents the write-off of capitalized
license bid costs and certain spectrum clearance costs, as well as the
write-down of the license retained by HPCS to its recoverable value.
In connection with the return of the spectrum, HPCS entered into management
agreements with Sprint PCS, the PCS group of Sprint Corporation, during
1998. These agreements provide HPCS with the exclusive right to build, own,
and manage a wireless voice and data services network in markets located in
Ohio, West Virginia, Kentucky, Virginia, Tennessee, and Maryland under the
Sprint PCS brand. HPCS is required to build out the wireless network
according to Sprint PCS specifications. The term of the agreements is 20
years with three successive 10-year renewal periods unless terminated by
either party under provisions outlined in the management agreements. The
management agreements commenced in June 1998, but payments of the
management fee did not commence until HPCS converted to a fully branded
Sprint PCS affiliate in October 1999. The management agreements included
indemnification clauses between HPCS and Sprint PCS to indemnify each party
against claims arising from violations of laws or the management
agreements, other than liabilities resulting from negligence or willful
misconduct of the party seeking to be indemnified.
In May 2000, HPCS expanded its management agreement with Sprint PCS. This
allows HPCS to have the exclusive right to build, own and manage a wireless
voice and data services network in markets located in Pennsylvania, New
York, Ohio and New Jersey.
The Sprint PCS agreements require HPCS to interface with the Sprint PCS
wireless network by building HPCS' network to operate on PCS frequencies
licensed to Sprint PCS in the 1900 MHz range. Under the Sprint PCS
agreements, HPCS has agreed to:
o construct and manage a network in HPCS' territory in compliance with
Sprint PCS' PCS licenses and the terms of the management agreement;
o distribute, during the term of the management agreement, Sprint PCS'
PCS products and services;
o conduct advertising and promotion activities in HPCS' territory; and
o manage that portion of Sprint PCS' customer base assigned to HPCS'
territory.
The management agreement specifies the terms of the Sprint PCS affiliation,
including the required network build-out plan. HPCS has agreed to operate
its network to provide for a seamless handoff of a call initiated in its
territory to a neighboring Sprint PCS network. The Sprint PCS management
agreements require HPCS to complete specified portions of its markets by
specified dates.
HPCS must comply with Sprint PCS' program requirements for technical
standards, customer service standards, national and regional distribution
and national accounts programs to the extent that Sprint PCS meets these
requirements.
A failure to meet the build-out requirements for any of HPCS' markets, or
to meet Sprint PCS' technical requirements, would constitute a breach of
the Sprint PCS agreements that could lead to their termination if not cured
101
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
within a cure period of 30 to 180 days, depending on the nature of the
breach. If Sprint PCS terminates these agreements, HPCS will no longer be
able to offer Sprint PCS products and services. Additionally, Sprint PCS
may purchase HPCS' operating assets or capital stock for 72% of the entire
business value. HPCS is currently in compliance with these requirements or
has obtained appropriate waivers from Sprint.
Expense related to the management fees charged under the agreement was
approximately $1,302,000 and $130,000 for the years ended December 31, 2000
and 1999, respectively. The management fee is determined as 8% of certain
collected personal communications services revenues (Note 1).
(5) Investments
The Company's long-term investments include the following:
2000 1999
-------------- --------------
Bright Personal Communications Services, LLC $ - $ 3,057,680
Illuminet 250,000 250,000
RTFC subordinated capital certificates - 1,177,898
Miscellaneous investments 137,169 57,235
-------------- --------------
$ 387,169 $ 4,542,813
============== ==============
As of December 31, 1999 the Company had an investment in BPCS. The Company
bought out the other members during 2000 (Note 2).
The Company holds $250,000 of the common stock in Illuminet, formerly USTN
Holdings, Inc., resulting in a 0.46% interest accounted for under the cost
method.
As part of the term loan facility for the construction of the personal
communications network (Note 8), the Company was required to purchase Rural
Telephone Finance Cooperative's (RTFC, the lender) subordinated capital
certificates with each draw on the loan. These certificates, totaling
approximately $2,895,000 as of December 31, 2000, will be redeemed by the
lender in 2001 and are recorded in prepayments, investments and other in
the accompanying consolidated balance sheet. The Company believes the
carrying value of this investment approximates fair market value.
(6) Lines of Credit
During 2000, CTC entered into an agreement with a bank for a line of credit
that provides maximum borrowings of $15,000,000, payable on demand.
Interest accrues on the outstanding balance at a fluctuating rate tied to
the LIBOR rate (8.3% as of December 31, 2000) and is due and payable
monthly. The outstanding balance at December 31, 2000 was $12,767,338. The
line of credit contains a covenant requiring minimum tangible net worth. As
of December 31, 2000, CTC was in compliance with the covenant.
During 1998, the Company entered into a revolving line of credit agreement
with a bank that provides for maximum borrowings of up to $10,000,000,
payable upon demand. The total outstanding balance as of December 31, 1999
was $4,300,000. Interest accrued at a rate determined by the bank on each
draw (7.6% at December 31, 1999) and was payable quarterly. This line of
credit was terminated when the line of credit above was originated.
102
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
The Company had a line of credit agreement with a bank that provided for
maximum borrowings of up to $4,000,000, payable upon demand. There was no
outstanding balance as of December 31, 1999. This line of credit was
terminated when the line of credit above was originated.
On September 26, 2000, HPCS entered into a $95,000,000 line of credit that
expires on September 30, 2008 as part of its senior secured credit facility
agreement (Note 8). As of December 31, 2000, HPCS had not borrowed on this
line of credit. HPCS pays an annual commitment fee of 1.375% of the unused
line at the end of each quarter. HPCS incurred $306,000 for the line of
credit commitment fee for the year ended December 31, 2000.
In May 2000, the Company entered into a $5,000,000 general corporate line
of credit with a bank, the proceeds of which were used for financing of
construction expenditures. Interest was at the bank's standard line of
credit rate plus 100 basis points and was payable quarterly beginning in
the first quarter after the initial advance. In September 2000, this line
of credit was fully repaid and terminated with the proceeds from the
financing described in Note 8 below.
In March 2000, the Company entered into a $5,000,000 interim revolving line
of credit with a bank, the proceeds of which were used for general working
capital purposes. Interest was at the bank's prevailing prime rate plus 150
basis points and was payable quarterly, beginning in the first quarter
after the initial advance. In September 2000, this line of credit was fully
repaid and terminated with the proceeds from the financing described in
Note 8 below.
(7) Short-Term Note Payable
In February 2000, HPCS purchased 78,900 shares of Horizon Telcom, Inc.
common stock from an external shareholder. This purchase was financed
through a $13,000,000, one year, unsecured 13% senior subordinated
promissory note to a third party lender. The lender converted 100% of the
outstanding principal and unpaid interest into HPCS' convertible preferred
stock on September 26, 2000, as part of HPCS' financing activities (Note
8). The value converted into convertible preferred stock was $14,066,611
(Note 11).
(8) Long-Term Debt
Scheduled maturities of long-term debt and long-term senior notes payable
are as follows:
Year Amount
------------------------------- -----------------
2001 $ 2,000,000
2002 2,000,000
2003 2,000,000
2004 2,375,000
2005 2,500,000
Thereafter 196,408,104
-----------------
207,283,104
Less: current maturities (2,000,000)
-----------------
$ 205,283,104
=================
103
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
The components of long-term debt outstanding at December 31, 2000 and 1999
are as follows:
2000 1999
---------------- -----------------
Accreted senior discount notes $ 135,283,104 $ -
Senior secured credit facility 50,000,000 -
Term loan payable - 23,557,965
Senior notes payable 20,000,000 22,000,000
---------------- -----------------
Total $ 205,283,104 $ 45,557,965
================ =================
On September 26, 2000, HPCS received $149,680,050 from the issuance of
$295,000,000 of senior discount notes due 2010. The notes accrete in value
until October 1, 2005 at a rate of 14% compounded semi-annually. Cash
interest on the notes will become payable on April 1 and October 1 of each
year, beginning on April 1, 2006. The senior discount notes include
warrants to purchase 3,805,500 shares of HPCS' class A common stock. The
warrants represent the right to purchase an aggregate of approximately 4.0%
of the issued and outstanding common stock of HPCS on a fully diluted
basis, assuming the exercise of all outstanding options and warrants to
purchase common stock and the conversion into shares of class A common
stock of the convertible preferred stock (Note 11).
The proceeds from the issuance of the discount notes were allocated to
long-term debt and the value of the warrants ($20,245,000 or $5.32 per
share) was allocated to additional paid-in capital. The fair value of the
warrants was estimated on the date of the grant using the Black-Scholes
option-pricing model with the following weighted average assumptions:
expected yield of 0.0%, a risk free interest rate of 6.5%, expected life of
10 years (equal to the term of the warrants) and a volatility of 95%.
On September 26, 2000, and concurrent with the sale of the convertible
preferred stock (Note 11) and the senior discount notes described above,
HPCS entered into a senior secured credit agreement with a financial
institution to provide an aggregate commitment, subject to certain
conditions, of up to $250,000,000 (including a $95,000,000 line of credit
described in Note 6). The credit facility bears interest at various
floating rates, which approximate one to six month LIBOR rates plus 3.5% -
4.0% (approximately 9.7% - 10.6% at December 31, 2000). At December 31,
2000, the outstanding balance on the senior secured credit agreement was
$50,000,000. HPCS pays a commitment fee of 1.375% on the unused portion of
the $250,000,000 facility. HPCS incurred a total of $680,000 of commitment
fee expense for the year ended December 31, 2000.
In connection with the acquisition of BPCS, HPCS assumed a ten-year secured
term loan totaling $35,400,000. The note was collateralized by the
equipment. In September 2000, this note was fully repaid and terminated
with the proceeds from the financing described above.
In May 2000, the Company entered into a $40,500,000 term loan facility with
a financial institution to purchase certain PCS equipment to construct
HPCS' personal communications network. Maximum advances on the note totaled
$38,475,000. This loan was secured by equipment, collateral assignments of
HPCS' tower leases, and pledges of HPCS stock and ownership interests in
BPCS. In September 2000, this loan was fully repaid and terminated with the
proceeds from the financing described above.
In December 1998, HPCS issued notes payable totaling $10,000,000 to finance
the build-out of the personal communications network and repay short-term
debt. The note was collateralized by the equipment purchased. This note was
repaid during 1999 with proceeds from the sale of the Company's PCS towers
(Note 1).
104
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
In June 1998, CTC issued Senior Notes (1998 Senior Notes) of $11,000,000
and $1,000,000 to insurance companies. Annual principal payments of
$1,200,000 begin in 2009 and continue until 2018. The interest rate on the
outstanding balance at December 31, 2000 and 1999 was 6.62%. The 1998
Senior Notes contain various financial covenants, the most restrictive
covenants being the minimum net worth requirement, the limitation of funded
debt requirement, and the restricted intercompany payments and investment
requirements. As of December 31, 2000, the Company was in compliance with
such covenants.
In November 1993, CTC issued Senior Notes (1993 Senior Notes) of $6,000,000
and $4,000,000 to insurance companies. Annual principal payments of
$2,000,000 begin in 2001 and continue until 2005. The interest rate on the
outstanding balance at December 31, 2000 and 1999 was 6.72%. The 1993
Senior Notes contain various financial covenants, the most restrictive
covenants being the minimum net worth requirement, the limitations on
funded debt requirement, and the restricted intercompany payments and
investment requirements. As of December 31, 2000, the Company was in
compliance with such covenants.
In August 1997, HPCS entered into a term loan facility with a bank to
purchase certain equipment to construct HPCS' personal communications
network. The note was collateralized by the same equipment. In addition,
certain obligations under this loan had been guaranteed by a third party
vendor. Maximum advances on the note total $23,557,965. As of December 31,
1999, the total outstanding balance was $23,557,965. In September 2000,
this note was fully repaid and terminated with the proceeds from the senior
secured credit agreement discussed above.
In October 1996, the FCC granted HPCS personal communications services
licenses. The licenses were financed through the FCC. The total amount
financed was $10,115,618 at December 31, 1997. The total debt was
eliminated during 1999 when HPCS returned the licenses to the FCC (Note 4).
In October 1994, the Company issued notes payable totaling $500,000 to
purchase United. The notes matured at $100,000 per year beginning in 1995.
The final payment on this note was made in 1999.
(9) Federal Income Taxes
The Company's Federal income tax expense (benefit) consists of:
Year Ended December 31,
-------------------------------------------------------
2000 1999 1998
----------------- --------------- ---------------
Current payable $ 3,495,027 $ (1,593,268) $ (883,803)
Deferred taxes (261,786) (483,527) 182,202
Investment tax credit (69,635) (82,036) (98,403)
----------------- --------------- ---------------
3,163,606 (2,158,831) (800,004)
Extraordinary loss:
Current payable (261,863) - -
----------------- --------------- ---------------
Total tax expense (benefit) $ 2,901,743 $ (2,158,831) $ (800,004)
================= =============== ===============
105
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
The Company's Federal income tax expense is computed as follows:
Year Ended December 31,
------------------------------------------------------
2000 1999 1998
----------------- --------------- --------------
Tax at statutory rate applied to pretax book loss $ (11,566,105) $ (2,356,633) $ (682,409)
Increase (decrease) in tax from:
Investment tax credits (69,635) (82,036) (98,403)
Change in valuation allowance 2,385,097 237,519 -
Non-deductible goodwill amortization 302,968 - -
Tax on interest on warrants 177,210 - -
Non-deduct stock option compensation 171,571 - -
Tax on excess loss account 11,463,395 - -
Tax on rate difference 102,205 - -
Other, net 196,900 42,319 (19,192)
----------------- --------------- --------------
Total tax expense (benefit) $ 3,163,606 $ (2,158,831) $ (800,004)
================= =============== ==============
Deferred income taxes result from temporary differences between the
financial reporting and tax basis amounts of existing assets and
liabilities. The source of these differences and tax effect of each are as
follows:
2000 1999 1998
--------------- --------------- ---------------
Deferred income tax assets:
Uncollectible accounts $ 601,944 $ 332,577 $ 256,843
Vacation 416,915 280,670 272,767
Pensions and other retirement benefits 895,820 712,061 465,006
Personal Communication Services Licenses and
start-up costs 654,293 381,276 476,387
Net operating loss carryforward - 903,292 -
Deferred gain on sale of fixed assets 1,415,488 1,016,036 -
Deferred income 2,479,716 - -
Interest expense on senior discount notes 1,880,148 - -
Other 389,513 256,459 -
--------------- --------------- ---------------
Total deferred income tax assets $ 8,733,837 $ 3,882,371 $ 1,471,003
=============== =============== ===============
Deferred income tax liabilities:
Property differences $ (8,821,255) $ (6,826,487) $ (5,871,315)
Other (585,428) (375,613) (373,300)
--------------- --------------- ---------------
Total deferred income tax liabilities $ (9,406,683) $ (7,202,100) $ (6,244,615)
=============== =============== ===============
Deferred income taxes, net $ (672,846) $ (3,319,729) $ (4,773,612)
Less: valuation allowance (2,622,616) (237,519) -
--------------- --------------- ---------------
Total deferred income taxes, net $ (3,295,462) $ (3,557,248) $ (4,773,612)
=============== =============== ===============
106
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Until September 26, 2000, HPCS was included in the consolidated federal
income tax return of the Horizon Telcom affiliated group. HPCS provided for
federal income taxes on a pro-rata basis, consistent with a consolidated
tax sharing agreement. As a result of the sale of the convertible preferred
stock, HPCS will not be able to participate in the tax sharing agreement
nor the filing of a consolidated federal income tax return with the Horizon
Telcom affiliated group. Thus, HPCS will file a separate federal income tax
return for the period after deconsolidation through December 31, 2000, and
for all subsequent periods.
The Company's consolidated income tax expense for the year was $2,901,743.
This expense was primarily a result of the recognition by HPCS of an excess
loss account on the deconsolidation from the Horizon Telcom affiliated
group and valuation reserves established against deferred tax assets of
HPCS.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some or all of the assets will not
be realized. Management considers, among other things, the scheduled
reversal of deferred tax assets and liabilities and estimates of future
taxable income in making this assessment. The Company has provided a
valuation allowance of $2,622,616 and $237,519 as of December 31, 2000 and
1999, respectively, against the deferred tax assets of HPCS.
HPCS also generated a tax of $4,256,818 on the stock dividend of 10% of the
Horizon Telcom stock held by HPCS (Note 13). The tax on the stock dividend
was charged directly to equity and not recorded as income tax expense.
As a result of HPCS' deconsolidation from the Horizon Telcom affiliated
group for tax purposes, the consolidated financial statements will not
reflect the tax benefit of future operating losses of HPCS until such time
as its operations become profitable.
(10) Pension Plans and Other Retirement Benefits
In December 1998, the Company adopted SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." This Statement revises
employers' disclosures about pension and other postretirement benefit plans
but does not change the measurement or recognition of costs associated with
those plans. It standardizes the disclosure requirements, eliminates
certain disclosures and requires additional information on changes in the
benefit obligations and fair values of plan assets that will facilitate
financial analysis. SFAS No. 132 supersedes the disclosure requirements of
SFAS No. 87, "Employers' Accounting for Pensions" and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions."
The pension and postretirement plans discussed below are maintained by
Horizon Telcom, Inc. Each subsidiary is charged for each plan based on its
employee participation in the respective plans.
Horizon Telcom, Inc. has two trusteed pension plans covering certain
salaried and hourly employees. The Company's funding policy is to be in
compliance with the Employee Retirement Income Security Act guidelines. The
plans' assets consist primarily of investments in common stocks, bonds,
notes, cash equivalents and life insurance policies.
In addition, Horizon Telcom, Inc. provides coverage of postretirement
medical, prescription drug, telephone service, and life insurance benefits
to eligible retirees whose status, at retirement from active employment,
qualifies for postretirement benefits. Coverage of postretirement benefits
is also provided to totally and permanently disabled active employees whose
status, at disablement, qualifies for postretirement benefits as a retiree
from active employment (retired disabled). Horizon Telcom, Inc. also
provides coverage of postretirement dental and vision benefits to certain
"enhanced" retirees. No future retirees will receive coverage of
postretirement dental and vision benefits.
107
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Certain eligible retirees are required to contribute toward the cost of
coverage under the postretirement health care and telephone service
benefits plans. No contribution is required for coverage under the
postretirement life insurance benefits plan.
The funding status of Horizon Telcom, Inc.'s consolidated Plans as of
December 31, 2000 and 1999 is as follows:
Pension Benefits Other Benefits
-------------------------- -------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
(in thousands)
Change in benefit obligation
Benefit obligation, beginning of year $ 11,783 $ 12,284 $ 7,747 $ 8,598
Service cost 343 346 163 234
Interest cost 1,015 898 399 480
Actuarial (gain) or loss 1,426 (1,212) (2,495) (1,358)
Benefits paid (620) (533) (190) (207)
Change in Plan provisions 288 - - -
----------- ----------- ----------- -----------
Benefit obligation, end of year 14,235 11,783 5,624 7,747
----------- ----------- ----------- -----------
Change in plan assets
Fair value of plan assets, beginning of year 18,146 18,432 - -
Actual return on plan assets 1,839 190 - -
Employer contributions 15 57 190 207
Benefits paid (620) (533) (190) (207)
----------- ----------- ----------- -----------
Fair value of plan assets, end of year 19,380 18,146 - -
----------- ----------- ----------- -----------
Funded status 5,145 6,363 (5,624) (7,747)
Unrecognized transition obligation (35) (35) 3,224 3,455
Unrecognized prior service cost 1,136 921 - -
Unrecognized actuarial (gain) or loss (2,213) (3,636) (2,318) 70
----------- ----------- ----------- -----------
Prepaid (accrued) benefit cost $ 4,033 $ 3,613 $ (4,718) $ (4,222)
=========== =========== =========== ===========
Weighted average assumption at December 31:
Discount rate 7.5% 8.0% 7.75% 6.75%
Expected return on plan assets 10.0 10.0 - -
Rate of compensation increase 4.0 4.5 - -
The assumed medical benefit cost trend rate used in measuring the
accumulated postretirement benefit obligation was 7% in 2000, 1999 and
1998, declining gradually to 5% for the under age 65 retirees and their
spouses and 6.5% in 2000, 1999 and 1998, declining gradually to 5% for the
over age 65 retirees and their spouses. The assumed dental and vision
benefit cost trend rates used in measuring the accumulated postretirement
benefit obligation were 6% in 2000, 1999 and 1998, declining gradually to
5% for retirees and their spouses. The telephone service benefit cost trend
rate for retirees and their spouses was estimated at 5% for all future
years in 2000, 1999 and 1998.
108
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
Pension Benefits Other Benefits
--------------------------------- -----------------------------------
2000 1999 1998 2000 1999 1998
----------- ----------- -------- ----------- ----------- -----------
(in thousands)
Components of net periodic benefit cost
Service cost $ 343 $ 346 $ 317 $ 163 $ 234 $ 259
Interest cost 1,015 898 838 399 480 541
Expected return on plan assets (1,785) (1,812) (1,560) - - -
Amortization of transition obligation - - - 230 230 230
Amortization of prior service cost 73 73 73 - - -
Recognized net actuarial gain (loss) (50) (154) (132) (128) - 38
----------- ----------- -------- ----------- ----------- -----------
Net periodic benefit cost $ (404) $ (649) $ (464) $ 664 $ 944 $ 1,068
=========== =========== ======== =========== =========== ===========
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change
in assumed health care cost trend rates would have the following effects
(in thousands):
1-Percentage-Point 1-Percentage
Increase Point Decrease
----------------- -----------------
Effect on total of service and interest cost
components $ 102 $ (81)
Effect on postretirement benefit obligation 881 (716)
Horizon Telcom, Inc. also has two defined contribution plans covering
eligible CTC and Services salaried and hourly employees. HPCS employees
were eligible to participate in Horizon Telcom's plan in 1999 and 1998. The
plans provide for participants to defer up to 19% of their annual
compensation as contributions to the plans. Horizon Telcom, Inc. matches a
participant's contributions equal to 25% of each participant's salary
deferral up to a maximum of 1% of a participant's compensation.
The Company's contributions to these plans were approximately $87,900,
$82,400 and $73,000 for 2000, 1999 and 1998, respectively, and are included
in selling, general and administrative expense of the Company.
In May 1999, HPCS adopted a defined contribution plan covering certain
eligible employees of HPCS. The plan provides for participants to defer up
to 15% of the annual compensation, as defined under the plan, as
contributions to the plan. HPCS has the option, at the direction of the
Board of Directors, to make a matching contribution to the plan. A matching
contribution of approximately $61,000 was made during 1999.
(11) Convertible Preferred Stock
HPCS has authorized 175,000,000 shares of convertible preferred stock at
$0.0001 par value. On September 26, 2000, an investor group led by Apollo
Management purchased $126,500,000 of HPCS' convertible preferred stock
(23,476,683 shares) in a private placement. Concurrent with the closing,
holders of the $14,100,000 short-term convertible note converted the
principal and unpaid interest into the same convertible preferred stock
(2,610,554 shares) purchased by the investor group. HPCS has the right,
under certain circumstances, to redeem $80,300,000 of the convertible
preferred stock on or before April 30, 2001 at 107% of the original issue
price. Holders of the convertible preferred stock have the option to
convert their shares (on a share for share basis) into class A common stock
of HPCS at any time. In addition, the convertible preferred stock converts
automatically into shares upon the completion of a public offering of
109
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
common class A stock by HPCS meeting specified criteria or upon the
occurrence of certain business combination transactions. The convertible
preferred stock pays a 7.5% stock dividend semi-annually, commencing April
30, 2001. The dividends are payable in additional preferred stock.
If HPCS has not completed either (i) a public offering of its class A
common stock in which HPCS receives at least $50,000,000 or (ii) a merger
or consolidation with a publicly listed company that has a market
capitalization of at least $100,000,000, in each case by the fifth
anniversary of the date that HPCS issued the convertible preferred stock,
the investor group may request that HPCS repurchase all of their shares of
convertible preferred stock at fair market value, as determined by three
investment banking institutions. If the investor group requests that HPCS
repurchase their convertible preferred stock and HPCS declines, HPCS will
be required to auction itself. If no bona fide offer is received upon an
auction, the repurchase right of the investor group expires. If, however, a
bona fide offer is received upon the auction, HPCS must sell or the
dividend rate on the convertible preferred stock will increase from 7.5% to
18.0% and HPCS will be required to re-auction itself annually until the
convertible preferred stock is repurchased. HPCS' new senior secured credit
facility and the senior discount notes prohibit HPCS from repurchasing any
convertible preferred stock.
Holders of HPCS' convertible preferred stock are entitled to vote on all
matters on an as-converted basis. In addition, the vote of at least a
majority of the outstanding shares of convertible preferred stock, voting
as a single class, shall be necessary for effecting or validating
significant corporate actions specified in the certificate of
incorporation.
HPCS has agreed that until the conversion of the preferred stock, HPCS will
adhere to certain restrictive covenants. Among other restrictions, the most
significant covenants relate to capital expenditures and asset sales,
restricted payments, additional debt incurrence, and equity issuance. As of
December 31, 2000, HPCS was in compliance with the covenants under the
agreement.
(12) Common Stock
In October 1999, the Company converted all of the issued and outstanding
shares of its common stock into class A common stock, without par value.
Additionally, the Company authorized a new class B common stock, consisting
of 500,000 authorized shares, at no par value.
In December 1999, the Company declared a stock split which distributed
three shares of class B common stock for each share of class A common stock
issued and outstanding at the time of the declaration. This resulted in the
issuance of 299,178 shares of class B common stock. Prior year financial
statements and loss per share data have been adjusted to reflect the above
change in shares.
Each holder of class A common stock is entitled to one vote per share.
Holders of class B common stock have no voting rights. Both classes of
common stock have equal dividend rights.
(13) Treasury Stock
In February 2000, HPCS purchased 78,900 shares of common stock of the
Company from the Company's largest unaffiliated shareholder for
$11,835,000. This represented approximately a 19.78% interest in the
Company. HPCS exchanged 40% of the shares owned (31,912 shares) as
consideration for the acquisition of BPCS (Note 2). This transaction
resulted in a gain of $10,513,200 and reduced the treasury stock to 11.78%.
110
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
On September 26, 2000, HPCS distributed 10% of its 11.78% ownership of the
Company in the form of a dividend, payable pro rata to the shareholders of
record on September 26, 2000. This transaction resulted in a gain of
$1,037,666, as part of the stock was distributed to owners other than the
Company. As a result of this dividend and the remaining 2% held by HPCS,
the Company has 10,993 shares of class A and 32,954 shares of class B
common stock held as treasury shares at December 31, 2000.
(14) Sprint Warrants
HPCS agreed to grant to Sprint PCS warrants to acquire 2,510,460 shares of
its class A common stock in exchange for the right to service PCS markets
in additional areas. By September 30, 2000, Sprint had substantially
completed its obligations under the agreement and HPCS had completed the
required purchase of certain Sprint Assets. HPCS valued the warrants and
recorded an intangible asset of approximately $13,356,000 (based on a share
price of $5.32 per share, valued using the Black-Scholes pricing model
using an expected dividend yield of 0.0%, a risk-free interest rate of
6.5%, expected life of 10 years and a volatility of 95%). The intangible
asset is being amortized over the remaining term of the Sprint PCS
management agreement, resulting in approximately $752,000 of amortization
expense per year. Amortization expense for the year ended December 31, 2000
was approximately $188,000. The warrants will be issued to Sprint at the
earlier of an initial public offering of HPCS' common stock or July 31,
2003.
(15) Incentive Stock Plan
In November 1999, the Company adopted the 1999 Stock Option Plan (the
Plan). The Plan is intended to provide officers and other employees of the
Company and any of its related corporations with opportunities to purchase
stock pursuant to the grant of options (incentive stock options).
Additionally, the Plan is intended to provide directors, officers and
employees of, and service providers to, the Company and any of its related
corporations with opportunities to purchase stock pursuant to the grant of
options (nonqualified stock options).
The Company may grant options for up to 10,000 shares of class B common
stock. An option's maximum term is ten years. Options vest based on the
terms of each individual agreement, currently over fours years from
issuance. In November 1999, the Company issued 950 options related to class
B common stock at an exercise price of $60 per share.
In November 1999, HPCS adopted the 1999 Stock Option Plan which was amended
in June 2000 and renamed the 2000 stock Option Plan (HPCS' Plan). The plan
is intended to provide officers and other employees of HPCS and any of its
related corporations with opportunities to purchase stock pursuant to the
grant of options (incentive stock options). Additionally, HPCS' Plan is
intended to provide directors, officers and employees of, and service
providers to, HPCS and any of its related corporations with opportunities
to purchase stock pursuant to the grant of options (nonqualified stock
options).
HPCS may grant options for up to 7,500,000 shares of class A common stock
and 4,196,884 shares of class B common stock. The exercise price of each
option is not to be less than the market price of HPCS' stock on the date
of grant and an option's maximum term is ten years. Options vest based on
the terms of each individual agreement, currently over four or six years
from issuance.
On November 17, 1999, HPCS issued 4,196,884 options related to class B
common stock at an exercise price of $0.12 per share. During 2000, HPCS
issued 116,971 options related to class A common stock at an exercise price
of $5.88 per share.
111
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
The Company applies APB Opinion 25 and related Interpretations in
accounting for the plans with respect to employees. The Company applies
SFAS No. 123 and related Interpretations in accounting for stock options
granted to nonemployees. Pursuant to this, the Company will recognize
approximately $2,180,000 in compensation expense over the period of the
options (through 2005). The accompanying consolidated financial statements
reflect a non-cash compensation charge of approximately $853,000 for the
year ended December 31, 2000.
Had compensation cost for both plans been determined based on the fair
value at the grant dates consistent with the method of SFAS No. 123, the
Company's net loss available to common shareholders and losses per common
share would have been increased to the pro forma amounts indicated below:
2000 1999
----------------- ------------------
Net loss
As reported $ (37,181,562) $ (4,481,098)
Pro forma (37,915,479) (4,519,366)
Basic and diluted loss per share
As reported $ (107.39) $ (11.23)
Pro forma (109.51) (11.33)
For the purpose of the SFAS No. 123 disclosure, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with an assumption of a risk-free interest rate of
6.5% and 5.5% for 2000 and 1999 options, respectively, for the Company and
HPCS and a dividend yield of 3.1% for the Company. HPCS options also
include a 95% volatility factor.
A summary of the status of both the Company's and HPCS' plans as of
December 31, 2000 and changes during the year ended on that date is
presented below:
Horizon Telcom, Inc. HPCS, Inc.
--------------------------- ----------------------------
Weighted-Average Weighted-Average
Exercise Exercise
Shares Price Shares Price
---------- ------------- ------------- -------------
Outstanding December 31, 1998 - $ - - $ -
Granted 950 60.00 4,196,884 0.12
Exercised - - - -
Forfeited - - - -
---------- ------------- ------------- -------------
Outstanding December 31, 1999 950 $ 60.00 4,196,884 $ 0.12
Granted - - 116,971 5.88
Exercised (123) 60.00 - -
Forfeited - - - -
---------- ------------- ------------- -------------
Outstanding December 31, 2000 827 $ 60.00 4,313,855 $ 0.28
========== ============= ============= =============
Options exercisable at year-end 295 1,166,250
Weighted-average fair value of
options granted during the year N/A $ 4.75
112
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
(16) Commitments and Contingencies
Operating Leases
The Company leases office space and various equipment under several
operating leases. In October 1999, HPCS signed a tower lease agreement
whereby it will lease the towers for substantially all of HPCS' cell sites.
The leases are operating leases with a term of five to ten years with three
consecutive five-year renewal option periods. In addition, HPCS will
receive a site development fee from the tower lessor for certain tower
sites which the lessor constructs on behalf of HPCS.
Future minimum operating lease payments are as follows:
Year Amount
----------------------------------------- ----------------
2001 $ 8,487,497
2002 7,714,020
2003 6,807,868
2004 6,490,053
2005 4,117,407
Thereafter 12,618,605
----------------
Future operating lease obligations $ 46,235,450
================
Rental expenses for all operating leases were approximately $5,539,500,
$2,525,500 and $1,480,700 for the years ended December 31, 2000, 1999, and
1998, respectively.
Legal Matters
The Company is party to legal claims arising in the normal course of
business. Although the ultimate outcome of the claims cannot be ascertained
at this time, it is the opinion of management that none of these matters,
when resolved, will have a material adverse impact on the Company's results
of operations or financial condition.
Vendor Agreement
In August 1999, HPCS entered into a wholesale network services agreement
with a third-party vendor. The initial term is through June 8, 2008 with
four automatic ten-year renewals. The monthly billings under the agreement
are based on usage. No minimum usage is required under the agreement.
Construction Expenditures
Construction expenditures in 2001 are estimated to be $138,000,000. The
majority of the estimated expenditures are for the build-out of the PCS
Network (Note 4). The Company expects to finance construction primarily
through available cash on hand at December 31, 2000 and additional external
financing.
113
HORIZON TELCOM, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2000 and 1999
And for each of the three years in the period ended December 31, 2000
- --------------------------------------------------------------------------------
(17) Disclosures About Fair Value of Financial Instruments
SFAS No. 107 requires disclosure of the fair value of all financial
instruments. For purposes of this disclosure, the fair value of a financial
instrument is the amount at which the instrument could be exchanged in a
current transaction between willing parties, other than in a forced or
liquidation sale. Fair value may be based on quoted market prices for the
same or similar financial instruments or on valuation techniques such as
the present value of estimated future cash flows using a discount rate
commensurate with the risks involved.
The estimates of fair value required under SFAS No. 107 require the
application of broad assumptions and estimates. Accordingly, any actual
exchange of such financial instruments could occur at values significantly
different from the amounts disclosed. As cash and temporary cash
investments, current receivables, current payables, and certain other
short-term financial instruments are all short term in nature, their
carrying amount approximates fair value. The fair value of the senior
secured notes, set forth below, was estimated using discounted cash flow
analyses based on current incremental borrowing rates for similar types of
borrowing arrangements. The senior secured credit facility is based on
market-driven rates and, therefore, its carrying value approximates fair
value. The senior discount notes were issued late in the year and
approximate market as of December 31, 2000.
Fair Value Recorded Value
------------------- --------------------
2000 $ 21,187,000 $ 22,000,000
1999 20,286,000 22,000,000
(18) Extraordinary Loss
As a result of the September 26, 2000 financings described earlier, the
Company retired long term debt payable to financial institutions. As a
result of this debt extinguishment, the Company expensed the unamortized
portion of the related financing costs as well as fees associated with the
debt extinguishments. These fees and expenses amounted to approximately
$748,000 and are shown on the consolidated statement of operations net of a
tax benefit of approximately $262,000.
(19) Subsequent Events
In February 2001, the Company decided, subject to certain conditions, to
distribute the remaining shares of Horizon Telcom stock held as treasury
stock by HPCS (7,249 shares with a book value of $1,120,262) to employees
of HPCS. Distribution of the stock is subject to approval by the Board of
Directors of the plan of distribution, the amount of award to be granted to
each employee and a possible financing plan related to the tax
withholdings.
On March 16, 2001, CTC increased its line of credit from $15,000,000 to
$30,000,000.
114
HORIZON TELCOM, INC.
FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS
Balance at
Beginning of Charged to Balance at
Description Period Expense Deductions(1) End of Period
- ----------------------------------------------- ----------------- -------------- --------------- ----------------
(Dollars in Thousands)
Accounts Receivable - Subscribers
Year Ended December 31, 1998
Allowance for doubtful accounts $ 599 $ 349 $ (285) $ 663
============== ============= ============= ================
Year Ended December 31, 1999
Allowance for doubtful accounts 663 781 (533) 911
============== ============= ============= ================
Year Ended December 31, 2000
Allowance for doubtful accounts 911 1,891 (976) 1,826
============== ============= ============= ================
Accounts Receivable - Other
Year Ended December 31, 1998
Allowance for doubtful accounts $ 50 $ -- $ -- $ 50
============== ============= ============= ================
Year Ended December 31, 1999
Allowance for doubtful accounts 50 20 (3) 67
============== ============= ============= ================
Year Ended December 31, 2000
Allowance for doubtful accounts 67 0 (2) 65
============== ============= ============= ================
- -----------------
(1) Represents amounts written off during the period less recoveries of amounts
previously written off.
115
ITEM 14. Changes In And Disagreements With Accountants On Accounting And
Financial Disclosure
None.
ITEM 15. Financial Statements and Exhibits
(a) Documents filed as part of this report
(1) Financial Statements: The following financial statements are
included in this Report as set forth in Item 13:
o Report of Independent Public Accountants
o Consolidated balance sheets as of December 31, 2000 and 1999
o Consolidated statements of operations for the years ended
December 31, 2000, 1999 and 1998
o Consolidated statements of stockholders' equity for the
years ended December 31, 2000, 1999 and 1998
o Consolidated statements of cash flows for the years ended
December 31, 2000, 1999 and 1998
o Notes to consolidated financial statements for the years
ended December 31, 2000, 1999 and 1998
(2) Consolidated Financial Statement Schedules: Schedule II -
Valuation and Qualifying Accounts is included immediately after
notes to consolidated financal statements. All other financial
statement schedules are not applicable.
(b) Exhibits
EXHIBIT
NO. DESCRIPTION
------- -----------
3.1** Articles of Incorporation of Horizon Telcom, Inc.
3.2** Code of Regulations of Horizon Telcom, Inc.
4.2* Indenture dated as of September 26, 2000 between Horizon
PCS, Inc., Horizon Personal Communications, Inc. Bright
Personal Communications Services, LLC and Wells Fargo Bank
Minnesota, National Association.
4.3* A/B Exchange Registration Rights Agreement made as of
September 26, 2000 by and among Horizon PCS, Inc. and
Donaldson, Lufkin & Jenrette Securities Corporation and
First Union Securities, Inc.
4.4* Form of Registered Note (included in Exhibit 4.2).
4.5* Note Guarantee of Horizon Personal Communications, Inc.
4.6* Note Guarantee of Bright Personal Communications Services,
LLC.
116
10.1* Form of Employment Agreement, dated September 26, 2000, by
and between Horizon PCS, Inc. and William A.McKell.
10.2* Form of Employment Agreement, dated September 26, 2000, by
and between Horizon PCS, Inc. and Peter M. Holland.
10.3*+ Sprint PCS Management Agreement between Sprint spectrum,
L.P., SprintCom, Inc. and Horizon Personal Communications,
Inc., dated June 8, 1998.
10.4* Sprint PCS Services Agreement between Sprint Spectrum L.P.
and Horizon Personal Communications, Inc., dated June 8,
1998.
10.5* Sprint Trademark and Service Mark License Agreement
between Sprint Communications Company, L.P. and Horizon
Personal Communications, Inc., dated June 8, 1998.
10.6* Sprint Spectrum Trademark and Service Mark License
Agreement between Sprint Spectrum L.P. and Horizon
Personal Communications, Inc., dated June 8, 1998.
10.7*+ Sprint PCS Management Agreement between Wirelessco, L.P.,
SprintCom, Inc., Sprint Spectrum, L.P. and Bright Personal
Communications Services, LLC, dated October 13, 1999.
10.8* Sprint PCS Services Agreement between Sprint Spectrum,
L.P. and Bright Personal Communications Services, LLC,
dated October 13, 1999.
10.9* Sprint Trademark and Service Mark License Agreement
between Sprint Communications Company, L.P. and Bright
Personal Communications Services, LLC, dated October 13,
1999.
10.10* Sprint Spectrum Trademark and Service Mark License
Agreement between Sprint Spectrum, L.P. and Bright
Personal Communications Services, LLC, dated October 13,
1999.
10.19*+ Network Services Agreement by and between West Virginia
PCS Alliance, L.C., Virginia PCS Alliance, L.C. and
Horizon Personal Communications, Inc., dated August 12,
1999.
10.21*+ PCS CDMA Product Supply Contract by and between Motorola,
Inc. and Horizon Personal Communications, Inc.
10.25* Horizon PCS, Inc. 2000 Stock Option Plan.
10.25.1** Horizon Telcom, Inc. 1999 Stock Option Plan.
10.26*+ Site Development Agreement by and between Horizon Personal
Communications, Inc. and SBA Towers, Inc., dated August
17, 1999.
10.27*+ Master Site Agreement by and between SBA Towers, Inc. and
Horizon Personal Communications, Inc., dated July, 1999.
10.28*+ Master Design Build Agreement by and between Horizon
Personal Communications, Inc. and SBA Towers, Inc., dated
August 17, 1999.
117
10.29*+ Master Site Agreement by and between SBA Towers, Inc. and
Bright Personal Communications Services, LLC, dated
October 1, 1999.
10.30*+ Master Design Build Agreement by and between Bright
Personal Communications Services, LLC and SBA Towers,
Inc., dated October 1, 1999.
10.31* Services Agreement, dated May 1, 2000, between Horizon
Personal Communications, Inc. and Horizon Services, Inc.
10.32* Lease Agreement, dated May 1, 2000 between The Chillicothe
Telephone Company and Horizon Personal Communications,
Inc.
10.33* Services Agreement, dated May 1, 2000 between Horizon
Personal Communications, Inc. and United Communications,
Inc.
10.34** Form of Horizon PCS, Inc. Indemnification Agreement.
10.35* Amended and Restated Tax Allocation Agreement dated May 1,
2000 by and among Horizon Telcom, Inc., The Chillicothe
Telephone Company, Horizon Personal Communications, Inc.,
United Communications, Inc., Horizon Services, Inc., and
Horizon PCS, Inc.
10.35.1* First Amendment to the Amended and Restated Tax Allocation
Agreement dated as of September 26, 2000 by and among
Horizon Telcom, Inc., The Chillicothe Telephone Company,
Horizon Personal Communications, Inc., United
Communications, Inc., Horizon Services, Inc., and Horizon
PCS, Inc.
10.37* Securities Purchase Agreement dated September 26, 2000 by
and among Horizon PCS, Inc., Apollo Investment Fund IV,
L.P., Apollo Overseas Partners IV, L.P., Ares Leveraged
Investment Fund, L.P., Ares Leveraged Investment Fund, II,
L.P. and First Union Capital Partners, LLC.
10.38* Investors Rights and Voting Agreement dated September 26,
2000 by and among Horizon PCS, Inc., Apollo Investment
Fund IV, L.P., Apollo Overseas Partners IV, L.P., Ares
Leveraged Investment Fund, L.P., Ares Leveraged Investment
Fund II, L.P. and First Union Capital Partners, LLC.
10.39* Registration Rights Agreement dated September 26, 2000 by
and among Horizon PCS, Inc., Apollo Investment Fund IV,
L.P., Apollo Overseas Partners IV, L.P., Ares Leveraged
Investment Fund, L.P., Ares Leveraged Investment Fund II,
L.P. and First Union Capital Partners, LLC.
10.40* Credit Agreement, dated as of September 26, 2000, by and
among Horizon Personal Communications, Inc., and Bright
Personal Communications Services, LLC, Horizon PCS, Inc.
(the "Parent") and certain Subsidiaries of the Parent, the
several banks and other financial institutions as may from
time to time become parties to this Agreement, First Union
National Bank, as Administrative Agent, Westdeutsche
Landesbank Girozentrale, as Syndication Agent and Arranger
and Fortis Capital Corp., as Documentation Agent.
10.40.1* First Amendment to Credit Agreement and Assignment, dated
November 20, 2000, by and among Horizon Personal
Communications, Inc. and Bright Personal Communications
Services, LLC, Horizon PCS, Inc. (the "Parent") and
certain Subsidiaries of the Parent, Existing Lenders, New
Lenders, First Union National Bank, as Administrative
118
Agent, Westdeutsche Landesbank Girozentrale, as
Syndication Agent and Arranger, and Fortis Capital Corp.,
as Documentation Agent.
10.41* Warrant Agreement dated as of September 26, 2000 between
Horizon PCS, Inc. and Wells Fargo Bank Minnesota, National
Association.
10.42* Warrant Registration Rights Agreement made as of September
26, 2000 by and among Horizon PCS, Inc. and Donaldson,
Lufkin & Jenrette Securities Corporation and First Union
Securities, Inc.
10.43** Note Purchase Agreement dated November 1, 1993 by and
among The Chillicothe Telephone Company, Northern Life
Insurance Company and Northwestern National Life Insurance
Company.
10.43.1** Amendment dated as of January 1, 1997 by and among The
Chillicothe Telephone Company, Northern Life
Insurance Company and Northwestern National Life
Insurance Company.
10.44** Note Purchase Agreement dated as of June 1, 1998 by and
among The Chillicothe Telephone Company, American
United Life Insurance Company, and the State Life
Insurance Company.
10.44.1** First Amendment to Note Purchase Agreement dated as of
April 1, 1999 by and among The Chillicothe
Telephone Company, American United Life Insurance
Company, and the State Life Insurance Company.
10.45** Business Loan Agreement dated as of March 16, 2001 between
The Chillicothe Telephone Company and the Huntington
National Bank.
21** Subsidiaries of the Company.
---------------------
* Incorporated by reference to the Exhibit of the same number filed with
the Registration Statement on Form S-4 of Horizon PCS, Inc. (File No.
333-51238).
** Filed herewith.
+ The Registrant requested confidential treatment for certain portions
of this exhibit pursuant to Rule 406 of the Securities Act of 1933, as
amended, in connection with the previously filed Registration
Statement on Form S-1 of the Registrant (File No. 333-37516).
(c) Financial statement schedules
See Item 15(a)(2).
119
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant has duly caused this registration statement to be signed
on its behalf by the undersigned, thereunto duly authorized.
HORIZON TELCOM, INC.
By /s/ Thomas McKell
---------------------------------
Thomas McKell
President and Chief
Executive Officer
Date: April 30, 2001
By /s/ Peter M. Holland
------------------------------------------
Peter M. Holland
Chief Financial Officer
(Principal Financial and Principal
Accounting Officer)
Date: April 30, 2001
120
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -----------
3.1** Articles of Incorporation of Horizon Telcom, Inc.
3.2** Code of Regulations of Horizon Telcom, Inc.
4.2* Indenture dated as of September 26, 2000 between Horizon
PCS, Inc., Horizon Personal Communications, Inc. Bright
Personal Communications Services, LLC and Wells Fargo Bank
Minnesota, National Association.
4.3* A/B Exchange Registration Rights Agreement made as of
September 26, 2000 by and among Horizon PCS, Inc. and
Donaldson, Lufkin & Jenrette Securities Corporation and
First Union Securities, Inc.
4.4* Form of Registered Note (included in Exhibit 4.2).
4.5* Note Guarantee of Horizon Personal Communications, Inc.
4.6* Note Guarantee of Bright Personal Communications Services,
LLC.
10.1* Form of Employment Agreement, dated September 26, 2000, by
and between Horizon PCS, Inc. and William A.McKell.
10.2* Form of Employment Agreement, dated September 26, 2000, by
and between Horizon PCS, Inc. and Peter M. Holland.
10.3*+ Sprint PCS Management Agreement between Sprint spectrum,
L.P., SprintCom, Inc. and Horizon Personal Communications,
Inc., dated June 8, 1998.
10.4* Sprint PCS Services Agreement between Sprint Spectrum L.P.
and Horizon Personal Communications, Inc., dated June 8,
1998.
10.5* Sprint Trademark and Service Mark License Agreement
between Sprint Communications Company, L.P. and Horizon
Personal Communications, Inc., dated June 8, 1998.
10.6* Sprint Spectrum Trademark and Service Mark License
Agreement between Sprint Spectrum L.P. and Horizon
Personal Communications, Inc., dated June 8, 1998.
10.7*+ Sprint PCS Management Agreement between Wirelessco, L.P.,
SprintCom, Inc., Sprint Spectrum, L.P. and Bright Personal
Communications Services, LLC, dated October 13, 1999.
121
10.8* Sprint PCS Services Agreement between Sprint Spectrum,
L.P. and Bright Personal Communications Services, LLC,
dated October 13, 1999.
10.9* Sprint Trademark and Service Mark License Agreement
between Sprint Communications Company, L.P. and Bright
Personal Communications Services, LLC, dated October 13,
1999.
10.10* Sprint Spectrum Trademark and Service Mark License
Agreement between Sprint Spectrum, L.P. and Bright
Personal Communications Services, LLC, dated October 13,
1999.
10.19*+ Network Services Agreement by and between West Virginia
PCS Alliance, L.C., Virginia PCS Alliance, L.C. and
Horizon Personal Communications, Inc., dated August 12,
1999.
10.21*+ PCS CDMA Product Supply Contract by and between Motorola,
Inc. and Horizon Personal Communications, Inc.
10.25* Horizon PCS, Inc. 2000 Stock Option Plan.
10.25.1** Horizon Telcom, Inc. 1999 Stock Option Plan.
10.26*+ Site Development Agreement by and between Horizon Personal
Communications, Inc. and SBA Towers, Inc., dated August
17, 1999.
10.27*+ Master Site Agreement by and between SBA Towers, Inc. and
Horizon Personal Communications, Inc., dated July, 1999.
10.28*+ Master Design Build Agreement by and between Horizon
Personal Communications, Inc. and SBA Towers, Inc., dated
August 17, 1999.
10.29*+ Master Site Agreement by and between SBA Towers, Inc. and
Bright Personal Communications Services, LLC, dated
October 1, 1999.
10.30*+ Master Design Build Agreement by and between Bright
Personal Communications Services, LLC and SBA Towers,
Inc., dated October 1, 1999.
10.31* Services Agreement, dated May 1, 2000, between Horizon
Personal Communications, Inc. and Horizon Services, Inc.
10.32* Lease Agreement, dated May 1, 2000 between The Chillicothe
Telephone Company and Horizon Personal Communications,
Inc.
10.33* Services Agreement, dated May 1, 2000 between Horizon
Personal Communications, Inc. and United Communications,
Inc.
122
10.34** Form of Horizon PCS, Inc. Indemnification Agreement.
10.35* Amended and Restated Tax Allocation Agreement dated May 1,
2000 by and among Horizon Telcom, Inc., The Chillicothe
Telephone Company, Horizon Personal Communications, Inc.,
United Communications, Inc., Horizon Services, Inc., and
Horizon PCS, Inc.
10.35.1* First Amendment to the Amended and Restated Tax Allocation
Agreement dated as of September 26, 2000 by and among
Horizon Telcom, Inc., The Chillicothe Telephone Company,
Horizon Personal Communications, Inc., United
Communications, Inc., Horizon Services, Inc., and Horizon
PCS, Inc.
10.37* Securities Purchase Agreement dated September 26, 2000 by
and among Horizon PCS, Inc., Apollo Investment Fund IV,
L.P., Apollo Overseas Partners IV, L.P., Ares Leveraged
Investment Fund, L.P., Ares Leveraged Investment Fund, II,
L.P. and First Union Capital Partners, LLC.
10.38* Investors Rights and Voting Agreement dated September 26,
2000 by and among Horizon PCS, Inc., Apollo Investment
Fund IV, L.P., Apollo Overseas Partners IV, L.P., Ares
Leveraged Investment Fund, L.P., Ares Leveraged Investment
Fund II, L.P. and First Union Capital Partners, LLC.
10.39* Registration Rights Agreement dated September 26, 2000 by
and among Horizon PCS, Inc., Apollo Investment Fund IV,
L.P., Apollo Overseas Partners IV, L.P., Ares Leveraged
Investment Fund, L.P., Ares Leveraged Investment Fund II,
L.P. and First Union Capital Partners, LLC.
10.40* Credit Agreement, dated as of September 26, 2000, by and
among Horizon Personal Communications, Inc., and Bright
Personal Communications Services, LLC, Horizon PCS, Inc.
(the "Parent") and certain Subsidiaries of the Parent, the
several banks and other financial institutions as may from
time to time become parties to this Agreement, First Union
National Bank, as Administrative Agent, Westdeutsche
Landesbank Girozentrale, as Syndication Agent and Arranger
and Fortis Capital Corp., as Documentation Agent.
10.40.1* First Amendment to Credit Agreement and Assignment, dated
November 20, 2000, by and among Horizon Personal
Communications, Inc. and Bright Personal Communications
Services, LLC, Horizon PCS, Inc. (the "Parent") and
certain Subsidiaries of the Parent, Existing Lenders, New
Lenders, First Union National Bank, as Administrative
Agent, Westdeutsche Landesbank Girozentrale, as
Syndication Agent and Arranger, and Fortis Capital Corp.,
as Documentation Agent.
10.41* Warrant Agreement dated as of September 26, 2000 between
Horizon PCS, Inc. and Wells Fargo Bank Minnesota, National
Association.
10.42* Warrant Registration Rights Agreement made as of September
26, 2000 by and among Horizon PCS, Inc. and Donaldson,
Lufkin & Jenrette Securities Corporation and First Union
Securities, Inc.
123
10.43** Note Purchase Agreement dated November 1, 1993 by and
among The Chillicothe Telephone Company, Northern Life
Insurance Company and Northwestern National Life Insurance
Company.
10.43.1** Amendment dated as of January 1, 1997 by and among The
Chillicothe Telephone Company, Northern Life
Insurance Company and Northwestern National Life
Insurance Company.
10.44** Note Purchase Agreement dated as of June 1, 1998 by and
among The Chillicothe Telephone Company, American
United Life Insurance Company, and the State Life
Insurance Company.
10.44.1** First Amendment to Note Purchase Agreement dated as of
April 1, 1999 by and among The Chillicothe
Telephone Company, American United Life Insurance
Company, and the State Life Insurance Company.
10.45** Business Loan Agreement dated as of March 16, 2001 between
The Chillicothe Telephone Company and the Huntington
National Bank.
21** Subsidiaries of the Company.
---------------------
* Incorporated by reference to the Exhibit of the same number filed with
the Registration Statement on Form S-4 of Horizon PCS, Inc. (File No.
333-51238).
** Filed herewith.
+ The Registrant requested confidential treatment for certain portions
of this exhibit pursuant to Rule 406 of the Securities Act of 1933, as
amended, in connection with the previously filed Registration
Statement on Form S-1 of the Registrant (File No. 333-37516).
124
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