SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the quarterly period ended December 31, 1997
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: 333-06957
HYPERION TELECOMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 25-1669404
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Main at Water Street
Coudersport, PA 16915-1141
(Address of principal (Zip code)
executive offices)
814-274-9830
(Registrant's telephone number including area code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
At February 17, 1998, 122,000 shares of Class A Common Stock, par value $0.01
per share, and 10,000,000 shares of Class B Common Stock, par value $0.01 per
share, of the registrant were outstanding.
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX
Page Number
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - March 31, 1997 and December 31, 1997....................3
Condensed Consolidated Statements of Operations - Three and Nine months ended
December 31, 1996 and 1997....................................................................4
Condensed Consolidated Statements of Cash Flows - Nine months ended
December 31, 1996 and 1997....................................................................5
Notes to Condensed Consolidated Financial Statements............................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations...................................................................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................31
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................32
Item 2. Changes in Securities.........................................................................32
Item 3. Defaults Upon Senior Securities..............................................................32
Item 4. Submission of Matters to a Vote of Security Holders..........................................32
Item 5. Other Information............................................................................33
Item 6. Exhibits and Reports on Form 8-K..............................................................33
SIGNATURES.............................................................................................34
Item 1. Financial Statements
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands, except share amounts)
March 31, December 31,
1997 1997
--------- ----------
ASSETS:
Current assets:
Cash and cash equivalents $ 59,814 $ 332,863
Other current assets 768 2,547
--------- ---------
Total current assets 60,582 335,410
U.S. government securities - pledged -- 85,027
Investments 44,685 73,958
Property, plant and equipment - net 53,921 112,883
Other assets - net 15,376 27,535
Deferred income taxes - net 37 37
--------- ---------
Total $ 174,601 $ 634,850
========= =========
LIABILITIES, PREFERRED STOCK, COMMON STOCK AND
OTHER STOCKHOLDERS' EQUITY (DEFICIENCY):
Current liabilities:
Accounts payable $ 2,342 $ 2,539
Due to affiliates - net 6,081 1,415
Other current liabilities 757 14,411
--------- ---------
Total current liabilities 9,180 18,365
13% Senior Discount Notes due 2003 187,173 207,918
12 1/4% Senior Secured Notes due 2004 -- 250,000
Note payable - Adelphia 25,855 34,454
Other debt 2,647 29,573
--------- ---------
Total liabilities 224,855 540,310
--------- ---------
12 7/8% Senior exchangeable
redeemable preferred stock -- 200,721
--------- ---------
Commitments and contingencies (Note 4)
Common stock and other stockholders' equity (deficiency): Class A common stock,
$0.01 par value, 300,000,000 shares authorized, 104,000 and 122,000 shares
outstanding,
respectively 1 1
Class B common stock, $0.01 par value, 150,000,000
shares authorized and 10,000,000 shares outstanding 100 100
Additional paid in capital 155 182
Class B common stock warrants 11,087 11,087
Loans to stockholders (3,000) (3,000)
Accumulated deficit (58,597) (114,551)
--------- ---------
Total common stock and other stockholders' deficiency (50,254) (106,181)
========= =========
Total $ 174,601 $ 634,850
========= =========
See notes to condensed consolidated financial statements.
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ---------------------
1996 1997 1996 1997
-------- -------- -------- --------
Revenues $ 1,334 $ 4,983 $ 3,611 $ 8,690
-------- -------- -------- --------
Operating expenses:
Network operations 752 2,657 2,339 5,263
Selling, general and administrative 2,545 3,840 4,736 9,099
Depreciation and amortization 1,002 3,344 2,583 7,027
-------- -------- -------- --------
Total 4,299 9,841 9,658 21,389
-------- -------- -------- --------
Operating loss (2,965) (4,858) (6,047) (12,699)
Other income (expense):
Gain on sale of investment -- -- 8,405 --
Interest income 1,190 5,725 4,319 7,951
Interest expense and fees (7,482) (16,770) (20,759) (35,934)
-------- -------- -------- --------
Loss before income taxes and
equity in net loss of joint ventures (9,257) (15,903) (14,082) (40,682)
Income tax benefit 63 -- 180 --
-------- -------- -------- --------
Loss before equity in net loss
of joint ventures (9,194) (15,903) (13,902) (40,682)
Equity in net loss of joint ventures (2,145) (2,858) (5,143) (9,284)
-------- -------- -------- --------
Net loss (11,339) (18,761) (19,045) (49,966)
Dividend requirements applicable to preferred stock -- (5,794) -- (5,794)
-------- -------- -------- --------
Net loss applicable to common stockholders $(11,339) $(24,555) $(19,045) $(55,760)
======== ======== ======== ========
Net loss per weighted average
share of common stock $ (1.07) $ (2.29) $ (1.80) $ (5.19)
======== ======== ======== ========
Weighted average shares of
common stock outstanding
(in thousands) 10,613 10,735 10,584 10,735
======== ======== ======== ========
See notes to condensed consolidated financial statements.
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Nine Months
Ended December 31,
------------------------
1996 1997
---------- ----------
Cash flows from operating activities:
Net loss $ (19,045) $ (49,966)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 1,555 5,269
Amortization 1,028 1,758
Noncash interest expense 17,123 24,680
Equity in net loss of joint ventures 5,143 9,284
Gain on sale of investment (8,405) --
Issuance of Class A common stock bonus -- 27
Deferred income tax benefit (180) --
Change in operating assets and liabilities net of effects of acquisitions:
Other assets - net (1,019) (3,646)
Accounts payable and other current liabilities 1,208 10,985
--------- ---------
Net cash used in operating activities (2,592) (1,609)
--------- ---------
Cash flows from investing activities:
Net cash used for acquisitions (5,040) (7,638)
Expenditures for property, plant and equipment (14,950) (34,834)
Proceeds from sale of investment 11,618 --
Investments in joint ventures (23,398) (46,119)
Investment in U.S. government securities - pledged -- (83,400)
--------- ---------
Net cash used in investing activities (31,770) (171,991)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of preferred stock -- 194,733
Proceeds from debt 163,705 250,000
Proceeds from sale and leaseback of equipment -- 14,876
Repayment of debt -- (402)
Advances to related parties (9,678) (62)
Proceeds from issuance of stock warrants 11,087 --
Costs associated with debt financing (6,374) (12,496)
Loans to stockholders (3,000) --
Repayment of note payable - Adelphia (25,000) --
--------- ---------
Net cash provided by financing activities 130,740 446,649
--------- ---------
Increase in cash and cash equivalents 96,378 273,049
Cash and cash equivalents, beginning of period -- 59,814
--------- ---------
Cash and cash equivalents, end of period $ 96,378 $ 332,863
========= =========
See notes to condensed consolidated financial statements.
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(Dollars in thousands)
Hyperion Telecommunications, Inc. is an 88% owned subsidiary of
Adelphia Communications Corporation ("Adelphia"). The accompanying unaudited
condensed consolidated financial statements of Hyperion Telecommunications, Inc.
and its majority owned subsidiaries (the "Company") have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission.
In the opinion of management, all adjustments, consisting of only
normal recurring accruals necessary to present fairly the unaudited results of
operations for the three and nine months ended December 31, 1996 and 1997, have
been included. These condensed consolidated financial statements should be read
in conjunction with the Company's consolidated financial statements included in
its Annual Report on Form 10-K for the fiscal year ended March 31, 1997. The
results of operations for the three and nine months ended December 31, 1997, are
not necessarily indicative of the results to be expected for the fiscal year
ending March 31, 1998.
1. Significant Events Subsequent to March 31, 1997:
On June 13, 1997, the Company entered into agreements with MCImetro
Access Transmission Services, Inc. ("MCI") pursuant to which the Company is
designated as MCI's preferred provider for new end user dedicated access
services in virtually all of the markets that the Company currently serves. The
Company also has certain rights of first refusal to provide MCI with certain
telecommunications services. Under this arrangement, the Company issued to MCI a
warrant (the "MCI warrant"), which expires June 13, 2000, to purchase 281,040
shares of Class A Common Stock of the Company at the lower of (i) $20 per share
of Class A Common Stock or (ii) the public offering price of the Company's Class
A Common Stock if the Company completes an initial public offering of its Class
A Common Stock. MCI can receive additional warrants to purchase additional
shares of the Company's Class A Common Stock at fair value, if MCI meets certain
purchase volume thresholds over the term of the agreement. Collectively, the
warrants would entitle MCI to purchase Class A Common Stock of the Company
representing between 2.5% and 8.5% of the total common stock of the Company, on
a fully diluted basis, with adjustments for future issuances of common stock.
On August 4, 1997, the Company entered into an Equity Contribution and
Exchange Agreement with Lenfest Telephony, Inc. ("Lenfest"), its 50% partner in
Hyperion of Harrisburg, whereby Lenfest will receive a warrant to receive
225,115 shares of Class A Common Stock of the Company in exchange for its 50%
partnership interest in Hyperion of Harrisburg. On February 12, 1998, the
Company consummated the agreement and thereby increased its ownership interest
in Hyperion of Harrisburg to 100%.
On August 11, 1997, the Company entered into Purchase Agreements with a
subsidiary of Tele-Communications, Inc. ("TCI"), a local partner in the Buffalo,
NY, Louisville, KY, and Lexington, KY markets, whereby TCI will receive
approximately $18,300 in cash for TCI's partnership interest in these markets.
On February 12, 1998, the Company consummated the agreements and thereby
increased its ownership interest in each of these markets to 100%.
On August 27, 1997, the Company issued $250,000 aggregate principal
amount of 12 1/4% Senior Secured Notes due September 1, 2004 (the "Senior
Secured Notes") in a private placement. The Senior Secured Notes are
collateralized through the pledge of the common stock of certain of its
wholly-owned subsidiaries. Of the proceeds to the Company of approximately
$244,000, net of commissions and other transaction costs, $83,400 was invested
in U.S. government securities and placed in an escrow account for payment in
full when due of the first six scheduled semi-annual interest payments on the
Senior Secured Notes as required by the Indenture. The remainder of such
proceeds will be used to fund the acquisition of increased ownership interests
in certain of its networks, for capital expenditures, including the construction
and expansion of new and existing networks, and for general corporate and
working capital purposes.
On September 12, 1997, the Company consummated an agreement with Time
Warner Entertainment-Advance/Newhouse ("TWEAN") to exchange interests in four
New York CLEC networks. As a result of the transaction, the Company paid TWEAN
$7,638 and increased its ownership in the networks serving Buffalo and Syracuse,
New York to 60% and 100%, respectively, and eliminated its interest in the
Albany and Binghamton networks, which became wholly owned by TWEAN. Accordingly,
the results of operations of the Buffalo and Syracuse networks have been
included in the Company's consolidated operating results effective September 12,
1997.
On October 9, 1997, the Company issued $200,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due October
15, 2007 in a private placement. Proceeds to the Company, net of commissions and
other transaction costs, were approximately $194,733. Such proceeds will be used
to fund the acquisition of increased ownership interests in certain of its
networks, for capital expenditures, including the construction and expansion of
new and existing networks, and for general corporate and working capital
purposes.
The Company entered into Purchase Agreements dated as of October 31,
1997, with subsidiaries of TCI and Sutton Capital Associates, Inc. ("Sutton"),
local partners in New Jersey Fiber Technologies, whereby TCI and Sutton will
receive approximately $26,000 and $328, respectively, for their partnership
interests in New Jersey Fiber Technologies. On February 12, 1998, the Company
consummated the agreements and thereby increased its ownership interest in New
Jersey Fiber Technologies to 100%.
On December 1, 1997, the Company announced that it had entered into a
partnership agreement with Allegheny Energy to provide competitive telephone
services. Allegheny Energy has agreed to construct fiber optic networks for
Hyperion through one of its affiliates which will partner with Hyperion in most,
if not all, of the contemplated networks. Allegheny Energy is an investor-owned
utility providing electricity in portions of Maryland, Ohio, Pennsylvania,
Virginia and West Virginia.
On December 31, 1997, the Company consummated an agreement for a
$24,489 long term lease facility with AT&T Capital Corporation. The lease
facility provides financing for certain of the networks' switching equipment.
Included in the lease facility is the sale and leaseback of certain switching
equipment for which the Company received $14,876.
2. Investments:
The equity method of accounting is used to account for investments in
joint ventures in which the Company holds less than a majority interest. Under
this method, the Company's initial investment is recorded at cost and
subsequently adjusted for the amount of its equity in the net income or losses
of its joint ventures. Dividends or other distributions are recorded as a
reduction of the Company's investment. Investments in joint ventures accounted
for using the equity method reflect the Company's equity in their underlying net
assets.
The Company's nonconsolidated investments are as follows:
Ownership March 31, December 31,
Percentage 1997 1997
--------------- ------------ ----------------
Investments accounted for using the equity method:
MediaOne Fiber Technologies (Jacksonville) 20.0 % $ 7,330 $ 7,979
Multimedia Hyperion Telecommunications (Wichita) 49.9 3,306 3,744
Louisville Lightwave 50.0 (1) 4,683 10,518
NewChannels Hyperion Telecommunications (Albany) -- (2) 924 --
NewChannels Hyperion Telecommunications (Binghamton) -- (2) 504 --
NHT Partnership (Buffalo) 60.0 (1)(3) 4,717 --
NewChannels Hyperion Telecommunications (Syracuse) 100.0 (4) 4,215 --
Hyperion of Harrisburg 50.0 (1) 5,246 15,615
MediaOne of Virginia (Richmond) 37.0 7,018 7,212
New Jersey Fiber Technologies (New Brunswick and Morristown) 19.7 (1) 3,340 8,185
PECO-Hyperion (Philadelphia) 50.0 10,750 19,400
PECO-Hyperion (Allentown, Bethlehem, Easton, Reading) 50.0 -- 511
Lexington Lightwave 50.0 (1) 2,311 5,498
Hyperion of York 50.0 1,402 3,000
Entergy Hyperion Telecommunications of Louisiana 50.0 -- 2,900
Entergy Hyperion Telecommunications of Mississippi 50.0 -- 3,150
Entergy Hyperion Telecommunications of Arkansas 50.0 -- 3,400
Other Various 949 1,360
------------ ----------------
56,695 92,472
Cumulative equity in net losses (12,010) (18,514)
------------ ----------------
Total Investments $ 44,685 $ 73,958
============ ================
<FN>
(1) As discussed in Note 1, the Company has consummated agreements on Feburary
12, 1998 which increased its ownership to 100% in these networks.
(2) As discussed below, the Company consummated an agreement which eliminated
its interest in these networks. The previous ownership percentages in the
Albany and Binghamton networks were 50% and 20% respectively.
(3) As discussed below, the Company consummated an agreement which increased
its ownership in the Buffalo network to 60% from 40% and accordingly has
consolidated this investment effective September 12, 1997.
(4) As discussed below, the Company consummated an agreement which increased
its ownership in the Syracuse network to 100% from 50% and accordingly has
consolidated this investment effective September 12, 1997.
</FN>
Summarized combined unaudited financial information for the
Company's investments being accounted for using the equity method of accounting,
excluding the entities involved in the TWEAN agreement (Albany, Binghamton,
Buffalo and Syracuse networks) as of and for the periods ended, is as follows:
March 31, December 31,
1997 1997
------------- --------------
Current assets $ 3,843 $ 7,477
Property,Plant and Equipment -net 132,059 197,947
Other non-current assets 2,621 3,745
Current liabilities 5,629 14,198
Non-current liabilities 43,974 57,040
Nine months ended December 31,
1996 1997
------------- -------------
Revenues $ 5,403 $ 10,086
Net loss (10,168) (20,212)
3. Purchase of Joint Venture Interests:
As discussed in Note 1, the Company has consummated agreements to
consolidate its ownership interest in several networks. As a result of the
transactions, the Company increased its ownership in the Syracuse, New York;
Buffalo, New York; Harrisburg, Pennsylvania; Louisville, Kentucky; Lexington,
Kentucky; Morristown, New Jersey; and New Brunswick, New Jersey networks to 100%
and eliminated its interest in the Albany and Binghamton, New York networks. The
following unaudited financial information for the nine month period ended
December 31, 1996 and 1997 and the unaudited balance sheet information as of
December 31, 1997 assumes that these transactions had occurred on April 1, 1996.
Nine months ended
December 31,
1996 1997
-------------- --------------
Revenues $ 5,739 $ 12,435
Net loss (25,080) (58,492)
Net loss applicable to common shareholders (25,080) (64,286)
Net loss per weighted average share of common stock (2.32) (5.87)
December 31,
1997
-------------
Current assets $ 273,662
Property, plant and equipment - net 215,441
Other non-current assets 153,668
Current liabilities 19,156
Non-current liabilities 517,672
Senior Exchangeable Redeemable Preferred Stock 200,721
4 Commitments and Contingencies:
Reference is made to Management's Discussion and Analysis of Financial
Condition and Results of Operations for a discussion of material commitments and
contingencies.
5 Supplemental Cash Flow Information:
The Company has an unsecured subordinated Note payable to Adelphia due
April 16, 2003. This obligation bears interest at 16.5% per annum with interest
payable quarterly in cash; by issuing additional subordinated notes; or a
combination of cash and additional subordinated notes, all of which is at the
Company's option. Interest converted to additional subordinated note principal
since the inception of the note on April 15, 1996 has totaled $8,599.
On September 12, 1997, the Company and TWEAN consummated a transaction
whereby a partnership that owned three operating networks was liquidated. Prior
to the liquidation, the Company contributed approximately $5,700 in cash to the
partnership and upon liquidation the Company received 100% ownership in the
Syracuse network and TWEAN received 100% ownership in the Albany and Binghamton
networks and the cash contributed.
The Company entered into capital leases for switching equipment of
$24,489 during the nine months ended December 31, 1997.
6 Net Loss Per Share:
Net loss per common share is computed based on the weighted average
number of common shares outstanding after giving effect to dividend requirements
on the Company's preferred stock. Diluted net loss per common share is not
presented because the MCI warrant discussed in Note 1 had an antidilutive effect
for the periods presented; however, the MCI warrant could have a dilutive effect
on earnings per share in future periods.
-------------------------------------------------
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
(Dollars in thousands)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction
with the Company's unaudited Condensed Consolidated Financial Statements and the
Notes thereto appearing elsewhere in this Form 10-Q and the Company's audited
Consolidated Financial Statements and Notes thereto filed on Form 10-K for the
fiscal year ended March 31, 1997.
Overview
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. Certain information included in this
Form 10-Q, including Management's Discussion and Analysis of Financial Condition
and Results of Operations, is forward-looking, such as information relating to
the effects of future regulation, future capital commitments and the effects of
competition. Such forward-looking information involves important risks and
uncertainties that could significantly affect expected results in the future
from those expressed in any forward-looking statements made by, or on behalf of,
the Company. These risks and uncertainties include, but are not limited to,
uncertainties relating to economic conditions, acquisitions and divestitures,
government and regulatory policies, the pricing and availability of equipment,
materials, and inventories, technological developments and changes in the
competitive environment in which the Company operates. Unless otherwise stated,
the information contained in this Form 10-Q is as of and for the three and nine
months ended December 31, 1996 and 1997.
The "Company" or "Hyperion" mean Hyperion Telecommunications, Inc.
together with its majority-owned subsidiaries, except where the context
otherwise requires. Unless the context otherwise requires, references herein to
the "networks," the "Company's networks" or the "Operating Companies' networks"
mean the 21 telecommunications networks (including three networks under
construction) owned as of December 31, 1997 by 18 Operating Companies (which, as
defined herein, are (i) wholly and majority owned subsidiaries of the Company or
(ii) joint venture partnerships and corporations managed by the Company and in
which the Company holds less than a majority equity interest with one or more
other partners).
The Company, through its Operating Companies, provides a competitive
alternative to the telecommunications services offered by the incumbent local
exchange carriers ("LECs") in its markets. Since its inception in October 1991
through December 31, 1997, the Company has experienced substantial growth,
building from its original two partnerships covering two networks to covering 21
networks and 43 cities through its 18 Operating Companies. The Operating
Companies' customers are principally medium and large businesses and government
and educational end users as well as Interexchange or Long Distance Carriers
("IXCs"). The Company believes that its strategy of utilizing local partners to
develop its networks has allowed the Company to build networks with greater
coverage, lower upfront and ongoing costs and superior service and reliability.
As of December 31, 1997, the Company's Operating Companies are made up
of five wholly-owned subsidiaries, two partnerships in which it is a majority
owner and 11 joint venture investments (through which the Company has an
interest in 14 networks) in which the Company owns 50% or less. Results of the
wholly and majority owned subsidiaries and partnerships are consolidated into
the Company's financial statements. The Company's pro rata share of the results
of the Operating Companies where the Company owns 50% or less are recorded under
the caption "Equity in net loss of joint ventures" in the Company's consolidated
financial statements and results of operations utilizing the equity method of
accounting. Correspondingly, the Company's initial investments in these
Operating Companies have been carried at cost, and subsequently have been
adjusted for the Company's pro rata share of the Operating Companies' net
losses, additional capital contributions to the Operating Companies, and
distributions from the Operating Companies to the Company. Adjusted for the
purchase of certain partners' interests, (see "Recent Developments"), Hyperion's
weighted average ownership in these Operating Companies is 76%, based upon gross
property plant and equipment.
The Company is responsible for the design, construction, management and
operation of the networks owned by the Operating Companies and receives
management fees from the Operating Companies for its management and network
monitoring services. Management fees are determined by local partner agreements
and vary depending upon the market. To date, a large portion of the Company's
revenues has been derived through management fees from its Operating Companies,
although in the future, the Company expects that majority owned Operating
Companies' revenues will represent an increasing proportion of the Company's
revenues.
The Company initiated its switched services deployment plan in 1997 and
currently provides switched services in 16 markets, 13 of which were placed in
operation during the nine month period ended December 31, 1997. Switches for all
remaining markets are expected to be operational during 1998. In the markets it
currently serves, the Company estimates that there are approximately 11 million
business access lines in service. The Company has experienced initial success in
the sale of access lines with approximately 28,000 access lines sold as of
December 31, 1997, of which approximately 11,800 lines are installed,
substantially all of which are serviced over the Company's networks.
Since its inception through December 31, 1997, the Company, in
conjunction with its local partners, has made substantial investments totaling
approximately $406,300 in designing, constructing and enhancing the Operating
Companies' fiber optic networks. As of December 31, 1997, as adjusted for the
purchase of certain partners' interests (see "Recent Developments") the gross
property, plant and equipment of the Company, its networks and the Company's
Network Operating and Control Center (the "NOCC"), including the Company's
investment in Telergy, was approximately $401,600 of which Hyperion's
proportionate share is approximately $305,100. As of December 31, 1997, the
Company's operating networks had approximately 4,326 route miles, approximately
199,945 fiber miles and were connected to approximately 1,776 buildings and 108
LEC central offices ("COs").
Recent Developments
On June 13, 1997, the Company entered into agreements with MCImetro
Access Transmission Services, Inc. ("MCI") pursuant to which the Company is
designated as MCI's preferred provider for new end user dedicated access
services in virtually all of the markets that the Company currently serves. The
Company also has certain rights of first refusal to provide MCI with certain
telecommunications services. Under this arrangement, the Company issued to MCI a
warrant, which expires June 13, 2000, to purchase 281,040 shares of Class A
Common Stock of the Company at the lower of (i) $20 per share of Class A Common
Stock or (ii) the public offering price of the Company's Class A Common Stock if
the Company completes an initial public offering of its Class A Common Stock.
MCI can receive additional warrants to purchase additional shares of the
Company's Class A Common Stock at fair value, if MCI meets certain purchase
volume thresholds over the term of the agreement. Collectively, the warrants
would entitle MCI to purchase Class A Common Stock of the Company representing
between 2.5% and 8.5% of the total Common Stock of the Company, on a fully
diluted basis, with adjustments for future issuances of common stock.
On August 4, 1997, the Company entered into an Equity Contribution and
Exchange Agreement with Lenfest Telephony, Inc. ("Lenfest"), its 50% partner in
Hyperion of Harrisburg, whereby Lenfest will receive a warrant to receive
225,115 shares of Class A Common Stock of the Company in exchange for its 50%
partnership interest in Hyperion of Harrisburg. On February 12, 1998, the
Company consummated the agreement and thereby increased its ownership interest
in Hyperion of Harrisburg to 100%.
On August 11, 1997, the Company entered into Purchase Agreements with a
subsidiary of Tele-Communications, Inc. ("TCI"), a local partner in the Buffalo,
NY, Louisville, KY, and Lexington, KY networks, whereby TCI will receive
approximately $18,300 in cash for TCI's partnership interest in these networks.
On February 12, 1998, the Company consummated the agreements and thereby
increased its ownership interest in each of these networks to 100%.
On August 27, 1997, the Company issued $250,000 aggregate principal
amount of 12 1/4% Senior Secured Notes due September 1, 2004 (the "Senior
Secured Notes") in a private placement. The Senior Secured Notes are
collateralized through the pledge of the common stock of certain of its
wholly-owned subsidiaries. Of the proceeds to the Company of approximately
$244,000, net of commissions and other transaction costs, $83,400, was invested
in U.S. government securities and placed in an escrow account for payment in
full when due of the first six scheduled semi-annual interest payments on the
Senior Secured Notes as required by the Indenture. The remainder of such
proceeds will be used to fund the acquisition of increased ownership interests
in certain of it's networks, for capital expenditures, including the
construction and expansion of new and existing networks, and for general
corporate and working capital purposes.
On September 12, 1997, the Company consummated an agreement with Time
Warner Entertainment-Advance/Newhouse ("TWEAN") to exchange interests in four
New York CLEC networks. As a result of the transaction, the Company paid TWEAN
$7,638 and increased its ownership in the networks serving Buffalo and Syracuse,
New York to 60% and 100%, respectively, and eliminated its interest in the
Albany and Binghamton networks, which became wholly owned by TWEAN. Accordingly,
the results of operations of the Buffalo and Syracuse networks have been
included in the Company's consolidated operating results effective September 12,
1997.
On October 9, 1997, the Company issued $200,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due October
15, 2007 in a private placement. Proceeds to the Company, net of commissions and
other transaction costs, were approximately $194,733. Such proceeds will be used
to fund the acquisition of increased ownership interests in certain of its
networks, for capital expenditures, including the construction and expansion of
new and existing networks, and for general corporate and working capital
purposes.
The Company entered into purchase agreements dated as of October 31,
1997, with subsidiaries of TCI and Sutton Capital Associates, Inc. ("Sutton"),
local partners in New Jersey Fiber Technologies (which owns the Morristown and
New Brunswick, NJ networks), whereby TCI and Sutton will receive approximately
$26,000 and $328, respectively, for their partnership interests in New Jersey
Fiber Technologies. On February 12, 1998, the Company consummated the agreements
and thereby increased its ownership interest in New Jersey Fiber Technologies to
100%.
On December 1, 1997, the Company announced that it had entered into a
partnership agreement with Allegheny Energy to provide competitive telephone
services. Allegheny Energy has agreed to construct fiber optic networks for
Hyperion through one of its affiliates which will partner with Hyperion in most,
if not all, of the contemplated networks. Allegheny Energy is an investor-owned
utility providing electricity in portions of Maryland, Ohio, Pennsylvania,
Virginia and West Virginia.
On December 31, 1997, the Company consummated an agreement for a
$24,489 long term lease facility with AT&T Capital Corporation. The lease
facility provides financing for certain of the networks switching equipment.
Included in the lease facility is the sale and leaseback of certain switching
equipment for which the Company received $14,876.
Results of Operations
Three Months Ended December 31, 1997 in Comparison with Three Months Ended
December 31, 1996
Revenues increased 274% to $4,983 for the three months ended December
31, 1997, from $1,334 for the same quarter in the prior fiscal year. Growth in
revenues of $3,649 resulted from an increase in revenues from majority and
wholly-owned Operating Companies of approximately $2,108 as compared to the same
period in the prior fiscal year due to increases in the customer base and the
consolidation of the Buffalo and Syracuse networks. The increase also resulted
from continued expansion in the number and size of Operating Companies and the
resultant increase in management fees of $1,372 over the same period in the
prior fiscal year.
Network operations expense increased 253% to $2,657 for the three
months ended December 31, 1997 from $752 for the same quarter in the prior
fiscal year. The increase was attributable to the expansion of operations at the
NOCC, and the increased number and size of the operations of the Operating
Companies which resulted in increased employee related costs and equipment
maintenance costs and the consolidation of the Buffalo and Syracuse networks.
Selling, general and administrative expense increased 51% to $3,840 for
the three months ended December 31, 1997 from $2,545 for the same quarter in the
prior fiscal year. The increase was due to an increase in the sales force
required to support the existing networks and corporate and NOCC overhead cost
increases to accommodate the growth in the number, size and operations of
Operating Companies managed and monitored by the Company and the consolidation
of the Buffalo and Syracuse networks.
Depreciation and amortization expense increased 234% to $3,344 during
the three months ended December 31, 1997 from $1,002 for the same quarter in the
prior fiscal year primarily as a result of increased amortization of deferred
financing costs and increased depreciation resulting from the higher depreciable
asset base at the NOCC and the majority and wholly owned Operating Companies and
the consolidation of the Buffalo and Syracuse networks.
Interest income for the three months ended December 31, 1997 increased
381% to $5,725 from $1,190 for the same quarter in the prior fiscal year as a
result of increased cash and cash equivalents and U.S. Government securities due
to the investment of the proceeds of the Senior Secured Notes and the Senior
Exchangeable Redeemable Preferred Stock.
Interest expense and fees increased 124% to $16,770 during the three
months ended December 31, 1997 from $7,482 for the same period in the prior
fiscal year. The increase was attributable to higher interest expense associated
with the accretion of the 13% Senior Discount Notes and interest on the Senior
Secured Notes.
Equity in net loss of joint ventures increased by 33% to $2,858 during
the three months ended December 31, 1997 from $2,145 for the same quarter in the
prior fiscal year as the nonconsolidated Operating Companies increased
operations. The net losses of the nonconsolidated Operating Companies for the
three months ended December 31, 1997 were primarily the result of increased
revenues only partially offsetting startup and other costs and expenses
associated with design, construction, operation and management of the networks
of the Operating Companies, and the effect of the typical lag time between the
incurrence of such costs and expenses and the subsequent generation of revenues
by a network. The increase was partially offset by the consolidation of the
Buffalo and Syracuse networks.
The number of nonconsolidated Operating Companies paying management
fees to the Company decreased from 12 at December 31, 1996 to 8 at December 31,
1997 due to the TWEAN transaction, as discussed above. These Operating Companies
and networks under construction paid management and monitoring fees to the
Company, which are included in revenues, aggregating approximately $2,140 for
the three months ended December 31, 1997, as compared with $768 for the same
quarter in the prior fiscal year. The nonconsolidated Operating Companies' net
losses, including networks under construction, but not including the Albany,
Binghamton, Buffalo, and Syracuse networks, for the three months ended December
31, 1996 and 1997 aggregated approximately $3,781 and $7,923 respectively.
Net loss increased from $11,339 for the three months ended December 31,
1996 to $18,761 for the same quarter in the current fiscal year. The increased
net loss was primarily attributable to increases in operating losses, interest
expense and equity in the net losses of the Company's joint ventures.
Nine Months Ended December 31, 1997 in Comparison with Nine Months Ended
December 31, 1996
Revenues increased 141% to $8,690 for the nine months ended December
31, 1997 from $3,611 for the same period in the prior fiscal year. Growth in
revenues of $5,079 resulted from an increase in revenues from majority and
wholly-owned Operating Companies of approximately $3,299 as compared to the same
period in the prior fiscal year due to increases in the customer base and the
consolidation of the Buffalo and Syracuse networks. The increase also resulted
from continued expansion in the number and size of Operating Companies and the
resultant increase in management fees of $1,508 over the same period in the
prior fiscal year.
Network operations expense increased 125% to $5,263 for the nine months
ended December 31, 1997 from $2,339 for the same period in the prior fiscal
year. The increase was attributable to the expansion of operations at the NOCC,
and the increased number and size of the operations of the Operating Companies
which resulted in increased employee related costs and equipment maintenance
costs and the consolidation of the Buffalo and Syracuse networks.
Selling, general and administrative expense increased 92% to $9,099 for
the nine months ended December 31, 1997 from $4,736 for the same period in the
prior fiscal year. The increase was due to an increase in the sales force
required to support the existing networks and corporate and NOCC overhead cost
increases to accommodate the growth in the number, size and operations of
Operating Companies managed and monitored by the Company and the consolidation
of the Buffalo and Syracuse networks.
Depreciation and amortization expense increased 172% to $7,027 during
the nine months ended December 31, 1997 from $2,583 for the same period in the
prior fiscal year primarily as a result of increased amortization of deferred
financing costs and increased depreciation resulting from higher capital
expenditures, and thus a higher depreciable asset base, at the NOCC and the
wholly and majority owned Operating Companies and the consolidation of the
Buffalo and Syracuse networks.
Interest income for the nine months ended December 31, 1997 increased
by 84% to $7,951 from $4,319 for the same period in the prior fiscal year as a
result of increased cash and cash equivalents and U.S. Government securities due
to the investment of the proceeds of the Senior Secured Notes and the Senior
Exchangeable Redeemable Preferred Stock.
Interest expense and fees increased 73% to $35,934 during the nine
months ended December 31, 1997 from $20,759 for the same period in the prior
fiscal year. The increase was attributable to higher interest expense associated
with the accretion of the 13% Senior Discount Notes and interest on the Senior
Secured Notes.
Equity in net loss of joint ventures increased by 81% to $9,284 during
the nine months ended December 31, 1997 from $5,134 for the same period in the
prior fiscal year as more nonconsolidated Operating Companies began operations.
The net losses of the nonconsolidated Operating Companies for the nine months
ended December 31, 1997 were primarily the result of revenues only partially
offsetting startup and other costs and expenses associated with design,
construction, operation and management of the networks of the Operating
Companies, and the effect of the typical lag time between the incurrence of such
costs and expenses and the subsequent generation of revenues by a network. The
increase was partially offset by the consolidation of the Buffalo and Syracuse
networks.
The number of nonconsolidated Operating Companies paying management
fees to the Company decreased from 12 at December 31, 1996 to 8 at December 31,
1997 due to the TWEAN transaction, as discussed above. These Operating Companies
and networks under construction paid management and monitoring fees to the
Company, which are included in revenues, aggregating approximately $3,809 for
the nine months ended December 31, 1997, an increase of approximately $1,508
over the same period in the prior fiscal year. The nonconsolidated Operating
Companies' net losses, including networks under construction, but not including
the Albany, Binghamton, Buffalo, and Syracuse networks, for the nine months
ended December 31, 1996 and 1997 aggregated approximately $10,168 and $20,212,
respectively.
Net loss increased from $19,045 for the nine months ended December 31,
1996 to $49,966 for the same period in the current fiscal year. The increase was
primarily attributable to a higher operating loss, increased interest expense,
increased equity in the net losses of the Company's joint ventures, the
consolidation of the Buffalo and Syracuse networks, and no gain similar to that
recognized in the prior fiscal year for the sale of the Company's investment in
TCG of South Florida.
Supplementary Operating Company Financial Analysis
The Company believes that working with local partners to develop
markets has enabled the Company to build larger networks in a rapid and cost
effective manner. The Company has entered into joint ventures with local
partners where the Company owns 50% or less of each partnership or corporation.
As a result of the Company's ownership position in these joint ventures, a
substantial portion of the Operating Companies' results have been reported by
the Company on the equity method of accounting for investments which only
reflects the Company's pro rata share of net income or loss of the Operating
Companies. Because all of the assets, liabilities and results of operations of
the Operating Companies are not presented in the Company's consolidated
financial statements, financial analysis of these Operating Companies based only
upon the Company's results does not represent a complete measure of the growth
or operations of the Operating Companies.
In order to provide an additional measure of the growth and performance
of all of the Company's networks, management of the Company analyzes a variety
of financial information including revenues; earnings before interest expense,
income taxes, depreciation and amortization ("EBITDA"); and capital
expenditures. While EBITDA is not an alternative indicator of operating
performance to operating income or an alternative to cash flows from operating
activities as a measure of liquidity as defined by generally accepted accounting
principles, and while EBITDA may not be comparable to other similarly titled
measures of other companies, the Company's management believes EBITDA is a
meaningful measure of performance. Revenues and EBITDA of the Operating
Companies indicate the level of operating activity in the Company's networks.
Capital expenditures of the Operating Companies along with network construction
statistics, such as route miles and buildings connected, indicate the
extensiveness of the Company's network construction and expansion efforts in
those markets. The information below includes the results of Albany and
Binghamton, NY networks through September 12, 1997. The financial information
set forth below, however, is not indicative of the Company's overall financial
position.
REVENUES
--------------------------------------
Three Months Ended Nine Months Ended
December 31, December 31,
Cluster 1996 1997 1996 1997
------- ------- ------- -------
Northeast $ 1,417 $ 2,385 $ 3,978 $ 5,980
Mid-Atlantic 615 2,378 1,427 5,084
Mid-South 328 504 843 1,452
Other Networks 1,438 2,380 3,727 6,758
------- ------- ------- -------
Total $ 3,798 $ 7,647 $ 9,975 $19,274
======= ======= ======= =======
There can be no assurance, however, that the Operating Companies will
continue to experience revenue growth at this rate, or at all. Furthermore,
there can be no assurance that the Company will be able to benefit from such
growth in revenues if such growth occurs.
EBITDA
--------------------------------------
Three Months Ended Nine Months Ended
December 31, December 31,
Cluster 1996 1997 1996 1997
------- ------- ------- -------
Northeast $ 422 $ 138 $ 680 $ (93)
Mid-Atlantic (651) (2,339) (2,430) (5,491)
Mid-South (177) (1,306) (601) (2,343)
Other Networks 285 766 969 2,020
------- ------- ------- -------
Total $ (121) $(2,741) $(1,382) $(5,907)
======= ======= ======= =======
Capital Expenditures
---------------------------------------
Three Months Ended Nine Months Ended
December 31, December 31,
Cluster 1996 1997 1996 1997
------- ------- ------- --------
Northeast $ 2,128 $ 9,593 $12,320 $ 18,774
Mid-Atlantic 11,255 15,330 43,321 43,239
Mid-South 4,235 20,054 10,425 40,681
Other Networks 4,164 2,359 10,948 18,830
------- ------- ------- --------
Total $21,782 $47,336 $77,014 $121,524
======= ======= ======= ========
Liquidity and Capital Resources
The development of the Company's business and the installation and
expansion of the Operating Companies' networks, combined with the construction
of the Company's NOCC, have resulted in substantial capital expenditures and
investments during the past several years. Capital expenditures by the Company
were $14,950 and $39,775 for the nine months ended December 31, 1996 and 1997,
respectively. Further, investments made by the Company in nonconsolidated
Operating Companies were $23,398 and $50,739 for the nine months ended December
31, 1996 and 1997, respectively. The significant increase for the nine months
ended December 31, 1997 as compared with the same period in the prior fiscal
year is largely attributable to capital expenditures necessary to enter and
develop the switching market. The Company expects that it will continue to have
substantial capital and investment commitments. The Company also expects to
continue to fund operating losses as the Company develops and grows its
business.
On August 27, 1997, the Company issued $250,000 aggregate principal
amount of 12 1/4% Senior Secured Notes due September 1, 2004 (the "Senior
Secured Notes") in a private placement. The Senior Secured Notes are
collateralized through the pledge of the common stock of certain of its
wholly-owned subsidiaries. Of the proceeds to the Company of approximately
$244,000, net of commissions and other transaction costs, $83,400, was invested
in U.S. government securities and placed in an escrow account for payment in
full when due of the first six scheduled semi-annual interest payments on the
Senior Secured Notes as required by the Indenture. The remainder of such
proceeds will be used to fund the acquisition of increased ownership interests
in certain of its networks, for capital expenditures, including the construction
and expansion of new and existing networks, and for general corporate and
working capital purposes.
On October 9, 1997, the Company issued $200,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due October
15, 2007. Proceeds to the Company, net of commissions and other transaction
costs, were approximately $194,733. Such proceeds will be used to fund the
acquisition of increased ownership interests in certain of it's networks, for
capital expenditures, including the construction and expansion of new and
existing networks, and for general corporate and working capital purposes.
On December 31, 1997, the Company consummated an agreement for a
$24,489 long term lease facility with AT&T Capital Corporation. The lease
facility provides financing for certain of the Operating Companies' switching
equipment.
Through December 31, 1997, Adelphia has made loans and advances
totaling approximately $72,300, including accrued interest, to the Company and
leased $3,400 in fiber network construction to certain Operating Companies.
During April 1996, the Company repaid $37,800 of such loans and advances. In
addition, Local Partners have invested approximately $93,000 as their pro rata
investment in those networks through December 31, 1997. These amounts exclude
previous investments in the South Florida Partnership which were sold on May 16,
1996. These partners have also provided additional capital of $57,200 for the
construction of the Company's networks through the partnership agreements by
funding the fiber construction of the network and leasing the fiber to the
partnership under long-term, renewable agreements. In addition, the Company used
$180,400 to fund its pro rata investment in the networks, capital expenditures
and operations. Collectively, these investments and the Fiber Lease Financings
have totaled $406,300 from the Company's inception through December 31, 1997.
The Company has experienced negative operating cash flow since its
inception. A combination of operating losses, substantial capital investments
required to build the Company's wholly and majority-owned networks and its
state-of-the-art NOCC, and incremental investments in the Operating Companies
has resulted in substantial negative cash flow. Prior to April 15, 1996, the
date of the issuance of the Senior Discount Notes, funding of the Company's cash
flow deficiency was principally accomplished through additional borrowings from
Adelphia. Prior to April 15, 1996, interest and fees on this unsecured credit
facility were based upon the weighted average cost of unsecured borrowings of
Adelphia. The average interest rate charged on borrowings from Adelphia for all
periods through April 15, 1996 was 11.3% (excluding fees charged which were
based on the amount borrowed) and 16.5% for the period since April 16, 1996.
The competitive local telecommunication service business is a
capital-intensive business. The Company's operations have required and will
continue to require substantial capital investment for (i) the installation of
electronics for switched services in the Company's networks, (ii) the expansion
and improvement of the Company's NOCC and existing networks, (iii) the design,
construction and development of additional networks and (iv) the acquisition of
additional ownership interests in existing or new networks. The Company has made
substantial capital investments and investments in Operating Companies in
connection with the deployment of switches in all of its operating markets. In
addition, the Company intends to increase spending on marketing and sales
significantly in the foreseeable future in connection with the expansion of its
sales force and marketing efforts generally. The Company estimates that it will
require approximately $230,000 to $260,000 to fund anticipated capital
expenditures, working capital requirements and operating losses of the Company,
investments in its existing Operating Companies and the acquisition of 100% of
the ownership interests in the Buffalo, Louisville, Lexington, New Brunswick and
Morristown networks through the fiscal year ending March 31, 1999. In addition,
expansion of the Company's networks will include the geographic expansion of the
Company's existing clusters and the development of new markets. The Company
expects to continue to build new networks in additional markets, which the
Company anticipates will include additional networks with utility partners and,
in the future, the Company may increase its ownership in the Operating Companies
and acquire existing networks. The Company expects that it will have adequate
resources to fund such expenditures through the net proceeds from the Senior
Secured Notes and the 12 7/8% Senior Exchangeable Redeemable Preferred Stock
offerings, anticipated bank and/or vendor financings by the Operating Companies,
internal sources of funds, including cash flow from operations generated by the
Company, and additional debt or equity financings, as appropriate. There can be
no assurance, however, as to the availability of funds from internal cash flow
or from the private or public equity or debt markets. In addition, the
expectations of required future capital expenditures are based on the Company's
current estimate. There can be no assurance that actual expenditures will not
significantly exceed current estimates or that the Company will not accelerate
its capital expenditures program.
In addition, the Company expects that pro rata investments by the
Company and its Local Partners as well as Fiber Lease Financings and anticipated
bank or vendor financings will be adequate to fund the requirements of the
Operating Companies for capital expenditures, operating losses and working
capital for existing networks, networks currently under construction and certain
of the Company's planned additional markets during fiscal years 1998 and 1999.
There can be no assurance as to the availability of funds from internal cash
flow, the Local Partners or other external sources or as to the terms of such
financings. In addition, the indentures relating to the 13% Senior Discount
Notes and the Senior Secured Notes provide certain restrictions upon the
Company's ability to incur additional indebtedness. The Company's inability to
fund pro rata investments required for the Operating Companies could result in a
dilution of the Company's interest in the individual Operating Companies or
could otherwise have a material adverse effect upon the Company and/or the
Operating Companies.
REGULATION
Overview
Telecommunications services provided by the Company and its networks
are subject to regulation by federal, state and local government agencies. At
the federal level, the FCC has jurisdiction over interstate and international
services. Jurisdictionally interstate services, which constitute the majority of
the Operating Companies' current services, are communications that originate in
one state and terminate in another. Intrastate services are communications that
originate and terminate in a single state. State regulatory commissions exercise
jurisdiction over intrastate services. Additionally, municipalities and other
local government agencies may regulate limited aspects of the Company's
business, such as use of rights-of-way. Many of the regulations issued by these
regulatory bodies may be subject to judicial review, the result of which the
Company is unable to predict. The networks are also subject to numerous local
regulations such as building codes and licensing.
Telecommunications Act of 1996
On February 8, 1996, the Telecommunications Act was signed into law. It
is considered to be the most comprehensive reform of the nation's
telecommunications laws since the Communications Act of 1934. The
Telecommunications Act has and will continue to result in substantial changes in
the marketplace for voice, data and video services. These changes include
opening the local exchange market to competition and will result in a
substantial increase in the addressable market for the Company's networks. Among
its more significant provisions, the Telecommunications Act (i) removes legal
barriers to entry in local telephone markets, (ii) requires incumbent LECs to
"interconnect" with competitors, (iii) establishes procedures for incumbent LEC
entry into new markets, such as long distance and cable television, (iv) relaxes
regulation of telecommunications services provided by incumbent LECs and all
other telecommunications service providers, and (v) directs the FCC to establish
an explicit subsidy mechanism for the preservation of universal service. As a
component of the need for explicit subsidy mechanism for universal service, the
FCC was also directed to revise and make explicit subsidies inherent in the
current access charge system.
Removal of Entry Barriers
Prior to enactment of the Telecommunications Act, many states limited
the services that could be offered by a company competing with the incumbent
LEC. See "--State Regulation." In these states, the incumbent LEC retained a
monopoly over basic local exchange services pursuant to state statute or
regulatory policy. In states with these legal barriers to entry, the Company had
been limited to the provision of dedicated telecommunications services, which
constitutes only a small portion of the local telephone market.
The Telecommunications Act prohibits state and local governments from
enforcing any law, rule or legal requirement that prohibits or has the effect of
prohibiting any person from providing interstate or intrastate
telecommunications services. States retain jurisdiction under the
Telecommunications Act to adopt laws necessary to preserve universal service,
protect public safety and welfare, ensure the continued quality of
telecommunications services and safeguard the rights of consumers.
This provision of the Telecommunications Act should enable the
Operating Companies to provide a full range of local telecommunications services
in any state. The Operating Companies will continue their policy of not
providing interLATA long distance services that compete with the major IXCs in
order to enable the Company to work with IXCs to provide an integrated local and
long distance service offering to end users. Although the Operating Companies
will be required to obtain certification from the state regulatory commission in
almost all cases, the Telecommunications Act should limit substantially the
ability of a state commission to deny a request for certification filed by an
Operating Company. While this provision of the Telecommunications Act expands
significantly the markets available to the Operating Companies, it also reduces
the barriers to entry by other potential competitors and therefore increases the
level of competition the Operating Companies will face in all their markets. See
"Competition." Delays in receiving regulatory approvals or the enactment of new
adverse regulation or regulatory requirements may have a materially adverse
effect upon the Operating Companies.
Some state commissions are currently considering actions to preserve
universal service and promote the public interest. The actions may impose
conditions on the certificate issued to an Operating Company which would require
it to offer service on a geographically widespread basis through the
construction of facilities to serve all residents and business customers in such
areas, the acquisition from other carriers of network facilities required to
provide such service, or the resale of other carriers' services. The Company
believes that state commissions have limited authority to impose such
requirements under the Telecommunications Act. The imposition of such conditions
by state commissions could increase the cost to the Operating Companies of
providing local exchange services, or could otherwise affect the Operating
Companies' flexibility to offer services.
Interconnection with LEC Facilities
A company cannot compete effectively with the incumbent LEC in the
market for switched local telephone services unless it is able to connect its
facilities with the incumbent LEC and obtain access to certain essential
services and resources under reasonable rates, terms and conditions. Incumbent
LECs historically have been reluctant to provide these services voluntarily and
generally have done so only when ordered to by state regulatory commissions. The
Telecommunications Act imposes a number of access and interconnection
requirements on all local exchange providers, including CLECs, with additional
requirements imposed on non-rural LECs. These requirements will provide access
to certain networks under reasonable rates, terms and conditions. Specifically,
LECs must provide the following:
Telephone Number Portability. Telephone number portability enables a
customer to keep the same telephone number when the customer switches local
exchange carriers. New entrants are at a competitive disadvantage without
telephone number portability because of inconvenience and costs to customers
that must change numbers.
Dialing Parity. All LECs must provide dialing parity, which means that
a customer calling to or from a CLEC network cannot be required to dial more
digits than is required for a comparable call originating and terminating on the
LEC's network.
Reciprocal Compensation. The duty to provide reciprocal compensation
means that LECs must terminate calls that originate on competing networks in
exchange for a given level of compensation and that they are entitled to
termination of calls that originate on their network for which they must pay a
given level of compensation.
Resale. A LEC may not prohibit or place unreasonable restrictions on
the resale of its services. In addition, incumbent LECs must offer bundled local
exchange services to resellers at a wholesale rate that is less than the retail
rate charged to end users.
Access to Rights-of-Way. All LECs, CLECs and other utilities must
provide access to their poles, ducts, conduits and rights-of-way on a
reasonable, nondiscriminatory basis.
Unbundling of Network Elements. LECs must offer access to various
unbundled elements of their network. This requirement allows new entrants to
purchase at cost-based rates, elements of an incumbent LEC's network that may be
necessary to provide service to customers not located in the new entrants'
networks.
Dependence on RBOCs and Incumbent LECs. While the Telecommunications
Act generally requires incumbent LECs, including RBOCs, to offer
interconnection, unbundled network elements and resold services to CLECs,
LEC-CLEC interconnection agreements may have short terms, requiring the CLEC to
continually renegotiate the agreements. LECs may not provide timely provisioning
or adequate service quality thereby impairing a CLEC's reputation with customers
who can easily switch back to the LEC. In addition, the prices set in the
agreements may be subject to significant rate increases if state regulatory
commissions establish prices designed to pass on to the CLECs part of the cost
of providing universal service.
On July 2, 1996 the FCC released its First Report and Order and Further
Notice of Proposed Rulemaking promulgating rules and regulations to implement
Congress' statutory directive concerning number portability (the "Number
Portability Order"). The FCC ordered all LECs to begin phased development of a
long-term service provider portability method in the 100 largest Metropolitan
Statistical Areas ("MSAs") no later than October 1, 1997, and to complete
deployment in those MSAs by December 31, 1998. Number portability must be
provided in those areas by all LECs to all requesting telecommunications
carriers. After December 31, 1998, each LEC must make number portability
available within six months after receiving a specific request by another
telecommunications carrier in areas outside the 100 largest area MSAs in which
the requesting carrier is operating or plans to operate. Until long-term service
portability is available, all LECs must provide currently available number
portability measures as soon as reasonably possible after a specific request
from another carrier. As new carriers are at a competitive disadvantage without
telephone number portability, the Number Portability Order should enhance the
Company's ability to offer service in competition with the incumbent LECs, if
these regulations are effective in promoting number portability. The Number
Portability Order sets interim criteria for number portability cost recovery.
The FCC deferred selecting a long-term number portability cost recovery scheme
to a further rulemaking proceeding which is not expected to be decided until
later this year. Further, the Number Portability Order is subject to Petitions
for Reconsideration filed at the FCC. To the extent that the outcome of the
Petitions results in new rules that decrease the LEC obligation to provide
number portability or increase the CLEC obligation to pay for number
portability, changes to the Number Portability Order could decrease the
Company's ability to offer service in competition with the LECs.
On August 8, 1996 the FCC released its First Report and Order and
Second Report and Order and Memorandum Opinion and Order promulgating rules and
regulations to implement Congress' statutory directive concerning the
interconnection obligations of all telecommunications carriers, including
obligations of CLEC and LEC networks and incumbent LEC pricing of
interconnection and unbundled elements (the "Local Competition Orders"). The
Local Competition Orders adopted a national framework for interconnection but
left to the individual states the task of implementing the FCC's rules. The
Local Competition Orders also established rules implementing the
Telecommunications Act requirements that LECs negotiate interconnection
agreements, and provide guidelines for review of such agreements by state
commissions.
On July 18, 1997, the U.S. Court of Appeals for the Eighth Circuit
("Eighth Circuit") vacated certain portions of the Local Competition Orders,
including provisions establishing a pricing methodology, a procedure permitting
new entrants to "pick and choose" among various provisions of existing
interconnection agreements between LECs and their competitors, and certain
provisions relating to the purchase of unbundled access to network elements. The
Operating Companies have negotiated and obtained state commission approval of a
number of interconnection agreements with incumbent LECs prior to this Eighth
Circuit decision. The Eighth Circuit decision creates uncertainty about
individual state rules governing pricing, terms, and conditions of
interconnection decisions, and could make negotiating and enforcing such
agreements in the future more difficult and protracted. It could also require
renegotiation of relevant portions of existing interconnection agreements, or
subject them to agreements to additional court and regulatory proceedings. It
remains to be seen whether Operating Companies can continue to obtain and
maintain interconnection agreements on terms acceptable to them in every state,
though most states have already adopted pricing rules, if not interim prices
which are for the most part consistent with the FCC's related pricing
provisions. The FCC has appealed the Eighth Circuit decision to the United
States Supreme Court, which has in turn granted certiorairi to review.
On October 14, 1997, the Eighth Circuit issued an Order on Rehearing of
the ruling that incumbent LECs need not provide combinations of network elements
to CLECs, even when the incumbent LEC has already combined the same elements
within its network. This recent Order broadens the restrictions previously
placed on combinations of network elements by the Eighth Circuit in its July 18,
1997 opinion striking down many of the pricing and unbundling rules issued by
the FCC. In the July 18 opinion, the Eighth Circuit held, among other things,
that incumbent LECs had no obligation under the Telecommunications Act to
combine network elements for CLECs. The court held that the incumbent LECs' only
obligation with respect to unbundling was to provide CLECs with access to the
individual network elements, leaving each CLEC to combine those network elements
itself. Accordingly, the Eighth Circuit vacated Section 51.315 (c)-(f) of the
FCC's unbundling rules, which had required incumbent LECs to combine network
elements at the request of CLECs except where such combinations were technically
infeasible or would impair the quality of the network. As a result of this
Order, incumbent LECs can now separate already combined network elements before
handing them off to the CLEC to recombine. This issue is incorporated among the
issues that will be argued before the Supreme Court on appeal.
Although the Number Portability Order, the Local Competition Orders and
the underlying statutory requirements are intended to benefit new entrants in
the local exchange market, such as the Operating Companies, it is uncertain how
effective these requirements will be. Ultimately the success of the
Telecommunications Act to bring the benefits of increased competition to
consumers will depend in large part upon state regulators' implementation of the
Telecommunications Act and the Local Competition Orders as well as numerous
rulemakings that should level the playing field between incumbent LECs and new
entrants such as the Company. For example, if CLECs are unable to obtain
favorable agreements with the incumbent LEC regarding call termination and
resale of incumbent LEC facilities and services through negotiation with the
incumbent LEC or arbitration at state public utility commissions, there is a
diminished likelihood that an Operating Company will be successful in its local
exchange market. In addition, the ability of CLECs to resell incumbent LEC
services obtained at wholesale rates may permit some CLECs to compete with the
Operating Companies without investing in facilities.
Moreover, these requirements place burdens on an Operating Company when
it provides switched local exchange services that will benefit potential
competitors. In particular, the obligation to offer services for resale means
that a company can resell the Operating Company's services without investing in
facilities, although unlike incumbent LECs, the Operating Companies are not
required to offer services for resale at discounted rates. Similarly, the
obligation to provide access to rights-of-way is of limited benefit to most of
the Operating Companies, which already have such access through their Local
Partners, but benefits other potential competitors to a greater degree.
LEC Entry into New Markets
The Company's principal competitor in each market it enters is the
incumbent LEC. Prior to enactment of the Telecommunications Act, incumbent LECs
generally were prohibited from providing cable television service pursuant to
the "telco/cable cross-ownership prohibition" contained in the Communications
Act of 1934, although the prohibition had been stayed by several courts and was
not being enforced by the FCC. In addition, the RBOCs generally were prohibited
by the Modified Final Judgment ("MFJ") from providing interLATA (i.e., long
distance) services within the region in which they provide local exchange
service.
The Telecommunications Act repeals the telco/cable cross-ownership
prohibition and permits incumbent LECs to provide cable television service.
Prior to the Telecommunications Act repeal, some LECs were investing in fiber
optic networks on a limited basis through the FCC's "video dialtone" regulatory
regime. With the telco/cable cross ownership prohibition removed, LECs are more
likely to invest in fiber optic networks because those facilities will be able
to generate a revenue stream previously unavailable on a widespread basis to the
incumbent LECs. While LEC entry into the video market may be a motivating factor
for construction of new facilities, these facilities also can be used by an
incumbent LEC to provide services that compete with the Company's networks.
The Telecommunications Act also eliminates the prospective effect of
the MFJ and establishes procedures under which an RBOC can enter the market for
interLATA services within its telephone service area. This is referred to as
"in-region" interLATA service. (RBOCs are currently permitted to provide
interLATA long distance services to customers outside of their local service
areas. This is referred to as "out-of-region" long distance service.) Before an
RBOC can provide in-region interLATA service, it must enter into a
state-approved interconnection agreement with a company that provides local
exchange service to business and residential customers predominantly over its
own facilities. Alternatively, if no such competitor requests interconnection,
reasonably expected to lead to facilities-based competition in the residential
and business local exchange markets, the RBOC can request authority to provide
in-region interLATA services if it offers interconnection under state-approved
terms and conditions. The interconnection offered or provided by the RBOC must
comply with a "competitive checklist" that is comparable to the interconnection
requirements discussed above. See "-- Interconnection with LEC Facilities."
The ability of the RBOCs to provide interLATA services enables them to
provide customers with a full range of local and long distance
telecommunications services. The provision of interLATA services by RBOCs is
expected to reduce the market share of the major long distance carriers, which
are the Company's networks' primary customers. Consequently, the entry of the
RBOCs into the long distance market may have adverse consequences on the ability
of CLECs to generate access revenues from the IXCs. To date Ameritech has sought
authority from the FCC to provide in-region interLATA service in Michigan, and
Southwestern Bell Telephone Company ("SWBT") has sought similar authority in
Oklahoma. The Department of Justice has opposed both requests, and both requests
have been denied by the FCC. On December 23, 1997, the FCC denied BellSouth's
request for in-region interLATA service in South Carolina, and a similar request
was denied on February 3, 1998 in Louisiana. More RBOC requests to provide
in-region interLATA service are expected to be filed with the FCC during the
coming year.
Further FCC rulings on Section 271 applications were complicated by a
Texas federal judge's ruling on December 31, 1997 that Section 271 of the 1996
Act is unconstitutional. This decision has been stayed pending appeal by the FCC
to the U.S. Court of Appeals for the Fifth Circuit.
Relaxation of Regulation
A long-term goal of the Telecommunications Act is to increase
competition for telecommunications services, thereby reducing the need for
regulation of these services. To this end, the Telecommunications Act requires
the FCC to streamline its regulation of incumbent LECs and permits the FCC to
forbear from regulating particular classes of telecommunications services or
providers. Since the Company is a non-dominant carrier and, therefore, is not
heavily regulated by the FCC, the potential for regulatory forbearance likely
will be more beneficial to the incumbent LECs than the Company in the long run.
In an exercise of its "forbearance authority," the FCC has ruled that
following a transition period nondominant interexchange carriers will no longer
be able to file tariffs with the FCC concerning their interexchange interstate
long distance services (the "IXC Detariffing Order"). The IXC Detariffing Order
has been appealed to the U.S. Court of Appeals for the District of Columbia. The
IXC Detariffing Order has been stayed and the appeal is still pending.
Pursuant to the forbearance provisions of the Telecommunications Act,
in March 1996, the Company filed a petition requesting that the FCC also forbear
from imposing tariff filing requirements on interstate exchange access services
provided by carriers other than incumbent LECs. In June 1997, the FCC granted
this request, concluding that allowing providers of exchange access service the
option of tariffing or detariffing their services is in the public interest. In
granting the Company's petition, the FCC requested further comment on whether or
not to mandate the detariffing of exchange access services. This proceeding is
pending, and there can be no assurance how the FCC will rule on this issue, or
what effect any such ruling may have upon competition within the
telecommunications industry generally, or on the competitive position of the
Company specifically.
The Telecommunications Act eliminates the requirement that incumbent
LECs obtain FCC authorization before constructing new facilities for interstate
services. The Telecommunications Act also limits the FCC's ability to review LEC
tariff filings. These changes will increase the speed with which incumbent LECs
are able to introduce new service offerings and new pricing of existing
services, thereby increasing the incumbent LECs' ability to compete with the
Company.
Universal Service and Access Charge Reform
One of the primary goals of the original Communications Act of 1934 was
to extend telephone service to all the citizens of the United States. This goal
has been achieved largely by keeping the rates for basic local exchange service
at a reasonable level. It was traditionally thought that incumbent LECs were
able to keep basic residential rates reasonable by subsidizing them with
revenues from business and IXC customers, and by subsidizing rural service at
the expense of urban customers. The existence and level of these subsidies has
been widely disputed in recent years because they are so difficult to quantify.
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 affirmed the policy principles for universal telephone service set
forth in the Telecommunications Act, including quality service, affordable
rates, access to advanced services, access in rural and high-cost areas,
equitable and non-discriminatory contributions, specific and predictable support
mechanisms, and access to advanced telecommunications services for schools,
health care providers and libraries. The Universal Service Order added
"competitive neutrality" to the FCC's universal service principles by providing
that universal service support mechanisms and rules should not unfairly
advantage or disadvantage one provider over another, nor unfairly favor or
disfavor one technology over another. The Universal Service Order also requires
all telecommunications carriers providing interstate telecommunications
services, including the Company, to contribute to universal service support. For
the first quarter of 1998, the FCC has set universal service contribution rates
of 3.19% of gross interstate and international revenues generally, and .72% of
intrastate, interstate and international revenues specifically to support
schools, libraries, and rural health care providers. These rates are expected to
change quarterly. Also, the FCC's existing system for subsidizing universal
service remains in effect and only ILECs are likely to be eligible to receive
such subsidies until such time as the FCC determines the new subsidy mechanism,
even though CLECs like Hyperion may be obligated to provide universal service.
In a related proceeding on May 16, 1997, the FCC issued an order to
implement certain reforms to its access charge rules (the "Access Charge Reform
Order"). Access charges are charges imposed by LECs on long distance providers
for access to the local exchange network and are designed to compensate the LEC
for its investment in the local network. The FCC regulates interstate access and
the states regulate intrastate access. The Access Charge Reform Order will
require incumbent LECs to substantially decrease over time the prices they
charge for switched and special access and change how access charges are
calculated. These changes are intended to reduce access charges paid by
interexchange carriers to LECs and shift certain usage-based charges to
flat-rated, monthly per-line charges. To the extent that these rules begin to
reduce access charges to reflect the forward-looking cost of providing access,
the Company's competitive advantage in providing customers with access services
might decrease. In addition, the FCC has determined that it will give incumbent
LECs pricing flexibility with respect to access charges. To the extent such
pricing flexibility is granted before substantial facilities-based competition
develops, such flexibility could be misused to the detriment of new entrants,
including the Company. Until the FCC adopts and releases rules detailing the
extent and timing of such pricing flexibility, the impact of these rules on the
Company cannot be determined.
Two aspects of the FCC's Access Charge Reform Order create potential
competitive benefits for alternative access providers, including the Company.
First, the abolition of the unitary rate structure option for local transport
may have an adverse effect on some interexchange carriers, making competitive
access services provided by the Company and others more attractive. Second, the
FCC ruled that incumbent LECs may no longer impose the transport interconnection
charge on competitive providers, such as the Company, that interconnect with the
incumbent LEC at the incumbent's end offices.
Both the Universal Service and Access Charge Reform Orders are subject
to petitions seeking reconsideration by the FCC and direct appeals to U.S.
Courts of Appeals. Until the time when any such petitions or appeals are
decided, there can be no assurance of how the Universal Service and/or Access
Charge Reform Orders will be implemented or enforced, or what effect the Orders
will have on competition within the telecommunications industry, generally, or
on the competitive position of the Company, specifically.
Federal Regulation
Through a series of regulatory proceedings, the FCC has established
different levels of regulation for "dominant carriers" and "non-dominant
carriers." Only LECs are classified as dominant; all other providers of domestic
interstate services, including the Operating Companies, are classified as
non-dominant carriers. As non-dominant carriers, the Operating Companies are
subject to relatively limited regulation by the FCC. The Operating Companies
must offer interstate services at just and reasonable rates in a manner that is
not unreasonably discriminatory, subject to the complaint provisions of the
Communications Act of 1934, as amended.
The FCC has adopted rules requiring incumbent LECs to provide
"collocation" to CAPs for the purpose of interconnecting their competing
networks. These rules enable the Operating Companies to carry a portion of a
customer's interstate traffic to an IXC even if the customer is not located on
the Company's network. The Company has requested collocation in some, but not
all, of its markets. The incumbent LECs have proposed collocation rates that are
being investigated by the FCC to determine whether they are excessive. If the
FCC orders the incumbent LECs to reduce these rates, collocation will be a more
attractive option for CLECs. Under the Local Competition Order, incumbent LECs
will also be required to provide both virtual collocation and actual collocation
at their switching offices.
Under the Telecommunications Act, an Operating Company may become
subject to additional federal regulatory obligations when it provides local
exchange service in a market. All LECs, including CLECs, must make their
services available for resale by other carriers, provide nondiscriminatory
access to rights-of-way, offer reciprocal compensation for termination of
traffic and provide dialing parity and telephone number portability. In
addition, the Telecommunications Act requires all telecommunications carriers to
contribute to the universal service mechanism established by the FCC and to
ensure that their services are accessible to and usable by persons with
disabilities. Moreover, the FCC is currently engaged in a number of rulemakings
in which it is considering regulatory implications of various aspects of local
exchange competition. Any or all of the proceedings may negatively affect CLECs,
including the Company. Most recently, the FCC has determined to investigate
whether or not to mandate operational support systems reporting standards for
the LECs, whether to regulate billing and collection functions, and whether to
assert jurisdiction over reciprocal compensation for local calls made to
Internet service providers.
Because the states are in the process of implementing rules consistent
with the Telecommunications Act and rules adopted by the FCC pursuant to the
Act, it is uncertain how burdensome or beneficial such rules will be for the
Company and the Operating Companies. The obligation to provide services for
resale by others potentially limits any competitive advantage held by the
Company by virtue of its state-of-the-art facilities because other carriers,
including the incumbent LEC and the IXCs, can simply resell the Operating
Companies' services. Similarly, the obligation to provide access to
rights-of-way benefits certain competitors more than the Company, which already
has such a significant amount of access through its Local Partners. Most of the
other obligations impose costs on the Operating Companies that also will be
borne by competing carriers so the competitive implication of these requirements
should not be significant if they are implemented fairly.
As part of its decision requiring incumbent LECs to provide virtual
collocation, the FCC also granted incumbent LECs flexibility to reduce their
rates for interstate access services in markets where a CAP is collocated. This
flexibility includes the ability to offer volume and term discounts and to
de-average access rates in different "zones" in a state based on the level of
traffic. In addition, the FCC has granted two incumbent LECs further flexibility
in their most competitive markets and the FCC could grant similar waivers in
markets served by the Operating Companies. The May 21, 1997 Order reforming the
FCC's price cap formula affords LECs greater flexibility in establishing rates
and provides additional incentives to foster efficiency. With the passage of the
Telecommunications Act and the anticipated increase in the level of competition
faced by incumbent LECs, the FCC could grant incumbent LECs substantial pricing
flexibility with regard to interstate access services. It is also anticipated
that the prices incumbent LECs charge for access services will be reduced as a
result of the FCC's reform of the access charge regime and the adoption of
universal service rules. To the extent these regulatory initiatives enable or
require incumbent LECs to offer selectively reduced rates for access services,
the rates the Operating Companies may charge for access services will be
constrained. The Operating Companies' rates also will be constrained by the fact
that competitors other than the incumbent LECs are subject to the same
streamlined regulatory regime as the Operating Companies and can price their
services to meet competition.
State Regulation
Most state public utility commissions require companies that wish to
provide intrastate common carrier services to be certified to provide such
services. These certifications generally require a showing that the carrier has
adequate financial, managerial and technical resources to offer the proposed
services in a manner consistent with the public interest.
Operating Companies have been certificated or are otherwise authorized
to provide telecommunications services in Arkansas, Florida, Kansas, Kentucky,
Louisiana, Mississippi, New Jersey, New York, Pennsylvania, Tennessee, Vermont
and Virginia. These certificates or other authorizations permit the Operating
Companies to provide a full range of local telecommunications services,
including basic local exchange service. The Operating Companies have interim
authority to provide a full range of local telecommunications services in
Pennsylvania and applications for permanent certificates are pending in that
state. In light of the Telecommunications Act, the Operating Companies will
request removal of any restrictions that now exist on its certificates in the
remaining states and anticipate that requests will be granted. See
"--Telecommunications Act of 1996 -- Removal of Entry Barriers." In addition,
the Telecommunications Act will enable the Company to enter new states providing
a full range of local services upon certification. In certain states, each of
the Company, its subsidiaries and the Operating Companies may be subject to
additional state regulatory requirements, including tariff filing requirements,
to begin offering the telecommunications services for which such entities have
been certificated. Many states also may have additional regulatory requirements
such as reporting and customer service and quality requirements, unbundling and
universal service contributions. In addition, in virtually every state, the
Company's certificate or other authorization is subject to the outcome of
proceedings by the state commission that address regulation of LECs and CLECs,
competition, geographic build-out, mandatory detariffing, and service
requirements, and universal service issues.
Certain of the states where the Operating Companies operate have
adopted specific universal service funding obligations. For example, in
Pennsylvania, pending the issuance of final rules, the Operating Company will be
required to make a universal service contribution based on an "assessment rate"
derived from dividing the Operating Company's gross intrastate operating
revenues into the statewide intrastate revenues generated by all other carriers.
The Operating Company's contribution to the Pennsylvania universal service fund
will be phased in over four years with 25 percent of the assessment rate
collected in the first year and equal increments added to the payment in the
second, third and fourth years. Vermont imposes a universal service fund
surcharge to finance state lifeline, relay and E-911 programs, and potentially
affordable service in high cost areas, and also imposes a gross revenues tax,
like many other states. In Kansas, the state regulatory commission has ordered
telecommunications companies to pay approximately 9% of their intrastate retail
revenues to the Kansas Universal Service Fund, beginning March 1, 1997.
Proceedings to adopt universal service funding obligation rules are pending or
contemplated in the other states in which the Operating Companies conduct
business.
In addition to obtaining certification, an Operating Company must
negotiate terms of interconnection with the incumbent LEC before it can begin
providing switched services. Under the Telecommunications Act, the FCC has
adopted interconnection requirements, certain portions of which have been
overturned by the Eighth Circuit. See "--Telecommunications Act of 1996 --
Interconnection with LEC Facilities." To date, many of the Operating Companies
have negotiated interconnection agreements with one or more of the incumbent
LECs. Specifically, state commissions have approved interconnection agreements
in Arkansas (Southwestern Bell), Kansas (Southwestern Bell), Kentucky
(BellSouth; GTE), Mississippi (BellSouth), New Jersey (Bell Atlantic), Tennessee
(BellSouth), Vermont (NYNEX), and Virginia (Bell Atlantic; Sprint-Centel). In
addition, two interconnection agreements have been approved by operation of law
in Pennsylvania (Bell Atlantic; GTE). Finally, Operating Companies in New York
interconnect with NYNEX (BA), pursuant to NYNEX tariffs on file with the New
York Public Service Commission while they await approval of their
interconnection agreements filed in December 1997. The Operating companies have
also signed interconnection agreements in Louisiana with BellSouth.
The Operating Companies are not presently subject to price regulation
or rate of return regulation in any state, although there can be no assurance
this will not change when the Operating Companies begin providing switched
services in some states. In most states, an Operating Company is required to
file tariffs setting forth the terms, conditions and prices for intrastate
services. In some states, an Operating Company's tariff lists a rate range or
sets prices on an individual case basis.
Several states have allowed incumbent LECs rate, special contract
(selective discounting) and tariff flexibility, particularly for services deemed
subject to competition. This pricing flexibility increases the ability of the
incumbent LEC to compete with an Operating Company and constrains the rates an
Operating Company may charge for its services. In light of the additional
competition that is expected to result from the Telecommunications Act, states
may grant incumbent LECs additional pricing flexibility. At the same time, some
incumbent LECs may request increases in local exchange rates to offset revenue
losses due to competition.
An investor who acquires as little as ten percent of the Company's
outstanding voting securities may have to obtain approval of certain state
public utility commissions before acquiring such an interest, because such
ownership might be deemed to constitute an indirect controlling interest in the
state Operating Company.
As the Company expands its operations into other states, it may become
subject to the jurisdiction of their respective public service commissions.
Several northeastern states have required NYNEX to comply with the
Telecommunications Act's requirements for in-region interLATA service as a
condition to approval of its merger with Bell Atlantic. Such requirements may
serve to expedite NYNEX-Bell Atlantic's entry into this marker and may also
reduce the incentive these RBOCs now have to negotiate and renegotiate
interconnection agreements with the Operating Companies since the existence of
such agreements is a prerequisite to such entry.
Local Government Authorizations
An Operating Company may be required to obtain from municipal
authorities street opening and construction permits, or operating franchises, to
install and expand its fiber optic networks in certain cities. In some cities,
the Local Partners or subcontractors may already possess the requisite
authorizations to construct or expand the Company's networks. An Operating
Company or its Local Partners also may be required to obtain a license to attach
facilities to utility poles in order to build and expand facilities. Because
utilities that are owned by a cooperative or municipality are not subject to
federal pole attachment regulation, there are no assurances that an Operating
Company or its Local Partners will be able to obtain pole attachments from these
utilities at reasonable rates, terms and conditions.
In some of the areas where the Operating Companies provide service,
their Local Partners pay license or franchise fees based on a percent of certain
revenue. In addition, in areas where the Company does not use facilities
constructed by a Local Partner, the Operating Company may be required to pay
such fees. There are no assurances that certain municipalities that do not
currently impose fees will not seek to impose fees in the future, nor is there
any assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, other companies providing local
telecommunications services, particularly the incumbent LECs, currently are
excused from paying license or franchise fees or pay fees that are materially
lower than those required to be paid by the Operating Company or Local Partner.
The Telecommunications Act requires municipalities to charge nondiscriminatory
fees to all telecommunications providers, but it is uncertain how quickly this
requirement will be implemented by particular municipalities in which the
Company operates or plans to operate or whether it will be implemented without a
legal challenge initiated by the Company or another CLEC.
If any of the existing Local Partner Agreements or Fiber Lease
Agreements held by a Local Partner or an Operating Company for a particular
market were terminated prior to its expiration date and the Local Partner or
Operating Company were forced to remove its fiber optic cables from the streets
or abandon its network in place, even with compensation, such termination could
have a material adverse effect on the Company.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
(c) Sales of Unregistered Securities
On October 9, 1997, Hyperion issued $200,000,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due 2007
(the "Preferred Stock") in a private placement to institutional investors
pursuant to exemptions from registration under Section 4(2) of the Securities
Act and Rule 144A and in reliance upon Regulation S. Gross proceeds were
$200,000,000 and net proceeds were approximately $194,733,000 after underwriting
discounts, commissions and other transaction costs of approximately $5,267,000.
The initial purchaser for the Preferred Stock was Bear Stearns & Co. Inc.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
At a meeting of the stockholders of the Company held on December 19,
1997, the following item was voted on:
(a) The election of the following persons to comprise the full Board
of Directors of the Company: John J. Rigas, Michael J. Rigas, Timothy J. Rigas,
James P. Rigas, Daniel R. Milliard, Charles R. Drenning, Paul D. Fajerski,
Randolph S. Fowler, Pete J. Metros and James L. Gray.
The voting on the above-mentioned item was as follows:
Class of Stock Votes For Votes Withheld Votes Against
Class A -- 122,000 --
Class B 96,333,400 3,666,600 --
12 7/8% Senior Exchangeable
Redeemable Preferred Stock -- 200,000 --
Item 5. Other Information
The attached Exhibit 99.01 provides certain financial and business
information of the Company for the three months ended December 31, 1997,
pursuant to Section 4.03(a)(iii) of the Indenture dated April 15, 1996 with
respect to the 13% Senior Discount Notes.
The attached Exhibit 99.02 provides certain financial and business
information of the Company for the three months ended December 31, 1997,
pursuant to Section 4.03(a)(iii) of the Indenture dated August 27, 1997 with
respect to the 12 1/4% Senior Secured Notes.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27.01 Financial Data Schedule (supplied for the information of
the Commission).
Exhibit 99.01 Schedule E - Form of Financial Information and Operating
Data of the Subsidiaries and the Joint Ventures
Presented by Cluster".
Exhibit 99.02 Schedule F - Form of Financial Information and Operating
Data of the Pledged Subsidiaries and the Joint
Ventures".
(b) Reports on Form 8-K:
Form 8-Ks were filed on October 7 and October 23, 1997 which reported
information under items 5 and 7 thereof. No financial statements were filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HYPERION TELECOMMUNICATIONS, INC.
(Registrant)
Date: February 17, 1998 By: /s/ Timothy J. Rigas
Timothy J. Rigas
Vice Chairman, Chief
Financial Officer
(authorized officer) and
Treasurer
Date: February 17, 1998 By: /s/ Edward E. Babcock, Jr.
Edward E. Babcock, Jr.
Vice President, Finance
and Chief Accounting
Officer
Exhibit Index
Exhibit 27.01 Financial Data Schedule (supplied for the information of
the Commission).
Exhibit 99.01 Schedule E - Form of Financial Information and Operating
Data of the Subsidiaries and the Joint Ventures
Presented by Cluster".
Exhibit 99.02 Schedule F - Form of Financial Information and Operating
Data of the Pledged Subsidiaries and the Joint
Ventures".