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FORM 10-K/A
Amendment No.1
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1998 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ------------------- to -------------------
Commission file number (333-41723)
BTI Telecom Corp.
(Exact name of registrant as specified in its charter)
North Carolina
(State or other jurisdiction of
incorporation or organization)
56-2047220
(I.R.S. Employer
Identification No.)
4300 Six Forks Road, Suite 500, Raleigh, North Carolina
(Address of principal executive offices)
27609
(Zip Code)
Registrant's telephone number, including area code: 800-849-9100
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K/A or any
amendment to this Form 10-K/A. [X]
No stock is held by non-affiliates of the registrant. As of February 28,
1999, the registrant had outstanding 100,000,000 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None
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NOTE RELATING TO FORWARD-LOOKING STATEMENTS
This Report contains certain "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
which represent the Company's expectations or beliefs, including, but not
limited to, statements concerning the Company's operations, its performance and
financial condition, its growth and acquisition strategies, anticipated growth
in revenues and anticipated capital expenditures, as well as statements
concerning the markets for the Company's services, industry performance and
possible changes in the regulatory environment. Any statements contained here
that are not statements of historical fact may be deemed to be forward-looking
statements that by their nature involve substantial risks and uncertainties,
certain of which are beyond the Company's control. These risks and
uncertainties include the Company's negative cash flow after capital
expenditures, significant capital requirements, the restrictive covenants under
its debt instruments, ability to manage growth and expansion (including into
the local services market), regulation, competition and dependence on key
personnel. Because of these and/or other factors, actual results may differ
materially from those described or implied by the forward-looking statements.
PART I
Item 1. Business
Overview
The Company is a leading provider of telecommunications services in the
Southeastern United States. The Company currently offers integrated
telecommunications services, including long distance, local, data, Internet
access and other enhanced services, primarily to small and medium-sized
business customers. In addition, the Company offers wholesale
telecommunications services, including switched, dedicated access, special
access and prepaid calling card services, primarily to telecommunications
carriers. As of December 31, 1998 the Company provided its integrated services
to approximately 30,000 business customers and its wholesale services to over
130 telecommunications carriers.
In November 1997, the Company began offering competitive local exchange
carrier ("CLEC") services to small and medium-sized business customers in
selected Southeastern markets. The Company is continuing the expansion of its
facilities-based local service offering into additional markets to offer a more
fully integrated complement of telecommunications services and plans to have a
total of nine Lucent 5ESS local switches installed by mid-1999. Through
December 31, 1998, the Company sold over 48,500 local access lines,
approximately 50% of which were sold to existing customers.
The Company utilizes an advanced telecommunications network consisting of
both leased and owned transmission capacity. The Company operates digital
switches in Atlanta, Dallas, New York, Orlando and Raleigh to manage its long
distance telecommunications traffic in the region. In addition, the Company
entered into an agreement with Qwest Communications in October 1997 to acquire,
through long-term lease on an indefeasible right to use ("IRU") basis,
approximately 3,250 route miles of fiber optic network. This network, which is
under construction, is expected to be placed into service in phases through the
third quarter of 1999 and will serve markets from New York to Miami and Atlanta
to Nashville. The Company believes that this network expansion will enable it
to carry a significant portion of its intraregional telecommunications traffic
over owned facilities, thereby reducing its costs of services by decreasing
payments to other carriers for use of their transport facilities. The Company
also currently operates an 80 route mile fiber optic network in the
Raleigh/Durham/Research Triangle Park area of North Carolina. The Company
leases network capacity primarily through its membership in the Associated
Communication Companies of America ("ACCA"), a 10-member trade association
co-founded by the Company in 1993. The ACCA negotiates with carriers for bulk
transmission capacity for its members. The collective buying power of its
members enables the ACCA to negotiate as if it were one of the larger
telecommunications service providers in the United States.
To leverage its regional network infrastructure, the Company offers
wholesale switched and dedicated access telecommunications services. The
Company's wholesale business provides services to other telecommunications
carriers including Nextel, GTE, Sprint, BellSouth Mobility, UUNet, PSI Net, CCI
(McLeod), Intermedia, ITC DeltaCom and WorldCom. In addition, during 1998 the
Company significantly expanded its offerings of prepaid calling cards to
wholesale distributors and service providers.
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Business Strategy
The Company's objective is to strengthen its market position as a leading
provider of telecommunications services in the Southeastern United States. To
achieve this objective, the Company intends to (1) leverage its current market
position, extensive customer base, brand name, service offerings and network
infrastructure to aggressively penetrate the local exchange market and enter
new markets while further penetrating existing markets and (2) continue to
expand its telecommunications network to lower the cost of providing services
to its customers. As part of its expansion strategy, the Company may make
acquisitions and enter into joint ventures or strategic alliances with
businesses that are related or complementary to its current operations;
however, the Company has no current understanding, commitment or agreement with
respect to any such transaction. The principal elements of the Company's
business strategy include:
o Providing Integrated Telecommunications Services. The Company believes
that there is substantial and growing demand, particularly in the
Southeastern United States, among small and medium-sized business
customers for an integrated package of services. The Company offers long
distance, local, data, Internet access, paging, advanced intelligent
network ("AIN") applications, operator and other enhanced services to
small and medium-sized businesses. Management believes that bundling local
telephony with the Company's current array of telecommunications services
enables it to offer "one-stop" integrated telecommunications service and
will allow it to leverage its existing infrastructure, increase customer
retention and better penetrate its target markets.
o Rapidly Penetrating the Local Exchange Market. The Company is among the
first providers of CLEC services in key markets in the Southeastern United
States and is leveraging its existing sales force and customer base to
rapidly gain CLEC market share. In November 1997, the Company began
offering local exchange services in selected markets primarily on a resale
basis. The Company has installed Lucent 5ESS local switches in Raleigh,
Charlotte, Greensboro, Atlanta and Orlando and plans to install four
additional switches to support local switched services in other markets by
mid-1999. The addition of these switches will allow the Company to provide
an increasing percentage of local service over its own facilities, which
should improve the Company's overall margins on these services.
o "Smart-Building" Its Network Expansion. The Company's strategy since its
inception has been to add customers before building or acquiring
additional network capacity. Management believes that using this
"smart-build" strategy reduces the risks associated with speculative
network expansion and allows it to focus its capital expenditures in
markets where network expansion will provide cost or competitive
advantages. The Company entered into an agreement with Qwest in October
1997 to lease on an IRU basis approximately 3,250 route miles of fiber
optic network to serve markets from New York to Miami and Atlanta to
Nashville. This network, which is expected to be placed into service in
phases through the third quarter of 1999, will enable the Company to carry
a significant portion of its intraregional telecommunications traffic over
its owned facilities, thereby reducing its cost of services by decreasing
payments to other carriers for use of their transport facilities.
o Building Market Share Through Personalized Sales, Marketing and Customer
Service. Management believes that the key to revenue growth in its target
markets is capturing and retaining customers through effective,
personalized sales, marketing and customer service programs. The Company's
direct sales force markets its entire range of services and is rewarded
for obtaining and maintaining face-to-face relationships with business
customers. The Company seeks to build long-term relationships with its
customers by responding rapidly and creatively to their telecommunications
needs. The Company currently has 18 sales offices staffed by
representatives trained in marketing the Company's services and providing
comprehensive customer service and support. The Company's customer-support
software and network architecture give its sales personnel, along with its
dealers and agents, immediate access to customer data, allowing for quick
and effective response to customer requests and needs. This software also
permits the Company to provide its customers one fully integrated monthly
billing statement for all of its current services, including local
services.
o Focusing on the Southeastern United States. The Company intends to
continue to focus on the high-growth Southeastern United States in order
to leverage its existing market presence and telecommunications network in
the region. In 1998, the Company derived over 80% of its integrated
services revenue from North Carolina, South Carolina, Georgia, Florida and
Virginia. The Company believes that its regional
3
focus will enable it to take advantage of economies of scale in network
infrastructure, operations and maintenance, sales, marketing and
management and further develop its long-standing customer and business
relationships in the region. The Company's market presence in the
Southeastern United States should provide opportunities to increase
revenues and gain market share in the region.
o Leveraging Network Infrastructure to Service Wholesale Marketplace. The
Company plans to continue leveraging its network capacity to provide a
full complement of services to its wholesale customers, including
telecommunications carriers, switchless resellers and prepaid calling card
providers. These services include origination, termination, SS7
connectivity, LATA transport services, end-user to end-user private lines,
dedicated data facilities and prepaid calling card services. This strategy
allows the Company to more efficiently utilize its network facilities,
while reducing its overall fixed network costs per minute. In addition,
management believes the strength of its wholesale customer base and
service offerings will more effectively position the Company to sell
excess capacity on the 3,250 miles of fiber optic network currently under
construction.
o Leveraging Proven Management Team. The Company's management team consists
of experienced telecommunications executives led by Peter T. Loftin,
Chairman and Chief Executive Officer of the Company, who founded BTI in
1984. Other members of the team include R. Michael Newkirk, President and
Chief Operating Officer, H.A. (Butch) Charlton, Executive Vice President,
and Brian K. Branson, Chief Financial Officer. These executives
collectively have over 60 years of experience in the telecommunications
industry.
Services
The Company offers (1) integrated telecommunications services, which
currently include long distance, local, data, Internet access, paging, AIN
applications, operator and other enhanced services and (2) wholesale
telecommunications services, including switched, dedicated access, special
access and prepaid calling card services. For the year ended December 31, 1998,
integrated telecommunications services and wholesale services represented 63.1%
and 36.9% respectively, of the Company's total revenues.
Integrated Telecommunications Services. The Company provides integrated
telecommunications services primarily to small and medium-sized business
customers located in the Southeastern United States. The Company's services
include:
o Long Distance. The Company offers a full range of domestic and
international long distance services, including "1+" outbound dialing
(switched and dedicated line) and inbound toll-free service.
o Local Services. The Company began offering local exchange services,
including local dial tone and enhanced features such as call forwarding,
call waiting, caller ID and voice mail, in selected markets throughout the
Southeastern United States in November 1997. See " -- Implementation of
Local Telecommunications Services."
o Data Services. The Company offers advanced data transmission services,
such as those required for local area networks ("LANs") and wide area
networks ("WANs"), to its customers via dial-up, dedicated point-to-point
and frame relay services.
o Internet Access. The Company offers dial-up and dedicated Internet access
and Web hosting services. The Web browser offered by the Company uses
"softcasting" to automatically download the latest version of the browser
software each time a user logs on.
o Paging. The Company offers advanced wireless paging services, including
digital and alphanumeric paging, PIN services, voicemail, out-dial
capability, locator service, fax-on-demand and broadcast faxing, through
its own platform facilities in Atlanta.
o Advanced Intelligent Network Applications. The Company offers AIN
functionality and services tailored to the individual needs of its
customers. Services include NPA/NXX routing and menu routing, virtual
private networks and other advanced custom applications.
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o Operator Services. The Company offers owners of pay telephones, and
multi-telephone facilities, such as hotels, hospitals and universities,
live or automated operators to assist their patrons in placing outbound
long distance calls and to transmit the calls over the Company's network.
o Other Enhanced Services. The Company offers conference calling services
(including toll-free access and valet, sub-conferencing and transcription
services), prepaid calling cards, and enhanced calling card services
(including features such as voice and fax mail, voice-activated speed
dialing, conference calling and network voice messaging). In addition, the
Company attempts to address customer specific requests for customized
services where appropriate.
Wholesale Services. The Company provides wholesale switched services to
telecommunications carriers, and dedicated and special access and private line
services to telecommunications carriers and other end-user customers, including
Nextel, GTE, Sprint Mid-Atlantic, BellSouth Mobility, UUNET, WorldCom, PSINet,
ITC-DeltaCom and CCI (McLeod). The Company's wholesale switched services
include origination, termination, SS7 connectivity and LATA transport services.
The Company's access services include dedicated access and special access
services. Dedicated access services include end-user to end-user private line
and dedicated data facilities. Special access services include
telecommunications lines that link the points-of-presence ("POPs") of one long
distance carrier, or the POPs of different long distance carriers, in a market
as well as lines that connect an end user to the local POP of its selected long
distance carrier. Private line services provide telecommunications connectivity
between various locations of a customer's operations to internally transmit
voice, video or data traffic. In addition, the Company also provides prepaid
calling card services to various distributors and telecommunications companies.
Implementation of Local Telecommunications Services
The Company began offering local exchange services in selected markets in
the Southeastern United States in November 1997. The Company has installed
Lucent 5ESS local switches in Raleigh, Charlotte, Greensboro, Atlanta and
Orlando and plans to install four additional switches to support local switched
services in other markets by mid-1999.
The Company is also collocating digital loop carriers in certain ILEC
central offices in these markets to facilitate cost-effective service to
smaller customers. As these facilities become operational, the Company will be
able to provide a greater percentage of its local service via its own
facilities, which should improve margins and the competitiveness of its
pricing.
In connection with offering local exchange services, the Company has
entered into the BellSouth Interconnection Agreement to (1) resell BellSouth's
local exchange services and (2) interconnect the Company's network with
BellSouth's network for the purpose of gaining access to the unbundled network
elements necessary to provide local exchange services. The BellSouth
Interconnection Agreement contains "most favored nation" provisions which grant
the Company the right to obtain the benefit of any arrangements entered into
during the term of the agreement between BellSouth and any other carrier that
materially differ from the rates, terms or conditions of the BellSouth
Interconnection Agreement. The BellSouth Interconnection Agreement expired in
January 1999. However, the parties are currently negotiating the renewal terms
and the Company expects the terms and conditions of the existing BellSouth
Interconnection Agreement to continue until the terms for renewal are agreed
upon.
The Company's ability to provide local switched services in its other
target markets is dependent upon obtaining favorable interconnection agreements
with local exchange carriers. In addition to the BellSouth Interconnection
Agreement, BTI has entered into interconnection agreements with GTE, Sprint,
Bell Atlantic and Southwestern Bell, and is currently negotiating
interconnection agreements with other local exchange carriers. Changes in the
regulatory environment could make negotiating such agreements more difficult
and protracted, and there can be no assurance that the Company will be able to
obtain interconnection agreements on terms acceptable to the Company.
Sales and Marketing
Integrated Telecommunications Services. The Company focuses its retail
sales efforts on small to medium-sized businesses in the Southeastern United
States. The Company believes that it can effectively compete in this
5
market based upon a combination of service, product diversity, price and
reliability. The Company markets its integrated telecommunications services
primarily through two channels: the Company's direct sales force (the "Partner
Program") and its network of independent dealers (the "Corporate Partner
Program"). In addition, when the Company adds local services in a given
geographic market, it launches an aggressive sales incentive program in that
market. The Company also markets long distance services to the residential
market through its Alliance Program and Academic Edge Program, and through a
number of multi-level marketing companies ("MLMs").
In 1996, 1997 and 1998, the Company's direct sales force generated 69.7%,
64.8% and 68.5% of integrated services revenues, respectively. The Company's
sales personnel call on prospective and existing business customers, conduct
analyses of business customers' telecommunications usage histories and service
needs, and demonstrate how the Company's various service packages will improve
a customer's communications capabilities in a cost-effective manner. Sales
personnel identify potential business customers by several methods, including
customer referral, market research, telemarketing and other networking
alliances such as endorsement agreements with trade associations and local
chambers of commerce. The Company's sales personnel work closely with the
Company's engineers and field support specialists to address customers' network
and service delivery needs and to design new service products and applications
for customers. The Company employed approximately 300 full-time sales and
support personnel as of December 31, 1998 in sales offices located in:
Charlotte, NC Charleston, SC Jacksonville, FL Roanoke, VA
Greensboro, NC Columbia, SC Orlando, FL Knoxville, TN
Greenville, NC Greenville, SC Tampa, FL Nashville, TN
Raleigh, NC Atlanta, GA Norfolk, VA
Wilmington, NC Ft. Lauderdale, FL Richmond, VA
During the fourth quarter of 1998, the Company announced that it will be
relocating two of its direct sales offices from Texas to Durham/Chapel Hill and
Winston-Salem, North Carolina, in an effort to more effectively focus sales
resources on underserved markets in its core Southeastern region.
The Company's Corporate Partner Program, established in 1992, is a network
of independent telephone equipment vendors and other agents authorized by the
Company to market its products and services. Authorized dealers receive
recurring commissions based on products and services sold, volume of usage and
retention of the customer. In 1996, 1997 and 1998, the Corporate Partner
Program generated 28.0%, 32.9% and 29.7% of integrated services revenues,
respectively. The Company has dealer managers who actively recruit dealers and
field support specialists who handle all customer service and billing
activities associated with sales made under the Corporate Partner Program.
The Company's direct sales force and its authorized dealer agents are
trained to emphasize the Company's customer-focused sales and customer service
approach. The Company reinforces this approach by tying a portion of each sales
representative's and dealer agent's compensation directly to the longevity of
their customer accounts. The Company's marketing strategy is built upon the
belief that customers prefer to have one company serve all of their
telecommunications needs. As part of this strategy, the Company generally
assigns to each customer its own dedicated field support specialist, thereby
providing the customer with a single point of contact to address its
telecommunications needs with the right mix of products and services in a
timely manner. The Company believes that this personalized attention to a
customer's needs, coupled with the Company's ability to provide one fully
integrated billing statement for all of its services is appealing to both
existing and prospective customers.
In order to capitalize on the excess capacity of its network in off-peak
hours, the Company markets long distance services to residential accounts
through its Alliance Program for trade associations and professional
organizations and its Academic Edge Program for colleges and universities, and
through a number of MLMs, including International Communications Corporation
(see "Item 13. Certain Relationships and Related Transactions"). By utilizing
off-peak network capacity and existing infrastructure, these
residential-targeted programs produce incremental revenue for the Company
without materially increasing fixed network costs.
Similarly, the Company's Academic Edge Program was launched in 1994 and
caters to the specialized needs of colleges and universities. Under the
program, the Company provides a revenue share to participating colleges and
universities in return for their selecting BTI as an official campus
telecommunications service provider. As of December 31, 1998, there were over
35 colleges and universities participating in the Academic Edge Program.
6
Wholesale Services. The Company established a wholesale service sales
force in November 1995. This group markets the Company's wholesale services to
telecommunications carriers and other end-user customers. The Company believes
it can compete effectively in this market based on a combination of price,
reliability, advanced technology, route diversity, ease of ordering and
customer service. The Company markets its wholesale services primarily through
12 direct sales personnel and 5 support specialists located primarily in the
Company's corporate headquarters. In general, these sales professionals locate
potential customers for the Company's wholesale services through customer
referrals, trade shows and industry alliances. When contacting a potential
customer, the Company's sales professionals work with network engineers to gain
a better understanding of the customer's operations and bulk telecommunications
transmission needs to develop innovative application-specific solutions to each
customer's requirements. The Company also markets its wholesale services
through print advertisements, event sponsorships, trade journals, direct mail
and trade forums.
Network Facilities
The Company operates an advanced telecommunications network including five
digital switches interconnected by leased and owned transmission capacity. The
Company currently has an Alcatel DEX 600E tandem switch in Raleigh and Alcatel
DEX 600 switches in Atlanta, Dallas, New York and Orlando. In addition, the
Company has installed Lucent 5ESS local switches in Raleigh, Charlotte,
Greensboro, Atlanta and Orlando, and intends to install four additional
switches by mid-1999. As of December 31, 1998, the Company had also deployed 37
digital loop carriers in certain ILEC central offices to facilitate providing
cost-effective local service to smaller business customers. Furthermore, the
Company recently installed five Ascend (formerly Cascade) 9000 switches to
enhance its network's frame relay operations. The Company owns and operates a
gateway pair of Alcatel Signaling Transfer Points ("STPs") in Atlanta and
Raleigh to provide SS7 common channel signaling throughout its network. The SS7
signaling system reduces connect time delays and provides additional technical
capabilities and efficiencies for call routing. The Company's network has also
been designed to use AIN applications technology to allow the Company greater
flexibility in data management and feature development. The Company's
investment in digital switching, SS7 signaling and AIN applications technology
has significantly increased network capacity, which has lowered the cost of
providing services and enabled the Company to sell excess capacity to other
telecommunications carriers.
In October 1997, the Company entered into an agreement with Qwest to lease
on an IRU basis approximately 3,250 route miles of fiber optic network to serve
markets from New York to Miami and Atlanta to Nashville. The Company has
selected Nortel to provide its optronics and dense wavelength division
multiplexing ("DWDM") equipment for this network. The Company believes that
this network, which is expected to be placed into service in phases through the
third quarter of 1999, will enable it to carry a significant portion of its
intraregional telecommunications traffic over its own facilities, thereby
reducing its cost of services by decreasing payments to other carriers for use
of their transport facilities. The Company leases fiber optic network capacity
from major facilities-based carriers (including AT&T, MCI and WorldCom) either
on its own or through its membership in the ACCA, a 10-member trade association
co-founded by the Company in 1993. The ACCA negotiates with carriers for bulk
transmission capacity for its members. The collective buying power of its
members enables the ACCA to negotiate as if it were one of the larger
telecommunications service providers in the United States.
The extent and manner of expansion of the Company's fiber optic network in
the future will be based on various factors, including:
(1) the number of its customers and volume of their telecommunications
traffic in a market;
(2) the anticipated operating cost savings associated with the transmission
of the telecommunications traffic in a given area using Company-owned
facilities in lieu of capacity purchased from other operators; and
(3) the expenditures required to acquire (by construction, purchase or
long-term lease) the required network facilities.
The Company also operates a fiber optic network extending approximately 80
route miles in North Carolina, linking Raleigh, Durham and the Research
Triangle Park area, to provide services in its Raleigh market.
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This network was built in a ring configuration in order to ensure redundancy,
deploying throughout a self-healing SONET architecture, high-quality fiber and
advanced transmission electronics.
Competition
The telecommunications industry is highly competitive. The Company
competes primarily on the basis of customer service, price, product
availability, reliability and variety of service offerings. The Company's
ability to compete effectively will depend on its ability to maintain high
quality services at prices generally equal to or below those charged by its
competitors. In particular, price competition in the integrated
telecommunications services and wholesale services markets has generally been
intense.
Many of the Company's competitors have substantially greater financial,
personnel, technical, marketing and other resources, larger numbers of
established customers and more prominent name recognition than the Company and
utilize more extensive transmission networks. In particular, regional Bell
operating companies ("RBOCs") such as BellSouth are now allowed to provide
interLATA long distance services outside their home regions, as well as
interLATA mobile services within their regions. They will be allowed to provide
interLATA long distance services within their regions after meeting certain
requirements of the Telecommunications Act intended to foster opportunities for
local telephone competition. The RBOCs already have extensive fiber optic
cable, switching, and other network facilities in their respective regions that
can be used for their long distance services.
In addition, other new competitors, such as ILECs (outside their home
regions), CLECs, switchless resellers, satellite carriers, public utilities and
cable companies, may enter the Company's current or future markets. IXC, Qwest,
Level 3 and Williams Communications, for example, are constructing nationwide
fiber optic systems with routes through portions of the Southeastern United
States. If industry capacity expansion results in capacity that exceeds overall
demand along any of the Company's routes, severe additional pricing pressure
could develop. The Company also faces increasing competition from firms
offering long distance data and voice services over the Internet. Such firms
could enjoy a significant cost advantage because they currently do not pay
carrier access charges or universal service fees.
The Company's principal competitor for local exchange services is the ILEC
in the particular market, including BellSouth in virtually all of the Company's
initial target markets. The ILECs will enjoy substantial competitive advantages
arising from their historical monopoly position in the local telephone market,
including their preexisting customer relationship with all or virtually all end
users. Furthermore, the Company will be highly dependent on the competing ILEC
for local network facilities and wholesale services required in order for the
Company to assemble its own products. The Company will also face competition
from other CLECs, including US LEC, Intermedia, MCI Metro, ITC DeltaCom, Inc.
and Time Warner, some of whom have already established local operations in the
Company's target markets.
Large long distance carriers, such as AT&T, MCI and Sprint, have begun to
offer a package of local and long distance telecommunications services. In June
1998, Sprint announced its intention to offer voice, data and video services
over its nationwide asynchronous transfer mode ("ATM") network, which Sprint
anticipates will significantly reduce its costs to provide such services.
Sprint plans to bill its customers based upon the amount of traffic carried,
irrespective of the time required to send the traffic or the traffic's
destination.
In addition, ILECs are expected to compete in each other's markets in some
cases. For example, in the future RBOCs may provide local services within their
respective geographic regions in competition with independent telephone
companies, as well as outside their regions. BellSouth recently announced its
intention to establish its own CLEC to obtain pricing flexibility to compete in
areas served by the Company. Wireless telecommunications providers may develop
into effective substitutes for wireline local telephone service. AT&T has
announced plans to offer local services using a new wireless technology. AT&T's
proposed wireless system would link residential and business telephones via
radio transmissions to the AT&T network. If successful, this new service could
further enhance AT&T's ability to market, on a nationwide basis, "one-stop"
telecommunications services.
A continuing trend toward consolidation, mergers, acquisitions and
strategic alliances in the telecommunications industry could also increase the
level of competition faced by the Company or its wholesale customers. The
telecommunications market is very dynamic, and additional competitive changes
are likely in the future.
8
Regulation
The following summary of regulatory developments and legislation does not
purport to describe all present and proposed federal, state and local
regulations and legislation affecting the telecommunications and cable
industries. Other existing federal and state regulations are currently the
subject of judicial proceedings, legislative hearings and administrative
proposals which could change, in varying degrees, the manner in which these
industries operate. Neither the outcome of these proceedings, nor their impact
upon the telecommunications and/or cable industries or the Company, can be
predicted at this time. This section sets forth a brief description of
regulatory and tariff issues pertaining to the operations of the Company.
Telecommunication Regulation
Overview. BTI is subject to federal, state and local regulation. The FCC
exercises jurisdiction over all interstate and international telecommunications
services. While carriers can provide domestic services without prior
authorization, the FCC requires prior authorization to construct and operate
international facilities or to provide resale of international services. State
regulatory commissions retain some jurisdiction over the same facilities and
services to the extent they are used to originate or terminate intrastate
common carrier communications. Local governments may require the Company to
obtain licenses, permits or franchises regulating the use of public
rights-of-way necessary to install and operate its networks.
Federal Regulation. The Telecommunications Act became effective February
8, 1996. The Telecommunications Act preempts state and local laws to the extent
that they prevent competitive entry into the provision of any
telecommunications service. Subject to this limitation, however, the state and
local governments retain most of their existing regulatory authority. The
Telecommunications Act imposes a variety of new duties on incumbent local
exchange carriers in order to promote competition in local exchange and access
services. Some duties are also imposed on non-incumbent local exchange
carriers, such as the Company. The duties created by the Telecommunications Act
include reciprocal compensation, resale, interconnection, unbundled network
elements, number portability, dialing parity and access to rights-of-way.
Incumbent local exchange carriers are required to negotiate in good faith
with carriers requesting any or all of the above arrangements. Certain FCC
rules regarding pricing and the unbundling of network elements that must be
made available are subject to further review by the Eighth Circuit Court and
the FCC. However, carriers still may negotiate agreements, and if the
negotiating carriers cannot reach agreement within a prescribed time, either
carrier may request binding arbitration of the disputed issues by the state
regulatory commission.
The Telecommunications Act also eliminates previous prohibitions on the
provision of interLATA long distance services by the RBOCs and the GTE
Operating Companies ("GTOCs"). The RBOCs are now permitted to provide interLATA
long distance service outside those states in which they provide local exchange
service ("out-of-region long distance service") upon receipt of any necessary
state and/or federal regulatory approvals that are otherwise applicable to the
provision of intrastate and/or interstate long distance service. Under the
Telecommunications Act, the RBOCs will be allowed to provide long distance
service within the regions in which they also provide local exchange service
("in-region service") upon specific approval of the FCC and satisfaction of
other conditions, including a checklist of interconnection requirements.
BellSouth has sought such authority in Louisiana and South Carolina. Both
requests were denied by the FCC and the denial was upheld by the United States
Court of Appeals for the D.C. Circuit. The GTOCs are permitted to enter the
long distance market without regard to limitations by region, although
regulatory approvals otherwise applicable to the provision of long distance
service will need to be obtained. The GTOCs are also subject to the provisions
of the Telecommunications Act that impose interconnection and other
requirements on incumbent local exchange carriers.
The Telecommunications Act imposes certain restrictions on the RBOCs in
connection with the RBOCs' entry into long distance services. Among other
things, the RBOCs must pursue such in region activities only through separate
subsidiaries with separate books and records, financing, management and
employees, and all affiliate transactions must be conducted on an arm's length
and nondiscriminatory basis. The RBOCs are also prohibited from jointly
marketing local and long distance services, equipment and certain information
services unless competitors are permitted to offer similar packages of local
and long distance services in their market. Further, the RBOCs must obtain
in-region long distance authority before jointly marketing local and long
distance services in a particular state. US West, Inc. and Ameritech
Corporation have each announced marketing arrangements with Qwest whereby they
will market Qwest long distance services in their respective regions. The
9
FCC found these arrangements to be unlawful. The FCC decision is on appeal. If
these arrangements are allowed to operate, and if other RBOCs enter into
similar arrangements, they may reduce the motivation of RBOCs to cooperate in
opening their markets to competition.
Prior to the passage of the Telecommunications Act, the FCC had already
established different levels of regulations for dominant and non-dominant
carriers. For domestic common carrier telecommunications regulation, ILECs,
including the RBOCs, are considered dominant carriers for the provision of
interstate access and interexchange services, while other interstate service
providers, such as the Company, are considered non-dominant carriers. The FCC
has recently proposed that the RBOCs offering out-of-region interstate long
distance services be regulated as non-dominant carriers, as long as such
services are offered by an affiliate of the RBOC that complies with certain
structural separation requirements. The FCC regulates many of the rates,
charges and services of dominant carriers to a greater degree than non-dominant
carriers.
The Company has obtained FCC authority to provide international services.
Services of non-dominant carriers are subject to relatively limited regulation
by the FCC. Non-dominant carriers are required to file tariffs listing the
rates, terms and conditions of interstate access and international services
provided by the carrier. Periodic reports concerning the carrier's interstate
circuits and deployment of network facilities also are required to be filed.
The FCC generally does not exercise direct oversight over cost justification
and the level of charges for services of non-dominant carriers, although it has
the power to do so. The Company must offer its interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remains subject to
FCC complaint procedures. Pursuant to these FCC requirements, the Company has
filed and maintains with the FCC a tariff for its interstate and international
services.
On October 29, 1996, the FCC adopted an order in which it eliminated the
requirement that non-dominant interstate carriers such as the Company maintain
tariffs on file with the FCC for domestic interstate interexchange services.
Following a nine-month transition period, relationships between carriers and
their customers will be set by contract. On February 13, 1997, the United
States Court of Appeals for the District of Columbia Circuit stayed the FCC's
order pending judicial review of the appeals. If the appeals are unsuccessful
and the FCC's order becomes effective, BTI believes that the elimination of the
FCC's tariff requirement will permit the Company to respond more rapidly to
changes in the marketplace. In the absence of tariffs, however, the Company
will be required to obtain agreements with its customers regarding many of the
terms of its existing tariffs, and uncertainties regarding such new contractual
terms could increase the risk of claims against the Company from its customers.
On May 8, 1997, the FCC issued an order to implement the provisions of the
Telecommunications Act relating to the preservation and advancement of
universal telephone service (the "Universal Service Order"). The Universal
Service Order requires all telecommunications carriers providing interstate
telecommunications services, including the Company, to contribute to universal
service support. Such contributions will be assessed based on interstate and
international end-user telecommunications revenues. The revenues for the high
cost and low income fund are the Company's estimated quarterly interstate and
gross end-user telecommunications revenues. The revenues for the schools and
libraries and rural healthcare fund are the Company's estimated quarterly
intrastate, interstate and international gross end-user telecommunications
revenues. Since the contribution factors are determined quarterly the Company
does not know the effect of such charges on the Company, but does not expect
the Universal Service Order to have a material adverse effect on the Company.
The FCC also imposes prior approval requirements on transfers of control
and assignments of operating authorizations. The FCC has the authority to
generally condition, modify, cancel, terminate or revoke operating authority
for failure to comply with federal laws and/or the rules, regulations and
policies of the FCC. Fines or other penalties also may be imposed for such
violations. There can be no assurance that the FCC or third parties will not
raise issues with regard to the Company's compliance with applicable laws and
regulations.
The FCC, through decisions announced in September 1992 and August 1993, as
modified by subsequent FCC and court decisions (the "Initial Interconnection
Decisions"), has ordered the RBOCs and all but one of the other local exchange
carriers having in excess of $100 million in gross annual revenue for regulated
services to provide expanded interconnection to local exchange carrier central
offices to any competitive access provider, interexchange carrier or end user
seeking such interconnection for the provision of interstate access services.
As a result of this decision and the Telecommunications Act, once the Company
has entered into interconnection
10
agreements with local exchange carriers, it will be able to reach most business
customers in its metropolitan service areas and can expand its potential
customer base. The Telecommunications Act now requires most ILECs to offer
physical collocation, enabling the interconnector to place its equipment in the
central office space of these ILECs.
On August 8, 1996, the FCC adopted the Interconnection Decision to
implement the interconnection, resale and number portability provisions of the
Telecommunications Act. Certain provisions of these rules were appealed. The
Eighth Circuit Court vacated certain provisions of the Interconnection
Decision, including the pricing rules and rules that would have permitted new
entrants to "pick and choose" among various provisions of existing
interconnection agreements between the ILECs and other carriers. The Supreme
Court reversed most aspects of the Eighth Circuit's decision and, among other
things, decided the FCC has general authority under the Act to promulgate rules
governing local interconnection pricing. The Supreme Court reinstated the FCC's
"pick and choose" rules. The Supreme Court remanded to the FCC for further
consideration its identification of the network elements that must be
unbundled. The overall impact of the Eighth Circuit Court and Supreme Court
decisions on the Company cannot yet be determined and there can be no assurance
that it will not have a material adverse affect on the Company. In addition,
other FCC rules relating to local service competition are still being
challenged and there can be no assurance that decisions with respect to such
rules will not be adverse to companies seeking to enter the local service
market.
In connection with the Initial Interconnection Decisions, the FCC granted
local exchange carriers additional flexibility in pricing their interstate
special and switched access services on a central office specific basis.
Although there can be no assurance, the Company anticipates that the FCC will
grant local exchange carriers increasing pricing flexibility as the number of
interconnection agreements and competitors increases. On May 7, 1997, the FCC
announced that it is adopting new pricing rules that restructure local exchange
carrier switched transport rates in order to facilitate competition for
switched access. In addition, the FCC adopted rules that will require ILECs to
substantially decrease the prices they charge for switched and special access,
and that will change how access charges are calculated. These changes are
intended to reduce access charges paid by interexchange carriers to local
exchange companies and shift certain usage-based charges to flat-rate, monthly
per-line charges.
On April 10, 1998, the FCC issued a Report to Congress on its
implementation of the universal service provision of the 1996
Telecommunications Act. In that report, the FCC stated that the provision of
transmission capacity to ISPs constitutes the provision of telecommunications
and is, therefore, subject to common carrier regulation. The FCC indicated it
would reexamine its policy of not requiring an ISP to contribute to the
universal service mechanisms when the ISP provides its own transmission
facilities and engages in data transport over those facilities in order to
provide an information service. Any such contribution would be related to the
ISP's provision of the underlying telecommunications services. The FCC noted it
did not have an adequate record to make a decision at that time on whether
certain forms of phone-to-phone IP telephony is a telecommunications service
rather than an information service. It noted that on the record before it, the
service appeared to have the same functionality as non-IP telephony and lacked
the characteristics that would render the service an information service.
The FCC has also been considering whether local carriers are obligated to
pay compensation to each other for the transport and termination of calls to
Internet service providers when a local call is placed from an end user of one
carrier to an Internet service provider served by the competing local exchange
carrier. Recently, the FCC determined that it had no rule addressing
inter-carrier compensation for these calls. In the absence of a federal rule,
the FCC determined that it would not be unreasonable for a state commission, in
some circumstances, to require payment of compensation for these calls. The FCC
also released for comment alternative federal rules to govern compensation for
these calls in the future. If state commissions, the FCC or the courts
determine that inter-carrier compensation does not apply, carriers may be
unable to recover their costs or will be compensated at a significantly lower
rate.
State Regulation. The Company is subject to various state laws and
regulations. Most public utilities commissions subject providers such as the
Company to some form of certification requirement, which requires providers to
obtain authority from the state public utilities commission prior to the
initiation of service. In most states, BTI also is required to file tariffs
setting forth the terms, conditions and prices for services that are classified
as intrastate. The Company also is required to update or amend its tariffs when
it adjusts its rates or adds new products, and is subject to various reporting
and record-keeping requirements.
11
Certificates of authority can generally be conditioned, modified,
canceled, terminated or revoked by state regulatory authorities for failure to
comply with state law and/or the rules, regulations and policies of state
regulatory authorities. Fines or other penalties also may be imposed for such
violations. There can be no assurance that state utilities commissions or third
parties will not raise issues with regard to the Company's compliance with
applicable laws or regulations.
The Company has obtained authority to provide intrastate, intraLATA long
distance service in states outside of its target markets because it believes
this capability enhances the Company's ability to attract business customers
that have offices outside of its target markets. The Company may also apply for
authority to provide services in other states in the future. The Company holds
certificates to offer local services in North Carolina, Alabama, Arkansas,
Delaware, the District of Columbia, Florida, Georgia, Kansas, Kentucky,
Louisiana, Maryland, Mississippi, Missouri, New Jersey, New York, Oklahoma,
Pennsylvania, South Carolina, Tennessee, Texas, Virginia and West Virginia, and
has an application pending for authority to offer local services in California.
While the Company expects and intends to obtain necessary operating authority
in each jurisdiction where it intends to operate, there can be no assurance
that each jurisdiction will grant the Company's request for authority.
Although the Telecommunications Act preempts the ability of states to
forbid local service competition, some states have not yet completed all
regulatory actions to comply with the Telecommunications Act. Furthermore, the
Telecommunications Act preserves the ability of states to impose reasonable
terms and conditions of service and other regulatory requirements.
The Company believes that, as the degree of intrastate competition
increases, the states will offer ILECs increasing pricing flexibility. This
flexibility may present ILECs with an opportunity to subsidize services that
compete with the Company's services with revenues generated from
non-competitive services, thereby allowing ILECs to offer competitive services
at prices below the cost of providing the service. The Company cannot predict
the extent to which this may occur or its impact on the Company's business.
Local Government Authorizations. The Company is required to obtain street
use and construction permits and licenses and/or franchises to install and
expand its fiber optic networks using municipal rights-of-way. In some
municipalities where the Company has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenues or on a per linear foot basis. There can be no
assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, ILECs do not pay such
franchise fees or pay fees that are substantially less than those required to
be paid by the Company. To the extent that competitors do not pay the same
level of fees as the Company, the Company could be at a competitive
disadvantage. Termination of the existing franchise or license agreements prior
to their expiration dates or a failure to renew the franchise or license
agreements and a requirement that the Company remove its facilities or abandon
its network in place could have a material adverse effect on the Company.
Employees
As of December 31, 1998, the Company employed a total of approximately 750
employees. The Company believes that its future success will depend on its
continued ability to attract and retain highly skilled and qualified employees.
None of the Company's employees are currently represented by a collective
bargaining agreement. The Company believes that its relations with its
employees are good.
Item 2. Properties
The Company leases offices and space in a number of locations, primarily
for sales offices and network equipment installations. The Company leases
approximately 95,000 square feet of office space for its corporate headquarters
in Raleigh, North Carolina, under a lease expiring in April 2005. The Company
leases space for sales offices in North Carolina, Florida, Georgia, South
Carolina, Tennessee, and Virginia. The leases for these offices expire between
May 1999 and April 2005. In addition, the Company leases rights-of-way, office
space and land for its network equipment. The leases for the office space and
land expire between September 1999 and June 2004 and the leases for the
rights-of-way are either perpetual or are renewable through 2023. The Company
believes that its leased facilities are adequate to meet its current needs and
that additional facilities are available to meet its needs for the foreseeable
future.
12
Item 3. Legal Proceedings
The Company is not a party to any pending legal proceedings that the
Company believes would, individually or in the aggregate, have a material
adverse effect on the Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter ended December 31, 1998.
PART II
Item 5. Market For Registrant's Common Equity and Related Stockholder Matters
There is no established public trading market for the Company's stock.
All of the outstanding shares are held by one person.
Since its conversion from an S corporation to a C corporation in September
1997, the Company has only paid cash dividends on its Common Stock to fund
shareholder tax liabilities arising from periods when the Company was an S
corporation. During these periods, the shareholders incurred tax liabilities on
behalf of the Company due to income of the Company reported on their individual
income tax returns. The Company's 10 1/2% Senior Notes and its credit
facilities do not allow it to pay dividends except for those to fund the
aforementioned tax liabilities. The Company anticipates that for the
foreseeable future any earnings will be retained for use in its business and,
accordingly, does not anticipate the payment of cash dividends.
The Company did not sell any unregistered equity securities during the
quarter ended December 31, 1999.
Item 6. Selected Financial and Operating Data
The following selected historical financial and operating data for the
five years ended December 31, 1998 were derived from the audited financial
statements of the Company. The selected data should be read in conjunction with
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations," the financial statements and notes thereto and other
financial and operating data contained elsewhere herein.
13
Year Ended December 31,
----------------------------------------------------------------
1994 1995 1996 1997 1998
------------ ----------- ----------- ------------- -------------
Statement of Operations Data (in thousands, except per
share data):
Revenues .................................................... $91,470 $114,493 $148,777 $ 194,949 $ 212,554
Operating expenses:
Cost of services ............................................ 54,425 68,199 90,820 139,030 150,901
Selling, general and administrative expenses ................ 33,671 44,732 53,791 60,131 80,011
------- -------- -------- ---------- ----------
Total operating expenses .................................... 88,096 112,931 144,611 199,161 230,912
------- -------- -------- ---------- ----------
Income (loss) from operations ............................... 3,374 1,562 4,166 (4,212) (18,358)
Interest expense ............................................ (750) (1,297) (1,695) (8,806) (25,430)
Interest income ............................................. 77 44 4 2,379 5,555
Gain on sale of marketable securities ....................... -- 62 131 -- --
------- -------- -------- ---------- ----------
Income (loss) before income taxes ........................... 2,701 371 2,606 (10,639) (38,233)
Income taxes ................................................ -- -- -- -- --
------- -------- -------- ---------- ----------
Net income (loss) ........................................... 2,701 371 2,606 $ (10,639) $ (38,233)
========== ==========
Pro forma income taxes(a) ................................... 1,135 156 1,094
------- -------- --------
Pro forma net income (loss)(a) .............................. $ 1,566 $ 215 $ 1,512
======= ======== ========
Cash dividends declared per common share(b) ................. $ 0.01 $ 0.01 $ 0.01 $ 0.01 $ 0.01
======= ======== ======== ========== ==========
Other Data (in thousands, except ratio data):
Capital expenditures, including line access fees ............ $ 4,435 $10,718 $ 8,401 $ 23,479 $ 69,434
Depreciation and amortization ............................... 2,749 3,073 4,471 6,613 11,457
Net cash provided by (used in) operating activities ......... 6,231 9,446 283 8,211 (6,418)
Net cash provided by (used in) investing activities ......... (4,530) (10,721) (8,681) (133,248) (49,466)
Net cash provided by (used in) financing activities ......... (1,701) 1,581 8,589 191,542 1,649
EBITDA(c) ................................................... 6,123 4,635 8,637 3,138 (6,854)
Ratio of earnings to fixed charges(d) ....................... 3.3 x 1.2 x 1.8 x -- --
Balance Sheet Data (at period end and in thousands):
Working capital (deficit) ................................... $(1,546) $(5,182) $(3,189) $ 76,842 4,599
Property and equipment, net ................................. 9,009 16,792 21,498 44,577 101,960
Total assets ................................................ 26,802 35,969 48,682 223,550 209,171
Debt and capital lease obligations .......................... 8,388 13,553 21,088 251,794 254,882
Shareholder's equity (deficit) .............................. 4,070 1,897 2,374 (69,574) (109,842)
- ----------
(a) Historical financial information for the three years in the period ended
December 31, 1996 does not include a provision for income taxes because,
prior to the Reorganization, BTI was an S corporation not subject to
income taxes. Net income has been adjusted on a pro forma basis to reflect
the tax that would have been paid by BTI if it had been subject to income
tax for the full period.
(b) The dividends were paid in part to provide funds for tax obligations owed
by BTI's shareholders as a result of BTI's S-corporation status prior to
the Reorganization.
(c) EBITDA consists of income (loss) before interest, income taxes,
depreciation, amortization, other income and expense and non-cash
compensation expense recorded in accordance with APB No. 25. EBITDA is
provided because it is a measure commonly used in the industry. EBITDA is
not a measurement of financial performance under generally accepted
accounting principles and should not be considered an alternative to net
income as a measure of performance or to cash flow as a measure of
liquidity. EBITDA is not necessarily comparable with similarly titled
measures for other companies.
(d) The ratio of earnings to fixed charges is computed by dividing income
before income taxes and fixed charges (other than capitalized interest) by
fixed charges. Fixed charges consist of interest charges, amortization of
debt issuance costs and discount or premium related to indebtedness,
whether expensed or capitalized, and that portion of rental expense the
Company believes to be representative of interest (estimated to be one-third
of such expense). For the years ended December 31, 1997 and 1998, earnings
were insufficient to cover fixed charges by $0.8 million and $10.6 million,
respectively.
14
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following analysis should be read in conjunction with the financial
statements and notes thereto and the other financial data appearing elsewhere
herein. The Company has included EBITDA data in the following analysis because
it is a measure commonly used in the industry. EBITDA consists of income (loss)
before interest, income taxes, depreciation, amortization, other income and
expense and non-cash compensation expense recorded in accordance with APB No.
25. EBITDA is not a measure of financial performance under generally accepted
accounting principles and should not be considered an alternative to net income
as a measure of performance or to cash flows as a measure of liquidity. EBITDA
is not necessarily comparable with similarly titled measures for other
companies.
Overview
The Company, which began operations in 1984 as Business Telecom, Inc., is
a leading provider of telecommunications services in the Southeastern United
States. The Company currently offers integrated telecommunications services
including long distance, local, data, Internet access and other enhanced
services, primarily to small and medium-sized business customers. In addition,
the Company offers wholesale telecommunications services, including switched,
dedicated access, special access and prepaid calling card services primarily to
telecommunications carriers.
The Company currently has sales offices in 18 markets primarily located in
the Southeastern United States, along with long distance switching operations
centers in Atlanta, Dallas, New York, Orlando and Raleigh and local switching
operations centers in Raleigh, Charlotte, Greensboro, Orlando and Atlanta. The
Company operates a fiber optic network, consisting of leased and owned
transmission capacity, concentrated within the Southeastern United States. The
Company uses multiple carriers to obtain competitive pricing and high quality
service for its customers while maintaining built-in flexibility and routing
diversity to mitigate the impact of service interruptions.
Company Reorganization. In September 1997, the Company undertook a series
of transactions (the "Transactions") to provide BTI with greater liquidity and
financial flexibility and to enhance its ability to execute its business
strategy, including rapidly penetrating the local exchange market and expanding
its network. The Transactions included the following:
(1) the Company issued $250.0 million aggregate principal amount of 10 1/2%
Senior Notes due 2007 (the "10 1/2% Notes");
(2) BTI repaid all $26.6 million of indebtedness outstanding under its
then-existing credit facility with General Electric Capital Corporation
("GE Capital"), including accrued interest thereon (the "BTI
Refinancing"), and entered into a five-year, $60.0 million senior
secured credit facility with GE Capital, guaranteed by the Company,
which was amended and restated effective June 30, 1998 to provide a
$30.0 million revolving credit facility and a $30.0 million capital
expenditure facility (the "Facilities");
(3) BTI repurchased the 50% interest in its shares held by A.B. Andrews
(the "Retiring Shareholder") for approximately $28.3 million (the "Share
Repurchase");
(4) BTI was merged with and into a wholly owned subsidiary of BTI Telecom
Corp. and converted from an S corporation to a C corporation (the
"Reorganization"); and
(5) BTI acquired all of the fiber optic network and facilities assets of
FiberSouth, Inc. ("FiberSouth"), for approximately $31.0 million, and
repaid approximately $5.3 million of FiberSouth indebtedness, together
with accrued interest thereon (the "FiberSouth Acquisition").
Revenue. The Company generates the majority of its revenues from: (1) the
sale of integrated telecommunications services, primarily to small and
medium-sized businesses; and (2) the sale of wholesale telecommunications
services, largely to other telecommunications carriers. For the years ended
December 31, 1996, 1997 and 1998 revenues from integrated services represented
approximately 82.7%, 59.1% and 63.1%, respectively, of the Company's total
revenue. During the past several years, market prices for many
telecommunications services have been declining, which is a trend that the
Company believes will likely continue. This decline will have a negative effect
on the Company's revenue and gross margin, which may not be offset completely
by savings from decreases in the Company's cost of services.
15
The Company's portfolio of integrated telecommunications services includes
long distance, local, data, Internet access, paging, AIN applications, operator
and other enhanced services. In order to capitalize on the excess capacity of
its network in off-peak hours, the Company markets long distance services to
the residential market through its Alliance Program for trade associations and
professional organizations and its Academic Edge Program for colleges and
universities.
The Company began offering local exchange services, primarily on a resale
basis, as part of its array of integrated telecommunications services in
selected markets in the Southeastern United States in November 1997. The
Company has installed Lucent 5ESS local switches in Raleigh, Charlotte,
Greensboro, Orlando and Atlanta, and plans to install four additional switches
in key Southeastern markets by mid-1999. The Company will initially resell ILEC
services in its other target markets, and intends to install network
infrastructure to support local switched services as market conditions warrant.
The introduction of local services contributed to lower gross margins in 1997
and 1998 as these services are initially being offered on a resale basis. The
Company expects these margins to improve as it provides more of these services
using its own local switching facilities. As of December 31, 1998, the Company
was providing local service in 11 states primarily on a resale basis. Through
December 31, 1998, the Company had sold over 48,500 local access lines,
approximately 50% of which were sold to existing customers. In addition, over
90% of the new local customers also purchased long distance or other services.
Through 1995, the Company's direct sales compensation structure consisted
of base salary plus one-time commissions on each customer's initial monthly
billings and nominal residual commissions. During 1996, the Company redesigned
its sales compensation structure in order to provide sales representatives with
greater long-term incentives and to encourage stronger customer relationships.
The new sales commission structure, known as the Partner Program, compensates
sales representatives by offering a base salary for a ramp-up period, with
higher commissions on initial billings, followed by more significant residual
commissions. As the Company anticipated, the implementation of the new sales
compensation structure initially caused increased turnover of sales personnel
and resulted in decreased integrated services revenues and customer retention.
Although revenue from integrated services decreased in 1997 as a result of
these changes, new sales activity and retail revenue have once again begun to
increase. In addition, during 1998 the Company announced that it will be
relocating two of its direct sales offices from Texas to its more strategic
North Carolina markets, in order to more effectively focus sales resources on
certain underserved markets in the Company's core Southeastern region.
The Company's portfolio of wholesale telecommunications services includes
switched and dedicated access services. The Company entered the wholesale
services business to leverage the network infrastructure developed for its
integrated telecommunications services. In 1996, the Company began to
aggressively pursue wholesale revenues to carriers, resellers and debit card
providers. The Company increased monthly wholesale revenue from $0.7 million in
January 1996 to $7.0 million in December 1998. Wholesale revenue as a
percentage of the Company's total annual revenue was 17.3% in 1996, 40.9% in
1997 and 36.9% in 1998.
Operating Expenses. The Company's primary operating expense categories
include cost of services and selling, general and administrative expenses
("SG&A"). Cost of services consists of the fixed costs of leased facilities and
the variable costs of origination, termination, and access services provided
through ILECs and other telecommunications companies. By using multiple
carriers for its transmission capacity, the Company is able to maintain network
diversity and take advantage of least-cost traffic routing. In addition, in
October 1997 the Company entered into an agreement with Qwest to lease on an
IRU basis approximately 3,250 route miles of fiber optic network from New York
to Miami and Atlanta to Nashville. This network, which is expected to become
substantially operational during the third quarter of 1999, will enable the
Company to carry a significant portion of its intraregional traffic over its
own facilities, thereby reducing its costs of services by decreasing payments
to other carriers for the use of their facilities. As of December 31, 1998,
approximately 300 miles of this network was operational.
SG&A includes all infrastructure costs such as selling expenses, customer
support, corporate administration, personnel, network maintenance, and
depreciation and amortization. Selling expenses include commissions for the
Company's direct sales program, which consist of a large percentage of
customers' first month's billings, plus a residual percentage of ongoing
monthly revenues. Selling expenses also include commissions paid to the
Company's Corporate Partners (third party agents), which are based upon a fixed
percentage of the customers' monthly billings. Depreciation and amortization is
primarily related to switching equipment, facilities, computer
16
equipment and software, and is expected to increase as the Company incurs
substantial capital expenditures to continue the expansion of its network
facilities. Depreciation and amortization also includes line access fees, which
represent installation charges paid primarily to ILECs for leased fiber optic
facilities in addition to internal costs for network setup.
In connection with the Transactions, the Company issued options to
purchase 3,332,600 shares of Common Stock to certain individuals under the
Company's 1994 Stock Plan and recorded approximately $2.1 million in
compensation expense with respect thereto in 1997. In connection with the
FiberSouth Acquisition, the Company also satisfied certain stock repurchase
obligations in 1997 and 1998.
Income Taxes. The Company generated a net loss for 1997 and 1998. Based
upon management's plans to expand the business through the construction and
expansion of its networks, customer base and product offerings, this trend is
expected to continue. Given these circumstances and the level of taxable income
expected to be generated from reversing temporary differences, the Company has
established a valuation allowance for the deferred tax assets associated with
these net operating losses. The Company will reduce the valuation allowance
when, based on the weight of available evidence, it is more likely than not
that some portion or all of the deferred tax assets will be realized.
Prior to the Company's reorganization during 1997, BTI elected to be taxed
for federal and state income tax purposes as an S corporation under the
provisions of the Internal Revenue Code; accordingly, income, losses and
credits were passed through directly to the shareholders rather than being
taxed at the corporate level. In conjunction with the Reorganization, the
Company converted from an S corporation to a C corporation and, as a result, is
subject to federal and state income taxes. Conversion to a C corporation
required the Company to adopt the provisions of Financial Accounting Standards
Board Statement No. 109 ("SFAS 109"), "Accounting for Income Taxes." The
cumulative effect of adoption of this standard is reflected in the Company's
financial statements for the twelve months ended December 31, 1997.
Throughout the period of time that BTI was an S corporation, shareholders
were paid dividends to fund tax obligations arising from income earned by BTI
that was reported on their individual income tax returns. The Company will
continue to reimburse shareholders for any tax obligations arising from the
income earned by BTI while its was an S corporation. The Company believes that
any such requirements will not have a material effect on the Company's
financial condition or results of operations.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue
Revenue increased 9.0% from $194.9 million in 1997 to $212.6 million in
1998. This $17.6 million increase was primarily driven by the Company's
introduction of local exchange services, which increased revenue by $11.8
million in 1998. The cumulative number of local access lines sold by the
Company increased from 2,300 at December 31, 1997 to 48,500 at December 31,
1998. The remaining revenue increase of $5.8 million consists of $7.1 million
in other retail services, offset by a decrease of $1.3 million in wholesale
service revenue in 1998.
Within wholesale service revenue, prepaid calling card revenue increased
$8.7 million from $5.0 million in 1997 to $13.7 million in 1998. This type of
service provides the Company with cash flow superior to traditional switched
services, because the customer is required to prepay. The increase in prepaid
calling card revenue was offset by a decrease in revenue from wholesale
switched origination and termination services. This decrease consisted
primarily of a volume decrease due to strategic pricing decisions by the
Company to preserve margins. Other factors contributing to this decrease
included competitive pricing pressures, access charge reform and consolidation
within the industry.
Cost of Services
Cost of services represented 71.0% of revenue for the year ended December
31, 1998, as compared to 71.3% for 1997. The relatively stable cost of services
percentage for 1998 as compared to 1997 reflects the impact of the introduction
of CLEC services, changes in the long distance revenue mix and cost
efficiencies gained in the Company's network operations. The revenue mix impact
included an increase in the percentage of revenue represented by higher margin
integrated services from 59.1% in 1997 to 63.1% in 1998. However,
17
because the Company is initially offering its local services primarily on a
resale basis, the increase in local service revenue has increased the Company's
cost percentage. As the Company completes the installation of its local
switches, an increasing portion of this service will be provided via
Company-owned facilities, which should improve margins for this service. In
addition, through the end of 1998 approximately 10% of the Company's planned
3,250 mile fiber network had been activated, which allowed the Company to begin
reducing certain fixed costs associated with leased facilities.
One trend that is indicative of the Company's progress during 1998 is the
continued reduction in its cost of services as a percentage of revenue on a
quarterly basis. This percentage decreased from 74.1% in the first quarter of
1998 to 66.2% in the fourth quarter.
In addition, cost of services has been adversely impacted by regulatory
matters, including increased costs related to the public payphone compensation
order. A Federal Communications Commission ("FCC") ruling established,
effective October 1997, a "per call compensation plan" that provides payphone
service providers with compensation for calls completed using their payphones.
During the first quarter of 1998, the Company began assessing a surcharge to
these payphone users in order to recover the amount of compensation and related
costs ordered by the FCC.
Construction of the fiber optic network and the continuing effect of
access charge reform are expected to reduce the Company's network costs in the
future. Management anticipates that its fiber optic network will become
substantially operational during the third quarter of 1999, and that its
network expansion will enable it to carry a significant portion of its
intraregional telecommunications traffic over owned facilities, thereby
decreasing payments to other carriers for use of their transport facilities.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses in 1998 were $68.5
million, or 32.2% of revenue, as compared to $53.5 million, or 27.5% of revenue
in 1997. The increase in SG&A expenses during 1998 is largely attributable to
the significant investments in human resources and increased marketing and
advertising efforts associated with the introduction of the Company's CLEC
services. These investments are intended to provide the Company with the
ability to continue to expand into new markets, maximize customer retention and
provide for growth in 1999 and beyond. The Company has also hired additional
personnel to facilitate the deployment of its fiber optic network. In addition,
depreciation and amortization was $11.5 million in 1998, representing an
increase of 73.2% over the prior year. The increase in depreciation and
amortization is primarily due to capital expenditures related to the expansion
of the Company's network facilities and support infrastructure to accommodate
expanded service offerings and increased traffic volume.
Other Income (Expense)
During 1998, interest expense was $25.4 million, compared to $8.8 million
in 1997. The increase in interest expense during 1998 is primarily attributable
to the Company's September 1997 issuance of the 10 1/2% Notes to finance
capital expenditures, working capital and the Company's introduction of CLEC
services. In addition, the Company capitalized $1.5 million of interest expense
associated with the construction of its local service facilities and fiber
networks during 1998.
Interest income increased to $5.6 million in 1998 from $2.4 million in
1997, due to the investment of a portion of the proceeds of the 10 1/2% Note
Offering.
EBITDA
Earnings before interest, taxes, depreciation and amortization and other
non-cash charges (EBITDA) is a common measurement of a company's ability to
generate cash flow from operations. EBITDA is not a measure of financial
performance under generally accepted accounting principles and should not be
considered an alternative to net income as a measure of performance or to cash
flows as a measure of liquidity. The Company experienced negative EBITDA of
$6.9 million for 1998, and positive EBITDA of $3.1 million for 1997. The
Company expects to begin generating positive EBITDA during 1999 as it continues
to expand its CLEC offerings and completes deployment of its fiber optic
network. The decrease in EBITDA experienced by the Company throughout 1998 is
primarily attributable to the additional SG&A associated with the Company's
introduction of CLEC services and the expansion of its fiber network.
18
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenue
Revenue increased 31.0% from $148.8 million for 1996 to $194.9 million for
1997, primarily as a result of a $54.0 million increase in wholesale services
revenue. The increase in wholesale revenue is attributable to increased sales
to existing customers as well as sales to new customers. This increase was
partially offset by a $7.9 million decrease in integrated services revenue
resulting from the implementation of the Company's new sales compensation
structure and to a lesser extent due to decreasing retail long distance rates
and increasing competitive pressures.
Cost of Services
Cost of services increased 53.1% from $90.8 million for 1996 to $139.0
million for 1997, primarily as a result of the increase in total call volume
resulting from increased wholesale revenue. Cost of services as a percentage of
revenue increased from 61.0% for 1996 to 71.3% for 1997, largely due to the
increase in lower margin wholesale revenue as a percentage of the Company's
total revenues. Wholesale revenue accounted for 40.9% of total revenue for
1997, up from 17.3% for 1996. In addition, the effect of spreading fixed
network costs over a reduced integrated services revenue base also contributed
to the increase in cost of services as a percentage of revenue in 1997 as
compared to 1996. Cost of services has also been adversely impacted by
regulatory matters, including increased costs related to the FCC's public
payphone compensation order.
Selling, General and Administrative Expenses
SG&A increased 8.5% from $49.3 million for 1996 to $53.5 million for 1997
though it declined as a percentage of total revenue from 33.1% in 1996 to 27.5%
in 1997. The decrease in SG&A as a percentage of revenue is largely
attributable to cost containment efforts implemented by the Company in the
second quarter of 1996. SG&A in 1997 also included the one-time charge of $2.1
million to recognize stock compensation expense relating to former employees in
connection with the Transactions. Depreciation and amortization increased 47.9%
from $4.5 million for 1996 to $6.6 million for 1997, due primarily to capital
expenditures related to the investment in new switching operations and
expansion of existing operations centers and infrastructure due to increased
traffic volume and expanded product offerings.
Other Income (Expense)
Interest expense was $1.7 million for 1996, as compared to $8.8 million
for 1997, primarily due to the issuance of the 10 1/2% Notes to finance capital
expenditures, working capital and the Company's introduction of CLEC services.
EBITDA
EBITDA decreased 63.7% from $8.6 million for 1996 to $3.1 million for
1997. The decrease is due primarily to an increase in cost of services,
partially offset by increased revenues.
Liquidity and Capital Resources
Cash Flows
For the year ended December 31, 1996, the Company generated cash flow from
operating activities of $0.3 million. This cash flow primarily resulted from
net income of $2.6 million combined with depreciation and amortization of $4.5
million, which was offset by an increase in accounts receivable of $6.6
million. Cash used in investing activities in 1996 was $8.7 million, primarily
consisting of $7.8 million in capital expenditures. Net cash provided by
financing activities was $8.6 million in 1996. This increase in cash was
primarily due to proceeds of long-term debt of $11.6 million which was
partially offset by $2.0 million in dividends paid to shareholders. These
dividends were paid in part to provide funds for tax obligations owed by BTI's
shareholders as a result of BTI's net income, due to its status as a subchapter
S corporation for income tax purposes during 1996.
For the year ended December 31, 1997, the Company generated $8.2 million
of positive cash flow from operating activities, primarily driven by a net loss
of $10.6 million, depreciation and amortization of $6.6 million, and increases
in accounts payable and accrued interest of $4.1 million and $7.1 million,
respectively. Cash used in investing activities in 1997 was $133.2 million,
including $74.6 million used to purchase securities
19
pledged to secure the first six scheduled interest payments on the 10 1/2%
Notes (the "Restricted Cash"). In addition, investing activities included $35.2
million utilized for the FiberSouth Acquisition and $22.8 million in capital
expenditures during 1997. Net cash provided by financing activities in 1997 was
$191.5 million. This amount consists of $250.0 million of gross proceeds from
the 10 1/2% Notes Offering, partially offset by $28.3 million used for the
Share Repurchase, $18.7 million used to payoff existing long-term debt and $9.5
million in financing costs. The Company also paid dividends of $1.6 million in
part to provide funds for tax obligations owed by BTI's shareholders as a
result of BTI's income reported on their income tax returns. In the
Reorganization, BTI converted from S corporation to C corporation status for
income tax purposes. As a result, the Company became fully subject to federal
and state income taxes and it recorded $2.8 million of deferred income tax
liabilities. There was no corresponding impact on the Company's results from
operations due to net operating losses generated during 1997, which were
partially offset by the recording of a valuation allowance.
For the year ending December 31, 1998, the Company used $6.4 million of
cash flow to fund operating activities. This amount consisted primarily of a
net loss of $38.2 million, offset by depreciation and amortization of $11.4
million, and an increase in accounts payable and accrued expenses of $20.1
million associated with the Company's capital expenditures and continued
operational expansion. Cash used in investing activities in 1998 was $49.5
million, including capital expenditures of $66.3 million and an increase in
other assets of $3.1 million, partially offset by the decrease in Restricted
Cash of $22.3 million. Capital expenditures during 1998 were primarily related
to the deployment of the fiber optic network and purchases of equipment for the
development of the Company's facilities-based local exchange services. The $3.1
million increase in other assets consisted of $1.6 million in capitalized
expenditures for line access fees, and the Company's $1.5 million purchase of a
multi-media franchise to secure service rights within the Raleigh, North
Carolina Market (see "Item 13 Certain Relationships and Related Transactions").
The decrease in Restricted Cash resulted from the provision of $26.3 million to
fund the March and September 1998 interest obligations on the 10 1/2% Notes,
net of $4.0 million in related investment earnings. In addition, during 1998
the Company satisfied stock and option repurchase obligations that arose in
connection with the Fibersouth Acquisition and under the 1994 Stock Plan. The
Company settled these obligations with a $2.3 million cash payment, which is
reflected as an adjustment to equity and represents a reallocation of the
original Fibersouth purchase price. Net cash provided by financing activities
in 1998 was $1.6 million which consisted primarily of $4.1 million in net
borrowings on long-term debt partially offset by a decrease in other long term
liabilities.
Debt
Effective June 30, 1998, the Company amended and restated its $60.0
million revolving credit facility to provide a $30.0 million revolving credit
facility based upon accounts receivable and a $30.0 million facility based upon
capital expenditures (the "Facilities"). Borrowings under the Facilities are
based upon a percentage of eligible accounts receivable and eligible capital
expenditures, respectively, as defined in the loan agreement. Borrowings under
the Facilities are secured by substantially all of the Company's assets and
bear interest at the 30, 60 or 90 day London Interbank Offered Rate ("LIBOR")
or the prime rate, plus an applicable spread which varies based upon the
Company's financial position. The Company is also required to pay a fee of
0.375% per year on the unused portion of the Facilities. At December 31, 1998,
$4.1 million was outstanding under the Facilities, in addition to $0.2 million
in letters of credit. The Facilities require the Company's compliance with
various financial and administrative covenants, including among others,
covenants limiting its ability to incur debt, create liens, make distributions
or stock repurchases, make capital expenditures, engage in transactions with
affiliates, sell assets and engage in mergers and acquisitions. In addition,
the Facilities contain affirmative covenants, including, among others,
covenants requiring maintenance of corporate existence, licenses and insurance,
payments of taxes and the delivery of financial and other information. The
Company is currently in compliance with these covenants, but there can be no
assurance that the Company will be able to continue meeting these covenants or,
if required, obtain additional financing on acceptable terms, and the failure
to do so may have a material adverse impact on the Company's business and
operations.
During the second quarter of 1998, Moody's adjusted the Company's
long-term credit rating from B2 to B3, citing concern that integrated services
revenue and operating cash flow were unlikely to grow as rapidly as Moody's had
initially expected when the 10 1/2% Notes were originally rated. Moody's
indicated that the trend in operating results had the effect of weakening the
Company's anticipated debt protection measures for the intermediate term.
However, Moody's indicated that the Company's strategy to improve operating
margins and
20
cash flows through the migration of its long distance and local traffic over
more of its own switches and network facilities continued to be a sound
business plan. Moody's also affirmed the Company's rating of B1 on the $60
million secured credit facilities.
In November 1998, Standard and Poor's ("S&P") lowered its corporate credit
and senior unsecured debt ratings on the Company's long-term debt from B+ to B
and lowered its rating from BB- to B+ on the Facilities. This rating action
reflected concerns similar to those cited by Moody's, and also noted the
anticipated operating margin improvements that should result from the migration
of long distance and local traffic to more of the Company's own switches and
fiber network. The revised rating also reflected a stable outlook for the
Company.
Capital Spending
The Company incurred total capital expenditures of $66.3 million during
1998, including $30.9 million related to its fiber optic network and $35.4
million in equipment and corporate infrastructure, primarily for the Company's
CLEC operations. The Company currently estimates that its aggregate capital
requirements will total approximately $42 million for 1999, including $23.6
million committed on existing projects. In addition, the Company expects to
make reduced capital expenditures thereafter and currently estimates that its
aggregate capital expenditures for the years 2000 through 2002 will be
approximately $60 million.
The actual amount and timing of the Company's capital requirements may
differ materially from the foregoing estimate as a result of regulatory,
technological or competitive developments (including market developments and
new opportunities) in the Company's industry. The Company believes that cash on
hand, borrowings expected to be available under the Credit Facility and cash
flow from operations will be sufficient to expand the Company's business as
currently planned. The Company expects to begin generating positive cash flow
from operations during 1999 as it continues to expand its CLEC offerings and
completes the deployment of its fiber optic network. In the event the Company's
plans change or its forecasts prove to be inaccurate, the foregoing sources of
funds may prove to be insufficient to fund the Company's planned growth and
operations. The Company may also require additional capital in the future (or
sooner than currently anticipated) for new business activities related to its
current and planned businesses, or in the event it decides to make additional
acquisitions or enter into joint ventures and strategic alliances. Sources of
additional capital may include public and private debt and equity offerings,
subject to compliance with the provisions in the Indentures and the Facilities.
Additional financing might not be available to the Company, or might not be
available on terms acceptable to the Company and within the restrictions
contained in the Company's financing arrangements.
Year 2000 Issues
Beginning in 1996, the Company conducted a thorough review of its
information technology and operating systems and non-information technology
systems, as well as the systems of its major customers, suppliers, and third
party network service providers to ensure that the systems would properly
recognize the Year 2000 and continue to process data. This review also included
the evaluation of internally developed software. As a result of this
assessment, the Company has developed a thorough plan to address the Year 2000
issue ("Year 2000 Plan"). The Year 2000 Plan has strong executive management
support and requires frequent updates to senior management. In addition, a
project manager and significant other programming and operational staff are
dedicated to the Plan's implementation. The Year 2000 Plan includes the
wide-ranging assessment of the Year 2000 problems that may affect the Company,
the development of remedies to address the problems discovered in the
assessment phase, testing of the remedies and the preparation of contingency
plans.
Implementation of the Plan began in 1997 and will continue through 1999.
The Company has completed the evaluation phase for its systems and is in the
remediation and testing phases of the Year 2000 Plan. The Company anticipates
that all major business-critical systems will be tested and Year 2000 compliant
by June 30, 1999. In that regard, the Company has received assurances or has
secured contractual stipulations from certain significant vendors that their
systems are either already Year 2000 compliant or will be by June 30, 1999.
These vendors include the Company's major suppliers of switching equipment,
fiber optic electronics, and billing and customer care systems. The Company
believes that these systems represent its most critical business systems. All
other systems are targeted for compliance by the end of the third quarter 1999.
The Company is currently testing the systems and applications that have been
corrected or reprogrammed.
21
As part of the Year 2000 Plan, the Company is seeking information from its
other significant hardware, software and other equipment vendors, third party
network providers, other material service providers and material customers
regarding their development and implementation of plans to become Year 2000
compliant. Responses received to date from the Company's vendors, service
providers and customers have indicated that such respondents are in the process
of implementing remediation procedures to ensure that their computer systems
will be Year 2000 compliant by December 31, 1999.
The Company is developing contingency plans to deal with potential Year
2000 related business interruptions that may occur, and these plans are
expected to be complete by March 31, 1999. These contingency plans will be
designed to address worst-case scenarios. Models of such worst-case scenarios
will be developed based upon the responses of the Company's vendors, service
providers and customers to the Company's requests for Year 2000 compliance
information.
Through December 31, 1998, the Company has spent approximately $0.7
million on Year 2000 projects and activities. The estimated total cost for Year
2000 projects and activities is $2.0 million, excluding capital expenditures.
Most of these capital expenditures, which include both equipment and software,
will not only provide for Year 2000 compliance, but also will otherwise enhance
the Company's operations. In most cases, the expenditures for system
modifications will be merely an acceleration of previously planned
improvements. Year 2000 project costs are being funded through operations and
existing credit facilities and are not expected to have a material effect on
the Company's financial condition or results from operations. Management of the
Company believes it has an effective program in place to resolve the Year 2000
issue in a timely manner. However, it is not possible to anticipate all
possible future outcomes, especially when third parties are involved. Failure
by the Company and/or its major vendors, third party network service providers
and other material service providers and customers to adequately address their
respective Year 2000 issues in a timely manner could have a material adverse
effect on the Company's business, results of operations and financial
condition.
Effects of New Accounting Standards
In 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information", which are both effective for fiscal
years beginning after December 15, 1997. SFAS No. 130 addresses reporting
amounts of other comprehensive income and SFAS No. 131 addresses reporting
segment information. As of January 1, 1998, the Company implemented SFAS No.
130. There are no material differences between net income and comprehensive
income as defined by SFAS 130 for the periods presented. SFAS 131 uses a
management approach to report financial and descriptive information about a
Company's operating segments. Operating segments are revenue-producing
components of the enterprise for which separate financial information is
produced internally for the Company's management. Under this definition, the
Company operated, for the years ended December 31, 1996, 1997 and 1998, as a
single segment.
In 1998, the Financial Accounting Standards Board issued SFAS No. 132,
"Employers Disclosures about Pensions and Other Postretirement Benefits" and
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
The Company does not expect any significant additional disclosure requirements
or other financial statement impacts to result from the adoption of the
statements.
Inflation
The Company does not believe inflation has had a significant impact on the
Company's operations.
Item 7A. Quantitative and Qualitative Disclosure
Although the Company invests its short-term excess cash balances, the
nature and quality of these investments are restricted under the terms of the
Indenture for the 10 1/2% Notes and the Company's internal investment policies.
These investments are limited primarily to U.S. Treasury securities, certain
time deposits, and high quality repurchase agreements and commercial paper
(with restrictions on the rating of the companies issuing these instruments).
The Company does not invest in any derivative or commodity type instruments. In
addition, the Company's restricted cash balance available to fund the next four
scheduled interest payments on the 10 1/2% Notes is invested in U.S. Treasury
securities in accordance with the terms of the related agreements. Accordingly,
the Company is subject to minimal market risk on any of its investments.
22
The majority of the Company's debt, which consists of $250 million of the
10 1/2% Notes, bears interest at a fixed rate. Although the actual service
requirements of this debt are fixed, changes in interest rates generally could
put the Company in a position of paying interest that differs from then
existing market rates. The remainder of the Company's debt consists of the
Facilities, which bear interest at variable rates based upon market conditions
and the financial position of the Company. As of December 31, 1998, borrowings
under this facility were $4.1 million. Management believes that this debt does
not currently create a significant amount of interest rate risk, and as such
has not engaged in any related hedging transactions. However, as market
conditions and outstanding borrowings under this debt change, management
intends to continue to evaluate the Company's risk, and it may enter hedging
transactions if conditions warrant.
Item 8. Financial Statements and Supplementary Data.
See page F-1.
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
23
PART III
Item 10. Directors and Executive Officers of the Registrant.
Name Age Position(s) with Company
- -------------------------------- ----- --------------------------------------------------------
Peter T. Loftin ................ 40 Chairman, Chief Executive Officer and Director
R. Michael Newkirk ............. 36 President, Chief Operating Officer and Director
H.A. (Butch) Charlton .......... 48 Executive Vice President
Anthony M. Copeland ............ 42 Executive Vice President, Secretary and General Counsel
Sean P. Pflaging ............... 30 Vice President, Network Services
Brian K. Branson ............... 33 Chief Financial Officer, Treasurer and Director
Thomas F. Darden ............... 43 Director
William M. Moore, Jr. .......... 59 Director
Paul J. Rizzo .................. 70 Director
PETER T. LOFTIN founded BTI in November 1983 and has served as Chief
Executive Officer and Chairman of the Board of Directors of BTI since that
time. Mr. Loftin has more than 15 years of experience in the telecommunications
industry. He is a founding member of the North Carolina Long Distance
Association, representing the state's independent long distance carriers. He
also serves on the Advisory Board of the Duke Heart Center at the Duke
University Medical Center, the Steering Committee for the North Carolina Museum
of Natural Sciences and the Board of the Chamber of Commerce of Raleigh, North
Carolina. Mr. Loftin attended North Carolina State University.
R. MICHAEL NEWKIRK joined BTI in 1986 and has served as its Chief
Operating Officer since October 1996, its President since July 1997 and as
Director since August 1997. Mr. Newkirk was Executive Vice President of BTI
from March 1994 until October 1996. Mr. Newkirk has over 15 years of experience
in the telecommunications industry and is President of the ACCA. He also serves
on the Board of Directors of America's Carriers Telecommunications Association
("ACTA"), a national organization that represents telecommunications companies
before legislative and regulatory bodies.
H.A. (BUTCH) CHARLTON has served as President and CEO of FiberSouth since
April 1997. He has also served as Executive Vice President of BTI since July
1997. Prior to joining FiberSouth, Mr. Charlton served from 1984 to 1997 with
DSC Communications Corporation, a manufacturer of telecommunications equipment
for local, long distance and cellular markets, most recently as Vice President
- -- Public Network Sales. Prior to joining DSC, Mr. Charlton spent 13 years with
Contel Corporation, a local exchange carrier, holding a variety of positions in
the engineering and network planning area. Mr. Charlton holds a B.S. in
Business Finance from the University of Texas at Dallas.
ANTHONY M. COPELAND joined BTI as General Counsel in 1992 after serving as
Chief Counsel for the North Carolina Department of Public Instruction and as
Assistant District Attorney for North Carolina's 10th Prosecutorial District.
Mr. Copeland has served on the North Carolina Board of Public
Telecommunications since July 1995, and in July 1996 was appointed to the Board
of Directors of the North Carolina Electronics and Information Technologies
Association. He is also a member of the Wake Technical Community College
Telecommunications Industry Advisory Committee, the Wake Education
Partnership-Technology Committee, the Federal Communications Bar Association,
the North Carolina State Bar and the North Carolina Bar Association. Mr.
Copeland received his A.B. from Duke University and his J.D. from the T.M.
Cooley Law School at Lansing, Michigan.
SEAN P. PFLAGING joined BTI in 1993 as a network analyst and served in
other managerial roles until January 1998 when he was appointed Vice President,
Network Services. Prior to joining BTI, Mr. Pflaging worked for Sprint
International. Mr. Pflaging holds a B.S. in Business and Accountancy from Wake
Forest University.
BRIAN K. BRANSON was named Chief Financial Officer of BTI in August 1996
and Treasurer and Director of BTI in August 1997. Mr. Branson joined BTI in
July 1992 as a financial analyst and served in a variety of financial roles
prior to his appointment as Chief Financial Officer. Prior to joining BTI, he
worked in the Entrepreneurial Services Group of Ernst & Young LLP. Mr. Branson
is a board member of the National Telecom Data Exchange. Mr. Branson is a
Certified Public Accountant and holds a B.S. in Accounting and an M.B.A. from
Elon College.
24
THOMAS F. DARDEN has served as Chairman of Cherokee Sanford Group LLC or
its predecessors and affiliates, which includes brick manufacturing,
environmental remediation and brownfield redevelopment companies, since 1984 and
since 1997, has served as a director of Waste Industries, Inc., a public
company. He is also a principal of Franklin Street/Fairview Capital, a private
investment company. He also acts as a Trustee of Shaw University, is a director
of Winston Hotels, Inc., and is a former Trustee of the Triangle Transit
Authority. In addition, Mr. Darden has served on the Board of Visitors and
currently serves on the Honors Advisory Board at the University of North
Carolina at Chapel Hill ("UNC-CH"). Mr. Darden holds a B.A. with Highest Honors
and an M.R.P. in Environmental Planning from UNC-CH , and a J.D. from Yale
University.
WILLIAM M. MOORE, JR. has served as Chairman of the Board of Trident
Financial Corp., a private company since 1975 and also serves as a director of
the following private companies: Franklin Street Partners; Anchor Capital
Corp.; Egret Holdings, Inc.; Oberlin Capital, LP; Trident Securities, Inc.; and
Franklin Street Trust Co.
PAUL J. RIZZO has served as Chairman of the Board of Franklin Street
Partners, a private investment company, since 1996 and also serves as a
director of the following public companies: Morgan Stanley Dean Witter & Co.;
Ryder System Inc.; The McGraw-Hill Companies, Inc.; and Johnson & Johnson.
Following his retirement as Vice Chairman of IBM in 1987, Mr. Rizzo became Dean
of the Kenan-Flagler Business School at UNC-CH. He returned to IBM in 1993 as
Vice Chairman and retired from that position in 1994. In addition, Mr. Rizzo
serves as a director of four private companies.
There are no family relationships between any director or officer of the
Company.
Item 11. Executive Compensation
Summary Compensation Information
The following table sets forth all compensation paid or accrued by the
Company for services rendered to it in all capacities for the fiscal years
ended December 31, 1998, 1997 and 1996, to BTI's Chief Executive Officer and
BTI's other executive officers who earned at least $100,000 in the respective
fiscal year (collectively, the "Named Officers").
Summary Compensation Table
Long-Term
Annual Compensation Compensation Awards
------------------------ -----------------------------------
Fiscal Stock Options All Other
Name and Principal Position Year Salary Bonus (Shares) Compensation
- ----------------------------------------------- -------- ----------- ---------- --------------- -----------------
Peter T. Loftin, Chairman and CEO ............. 1998 $875,016 $ 2,537 0 $ 138,982(1)
1997 500,000 129,403 0 210,000(2)
1996 500,000 20,763 0 190,000(3)
R. Michael Newkirk, President and COO ......... 1998 168,750 130,000 250,000 16,736(4)
1997 125,000 210,313 1,732,960 17,478(5)
1996 100,000 137,706 0 13,728(6)
Anthony M. Copeland, Executive Vice
President and General Counsel ............... 1998 145,000 20,000 125,000 12,290(7)
1997 120,000 52,048 33,330 12,857(8)
1996 100,000 17,586 0 0
H.A. (Butch) Charlton, Executive
Vice President .............................. 1998 175,000 50,000 125,000 8,300(9)
1997 122,052 34,428 33,330 0(10)
Brian K. Branson, Chief Financial Officer
and Treasurer ............................... 1998 121,667 0 125,000 13,001(11)
1997 95,000 30,929 33,330 13,246(12)
- ----------
(1) Includes $62,000 of relocation expenses, $5,190 medical insurance premium
cost, $2,213 disability insurance cost, $4,793 telephone expense, $21,161
tax planning/consulting cost and $43,625 car allowance and personal use of
Company vehicles.
(2) Includes $168,000 of relocation expenses and a $42,000 car allowance.
25
(3) Includes $148,000 of relocation expenses and a $42,000 car allowance.
(4) Includes $4,800 of BTI's matching 401(k) Plan and $11,936 representing the
taxable portion of certain car lease payments.
(5) Includes $11,177, representing the taxable portion of certain car lease
payments, and $6,301 of BTI's matching contributions to the 401(k) Plan.
Current annual base salary is $150,000.
(6) Includes a $10,200 car allowance and $3,528 of BTI's matching contributions
to the 401(k) Plan.
(7) Includes $4,770 of BTI's matching contributions to the 401(k) Plan and
$7,520 representing the taxable portion of certain car lease payments.
(8) Includes $3,825 car allowance, $4,750 of BTI's matching contributions to
the 401(k) Plan, and $4,282 representing the taxable portion of certain
car lease payments.
(9) Includes $4,800 of BTI's matching contribution to the 401(k) Plan and
$3,500 representing the taxable portion of certain car lease payments.
(10) Salary includes $71,010 paid by FiberSouth and $51,042 paid by BTI.
Bonuses paid include $22,000 paid by FiberSouth and $12,428 paid by BTI.
Current annual base salary is $175,000.
(11) Includes $3,041 of BTI's matching contributions to the 401(k) Plan and
$9,960 representing the taxable portion of certain car lease payments.
(12) Includes $2,000 car allowance, $3,148 of BTI's matching contributions to
the 401(k) Plan, and $8,098 representing the taxable portion of certain
car lease payments.
Option Grants, Exercises and Holdings and Fiscal Year-End Option Values
The following table summarizes all option grants during the fiscal year
ended December 31, 1998 to the Named Officers:
Option Grants During Fiscal Year Ended December 31, 1998
Potential Realizable Value
at Assumed Annual Rates
of Stock Price
Appreciation
Number of Shares % of Total Options Exercise or
Underlying Granted to Employees Base Price Expiration on for Option Term(2)
Name Options Granted in Fiscal Year 1997 Per Share(1) Date 5% 10%
- ------------------------------- ------------------ ---------------------- -------------- ----------- ----------- -------------
R. Michael Newkirk ............ 250,000 25.5% $ 3.00 12/21/08 $471,671 $1,195,307
Anthony M. Copeland ........... 125,000 12.7% $ 3.00 12/21/08 $235,835 $ 597,653
H.A. (Butch) Charlton ......... 125,000 12.7% $ 3.00 12/21/08 $235,835 $ 597,653
Brian K. Branson .............. 125,000 12.7% $ 3.00 12/21/08 $235,835 $ 597,653
- ----------
(1) The exercise price may be paid in cash or by any other means determined by
the Company's Board of Directors.
(2) The compounding assumes a 10-year exercise period for all option grants.
These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises are dependent on the future
performance of the Common Stock, which is not currently publicly traded.
The amounts reflected in this table may not necessarily be achieved.
26
The following table sets forth certain information concerning the number
and value of unexercised options held by the Named Officers as of December 31,
1998. No stock options were exercised in 1998.
Fiscal Year End Option Values
Number of Securities Underlying Value of Unexercised
Unexercised Options at In-the-Money Options
December 31, 1998 at December 31, 1998(2)
------------------------------- ------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------- ------------- --------------- ------------- --------------
R. Michael Newkirk ............ 1,749,633 166,667 $4,982,237 $ 0
Anthony M. Copeland ........... 41,667 116,663 0 99,657
H.A. (Butch) Charlton ......... 74,997 83,333 99,657 0
Brian K. Branson .............. 41,667 116,663 0 99,657
- ----------
(1) Value based on the difference between the fair market value of a share of
Common Stock at December 31, 1998 ($3.00), as determined in good faith by
the Board of Directors, and the exercise price of the options.
Director Compensation
Directors of the Company receive no compensation for serving as such. In
1998, each director who was not an employee of the Company was granted an
option to purchase 3,333 shares of Common Stock at an exercise price of $3.00
per share, vesting in full on the first anniversary of the date of grant.
Employment Agreement
In April 1997, H.A. (Butch) Charlton entered into a two-year employment
agreement with FiberSouth pursuant to which Mr. Charlton became President of
FiberSouth. The agreement provides for an annual base salary of $175,000, a
signing bonus of $20,000 and a guaranteed bonus of $50,000 payable in April
1998. BTI has agreed to reimburse Mr. Charlton for up to three months' living
expenses in connection with his relocation to Raleigh, North Carolina. The
agreement also entitled Mr. Charlton to receive stock in FiberSouth. Upon
consummation of the FiberSouth Acquisition, such right was converted into the
right to receive stock options under the 1997 Plan.
Compensation Committee Interlocks and Insider Participation
The Company does not have a Board Compensation Committee. Peter T. Loftin,
Chairman of the Board, Chief Executive Officer and the sole shareholder of the
Company, was the only current or former officer or employee of the Company or
any of its subsidiaries who, during 1998, participated in deliberations of the
Company's Board of Directors concerning executive officer compensation. No
executive officer of the Company serves as a member of the Board of Directors
or Compensation Committee of any entity which has one or more executive
officers serving as a member of the Company's Board of Directors or
Compensation Committee.
27
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock as of February 28, 1999 by
(i) each shareholder who is known by the Company to beneficially own 5% or more
of any class of the Company's capital stock, (ii) each director of the Company,
(iii) each Named Officer and (iv) all directors and executive officers as a
group.
In accordance with Rule 13d-3 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), a person is deemed to be a "beneficial owner"
of a security if he or she has or shares the power to vote or direct the
disposition of such security. A person also is deemed to be a beneficial owner
of any securities of which that person has the right to acquire beneficial
ownership within 60 days. The percentage ownership of each shareholder is
calculated based on the total number of outstanding shares of Common Stock and
those shares of Common Stock that may be acquired by such shareholder within 60
days. Consequently, the denominator for calculating such percentage may be
different for each shareholder. Unless otherwise indicated in the footnotes to
this table, each of the shareholder named in this table has sole voting and
investment power with respect to the shares shown as beneficially owned.
Beneficial Ownership
--------------------------------
Name of Beneficial Owner Number of Shares Percent
- --------------------------------------------------------------------- ------------------ -----------
Peter T. Loftin ..................................................... 100,000,000 100.0%
Thomas F. Darden (1) ................................................ 3,333 *
William M. Moore, Jr. (1) ........................................... 3,333 *
Paul J. Rizzo (1) ................................................... 3,333 *
R. Michael Newkirk (1) .............................................. 1,749,633 1.7
H.A. (Butch) Charlton (1) ........................................... 74,997 *
Anthony M. Copeland ................................................. 41,667 *
Brian K. Branson .................................................... 41,667 *
Directors and executive officers as a group (9 persons) (2) ......... 101,959,630 100.0%
- ----------
* Less than one percent.
(1) Consists entirely of shares of Common Stock that such person has the right
to purchase pursuant to options.
(2) Includes 1,959,630 shares of Common Stock that such persons have the right
to purchase pursuant to options.
Item 13. Certain Relationships and Related Transactions
The Company leases on a month-to-month basis a townhouse in Raleigh, North
Carolina for relocation of employees and a condominium in Wilmington, North
Carolina for corporate and customer entertainment from Peter T. Loftin,
Chairman and Chief Executive Officer and the sole shareholder of the Company.
Payments by the Company for the townhouse were $30,000 in 1998. Payments by the
Company for the condominium were $30,000 in 1998.
The Company also leases a corporate aircraft from an entity controlled by
Mr. Loftin. Payments by the Company for the aircraft, which is subject to a
five-year lease entered into in November 1995, were $343,000 in 1998. This
lease is a "dry" lease, which means that the Company pays all costs of
operation of the aircraft. The Company has an option to renew this lease for an
additional five years.
Since February 1997, BTI has sold certain integrated telecommunications
services to agents and customers of an MLM through International Communications
Corporation ("ICC"), a company which is 50% owned by Mr. Loftin. BTI pays ICC
between a 5% and 20% commission on all sales through it. During 1998, BTI had
paid ICC $493,000 in commissions pursuant to this arrangement.
Pursuant to a Shareholders' Agreement Mr. Loftin was entitled to receive
distributions in amounts sufficient to pay his taxes resulting from ownership
of BTI while it was an S corporation. In addition, he was entitled to receive
dividends in an amount equal to $61,736 per month (the "Additional Dividends").
Pursuant to the Shareholders' Agreement, Mr. Loftin was required to loan the
Additional Dividends paid to him through June 1996 to BTI. This loan, which as
of December 31, 1998 totaled $762,507, net of certain advances to Mr. Loftin,
bears interest at prime and is payable over 24 months through September 1999.
The Shareholders' Agreement and the
28
right to receive Additional Dividends terminated in September 1997. However,
the Company is required to reimburse Mr. Loftin for his tax obligations arising
from income earned by BTI while it was an S corporation. The Company believes
that any such reimbursements will not have a material adverse effect on the
Company.
In July 1998, the Company acquired a multi-media franchise for Raleigh,
North Carolina from FiberSouth, whose sole director, Chief Executive Officer
and principal shareholder is Mr. Loftin, for approximately $1.5 million in
cash. The transaction is subject to approval by the City of Raleigh, which the
Company expects is forthcoming.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following Financial Statements, Financial Statement Schedules and
Exhibits are filed as part of this report:
(1) Financial Statements.
See Index to Consolidated Financial Statements on page F-1.
(2) Financial Statement Schedules.
See Index to Consolidated Financial Statements on page F-1.
All other financial statement schedules for which provision is made in
Regulation S-X are omitted because they are not required under the related
instructions, are inapplicable, or the required information is given in the
financial statements, including the notes thereto and, therefore, have been
omitted.
(3) Exhibits.
See Exhibit Index.
(b) The Registrant filed no reports on Form 8-K during the fourth quarter
of the fiscal year ended December 31, 1998.
29
BTI TELECOM CORP.
Audited Financial Statements
and Additional Financial Information
Years ended December 31, 1998, 1997, and 1996
Contents
Report of Independent Auditors ...................................... F-2
Audited Financial Statements
Consolidated Balance Sheets ....................................... F-3
Consolidated Statements of Operations ............................. F-4
Consolidated Statements of Shareholders' Equity (Deficit) ......... F-5
Consolidated Statements of Cash Flows ............................. F-6
Notes to Consolidated Financial Statements ........................ F-7
Additional Financial Information
Schedule II -- Valuation and Qualifying Accounts .................. F-16
F-1
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDER
BTI TELECOM CORP.
We have audited the accompanying consolidated balance sheets of BTI
Telecom Corp. as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholder's equity (deficit) and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These consolidated financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated 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 BTI Telecom
Corp. at December 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
Ernst & Young LLP
Raleigh, North Carolina
February 17, 1999
F-2
BTI TELECOM CORP.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31
1997 1998
------------ -------------
Assets
Current assets:
Cash and cash equivalents .................................. $ 67,002 $ 12,767
Restricted cash ............................................ 25,016 27,282
Accounts receivable, net ................................... 22,065 25,840
Accounts and notes receivable from related parties ......... 645 344
Other current assets ....................................... 2,303 1,551
--------- ----------
Total current assets ...................................... 117,031 67,784
Equipment, furniture and fixtures:
Equipment, furniture and fixtures .......................... 53,744 103,416
Construction in progress ................................... 10,154 27,052
Less: accumulated depreciation and amortization ............ (19,321) (28,508)
--------- ----------
Total equipment, furniture and fixtures ...................... 44,577 101,960
Other assets, net ............................................ 11,916 13,929
Restricted cash, non-current ................................. 50,026 25,498
--------- ----------
Total assets ................................................. $ 223,550 $ 209,171
========= ==========
Liabilities and shareholder's deficit
Current liabilities:
Accounts payable ........................................... $ 27,305 $ 46,376
Accrued expenses ........................................... 2,505 3,461
Accrued interest ........................................... 7,232 7,772
Shareholder note payable, current portion .................. 944 763
Other liabilities .......................................... 2,203 4,813
--------- ----------
Total current liabilities ................................. 40,189 63,185
Commitments and contingencies (Note 10)
Long-term debt ............................................... 250,000 254,119
Shareholder note payable, less current portion ............... 762 --
Other long-term liabilities .................................. 2,173 1,709
--------- ----------
Total liabilities ......................................... 293,124 319,013
Shareholder's deficit:
Common stock, no par value, authorized
500,000,000 shares, issued and outstanding
100,000,000 in 1997 and 1998 .............................. 37 37
Additional paid-in capital ................................. 738 785
Accumulated deficit ........................................ (70,349) (110,664)
--------- ----------
Total shareholder's deficit ............................... (69,574) (109,842)
--------- ----------
Total liabilities and shareholder's deficit .................. $ 223,550 $ 209,171
========= ==========
See accompanying notes to consolidated financial statements.
F-3
BTI TELECOM CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Year Ended December 31
----------------------------------------------
1996 1997 1998
------------ -------------- --------------
Revenue ................................................ $ 148,777 $ 194,949 $ 212,554
Cost of services ....................................... 90,820 139,030 150,901
--------- ---------- ----------
Gross profit ......................................... 57,957 55,919 61,653
Selling, general and administrative expenses ........... 49,320 53,518 68,554
Depreciation and amortization .......................... 4,471 6,613 11,457
--------- ---------- ----------
Income (loss) from operations .......................... 4,166 (4,212) (18,358)
Other income (expense)
Interest expense ..................................... (1,695) (8,806) (25,430)
Gain on sale of marketable equity securities ......... 131 -- --
Interest income ...................................... 4 2,379 5,555
--------- ---------- ----------
Net income (loss) before income taxes .................. 2,606 (10,639) (38,233)
Income taxes ........................................... -- -- --
Net income (loss) ...................................... $ 2,606 $ (10,639) $ (38,233)
========= ========== ==========
Basic and diluted earnings (loss) per share ............ $ 0.01 $ (0.06) $ (0.38)
========= ========== ==========
Weighted average shares outstanding .................... 200,000 172,603 100,000
========= ========== ==========
See accompanying notes to consolidated financial statements.
F-4
BTI TELECOM CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY (DEFICIT)
(In thousands)
Additional Total
Common Paid-in Retained Shareholder's
Stock Capital Earnings (Deficit) Equity (Deficit)
-------- ------------ -------------------- -----------------
Balance at December 31,1995 ..................... $ 73 $ 327 $ 1,497 $ 1,897
Net income .................................... -- -- 2,606 2,606
Distributions ................................. -- -- (2,048) (2,048)
Decrease in unrealized gains .................. -- -- (80) (80)
----- ------ --------- ---------
Balance at December 31,1996 ..................... $ 73 $ 327 $ 1,975 $ 2,375
Net loss ...................................... -- -- (10,639) (10,639)
Distributions ................................. -- -- (1,587) (1,587)
Repurchase of shares .......................... (36) (327) (27,922) (28,285)
Acquisition of FiberSouth ..................... -- -- (32,175) (32,175)
Compensation related to stock options ......... -- 738 -- 738
Decrease in unrealized gains .................. -- -- (1) (1)
----- ------ ------------ ------------
Balance at December 31,1997 ..................... $ 37 $ 738 $ (70,349) $ (69,574)
Net loss ...................................... -- -- (38,233) (38,233)
Distributions ................................. -- -- (606) (606)
Compensation related to stock options ......... -- 47 -- 47
Decrease in unrealized gains .................. -- -- (1) (1)
Settlement of stock and option repurchase
obligations .................................. -- -- (1,475) (1,475)
----- ------ ----------- -----------
Balance at December 31,1998 ..................... $ 37 $ 785 $(110,664) $(109,842)
===== ====== =========== ===========
See accompanying notes to consolidated financial statements.
F-5
BTI TELECOM CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year ended December 31
-------------------------------------------
1996 1997 1998
----------- ------------- -------------
Operating Activities:
Net income (loss) ................................................... $ 2,606 $ (10,639) $ (38,233)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation ...................................................... 4,101 5,427 9,201
Amortization ...................................................... 370 1,186 2,256
Non-cash compensation related to stock options .................... -- 738 47
Changes in operating assets & liabilities:
Accounts and notes receivable ..................................... (6,594) 307 (3,775)
Accounts and notes receivable from related parties ................ (568) (645) 301
Other assets ...................................................... (560) (437) 150
Accounts payable and accrued expenses ............................. 450 4,168 20,057
Accrued interest expense .......................................... -- 7,100 540
Other liabilities ................................................. 478 1,006 3,038
-------- ---------- ---------
Net cash provided by (used in) operating activities ................. 283 8,211 (6,418)
Investing Activities:
Change in restricted cash ........................................... (459) (74,583) 22,262
Sales of marketable securities ...................................... 179 -- 6
Purchases of equipment, furniture and fixtures, net ................. (7,812) (22,792) (66,311)
Purchase of FiberSouth assets ....................................... -- (35,186) --
Purchase of other assets ............................................ (589) (687) (3,123)
Settlement of FiberSouth stock option repurchase obligation ......... -- -- (2,300)
-------- ---------- ---------
Net cash used in investing activities ............................... (8,681) (133,248) (49,466)
Financing Activities:
Net proceeds (payments) of long-term debt ........................... 11,627 (18,671) 4,119
Proceeds from shareholder notes ..................................... 370 -- --
Proceeds from senior notes .......................................... -- 250,000 --
Decrease in other long-term liabilities ............................. (690) (391) (1,032)
Increase in deferred financing costs and other assets ............... (670) (9,524) (832)
Repurchase of common stock .......................................... -- (28,286) --
Distributions paid .................................................. (2,048) (1,586) (606)
-------- ---------- ---------
Net cash provided by financing activities ........................... 8,589 191,542 1,649
-------- ---------- ---------
Increase (decrease) in cash and cash equivalents .................... 191 66,505 (54,235)
Cash and cash equivalents at beginning of period .................... 306 497 67,002
-------- ---------- ---------
Cash and cash equivalents at end of period .......................... $ 497 $ 67,002 $ 12,767
======== ========== =========
See accompanying notes to consolidated financial statements.
F-6
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business -- BTI Telecom Corp. and its wholly owned
subsidiaries (the "Company" or "BTITC") provide integrated telecommunications
services, including long distance, local, data, internet access and other
enhanced services, primarily to small to medium-sized business customers
located in the southeastern United States. The Company also provides wholesale
telecommunication services, including switched, dedicated access, special
access and prepaid calling card services primarily to telecommunication
carriers. The Company serves its customers utilizing an advanced digital fiber
optic telecommunications network consisting of both leased and owned
transmission capacity.
Basis of Presentation -- The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries after elimination of
all significant intercompany transactions.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents -- The Company considers highly liquid,
short-term investments with a maturity of three months or less when purchased
to be cash equivalents.
Restricted Cash -- Restricted cash consists of pledged securities being
held as security for certain scheduled interest payments due on the Company's
ten year 10 1/2% notes ("Senior Notes") issued in September 1997. The
securities were purchased pursuant to the pledge agreement executed in
connection with the issuance of the Senior Notes. The balance as of December
31, 1998 includes securities pledged for the remaining scheduled interest
payments through September 2000. (Note 2)
Equipment, Furniture and Fixtures -- Equipment, furniture and fixtures is
stated at cost, including labor and other direct costs associated with the
installation of network facilities. Improvements that significantly add to
productive capacity or extend the useful life are capitalized, while repairs
and maintenance are expensed as incurred. Depreciation is provided using the
straight-line method over the estimated useful lives of various assets, ranging
from 5 to 20 years.
Interest is capitalized as part of the cost of constructing the Company's
fiber optic network. The amount capitalized for the year ended December 31,
1998 was approximately $1.5 million. There were no amounts capitalized in 1996
or 1997.
Costs associated with fiber optic network segments under construction are
classified as "Construction in progress" in the accompanying consolidated
balance sheets. Upon completion of network segments, these costs will be
transferred into service and depreciated over their useful lives.
Other Assets -- Costs incurred in connection with obtaining long-term
financing have been deferred and are being amortized over the terms of the
related debt agreements. Deferred costs relating to long-term financing at
December 31, 1997 and 1998 were $10.4 million and $11.2 million, respectively.
Accumulated amortization of these costs at December 31, 1997 and 1998 were $0.6
million and $2.1 million, respectively.
Line access costs are capitalized and amortized over the estimated period
the related lines will be used by the Company (24 months to 60 months) using
the straight line method. Deferred line access costs at December 31, 1997 and
1998 were $5.8 million and $7.5 million, respectively, with accumulated
amortization of $4.0 million and $4.8 million, respectively.
The balance in "Other Assets" as of December 31, 1998 also includes $1.5
million for the multi-media franchise the Company purchased from a related
company (Note 9).
Supplemental Cash Flow Information -- The Company paid interest of $1.5
million, $1.7 million and $26.4 million for the years ended December 31, 1996,
1997 and 1998, respectively. The transfer of paging equipment
F-7
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
from inventory to equipment for the years ended December 31, 1996, 1997, and
1998 was $0.6 million, $0.4 million, and $0.3 million, respectively. The
Company paid no income taxes for the years ended December 31, 1996, 1997 and
1998, respectively.
Concentrations of Credit Risk -- Financial instruments that potentially
subject the Company to concentration of credit risk consist principally of
trade accounts receivable which are unsecured. The Company's risk is limited
due to the fact that there is no significant concentration with one particular
customer. The Company uses the allowance method of accounting for uncollectible
accounts receivable. The provision for uncollectible accounts was $4.8 million
and $5.3 million as of December 31, 1997 and 1998, respectively.
Advertising Expense -- In accordance with Statement of Position 93-7
"Reporting on Advertising Costs," the Company capitalized $0.5 million in
direct response advertising costs in 1997, the total of which is completely
amortized as of December 31, 1998. All other advertising costs are expensed as
incurred. The Company expensed $0.6 million, $1.1 million and $3.1 million in
advertising costs during 1996, 1997 and 1998, respectively.
Basic and Diluted Earnings (Loss) Per Share -- Basic earnings (loss) per
share is calculated by dividing net income (loss) by the weighted average
number of common shares outstanding for the period. Diluted earnings (loss) per
share includes any dilutive effects of options, warrants and convertible
securities. At December 31, 1997 and 1998, common stock equivalents are
excluded from the earnings (loss) per share calculations due to their
anti-dilutive effect as a result of the Company's net loss for these years.
There were no options issued or other common stock equivalents as of December
31, 1996. The Company had no warrants or convertible securities outstanding at
December 31, 1996, 1997 and 1998.
Revenue Recognition -- Revenue for telecommunications services is
recognized as services are provided. Due to the timing of the Company's billing
cycles, at any point in time certain services have been provided to customers
which have not yet been billed. Revenue which has been earned but not yet
billed to customers, amounts to $5.4 million and $5.0 million at December 31,
1997 and 1998, respectively, and is recorded as accounts receivable in the
Company's consolidated balance sheets. Additionally, the Company invoices
customers one month in advance for certain recurring services resulting in
advance billings of $1.0 million and $3.9 million at December 31, 1997 and
1998, respectively. These advance billings are recorded as accounts payable in
the Company's consolidated balance sheets.
Accounting for Stock Options -- In 1996, the Company adopted Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for
Stock-Based Compensation," which gives companies the option to adopt the fair
value method for expense recognition of employee stock options and other
stock-based awards or to continue to account for such items using the intrinsic
value method as outlined under Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock Issued to Employees" with pro forma disclosures of
net income (loss) and net income (loss) per share as if the fair value method
had been applied. The Company has elected to continue to apply APB 25 for stock
options and other stock based awards and has disclosed pro forma net loss and
net loss per share as if the fair value method had been applied.
Income Taxes -- 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 anticipated
to be in effect when those differences are expected to reverse. The Company
provides a valuation allowance for its deferred tax assets when it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.
Prior to the Company's reorganization in 1997 (Note 2), the Company had
elected to be taxed for federal and state purposes as an S corporation under
the provisions of the Internal Revenue Code. Consequently, income, losses and
credits were passed through directly to the shareholders, rather than being
taxed at the corporate level.
Segment Reporting -- In June 1997, the Financial Accounting Standards
Board (the "FASB") issued Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related
F-8
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued
Information" ("SFAS 131"). SFAS 131 uses a management approach to report
financial and descriptive information about a Company's operating segments.
Operating segments are revenue-producing components of the enterprise for which
separate financial information is produced internally for the Company's
management. Under this definition, the Company operated, for all years
presented, as a single segment.
Comprehensive Income -- In June 1997, the FASB issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 requires that total comprehensive income and comprehensive
income per share be disclosed with equal prominence as net income and earnings
per share. Comprehensive income is defined as changes in shareholder's equity
exclusive of transactions with owners such as capital contributions and
dividends. The Company adopted this Standard in 1998. The Company did not
report any comprehensive income items in any of the years presented.
Recently Issued Accounting Standards -- In June 1998, the FASB issued
Statement of Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Company expects to adopt the new
Statement effective January 1, 2000. The Statement will require the recognition
of all derivatives on the Company's consolidated balance sheet at fair value.
The Company does not anticipate that the adoption of this Statement will have a
significant effect on its results of operations or financial position.
Reclassifications -- Certain amounts in the December 31, 1996 and 1997
financial statements have been reclassified to conform to the December 31, 1998
presentation.
NOTE 2: ISSUANCE OF SENIOR NOTES AND RELATED TRANSACTIONS
In September 1997, the Company issued ten-year Senior Notes with a
principal value of $250 million. The Senior Notes bear interest at the rate of
10 1/2% per annum and mature in 2007. Pursuant to the pledge agreement executed
in connection with the issuance of the Senior Notes, the Company utilized $74.1
million of the loan proceeds to purchase a portfolio of pledged securities.
These securities are being held in escrow for the payment of the first six
scheduled interest payments due on the Senior Notes; the first two of such
interest payments have been made as of December 31, 1998. The pledged
securities are included in the "Restricted cash" captions of the consolidated
balance sheets.
In connection with the issuance of the Senior Notes during September 1997,
the Company also consummated the following transactions:
(i) The Company, which began operations through Business Telecom, Inc. ("BTI")
in 1984, was reorganized into a new corporate structure consisting of BTI
Telecom Corp. as the parent company and BTI as a wholly owned subsidiary
and converted from an S corporation to a C corporation subject to income
tax.
(ii) BTI entered into an amended and restated revolving credit facility (the
"Credit Facility") guaranteed by the Company, which will provide up to
$60.0 million of availability to be used for working capital and other
purposes, including capital expenditures. BTI repaid all indebtedness
outstanding under its then existing credit agreement together with accrued
interest thereon. (The Credit Facility has been subsequently amended. See
Note 4).
(iii) BTI repurchased 50% of its outstanding common stock not held by its
Chairman and Chief Executive Officer under the terms of the Common Stock
Repurchase Agreement (Note 6).
(iv) The Company acquired certain fiber optic assets and the related business
of FiberSouth, Inc. ("FiberSouth") for cash and assumption of debt. The
acquisition was accounted for using the historical basis of the assets
acquired under the provisions of AIN No. 39 of APB No. 16, "Business
Combinations." The transaction resulted in the acquisition of
approximately $3.1 million in net assets and a corresponding charge to
equity of $32.2 million. Accordingly, the acquisition is reflected in the
Company's financial statements at September 30, 1997. The operations of
FiberSouth are included in the Company's operations since the date of the
acquisition.
F-9
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 2: ISSUANCE OF SENIOR NOTES AND RELATED TRANSACTIONS -- Continued
(v) The Company's Board of Directors approved an increase in the number of no
par value common stock authorized from 200,000 shares to 100,000,000
shares. (In April, 1998 a 10-for-1 split of the Company's Common Stock was
effected. See Note 6.) The Board of Directors also authorized 10,000,000
shares $.01 par value preferred stock. As of December 31, 1997 and 1998,
there were no shares of preferred stock outstanding.
NOTE 3: EQUIPMENT, FURNITURE AND FIXTURES
Major classes of equipment, furniture and fixtures at December 31 are
summarized below:
1997 1998
(In thousands) --------- -----------
Data processing equipment ........................ $ 6,683 $ 9,864
Telephone service equipment ...................... 31,560 57,239
Fiber optic network .............................. 7,550 24,517
Paging equipment ................................. 1,687 2,892
Office furnishings and equipment ................. 3,071 3,651
Leasehold improvements ........................... 2,937 4,970
Vehicles ......................................... 256 283
Construction in progress ......................... 10,154 27,052
Less: accumulated depreciation ................... 19,321 28,508
------- --------
Total equipment, furniture and fixtures .......... $44,577 $101,960
======= ========
Depreciation expense was $4.1 million, $5.4 million and $9.2 million for
the years ended December 31, 1996, 1997 and 1998, respectively.
NOTE 4: LONG-TERM DEBT AND REVOLVING CREDIT FACILITIES
Long-term debt consisted of the following at December 31:
1997 1998
(In thousands) ----------- -----------
Unsecured 10 1/2% Senior Notes, due 2007 .......... $250,000 $250,000
Revolving Credit Facilities, due 2002 ............. -- 4,119
-------- --------
$250,000 $254,119
======== ========
Senior Notes -- On September 22, 1997, the Company issued $250 million of
10 1/2% Unsecured Senior Notes. The entire original principal balance is due
September 2007, with interest payable semi-annually on March 15th and September
15th of each year (Note 2). The Senior Notes contain various financial and
administrative covenants with which the Company must comply, including certain
restrictions on the payment of dividends under circumstances specified in the
debt agreement.
Revolving Credit Facilities -- In 1998, the Company amended and restated
its existing $60.0 million revolving credit facility to provide a $30.0 million
revolving credit facility and a $30.0 million capital expenditure facility (the
"Facilities"). Borrowings under the Facilities are based upon a percentage of
eligible accounts receivable and eligible capital expenditures, respectively, as
defined in the loan agreement. Borrowings under the Facilities can be used for
working capital and other purposes. Borrowings outstanding at December 31, 1998
are under the revolving credit facility. In addition, there was $0.2 million
outstanding in letters of credit at December 31, 1998. The Facilities agreement
expires and amounts outstanding under the Facilities are secured by
substantially all of the Company's assets and bear interest, at the Company's
option, at either the 30, 60 or 90 day LIBOR rate (5.06%, 5.07%, and 5.07% at
December 31, 1998, respectively) or the prime rate (7.75% at December 31, 1998),
plus an applicable margin. This margin varies based on the Company's financial
position from 0.00%-2.25% for borrowings under the prime rate option and
F-10
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 4: LONG-TERM DEBT AND REVOLVING CREDIT FACILITIES -- Continued
from 1.50%-3.75% for borrowings under the LIBOR option. The Company is also
required to pay a fee of 0.375% per year on the unused commitment. The
Facilities contain various financial and administrative covenants with which
the Company must comply on a monthly and quarterly basis, including certain
restrictions on the payment of dividends.
In accordance with Statement of Financial Accounting Standards No. 107,
"Disclosures about Fair Value of Financial Instruments," the Company estimates
that the fair value of the long-term debt at December 31, 1998 is $192.8
million as compared to the carrying value of $254.1 million. The fair value of
long-term debt is determined based on negotiated trades for the securities or
is estimated using rates currently available to the Company for debt with
similar terms and maturities.
NOTE 5: INCOME TAXES
In connection with the September 1997 Reorganization, the Company
converted from S corporation to C corporation status for federal and state
income tax purposes. As a result, the Company became fully subject to federal
and state income taxes and adopted the provisions of Statement of Financial
Accounting Standards No. 109 "Accounting for Income Taxes" ("FAS 109"). The
cumulative effect of adopting FAS 109 is reflected in the Company's financial
statements for the year ended December 31, 1997.
The significant components of the Company's deferred tax assets and
liabilities at December 31 were as follows:
1997 1998
(In thousands) ----------- ------------
Deferred tax liabilities:
Tax over book depreciation .............. $ 1,437 $ 3,123
Line access costs ....................... 744 826
FiberSouth asset purchase ............... 555 624
Other ................................... 10 134
-------- ---------
Total deferred tax liabilities ............ 2,746 4,707
Deferred tax assets:
Stock options ........................... 660 678
Net operating loss carryforward ......... 2,770 19,761
Accounts receivable reserve ............. 1,930 2,108
Other ................................... 422 638
-------- ---------
Total deferred tax assets ................. 5,782 23,185
Less: valuation allowance ................. (3,609) (19,051)
-------- ---------
Net deferred tax liabilities .............. $ (573) $ (573)
======== =========
For the years ended December 31, 1997 and 1998, the Company generated net
operating losses ("NOLs") that may be used to offset future taxable income. The
Company has established a valuation allowance for the net deferred tax assets
associated with these net operating losses. The Company will reduce the
valuation allowance when, based on the weight of available evidence, it is more
likely than not that some portion or all of the deferred tax assets will be
realized.
At December 31, 1998 the Company had a net operating loss carryforward of
approximately $49.4 million for federal and state income tax purposes which
will begin to expire in the year 2012.
F-11
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 5: INCOME TAXES -- Continued
The reconciliation of the federal statutory income tax rate with the
effective income tax rate reflected in the financial statements is as follows
for the years ended December 31:
1997 1998
------------ ------------
Federal income tax benefit at statutory rate ............... 35.0% 35.0%
State income tax benefit (net of federal benefit) .......... 5.0% 5.0%
Change in valuation allowance .............................. (40.0%) (40.0%)
----- -----
0.0% 0.0%
===== =====
The following unaudited pro forma income tax information is presented in
accordance with SFAS 109 as if the Company had been a C Corporation subject to
federal and state income taxes for 1996. Accordingly, all deferred tax assets
and liabilities associated with the retroactive adjustment of SFAS 109 are
reflected in the Company's balance sheet and statement of operations as of and
for the years ended December 31, 1997 and 1998.
December 31, 1996
(In thousands) ------------------
Earnings before pro forma adjustments ................. $2,606
Pro forma adjustment:
Provision for income taxes to increase tax expense to
estimated effective rate of 42.0% .................. 1,094
------
Pro forma net income ................................ $1,512
======
NOTE 6: SHAREHOLDER'S EQUITY
Stock Split -- In April 1998, the Board of Directors of the Company
approved and the Company effected a 10-for-1 split of the outstanding Common
Stock of the Company in the form of a stock dividend with no change in the par
value of Common Stock authorized and outstanding, and increased the number of
common shares authorized from 100 million to 500 million. Historical share and
per share data have been retroactively adjusted to reflect these changes.
Common Stock Repurchase Agreement -- In July 1992, the Company entered
into an agreement with one of its shareholders (the "Retiring Shareholder") to
purchase the outstanding common shares held by his estate upon his death. The
agreement was amended in June 1996, at which time a purchase price for the
common shares held by the Retiring Shareholder was agreed upon and provision
was made for the shares to be repurchased at any time. In 1997, the Company
exercised its option to purchase the Retiring Shareholder's outstanding shares
for $28.3 million (Note 2).
Pursuant to the agreement, the Company was required to make monthly
distributions to each shareholder of $61,700 beginning in July 1992 until
closing of the repurchase. The 1992 agreement required that an escrow account
be established into which the non-Retiring Shareholder was required to deposit
his pro rata share of these distributions. Under the provisions of the 1992
agreement, the non-Retiring Shareholder remitted those funds back to the
Company in exchange for subordinated notes payable. The 1996 amended agreement
allowed the non-Retiring Shareholder to retain his pro rata share of the
monthly distributions. During 1997, the subordinated note agreement was amended
to include a 24-month repayment schedule. The balance in shareholder note
payable at December 31, 1997 and 1998 of $1.7 million and $0.8 million,
respectively, represents the amounts remitted back to the Company by the
non-Retiring Shareholder under the original agreement, plus accrued interest at
8.5%.
Stock and Option Repurchase Agreements -- In 1994, the Company entered
into agreements with certain former employees to repurchase stock options that
had been granted under the Company's 1994 Stock Plan. The measurement date for
compensation relating to the stock options did not occur until September 1997,
at which
F-12
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 6: SHAREHOLDER'S EQUITY -- Continued
time an estimate for this liability was recorded (Note 7). In addition, the
Company assumed certain stock repurchase obligations in connection with its
acquisition of the fiber optic assets of FiberSouth in 1997. In May 1998, the
Company satisfied these obligations to a former employee in accordance with the
repurchase agreements. As a result of this transaction, the Company recorded a
$1.5 million adjustment to equity in the second quarter of 1998 which decreased
equity by the difference between the estimated liability and the actual
settlement amount. This adjustment represents a reallocation of the original
FiberSouth purchase price.
Dividends -- Throughout the period of time that BTI was an S corporation,
income, losses and credits were passed through directly to shareholders and the
shareholders were provided, in the form of dividends, the funds necessary to
meet tax obligations arising from income earned by BTI. The Company will
continue to reimburse shareholders for any tax obligations arising from income
earned by BTI while it was an S corporation. The Company paid dividends of $0.6
million, $0.4 million and $0.6 million in 1996, 1997 and 1998 to shareholders
for the reimbursement of these tax obligations. The Company believes that any
such future reimbursements will not have a material effect on the Company's
financial condition or results of operations.
NOTE 7: STOCK-BASED COMPENSATION
In 1994, the Company formalized the 1994 Stock Plan (the "1994 Plan")
which will terminate in March 2005, unless sooner terminated by the Board of
Directors. The 1994 Plan provided that an aggregate of 4,998,900 of the
Company's authorized shares be reserved for future issuance. In the case of
initial grants, the exercise price and vesting terms will be fixed by the
compensation committee on the date of grant. The 1994 Plan permits the grant of
options for a term of up to 10 years. Under the terms of the 1994 Plan, the
Company committed to grant certain options to an officer and two former
employees of the Company effective at the time the Company purchased the
outstanding shares of the Retiring Shareholder. The measurement date for
compensation related to these options did not occur until the repurchase of the
shares from the Retiring Shareholder in September 1997. Accordingly, the
Company recognized compensation expense of approximately $2.1 million
coincident with the measurement date. As certain of the employees to whom the
options were committed were no longer employed by the Company, the accrued
compensation included provisions for the estimated amounts to be paid to these
former employees in connection with their option commitments of 3,332,600
shares as well as other accrued amounts. Included in the $2.1 million is $0.7
million in non-cash compensation expense representing the difference in the
fair value of the options and the exercise price at the date of grant for
1,666,300 options granted to an existing officer. These options vested
immediately upon issuance. The Company did not grant any options under the 1994
Plan during the year ended December 31, 1998.
In 1997, the Company established the 1997 Stock Plan (the "1997 Plan")
which will terminate in August 2007, unless sooner terminated by the Board of
Directors, for the purpose of attracting and retaining certain key employees of
the Company. The 1997 Plan provided that an aggregate of 5,000,000 of the
Company's authorized shares be reserved for future issuance. In the case of
initial grants, the exercise price and vesting terms will be fixed by the
compensation committee on the date of grant. The 1997 Plan permits the grant of
options for a term of up to ten years. The Company granted options to purchase
199,980 and 980,791 common shares under the 1997 Plan during the years ended
December 31, 1997 and 1998, respectively. Outstanding options vest at various
times from the date of issuance to 2 years after the date of issuance. The
Company recognized $47,040 in compensation expense during 1998 representing the
difference between the estimated fair value of the options and the exercise
price at the date of grant.
The Company has elected to account for its stock-based compensation plan
under the provisions of APB Opinion No.25, which requires compensation cost to
be measured by the quoted market price at the measurement date less the amount,
if any, an employee is required to pay. The required pro forma-disclosures in
accordance with SFAS No. 123, are as follows for the years ended December 31
(in thousands, except per share data):
F-13
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 7: STOCK-BASED COMPENSATION -- Continued
1997 1998
------------- -------------
Net loss
Actual ............ $ (10,639) $ (38,233)
Pro forma ......... $ (10,649) $ (38,375)
Loss per share
Actual ............ $ (.06) $ (.38)
Pro forma ......... $ (.06) $ (.38)
Option activity under the Company's plans as of December 31 is summarized
below (in thousands, except per share amounts):
1997 1998
--------------------- --------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
-------- ---------- -------- ---------
Outstanding at beginning of year ........... -- $ -- 1,866 $ .13
Options granted ............................ 1,866 .13 981 3.00
----- ----- ----- ------
Outstanding at end of year ................. 1,866 $ .13 2,847 $ 1.13
===== ===== ===== ======
Options exercisable at end of year ......... 1,720 2,106
Shares available for future grant .......... 8,133 7,152
The weighted-average remaining contractual life of options as of December
31, 1998 is 7.59 years.
The per share weighted average fair value of stock options granted by the
Company during 1997 and 1998 was approximately $.45 and $.22, respectively, on
the dates of grant.
The following assumptions were used by the Company to determine the fair
value of stock options granted using the minimum value option-pricing model for
years ending December 31:
1997 1998
----------- ------------
Dividend yield ................... 0% 0%
Expected option life ............. 1.5 years 1.5 years
Risk-free interest rate .......... 5.46% 5.0%
At December 31, 1998, the Company has reserved 9,998,900 shares of common
stock for future issuance related to the stock option plans.
NOTE 8: EMPLOYEE BENEFIT PLANS
The Company sponsors a 401(k) Plan and Trust covering substantially all
employees. Participants may elect to defer up to 15% of their salary, not to
exceed $10,000 annually, which was the maximum allowed by the Internal Revenue
Service in 1998. The Company matched 50% of employee contributions in 1996,
1997 and 1998, up to a maximum of 6% of each employee's annual salary. Employer
contributions for the years ended December 31, 1996, 1997 and 1998 were $0.3
million, $0.2 million and $0.2 million, respectively.
NOTE 9: RELATED PARTY TRANSACTIONS
The Company has historically funded certain operating expenses on behalf
of two affiliates related through common ownership. Accounts receivable from
these affiliates included $0.6 million and $0.3 million at December 31, 1997
and 1998, respectively. In 1996 and up until the date of acquisition in 1997,
the Company paid approximately $1.4 million and $1.0 million, respectively, to
FiberSouth, a Company related through common ownership, for local access
services.
F-14
BTI TELECOM CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
NOTE 9: RELATED PARTY TRANSACTIONS -- Continued
During 1995, the Company entered into an operating lease for an airplane
with a company under common ownership. Rent expense related to this lease was
approximately $0.3 million for the years ending December 31, 1996, 1997 and
1998. The Company also leases certain facilities from a shareholder (Note 10).
Effective July 15, 1998, the Company purchased a multi-media franchise
from FiberSouth for $1.5 million, subject to approval for the right to operate
by the City of Raleigh. As a result, the Company will have the right to offer
multi-media services in Raleigh. The Company anticipates that the transaction
will be approved in the first quarter of 1999.
In 1997 and 1998, the Company sold certain integrated telecommunications
services to agents and customers of an affiliate related through common
ownership. The Company pays the affiliate a commission on all sales made
through the affiliate. The commissions totaled $.2 and $.5 million in 1997 and
1998, respectively.
NOTE 10: COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
Legal Matters -- The Company is subject to various legal proceedings,
including regulatory, judicial and administrative matters, all of which have
arisen in the ordinary course of business. The Company's management believes
that the ultimate resolution of these matters will not have a material adverse
effect on the financial condition, results of operations or cash flows of the
Company.
Operating leases -- The Company rents its facilities and certain office
and other equipment under operating leases which contain certain escalating
clauses and various renewal and buy-out provisions. Future minimum lease
payments under the leases, which have remaining terms in excess of one year,
are as follows:
1999 2000 2001 2002 Thereafter
(In thousands) --------- --------- --------- --------- -----------
$4,038 $3,703 $3,079 $2,995 $8,931
====== ====== ====== ====== ======
Total rent expense was $3.9 million, $4.1 million and $5.1 million
(including facilities rent of $65,000, $60,000 and $60,000, respectively, paid
to a related party) in 1996, 1997 and 1998, respectively.
Other Matters -- During 1997, the Company signed a contract for the
indefeasible right to use certain optical fibers in a communication system.
Commitments to purchase optical fibers under this contract total approximately
$50.1 million, $27.4 million of which was fulfilled through December 31, 1998.
The remaining commitments extend through the end of 1999.
During 1997, the Company signed a commitment with a municipality to
finalize the terms of the Company's $3.1 million contribution to partially fund
the construction of a performing arts center. The contribution will be paid
over a ten year period commencing in 1998 and is payable in cash and in-kind
service (telephone and data transmission service). As of December 31, 1998, the
Company has paid $0.3 million of this commitment.
Significant Customer -- During 1997, one customer accounted for
approximately 12% of consolidated revenue. There were no significant customer
concentrations in 1996 or 1998.
F-15
BTI TELECOM CORP.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 1996, 1997 and 1998
(In thousands)
Additions
Balance at Charged to Deductions Balance at
Beginning of Costs and from End
Period Expenses Reserves of Period
-------------- ------------ ------------ -----------
Year ended December 31, 1996:
Allowance for doubtful accounts ......... $2,335 $3,440 $ (2,741) $3,034
====== ====== ======== ======
Year ended December 31, 1997:
Allowance for doubtful accounts ......... $3,034 $4,362 $ (2,571) $4,825
====== ====== ======== ======
Year ended December 31, 1998:
Allowance for doubtful accounts ......... $4,825 $4,183 $ (3,737) $5,271
====== ====== ======== ======
F-16
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
BTI TELECOM CORP.
Date: May 25, 1999 By: /s/ BRIAN K. BRANSON
--------------------------------
BRIAN K. BRANSON
Chief Financial Officer
BTI TELECOM CORP.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
INDEX TO EXHIBITS
Exhibit No. Description
- ------------- --------------------------------------------------------------------------------------------------
2.1* Agreement and Plan of Merger dated as of September 17, 1997, among Business Telecom, Inc.,
BTI Telecom Corp., and BTI OpCo Inc.
2.2* Asset Purchase Agreement dated September 17, 1997, between FiberSouth, Inc. and Business
Telecom, Inc.
3.1* Articles of Incorporation of BTI Telecom Corp.
3.2** Bylaws of BTI Telecom Corp., as amended.
4.1* Indenture dated as of September 22, 1997, among BTI Telecom Corp., Business Telecom, Inc.
and First Trust of New York, National Association, as Trustee, relating to the 102% Senior Notes
due 2007 of BTI Telecom Corp.
4.2* Registration Rights Agreement dated September 22, 1997, between BTI Telecom Corp. and
Morgan Stanley & Co. Incorporated and Merrill Lynch, Pierce, Fenner & Smith Incorporated.
4.3* Pledge and Security Agreement dated as of September 22, 1997, from BTI Telecom Corp., as
Pledgor, and Business Telecom, Inc., as Guarantor, to First Trust of New York, National
Association, as Trustee.
10.1* 1994 Stock Plan.
10.2* 1997 Stock Plan.
10.3* Second Amended and Restated Loan Agreement dated September 22, 1997, between Business
Telecom, Inc. and General Electric Capital Corporation and the other financial institutions party
thereto from time to time as Lenders and General Electric Capital Corporation as Agent (the
"GE Capital Agreement").
10.4* Future Advance Promissory Note, dated June 30, 1997, made by ComSouth Cable International,
Inc. in favor of Business Telecom, Inc.
10.5* Subordinated Promissory Note, dated August 31, 1997, made by Business Telecom, Inc. in favor
of Peter T. Loftin.
10.6* Employment Letter Agreement, dated March 20, 1997 and March 26, 1997, between FiberSouth,
Inc. and H.A. (Butch) Charlton, as amended effective October 1, 1997.
10.7* Interconnection Agreement, dated November 5, 1997, between Business Telecom, Inc. and
BellSouth Telecommunications, Inc.
10.8* Lease, dated May 13, 1994, between RBC Corporation and Business Telecom, Inc., as amended
March 1, 1995, November 30, 1995 and May 15, 1997 (the "Lease").
10.9 + IRU Agreement dated October 31, 1997, between QWEST Communications Corporation and
Business Telecom, Inc.
10.10 First and Second Amendments to the GE Capital Agreement.
10.11 Amendments Four, Five and Six to the Lease.
11.1 Computation of Earnings Per Common Share.
12.1 Computation of Ratio of Earnings to Fixed Charges.
21.1** Subsidiaries of BTI Telecom Corp.
27.1 Financial Data Schedule for the Year Ended December 31, 1998.
- ----------
* Filed as an exhibit to the Registration Statement on Form S-4 (File No.
333-41723).
** Filed as an exhibit to the Annual Report on Form 10-K for the year ended
December 31, 1997.
+ Confidential treatment requested.