10-K405/A 1 d86030a1e10-k405a.txt AMENDMENT NO. 1 TO FORM 10-K - FISCAL END 12/31/00 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K/A (AMENDMENT NO.1) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . COMMISSION FILE NUMBER: 0-24509 ALLEGIANCE TELECOM, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 75-2721491 (State of Incorporation) (IRS Employer Identification No.) 9201 NORTH CENTRAL EXPRESSWAY 75231 DALLAS, TEXAS (Zip Code) (Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (214) 261-7100 Securities Registered Pursuant to Section 12(b) of the Act: NONE Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.01, QUOTED ON THE NASDAQ NATIONAL MARKET Indicate by check mark whether Allegiance Telecom (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 it was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Allegiance Telecom's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Based on the closing sales price on the Nasdaq National Market on March 26, 2001 of $16.00, the aggregate market value of our voting stock held by non-affiliates on such date was approximately $1,210,228,816. Shares of common stock held by directors and certain executive officers and by each person who owns or may be deemed to own 10% or more of our outstanding common stock have been excluded, since such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of March 26, 2001, Allegiance Telecom, Inc. had 112,923,174 shares of common stock issued and outstanding. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS TO ALLEGIANCE TELECOM, INC.'S ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDING DECEMBER 31, 2000
PAGE ---- PART I.................................................................. 1 Item 1. Business.................................................... 1 Item 2. Properties.................................................. 20 Item 3. Legal Proceedings........................................... 20 Item 4. Submission of Matters to a Vote of Security Holders......... 20 PART II................................................................. 21 Item 5. Market for Allegiance Telecom's Common Stock and Related Stockholder Matters......................................... 21 Item 6. Selected Financial Data..................................... 22 Item 7. Management's Discussion & Analysis of Financial Condition & Results of Operations....................................... 23 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................................ 33 Item 8. Consolidated Financial Statements and Supplementary Data.... 33 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 33 PART III................................................................ 34 Item 10. Directors and Executive Officers of Allegiance Telecom...... 34 Item 11. Executive Compensation...................................... 40 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 46 Item 13. Certain Relationships and Related Transactions.............. 49 PART IV................................................................. 50 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 50 Signatures............................................................ 51 Financial Statements.................................................. F-1 Schedule I -- Report of Independent Public Accountants on Financial Statement Schedule..................................... S-I Schedule II -- Valuation and Qualifying Accounts...................... S-II Index to Exhibits..................................................... E-1
i 3 PART I ITEM 1. BUSINESS OVERVIEW Allegiance Telecom, Inc. is a leading competitive provider of telecommunications services to small and medium-sized businesses in major metropolitan areas across the United States. We offer an integrated set of telecommunications services including local, long distance, data and a full suite of Internet services. Our principal competitors are the established telephone companies, such as the regional Bell operating companies, as well as other integrated communications providers. Our business plan covers 36 of the largest metropolitan areas in the United States. Our network rollout has proceeded on schedule, with 27 markets operational as of December 31, 2000, consisting of Atlanta, Baltimore, Boston, Chicago, Cleveland, Dallas, Denver, Detroit, Fort Worth, Houston, Long Island, Los Angeles, Miami, Minneapolis/St. Paul, New York, Northern New Jersey, Oakland, Orange County, Philadelphia, Phoenix, St. Louis, San Diego, San Francisco, San Jose, Seattle, Tampa and Washington, D.C. In addition, San Antonio became operational on March 6, 2001. We expect to complete the rollout of our 36 targeted markets by the end of 2001. With a strategy focusing on the central business districts and suburban commercial districts in these areas, we plan to address a majority of the non-residential lines in most of our targeted markets. We estimate that our 36 target markets include over 30 million non-residential lines, representing approximately 57% of the total non-residential lines in the United States which provide us with a large base of potential customers. The number of non-residential lines that we actually service will depend on our ability to obtain market share from our competitors. We were formed in 1997 by a management team of industry veterans to take advantage of the opportunity for local communications competition created by the Telecommunications Act of 1996. Since we formed our company, we have focused on building a reliable nationwide network based on proven technologies, a strong nationwide direct sales force and efficient information processing systems to support our operations. We believe that by doing so we have positioned ourselves to compete effectively with the monopoly local telephone companies, also referred to as "incumbent local carriers," most of whom do not address our customers with direct sales efforts and are burdened by legacy operational support systems. We believe the Telecommunications Act of 1996, by opening the local telecommunications market to competition, has created an attractive opportunity for companies like us. Most importantly, this law provided that companies designated as "competitive local exchange carriers" would have the right to lease various essential elements of the networks owned by the monopoly local telephone companies. These established telephone companies own what is commonly referred to as the "last mile" of the communications network, meaning the portion of the network connecting central office telephone switches to end user customers. Duplicating this portion of the network would require far more capital investment than any new competitor could justify, especially when trying to serve small and medium-sized business customers. Thus, prior to the enactment of this legislation, local competition generally existed only with respect to very large businesses, where the potential revenue from a single customer or group of customers in a single building could justify the construction of direct connections to the customer premises. The requirement to make essential elements of the existing networks available to competitors, therefore, has enabled us to more efficiently provide local telecommunications services to small and medium-sized business customers located throughout a metropolitan area because we can focus our capital investment in state-of-the art technology while we lease last mile copper wires and other network facilities from the established telephone companies. As we have developed our local networks to service end user customers, we have also attempted to capitalize on our expertise and investment in the edge of the network, the part of the telecommunications network that connects directly to customers, by maximizing the use of our network assets. In building a nationwide network to serve end user customers, we have fixed costs in many assets that are underutilized during those times of day when our small to medium-sized business customers are not placing or receiving as many voice and data calls. We have taken advantage of this underutilization by providing network solutions to other service providers, primarily the leading national providers. These national network providers also have 1 4 end user customers but do not have the facilities and expertise to directly access these customers through the last mile of the communications network. Many of these providers focus on the residential Internet access market. The traffic patterns in that market generally complement those of our end user business customers, making this business an incremental revenue opportunity that leverages our fixed network assets. The other way we intend to serve our customers and leverage our focus on the small and medium-sized business end users is by providing innovative applications of existing technologies. An example is our Integrated Access Service which delivers high-speed, "always on" Internet access and allows multiple voice, data and Internet combinations over a single line. In addition, we have developed electronic commerce products designed to help these customers market their products and services on-line, improve communication and collaboration and increase productivity. While these types of products and solutions are readily available to larger business customers that can afford to devote the resources necessary to develop and customize them internally, we believe that smaller business customers are demanding easy to use electronic commerce solutions that allow them, with minimal design and development costs, to market products on-line and increase their own productivity. OUR SERVICES We tailor our service offerings to meet the specific needs of the small and medium-sized business customers. We believe that our close contact with customers through our direct sales force and customer care personnel enable us to tailor service offerings to meet customers' needs and to creatively package services to provide "one-stop shopping" solutions for those customers. For example, we offer local and long distance voice services together with Internet access in all of our markets, enabling customers to look to a single provider for their communications needs. Local Telephone Services. We offer local telephone services, including basic local voice services as well as other features such as: o call forwarding; o call waiting; o caller number identification and/or calling name identification; o call transfer; o automatic call back; o distinctive ringing; o station-to-station four-digit dialing without a private branch exchange; and o voice mail. By offering basic local voice services, we receive originating and terminating access revenues for long distance calls placed or received by our local service customers. We offer local telephone services over traditional copper wire lines as well as over various high capacity lines. We also offer our "Integrated Access Service" which is an integrated voice and data offering over a single high capacity line. High Speed Data Services and Other Internet Services. We offer high speed data transmission services, such as: o wide area network interconnection, which are remote computer communications systems that allow file sharing among geographically distributed workgroups; wide area networks typically use links provided by local telephone companies; and o broadband Internet access, also known as "wideband," which allows large quantities of data to be transmitted over the Internet to and from the customer's premises. 2 5 Many of our current and future target small and medium-sized business customers do not use data or Internet access services in their businesses. If the current trend of conducting business electronically over the Internet continues, we expect that small and medium-sized businesses will increasingly find the need to purchase Internet access services. To facilitate this expected trend and to assist our customers in taking advantage of the opportunities offered by electronic commerce, we have continued to expand our Internet access services. In addition to Internet access, our basic Internet access package includes domain name registration, email accounts and email storage space. We have also invested in acquiring and growing our website hosting business which allows our customers to maintain a website that can be located on our computers and supported and maintained by our webhosting personnel. Our web hosting packages include user-friendly tools that help customers design their own web site without needing any extensive programming skills and electronic commerce services that make it easy to set up an online retail presence, complete with secure online ordering, shopping cart and credit card processing capabilities. We believe that with the recent growth in demand for Internet services, many Internet service providers are unable to obtain network capacity rapidly enough to meet customer demand and eliminate network congestion problems, especially at the edge of the communications network where we have focused our own business. We have attempted to address this demand by offering local services to Internet service providers, primarily the national service providers. These services include the management of local telephone numbers, the provision and management of modems and the provision of Internet access. Long Distance Services. We offer a full range of domestic and international long distance services. These services include "1+" outbound calling, inbound toll free service and such complementary services as calling cards, operator assistance and conference calling. Because the primary focus of our direct sales force is selling local services or complete communications solutions, we offer long distance services only to customers who also purchase local service from us. SALES AND CUSTOMER CARE We offer our services primarily to small and medium-sized businesses. Unlike large corporate, government, or other institutional users, small and medium-sized businesses often have no in-house telecommunications manager. Based on our management's previous experience, we believe that a direct sales and customer care program focusing on complete, "one-stop shopping" solutions offers a competitive advantage in serving this type of customer's total communications needs. Although the vast majority of our sales force is focused primarily on the small and medium-sized business segment, we also provide services to large businesses such as national retail chain stores and to other telecommunications service providers such as Internet service providers. As a result, we have organized our sales organization to serve each of these three different types of customers. For the small and medium-sized business customer market, we organize account executives into teams of eight persons with a team manager and a sales support specialist for each market. These teams use telemarketing to "qualify" leads and set up initial appointments. We closely manage the number of sales calls that account executives make per week, with the goal of eventually calling on every prospective business customer in an account executive's sales territory. We use commission plans and incentive programs to reward and retain the top performers and encourage strong customer relationships. The sales team managers for each market report to a city sales vice president who in turn reports to a regional vice president. Our national account teams focus on multi-location, national companies. Through consultative selling, we are able to offer these companies one-stop shopping by leveraging our nationwide network footprint. We believe we have a competitive advantage with respect to this opportunity because the regional Bell operating companies to date have not offered many services beyond their established regions. When selling to other communications providers such as Internet service providers, our direct sales force of experienced high-end sales representatives work closely with these other providers to address their needs to enhance the function and efficiency of their own networks. These sales representatives are supported by our 3 6 pre-sales engineers, program managers and service coordinators, who proactively manage the account before and after the sale. The productivity of our sales force is recorded and made available on our internal computer systems on a continuous basis. This allows our management to track sales volumes by market, by sales team and by sales representative at any time. We believe the development of this system had enabled us to more effectively manage our sales force and has enhanced our ability to forecast our revenues. We maintain an extensive customer care center in Dallas, Texas. This operation includes customer care representatives who receive calls from customers experiencing service problems; when a call is received, our representatives open trouble tickets for that customer. These trouble tickets provide a written record of the nature of the customer's service issue and allow us to more efficiently address service issues and analyze the root cause of any problems that may occur in our network. Our customer care representatives are trained to proactively resolve customer service problems. If the front-line customer care representatives are unable to do so, they escalate the issue to our national repair center team that specializes in handling more complex service issues. The efforts of our customer care function are enhanced by our state-of-the-art network operations control center, also located in Dallas. Through this center, we monitor the performance of our network at all times so that we can maintain a high level of network performance. Our customer care personnel are also skilled in working with the customer care organizations of other carriers such as the established local telephone companies. This coordination is essential to successful customer service because our customers' service issues can be caused by problems on the networks of other carriers. INFORMATION SYSTEMS AND COMPLETING CUSTOMER ORDERS Providing local voice and data services is a complex process that requires extensive coordination between the customer's old and new service providers. Our primary competitors are the incumbent local carriers, so most of our sales involve us working closely with these companies to efficiently move customers from their networks to ours. We believe that a key to success in our business is the ability to develop customized information systems and procedures that allow us to process large order volumes and provide the necessary customer service. As a result, we have devoted significant resources to this aspect of our operations. Our systems must enable us to enter, schedule, provision, and track a customer's order from the point of sale to the installation and testing of service. They must also permit us to interface with trouble management, inventory, billing, collection and customer service systems. The existing systems currently employed by most carriers, which were developed prior to the passage of the Telecommunications Act, generally require multiple entries of customer information to accomplish order management, provisioning, switch administration and billing. This process is not only labor intensive, but it creates numerous opportunities for errors in provisioning service and billing, delays in installing orders, service interruptions, poor customer service, increased customer turnover, and significant added expenses due to duplicated efforts and decreased customer satisfaction. We believe that the practical problems and costs of upgrading existing systems are often prohibitive for companies whose existing systems support a large number of customers with ongoing service. Because we do not have systems designed prior to the expanded interaction between carriers introduced by the Telecommunications Act, our team of engineering and information technology professionals is free to develop operations support and other back office systems designed to facilitate a smooth, efficient order management, provisioning, trouble management, billing and collection and customer care process. NETWORK ARCHITECTURE An important element of our strategy is to install Lucent Series 5ESS(R)-2000 digital switches, an electronic device used to connect two separate entities, and related equipment at a central location in each market. As of December 31, 2000, we had deployed 26 switches to serve 27 markets. We have also deployed new technology called "softswitches" to complement our existing network infrastructure of digital switches, which is based on a traditional circuit-switched technology. Softswitch technology allows us to use "packet switching;" we believe that packet switching will allow for greater capital efficiencies and rapid deployment of enhanced services required by our customers. Circuit switching is a reliable technology in which the entire 4 7 circuit is dedicated to the transmission of a single user's phone call and as a result, the circuit cannot be used by anyone else until the call ends. With packet switching, much more traffic can move over a line simultaneously. Our nationwide network is controlled and monitored by a state-of-the-art network operations control center located in Dallas. We also have locally based switch engineers and technicians to manage each switch and other telecommunications equipment. We lease local network facilities from established telephone companies to connect our switches to the established telephone companies' wire centers serving major areas of business concentrations in each market. Initially leasing these facilities allows us to begin operations in a new market more quickly and generally at a lower upfront cost than building these facilities; however, we may choose to purchase fiber technology such as dark fiber, as and when we experience sufficient growth in our traffic volume and customer base or as other factors make fiber technology more attractive. "Dark fiber" is a type of fiber where no light is transmitted through it while it is unused. We have already implemented this next phase by acquiring indefeasible rights to use fiber from various vendors in 25 of our markets. These fiber rings are expected to provide us with a reliable, diverse and robust connection to most of our central office locations throughout a market. IMPLEMENTATION OF SERVICES To offer services in a market, we generally must secure certification from the state regulator and typically must file tariffs or price lists for the services that we will offer. The certification process varies from state to state; however, the fundamental requirements are largely the same. State regulators require new entrants to demonstrate that they have secured adequate financial resources to establish and maintain good customer service. New entrants must also show that they possess the knowledge and ability required to establish and operate a telecommunications network. Before providing local service, a new entrant must negotiate and execute an interconnection agreement with the incumbent local carrier. While such agreements can be voluminous and may take months to negotiate, most of the key interconnection issues have now been thoroughly addressed and commissions in most states have ruled on arbitrations between the incumbent carriers and new entrants. However, interconnection rates and conditions may be subject to change as the result of future commission actions or other changes in the regulatory environment. Under a United States Supreme Court ruling, new entrants may adopt either all or portions of an interconnection agreement already entered into by the incumbent carrier and another carrier. We have selectively adopted this approach to enable us to enter markets quickly, while at the same time preserving our right to replace the adopted agreement with a customized interconnection agreement that can be negotiated once service has already been established. While such interconnection agreements include key terms and prices for interconnection, a significant joint implementation effort must be made with the incumbent carrier to establish operationally efficient and reliable traffic interchange arrangements. Such arrangements must include those between our network and the facilities of other service providers as well as public service agencies. For example, we worked closely with Southwestern Bell to devise and implement an efficient 911 call routing plan that will meet the requirements of each individual 911 service bureau in Southwestern Bell areas that we will serve using our own switches. We routinely meet with key personnel from 911 service bureaus to obtain their acceptance and to establish dates for circuit establishment and joint testing. We have entered into interconnection agreements with the incumbent carriers in each of the states in which our current geographic markets are located. REGULATION Our business is subject to federal, state and local regulation. 5 8 Federal Regulation The FCC regulates interstate and international telecommunications services, including the use of local telephone facilities to originate and terminate interstate and international calls. We provide such services on a common carrier basis. The FCC imposes certain regulations on common carriers such as the incumbent local carriers that have some degree of market power. The FCC imposes less regulation on common carriers without market power including, to date, competitive local carriers like us. The FCC requires common carriers to receive an authorization to construct and operate telecommunications facilities, and to provide or resell telecommunications services, between the United States and international points. Under the Telecommunications Act, any entity, including cable television companies and electric and gas utilities, may enter any telecommunications market, subject to reasonable state regulation of safety, quality and consumer protection. Because implementation of the Telecommunications Act is subject to numerous federal and state policy rulemaking proceedings and judicial review there is still uncertainty as to what impact such legislation will have on us. The Telecommunications Act is intended to increase competition. This Act opens the local services market by requiring incumbent local carriers to permit interconnection to their networks and establishing incumbent local carriers' obligations with respect to: Reciprocal Compensation. Requires all local exchange carriers to complete calls originated by competing local exchange carriers under reciprocal arrangements at prices based on tariffs or negotiated prices. Resale. Requires all incumbent local carriers and competitive local carriers to permit resale of their telecommunications services without unreasonable restrictions or conditions. In addition, incumbent local carriers are required to offer wholesale versions of all retail services to other telecommunications carriers for resale at discounted rates, based on the costs avoided by the incumbent local carrier in the wholesale offering. Interconnection. Requires all incumbent local carriers and competitive local carriers to permit their competitors to interconnect with their facilities. Requires all incumbent local carriers to permit interconnection at any technically feasible point within their networks, on nondiscriminatory terms, at prices based on cost, which may include a reasonable profit. At the option of the carrier seeking interconnection, collocation of the requesting carrier's equipment in the incumbent local carriers' premises must be offered, except where an incumbent local carrier can demonstrate space limitations or other technical impediments to collocation. Unbundled Access. Requires all incumbent local carriers to provide nondiscriminatory access to unbundled network elements including, network facilities, equipment, features, functions, and capabilities, at any technically feasible point within their networks, on nondiscriminatory terms, at prices based on cost, which may include a reasonable profit. Number Portability. Requires all incumbent local carriers and competitive local carriers to permit users of telecommunications services to retain existing telephone numbers without impairment of quality, reliability or convenience when switching from one telecommunications carrier to another. Dialing Parity. Requires all incumbent local carriers and competitive local carriers to provide "1+" equal access to competing providers of telephone exchange service and toll service, and to provide nondiscriminatory access to telephone numbers, operator services, directory assistance, and directory listing, with no unreasonable dialing delays. Access to Rights-of-Way. Requires all incumbent local carriers and competitive local carriers to permit competing carriers access to poles, ducts, conduits and rights-of-way at regulated prices. Incumbent local carriers are required to negotiate in good faith with carriers requesting any or all of the above arrangements. If the negotiating carriers cannot reach agreement within a prescribed time, either carrier may request binding arbitration of the disputed issues by the state regulatory commission. Where an 6 9 agreement has not been reached, incumbent local carriers remain subject to interconnection obligations established by the FCC and state telecommunication regulatory commissions. In August 1996, the FCC released a decision establishing rules implementing the incumbent local carrier interconnection obligations described above. On July 18, 1997, the United States Court of Appeals for the Eighth Circuit vacated certain portions of this decision and narrowly interpreted the FCC's power to prescribe and enforce rules implementing the Telecommunications Act. On January 25, 1999, the United States Supreme Court reversed the Eighth Circuit decision and reaffirmed the FCC's broad authority to issue rules implementing the Telecommunications Act, although it did vacate a rule determining which network elements the incumbent local carriers must provide to competitors on an unbundled basis. On November 5, 1999, the FCC issued revised rules that largely reaffirmed, and in some respects expanded, the duty of incumbent carriers to offer unbundled network elements. These rules may be subject to further court appeals, and we cannot predict the outcome of such proceedings. We, however, lease only the basic unbundled network elements from the incumbent local carrier and therefore do not expect reconsideration of the unbundling rules to have an adverse effect on our business strategy. On December 9, 1999, the FCC released an order requiring the incumbent carriers to offer "line sharing" arrangements that will permit competitors like us to offer digital subscriber line, also known as DSL service-over the same copper wires used by the incumbent to provide voice service. The specific prices and terms of these arrangements will be determined by future decisions of state utility commissions, and cannot be predicted at this time. The FCC's ruling may also be challenged in court. We expect, however, that this order, if implemented, will allow us to offer DSL services at a lower cost than is now possible. On March 17, 2000, the U.S. Court of Appeals for the District of Columbia Circuit vacated certain FCC rules relating to collocation of competitors' equipment in incumbent local carrier central offices. This decision requires the FCC to limit collocation to equipment that is "necessary" for interconnection with the incumbent local carrier or access to the incumbent local carrier's unbundled network elements. We believe that all of the equipment we currently place in collocation arrangements is necessary for these purposes, and therefore our collocation arrangements should not be adversely affected by the court decision. However, any disputes over the "necessary" status of particular items of equipment may have to be resolved by the FCC or by state commissions, and such disputes could adversely affect our collocation plans. While these court and FCC proceedings were pending, we entered into interconnection agreements with a number of incumbent local carriers through negotiations or, in some cases, adoption of another competitive local carrier's approved agreement. These agreements remain in effect, although in some cases one or both parties may be entitled to demand renegotiation of particular provisions based on intervening changes in the law. However, it is uncertain whether we will be able to obtain renewal of these agreements on favorable terms when they expire. The Telecommunications Act codifies the incumbent local carriers' equal access and nondiscrimination obligations and preempts inconsistent state regulation. The Telecommunications Act also contains special provisions that replace prior antitrust restrictions that prohibited the regional Bell operating companies from providing long distance services and engaging in telecommunications equipment manufacturing. The Telecommunications Act permits the regional Bell operating companies to enter the out-of-region long distance market immediately upon its enactment. Further, provisions of the Telecommunications Act permit a regional Bell operating company to enter the long distance market in its in-region states if it satisfies several procedural and substantive requirements, including: o obtaining FCC approval upon a showing that the regional Bell operating company has entered into interconnection agreements or, under some circumstances, has offered to enter into such agreements in those states in which it seeks long distance relief; o the interconnection agreements satisfy a 14-point "checklist" of competitive requirements; and o the FCC is satisfied that the regional Bell operating company's entry into long distance markets is in the public interest. 7 10 The FCC has granted approval to Verizon (formerly known as Bell Atlantic) to provide in-region long distance service in New York and to SBC Communications to provide in-region long distance service in Texas, Oklahoma and Kansas. In addition, Verizon has filed a petition to offer such service in Massachusetts. It is possible that other regional Bell operating companies may petition and receive approval to offer long distance services in one or more states. This may have an unfavorable effect on our business. We are legally able to offer our customers both long distance and local exchange services, which the regional Bell operating companies, other than Verizon in New York and SBC in Texas, Oklahoma and Kansas, currently may not do. Our ability to offer "one-stop shopping" gives us a marketing advantage that we would no longer enjoy. See "-- Competition." On May 8, 1997, the FCC released an order establishing a significantly expanded federal universal service subsidy regime. For example, the FCC established new subsidies for telecommunications and information services provided to qualifying schools and libraries with an annual cap of $2.25 billion and for services provided to rural health care providers with an annual cap of $400 million, and expanded the federal subsidies for local exchange telephone services provided to low-income consumers. The FCC more recently adopted rules for subsidizing service provided to consumers in high cost areas, which may result in further substantial increases in the overall cost of the subsidy program. Providers of interstate telecommunications service, such as us must pay for a portion of these programs. Our share of these federal subsidy funds will be based on our share of certain defined interstate telecommunications end user gross revenues. Currently, the FCC is assessing such payments on the basis of a provider's revenue for the previous year. Under authority granted by the FCC, we resell the international telecommunications services of other common carriers between the United States and international points. In connection with such authority, our subsidiary, Allegiance Telecom International, Inc., has filed tariffs with the FCC stating the rates, terms and conditions for our international services. On March 16, 2001, the FCC ruled that carriers must detariff international services, which will require us to cancel the tariffs we currently have on file within nine months of the effective date of the FCC's order. With respect to our domestic service offerings, certain of our subsidiaries have filed tariffs with the FCC stating the rates, terms and conditions for their interstate services. Our tariffs are generally not subject to pre- effective review by the FCC, and can be amended on one day's notice. However, the FCC does have jurisdiction to require changes in these tariffs. See "Risk Factors -- The Regulation of Access Charges Involves Uncertainties, and the Resolution of These Uncertainties Could Adversely Affect Our Business." The FCC has ordered carriers that provide interstate long distance services to detariff their retail services no later than July 31, 2001. Pursuant to this order, we will be required to cancel our FCC interstate tariffs no later than July 31, 2001. Our access services compete with the services provided by the incumbent local carriers. With limited exceptions, the current policy of the FCC for most interstate access services dictates that incumbent local carriers charge all customers the same price for the same service. Thus, the incumbent local carriers generally cannot lower prices to those customers likely to contract for their services without also lowering charges for the same service to all customers in the same geographic area, including those whose telecommunications requirements would not justify the use of such lower prices. The FCC has, however, adopted rules that significantly lessen the regulation of incumbent local carriers that are subject to competition in their service areas and provide such incumbent local carriers with additional flexibility in pricing some interstate switched and special access services on a central office specific or customer specific basis. Pricing flexibility relieves incumbent local carriers from regulatory constraints in setting rates for services that are subject to competition and as a result, allows them to react more rapidly to market forces. Incumbent local carriers around the country have been contesting whether the obligation to pay reciprocal compensation to competitive local carriers should apply to local telephone calls from an incumbent local carrier's customers to Internet service providers served by competitive local carriers. The incumbent local carriers claim that this traffic is interstate in nature and therefore should be exempt from compensation arrangements applicable to local, intrastate calls. Competitive local carriers have contended that the interconnection agreements provide no exception for local calls to Internet service providers and reciprocal compensation is therefore applicable. Currently, over 30 state commissions and several federal and state courts 8 11 have ruled that reciprocal compensation arrangements do apply to calls to Internet service providers, while seven jurisdictions have ruled to the contrary. A number of these rulings are subject to appeal. Additional disputes over the appropriate treatment of Internet service provider traffic are pending in other states. On February 26, 1999, the FCC released a Declaratory Ruling determining that Internet service provider traffic is interstate for jurisdictional purposes, but that its current rules neither require nor prohibit the payment of reciprocal compensation for such calls. In the absence of a federal rule, the FCC determined that state commissions have authority to interpret and enforce the reciprocal compensation provisions of existing interconnection agreements, and to determine the appropriate treatment of Internet service provider traffic in arbitrating new agreements. The FCC also requested comment on alternative federal rules to govern compensation for such calls in the future. In response to the FCC ruling, some regional Bell operating companies have asked state commissions to reopen previous decisions requiring the payment of reciprocal compensation on Internet service provider calls. Some Bell companies have also appealed the FCC's Declaratory Ruling to the United States Court of Appeals for the District of Columbia Circuit, which issued a decision on March 24, 2000, vacating the Ruling. The court held that the FCC had not adequately explained its conclusion that calls to Internet service providers should not be treated as "local" traffic. We view this decision as favorable, but the court's direction to the FCC to re-examine the issue will likely result in further delay in the resolution of pending compensation disputes, and there can be no assurance as to the ultimate outcome of these proceedings or as to the timing of such outcome. Internet service providers are among our target customers, and adverse decisions in state proceedings could limit our ability to service this group of customers profitably. Given the uncertainty as to whether reciprocal compensation should be payable in connection with calls to Internet service providers, we recognize such revenue only when realization of it is certain. See "Risk Factors -- We Could Lose Revenue if Calls to Internet Service Providers Are Treated As Long Distance Interstate Calls." State Regulation The Telecommunications Act is intended to increase competition in the telecommunications industry, especially in the local exchange market. With respect to local services, incumbent local carriers are required to allow interconnection to their networks and to provide unbundled access to network facilities, as well as a number of other pro-competitive measures. Because the implementation of the Telecommunications Act is subject to numerous state rulemaking proceedings on these issues, it is currently difficult to predict how quickly full competition for local services, including local dial tone, will be introduced. State regulatory agencies have regulatory jurisdiction when our facilities and services are used to provide intrastate services. A portion of our current traffic may be classified as intrastate and therefore subject to state regulation. We expect that we will offer more intrastate services, including intrastate switched services, as our business and product lines expand and state regulations are modified to allow increased local services competition. To provide intrastate services, we generally must obtain a certificate of public convenience and necessity from the state regulatory agency and comply with state requirements for telecommunications utilities, including state tariffing requirements. State agencies, like the FCC, require us to file periodic reports, pay various fees and assessments, and comply with rules governing quality of service, consumer protection, and similar issues. Although the specific requirements vary from state to state, they tend to be more detailed than the FCC's regulation because of the strong public interest in the quality of basic local exchange service. We intend to comply with all applicable state regulations, and as a general matter do not expect that these requirements of industry-wide applicability will have a material adverse effect on our business. However, no assurance can be given that the imposition of new regulatory burdens in a particular state will not affect the profitability of our services in that state. Local Regulation Our networks are subject to numerous local regulations such as building codes and licensing. Such regulations vary on a city by city and county by county basis. If we decide in the future to install our own fiber optic transmission facilities, we will need to obtain rights-of-way over private and publicly owned land. There 9 12 can be no assurance that such rights-of-way will be available to us on economically reasonable or advantageous terms. COMPETITION The telecommunications industry is highly competitive. We believe that the principal competitive factors affecting our business are pricing levels and clear pricing policies, customer service, accurate billing and, to a lesser extent, variety of services. Our ability to compete effectively depends upon our continued ability to maintain high quality, market-driven services at prices generally equal to or below those charged by our competitors. To maintain our competitive posture, we believe we must be in a position to reduce our prices in order to meet reductions in rates, if any, by others. Any such reductions could materially adversely affect us. Many of our current and potential competitors have financial, personnel and other resources, including brand name recognition, substantially greater than we do or expect to have in the near term. Competition for Local Telephone Services. In each of our targeted markets, we will compete principally with the existing incumbent carriers serving that area, such as Ameritech, BellSouth, SBC, Verizon or Qwest. We believe that one of the objectives of the regional Bell operating companies is to be able to offer long distance service in their service territories. Certain companies have already achieved this goal. Verizon has done so in New York and Southwestern Bell has done so in Texas, Oklahoma and Kansas. We believe the regional Bell operating companies expect to offset share losses in their local markets by capturing a significant percentage of the in-region long distance market, especially in the residential segment where the regional Bell operating companies' strong regional brand names and extensive advertising campaigns may be very successful. We also face competition from other current and potential market entrants, including long distance carriers such as AT&T, WorldCom and Sprint seeking to enter, reenter or expand entry into the local exchange market and from resellers of local exchange services, cable television companies, electric utilities, wireless telephone system operators and private networks built by large end users. In addition, a continuing trend toward consolidation of telecommunications companies and the formation of strategic alliances within the telecommunications industry, as well as the development of new technologies, could give rise to significant new competitors. The Telecommunications Act includes provisions that impose certain regulatory requirements on all local exchange carriers, including competitors such as us, while granting the FCC expanded authority to reduce the level of regulation applicable to any or all telecommunications carriers, including incumbent carriers. The manner in which these provisions of the Telecommunications Act are implemented and enforced could have a material adverse effect on our ability to successfully compete against other telecommunications service providers. We also compete with equipment vendors and installers, and telecommunications management companies with respect to certain portions of our business. Competition for Long Distance Services. The long distance telecommunications industry has numerous entities competing for the same customers and a high average turnover rate, as customers frequently change long distance providers in response to the offering of lower rates or promotional incentives by competitors. Prices in the long distance market have declined significantly in recent years and are expected to continue to decline. We expect to increasingly face competition from companies offering long distance data and voice services over the Internet. Such companies could enjoy a significant cost advantage because they do not currently pay carrier access charges or universal service fees. The FCC has granted approval to Verizon to provide in-region long distance service in New York and to SBC to provide such services in Texas, Oklahoma and Kansas. Competition for Data/Internet Services. The Internet services market is highly competitive and there are limited barriers to entry. We expect competition to continue to intensify. Our competitors in this market include Internet service providers, other telecommunications companies, online service providers and Internet software providers. Most of the regional Bell operating companies have begun to or have announced plans to rapidly roll out high speed data services. 10 13 Competition from International Telecommunications Providers. Under the recent World Trade Organization agreement on basic telecommunications services, the United States and 72 other members of the World Trade Organization committed themselves to opening their respective telecommunications markets and/or foreign ownership and/or to adopting regulatory measures to protect competitors against anticompetitive behavior by dominant telecommunications companies, effective in some cases as of January 1998. Although we believe that this agreement could provide us with significant opportunities to compete in markets that were not previously accessible and to provide more reliable services at lower costs than we could have provided prior to implementation of this agreement, it could also provide similar opportunities to our competitors and facilitate entry by foreign carriers into the U.S. market. There can be no assurance that the pro-competitive effects of the World Trade Organization agreement will not have a material adverse effect on our business, financial condition and results of operations or that members of the World Trade Organization will implement the terms of this agreement. EMPLOYEES As of December 31, 2000, we had 3,249 full-time employees. We believe that our future success will depend on our continued ability to attract and retain highly skilled and qualified employees. None of our employees is currently represented by a collective bargaining agreement. RISK FACTORS We Anticipate Having Future Operating Losses and Negative EBITDA as We Continue to Expand Our Business and Enter into New Markets The expansion and development of our business and the deployment of our networks, systems and services will require significant capital expenditures, a substantial portion of which will need to be incurred before the realization of sufficient revenue. We expect that we will have future operating losses and that our future adjusted EBITDA will be negative while we develop and expand our business and until we establish a sufficient revenue-generating customer base. Adjusted EBITDA represents earnings before interest, income taxes, depreciation and amortization, management allocation charges and non-cash deferred compensation. Adjusted EBITDA should not be construed as a substitute for operating income (loss) or cash flow from operations determined in accordance with generally accepted accounting principles. For the year ended December 31, 2000, we had net operating losses and net losses applicable to common stock of $277.6 million and negative adjusted EBITDA of $117.9 million. We typically do not expect to achieve positive adjusted EBITDA in any market until at least our third year of operation of that market. We can make no assurances that we will achieve or sustain profitability or generate sufficient operating income or adjusted EBITDA to meet our working capital, capital expenditure and debt service requirements, and if we are unable to do so, this would have a material adverse effect on our business, financial condition and results of operations. We Could Lose Revenue if Calls to Internet Service Providers Are Treated As Long Distance Interstate Calls We earn "reciprocal compensation" revenue by terminating on our network, local calls that originate on another carrier's network. We believe that under the Telecommunications Act other local exchange carriers should have to compensate us when their customers place calls to Internet service providers who are our customers. Most incumbent local carriers disagree. A majority of our reciprocal compensation revenues are from calls to our customers that are Internet service providers. Regulatory decisions providing that other carriers do not have to compensate us for these calls could limit our ability to service this group of customers profitably and could have a material adverse effect on us. Given the uncertainty as to whether reciprocal compensation should be payable in connection with calls to Internet service providers, we recognize such revenue only when realization of it is certain, which in most cases is upon receipt of cash. In addition, we anticipate that the per minute reciprocal compensation rate we receive from incumbent local carriers under our new interconnection agreements will be lower than it was under our previous agreements. These reductions in reciprocal compensation will have a material adverse effect on us if we are unable to offset them with other revenues. 11 14 The obligation to pay reciprocal compensation does not extend to long distance interstate calls. The FCC in its Declaratory Ruling of February 26, 1999, determined that Internet service provider traffic is interstate for jurisdictional purposes, but also determined that its current rules neither require nor prohibit the payment of reciprocal compensation for such calls. In the absence of a federal rule, the FCC determined that state commissions have authority to interpret and enforce the reciprocal compensation provisions of existing interconnection agreements and to determine the appropriate treatment of Internet service provider traffic in arbitrating new agreements. The Court of Appeals for the District of Columbia Circuit issued a decision on March 24, 2000, vacating the Declaratory Ruling. The court held that the FCC had not adequately explained its conclusion that calls to Internet service providers should not be treated as "local" traffic. We view this decision as favorable, but the court's direction to the FCC to re-examine the issue will likely result in further delay in the resolution of pending compensation disputes, and there can be no assurance as to the ultimate outcome of these proceedings or as to the timing of such outcome. Currently, over 30 state commissions and several federal and state courts have ruled that reciprocal compensation arrangements do apply to calls to Internet service providers, while seven jurisdictions have ruled to the contrary. A number of these rulings are subject to appeal. Additional disputes over the appropriate treatment of Internet service provider traffic are pending in other states and federal legislation seeking to resolve this issue has been and continues to be proposed and considered. The Regulation of Access Charges Involves Uncertainties, and the Resolution of These Uncertainties Could Adversely Affect Our Business We earn "access charge" revenue by connecting our voice service customers to their selected long distance carriers for outbound calls or by delivering inbound long distance traffic to our voice service customers. Our interstate access charges were filed largely mirroring those used by the National Exchange Carrier Association (NECA), an association of independent local exchange carriers and our state access charges were generally set the same as those of state associations similar to NECA or of individual incumbent carriers operating in other areas within the same state. These charges are generally higher than those charged by the larger carriers operating in the same areas because these large carriers have many more customers and therefore have lower per unit costs. Access charges are intended to compensate the local exchange carrier for the costs incurred in originating and terminating long distance calls on its network and we believe our access charges are appropriately set at levels approximately the same as those of the smaller carriers. Access charge levels in general, and those charged by smaller carriers in particular, are subject to various disputes and are under review by the FCC. AT&T has challenged the switched access rates of Allegiance and other carriers and has withheld some or all payments for the switched access services that they continue to receive. AT&T has asserted that they have not ordered switched access service from us and/or that our charges for switched access services are higher than those of the larger carriers serving the same territory and are therefore unjust and unreasonable. AT&T has refused to pay us any originating access charges at our tariffed rates. Given the uncertainty as to whether such amounts will ultimately be paid to Allegiance by AT&T, we recognize such access revenues only when realization of it is certain. On March 30, 2000, we filed a lawsuit against each of AT&T and Sprint in the Federal District Court of the District of Columbia requesting that such parties pay us for outstanding interstate and intrastate access charges. AT&T and Sprint filed counterclaims against us alleging that our access charges fail to comply with the Telecom Act because they are unjust and unreasonable. We have settled this dispute with Sprint and in doing so have reached an agreement with respect to access charges payable by them for originating and terminating calls on our local networks. Although we believe we will ultimately receive payment for AT&T for the amounts owed to us by them, we cannot provide any assurance as to the amount of payments that we will ultimately receive, the actual outcome of the FCC proceedings or our lawsuit or the positions various states will take on the similar issue of intrastate switched access rates. If we do not receive payment from AT&T for interstate and intrastate access charges that we believe are owed to us, this will have a material adverse effect on us unless we are able to offset this access revenue with other revenues. In addition, our switched access rates will have to be adjusted to comply with future decisions of the FCC or state commissions and these adjustments could have a material adverse effect on us. 12 15 On July 5, 1999, the FCC issued a ruling to address the issue of competitive carrier access charges in the context of a complaint filed by MGC Communications, Inc. (now known as Mpower Communications), a carrier that had not been receiving payments from AT&T. In that ruling, the FCC stated that "AT&T is liable to MGC, at MGC's tariffed rate, for the originating access service that it received . . ." The FCC indicated that AT&T had no obligation to purchase access from MGC based on the arguments that MGC had made, but the FCC also made clear that there may be other requirements that could limit AT&T's ability to not purchase such access from a competitive local carrier. In response to that FCC decision, AT&T filed a Petition for Review with the FCC, which was denied on December 28, 1999. The FCC is also reviewing the switched access rate level issue and related matters in its Access Charge Reform docket. In this docket, the FCC has requested comment as to whether long distance carriers, also known as "interexchange carriers," may refuse to purchase switched access services from particular carriers. We are an active participant in that proceeding. On May 31, 2000, the FCC approved a proposal made by a coalition of the largest incumbent local carriers, AT&T and Sprint, to restructure interstate access charges. Pursuant to the proposal, certain incumbent carriers, designated as "price cap" incumbent local carriers, are required to reduce their interstate access rates to targeted levels approved by the FCC or submit cost studies to justify different rates. We anticipate that implementation of the FCC's decision will lead to an industry wide reduction in interstate access rates, even by those carriers that are not bound by the decision, including smaller carriers. Reduction in interstate access rates will have a material adverse effect on us unless we are able to offset the access revenue with other revenues. Several states, including Colorado, Maryland, Massachusetts, Missouri, New Jersey, New York, Texas, Virginia and Washington, have proposed or required that access charges of competitive local carriers be limited to those charged by incumbent local carriers operating in the same area as the competitive local carriers with respect to calls originating or terminating in such area, except where the competitive carrier in question can establish that its costs justify a higher access rate through a formal cost proceeding. We believe that it is possible that other states will enact similar requirements. We also believe, however, that it is more likely that many states will use the same approach for intrastate long distance as the FCC ultimately decides to use for interstate long distance. Our Success Depends on Our Key Personnel and We May Not Be Able to Replace Key Executives Who Leave We are managed by a small number of key executive officers, most notably Royce J. Holland, our Chairman and Chief Executive Officer, who is widely recognized as one of the pioneers in managing providers of competitive local exchange services. The loss of services of one or more of these key individuals, particularly Mr. Holland, could materially and adversely affect our business and our prospects. Most of our executive officers do not have employment agreements, and we do not maintain key person life insurance for any of our executive officers. The competition for qualified personnel in the telecommunications industry is intense. For this reason, we cannot assure you that we will be able to hire or retain necessary personnel in the future. We Are Dependent on Effective Billing, Customer Service and Information Systems and We May Have Difficulties in Developing These Systems Sophisticated back office information and processing systems are vital to our growth and our ability to monitor costs, bill customers, initiate, implement and track customer orders and achieve operating efficiencies. We cannot assure you that these systems will be successfully implemented on a timely basis or at all or will perform as expected because: o we have and will likely continue to have difficulties in getting products and services from our vendors delivered in a timely and effective manner, at acceptable costs and at the service and performance level required; o we may fail to adequately identify all of our information and processing needs; 13 16 o our processing or information systems may fail or be inadequate; o we may not be able to effectively integrate such products or services; o we may fail to upgrade systems as necessary; and o third party vendors may cancel or fail to renew license agreements that relate to these systems. Under Certain Circumstances We May Need Additional Capital to Expand Our Business and Increase Revenue We may need additional capital to fund capital expenditures, working capital, debt service and cash flow deficits during the period in which we are expanding and developing our business and deploying our networks, services and systems. We believe that the borrowings expected to be available under our credit facilities, together with our cash on hand, will be sufficient to pre-fund our expanded business plan. However, we will only be able to borrow under these credit facilities if we are in compliance with the financial covenants and other conditions. In the event we cannot borrow under these credit facilities or if our estimates of capital requirements are inaccurate, we may need to access alternative sources of capital. If we are unable to do so we may not be able to expand as we expect, which may have an adverse effect on us. The actual amount and timing of our future capital requirements may differ materially from our estimates as a result of financial, business and other factors, many of which are beyond our control, as well as prevailing economic conditions. Our Substantial Indebtedness Could Make Us Unable to Service Indebtedness and Meet Our Other Requirements and Could Adversely Affect Our Financial Health We have a significant amount of debt outstanding and plan to access additional debt financing to fund our expanded business plan, including under our credit facilities. On December 31, 2000, we had $566.3 million of outstanding indebtedness. This level of debt could: o impair our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes; o require us to dedicate a substantial portion of our cash flow from operations to the payment of principal and interest on our indebtedness, thereby reducing the funds available for the growth of our networks; o place us at a competitive disadvantage with those of our competitors who do not have as much debt as we do; o impair our ability to adjust rapidly to changing market conditions; and o make us more vulnerable if there is a downturn in general economic conditions or in our business. We cannot assure you that we will be able to meet our working capital, capital expenditure and debt service requirements and if we are unable to do so, this could have a material adverse effect on our business, financial condition and results of operations. Limitations Imposed by Restrictive Covenants Could Limit How We Conduct Business and a Default Under Our Indentures and Financing Agreements Could Significantly Impact Our Ability to Repay Our Indebtedness Our indentures and our credit facilities contain covenants that restrict our ability to: o incur additional indebtedness; o pay dividends and make other distributions; o prepay subordinated indebtedness; 14 17 o make investments and other restricted payments; o enter into sale and leaseback transactions; o create liens; o sell assets; and o engage in certain transactions with affiliates. Our current and future financing arrangements contain and will continue to contain similar or more restrictive covenants, as well as other covenants that will require us to maintain specified financial ratios and satisfy financial tests. As a result of these restrictions, we are limited in how we conduct business and we may be unable to raise additional debt or equity financing to operate during general economic or business downturns, to compete effectively or to take advantage of new business opportunities. This may affect our ability to generate revenues and make profits. Without sufficient revenues and cash, we may not be able to pay interest and principal on our indebtedness. Our failure to comply with the covenants and restrictions contained in our indentures and other financing agreements could lead to a default under the terms of these agreements. If such a default occurs, the other parties to such agreements could declare all amounts borrowed and all amounts due under other instruments that contain provisions for cross-acceleration or cross-default due and payable. In addition, lenders under our current and future financing arrangements could terminate their commitments to lend to us. If that occurs, we cannot assure you that we would be able to make payments on our indebtedness, meet our working capital or meet our capital expenditure requirements, or that we would be able to find additional alternative financing. Even if we could obtain additional alternative financing, we cannot assure you that it would be on terms that are favorable or acceptable to us. We May Not Have the Funds Necessary to Finance the Change of Control Offer Which May Be Required By Our Financing Agreements Our indentures provide that upon a change of control, each note holder will have the right to require us to purchase all or a portion of such holder's notes. We would be required to purchase the notes at a purchase price of 101% of the accreted value of the 11 3/4% notes and 101% of the principal amount of the 12 7/8% notes, plus any accrued and unpaid interest to the date of repurchase. Our credit facilities provides that upon a change of control, we may be required to repay all of our obligations under these credit facilities. It is possible that we will not have sufficient funds at that time to repurchase our notes or repay any debt outstanding under our credit facilities. If We Do Not Interconnect with and Maintain Efficient Working Relationships with Our Primary Competitors, the Incumbent Local Carriers, Our Business Will Be Adversely Affected Many new carriers, including us, have experienced difficulties in working with the incumbent local carriers with respect to initiating, interconnecting, and implementing the systems used by these new carriers to order and receive unbundled network elements and wholesale services and locating the new carriers' equipment in the offices of the incumbent local carriers. As a new carrier, we must coordinate with incumbent local carriers so that we can provide local service to customers on a timely and competitive basis. The Telecommunications Act created incentives for regional Bell operating companies to cooperate with new carriers and permit access to their facilities by denying such companies the ability to provide in-region long distance services until they have satisfied statutory conditions designed to open their local markets to competition. The FCC recently granted approval to Verizon to provide in-region long distance service in New York and to SBC Communications to provide in-region long distance service in Texas, Oklahoma and Kansas. Other regional Bell operating companies in our markets may petition and receive approval from the FCC to offer long distance services. These companies may not be accommodating to us once they are permitted to offer long distance service. If we cannot obtain the cooperation of a regional Bell operating company in a region, whether or not it has been authorized to offer long distance service or a regional Bell operating 15 18 company otherwise fails to meet our requirements, for example, because of labor shortages, work stoppages or disruption caused by mergers or other organizational changes, our ability to offer local services in such region on a timely and cost-effective basis will be adversely affected. The Need to Move from Tariffs to Individual Contracts for Domestic Interstate and International Long Distance Services May Increase Our Costs In a decision issued April 28, 2000, the United States Court of Appeals for the District of Columbia affirmed the FCC's 1996 order that prohibits the filing of tariffs for domestic interstate long distance service. The FCC's order, which had been stayed by the Court pending its decision, goes into effect on July 31, 2001, as of which date carriers must cancel all interstate domestic long distance tariffs on file with the FCC and file no new tariffs for such service. Although the FCC will not accept interstate long distance tariffs for filing after July 31, 2001, carriers will still be required to maintain and make available to the public upon request the rates, terms and conditions applicable to their domestic long distance services. In the absence of retail tariffs, we will be required to memorialize our legal relationship with our long distance customers by some other means, such as individual contracts setting forth the rates, terms and conditions of service. Negotiating individual contracts in this manner is likely to increase our cost of providing domestic interstate long distance services. In an order issued March 16, 2001, the FCC ruled that carriers likewise are prohibited from filing tariffs for international long distance service. Within nine months of the effective date of the FCC's order, carriers will be required to cancel all international long distance tariffs on file with the FCC and file no new tariffs for such service. Our Principal Competitors for Local Services, the Incumbent Local Carriers, and Potential Additional Competitors, Have Advantages that May Adversely Affect Our Ability to Compete with Them The telecommunications industry is highly competitive. Many of our current and potential competitors in the local market have financial, technical, marketing, personnel and other resources, including brand name recognition, substantially greater than ours, as well as other competitive advantages over us. In each of the markets targeted by us, we will compete principally with the incumbent local carrier serving that area. These incumbent local carriers enjoy advantages that may adversely affect our ability to compete with them. Incumbent local carriers are established providers of local telephone services to all or virtually all telephone subscribers within their respective service areas. Incumbent local carriers also have long-standing relationships with federal and state regulatory authorities. FCC and state administrative decisions and initiatives provide the incumbent local carriers with pricing flexibility for their: o private lines, which are private, dedicated telecommunications connections between customers; o special access services, which are dedicated lines from a customer to a long distance company provided by the local phone company; and o switched access services, which refers to the call connection provided by the local phone company's switch between a customer's phone and the long distance company's switch. In addition, with respect to competitive access services, such as special access services as opposed to switched access services, the FCC recently approved incumbent local carriers increased pricing flexibility and deregulation for such access services after certain competitive levels are reached. If the incumbent local carriers are allowed by regulators to offer discounts to large customers through contract tariffs, engage in aggressive volume and term discount pricing practices for their customers, and/or seek to charge competitors excessive fees for interconnection to their networks, competitors such as us could be materially adversely affected. If future regulatory decisions afford the incumbent local carriers increased pricing flexibility or other regulatory relief, such decisions could also have a material adverse effect on competitors such as us. We also face, and expect to continue to face, competition in the local market from other current and potential market entrants, including long distance carriers seeking to enter, reenter or expand entry into the local exchange marketplace such as AT&T, WorldCom and Sprint, and from other competitive local carriers, resellers, competitive access providers, cable television companies, electric utilities, microwave carriers, 16 19 wireless telephone system operators and private networks built by large end users. In addition, the development of new technologies could give rise to significant new competitors in the local market. Significant Competition in Providing Long Distance and Internet Services Could Reduce the Demand for and Profitability of Our Services We also face significant competition in providing long distance and Internet services. Many of these competitors have greater financial, technological, marketing, personnel and other resources than those available to us. The long distance telecommunications market has numerous entities competing for the same customers and a high average turnover rate, as customers frequently change long distance providers in response to the offering of lower rates or promotional incentives. Prices in the long distance market have declined significantly in recent years and are expected to continue to decline. We face competition from large carriers such as AT&T, WorldCom and Sprint and many smaller long distance carriers. Other competitors are likely to include regional Bell operating companies providing long distance services outside of their local service area and, with the removal of regulatory barriers, long distance services within such local service areas, other competitive local carriers, microwave and satellite carriers and private networks owned by large end users. The FCC has recently granted approval to provide in-region long distance service to Verizon in New York and to SBC Communications in Texas, Oklahoma and Kansas and other regional Bell operating companies may petition and be granted such approval in the future. We may also increasingly face competition from companies offering local and long distance data and voice services over the Internet. Such companies could enjoy a significant cost advantage because they do not currently pay many of the charges or fees that we have to pay. The Internet services market is highly competitive and there are limited barriers to entry. We expect that competition will continue to intensify. Our competitors in this market include Internet service providers, other telecommunications companies, online service providers and Internet software providers. Most of the regional Bell operating companies and GTE Corporation operating units have announced plans to rapidly roll out DSL services. Some of these entities, including SBC Communications, Qwest (f/k/a US West) and Verizon, have already commenced deployment of DSL services in selected markets and may in the future deploy DSL services on a widespread basis. Our Need to Comply with Extensive Government Regulation Can Increase Our Costs and Slow Our Growth Our networks and the provision of telecommunications services are subject to significant regulation at the federal, state and local levels. Delays in receiving required regulatory approvals or the enactment of new adverse regulation or regulatory requirements may slow our growth and have a material adverse effect upon us. The FCC exercises jurisdiction over us with respect to interstate and international services. We must obtain, and have obtained through our subsidiary, Allegiance Telecom International, Inc., prior FCC authorization for installation and operation of international facilities and the provision, including by resale, of international long distance services. Additionally, we file publicly available tariffs detailing our services and pricing with the FCC for both international and domestic long-distance services. As noted above, as of July 31, 2001, we will be prohibited from filing tariffs with the FCC for domestic interstate long distance service and will be required to cancel any such tariffs on file as of that date. As of nine months from the effective date of the FCC's March 16, 2001 order detariffing international services, we will be prohibited from filing tariffs with the FCC for international long distance service and will be required to cancel any such tariffs on file as of that date. State regulatory commissions exercise jurisdiction over us because we provide intrastate services. We are required to obtain regulatory authorization and/or file tariffs at state agencies in most of the states in which we operate. If and when we seek to build our own network segments, local authorities regulate our access to municipal rights-of-way. Constructing a network is also subject to numerous local regulations such as building codes and licensing. Such regulations vary on a city by city and county by county basis. 17 20 Regulators at both the federal and state level require us to pay various fees and assessments, file periodic reports, and comply with various rules regarding the contents of our bills, protection of subscriber privacy, and similar matters on an ongoing basis. We cannot assure you that the FCC or state commissions will grant required authority or refrain from taking action against us if we are found to have provided services without obtaining the necessary authorizations, or to have violated other requirements of their rules and orders. Regulators or others could challenge our compliance with applicable rules and orders. Such challenges could cause us to incur substantial legal and administrative expenses. Deregulation of the Telecommunications Industry Involves Uncertainties, and the Resolution of These Uncertainties Could Adversely Affect Our Business The Telecommunications Act provides for a significant deregulation of the domestic telecommunications industry, including the local exchange, long distance and cable television industries. The Telecommunications Act remains subject to judicial review and additional FCC rulemaking, and thus it is difficult to predict what effect the legislation will have on us and our operations. There are currently many regulatory actions underway and being contemplated by federal and state authorities regarding interconnection pricing and other issues that could result in significant changes to the business conditions in the telecommunications industry. We cannot assure you that these changes will not have a material adverse effect upon us. The Regulation of Interconnection with Incumbent Local Carriers Involves Uncertainties, and the Resolution of These Uncertainties Could Adversely Affect Our Business Although the incumbent local carriers are required under the Telecommunications Act to unbundle and make available elements of their network and permit us to purchase only the origination and termination services that we need, thereby decreasing our operating expenses, such unbundling may not be done as quickly as we require and may be priced higher than we expect. This is important because we rely on the facilities of these other carriers to connect to our high capacity digital switches so that we can provide services to our customers. Our ability to obtain these interconnection agreements on favorable terms, and the time and expense involved in negotiating them, can be adversely affected by legal developments. A recent Supreme Court decision vacated a FCC rule determining which network elements the incumbent local carriers must provide to competitors on an unbundled basis. On November 5, 1999, the FCC released an order revising its unbundled network element rules to conform to the Supreme Court's interpretation of the law, and reaffirmed the availability of the basic network elements, such as local loops, the connection from a customer's location to the established telephone company, and dedicated transport, used by us. It is likely that this order may be subject to further agency reconsideration and/or court review. While these court and FCC proceedings were pending, we entered into interconnection agreements with a number of incumbent local carriers through negotiations or, in some cases, adoption of another competitive local carrier's approved agreement. These agreements remain in effect, although in some cases one or both parties may be entitled to demand renegotiation of particular provisions based on intervening changes in the law. However, it is uncertain whether any of these agreements will be so renegotiated or whether we will be able to obtain renewal of these agreements on as favorable terms when they expire. On July 19, 2000, in a decision on remand from the Supreme Court, the United States Court of Appeals for the Eighth Circuit vacated certain of the FCC's total element long run incremental (TELRIC) pricing rules. While sustaining the FCC's use of a forward-looking incremental cost methodology to set rates for interconnection and unbundled network elements, the Court rejected the FCC's conclusion that the costs should be based on the use of the most efficient technology currently available and the lowest cost network configuration. Instead, the Court stated that the statute required that costs be based on the use of the incumbent local carrier's existing facilities and actual network equipment but that these costs should not be based on the historic costs actually paid by such carrier for network elements. The Court also found that the FCC erred in using avoidable, rather than actually avoided, costs to calculate the wholesale discount for resale products. Interconnection and unbundled network element rates set using the Court's methodology may be 18 21 higher than and the wholesale discounts set using the Court's methodology may be lower than the comparable rates established using the FCC's methodology. The Supreme Court has agreed to review the Eighth Circuit's decision and the Eighth Circuit in turn has stayed issuance of the mandate vacating the TELRIC rules pending the Supreme Court's decision. It is difficult to evaluate the potential impact of this ruling on the prices we pay incumbent local carriers for unbundled network elements until the Supreme Court rules. We believe that the pricing of unbundled network elements approved by many state commissions and reflected in many of our interconnection agreements is already materially in compliance with the standard set forth in the Eighth Circuit's ruling. This ruling could have a material adverse effect on us, however, if it is interpreted to authorize materially higher charges for unbundled network elements than those prevailing in our current interconnection agreements. Future Sales of Our Stock by Existing Stockholders May Adversely Affect Our Stock Price As of March 26, 2001, we had 112,923,174 million shares of common stock outstanding. Many of these shares are "restricted securities" under the federal securities laws, and such shares are or will be eligible for sale subject to restrictions as to timing, manner, volume, notice and the availability of current public information regarding us. Sales of substantial amounts of stock in the public market, or the perception that sales could occur, could depress the prevailing market price for our stock. Sales may also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we deem appropriate. Our Forward-Looking Statements May Materially Differ from Actual Events or Results This annual report on Form 10-K contains "forward-looking statements," within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and we intend that such forward-looking statements be subject to the safe harbors created by this law. You generally can identify these statements by our use of forward-looking words such as "plans," "estimates," "believes," "expects," "may," "will," "should" or "anticipates" or the negative or other variations of such terms or comparable terminology, or by discussion of strategy that involve risks and uncertainties. We often use these types of statements when discussing our plans and strategies, our anticipation of revenues from designated markets, and statements regarding the development of our businesses, the markets for our services and products, our anticipated capital expenditures, operations support systems or changes in regulatory requirements and other statements contained in this report regarding matters that are not historical facts. We caution you that these forward-looking statements are only predictions and estimates regarding future events and circumstances. We cannot assure you that we will achieve the future results reflected in these statements. The risks we face that could cause us not to achieve these results include, but are not limited to, our ability to do the following in a timely manner, at reasonable costs and on satisfactory terms and conditions: o successfully market our services to current and new customers; o interconnect with and develop cooperative working relationships with incumbent local carriers; o develop efficient operations support systems and other back office systems; o successfully and efficiently transfer new customers to our networks and access new geographic markets; o identify, finance, complete and integrate suitable acquisitions; o borrow under our credit facilities or borrow under alternative financing sources; o install new switching facilities and other network equipment; o electronically interface with incumbent local carriers; and o obtain leased fiber optic line capacity, rights-of-way, building access rights and any required governmental authorizations, franchises and permits. 19 22 Regulatory, legislative and judicial developments could also cause actual results to differ materially from the future results reflected in such forward-looking statements. You should consider all of our subsequent written and oral forward-looking statements only in light of such cautionary statements. You should not place undue reliance on these forward-looking statements and you should understand that they represent management's view only as of the dates we make them. ITEM 2. PROPERTIES We own or lease, in our operating territories, telecommunications property which includes: o owning switches and other telecommunications equipment; o leasing high capacity digital lines that interconnect our network with incumbent local carrier networks; o leasing high capacity digital lines that connect our switching equipment to our transmission equipment located in incumbent local carrier central offices; o leasing local loop lines which connect our customers to our network; and o leasing space in incumbent local carrier central offices for collocating our transmission equipment. We are headquartered in Dallas, Texas and lease offices and space in a number of locations, primarily for sales offices and network equipment installations. We believe that our leased facilities are adequate to meet our current needs in our operational markets, and that additional facilities are available to meet our development and expansion needs in existing and projected target markets for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS We are not party to any legal proceeding that we believe would, individually or in the aggregate, have a material adverse effect on our financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We did not submit any matter to a vote of our stockholders during the fourth quarter of 2000. 20 23 PART II ITEM 5. MARKET FOR ALLEGIANCE TELECOM'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION Our common stock is listed on the Nasdaq National Market. Our ticker symbol is "ALGX." We completed the initial public offering of our common stock in July 1998. Prior to July 1, 1998, no established public trading market for the common stock existed. The following table sets forth on a per share basis, the high and low sale prices per share for our common stock as reported on the Nasdaq National Market for the periods indicated:
HIGH LOW -------- -------- Year ended December 31, 1999: First quarter............................................. $ 20.67 $ 7.71 Second quarter............................................ 39.00 16.92 Third quarter............................................. 43.50 26.67 Fourth quarter............................................ 61.75 35.04 Year ended December 31, 2000: First quarter............................................. 110.08 60.67 Second quarter............................................ 80.250 45.000 Third quarter............................................. 77.875 32.750 Fourth quarter............................................ 41.500 12.8125
The prices above have been restated to reflect our 3-for-2 stock split, in the form of a 50% stock dividend, effected on February 28, 2000. STOCKHOLDERS There were 224 owners of record of Allegiance common stock as of March 26, 2001. This number excludes stockholders whose stock is held in nominee or street name by brokers and we believe that we have a significantly larger number of beneficial holders of common stock. A recent reported closing price of our common stock on the Nasdaq National Market is set forth on the front cover of this report. DIVIDENDS We do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will be dependent upon then existing conditions, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects, and other factors our board of directors deems relevant. In addition, our current financing arrangements effectively prohibit us from paying cash dividends for the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES On May 17, 2000, we acquired CONNECTnet Internet Network Services through a subsidiary merger, and a portion of the consideration for CONNECTnet was 167,080 shares of our common stock. The shares issued in this transaction are subject to transfer restrictions imposed by the securities laws which are noted on the stock certificates. This transaction was exempt from registration under the Securities Act pursuant to Regulation D of the Securities Act. On June 30, 2000, we acquired InterAccess Co. through a subsidiary merger, and a portion of the consideration for InterAccess was 301,934 shares of our common stock. The shares issued in this transaction are subject to transfer restrictions imposed by the securities laws which are noted on the stock certificates. This transaction was exempt from registration under the Securities Act pursuant to Regulation D of the Securities Act. 21 24 On October 25, 2000, we acquired the assets of CTSnet, a division of Datel Systems Incorporated, and a portion of the consideration for these assets was 463,970 shares of our common stock. The shares issued in this transaction are subject to transfer restrictions imposed by the securities laws which are noted on the stock certificates. This transaction was exempt from registration under the Securities Act pursuant to Regulation D of the Securities Act. On November 30, 2000, we acquired Jump.Net, Inc. through a subsidiary merger, and a portion of the consideration for Jump.Net was 498,456 shares of our common stock. The shares issued in this transaction are subject to transfer restrictions imposed by the securities laws which are noted on the stock certificates. This transaction was exempt from registration under the Securities Act pursuant to Regulation D of the Securities Act. ITEM 6. SELECTED FINANCIAL DATA Selected Financial Data (dollars in thousands, except share and per share information) The selected consolidated financial data presented below as of and for the years ended December 31, 2000, 1999 and 1998, and for the period from inception (April 22, 1997) through December 31, 1997, were derived from our audited consolidated financial statements and should be read in conjunction with "Management's Discussion & Analysis of Financial Condition & Results of Operations" and audited financial statements and the notes thereto contained elsewhere in this report.
As of December 31, Balance Sheet Data: 2000 1999 1998 1997 ------------ ------------ ------------ ------------ Cash and cash equivalents $ 396,103 $ 502,234 $ 262,502 $ 5,726 Short-term investments 261,856 23,783 143,390 -- Short-term investments, restricted(1) 12,952 25,518 25,543 -- Working capital(2) 618,255 484,458 367,492 2,046 Property and equipment, net of accumulated depreciation 744,903 377,413 144,860 23,900 Long-term investments, restricted(1) 829 13,232 36,699 -- Total assets 1,668,839 1,033,875 637,874 30,047 Long-term debt 566,312 514,432 471,652 -- Redeemable cumulative convertible preferred stock -- -- -- 33,409 Redeemable warrants -- -- 8,634 -- Stockholders' equity (deficit) 958,485 443,616 110,430 (7,292) ------------ ------------ ------------ ------------
Period From Inception (April 22, 1997) Year Ended Year Ended Year Ended Through December 31, December 31, December 31, December 31, Statement of Operations Data: 2000 1999 1998 1997 ------------- ------------- ------------- --------------- Revenues $ 285,227 $ 99,061 $ 9,786 $ -- Network expenses 150,718 62,542 9,529 151 Selling, general and administrative expenses 252,368 140,745 46,089 3,426 Depreciation and amortization expense 130,826 55,822 9,003 13 Management ownership allocation charge 6,480 18,789 167,312 -- Noncash deferred compensation expense 10,127 7,851 5,307 210 ------------- ------------- ------------- --------------- Loss from operations (265,292) (186,688) (227,454) (3,800) Interest income 56,969 31,354 19,918 112 Interest expense (69,244) (59,404) (38,952) -- ------------- ------------- ------------- --------------- Net loss (277,567) (214,738) (246,488) (3,688) Accretion of redeemable preferred stock and warrant values -- (130) (11,972) (3,814) ------------- ------------- ------------- --------------- Net loss applicable to common stock $ (277,567) $ (214,868) $ (258,460) $ (7,502) ============= ============= ============= ============= Net loss per share, basic and diluted(3) $ (2.58) $ (2.37) $ (7.02) $ (11,740.22) ============= ============= ============= ============= Weighted average number of shares outstanding, basic and diluted(3) 107,773,112 90,725,712 36,825,519 639 ============= ============= ============= ============= Other Financial Data: Adjusted EBITDA(4) $ (117,859) $ (104,226) $ (45,832) $ (3,577) Net cash used in operating activities (102,552) (111,483) (20,697) (1,943) Net cash used in investing activities (716,708) (152,217) (315,743) (21,926) Net cash provided by financing activities 713,129 503,432 593,216 29,595 Capital expenditures (445,183) (263,985) (113,539) (21,926) Gross margin(5) 47.2% 36.9% 2.6% -- ============= ============= ============= =============
(1) Reflects the purchase of U.S. government securities which have been placed in a pledge account to fund the first three years' interest payments on the 12 7/8% senior notes due 2008. The first semiannual installment was paid in November 1998. The securities are stated at their accreted value, which approximates fair value, and are classified as either short-term or long-term based upon their respective maturity dates. (2) Working capital was calculated as total current assets, less restricted short-term investments, less total current liabilities. (3) All periods presented reflect a three-for-two stock split effected on February 28, 2000. (4) Adjusted EBITDA consists of earnings before interest, income taxes, depreciation and amortization, management ownership allocation charge and non-cash deferred compensation. While not a measure under generally accepted accounting principles, adjusted EBITDA is a measure commonly used in the telecommunications industry and is presented to assist in understanding the Company's operating results. Adjusted EBITDA should not be construed as a substitute for operating income (loss) or cash flow from operations determined in accordance with generally accepted accounting principles. The calculation of adjusted EBITDA does not include our cash outlays for capital expenditures and debt service and should not be deemed to represent funds available to us. See "Management's Discussion & Analysis of Financial Condition & Results of Operations" for a discussion of our financial operations and liquidity as determined in accordance with generally accepted accounting principles. (5) Gross margin was calculated as revenues less network expenses, divided by revenues. See "Management's Discussion & Analysis of Financial Condition & Results of Operations" for a discussion of the components included in revenues and network expenses. 22 25 ITEM 7. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS OVERVIEW Allegiance Telecom, Inc. is a leading competitive provider of telecommunications services to small- to medium-sized businesses in major metropolitan areas across the United States. We offer an integrated set of telecommunications services including local, long distance, data and a full suite of Internet services. Our principal competitors are incumbent local exchange carriers, such as the regional Bell operating companies, as well as other integrated communications providers. Our business plan covers 36 of the largest metropolitan areas in the United States. Our network rollout has proceeded on schedule, with 27 markets operational as of December 31, 2000, consisting of Atlanta, Baltimore, Boston, Chicago, Cleveland, Dallas, Denver, Detroit, Fort Worth, Houston, Long Island, Los Angeles, Miami, Minneapolis/St. Paul, New York, Northern New Jersey, Oakland, Orange County, Philadelphia, Phoenix, St. Louis, San Diego, San Francisco, San Jose, Seattle, Tampa and Washington, D.C. In addition, San Antonio became operational on March 6, 2001. We are on track to add the eight remaining markets by the end of 2001. We believe we have successfully raised the projected capital required to build our networks and operate in each of these markets to the point at which projected operating cash flow from the market is sufficient to fund its projected operating costs and capital expenditures. We were formed in 1997 by a management team of industry veterans to take advantage of the opportunity for facilities-based local communications competition created by the Telecommunications Act of 1996. Since we formed our company, we have focused on building a reliable nationwide network based on proven technologies, a strong nationwide direct sales force and efficient information processing systems to support our operations. We believe that by doing so we have positioned ourselves to compete effectively with the incumbent carriers, most of whom do not address our customers with direct sales efforts and are burdened by legacy operations support systems. We use multiple technologies and a mixture of leased and owned facilities at the edge of the communications network so that we can most effectively serve our customer base where it is physically located. We install state-of-the-art voice and data aggregation and switching equipment in the central offices or "hubs" of the existing local incumbent carrier's networks. These central offices connect directly to customers through the "local loop," which consists of the existing copper wire and fiber running from the central offices to each customer location. The local loop is owned by the incumbent carriers but can be leased by competitive carriers under the terms of the Telecommunications Act of 1996. Our local loop presence provides us with a flexible platform for delivering traditional voice and data access services to our end-user customers. We connect our central office locations to our main switching center in each market by either leasing additional network elements from the incumbent carriers and other providers on a short-term basis or by using dedicated fiber on a long-term basis. We have increasingly focused on dedicated fiber because of the growth of our customer base and traffic volume and the increased availability of this fiber throughout the major metropolitan areas in the United States. As we have developed our local networks to service end-user customers, we have also attempted to capitalize on our expertise and investment in the edge of the network by maximizing the use of our network assets. In building a nationwide network to serve end-user customers, we have fixed costs in many assets that are underutilized during those times of day when our small- to medium-sized business customers are not placing or receiving as many voice and data calls. We have taken advantage of this underutilization by providing network solutions to other service providers, primarily the leading national providers. These national network providers also have end-user customers but do not have the facilities and expertise to directly access 23 26 these customers through the local loop. Many of these providers focus on the residential Internet access market. The traffic patterns in that market generally complement those of our end-user business customers, making this business an incremental revenue opportunity that leverages our fixed network costs. The other way we try to serve our customers and leverage our focus on the small- to medium-sized business end users is by providing innovative applications of existing technologies. An example is our Integrated Access Service which delivers high-speed, "always on" Internet access and allows multiple voice, data and Internet combinations over a single access line. In addition, we have developed electronic commerce products designed to help these customers market their products and services online, improve communication and collaboration and increase productivity. While these types of products and solutions are readily available to larger business customers that can afford to devote the resources necessary to develop and customize them internally, we believe that smaller business customers are demanding easy to use electronic commerce solutions that allow them, with minimal design and development costs, to market products online and increase their own productivity. We and many financial analysts evaluate the growth of our business by focusing on various operational data in addition to financial data. Within each of our metropolitan markets, we have located our equipment in the central offices of the established telephone companies. This practice is commonly referred to as a colocation. The number of colocations that we have indicates the number of different local geographic areas that we can serve within each of our markets. Once we are colocated in a central office, we can then begin offering service to all of the customers that have local loop connections to that central office. "Lines sold" by us represents the number of lines for which customers have placed orders with us to provide services. "Lines installed" represents the lines sold that are now being used by us to provide our services. Although the number of lines we service for each customer varies significantly, our primary focus is on the small- to medium-sized business customer. Over 90% of our customers have 20 lines or less. We plan to continue to focus on the small- to medium-sized business customer and expect that the number of lines per customer will remain at 20 or less for the vast majority of our customers. The number of customers set forth below represents that number of customers for whom we have installed lines. The table below provides these and other selected key operational data for the years ended, each on a cumulative basis:
As of December 31, 2000 1999 1998 ------------ ------------ ----------- Markets served 27 19 9 Number of switches deployed 26 15 7 Central office colocations 636 327 101 Lines sold 843,400 337,500 86,500 Lines installed 607,700 241,700 47,700 Customers 101,600 19,800 3,800 Sales force employees 1,333 707 295 Total employees 3,249 1,784 649 ------------ ------------ -----------
RESULTS OF OPERATIONS Year ended December 31, 2000 compared with year ended December 31, 1999 For the years ended December 31, 2000 and 1999, we generated revenues of approximately $285.2 million and $99.1 million, respectively. The increase in revenue is attributable to an increase in number of customers and the number of lines installed. For the years ended December 31, 2000 and 1999, we sold 505,900 lines and 251,000 lines, and installed 366,000 lines and 194,000 lines, respectively. The services we provide over our own switches generate higher margins than services provided by other carriers that are resold by us. Over 90% of our installed lines were provided over our own switches, representing approximately 92% of our revenues as of December 31, 2000, and we expect this level of facilities-based service to remain constant over time. Gross margin has increased from approximately 37% for the year ended December 31, 1999 to approximately 47% for the year ended December 31, 2000. Gross margin is calculated as revenues less network expenses, divided by revenues. We expect our gross margins to continue to improve as our revenues increase and as we realize cost efficiencies in our network expenses. 24 27 Local voice service revenues for the years ended December 31, 2000 and 1999 were $208.8 million and $90.2 million, respectively. Local voice service revenues as a percent of total revenues has decreased from approximately 91% for the year ended December 31, 1999 to approximately 73% for the year ended December 31, 2000. Local voice service revenues consisted of: o the monthly recurring charge for basic local voice service; o usage-based charges for local and toll calls in certain markets; o charges for services such as call waiting and call forwarding; o certain non-recurring charges, such as set-up charges for additional lines for an existing customer; and o interconnection revenues from switched access charges to long distance carriers and reciprocal compensation charges to other local carriers. Components of our local voice service revenues are subject to various federal and state regulations and to disputes and uncertainties and we expect local voice service revenues to continue to decrease as a percent of total revenues, as a result of the resolution of certain of these regulatory disputes and uncertainties. Specifically we expect and have modified our business plans to anticipate a decrease in switched access revenues and reciprocal compensation revenues. See the discussion under "Risk Factors," which contains a detailed discussion of the risks and uncertainties associated with our local voice revenues. Long distance service revenues for the years ended December 31, 2000 and 1999 were $11.2 million and $2.9 million, respectively. Long distance service revenues as a percent of total revenues has increased from approximately 3% for the year ended December 31, 1999 to approximately 4% for the year ended December 31, 2000. We reduced our pricing of long distance services during 2000 to respond to competitive pressures and we anticipate long distance pricing to continue at historically low levels given the current competitive environment. Although these reduced prices decrease our margins, we anticipate that more of our local service customers will purchase long distance service from us at our current pricing levels and through our continuing effort to promote the benefits of purchasing local, long distance and data services from a single provider. Data revenues, including revenues generated from Internet access, Web hosting and high-speed data services, for the years ended December 31, 2000 and 1999 were $65.2 million and $6.0 million, respectively. Data revenues as a percent of total revenues has increased from approximately 6% for the year ended December 31, 1999 to approximately 23% for the year ended December 31, 2000. We expect data revenues to continue to increase as a percent of total revenues (a) as we expand our data services offerings to existing local and long distance voice customers, (b) as we increase our offerings of packaged services that combine voice and data services which we market as the Allegiance Telecom Total Communications Options and (c) as more small and medium-sized businesses turn to the Internet to enhance their productivity. We also believe that the continuing evolution of communications networks will promote the integration of voice and data services over the same facilities, thereby further increasing the availability of data offerings. During 2000, we signed a long-term contract to provide data services to Genuity Solutions, Inc., a network services provider and operator of a nationwide Internet network. This contract establishes Genuity as our largest customer. Total revenues from Genuity for the year ended December 31, 2000 were $22.3 million. We have had discussions, and will continue to have discussions in the foreseeable future, concerning potential acquisitions of Internet service providers, Web hosting and data services providers, and other providers of telecommunications and Internet services. During the year ended December 31, 2000, we completed the acquisitions of CONNECTnet Internet Network Services, InterAccess Co., CTSnet and Jump.Net, Inc., regional Internet service providers, and of Virtualis Systems, Inc., an Internet-based, Web-hosting applications specialist. We have utilized the purchase method of accounting for all of these acquisitions. Accordingly, we have recognized the revenues earned since the closing of each of these acquisitions in our condensed consolidated statement of operations for the period ended December 31, 2000. For the years ended December 31, 2000 and 1999, network expenses were $150.7 million and $62.5 million, respectively. The increase in network expenses is consistent with the deployment of our networks and initiation and growth of our services during 2000. Network expenses included: o the cost of leasing local loop lines which connect our customers to our network; o the cost of leasing high-capacity digital lines that interconnect our network with the networks of the incumbent local exchange carriers; o the cost of leasing high-capacity digital lines that connect our switching equipment to our transmission equipment located in the central offices of the incumbent local exchange carrier; o the cost of expanding our network to additional colocation sites within a market; o the cost of completing local and long distance calls originated by our customers; o the cost of leasing space in incumbent local exchange carrier central offices for colocating our transmission equipment; and o the cost of leasing our nationwide Internet network. 25 28 The costs to lease local loop lines and high-capacity digital lines from the incumbent local exchange carriers vary by carrier and are regulated by state authorities under the Telecommunications Act of 1996. We believe that in many instances there are multiple carriers in addition to the incumbent local exchange carriers from whom we can lease high-capacity lines, and that we can generally lease those lines at lower prices than are charged by the incumbent local exchange carriers. We expect that the costs associated with these leases will increase with customer volume and will be a significant part of our ongoing cost of services. When we open new markets, we incur significant general and administrative expenses and network expenses before we begin to generate revenue from operations. Many of the network expenses, such as for transport facilities and colocation rent and power charges, are fixed costs that we do not recover until we build up a sufficient volume of traffic from customers. Consequently, as we continue to open new markets throughout 2001, we will continue to generate operating losses and do not expect to generate positive cash flow from operations until some time in 2002. In constructing switching and transmission equipment for a new market, we capitalize as a component of property and equipment only the non-recurring charges associated with our initial network facilities and the monthly recurring costs of those network facilities until the switching equipment begins to carry revenue-producing traffic. Typically, the recurring charges for one to three months are capitalized. We generally expense the monthly recurring costs resulting from the growth of existing colocation sites, and the costs related to expansion of the network to additional colocation sites in operational markets as we incur these charges. We incur "reciprocal compensation" costs in providing both voice and data services and expect reciprocal compensation costs to be a major portion of our cost of services. We must enter into an interconnection agreement with the incumbent local exchange carrier in each market to make widespread calling available to our customers. These agreements typically set the cost per minute to be charged by each party for the calls that are exchanged between the two carriers' networks. Generally, a carrier must compensate another carrier when a local call by the first carrier's customer terminates on the other carrier's network. These reciprocal compensation costs will grow as our customers' outbound calling volume grows. The cost of securing long distance service capacity is a variable cost that increases in direct relationship to increases in our customer base and increases in long distance calling volumes. We believe that these costs, measured as a percentage of long distance revenues, will be relatively consistent from period to period. However, we do expect period-over-period growth in the absolute cost of such capacity, and that the cost of long distance capacity will be a significant portion of our cost of long distance services. We install voice and data aggregation and switching equipment in the central offices of local incumbent exchange carriers' networks. We incur rent and utility charges in leasing this space. These costs will increase as we expand to additional colocation sites and increase the capacity of our existing colocations. We have developed a national Internet data network by connecting our markets with leased high-capacity digital lines. The costs of these lines will increase as we increase capacity to address customer demand, open new markets and connect additional markets to our Internet network. Selling, general and administrative expenses increased to $252.4 million for the year ended December 31, 2000 from $140.7 million for the year ended December 31, 1999, primarily due to the growth of our business. Selling, general and administrative expenses include salaries and related personnel costs, administration and facilities costs, sales and marketing costs, customer care and billing costs, and professional fees. The number of employees increased to 3,249 as of December 31, 2000, from 1,784 as of December 31, 1999. As of December 31, 2000, the sales force, including sales managers and sales administrators, had grown to 1,333 from 707 as of December 31, 1999. As we continue to grow in terms of number of markets, customers and employees, we expect that ongoing selling, general and administrative expenses will increase. 26 29 We amortized $6.5 million and $18.8 million of the deferred management ownership allocation charge, a non-cash charge to income, for the years ended December 31, 2000 and 1999, respectively. Our original private equity fund investors and original management team investors owned 95.0% and 5.0%, respectively, of the ownership interests of Allegiance Telecom, LLC, an entity that owned substantially all of our outstanding capital stock prior to our initial public offering of common stock. As a result of that offering, the assets of Allegiance Telecom, LLC, which consisted almost entirely of such capital stock, were distributed to the original fund investors and management investors in accordance with the Allegiance Telecom, LLC limited liability company agreement. This agreement provided that the equity allocation between the fund investors and management investors would be 66.7% and 33.3%, respectively, based upon the valuation implied by the initial public offering. We recorded the increase in the assets of Allegiance Telecom, LLC allocated to the management investors as a $193.5 million increase in additional paid-in capital. This transaction was recorded during the third quarter of 1998. Of this charge, we recorded $122.5 million as a non-cash, non-recurring charge to operating expense and $71.0 million as a deferred management ownership allocation charge. We will further amortize this deferred charge at $0.2 million during 2001. This period is the time frame over which we have the right to repurchase a portion of the securities, at the lower of fair market value or the price paid by the employee, in the event the management employee's employment with Allegiance is terminated. During 2000, we repurchased 289,527 shares from terminated management employees, and reversed the remaining deferred charge of $0.1 million related to these shares to additional paid-in capital. During 1999, we repurchased 37,968 shares from terminated management employees, and reversed the remaining deferred charge of $0.6 million related to these shares to additional paid-in capital. For the years ended December 31, 2000 and 1999, we recognized $10.1 million and $7.8 million, respectively, of amortization of deferred compensation expense. Such deferred compensation was recorded in connection with membership units of Allegiance Telecom, LLC sold to certain management employees and options granted to certain employees under our 1997 stock option plan and 1998 stock incentive plan. During the years ended December 31, 2000 and 1999, depreciation expense was $104.2 million and $49.1 million, respectively. Such increase was consistent with the deployment of our networks and initiation of services in 27 markets by December 31, 2000. In connection with the acquisitions completed during 2000 and 1999, we assigned an aggregate of $28.2 million of the purchase price to customer lists and workforces. We also recorded an aggregate of $128.2 million of goodwill. Each of these intangible assets is being amortized over their estimated useful lives of three years. For the years ending December 31, 2000 and 1999, we recorded $22.3 million and $5.7 million of amortization for goodwill and $4.4 million and $1.0 million of amortization of customer lists and workforces, respectively. Our purchase price allocation for the acquisitions made in 2000 is subject to post acquisition due diligence of the acquired entities and may be adjusted as additional information is obtained. For the years ended December 31, 2000 and 1999, interest expense was $69.2 million and $59.4 million, respectively. Interest expense reflects the accretion of the 11 3/4% notes and related amortization of the original issue discount, and the amortization of the original issue discount on the 12 7/8% notes. Interest expense in 2000 also includes amortization of deferred debt issuance costs related to our new $500 million senior secured credit facilities. Unamortized deferred debt issuance costs of $5.9 million related to the $225 million revolving credit facility were charged to interest expense during first quarter 2000, upon termination of the $225 million revolving credit facility and completion of the $500 million senior secured credit facilities. The amount of interest capitalized for the years ended December 31, 2000 and 1999 was $14.4 million and $6.0 million, respectively. Interest income for years ended December 31, 2000 and 1999 was $57.0 million and $31.4 million, respectively. Interest income results from the investment of short-term investments, cash and cash equivalents and from U.S. government securities, which we purchased and placed in a pledge account to secure the semiannual payments of interest through May 2001 on the 12 7/8% notes. Interest income during 2000 is greater than for the comparable periods in 1999 because we had additional cash invested in interest-bearing instruments as a result of our February 2000 equity offering. 27 30 From February 1998 through March 1999, we recorded accretion of our redeemable warrants to reflect the possibility that they would be redeemed at fair market value in February 2008. Amounts were accreted using the effective interest method and management's estimate of the future fair market value of such warrants at the time redemption is permitted. Amounts accreted increased the recorded value of such warrants on the balance sheet and resulted in non-cash charges to increase the net loss applicable to common stock. As the terms and conditions of the warrant agreement do not specify a date certain for redemption of the warrants and the exchange of warrants for cash is no longer beyond the control of management, we ceased accretion of the warrants and reclassified the accreted value of the redeemable warrants at April 1, 1999 to the stockholders' equity section. If a repurchase event occurs in the future or becomes probable, we will adjust the warrants to the estimated redemption value at that time. Our net loss for the year ended December 2000, after amortization of the non-cash management ownership allocation charge and amortization of deferred compensation, was $277.6 million. Our net loss for the year ended December 31, 1999, after amortization of the non-cash management ownership allocation charge and amortization of deferred compensation but before the accretion of warrant values, was $214.7 million. After deducting accretion of redeemable warrant values, the net loss applicable to common stock was $214.9 million for the year ended December 31, 1999. Many securities analysts use the measure of earnings before deducting interest, taxes, depreciation and amortization, also commonly referred to as "EBITDA" as a way of measuring the performance of a company. EBITDA is not derived pursuant to generally accepted accounting principles, and therefore should not be construed as an alternative to operating income (loss), as an alternative to cash flows from operating activities, or as a measure of liquidity. We had adjusted EBITDA losses of $117.9 million and $104.2 million for years ended December 31, 2000 and 1999, respectively. In calculating adjusted EBITDA, we also exclude the non-cash charges to operations for the management ownership allocation charge and deferred compensation expense totaling $16.6 million and $26.6 million for the years ended December 31, 2000 and 1999, respectively. We expect to continue to experience operating losses and negative adjusted EBITDA as a result of our development and market expansion activities. We typically do not expect to achieve positive adjusted EBITDA in any market until at least its third year of operation. Year ended December 31, 1999 compared with year ended December 31, 1998 For the years ended December 31, 1999 and 1998, we generated revenues of $99.1 million and $9.8 million, respectively. The increase in revenue is attributable to an increase in number of customers and the number of lines installed. For the years ended December 31, 1999 and 1998, we sold 251,000 lines and 86,500 lines, and installed 194,000 lines and 47,700 lines, respectively. Facilities-based lines represented 86% of all lines installed and 90% of revenues at December 31, 1999 as compared to 64% of lines installed and 48% of revenues at December 31, 1998. Gross margin increased from approximately 3% for the year ended December 31, 1998 to approximately 37% for the year ended December 31, 1999. Gross margin is calculated as revenues less network expenses, divided by revenues. Local voice service revenues for the years ended December 31, 1999 and 1998 were $90.2 million and $9.2 million, respectively. Local voice service revenues as a percent of total revenues decreased from approximately 93% for the year ended December 31, 1998 to approximately 91% for the year ended December 31, 1999. Long distance service revenues for the years ended December 31, 1999 and 1998 were $2.9 million and $0.7 million, respectively. Long distance service revenues as a percent of total revenues decreased from approximately 7% for the year ended December 31, 1998 to approximately 3% for the year ended December 31, 1999. Data revenues, including revenues generated from Internet access, Web hosting and high-speed data services, for the year ended December 31, 1999 were $6.0 million, representing approximately 6% of our total revenues. Such data revenues were not material in the year ended December 31, 1998. During the year ended December 31, 1999, we completed the acquisitions of the common stock of Kivex, Inc. and ConnectNet, Inc. and the acquisition of certain assets of ConnecTen, L.L.C. We have recognized the revenues earned since the closing of each of these acquisitions in our condensed consolidated statement of operations for the period ended December 31, 1999. For the years ended December 31, 1999 and 1998, network expenses were $62.5 million and $9.5 million, respectively. The increase in network expenses is consistent with the deployment of our networks and initiation and growth of our services during 1999 and 1998. 28 31 Selling, general and administrative expenses increased to $140.7 million for the year ended December 31, 1999 from $46.1 million for the year ended December 31, 1998, primarily due to the growth of our business. Selling, general and administrative expenses include salaries and related personnel costs, administration and facilities costs, sales and marketing costs, customer care and billing costs, and professional fees. The number of employees increased to 1,784 as of December 31, 1999, from 649 as of December 31, 1998. As of December 31, 1999, the sales force, including sales managers and sales administrators, had grown to 707 from 295 as of December 31, 1998. We amortized $18.8 million and $167.3 million of the deferred management ownership allocation charge, a non-cash charge to income, for the years ended December 31, 1999 and 1998, respectively. During 1999, we repurchased 37,968 shares from terminated management employees, and reversed the remaining deferred charge of $0.6 million related to these shares to additional paid-in capital. For the years ended December 31, 1999 and 1998, we recognized $7.8 million and $5.3 million, respectively, of amortization of deferred compensation expense. Such deferred compensation was recorded in connection with membership units of Allegiance Telecom, LLC sold to certain management employees and options granted to certain employees under our 1997 stock option plan and 1998 stock incentive plan. During the years ended December 31, 1999 and 1998, depreciation expense was $49.1 million and $9.0 million, respectively. Such increase was consistent with the deployment of our networks and initiation of services in 19 markets by December 31, 1999. In connection with the acquisitions completed during 1999, we assigned an aggregate of $5.7 million of the purchase price to customer lists and workforces. We also recorded an aggregate of $34.2 million of goodwill. Each of these intangible assets is being amortized over their estimated useful lives of three years, beginning at their respective date of acquisition. For the year ending December 31, 1999, we recorded $5.7 million of amortization for goodwill and $1.0 million of amortization of customer lists and workforces, respectively. For the years ended December 31, 1999 and 1998, interest expense was $59.4 million and $39.0 million, respectively. Interest expense reflects the accretion of the 11 3/4% notes and related amortization of the original issue discount, and the amortization of the original issue discount on the 12 7/8% notes. The 12 7/8% notes were issued on July 7, 1998. The amount of interest capitalized for the years ended December 31, 1999 and 1998 was $6.0 million and $2.8 million, respectively. Interest income for years ended December 31, 1999 and 1998 was $31.4 million and $19.9 million, respectively. Interest income results from the investment of short-term investments, cash and cash equivalents and from U.S. government securities, which we purchased and placed in a pledge account to secure the semiannual payments of interest through May 2001 on the 12 7/8% notes. Interest income during 1999 is greater than for the comparable periods in 1998 because we had additional cash invested in interest-bearing instruments primarily as a result of our April 1999 equity offering. Our net loss for the year ended December 1999, after amortization of the non-cash management ownership allocation charge and amortization of deferred compensation but before the accretion of warrant values, was $214.7 million. Our net loss for the year ended December 31, 1998, after amortization of the non-cash management ownership allocation charge and amortization of deferred compensation but before the accretion of the redeemable convertible preferred stock and warrant values, was $246.5 million. After deducting accretion of redeemable warrant values, the net loss applicable to common stock was $214.9 million for the year ended December 31, 1999. After deducting accretion of redeemable convertible preferred stock and warrant values, the net loss applicable to common stock was $258.5 million for the year ended December 31, 1998. We had adjusted EBITDA losses of $104.2 million and $45.8 million for years ended December 31, 1999 and 1998, respectively. In calculating adjusted EBITDA, we also exclude the non-cash charges to operations for the management ownership allocation charge and deferred compensation expense totaling $26.6 million and $172.6 million for the years ended December 31, 1999 and 1998, respectively. 29 32 LIQUIDITY AND CAPITAL RESOURCES Our financing plan is predicated on the prefunding of each market's expansion to positive free cash flow. By using this approach, we avoid being in the position of seeking additional capital to fund a market after we have already made a significant capital investment in that market. We believe that by raising all required capital prior to making any commitments in a market, we can raise capital on more favorable terms and conditions. On January 3, 2000, we announced a significant expansion of our business plan to include a total of 36 target markets and which: o included an increase in our colocation footprint by approximately 100 central offices in our initial 24 target markets; and o provided for the acquisition of dark fiber capacity in an additional 16 of our target markets as well as connecting the Boston--New York--Washington, D.C. corridor. We do not begin to develop a new market until we have raised the capital that we project to be necessary to build and operate our network in the market to the point at which operating cash flow from the market is sufficient to fund its ongoing operating costs and capital expenditures. We believe that all of our 36 target markets are now fully funded in this manner. We also believe that our existing cash on hand, together with cash from our committed $500 million of senior secured credit facilities, are sufficient to fully fund our operations, planned capital investments and debt service requirements until such time as we have positive cash flow from operations on a consolidated basis to fund these items. We may decide to seek additional capital in the future to expand our business. Sources of additional financing may include vendor financing, bank financing and/or the private or public sale of our equity or debt securities. We cannot assure you, however, that such financing will be available at all or on terms acceptable to us, or that our estimate of additional funds required is accurate. The actual amount and timing of future capital requirements may differ materially from our estimates as a result of, among other things: o the cost of the development of our networks in each of our markets; o a change in or inaccuracy of our development plans or projections that leads to an alteration in the schedule or targets of our roll-out plan; o the extent of price and service competition for telecommunications services in our markets; o the demand for our services; o regulatory and technological developments, including additional market developments and new opportunities in our industry; o an inability to borrow under our new credit facilities; and o the consummation of acquisitions. Our cost of rolling out our networks and operating our business, as well as our revenues, will depend on a variety of factors, including: o our ability to meet our roll-out schedules; o our ability to negotiate favorable prices for purchases of equipment; o our ability to develop, acquire and integrate the necessary operations support systems and other back office systems; o the number of customers and the services for which they subscribe; o the nature and penetration of new services that we may offer; and o the impact of changes in technology and telecommunication regulations. As such, actual costs and revenues may vary from expected amounts, possibly to a material degree, and such variations are likely to affect our future capital requirements. 30 33 For the years ended December 31, 2000 and 1999, we made capital expenditures of $445.2 million and $264.0 million, respectively. We also used capital during these periods to fund our operations. As of December 31, 2000, we had transmission equipment colocated in 636 central offices. In April 2000, we executed a procurement agreement with Lucent Technologies, Inc. for a broad range of advanced telecommunications equipment, software and services. This agreement contains a three-year $350 million purchase commitment. We must complete purchases totaling $80 million by December 31, 2000, an aggregate of $180 million of purchases by December 31, 2001, and the full $350 million of aggregate purchases on or before December 31, 2002. If we do not meet the required intermediate purchase milestones, we will be required to provide cash settlement in an amount equal to the shortfall. Such payments may be applied to future purchases during the commitment period. If we do not purchase $350 million of products and services from Lucent and its affiliates by December 31, 2002, we will be required to provide cash settlement in an amount equal to the shortfall. As of December 31, 2000, we have completed purchases totaling approximately $103.4 million, and we expect to be able to meet the required purchase milestones for the remainder of the purchase agreement. Pursuant to our expanded business plan, we expect to incur approximately $350 million of capital expenditures in 2001, which includes the Lucent capital expenditure requirement for 2001. We have purchased dedicated fiber rings in 24 of our markets. As of December 31, 2000, we had three dedicated fiber rings in operation, one each in New York, Dallas and Houston. The cost of these rings includes both the amounts we pay to the fiber ring provider as well as the cost of the electronic equipment that we purchase and install on the rings to make them operational. Our total costs to date have been $40.5 million, and our budget to complete the fiber rings for which we have commitments is approximately $253.1 million. We plan to fund this cost with our available cash. As of December 31, 2000, we had approximately $658.0 million of unrestricted cash and short-term investments. In addition, $13.0 million of restricted U.S. government securities have been placed in a pledge account to fund interest payments on our 12 7/8% notes through May 2001. On February 28, 2000, a three-for-two stock split of our common stock was effected in the form of a 50% dividend to shareholders of record on February 18, 2000. All references to the number of common shares and per share amounts have been restated to reflect the stock split for the periods presented. On February 3, 1998, we raised gross proceeds of approximately $250.5 million in an offering of 445,000 units, each unit consisting of one 11 3/4% senior discount note and one redeemable warrant. Net proceeds of approximately $240.7 million were received from that offering. The 11 3/4% notes have a principal amount at maturity of $445.0 million and an effective interest rate of 12.21%. The 11 3/4% notes mature on February 15, 2008. From and after February 15, 2003, interest on such notes will be payable semiannually in cash at the rate of 11 3/4% per annum. The accretion of original issue discount will cause an increase in indebtedness from December 31, 2000 to February 15, 2003 of $102.2 million. We completed the initial public offering of our common stock and the offering of the 12 7/8% senior discount notes early in the third quarter of 1998. We raised net proceeds of approximately $137.8 million from our initial public offering of common stock and approximately $124.8 million from the offering of these notes. The 12 7/8% notes mature on May 15, 2008. Interest on these notes is payable in cash semiannually, commencing November 15, 1998. The 12 7/8% notes were sold at less than par, resulting in an effective rate of 13.24%, and the value of the 12 7/8% notes is being accreted, using the effective interest method, from the $200.9 million gross proceeds realized at the time of the sale to the aggregate value at maturity, $205.0 million, over the period ending May 15, 2008. The accretion of original issue discount will cause an increase in indebtedness from December 31, 2000 to May 15, 2008 of $3.5 million. In connection with the sale of the 12 7/8% notes, we purchased U.S. government securities for approximately $69.0 million and placed them in a pledge account to fund interest payments for the first three years the 12 7/8% notes are outstanding. The first interest payment was made in November 1998. 31 34 Such U.S. government securities are reflected in the balance sheet as of December 31, 2000, at an accreted value of approximately $13.0 million, which is classified as a current asset. On April 20, 1999, we completed the public offering of 17,739,000 shares of our common stock at a price of $25.33 per share, raising gross proceeds of $449.4 million. After underwriters' fees and other expenses, we realized net proceeds of approximately $430.3 million. On April 28, 1999, the underwriters of this offering exercised an option to purchase an additional 3,302,100 shares of common stock at the same price per share. As a result, we raised an additional $83.6 million of gross proceeds and $80.3 million of net proceeds, at that time. On February 2, 2000, we completed the public offering of 9,900,000 shares of our common stock at a price of $70.00 per share, raising gross proceeds of $693.0 million. After underwriters' fees and other expenses, we realized net proceeds of approximately $665.6 million. On February 29, 2000, the underwriters of this offering exercised an option to purchase an additional 803,109 shares of common stock at the same price per share. As a result, we raised an additional $56.2 million of gross proceeds and $54.1 million of net proceeds. In February 2000, we closed on $500.0 million of new senior secured credit facilities, which replaced the $225 million revolving credit facility. These new senior secured credit facilities consist of a $350.0 million revolving credit facility and a $150.0 million delayed draw term loan facility. These credit facilities are available, subject to satisfaction of certain terms and conditions, to provide purchase money financing for network build-out, including the cost to develop, acquire and integrate the necessary operations support and back office systems, as well as for additional dark fiber purchases and central office colocations. Interest on amounts drawn is variable, based on leverage ratios, and is expected to be the London Interbank Offered Rate + 3.25%. The initial commitment fee on the unused portion of these credit facilities will be 1.5% per annum, paid quarterly and will be reduced based upon usage. These credit facilities contain certain representations, warranties, covenants and events of default customary for credit of this nature and otherwise agreed upon by the parties. 32 35 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our investment policy is limited by our existing bond indentures. We are restricted to investing in financial instruments with a maturity of one year or less. The indentures require investments in high quality instruments, such as obligations of the U.S. government or any agency thereof guaranteed by the United States of America, money market deposits and commercial paper with a rating of A1/P1. We are thus exposed to market risk related to changes in short-term U.S. interest rates. We manage these risks by closely monitoring market rates and the duration of our investments. We do not enter into financial or commodity investments for speculation or trading purposes and are not a party to any financial or commodity derivatives. Interest income earned on our investment portfolio is affected by changes in short-term interest rates. We believe that we are not exposed to significant changes in fair value because of our conservative investment strategy. However, the estimated interest income for 2001, based on the estimated average 2000 earned rate on investments, is $29.0 million. Assuming a 100-basis-point drop in the estimated average rate, we would be exposed to a $4.6 million reduction in interest income for the year. The following table illustrates this impact on a quarterly basis: (dollars in millions)
QUARTER ENDING MARCH 2001 JUNE 2001 SEPTEMBER 2001 DECEMBER 2001 TOTAL ----------- ----------- -------------- ------------- ----------- Estimated average investments $ 609.4 $ 494.2 $ 401.5 $ 336.7 N/A Estimated average interest earned at the average rate of 6.3% for the year ended December 31, 2000 $ 9.6 $ 7.8 $ 6.3 $ 5.3 $ 29.0 Estimated impact of interest rate drop $ 1.5 $ 1.2 $ 1.0 $ 0.9 $ 4.6 ----------- ----------- ----------- ----------- -----------
Our outstanding long-term debt consists principally of long-term, fixed rate notes, not subject to interest rate fluctuations. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item 8 is included in pages F-1 through F-19 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 33 36 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF ALLEGIANCE TELECOM WHO ARE ALLEGIANCE TELECOM'S DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES? The following sets forth certain information regarding Allegiance Telecom's Board of Directors, executive officers and other key employees, as of March 12, 2001.
NAME AGE POSITION(S) ---- --- ----------- Royce J. Holland.................. 52 Chairman of the Board and Chief Executive Officer C. Daniel Yost.................... 52 President, Chief Operating Officer and Director Thomas M. Lord.................... 44 Executive Vice President of Corporate Development, Chief Financial Officer and Director Anthony J. Parella................ 41 Executive Vice President and Director Dana A. Crowne.................... 40 Senior Vice President and Chief Technology Officer Bill Francis...................... 63 Senior Vice President of Network Engineering and Operations Stephen N. Holland................ 49 Senior Vice President of Internal Audit and Corporate Quality Assurance Tae Kim........................... 37 Senior Vice President of Business Development Christopher M. Malinowski......... 38 Senior Vice President of Strategic Sales G. Clay Myers..................... 41 Senior Vice President of Finance and Accounting J. Timothy Naramore............... 38 Senior Vice President and Chief Information Officer Mark B. Tresnowski................ 41 Senior Vice President, General Counsel and Secretary Mark M. Washburn.................. 38 Senior Vice President of Web Hosting James E. Crawford, III............ 55 Director John B. Ehrenkranz................ 35 Director Paul J. Finnegan.................. 47 Director Richard D. Frisbie................ 51 Director Howard I. Hoffen.................. 37 Director Reed E. Hundt..................... 53 Director James N. Perry, Jr................ 40 Director
--------------- Royce J. Holland, Allegiance's Chairman of the Board and Chief Executive Officer since August 1997, has more than 25 years of experience in the telecommunications, independent power and engineering/ construction industries. Prior to founding Allegiance in April 1997, Mr. Holland was one of several co-founders of MFS Communications, Inc. ("MFS Communications") where he served as President and Chief Operating Officer from April 1990 until September 1996 and as Vice Chairman from September 1996 to February 1997. In January 1993, Mr. Holland was appointed by President George Bush to the 34 37 National Security Telecommunications Advisory Committee. Mr. Holland served as the Chairman of the Association for Local Telecommunications Services, the industry trade organization for the competitive local telephone sector from December 1998 to January 2000. Mr. Holland was appointed by Texas Governor George W. Bush to the Texas (Electronic) E-Government Task Force in 1999 and subsequently served as a member of the Bush/Cheney presidential transition team in 2000-2001. Mr. Holland also presently serves on the board of directors of CSG Systems, a publicly traded billing services company, Choice One Communications Inc., a publicly traded competitive local exchange carrier that may compete with Allegiance, CompleTel Europe, N.V., a publicly traded European facilities-based competitive local exchange carrier and MetaSolv Software, Inc., a publicly traded telecommunications software provider. Mr. Holland's brother, Stephen N. Holland, is employed as Allegiance's Senior Vice President of Internal Audit and Corporate Quality Assurance. C. Daniel Yost, who joined Allegiance as President and Chief Operating Officer in February 1998, was elected to Allegiance's Board of Directors in March 1998. Mr. Yost has more than 26 years of experience in the telecommunications industry. From July 1997 until he joined Allegiance, Mr. Yost was the President and Chief Operating Officer for U.S. Operations of Netcom On-Line Communications Services, Inc., a leading Internet service provider. Mr. Yost served as the President, Southwest Region of AT&T Wireless Services, Inc. from June 1994 to July 1997. Prior to that, from July 1991 to June 1994, Mr. Yost was the President, Southwest Region of McCaw Cellular Communications/LIN Broadcasting. Mr. Yost also presently serves on the board of directors of ADC Telecommunications Inc., a publicly traded telecommunications equipment and services company, Ace Cash Express Inc., a publicly traded provider of retail financial services and DSET Corporation, a publicly traded software licensing and services company for telecommunications services. Thomas M. Lord, a co-founder and Director of Allegiance and its Executive Vice President of Corporate Development and Chief Financial Officer since August 1997, is responsible for overseeing Allegiance's mergers and acquisitions, corporate finance and investor relations functions. Mr. Lord is an 18-year veteran in investment banking, securities research and portfolio management, including serving as a Managing Director of Bear, Stearns & Co. Inc. from January 1986 to December 1996. In the five-year period ending December 1996, Mr. Lord oversaw 43 different transactions valued in excess of $6.2 billion for the telecommunications, information services and technology industries. Anthony J. Parella, Allegiance's Executive Vice President since July 2000, joined Allegiance as Regional Vice President -- Central Division in August 1997, was promoted to National Vice President of Field Sales in August 1998 and later became our Senior Vice President of Field Sales and Customer Care in October 1999. Mr. Parella became a member of Allegiance's Board of Directors in December 1999. Mr. Parella has more than 10 years of experience in the telecommunications industry. Prior to joining Allegiance, Mr. Parella was Vice President and General Manager for MFS Intelenet, Inc., an operating unit of MFS Communications, from February 1994 to January 1997, where he was responsible for the company's sales and operations in Texas. Mr. Parella also served as Director of Commercial Sales for Sprint Corporation from 1991 to January 1994. Dana A. Crowne, Allegiance's Senior Vice President and Chief Technology Officer since March 1999, joined Allegiance in August 1997 as Senior Vice President and Chief Engineer. Prior to joining Allegiance, Mr. Crowne held various management positions at MFS Communications from the time of its founding in 1988, where his responsibilities included providing engineering support and overseeing budgets for the construction of MFS Communications' networks. Mr. Crowne ultimately became Vice President, Network Optimization for MFS Communications from January 1996 to May 1997 and managed the company's network expenses and planning and its domestic engineering functions. Prior to joining MFS Communications, Mr. Crowne designed and installed fiber optic transmission systems for Morrison-Knudsen and served as a consultant on the construction of private telecommunications networks with JW Reed and Associates. Bill Francis, Allegiance's Senior Vice President of Network Engineering and Operations since January 2001, joined Allegiance as Vice President Network Implementation in April 1998. Mr. Francis brings over 35 38 30 years of telecommunications experience to his new responsibility for the network engineering and operations at Allegiance. Prior to joining Allegiance, Mr. Francis served as Director of Network Provisioning at AT&T Wireless, responsible for all network provisioning, from January 1992 to April 1998. Prior to that, Mr. Francis held a variety of technical and leadership positions with Southwestern Bell from 1969 to 1992. Stephen N. Holland, Allegiance's Senior Vice President of Internal Audit and Corporate Quality Assurance since September 2000, joined Allegiance in September 1997 as Senior Vice President and Chief Information Officer. Prior to that time, Mr. Holland held several senior level positions involving management of or consulting on information systems, accounting, taxation and finance. Mr. Holland's experience includes serving as Practice Manager and Information Technology Consultant for Oracle Corporation from June 1995 to September 1997, as Chief Financial Officer of Petrosurance Casualty Co. from September 1992 to June 1995, as Manager of Business Development for Electronic Data Systems, and as a partner of Price Waterhouse. Mr. Holland's brother, Royce J. Holland, presently serves as Allegiance's Chairman of the Board and Chief Executive Officer. Tae Kim, Allegiance's Senior Vice President of Business Development since November 2000, joined Allegiance as Vice President of Planning and Analysis in 1997. Previously, Mr. Kim was with MFS Communications where he was Vice President of Network Optimization from 1996 to 1997 and Director of Market Development from 1993 to 1995. Prior to that, he worked in corporate strategy for Ameritech, Inc. in the cellular and personal communications services arenas. Christopher M. Malinowski, Allegiance's Senior Vice President of Strategic Sales since November 2000, joined Allegiance in February 1998 as Vice President of National Accounts. Mr. Malinowski brings 14 years of sales and marketing expertise in the telecommunications field and is responsible for Allegiance large account sales including, wholesale, enterprise and government. Mr. Malinowski has been operating in the competitive local telecommunications arena for the past 11 years. Prior to coming to Allegiance, he was with MFS Communications from 1990 to 1998 where he held a variety of positions including, Account Executive, Sales Manager, City Director, City Vice President and Vice President, General Manager of the Southern Region. G. Clay Myers joined Allegiance as Senior Vice President of Finance and Accounting in December 1999. Prior to joining Allegiance, Mr. Myers was the Vice President, Finance, Chief Financial Officer and Treasurer of PageMart Wireless, Inc. Prior to PageMart, Mr. Myers was Senior Operations Manager for Dell Computer Corporation from 1991 to 1993 and was with Ernst & Young, LLP from 1982 to 1991. Mr. Myers is a certified public accountant. J. Timothy Naramore, Allegiance's Senior Vice President and Chief Information Officer since July 2000, joined Allegiance as Director of Web Enablement in June 1998 and later became Vice President of Information Systems in September 1999. Mr. Naramore brings over 18 years of information systems development experience to his role and is currently responsible for developing, implementing and supporting the internal back office systems at Allegiance. Prior to joining Allegiance, Mr. Naramore served as Director of Engineering at Netcom On-Line Communications Services, Inc. overseeing the development of their web hosting operation, from May 1997 to June 1998. Prior to that, Mr. Naramore held a variety of technical and leadership positions in the information systems group at Frito-Lay, Inc. from 1988 to 1997. Mark B. Tresnowski became Allegiance's Senior Vice President and General Counsel in February 1999. Mr. Tresnowski has been Allegiance's Secretary since September 1997. Mr. Tresnowski practiced law at Kirkland & Ellis for 13 years and was a partner of that firm from October 1992 to January 1999. In private practice, Mr. Tresnowski specialized in private and public financings, mergers and acquisitions and securities law. Mark M. Washburn joined Allegiance as Senior Vice President of Web Hosting in March 2001 after Allegiance purchased the Web hosting assets of HarvardNet, Inc. Mr. Washburn was the President and Chief Executive Officer of HarvardNet from January 1999 through March 2001, its Chief Operating 36 39 Officer from October 1998 through January 1999 and a member of HarvardNet's board of directors since October 1998. Mr. Washburn was previously Vice President of Sales, Central Region, for Level 3 Communications from April 1998 to October 1998. Prior to Level 3, he served as the Vice President of Sales and Marketing for XCOM Technologies, a venture-backed, facilities-based data competitive local exchange carrier focused on the Internet service provider marketplace from June 1997 until April 1998. Mr. Washburn served from February 1989 to June 1997 with MFS Communications in sales and general management positions, most recently as its New England area Vice President. James E. Crawford, III, who was elected to Allegiance's Board of Directors in August 1997, is a Managing Member of Frontenac Company, a Chicago-based private equity investing firm, where he specializes in investing in companies in the telecommunications and technology industries. Mr. Crawford also presently serves on the board of directors of Focal Communications Corporation, a publicly traded competitive local exchange carrier that competes with Allegiance in certain markets, Optika Incorporated, a publicly traded imaging software document company and Action Point, Inc., a publicly traded document imaging software company. John B. Ehrenkranz, who was elected to Allegiance's Board of Directors in March 1998, is a Managing Director of Morgan Stanley & Co. Incorporated where he has been employed since 1987. Mr. Ehrenkranz also presently serves on the board of directors of Choice One Communications Inc., a publicly traded competitive local exchange carrier that may compete with Allegiance. Mr. Ehrenkranz is also a Managing Director of Morgan Stanley Dean Witter Capital Partners. Paul J. Finnegan, who was elected to Allegiance's Board of Directors in August 1997, is a Managing Director of Madison Dearborn Partners, Inc., a Chicago-based private equity investing firm, where he specializes in investing in companies in the telecommunications industry. Mr. Finnegan also presently serves on the board of directors of CompleTel Europe, N.V., a publicly traded European facilities-based competitive local exchange carrier and Rural Cellular Corporation, a publicly traded rural cellular telephone operator. Richard D. Frisbie, who was elected to Allegiance's Board of Directors in August 1997, is a Managing Member of Battery Partners IV, LLC which is the general partner of Battery Ventures IV, and a Managing Member of Battery Partners V, LLC which is the general partner of Battery Ventures V, a Boston-based private equity investing firm, where he specializes in investing in companies in the telecommunications industry. Howard I. Hoffen was appointed to Allegiance's Board of Directors in February 2001. Mr. Hoffen is Chairman and Chief Executive Officer of Morgan Stanley Dean Witter Private Equity. Mr. Hoffen joined Morgan Stanley & Co. Incorporated in 1985 and Morgan Stanley Dean Witter Private Equity in 1986. He has been a Managing Director of Morgan Stanley & Co. Incorporated since 1997. Mr. Hoffen also presently serves on the board of directors of Catalytica Energy Systems Inc., a publicly traded company. Reed E. Hundt was elected to Allegiance's Board of Directors in March 1998. Mr. Hundt served as Chairman of the Federal Communications Commission from 1993 to 1997. He currently serves as Chairman of The Forum on Communications and Society at The Aspen Institute, is a senior advisor on information industries to McKinsey & Company, a worldwide management consulting firm and a special advisor to Madison Dearborn Partners, Inc., a Chicago-based private equity investing firm. Mr. Hundt is a venture partner at Benchmark Capital, a venture capital firm and a principal of Charles Ross Partners, LLC, a consulting firm. Mr. Hundt also presently serves on the board of directors of Novell, Inc., a publicly traded network software company. Prior to joining the FCC, Mr. Hundt was a partner at Latham & Watkins, an international law firm. James N. Perry, Jr., who was elected to Allegiance's Board of Directors in August 1997, is a Managing Director of Madison Dearborn Partners, Inc., a Chicago-based private equity investing firm, where he specializes in investing in companies in the telecommunications industry. Mr. Perry also presently serves on the board of directors of Focal Communications Corporation, a publicly traded competitive local exchange carrier that competes with Allegiance in certain markets, VoiceStream Wireless Corp., a publicly 37 40 traded provider of personal communications services and CompleTel Europe, N.V., a publicly traded European facilities-based competitive local exchange carrier. Our Chief Executive Officer, President and Chief Financial Officer are elected annually by the Board of Directors at its first meeting held after each annual meeting of stockholders or as soon thereafter as convenient. ABOUT THE BOARD OF DIRECTORS AND ITS COMMITTEES. Board Our by-laws provide that the number of Directors shall be determined by resolution of our Board of Directors. The Board currently consists of 11 Directors. Our by-laws provide that our Directors will be elected by plurality vote of our stockholders, without cumulative voting. No Director may be removed from office without cause and without the vote of the holders of a majority of the outstanding voting stock. The Board of Directors is divided into three classes, as nearly equal in number as possible, with each Director serving a three-year term and one class being elected at each year's annual meeting of stockholders. Messrs. Hoffen, Holland, Hundt and Perry are Class III Directors whose terms expire at the 2001 annual meeting of our stockholders. Messrs. Crawford, Ehrenkranz, Finnegan and Parella are Class I Directors whose terms expire at the 2002 annual meeting of our stockholders. Messrs. Frisbie, Lord and Yost are Class II Directors whose terms expire at the 2003 annual meeting of our stockholders. At each annual meeting of our stockholders, successors to the class of Directors whose term expires at such meeting will be elected to serve for three-year terms and until their successors are elected and qualified. Board Committees Our Board of Directors currently has three committees: - Executive Committee - Audit Committee - Compensation Committee The Executive Committee is currently comprised of Messrs. Crawford, Hoffen, Holland and Perry. The Audit Committee is currently comprised of Messrs. Ehrenkranz, Finnegan and Hundt. The Compensation Committee is currently comprised of Messrs. Crawford, Frisbie, Hoffen and Perry. Compensation of Directors We reimburse the members of our Board of Directors for their reasonable out-of-pocket expenses incurred in connection with attending Board or committee meetings. Additionally, we are contractually obligated to maintain our present level of directors' and officers' insurance. Members of our Board of Directors generally receive no other compensation for services provided as a Director or as a member of any Board committee. However, in March 1998, prior to Reed E. Hundt joining the Board of Directors, we issued to Mr. Hundt, options to purchase 75,934 shares of common stock and 75,934 shares of common stock to Charles Ross Partners, LLC, of which Mr. Hundt is a member. The options were issued with an exercise price of $1.6467 per share. All of such options are currently vested. On December 8, 1999, Reed E. Hundt was granted options to purchase 37,500 shares of Allegiance common stock, at an exercise price of $50.00 per share. 33.33% of such options vested on December 8, 2000, and an additional 8.33% of such options will vest every three months after that date, until December 8, 2002, when all such options become exercisable. On November 30, 2000, Reed E. Hundt was granted options to purchase 37,500 shares of Allegiance common stock, at an exercise price of $14.0156 per share. On the grant date, 33.33% of these options are vested and an additional 8.33% will vest every three months after that date, until November 30, 2002, when all such options become exercisable. All of the option share numbers and the option exercise prices in this report have been adjusted to reflect our 3-for-2 stock split, in the form of a 50% stock dividend, of our common stock effected February 28, 2000. 38 41 SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE. Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our Directors, executive officers and persons who own more than 10% of our common stock, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other equity securities of Allegiance. Such persons are also required by SEC regulations to furnish Allegiance with copies of all Section 16(a) reports they file. Based on written representations received from such persons, Allegiance believes that each of its executive officers, Directors and greater than 10% owners complied with all Section 16(a) filing requirements applicable to them during 2000. 39 42 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE. The following table sets forth certain summary information for the years ended December 31, 2000, 1999 and 1998, concerning the compensation paid and awarded to (a) Allegiance's Chief Executive Officer and (b) the four other executive officers who, based on salary and bonus compensation from Allegiance, were the most highly compensated officers of Allegiance for the year ended December 31, 2000 (such five executive officers, the "Named Executive Officers").
LONG TERM COMPENSATION ------------ ANNUAL COMPENSATION SECURITIES -------------------- UNDERLYING NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) --------------------------- ---- --------- -------- ------------ Royce J. Holland.................................... 2000 $250,000 (1) 21,404 Chairman of the Board and 1999 $225,100 $150,000 -- Chief Executive Officer 1998 $206,928 $150,000 -- C. Daniel Yost...................................... 2000 $250,000 (1) 21,404 President and Chief 1999 $225,000 $150,000 -- Operating Officer 1998 $194,742 $100,000 -- Thomas M. Lord...................................... 2000 $225,000 (1) 21,404 Executive Vice President of 1999 $200,000 $150,000 -- Corporate Development and 1998 $179,850 $150,000 -- Chief Financial Officer Anthony J. Parella.................................. 2000 $185,600 (1) 1,207,135 Executive Vice President 1999 $150,803 $ 80,000 300,000 1998 $133,691 $ 60,000 Mark B. Tresnowski.................................. 2000 $215,000 (1) 805,703 Senior Vice President, 1999 $184,616 $ 80,000 495,000 General Counsel and Secretary 1998 -- -- --
--------------- (1) The absence of cash bonuses for the Named Executive Officers was taken into account in determining year end stock option grants for such officers. See also discussion below regarding outperform stock option grants. 40 43 OPTION GRANTS IN LAST FISCAL YEAR. The following table sets forth information concerning the award of stock options to the Named Executive Officers during fiscal 2000.
EXERCISE PERCENT OF PRICE/ POTENTIAL REALIZABLE VALUE AT NUMBER OF TOTAL MARKET ASSUMED ANNUAL RATES OF STOCK SECURITIES OPTIONS PRICE PER PRICE APPRECIATION FOR OPTION UNDERLYING GRANTED TO SHARE AT TERM(4) OPTIONS EMPLOYEES IN GRANT EXPIRATION ------------------------------ NAME GRANTED(#) FISCAL YEAR DATE DATE 5%($) 10%($) ---- ------------- ------------ --------- ---------- ------------- -------------- Royce J. Holland........ 21,404(1) 0.13% $14.0156 3/31/2003 (5) (5) C. Daniel Yost.......... 21,404(1) 0.13% $14.0156 3/31/2003 (5) (5) Thomas M. Lord.......... 21,404(1) 0.13% $14.0156 3/31/2003 (5) (5) Anthony J. Parella(2)... 300,000 1.82% $50.1250 8/2/2006 $5,114,189 $11,602,349 600,000 3.64% $14.0156 11/30/2006 $2,859,987 $ 6,488,335 7,135 0.04% $14.0156 3/31/2003 (5) (5) Mark B. Tresnowski(3)... 150,000 0.91% $61.5000 1/1/2006 $3,137,383 $ 7,117,651 150,000 0.91% $14.0156 11/30/2006 $ 714,997 $ 1,622,084 10,703 0.06% $14.0156 3/31/2003 (5) (5)
--------------- (1) Each of Royce Holland, Dan Yost and Tom Lord was granted 21,404 outperform stock options on November 30, 2000. 25% of these options vest on each of February 28, 2001, May 31, 2001, August 31, 2001 and November 30, 2001. None of these options are exercisable until November 30, 2001. Please see the discussion below regarding the outperform stock options. (2) Tony Parella was granted (a) 300,000 non-qualified stock options on August 2, 2000 (34% of these options vest on August 2, 2001, with 2.75% additional options vesting each month thereafter), (b) 600,000 non-qualified stock options on November 30, 2000 (176,250 of these options vest on June 30, 2001 with 2.75% additional options vesting on August 1, 2001 and each month thereafter; and 102,000 of these options vest on August 2, 2001 with 2.75% additional options vesting each month thereafter), and (c) 7,135 outperform stock options on November 30, 2000 (25% of these options vest on each of February 28, 2001, May 31, 2001, August 31, 2001 and November 30, 2001 and none of these options are exercisable until November 30, 2001). Please see the discussion below regarding the outperform stock options. (3) Mark Tresnowski was granted (a) 150,000 non-qualified stock options on January 1, 2000 (34% of such options vested on January 1, 2001, with 2.75% additional options vesting each month thereafter), (b) 150,000 non-qualified stock options on November 30, 2000 (75,750 of these options vest on June 30, 2001 with 2.75% additional options vesting on August 1, 2001 and each month thereafter), and (c) 10,703 outperform stock options on November 30, 2000 (25% of these options vest on each of February 28, 2001, May 31, 2001, August 31, 2001 and November 30, 2001 and none of these options are exercisable until November 30, 2001). Please see the discussion below regarding the outperform stock options. (4) These assumed rates of appreciation are provided in order to comply with the requirements of SEC and do not represent our expectation as to the actual rate of appreciation of the common stock. The actual value of the options will depend on the performance of our common stock, and may be greater or less than the amounts shown, and will also depend on an optionee's continued employment through the vesting period. (5) Since the value of these outperform stock options are based on the performance of our common stock compared to the performance of the Nasdaq 100 Index, applying a 5% and 10% assumed rate of annual stock price appreciation does not accurately reflect the terms of these options. Please see the table and discussion below regarding the outperform stock options. 41 44 EXERCISE OF STOCK OPTIONS AND FISCAL YEAR-END OPTION VALUES. The following table sets forth information concerning the exercise of stock options by the Named Executive Officers during fiscal 2000 and the value of such officers' unexercised options at December 31, 2000.
VALUE OF UNEXERCISED IN-THE-MONEY NUMBER OF SECURITIES VALUE OF UNEXERCISED IN-THE- OSOS AT UNDERLYING UNEXERCISED MONEY OPTIONS (OTHER THAN 12/31/00 SHARES OPTIONS AT 12/31/00(#) OSOS) AT 12/31/00($)(1) ($)(2) ACQUIRED ON VALUE --------------------------- ----------------------------- ------------- NAME EXERCISE(#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE UNEXERCISABLE ---- ----------- ---------- ----------- ------------- ------------ -------------- ------------- Royce J. Holland..... -- -- -- 21,404 -- -- $1,511,345 C. Daniel Yost....... -- -- -- 21,404 -- -- $1,511,345 Thomas M. Lord....... -- -- -- 21,404 -- -- $1,511,345 Anthony J. Parella... -- -- 118,500 1,088,635 -- $4,950,000 $ 503,806 Mark B. Tresnowski... 40,000 $2,130,152 264,425 501,278 $5,711,316 $5,353,729 $ 755,744
--------------- (1) The value of unexercised in-the-money (i.e., options that had a positive spread between the exercise price and the fair market value of the common stock) options that are not outperform stock options as of December 31, 2000, is based on the December 29, 2000 closing price of $22.2656 per share of our common stock as reported on the Nasdaq National Market. (2) Outperform stock options are being valued based on the outperform multiplier and the change to the outperform stock option exercise price as of December 31, 2000 in accordance with their option agreements. The exercise price of an outperform stock option is subject to change based on the percentage change in the Nasdaq 100 for the period from the date of grant to the day before the options are exercised. Please see the discussion below regarding the outperform stock options. OUTPERFORM STOCK OPTION GRANTS. In 2000, Allegiance granted outperform stock options ("OSOs") under its 1998 Stock Incentive Plan to certain employees. A holder of an OSO is entitled to receive shares of our common stock (or cash, in the discretion of the Compensation Committee in connection with a change of control of Allegiance) based on the performance of our common stock compared to the performance of the Nasdaq 100 Index. The exercise price of OSOs may increase or decrease based on the aggregate percentage increase or decrease in the Nasdaq 100 Index. The value received for awards under an OSO agreement is based on a formula involving a multiplier (not to exceed eight) related to how much our common stock outperforms the Nasdaq 100 Index. To the extent that our common stock outperforms the Nasdaq 100 Index, the value of these outperform stock options to an option holder may exceed the value of our standard non-qualified stock options. For example, an executive receives 1,000 OSOs on November 30, 2000 at an exercise price of $14.0156. Assume that from November 30, 2000 to March 31, 2002, our common stock price increases from $14.0156 to $20 (a 42.698% increase). Assume also that during this same period, the Nasdaq 100 Index increases from 2341.70 to 2500 (a 6.76% increase). The original exercise price of the OSO changes based on the percentage change in the Nasdaq 100 Index, and therefore, the exercise price of these OSOs would increase from $14.0156 to $14.9631. Because our common stock outperformed the Nasdaq 100 Index by more than 10%, a multiplier of eight (the maximum multiplier) would be applied to the value of the OSO. As a result, these options would be worth $40,296 on March 31, 2002. If the performance of our common stock does not exceed the performance of the Nasdaq 100 Index, an OSO will have no value. All of the OSOs granted in 2000 were granted on November 30, 2000, have an initial exercise price of $14.0156 and vest 25% on each of February 28, 2001, May 31, 2001, August 31, 2001 and November 30, 2001. None of these options are exercisable until November 30, 2001 and are thereafter exercisable until March 31, 2003 (unless the term is extended by the Compensation Committee). The vesting of these options accelerates if the recipient is terminated by the company without cause (as defined in each agreement) or if such person's employment is terminated because of death or permanent disability. 42 45 EXECUTIVE AGREEMENTS. Royce J. Holland Executive Agreement In August 1997, Allegiance, Allegiance Telecom, LLC, and Royce Holland entered into an Executive Purchase Agreement, a Securityholders Agreement, Stock Purchase Agreement and a Registration Agreement. The Registration Agreement was amended and restated on September 13, 1999. Certain of these agreements are also described under "Certain Relationships and Related Transactions" above. In December 1999, Allegiance and Royce Holland amended and restated the Executive Purchase Agreement. These agreements include, among others, the following terms: Restrictions on Transfer; Holdback and "Drag Along" Agreements. Mr. Holland's Allegiance Telecom common stock issued under his Executive Purchase Agreement is currently 100% vested. However, his executive securities are subject to various restrictions on transferability, holdback periods in the event of a public offering of Allegiance's securities and provisions requiring the holder of such shares to approve and, if requested by Allegiance, sell its shares in any sale of Allegiance that is approved by the Board. Terms of Employment. Mr. Holland is an "at will" employee and, thus, may be terminated by Allegiance at any time and for any reason. Mr. Holland is not entitled to receive any severance payments upon any such termination. Noncompetition and Nonsolicitation Agreements. During the noncompete period described below, Mr. Holland may not hire or attempt to induce any employee of Allegiance to leave Allegiance's employ, nor attempt to induce any customer or other business relation of Allegiance to cease doing business with Allegiance, nor in any other way interfere with Allegiance's relationships with its employees, customers, and other business relations. Also, during this noncompete period, Mr. Holland may not participate in any business engaged in the provision of competitive local exchange telecommunications services in any metropolitan statistical area in which Allegiance is engaged in business or has at any time had an approved business plan to engage in business. The noncompete period in this agreement is the period of employment and the one year following termination of employment for any reason, but terminates immediately upon a qualified sale of Allegiance. Gross-Up for Excise Taxes. In addition, the Holland Executive Purchase Agreement contains a "gross-up" provision pursuant to which any payment, which would be subject to certain excise taxes occurring as a result of such agreement, would include an additional gross-up payment resulting in the executive retaining an additional amount equal to these excise taxes. C. Daniel Yost Executive Agreement In January 1998, Allegiance, Allegiance Telecom, LLC, and Dan Yost entered into an Executive Purchase Agreement, a Securityholders Agreement and a Registration Agreement. The Registration Agreement was amended and restated on September 13, 1999. Certain of these agreements are also described under "Certain Relationships and Related Transactions" above. In December 1999, Allegiance and Dan Yost amended and restated the Executive Purchase Agreement, containing substantially the same terms as those described above for Royce Holland. Mr. Yost's Allegiance Telecom common stock issued under his Executive Purchase Agreement is currently 100% vested. Thomas M. Lord Executive Agreement In August 1997, Allegiance, Allegiance Telecom, LLC, and Tom Lord entered into an Executive Purchase Agreement, a Securityholders Agreement, Stock Purchase Agreement and a Registration Agreement. The Registration Agreement was amended and restated on September 13, 1999. Certain of these agreements are also described under "Certain Relationships and Related Transactions" above. In December 1999, Allegiance and Tom Lord amended and restated the Executive Purchase Agreement, containing 43 46 substantially the same terms as those described above for Royce Holland. Mr. Lord's Allegiance Telecom common stock issued under his Executive Purchase Agreement is currently 100% vested. Anthony J. Parella Executive Agreement In August 1997, Allegiance, Allegiance Telecom, LLC and Tony Parella entered into an Executive Purchase Agreement, a Securityholders Agreement, Stock Purchase Agreement and a Registration Agreement. The Registration Agreement was amended and restated on September 13, 1999. Certain of these agreements are also described under "Certain Relationships and Related Transactions" above. These agreements include, among others, the following terms: Restrictions on Transfer; Holdback and "Drag Along" Agreements. Mr. Parella's Allegiance Telecom common stock issued under his Executive Purchase Agreement is currently 100% vested. However, these executive securities are subject to various restrictions on transferability, holdback periods in the event of a public offering of Allegiance's securities and provisions requiring the holder of such shares to approve and, if requested by Allegiance, sell its shares in any sale of Allegiance that is approved by the Board. Terms of Employment. Mr. Parella is an "at will" employee and, thus, may be terminated by Allegiance at any time and for any reason. Mr. Parella is not entitled to receive any severance payments upon any such termination. Anthony J. Parella and Mark B. Tresnowski Stock Option Agreements We have granted to Tony Parella, an aggregate of 1,207,135 stock options as follows: (1) 300,000 non-qualified stock options were granted on October 1, 1999, with an exercise price of $35.0832 (34% of such options vested on October 1, 2000, and an additional 2.75% will vest each month thereafter); (2) 300,000 non-qualified stock options were granted on August 2, 2000, with an exercise price of $50.125 (34% of such options will vest on August 8, 2001, and an additional 2.75% will vest each month thereafter); (3) 600,000 non-qualified stock options were granted on November 30, 2000, with an exercise price of $14.0156 (176,250 of these options vest on June 30, 2001 with 2.75% additional options vesting on August 1, 2001 and each month thereafter; and 102,000 of these options vest on August 2, 2001 with 2.75% additional options vesting each month thereafter); and (4) 7,135 outperform stock options were granted on November 30, 2000, with an exercise price of $14.0156. We have granted to Mark Tresnowski, an aggregate of 805,703 stock options as follows: (1) 495,000 non-qualified stock options were granted on February 1, 1999, with an exercise price of $0.6666 (34% of such options vested on February 1, 2000, and an additional 2.75% will vest each month thereafter); (2) 150,000 non-qualified stock options were granted on January 1, 2000, with an exercise price of $61.5000 (34% of such options vested on January 1, 2001, and an additional 2.75% will vest each month thereafter); (3) 150,000 non-qualified stock options were granted on November 30, 2000, with an exercise price of $14.0156 (75,750 of these options vest on June 30, 2001 with 2.75% additional options vesting on August 1, 2001 and each month thereafter); and (4) 10,703 outperform stock options were granted on November 30, 2000, with an exercise price of $14.0156. All of these stock option agreements, except for the outperform stock option agreements described above, provide that upon the consummation of a Change in Control, if such executive is still employed by Allegiance immediately prior to such consummation, all unvested options become vested options. A "Change in Control" is defined as any of the following events: (i) if any "person" or "group" as those terms are used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, other than any employee benefit plan of Allegiance or a trustee or other administrator or fiduciary holding securities under an employee benefit plan of Allegiance ("Exempt Person"), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Securities Exchange Act), directly or indirectly, of securities of Allegiance representing 50% or more of the combined voting power of Allegiance's then outstanding securities; or (ii) during any period of two consecutive years, individuals who at the beginning of such 44 47 period constitute the Board of Directors of Allegiance and any new directors whose election by the Board or nomination for election by Allegiance's stockholders was approved by at least two-thirds of the directors then still in office who either were directors at the beginning of the period or whose election was previously so approved, cease for any reason to constitute a majority thereof; or (iii) the stockholders of Allegiance approve a merger or consolidation of Allegiance with any other corporation, other than a merger or consolidation (A) which would result in all or a portion of the voting securities of Allegiance outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than 50% of the combined voting power of the voting securities of Allegiance or such surviving entity outstanding immediately after such merger or consolidation or (B) by which the corporate existence of Allegiance is not affected and following which Allegiance's chief executive officer and directors retain their positions with Allegiance (and constitute at least a majority of the Board); or (iv) the stockholders of Allegiance approve a plan of complete liquidation of Allegiance or an agreement for the sale or disposition by Allegiance of all or substantially all Allegiance's assets, other than a sale to an Exempt Person. In addition, these agreements (other than the outperform stock option agreements) contain a "gross-up" provision pursuant to which any payment, which would be subject to certain excise taxes occurring as a result of these agreements, would include an additional gross-up payment resulting in the executive retaining an additional amount equal to these excise taxes. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. The Board of Directors has established a Compensation Committee, which is responsible for decisions regarding salaries, incentive compensation, stock options and other matters regarding executive officers and employees of Allegiance. No current member of the Compensation Committee is an Allegiance employee. 45 48 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the beneficial ownership of the outstanding common stock of Allegiance as of March 12, 2001 by: - each of the Directors, - each of the Named Executive Officers, - all Directors and Named Executive Officers as a group, and - each owner known by Allegiance to own beneficially more than 5% of its outstanding common stock. Beneficial ownership of less than one percent is indicated by an asterisk. The percentages specified below are based on 111,113,900 shares of common stock outstanding as of March 12, 2001. Shares subject to options exercisable within 60 days of such date are considered for the purpose of determining the percent of the class held by the holder of such options, but not for the purpose of computing the percentage held by others. Unless otherwise noted, the address for each Director and Named Executive Officer of Allegiance is c/o Allegiance Telecom, Inc., 9201 Central Expressway, Dallas, Texas 75231.
SHARES BENEFICIALLY OWNED ------------------------- PERCENT OF NAME OF BENEFICIAL OWNER NUMBER CLASS ------------------------ ----------- ----------- DIRECTORS AND NAMED EXECUTIVE OFFICERS: Royce J. Holland(1)......................................... 5,872,635 5.3 C. Daniel Yost.............................................. 2,036,919 1.8 Thomas M. Lord(2)........................................... 2,268,284 2.0 Anthony J. Parella(3)....................................... 611,082 * Mark B. Tresnowski(4)....................................... 405,119 * James E. Crawford, III(5)(6)................................ 1,263,718 1.1 John B. Ehrenkranz(7)....................................... -- - Paul J. Finnegan(8)......................................... 45,512 * Richard D. Frisbie(9)....................................... 86,355 * Howard I. Hoffen(10)........................................ -- - Reed E. Hundt(11)........................................... 98,231 * James N. Perry, Jr.(8)(12).................................. 37,723 * All Directors and Named Executive Officers as a group (12 persons).................................................. 12,725,578 11.4 OTHER 5% OWNERS: Morgan Stanley Dean Witter Capital Partners(13)............. 13,453,369 12.1 Madison Dearborn Capital Partners II, L.P................... 7,307,325 6.6 Massachusetts Financial Services Company(14)................ 11,669,795 10.5 Putnam Investments, LLC(15)................................. 8,679,179 7.8 T. Rowe Price Associates, Inc.(16).......................... 6,450,100 5.8 Wellington Management Company, LLP(17)...................... 5,626,880 5.1
--------------- * Denotes less than one percent. (1) Consists of: (a) 2,957,907 shares of common stock owned directly by Mr. Holland, (b) 2,910,828 shares of common stock owned by the Royce J. Holland Family Limited Partnership, of which Royce J. Holland is the sole general partner and (c) 3,900 shares of common stock held by Mr. Holland as custodian for his children, as to which 3,900 shares Mr. Holland disclaims beneficial ownership. (2) Consists of (a) 1,059,141 shares of common stock owned directly by Mr. Lord and (b) 1,209,143 shares of common stock owned by Mr. Lord's wife and children. 46 49 (3) Consists of: (a) 451,332 shares of common stock owned directly by Mr. Parella and (b) options to acquire 143,250 shares of common stock that have vested as of March 12, 2001 and an additional 16,500 option shares that vest within 60 days. See discussion above regarding "Executive Agreements." (4) Consists of: (a) 5,132 shares of common stock owned directly by Mr. Tresnowski and (b) options to acquire 364,512 shares of common stock that have vested as of March 12, 2001 and an additional 35,475 shares that vest within 60 days. See discussion above regarding "Executive Agreements." (5) 1,169,790 shares of common stock are owned by Frontenac VII Limited Partnership and 62,952 shares of common stock are owned by Frontenac Masters VII Limited Partnership. Mr. Crawford is a Managing Member of Frontenac Company, VII, L.L.C., the general partner of Frontenac VII Limited Partnership and Frontenac Masters VII Limited Partnership and his address is c/o Frontenac Company, 135 S. LaSalle Street, Suite 3800, Chicago, IL 60603. He disclaims beneficial ownership of these shares of common stock, except to the extent of his pecuniary interest. (6) Consists of: (a) 26,272 shares of common stock owned directly by Mr. Crawford, (b) 750 shares owned by Mr. Crawford's spouse, (c) 150 shares owned by Mr. Crawford's son, (d) 1,452 shares held in a dynasty trust for the benefit of Mr. Crawford's son, and 1,452 shares held in a dynasty trust for the benefit of Mr. Crawford's daughter, and (e) 900 shares held by Mr. Crawford as custodian for his son. Mr. Crawford disclaims ownership of the 3,954 shares of common stock described in clauses (c) through (e). (7) Mr. Ehrenkranz is a Managing Director of Morgan Stanley Dean Witter Capital Partners, the managing member of the general partner of the funds described in footnote (13) below and their address is c/o Morgan Stanley Dean Witter Capital Partners, 1221 Avenue of the Americas, New York, NY 10020. (8) Messrs. Finnegan and Perry are Managing Directors of Madison Dearborn Partners, Inc., the general partner of the general partner of Madison Dearborn Capital Partners II, L.P. and their address is c/o Madison Dearborn Partners, Inc., Three First National Plaza, Suite 3800, Chicago, IL 60602. (9) Consists of: (a) 62,583 shares of common stock owned directly by Mr. Frisbie and (b) 23,772 shares of common stock owned through trusts. Mr. Frisbie is a Managing Member of Battery Partners IV, LLC, the general partner of Battery Ventures IV, L.P. and a Managing Member of Battery Investment Partners IV, LLC and his address is c/o Battery Ventures, 20 William Street, Wellesley, MA 02181. (10) Mr. Hoffen is Chairman, CEO and Director of Morgan Stanley Dean Witter Private Equity and his address is c/o Morgan Stanley Dean Witter Capital Partners, 1221 Avenue of the Americas, New York, NY 10020. (11) Consists of options to acquire 91,903 shares of common stock that have vested as of March 12, 2001 and an additional 6,328 option shares that vest within 60 days. Mr. Hundt's address is c/o Charles Ross Partners, 1909 K Street, NW, Suite 820, Washington, DC 20006. For an additional discussion of these options, see above section titled "Compensation of Directors." (12) Consists of: (a) 15,089 shares held directly by Mr. Perry through a living trust and (b) 22,634 shares owned by a family limited partnership. (13) These shares of common stock are owned by Morgan Stanley Capital Partners III, L.P. (11,865,451 shares), MSCP III 892 Investors, L.P. (1,214,813 shares) and Morgan Stanley Capital Investors, L.P. (373,105 shares). (14) Of these shares, Massachusetts Financial Services Company has sole voting power as to 11,554,395 shares and sole dispositive power as to 11,669,795 shares. Massachusetts Financial Services Company's address is 500 Boylston Street, Boston, MA 02116. Information is as of February 9, 2001 and is derived from SEC filings. (15) Of these shares, Putnam Investments, LLC, has shared voting power as to 87,993 shares and shared dispositive power as to 8,679,179 shares. Putnam Investments, LLC is a wholly-owned subsidiary of Marsh & McLennan Companies, Inc. Putnam Investments, LLC's address is One Post Office 47 50 Square, Boston, Massachusetts 02109. Information is as of February 15, 2001 and is derived from SEC filings. (16) These shares of common stock are owned by various individual and institutional investors which T. Rowe Price Associates, Inc. serves as investment advisor with sole dispositive power as to 6,450,100 shares and sole power to vote 1,184,800 shares. For purposes of the reporting requirements of the Securities Exchange Act of 1934, T. Rowe Price Associates, Inc. is deemed to be a beneficial owner of such shares; however, T. Rowe Price Associates, Inc. expressly disclaims that it is, in fact, the beneficial owner of such securities. T. Rowe Price Associates, Inc.'s address is 100 E. Pratt Street, Baltimore, MD 21202. Information is as of February 12, 2001 and is derived from SEC filings. (17) Of these shares, Wellington Management Company, LLP has shared voting power as to 4,915,780 shares and shared dispositive power as to 5,626,880 shares. These shares are owned of record by clients of Wellington Management Company, LLP, in its capacity as an investment advisor. Wellington Management Company, LLP's address is 75 State Street, Boston, MA 02109. Information is as of February 12, 2001 and is derived from SEC filings. 48 51 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Securityholders Agreement Allegiance, Madison Dearborn Capital Partners II, LP, Morgan Stanley Capital Partners III, LP, MSCP III 892 Investors, LP, Morgan Stanley Capital Investors, LP, Frontenac VII Limited Partnership, Frontenac Masters VII Limited Partnership, Battery Ventures IV, LP, Battery Investment Partners IV, LLC, Royce J. Holland, Thomas M. Lord, Anthony J. Parella and certain other stockholders are parties to a Securityholders Agreement dated as of August 13, 1997. Under the terms of this agreement, in the event of an approved sale of Allegiance, each of the fund investors, management investors and their transferees agrees to approve and, if requested, to sell its shares in such sale of Allegiance. Most of the other provisions of this agreement, apart from certain provisions thereof, terminated upon the consummation of our initial public offering of common stock. Registration Agreement Allegiance, Madison Dearborn Capital Partners II, LP, Morgan Stanley Capital Partners III, LP, MSCP III 892 Investors, LP, Morgan Stanley Capital Investors, LP, Frontenac VII Limited Partnership, Frontenac Masters VII Limited Partnership, Battery Ventures IV, LP, Battery Investment Partners IV, LLC, Vulcan Ventures Incorporated, Royce J. Holland, Thomas M. Lord, Anthony J. Parella and certain other stockholders listed therein are parties to an Amended and Restated Registration Agreement dated as of September 13, 1999. The Morgan Stanley funds, Madison Dearborn Capital Partners, and Frontenac Company funds each are entitled to demand two long-form registrations, such as registration on Form S-1, and unlimited short-form registrations, such as registration on Form S-3, and the Battery Ventures funds are entitled to demand one long-form registration and unlimited short-form registrations. In addition, the stockholders party to the registration agreement may "piggyback" on primary or secondary registered public offerings of Allegiance's securities. Allegiance has agreed to pay the registration expenses in connection with these demand and "piggyback" registrations. Each stockholder party to this registration agreement is subject to holdback restrictions in the event of a public offering of Allegiance securities. Allegiance, Morgan Stanley & Co. Incorporated, Salomon Brothers Inc, Bear Stearns & Co. Inc. and Donaldson Lufkin & Jenrette Securities Corporation are parties to a Warrant Registration Rights Agreement dated as of February 3, 1998. Allegiance has an effective shelf registration statement with respect to the issuance of the common stock issuable upon exercise of the redeemable warrants. Allegiance is required to maintain the effectiveness of such registration statement until all redeemable warrants have expired or been exercised. Allegiance is required to pay the expenses associated with such registration. Voting Agreements Allegiance, Madison Dearborn Capital Partners II, LP, Morgan Stanley Capital Partners III, LP, MSCP III 892 Investors, LP, Morgan Stanley Capital Investors, LP, Frontenac VII Limited Partnership, Frontenac Masters VII Limited Partnership, Battery Ventures IV, LP, Battery Investment Partners IV, LLC, Royce J. Holland, Thomas M. Lord, Anthony J. Parella and certain other stockholders listed therein are parties to an Stock Purchase Agreement dated as of August 13, 1997. The parties to such agreement have each agreed to vote all of their shares in such a manner as to elect the following persons to serve as Directors: Madison Dearborn Capital Partners, Morgan Stanley funds, and Frontenac Company funds each have the right to designate two Directors; Battery Ventures funds have the right to designate one Director; Allegiance's Chief Executive Officer has the right to serve as a Director; the management investors have the right to designate three Directors; and the final two directorships may be filled by representatives designated by the fund investors and acceptable to the management investors. In the event Madison Dearborn Capital Partners II, LP's beneficial ownership of common stock is less than 30% but equal to or greater than 15% of its original investment, it will be entitled to designate one Director instead of two; in the event that its beneficial ownership of common stock is less than 15% of its original investment, it will not have a right to designate a Director to the Board. In the event the Morgan Stanley funds' beneficial ownership of common stock is less than 30% but equal to or greater than 15% of their original investment, they will be entitled to designate one Director instead of two; in the event their beneficial ownership of common stock is less than 15% of their original investment, they will not have a right to designate a Director to the Board. As a result of Frontenac Company funds' current beneficial stock ownership, the Frontenac Company funds no longer have a right to designate any Directors to the Board. As a result of the Battery Ventures funds' current beneficial stock ownership, the Battery Ventures funds no longer have a right to designate a Director to the Board. Indebtedness of Management In connection with the employment of G. Clay Myers, our Senior Vice President of Finance and Accounting, Mr. Myers borrowed $250,000 from Allegiance on December 6, 1999. Mr. Myers issued a promissory note payable to Allegiance for this amount, which note is payable on December 6, 2002. Such note accrues interest at a rate of 5.74%, payable when the note is due. In the event Mr. Myers' resigns or is terminated by Allegiance for "cause" (as such term is defined in the note), then the note will become immediately due and payable. The note is secured by a pledge of Mr. Myers' Allegiance stock options. 49 52 Other During 2000, Allegiance personnel and advisors traveled at various times on company business on an airplane owned and operated by a company that is wholly-owned by Thomas M. Lord and members of his immediate family. Mr. Lord is one of our Directors and our Executive Vice President and Chief Financial Officer. Total charges to us for our use of this airplane in 2000 were $169,500. The air travel rate billed to us for use of the airplane was at least as favorable as the rate charged by private aircraft owners unaffiliated with our company. Morgan Stanley & Co. Incorporated, an affiliate of Morgan Stanley Dean Witter Capital Partners, one of our original equity investors, was one of the underwriters in our February 2000 common stock offering and received fees of approximately $2.9 million in connection with such offering. Morgan Stanley Senior Funding, Inc., an affiliate of Morgan Stanley Dean Witter Capital Partners, is a lender of our new senior secured credit facilities and received fees of approximately $1.1 million in 2000 in connection with such credit facilities. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements (located on pages F-1 through F-19 of this report). Report of Independent Public Accountants. Consolidated Balance Sheets as of December 31, 2000 and 1999. Consolidated Statements of Operations for the years ended December 31, 2000, 1999 and 1998. Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 2000, 1999 and 1998. Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998. Notes to Consolidated Financial Statements. (a)(2) Financial Statement Schedules: Report of Independent Public Accountants on Financial Statement Schedule located on page S-I of this report. Valuation and Qualifying Accounts for the years ended December 31, 2000, 1999 and 1998 located on page S-II of this report. (a)(3) The exhibits filed in response to Item 601 of Regulation S-K are listed in the Exhibit Index starting on page E-1 of this report. (b) Reports on Form 8-K There were no reports filed during the three months ended December 31, 2000. 50 53 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange act of 1934, Allegiance Telecom, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on April 17, 2001. ALLEGIANCE TELECOM, INC. By /s/ ROYCE J. HOLLAND ----------------------------------- Royce J. Holland, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Allegiance Telecom, Inc. and in the capacities indicated on April 17, 2001.
SIGNATURE CAPACITY --------- -------- /s/ ROYCE J. HOLLAND Chairman of the Board and Chief Executive ----------------------------------------------------- Officer (Principal Executive Officer) Royce J. Holland * President, Chief Operating Officer and ----------------------------------------------------- Director C. Daniel Yost * Executive Vice President, Chief Financial ----------------------------------------------------- Officer and Director (Principal Financial Thomas M. Lord Officer) * Senior Vice President of Finance and ----------------------------------------------------- Accounting (Principal Accounting Officer) G. Clay Myers * Executive Vice President and Director ----------------------------------------------------- Anthony J. Parella * Director ----------------------------------------------------- James E. Crawford, III * Director ----------------------------------------------------- John B. Ehrenkranz
51 54
SIGNATURE CAPACITY --------- -------- * Director ----------------------------------------------------- Paul J. Finnegan * Director ----------------------------------------------------- Richard D. Frisbie * Director ----------------------------------------------------- Howard I. Hoffen * Director ----------------------------------------------------- Reed E. Hundt * Director ----------------------------------------------------- James N. Perry, Jr.
* Pursuant to the Power of Attorney executed by such officers and directors and previously filed with the Securities and Exchange Commission. /s/ MARK B. TRESNOWSKI --------------------------- Mark B. Tresnowski Attorney-in-Fact 52 55 Report of Independent Public Accountants To the Board of Directors and Stockholders of Allegiance Telecom, Inc.: We have audited the accompanying consolidated balance sheets of Allegiance Telecom, Inc. (a Delaware corporation) and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the years ended December 31, 2000, 1999 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Allegiance Telecom, Inc. and its subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the years ended December 31, 2000, 1999 and 1998, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Dallas, Texas, February 12, 2001 F-1 56 Allegiance Telecom, Inc. and Subsidiaries Consolidated Balance Sheets As of December 31, 2000 and 1999 (in thousands, except share and per share data)
Assets 2000 1999 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 396,103 $ 502,234 Short-term investments 261,856 23,783 Short-term investments, restricted 12,952 25,518 Accounts receivable (net of allowance for doubtful accounts of $19,697 and $7,800, respectively) 93,803 30,344 Prepaid expenses and other current assets 5,563 1,770 ------------ ------------ Total current assets 770,277 583,649 PROPERTY AND EQUIPMENT: Property and equipment 907,182 435,526 Accumulated depreciation (162,279) (58,113) ------------ ------------ Property and equipment, net 744,903 377,413 DEFERRED DEBT ISSUANCE COSTS (net of accumulated amortization of $7,048 and $2,610, respectively) 23,710 21,668 LONG-TERM INVESTMENTS, RESTRICTED 829 13,232 GOODWILL (net of accumulated amortization of $28,025 and $5,746 respectively) 100,184 28,465 OTHER ASSETS, net 28,936 9,448 ------------ ------------ Total assets $ 1,668,839 $ 1,033,875 ============ ============ Liabilities And Stockholders' Equity CURRENT LIABILITIES: Accounts payable $ 80,814 $ 44,805 Accrued liabilities and other current liabilities 58,256 28,868 ------------ ------------ Total current liabilities 139,070 73,673 LONG-TERM DEBT 566,312 514,432 OTHER LONG-TERM LIABILITIES 4,972 2,154 COMMITMENTS AND CONTINGENCIES (see Note 9) STOCKHOLDERS' EQUITY: Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding at December 31, 2000 and 1999, respectively -- -- Common stock, $.01 par value, 150,000,000 shares authorized, 110,392,114 and 97,459,677 shares issued and 110,064,619 and 97,421,709 shares outstanding at December 31, 2000 and 1999, respectively 1,104 975 Additional paid-in capital 1,730,652 940,120 Common stock in treasury, at cost, 327,495 and 37,968 shares at December 31, 2000 and 1999, respectively (45) (5) Common stock warrants 1,877 3,719 Deferred compensation (16,531) (13,573) Deferred management ownership allocation charge (175) (6,790) Accumulated deficit (758,397) (480,830) ------------ ------------ Total stockholders' equity 958,485 443,616 ------------ ------------ Total liabilities and stockholders' equity $ 1,668,839 $ 1,033,875 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-2 57 Allegiance Telecom, Inc. and Subsidiaries Consolidated Statements of Operations For the years ended December 31, 2000, 1999 and 1998 (in thousands, except share and per share data)
2000 1999 1998 ------------- ------------- ------------- REVENUES $ 285,227 $ 99,061 $ 9,786 OPERATING EXPENSES: Network 150,718 62,542 9,529 Selling, general and administrative 252,368 140,745 46,089 Depreciation and amortization 130,826 55,822 9,003 Management ownership allocation charge 6,480 18,789 167,312 Noncash deferred compensation 10,127 7,851 5,307 ------------- ------------- ------------- Total operating expenses 550,519 285,749 237,240 ------------- ------------- ------------- Loss from operations (265,292) (186,688) (227,454) OTHER INCOME (EXPENSE): Interest income 56,969 31,354 19,918 Interest expense (69,244) (59,404) (38,952) ------------- ------------- ------------- Total other income (expense) (12,275) (28,050) (19,034) ============= ============= ============= NET LOSS (277,567) (214,738) (246,488) ACCRETION OF REDEEMABLE PREFERRED STOCK AND WARRANT VALUES -- (130) (11,972) ------------- ------------- ------------- NET LOSS APPLICABLE TO COMMON STOCK $ (277,567) $ (214,868) $ (258,460) ============= ============= ============= NET LOSS PER SHARE, basic and diluted $ (2.58) $ (2.37) $ (7.02) ============= ============= ============= WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING, basic and diluted 107,773,112 90,725,712 36,825,519 ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-3 58 Allegiance Telecom, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity (Deficit) For the years ended December 31, 2000, 1999 and 1998 (in thousands, except share and per share data)
PREFERRED STOCK COMMON STOCK ------------------------ ------------------------------ Number Number of Shares Amount of Shares Amount ------------ ---------- ------------- ------------- Balance, December 31, 1997 -- $ -- 639 $ -- Accretion of redeemable preferred stock and warrant values -- -- -- -- Initial public offering -- -- 15,000,000 150 Conversion of redeemable preferred stock -- -- 60,511,692 605 Deferred compensation -- -- -- -- Amortization of deferred compensation -- -- -- -- Net loss -- -- -- -- ------------ ---------- ------------- ------------- Balance, December 31, 1998 -- -- 75,512,331 755 Issuance of stock under the employee stock purchase plan (see Note 11) -- -- 145,574 2 Acquisition of treasury stock -- -- -- -- Exercise of employee stock options -- -- 200,170 2 Accretion of redeemable warrant values -- -- -- -- Reclassification of common stock warrants (see Note 6) -- -- -- -- Conversion of common stock warrants -- -- 560,502 6 Secondary offering of common stock -- -- 21,041,100 210 Deferred compensation -- -- -- -- Amortization of deferred compensation -- -- -- -- Net loss -- -- -- -- ------------ ---------- ------------- ------------- Balance, December 31, 1999 -- -- 97,459,677 975 Issue of stock under the employee stock purchase plan (see Note 11) -- -- 109,727 1 Acquisition of treasury stock -- -- -- -- Exercise of employee stock options -- -- 700,820 7 Stock split -- -- (577) -- Conversion of common stock warrants -- -- 205,331 2 Secondary offering of common stock -- -- 10,703,109 107 Common stock issued for business acquisitions -- -- 1,214,027 12 Common stock options issued for business acquisitions -- -- -- -- Deferred compensation -- -- -- -- Amortization of deferred compensation -- -- -- -- Net loss -- -- -- -- ============ ========== ============= ============= Balance, December 31, 2000 -- $ -- 110,392,114 $ 1,104 ============ ========== ============= ============= TREASURY STOCK ------------------------------ Additional Paid-In Number Capital of Shares Amount ------------- ------------- ------------- Balance, December 31, 1997 $ 3,008 -- $ -- Accretion of redeemable preferred stock and warrant values -- -- -- Initial public offering 137,607 -- -- Conversion of redeemable preferred stock 65,201 -- -- Deferred compensation 210,663 -- -- Amortization of deferred compensation -- -- -- Net loss -- -- -- ------------- ------------- ------------- Balance, December 31, 1998 416,479 -- -- Issuance of stock under the employee stock purchase plan (see Note 11) 1,466 -- -- Acquisition of treasury stock -- (37,968) (5) Exercise of employee stock options 563 -- -- Accretion of redeemable warrant values -- -- -- Reclassification of common stock warrants (see Note 6) -- -- -- Conversion of common stock warrants 5,043 -- -- Secondary offering of common stock 510,408 -- -- Deferred compensation 6,161 -- -- Amortization of deferred compensation -- -- -- Net loss -- -- -- ------------- ------------- ------------- Balance, December 31, 1999 940,120 (37,968) (5) Issue of stock under the employee stock purchase plan (see Note 11) 4,408 -- -- Acquisition of treasury stock -- (289,527) (40) Exercise of employee stock options 4,763 -- -- Stock split (52) -- -- Conversion of common stock warrants 1,841 -- -- Secondary offering of common stock 719,568 -- -- Common stock issued for business acquisitions 44,159 -- -- Common stock options issued for business acquisitions 3,852 -- -- Deferred compensation 11,993 -- -- Amortization of deferred compensation -- -- -- Net loss -- -- -- ============= ============= ============= Balance, December 31, 2000 $ 1,730,652 (327,495) $ (45) ============= ============= ============= Management Ownership Deferred Allocation Warrants Compensation Charge ------------- ------------- ------------- Balance, December 31, 1997 $ -- $ (2,798) $ -- Accretion of redeemable preferred stock and warrant values -- -- -- Initial public offering -- -- -- Conversion of redeemable preferred stock -- -- -- Deferred compensation -- (17,126) (193,537) Amortization of deferred compensation -- 5,307 167,312 Net loss -- -- -- ------------- ------------- ------------- Balance, December 31, 1998 -- (14,617) (26,225) Issuance of stock under the employee stock purchase plan (see Note 11) -- -- -- Acquisition of treasury stock -- -- -- Exercise of employee stock options -- -- -- Accretion of redeemable warrant values -- -- -- Reclassification of common stock warrants (see Note 6) 8,764 -- -- Conversion of common stock warrants (5,045) -- -- Secondary offering of common stock -- -- -- Deferred compensation -- (6,807) 646 Amortization of deferred compensation -- 7,851 18,789 Net loss -- -- -- ------------- ------------- ------------- Balance, December 31, 1999 3,719 (13,573) (6,790) Issue of stock under the employee stock purchase plan (see Note 11) -- -- -- Acquisition of treasury stock -- -- -- Exercise of employee stock options -- -- -- Stock split -- -- -- Conversion of common stock warrants (1,842) -- -- Secondary offering of common stock -- -- -- Common stock issued for business acquisitions -- -- -- Common stock options issued for business acquisitions -- (957) -- Deferred compensation -- (12,128) 135 Amortization of deferred compensation -- 10,127 6,480 Net loss -- -- -- ============= ============= ============= Balance, December 31, 2000 $ 1,877 $ (16,531) $ (175) ============= ============= ============= Accumulated Deficit Total ------------- ------------- Balance, December 31, 1997 $ (7,502) $ (7,292) Accretion of redeemable preferred stock and warrant values (11,972) (11,972) Initial public offering -- 137,757 Conversion of redeemable preferred stock -- 65,806 Deferred compensation -- -- Amortization of deferred compensation -- 172,619 Net loss (246,488) (246,488) ------------- ------------- Balance, December 31, 1998 (265,962) 110,430 Issuance of stock under the employee stock purchase plan (see Note 11) -- 1,468 Acquisition of treasury stock -- (5) Exercise of employee stock options -- 565 Accretion of redeemable warrant values (130) (130) Reclassification of common stock warrants (see Note 6) -- 8,764 Conversion of common stock warrants -- 4 Secondary offering of common stock -- 510,618 Deferred compensation -- -- Amortization of deferred compensation -- 26,640 Net loss (214,738) (214,738) ------------- ------------- Balance, December 31, 1999 (480,830) 443,616 Issue of stock under the employee stock purchase plan (see Note 11) -- 4,409 Acquisition of treasury stock -- (40) Exercise of employee stock options -- 4,770 Stock split -- (52) Conversion of common stock warrants -- 1 Secondary offering of common stock -- 719,675 Common stock issued for business acquisitions -- 44,171 Common stock options issued for business acquisitions -- 2,895 Deferred compensation -- -- Amortization of deferred compensation -- 16,607 Net loss (277,567) (277,567) ============= ============= Balance, December 31, 2000 $ (758,397) $ 958,485 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. F-4 59 Allegiance Telecom, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the years ended December 31, 2000, 1999 and 1998 (in thousands)
2000 1999 1998 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(277,567) $(214,738) $(246,488) Adjustments to reconcile net loss to cash used in operating activities-- Depreciation and amortization 130,826 55,822 9,003 Provision for uncollectible accounts receivable 25,914 7,496 577 Accretion of investments (5,387) (4,145) (3,427) Accretion of Series B and 12 7/8% notes 38,645 34,107 28,333 Amortization of deferred debt issuance costs 10,293 1,876 734 Amortization of management ownership allocation charge and deferred compensation 16,607 26,640 172,619 Changes in assets and liabilities, net of effects of acquisitions-- Increase in accounts receivable (88,391) (31,224) (6,760) Increase in prepaid expenses and other current assets (2,283) (385) (998) Increase in other assets (690) (3,138) (1,202) Increase in accounts payable 31,429 31,412 4,704 (Decrease) increase in accrued liabilities and other current liabilities 18,052 (15,206) 22,208 --------- --------- --------- Net cash used in operating activities (102,552) (111,483) (20,697) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (445,183) (263,985) (113,539) Purchases of subsidiaries, net of cash acquired (63,808) (35,478) -- Purchases of investments (329,884) (62,313) (291,262) Proceeds from sale of investments 122,167 209,559 89,058 --------- --------- --------- Net cash used in investing activities (716,708) (152,217) (315,743) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long-term debt -- -- 443,212 Proceeds from issuance of redeemable warrants -- -- 8,184 Proceeds from issuance of common stock, net 728,855 512,655 137,757 Deferred debt issuance costs (12,334) (7,929) (16,812) Proceeds from redeemable capital contributions -- -- 20,875 Purchase of treasury stock (40) (5) -- Payments on capital lease obligations (3,300) (1,285) -- Other (52) (4) -- --------- --------- --------- Net cash provided by financing activities 713,129 503,432 593,216 --------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (106,131) 239,732 256,776 CASH AND CASH EQUIVALENTS, beginning of period 502,234 262,502 5,726 --------- --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 396,103 $ 502,234 $ 262,502 ========= ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest 34,605 37,233 9,384 ========= ========= ========= SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Assets acquired under capital lease obligations 14,511 12,960 871 Fair value of assets acquired in business acquisitions 38,056 10,166 -- Liabilities assumed in business acquisitions 19,074 8,898 -- Common stock issued for business acquisitions (1,214,027 shares) 44,171 -- -- Common stock options issued for business acquisitions (182,324 shares) 2,895 -- -- ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. F-5 60 Allegiance Telecom, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2000, 1999 and 1998 (dollars in thousands, except share and per share data) 1. GENERAL: Allegiance Telecom, Inc., an integrated communications provider, was incorporated on April 22, 1997, as a Delaware corporation, for the purpose of providing voice, data and Internet services to small- to medium-sized businesses in major metropolitan areas across the United States. Allegiance Telecom, Inc. and its subsidiaries are referred to herein as the "Company." The Company's business plan is focused on offering services in 36 of the largest metropolitan areas in the United States. As of December 31, 2000, the Company is operational in 27 markets: Atlanta, Baltimore, Boston, Chicago, Cleveland, Dallas, Denver, Detroit, Fort Worth, Houston, Long Island, Los Angeles, Miami, Minneapolis/St. Paul, New York City, Northern New Jersey, Oakland, Orange County, Philadelphia, Phoenix, St. Louis, San Diego, San Francisco, San Jose, Seattle, Tampa and Washington, D.C. The Company's success will be affected by the challenges, expenses and delays encountered in connection with the formation of any new business, and the competitive environment in which the Company operates. The Company's performance will further be affected by its ability to assess and access potential markets, implement interconnection and colocation with the facilities of incumbent local exchange carriers, lease adequate trunking capacity from and otherwise develop efficient and effective working relationships with incumbent local exchange carriers and other carriers, obtain peering agreements with Internet service providers, collect interexchange access and reciprocal compensation charges, purchase and install switches in additional markets, implement efficient operations support systems and other back office systems, develop and retain a sufficient customer base and attract, retain and motivate qualified personnel. The Company's networks and the provisioning of telecommunications services are subject to significant regulation at the federal, state and local levels. Delays in receiving required regulatory approvals or the enactment of new adverse regulation or regulatory requirements may have a material adverse effect upon the Company. Although management believes that the Company will be able to successfully mitigate these risks, there is no assurance that the Company will be able to do so or that the Company will ever operate profitably. Expenses are expected to exceed revenues in each market in which the Company offers service until a sufficient customer base is established. It is anticipated that obtaining a sufficient customer base will take several years, and positive cash flows from operations are not expected in the near future. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Consolidation--The accompanying financial statements include the accounts of Allegiance Telecom, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Cash and Cash Equivalents--The Company includes as cash and cash equivalents, cash, marketable securities and commercial paper with original maturities of three months or less at the date of purchase. Short-Term Investments--Short-term investments consist primarily of commercial paper with original maturities between three and 12 months at the date of purchase. Such short-term investments are carried at their accreted value, which approximates fair value. Restricted Investments--Restricted investments consist primarily of U.S. government securities purchased in connection with the issuance of the Company's outstanding 12 7/8% notes (see Note 6) to secure the first six scheduled payments of interest on the 12 7/8% notes. These investments are classified as current or non-current based upon the maturity dates of each of the securities at the balance sheet date. F-6 61 Restricted investments also include $829 and $900, at December 31, 2000 and 1999, respectively, in certificates of deposit held as collateral for letters of credit issued on behalf of the Company. Prepaid Expenses and Other Current Assets--Prepaid expenses and other current assets consist of prepaid rent, prepaid insurance and refundable deposits. Prepayments are expensed on a straight-line basis over the corresponding life of the underlying agreements. Property and Equipment--Property and equipment includes network equipment, leasehold improvements, software, office equipment, furniture and fixtures and construction-in-progress. These assets are stated at cost, which includes direct costs and capitalized interest and are depreciated over their respective useful lives using the straight-line method. During the years ended December 31, 2000, 1999 and 1998, $14,366, $6,019 and $2,798, respectively, of interest expense was capitalized related to construction-in-progress. Repair and maintenance costs are expensed as incurred. Property and equipment at December 31, 2000 and 1999, consist of the following:
USEFUL LIVES 2000 1999 (IN YEARS) --------- --------- ------------ Network equipment $ 569,410 $ 266,727 3-7 Leasehold improvements 98,788 52,980 3-10 Software 63,435 26,169 3 Office equipment 24,528 11,073 2-3 Furniture and fixtures 13,879 6,061 3-5 --------- --------- ------------ Property and equipment, in service 770,040 363,010 Less: Accumulated depreciation (162,279) (58,113) --------- --------- Property and equipment, in service, net 607,761 304,897 Construction-in-progress 137,142 72,516 --------- --------- Property and equipment, net $ 744,903 $ 377,413 --------- ---------
Goodwill--Goodwill represents the excess of the purchase price over the fair value of net assets of acquired businesses and is amortized on a straight-line basis over an estimated useful life of three years. Revenue Recognition--Revenues for voice, data and other services to end users are recognized in the month in which the service is provided. Amounts invoiced and collected in advance of services provided are recorded as deferred revenue (see Note 5 for amounts of deferred revenue). Revenues for carrier interconnection and access are recognized in the month in which the service is provided, except for reciprocal compensation generated by calls placed to Internet service providers connected to the Company's network. The ability of competitive local exchange carriers (such as the Company) to earn local reciprocal compensation generated by calls placed to Internet service providers is the subject of numerous regulatory and legal challenges. Until this issue is ultimately resolved, the Company has adopted a policy of recognizing this revenue only when realization is certain. In December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101), which provides additional guidance on revenue recognition as well as criteria for when revenue is realized and earned and related costs are incurred. The Company adopted SAB 101 on October 1, 2000. The adoption of SAB 101 did not have a material effect on the Company's results of operations. Stock Splits--In connection with its initial public offering of common stock on July 7, 1998 (see Note 7), the Company effected a 426.2953905-for-one stock split and on February 28, 2000, the Company also effected a three-for-two stock split in the form of a 50% stock dividend. All references to the number of common shares and per share amounts have been restated to reflect both stock splits for all periods presented. Loss Per Share--The Company calculates net loss per share under the provisions of SFAS No. 128, "Earnings per Share." The net loss applicable to common stock includes the accretion of redeemable cumulative convertible preferred stock and warrant values of $130 and $11,972 for the years ended December 31, 1999 and 1998, respectively. F-7 62 The securities listed below were not included in the computation of diluted loss per share, as the effect from the conversion would be antidilutive.
December 31, 2000 1999 1998 ---------- ---------- ---------- Common Stock Warrants 207,973 413,318 973,872 1997 Nonqualified Stock Option Plan 736,250 1,086,341 1,340,309 1998 Stock Incentive Plan 20,345,100 6,394,661 593,653 Employee Stock Discount Purchase Plan 82,270 31,935 66,936 ---------- ---------- ----------
Segment Reporting -- The Company has adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 establishes how public enterprise businesses determine operating segments and the financial and descriptive information required to be disclosed relating to a company's operating segments. The application of SFAS 131 has no material impact on the Company's current disclosures of its one operating segment, providing telecommunications services. Use of Estimates in Financial Statements--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. Reclassifications--Certain amounts in the prior period's consolidated financial statements have been reclassified to conform with the current period presentation. 3. ACQUISITIONS: During 2000, the Company acquired the following four regional Internet service providers: CONNECTnet Internet Network Services, InterAccess Co., CTSnet, a division of Datel Systems Incorporated, and Jump.Net, Inc. In addition, during 2000, the Company acquired Virtualis Systems, Inc., an Internet-based, Web-hosting applications specialist. The Company acquired these entities for an aggregate purchase price of $113,675, consisting of $63,949 in cash, 1,214,027 shares of the Company's common stock, and 182,324 options granted to employees to purchase shares of the Company's common stock. Included in the aggregate purchase price as of December 31, 2000 is $862 consisting of cash and approximately 24,923 shares of the Company's common stock which have been held as security for indemnification claims against the former owners of the acquired entities. The excess of the purchase price over the fair value of the net assets acquired has been recorded as goodwill of $94,552. The purchase agreement with CTSnet provides for additional contingent consideration payable in cash and shares of the Company's common stock effective six months following the closing date. The contingent consideration is based on the satisfaction of certain conditions, including the maintenance of certain minimum recurring revenues. Based on information available at December 31, 2000, the contingent consideration would be approximately $5,400 (consisting of $3,300 cash and approximately 92,794 shares of the Company's common stock). If such contingent consideration becomes due and payable, such additional purchase price will result in the recording of a corresponding amount of goodwill. The merger agreement with Jump.Net, Inc. provides for additional contingent consideration payable in cash and shares of the Company's common stock in two distributions following the closing date. The contingent purchase payments are based on the satisfaction of certain conditions, including the maintenance of certain minimum recurring revenues. Based on information available at December 31, 2000, the contingent consideration would be approximately $4,000 (consisting of $1,827 cash and approximately 99,694 shares of the Company's common stock). If such contingent consideration becomes due and payable, such additional purchase price will result in the recording of a corresponding amount of goodwill. The merger agreement with Virtualis Systems, Inc. provides for additional contingent consideration payable in cash effective six months following the closing date. The contingent consideration is based on the satisfaction of certain conditions. Based on information available at December 31, 2000, the contingent consideration would be approximately $6,300. Additionally, the agreement provides for potential earnout payments totaling up to $12 million, based on Virtualis meeting certain quarterly revenue targets through August 31, 2001. If such contingent consideration and earnout payments become due and payable, such additional purchase price will result in the recording of a corresponding amount of goodwill. F-8 63 During 1999, the Company acquired 100% of the outstanding stock of ConnectNet, Inc. and Kivex, Inc. and certain assets of ConnecTen, L.L.C. for cash. Each of the acquisitions discussed above were accounted for using the purchase method of accounting. Accordingly, the net assets and results of operations of the acquired companies have been included in the Company's consolidated financial statements since the acquisition dates. The purchase price of the acquisitions was allocated to assets acquired, including identified intangible assets, and liabilities assumed, based on their respective estimated fair values at acquisition. The Company's purchase price allocation of the acquisitions made in 2000 is preliminary, subject to post-acquisition due diligence of the acquired entities, and may be adjusted as additional information is obtained. During the year ended December 31, 2000, immaterial adjustments were made to the purchase price allocation of the entities acquired in 1999. These adjustments are included in goodwill at December 31, 2000. The following presents the unaudited pro forma results of operations of the Company for the years ended December 31, 1999 and 1998 as if the acquisition of Kivex, Inc. had been consummated at the beginning of each of the periods presented. The pro forma results of operations are prepared for comparative purposes only and do not necessarily reflect the results that would have occurred had the acquisition occurred at the beginning of the periods presented or the results which may occur in the future. The pro forma results of operations for ConnecTen, L.L.C., ConnectNet, Inc. CONNECTnet Internet Network Services, InterAccess Co., CTSnet, Jump.Net, Inc., and Virtualis Systems, Inc., are not included in this table as the results would not have been material to the Company's results of operations.
1999 1998 ------------ ------------ Revenues $ 102,999 $ 13,300 Net loss before extraordinary items (225,594) (277,580) Net loss applicable to common stock (225,594) (277,580) Net loss per share, basic and diluted (2.49) (7.54) ------------ ------------
4. OTHER ASSETS: Other assets consisted of the following:
December 31, 2000 1999 ------------ ------------ Acquired intangibles $ 28,171 $ 5,705 Long-term deposits 3,917 2,143 Other 2,231 2,616 ------------ ------------ Total other assets 34,319 10,464 Less: Accumulated amortization (5,383) (1,016) ------------ ------------ Other assets, net $ 28,936 $ 9,448 ============ ============
Acquired intangibles were obtained in connection with the acquisitions made in 2000 and 1999 (see Note 3). These assets are being amortized over their estimated useful lives of three years using the straight-line method. F-9 64 5. ACCRUED LIABILITIES AND OTHER CURRENT LIABILITIES: Accrued liabilities and other current liabilities consisted of the following:
December 31, 2000 1999 ------------ ------------ Accrued employee compensation and benefits $ 5,915 $ 4,709 Accrued network expenses 12,410 7,896 Business acquisition costs 4,461 -- Accrued taxes 5,797 3,823 Accrued interest expense 5,216 3,449 Deferred revenue 13,488 -- Other 10,969 8,991 ------------ ------------ Accrued liabilities and other current liabilities $ 58,256 $ 28,868 ============ ============
6. Long-Term Debt: Long-term debt consisted of the following:
December 31, 2000 1999 -------- -------- Series B 11 3/4% notes, face amount $445,000 due February 15, 2008; effective interest rate of 12.21%; at accreted value $342,758 $304,393 127/8% senior notes, face amount $205,000 due May 15, 2008; effective interest rate of 13.24%; at accreted value 201,539 201,259 Capital lease obligations, net of current portion 22,015 8,780 -------- -------- Long-term debt $566,312 $514,432 ======== ========
Series B 11 3/4% Notes Due 2008--On February 3, 1998, the Company raised gross proceeds of approximately $250,477 in an offering of 445,000 units, each of which consists of one 11 3/4% senior discount note due 2008 of the Company and one redeemable warrant to purchase 2.18847599262 shares of common stock at an exercise price of $.01 per share, subject to certain antidilution provisions. Of the gross proceeds, $242,294 was allocated to the 11 3/4% notes and $8,184 was allocated to the redeemable warrants. The redeemable warrants became exercisable in connection with the Company's initial public offering (see Note 7) in July 1998. A registration statement on Form S-4 (File No. 333-49013) registering the 11 3/4% notes, and offering to exchange any and all of the outstanding 11 3/4% notes for Series B 11 3/4% notes due 2008, was declared effective by the Securities and Exchange Commission on May 22, 1998. This exchange offer terminated on June 23, 1998, after substantially all of the outstanding 11 3/4% notes were exchanged. The terms and conditions of the Series B notes are identical to those of the 11 3/4% notes in all material respects. The Series B notes have a principal amount at maturity of $445,000 and an effective interest rate of 12.21%. The Series B notes mature on February 15, 2008. From and after February 15, 2003, interest on the Series B notes will be payable semi-annually in cash at the rate of 11 3/4% per annum. The Company is required to make an offer to purchase the redeemable warrants for cash at the relevant value upon the occurrence of a repurchase event, as defined in the applicable warrant agreement. Through March 31, 1999, the Company was recognizing the potential future redemption value of the redeemable warrants by recording accretion of the redeemable warrants to their estimated fair market value at February 3, 2008, using the effective interest method. Accretion recorded in the three months ended March 31, 1999, and year ended December 31, 1998, was $130 and $451, respectively. F-10 65 Effective April 1, 1999, the Company determined that accreting the redeemable warrants to a future potential redemption value was no longer applicable, as the redemption of the redeemable warrants for cash is no longer beyond the control of the Company, and the redemption date and amount are not reasonably determinable. Accordingly, the accreted value of the redeemable warrants at April 1, 1999, was reclassified to stockholders' equity as common stock warrants, and no further accretion will be recorded. If a repurchase event occurs in the future or becomes probable, the Company will adjust the warrants to the estimated redemption value at that time. Under the terms of the Series B notes, the Company may redeem these notes at certain times and in certain amounts. 12 7/8% Senior Notes Due 2008--On July 7, 1998, the Company raised approximately $200,919 of gross proceeds from the sale of its 12 7/8% senior discount notes due 2008 of which approximately $69,033 was used to purchase U.S. government securities, which were placed in a pledged account to secure and fund the first six scheduled payments of interest on the notes (see Note 2). The 12 7/8% notes have a principal amount at maturity of $205,000 and an effective interest rate of 13.24%. The 12 7/8% notes mature on May 15, 2008. Interest on the 12 7/8% notes is payable semiannually in cash at the rate of 12 7/8% on May 15 and November 15 of each year. As of December 31, 2000 and 1999, the Company has recorded accrued interest associated with the 12 7/8% notes of $3,299 and $3,299, respectively, which is included in other current liabilities. Under the terms of the 12 7/8% notes, the Company may redeem these notes at certain times and in certain amounts. Upon a change of control, as defined, the Company is required to make an offer to purchase the 12 7/8% notes at a purchase price of 101% of the principal amount thereof, together with accrued interest, if any. $500 Million Credit Facilities--In February 2000, the Company completed $500 million of senior secured credit facilities to replace a previous revolving credit facility. These credit facilities consist of a $350 million seven-year revolving credit facility and a $150 million two-year delayed draw term loan facility. These credit facilities will be available, subject to satisfaction of certain terms and conditions, to provide purchase money financing for network build out, including the cost to develop, acquire and integrate the necessary operations support and back office systems, as well as for additional dark fiber purchases and central office colocations. Interest on amounts drawn is variable based on the Company's leverage ratio and is initially expected to be LIBOR plus 3.25%. The initial commitment fee on the unused portion of the credit facilities is 1.5% and will step down based upon usage. Unamortized deferred debt issuance costs of $5,854 related to the previous revolving credit facility were expensed as additional interest expense upon its termination in February 2000. The Company has made no borrowings under the $500 million credit facilities as of December 31, 2000. The $500 million credit facilities, the Series B notes and the 12 7/8% notes carry certain restrictive covenants that, among other things, limit the ability of the Company to incur indebtedness, create liens, engage in sale-leaseback transactions, pay dividends or make distributions in respect of their capital stock, redeem capital stock, make investments or certain other restricted payments, sell assets, issue or sell stock of certain subsidiaries, engage in transactions with stockholders or affiliates, effect a consolidation or merger and require the Company to maintain certain operating and financial performance measures. However, these limitations are subject to a number of qualifications and exceptions (as defined in the indentures relating to each series of notes and the credit agreement relating to the $500 million credit facilities). The Company was in compliance with all such restrictive covenants at December 31, 2000. F-11 66 Capital Lease Obligations--On May 29, 1998, the Company entered into a capital lease agreement for optical fiber rings, with an initial term of ten years at a total cost of $3,485. During 2000, 1999 and 1998, the Company paid $348, $0 and $871, respectively, under the agreement. The remainder of the obligation is not reflected in the financial statements, since the remaining payment is contingent upon the timing of completion of network segments, as defined in the agreement. On December 4, 1998, the Company entered into a capital lease agreement for 12 optical fibers configured in two separate rings, with an initial term of 15 years. Total costs associated with the capital lease were dependent upon the timing of completion of connectivity of the optical fibers with the Company's network, which was completed in two phases. The Company incurred recurring monthly charges of $29 after the completion of phase one. After completion of phase two, the Company paid a one-time fee of $77 and the recurring monthly charge increased to $77. A capital lease obligation of $7,160 and $7,421 is recorded in the financial statements at December 31, 2000 and 1999. This capital lease was not reflected in the financial statements as of December 31, 1998, since the total cost and timing of payments were contingent upon the timing of completion of the phases, as defined in the agreement. On June 8, 1999, the Company signed a capital lease agreement for 12 dedicated optical fibers, with an initial term of 15 years. Total costs associated with the capital lease are dependent upon the timing of completion of connectivity of the optical fibers with the Company's network, which was completed in two phases. The Company incurred recurring monthly charges of $5 per fiber until all fibers were accepted. Upon acceptance of all fibers, the recurring monthly charge increased to $55. A capital lease obligation of $5,180 and $600 is included in the financial statements at December 31, 2000 and 1999. The obligation at December 31, 1999 represents the present value of future minimum lease payments related only to the fibers accepted at that time, since the total cost and timing of payments was contingent upon the timing of completion of connectivity of the fibers. On December 30, 1999, the Company signed a capital lease agreement for optical fiber capacity in 12 of the U.S. markets served by the Company with an initial term of 20 years. Total cost associated with the capital lease is dependent upon the timing of completion of connectivity of the optical fibers with the Company's network, which is to be completed in accordance with applicable product orders. The Company will incur variable monthly charges contingent on the number of fibers accepted. Upon acceptance of all planned fibers, the Company will pay a recurring monthly charge of $588. A separate capital lease obligation is recognized for each product order upon its respective commencement date. As of December 31, 2000, seven product orders have been executed. A capital lease obligation of $4,911 is included in the financial statements at December 31, 2000 in connection with these product orders. On December 30, 1999, the Company signed a capital lease agreement for use of a fiber optic communications system in various metropolitan areas for an initial term of 20 years. An initial payment to prefund design, planning and engineering of $4,949 was made in 2000. Upon acceptance of each segment, the Company will pay a scheduled fee and will only incur monthly recurring maintenance charges thereafter. No segments have been accepted as of December 31, 2000. Total remaining fees under this lease are approximately $15 million. On October 16, 2000, the Company signed a capital lease agreement for 12 dedicated optical fibers, with an initial term of 20 years. Total costs associated with the capital lease are dependent upon the completion of connectivity of the optical fibers with the Company's network, which is to be completed in two phases. No phases have been completed as of December 31, 2000. This capital lease is not reflected in the financial statements as of December 31, 2000, since the total cost and timing of payments is contingent upon the timing of completion of the phases, as defined in the agreement. F-12 67 At December 31, 2000, future obligations related to capital leases reflected in these consolidated financial statements, and included in long-term debt, are as follows: 2001 $ 4,476 2002 2,781 2003 2,249 2004 2,223 2005 and thereafter 24,065 -------- Total minimum lease payments 35,794 Amounts representing interest (11,669) -------- Present value of minimum lease payments 24,125 Current Portion (2,110) Long-term capital lease obligations $ 22,015 ========
The current portion of capital lease obligations of $2,110 is included in accrued liabilities at December 31, 2000. 7. CAPITALIZATION: Stock Purchase Agreement And Securityholders Agreement--On August 13, 1997, the Company entered into a stock purchase agreement with Allegiance Telecom, LLC. Allegiance Telecom, LLC purchased 40,498,062 shares of 12% redeemable cumulative convertible preferred stock, par value $.01 per share, for aggregate consideration of $5,000. Allegiance Telecom, LLC agreed to make additional contributions as necessary to fund expansion into new markets (Subsequent Closings). In order to obtain funds through Subsequent Closings, the Company submitted a proposal to Allegiance Telecom, LLC detailing the funds necessary to build out the Company's business in a new market. Allegiance Telecom, LLC was not required to make any contributions until it approved the proposal. The maximum commitment of Allegiance Telecom, LLC was $100,000. No capital contributions were required to be made after the Company consummated an initial public offering of its stock (which occurred on July 7, 1998). Allegiance Telecom, LLC contributed a total of $50,133 prior to the Company's initial public offering. Each security holder in Allegiance Telecom, LLC had the right to require Allegiance Telecom, LLC to repurchase all of the outstanding securities held by such security holder at the greater of the original cost (including interest at 12% per annum) for such security or the fair market value, as defined in the securityholders agreement, at any time and from time to time after August 13, 2004, but not after the consummation of a public offering or sale of the Company. If repurchase provisions had been exercised, the Company had agreed, at the request and direction of Allegiance Telecom, LLC, to take any and all actions necessary, including declaring and paying dividends and repurchasing preferred or common stock, to enable Allegiance Telecom, LLC to satisfy its repurchase obligations. Because of the redemption provisions of the outstanding securities, the Company recognized the accretion of the value of the redeemable preferred stock to reflect management's estimate of the potential future fair market value of the redeemable preferred stock payable in the event the repurchase provisions were exercised. Amounts were accreted using the effective interest method assuming the redeemable preferred stock was redeemed at a redemption price based on the estimated potential future fair market value of the equity of the Company in August 2004. The accretion was recorded each period prior to the initial public offering as an increase in the balance of redeemable preferred stock outstanding and a noncash increase in the net loss applicable to common stock. Redeemable Cumulative Convertible Preferred Stock--In connection with the Company's initial public offering, the redeemable preferred stock was converted into the Company's common stock, on a one-for-one basis, and the amounts accreted were reclassified as a component of additional paid-in capital. In addition, the redemption provisions and the obligation of Allegiance Telecom, LLC to make additional contributions to the Company (and the obligation of the members of Allegiance Telecom, LLC to make capital contributions) were terminated. No dividends were declared in 1998. F-13 68 In 1998, prior to the conversion of the redeemable preferred stock, the Company recorded accretion of $11,521. Capital contributed in the Subsequent Closings occurring in October 1997 and January 1998 and other capital contributions totaled approximately $45,133. In February and March 1998, the Company issued 273,362 shares of redeemable preferred stock for aggregate consideration of $337. In connection with the consummation of the initial public offering, the outstanding shares of the redeemable preferred stock were converted into 60,511,692 shares of common stock. Upon the conversion of the redeemable preferred stock, the obligation of the Company to redeem the redeemable preferred stock also terminated and, therefore, the accretion of the redeemable preferred stock value recorded to the date of the initial public offering, $15,335 was reclassified to additional paid-in capital along with $50,470 proceeds from the issuance of the redeemable preferred stock and redeemable capital contributions. Preferred Stock--In connection with the Company's initial public offering, the Company authorized 1,000,000 shares of preferred stock with a $.01 par value. At December 31, 2000 and 1999, no shares of preferred stock were issued and outstanding. Common Stock--On July 7, 1998, the Company raised $150,000 of gross proceeds in the Company's initial public offering. The Company sold 15,000,000 shares of its common stock at a price of $10 per share. In connection with the initial public offering, the outstanding shares of redeemable preferred stock were converted into 60,511,692 shares of common stock and the Company increased the number of authorized common stock to 150,000,000. In April 1999, the Company received $533,041 of gross proceeds from the sale of the Company's common stock. The Company sold 21,041,100 shares at a price of $25.33 per share. Net proceeds from this offering were $510,618. On February 2, 2000, the Company raised $693,000 of gross proceeds from the sale of the Company's common stock. The Company sold 9,900,000 shares at a price of $70 per share. Net proceeds from this offering were $665,562. On February 29, 2000, the underwriters of this offering exercised an option to purchase an additional 803,109 shares of common stock, providing an additional $56,218 gross proceeds and $54,113 net proceeds to the Company. On February 28, 2000, a three-for-two stock split of the Company's common stock was effected in the form of a 50% stock dividend to shareholders of record on February 18, 2000. Par value remained unchanged at $.01 per share. All references to the number of common shares and per share amounts have been restated to reflect the stock split for all periods presented. At December 31, 2000 and 1999, 110,392,114 and 97,459,677 shares were issued and 110,064,619 and 97,421,709 were outstanding, respectively. Of the authorized but unissued common stock, 27,860,415 and 19,902,712 shares were reserved for issuance upon exercise of options issued under the Company's stock option, stock incentive and stock purchase plans (see Note 11) and 208,039 and 413,370 shares were reserved for issuance, sale and delivery upon the exercise of warrants (see Note 6) at December 31, 2000 and 1999, respectively. Warrants--During 2000 and 1999, 93,830 and 256,139 warrants, formerly referred to as redeemable warrants (see Note 6), were exercised to purchase 205,331 and 560,502 shares of common stock, respectively. Fractional shares are not issued, cash payments are made in lieu thereof, according to the terms of the warrant agreement. At December 31, 2000 and 1999, 95,031 and 188,861 warrants, respectively, were outstanding. The warrants will expire on February 3, 2008. Deferred Compensation--During 1998 and 1997, certain management investors acquired membership units of Allegiance Telecom, LLC at amounts less than the estimated fair market value of the membership units, consequently, the Company recognized deferred compensation of $10,090 and $978 at December 31, 1998 and 1997, respectively, of which $2,767, $2,767 and $2,726 was amortized to expense during the periods ended December 31, 2000, 1999 and 1998, respectively. In connection with the initial public offering, the redeemable preferred stock was converted into common stock and Allegiance Telecom, LLC was dissolved. The deferred compensation charge is amortized based upon the period over which F-14 69 the Company has the right to repurchase certain of the securities (at the lower of fair market value or the price paid by the employee) in the event the management investor's employment with the Company is terminated. Deferred compensation also includes stock options granted at an exercise price less than market value and stock options subject to variable plan accounting (see Note 11). Deferred Management Ownership Allocation Charge--On July 7, 1998, in connection with the initial public offering, certain venture capital investors and certain management investors owned 95.0% and 5.0%, respectively, of the ownership interests of Allegiance Telecom, LLC, which owned substantially all of the Company's outstanding capital stock. As a result of the successful initial public offering, Allegiance Telecom, LLC was dissolved and its assets (which consisted almost entirely of such capital stock) were distributed to the venture capital investors and management investors in accordance with the Allegiance Telecom, LLC's limited liability company agreement. This agreement provided that the equity allocation between the venture capital investors and the management investors be 66.7% and 33.3%, respectively, based upon the valuation implied by the initial public offering. The Company recorded the increase in the value of the assets of Allegiance Telecom, LLC allocated to the management investors as a $193,537 increase in additional paid-in capital, of which $122,476 was recorded as a noncash, nonrecurring charge to operating expenses and $71,061 was recorded as a deferred management ownership allocation charge. The deferred charge was amortized at $6,480, $18,789 and $44,836 as of December 31, 2000, 1999 and 1998, and will be further amortized at $175 during 2001, which is the period over which the Company has the right to repurchase certain of the securities (at the lower of fair market value or the price paid by the employee) in the event the management investor's employment with the Company is terminated. The Company repurchased 289,527 and 37,968 shares from terminated management investors during 2000 and 1999, respectively. A remaining deferred charge of $135 and $646, respectively, related to these shares was reversed to additional paid-in-capital upon the repurchase of the shares. 8. RELATED PARTIES: During 1999, in connection with the revolving credit facility (see Note 6) and the April 1999 equity offering (see Note 7), the Company incurred approximately $1,032 and $3,898, respectively in fees to an affiliate of an investor in the Company. During 2000, in connection with the new credit facilities (see Note 6) and the February 2000 equity offering (see Note 7), the Company incurred approximately $1,091 and $2,944, respectively, in fees to an affiliate investor of the Company. 9. COMMITMENTS AND CONTINGENCIES: The Company has entered into various operating lease agreements, with expirations through 2013, for network facilities, office space and equipment. Future minimum lease obligations related to the Company's operating leases as of December 31, 2000 are as follows: 2001 $18,714 2002 20,121 2003 20,444 2004 19,208 2005 and thereafter 96,196 -------
Total rent expense for the years ended December 31, 2000, 1999 and 1998, was $16,950, $10,948 and $2,992. In April 2000, the Company executed a procurement agreement with Lucent Technologies, Inc. for a broad range of advanced telecommunications equipment, software and services. This agreement contains a three-year $350 million purchase commitment. The Company must complete purchases totaling $80 million by December 31, 2000, an aggregate of $180 million of purchases by December 31, 2001, and the full $350 million of aggregate purchases on or before December 31, F-15 70 2002. As of December 31, 2000, the Company has completed purchases totaling $103,367, and expects to meet the required purchase milestones for the remainder of the procurement agreement. If the Company does not meet the required intermediate purchase milestones, the Company will be required to provide cash settlement in an amount equal to the shortfall. Such cash settlements may be applied to future purchases during the commitment period. If the Company does not purchase $350 million of products and services from Lucent and its affiliates by December 31, 2002, the Company will be required to provide cash settlement in an amount equal to the cumulative shortfall. 10. FEDERAL INCOME TAXES: The Company accounts for income tax under the provisions of SFAS No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires an asset and liability approach which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events which have been recognized in the Company's financial statements. The Company had approximately $460,000 and $220,000 of net operating loss carryforwards for federal income tax purposes at December 31, 2000 and 1999, respectively. The net operating loss carryforwards will begin to expire in the years 2012 through 2019 if not previously utilized. The Company has recorded a valuation allowance equal to the net deferred tax assets at December 31, 2000 and 1999, due to the uncertainty of future operating results. The valuation allowance will be reduced at such time as management is able to determine that the realization of the deferred tax assets is more likely than not to occur. Any reductions in the valuation allowance will reduce future provisions for income tax expense. The Company's deferred tax assets and liabilities and the changes in those assets are:
2000 1999 Changes ----------- ----------- ----------- Start-up costs capitalized for tax purposes $ 1,503 $ 514 $ 989 Net operating loss carryforward 172,903 75,736 97,167 Amortization of original issue discount 35,524 17,834 17,690 Depreciation (20,226) (10,253) (9,973) Allowance for doubtful accounts 7,299 2,652 4,647 Accrued liabilities and other 2,547 1,767 780 Valuation allowance (199,550) (88,250) (111,300) ----------- ----------- ----------- $ -- $ -- $ -- =========== =========== ===========
Amortization of the original issue discount on the Series B notes and the 12 7/8% notes as interest expense is not deductible in the income tax return until paid. Amortization of goodwill created in a stock acquisition is not deductible in the Company's income tax return; therefore, the effective income tax rate differs from the statutory rate. Under existing income tax law, all operating expenses incurred prior to commencing principal operations and expansion into new markets are capitalized and amortized over a five-year period for tax purposes. 11. STOCK OPTION/STOCK INCENTIVE/STOCK PURCHASE PLANS: At December 31, 2000, the Company had three stock-based compensation plans, the 1997 Nonqualified Stock Option Plan, the 1998 Stock Incentive Plan and the Employee Stock Discount Purchase Plan. The Company applies the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25) and the related interpretations in accounting for the Company's plans. Had compensation cost for the Company's plans been determined based on the fair value of the options as of the grant dates for awards under the plans consistent with the method prescribed in SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net loss applicable to common stock and net loss per share would have increased to the pro forma amounts indicated below. The Company utilized the following assumptions in calculating the estimated fair value of each option on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants: F-16 71
2000 1999 1998 ---------- ---------- ---------- Dividend yield --% --% --% Expected volatility 109.9% 83.4% 89.1% Expected life 4.4 3.5 6.0 Risk-free interest rate: 1997 Option Plan 5.83% 5.70% 5.63% 1998 Stock Incentive Plan 5.83% 5.70% 4.70% ---------- ---------- ----------
2000 1999 1998 ----------- ----------- ----------- Net loss applicable to common stock--as reported $ (277,567) $ (214,868) $ (258,460) Net loss applicable to common stock--pro forma $ (407,506) (228,839) (259,797) Net loss per share, basic and diluted--as reported (2.58) (2.37) (7.02) Net loss per share, basic and diluted--pro forma (3.78) (2.52) (7.05) ----------- ----------- -----------
1997 Nonqualified Stock Option Plan And 1998 Stock Incentive Plan--Under the 1997 option plan, the Company granted options to key employees, a director and a consultant of the Company for an aggregate of 1,580,321 shares of common stock. The Company will not grant options for any additional shares under the 1997 option plan. Under the 1998 stock incentive plan, the Company may grant options to certain employees, directors, advisors and consultants of the Company. The 1998 stock incentive plan provides for issuance of the following types of incentive awards: stock options, stock appreciation rights, restricted stock, performance grants and other types of awards that the Compensation Committee of the Board of Directors deems consistent with the purposes of the 1998 stock incentive plan. The Company has 23,590,841 shares of common stock reserved for issuance under the 1998 stock incentive plan at December 31, 2000. Options granted under both plans generally have a term of six years and vest over a three-year period and the Compensation Committee of the Board of Directors administers both option plans. A summary of the status of the 1997 option plan as of December 31, 2000, 1999 and 1998 is presented in the table below:
December 31, 2000 December 31, 1999 December 31, 1998 ---------------------------- -------------------------- ---------------------------- Weighted Weighted Weighted Average Average Average Shares Exercise Price Shares Exercise Price Shares Exercise Price ----------- -------------- ---------- -------------- ----------- -------------- Outstanding, beginning of period 1,088,283 $ 1.7 1,340,344 $ 1.82 282,666 $ 1.65 Granted -- -- -- -- 1,297,655 1.84 Exercised (334,216) 1.76 (155,686) 1.84 -- -- Forfeited (17,657) 1.89 (96,375) 2.15 (239,977) 1.73 ----------- ----------- ----------- ----------- ----------- ----------- Outstanding, end of period 736,250 1.80 1,088,283 1.79 1,340,344 1.82 =========== =========== =========== =========== =========== =========== Options exercisable at period-end 586,485 523,301 66,718 =========== =========== =========== =========== =========== =========== Weighted average fair value of options granted $ -- $ -- $ 1.44 =========== =========== =========== =========== =========== ===========
F-17 72 The following table sets forth the range of exercise prices and weighted average remaining contractual life at December 31, 2000 under the 1997 option plan:
Options Outstanding Options Exercisable ----------------------------------------------------------------------- --------------------------------- Weighted Weighted Weighted Number Average Average Number Average Exercise Price of Shares Contractual Life Exercise Price of Shares Exercise Price -------------- -------------- ---------------- -------------- -------------- -------------- $ 1.65 562,445 3.1 $ 1.65 453,958 $ 1.65 2.31 173,806 3.2 2.31 132,527 2.31 -------------- -------------- -------------- -------------- -------------- -------------- 736,250 586,485 -------------- -------------- -------------- -------------- -------------- --------------
A summary of the status of the 1998 stock incentive plan as of December 31, 2000, 1999 and 1998 is presented in the table below:
December 31, 2000 December 31, 1999 December 31, 1998 ----------------------------- ---------------------------- ---------------------------- Weighted Weighted Weighted Average Average Average Shares Exercise Price Shares Exercise Price Shares Exercise Price ----------- -------------- ----------- -------------- ----------- -------------- Outstanding, beginning of period 6,428,607 $ 26.66 593,717 $ 6.70 -- $ -- Granted 16,501,538 33.27 6,723,866 28.04 650,062 6.72 Exercised (366,604) 11.47 (42,555) 6.47 -- -- Forfeited (2,218,441) 50.19 (846,421) 24.63 (56,345) 6.86 ----------- ----------- ----------- ----------- ----------- ----------- Outstanding, end of period 20,345,100 29.73 6,428,607 26.66 593,717 6.70 =========== =========== =========== =========== =========== =========== Options exercisable at period-end 2,184,113 140,779 -- =========== =========== =========== =========== =========== =========== Weighted average fair value of options granted $ 26.38 $ 24.56 $ 5.04 =========== =========== =========== =========== =========== ===========
The following table sets forth the exercise prices and weighted average remaining contractual life at December 31, 2000 under the 1998 stock incentive plan:
Options Outstanding Options Exercisable ------------------------------------------------------------------------ -------------------------- Weighted Weighted Weighted Range of Number Average Average Number Average Exercise Prices of Shares Contractual Life Exercise Price of Shares Exercise Price --------------- --------- ---------------- -------------- --------- -------------- $0.00 - 19.99 977,537 4.1 $ 4.26 523,470 $ 4.06 10.00 - 14.99 8,944,056 5.7 14.00 72,535 13.24 15.00 - 34.99 1,106,323 4.5 22.25 245,045 16.66 35.00 - 39.99 3,782,403 4.2 35.47 1,294,532 35.36 40.00 - 59.99 2,376,708 5.4 46.49 35,098 52.76 60.00 - 79.99 3,158,073 4.9 65.29 13,433 77.26 20,345,100 2,184,133
As the estimated fair market value of the Company's common stock (as implied by the initial public offering price) exceeded the exercise price of certain options granted during 1998 and 1997, the Company recognized deferred compensation of $7,635 and $2,031 at December 31, 1998 and 1997, respectively, of which $2,889, $3,004 and $2,581 was amortized to expense during the year ended December 31, 2000, 1999 and 1998, respectively. In 1998, the Company reversed $599 of unamortized deferred compensation related to options forfeited. F-18 73 In February 1999, the Company granted employee stock options under the 1998 stock incentive plan with an exercise price below market value at the date of grant. A deferred compensation charge of $6,807 was recognized, and $2,269 and $2,080 has been amortized to expense at December 31, 2000 and 1999, respectively. During 2000, the Company recognized a deferred compensation charge of $957 as a result of an exchange of unvested stock options of acquired businesses (see Note 3) for employee stock options under the Company's 1998 stock incentive plan. $96 has been amortized to expense at December 31, 2000. In November 2000, the Company granted non-qualified, outperform stock options to certain key employees under the 1998 stock incentive plan. These outperform options are notated as such due to the nature of the options in which the ultimate number and exercise price of the options are dependent on the performance of the Company's exchange-traded stock price relative to the performance of the NASDAQ 100 Index. As the number of options and the exercise price were not fixed at the date of grant, the Company will account for these options using variable plan accounting under APB No. 25. This accounting will require the Company to measure and record compensation ratably from the date of grant until the options are exercised. The outperform stock options vest in equal quarterly amounts through November 2001 and generally expire on March 31, 2003. If the Company's exchange-traded stock price outperforms the NASDAQ 100 Index on a go-forward basis, it is possible that the Company could have material compensation charges in future periods related to unexercised outperform stock options. At December 31, 2000, the Company recorded a deferred compensation charge of $12,128 and compensation expense of $2,106 through that date. Employee Stock Discount Purchase Plan--The Company's stock purchase plan is intended to give employees a convenient means of purchasing shares of common stock through payroll deductions. Each participating employee's contributions will be used to purchase shares for the employee's share account as promptly as practicable after each calendar quarter. The cost per share will be 85% of the lower of the closing price of the Company's common stock on the Nasdaq National Market on the first or the last day of the calendar quarter. The Company has 3,203,265 shares of common stock reserved for issuance under the stock purchase plan at December 31, 2000. During 2000 and 1999, 109,727 and 145,574 shares were issued under the stock purchase plan for proceeds of $4,409 and $1,468, respectively. As of December 31, 1998, no shares had been issued under the stock purchase plan. As of December 31, 2000, participants have contributed $1,557, which will be used to purchase 82,270 shares in January 2001. The Compensation Committee of the Board of Directors administers the stock purchase plan. 12. LONG-TERM SALES CONTRACT: During 2000, the Company signed a long-term contract to provide data services to Genuity Solutions, Inc., a network service provider and operator of a nationwide Internet network. This contract establishes Genuity as the Company's largest customer. Total revenues from Genuity for the year ended December 31, 2000 were $22,274. F-19 74 SCHEDULE I -- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors and Stockholders of Allegiance Telecom, Inc.: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheets of Allegiance Telecom, Inc. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for the years ended December 31, 2000, 1999, and 1998 incorporated by reference in this Form 10-K and have issued our report thereon dated February 12, 2001. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedule II -- Valuation and Qualifying Accounts is not a required part of the basic consolidated financial statements but is supplementary information required by the Securities and Exchange Commission. This information has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Dallas, Texas February 12, 2001 S-I 75 ALLEGIANCE TELECOM, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (DOLLARS IN THOUSANDS)
ADDITIONS --------------------- BALANCE AT CHARGED TO CHARGED BEGINNING OF COSTS AND TO OTHER BALANCE AT DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS END OF PERIOD ----------- ------------ ---------- -------- ---------- ------------- ALLOWANCE FOR DOUBTFUL ACCOUNTS Year Ended December 31, 2000........ $7,800 $25,914 $555 $(21,631) $12,638 Year Ended December 31, 1999........ $ 577 $ 7,397 $222 $ (396) $ 7,800 Year Ended December 31, 1998........ $ -- $ 650 $ -- $ (73) $ 577
S-II 76 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION ----------- ----------- 1.1 Form of Underwriting Agreement (Exhibit 1.1 to Allegiance's Registration Statement on Form S-1, as amended, Registration No. 333-53479 (the "Form S-1 Registration Statement")). 3.1 Amended and Restated Certificate of Incorporation (Exhibit 3.1 to Allegiance's Form 10-Q for the period ended June 30, 1998). 3.2 Certificate of Correction to Amended and Restated Certificate of Incorporation (Exhibit 3.2 to Allegiance's Form 10-K for the period ended December 31, 1998). 3.3 Amended and Restated By-Laws (Exhibit 3.2 to Allegiance's Form 10-Q for the period ended June 30, 1998). 4.1 Indenture, dated as of July 7, 1998, by and between Allegiance and The Bank of New York, as trustee (including the Form of Notes) (Exhibit 4.1 to Allegiance's Registration Statement on Form S-1, as amended, Registration No. 333-69543). 4.2 Indenture, dated as of February 3, 1998, by and between Allegiance and The Bank of New York, as trustee (Exhibit 4.2 to Allegiance's Registration Statement on Form S-4, as amended, Registration No. 333-49013 (the "Form S-4 Registration Statement")). 4.3 Form of 11 3/4% Senior Discount Notes (Exhibit 4.3 to the Form S-4 Registration Statement). 4.4 Collateral Pledge and Security Agreement, dated as of July 7, 1998, by and between Allegiance and The Bank of New York, as trustee (Exhibit 4.4 to Allegiance's Registration Statement on Form S-1, as amended, Registration No. 333-69543). 10.1 Stock Purchase Agreement, dated August 13, 1997, between Allegiance LLC and Allegiance (Exhibit 10.1 to the Form S-4 Registration Statement). 10.2 Securityholders Agreement, dated August 13, 1997, among Allegiance LLC, the Fund Investors, the Management Investors and Allegiance (Exhibit 10.2 to the Form S-4 Registration Statement). 10.3 Amended and Restated Registration Agreement, dated September 13, 1999, among certain stockholders and Allegiance (Exhibit 99.4 to Allegiance's Form 8-K filed with the SEC on September 22, 1999). 10.4 Warrant Registration Rights Agreement, dated as of January 29, 1998, by and among Allegiance and Morgan Stanley & Co. Incorporated, Salomon Brothers Inc, Bear, Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette Securities Corporation, as initial purchasers of the 11 3/4% Senior Discount Notes (Exhibit 10.11 to the Form S-4 Registration Statement). +10.5 Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan (Exhibit 10.4 to the Form S-4 Registration Statement). +10.6 Allegiance Telecom, Inc. 1998 Stock Incentive Plan (Exhibit 10.6 to the Form S-1 Registration Statement). +10.7 First Amendment to the Allegiance Telecom, Inc. 1998 Stock Incentive Plan (Exhibit 10.7 to Allegiance's Form 10-K for the period ended December 31, 1998). +10.8 Second Amendment to the Allegiance Telecom, Inc. 1998 Stock Incentive Plan (Exhibit 10.8 to Allegiance's Form 10-K for the period ended December 31, 1999). *+10.9 Third Amendment to the Allegiance Telecom, Inc. 1998 Stock Incentive Plan. +10.10 Amended and Restated Executive Purchase Agreement, dated December 13, 1999, between Allegiance and Royce J. Holland (Exhibit 10.9 to Allegiance's Form 10-K for the period ended December 31, 1999).
E-1 77
EXHIBIT NO. DESCRIPTION ----------- ----------- +10.11 Amended and Restated Executive Purchase Agreement, dated December 13, 1999, between Allegiance and Thomas M. Lord (Exhibit 10.10 to Allegiance's Form 10-K for the period ended December 31, 1999). +10.12 Amended and Restated Executive Purchase Agreement, dated December 13, 1999, between Allegiance and C. Daniel Yost (Exhibit 10.11 to Allegiance's Form 10-K for the period ended December 31, 1999). +10.13 Form of Executive Purchase Agreement among Allegiance LLC, Allegiance and each of the other Management Investors (Exhibit 10.8 to the Form S-4 Registration Statement). 10.14 Warrant Agreement, dated February 3, 1998, by and between Allegiance and The Bank of New York, as Warrant Agent (including the form of the Warrant Certificate) (Exhibit 10.9 to the Form S-4 Registration Statement). *10.15 Master Procurement Agreement, dated April 28, 2000 between Allegiance and Lucent Technologies Inc.** 10.16 Form of Indemnification Agreement by and between Allegiance and its directors and officers (Exhibit 10.13 to the Form S-1 Registration Statement). 10.17 Credit and Guaranty Agreement, dated February 15, 2000, among Allegiance Telecom, Inc., Allegiance Telecom Company Worldwide, certain subsidiaries of Allegiance Telecom, Inc., various lenders, Goldman Sachs Credit Partners L.P., a Syndication Agent and Sole Lead Arranger, Toronto Dominion (Texas), Inc., as Administrative Agent, and BankBoston, N.A. and Morgan Stanley Senior Funding, Inc., as Co-Documentation Agents (Exhibit 10.16 to Allegiance's Form 10-K for the period ended December 31, 1999). *11.1 Statement Regarding Computation of Per Share Earnings (Loss) for the year ended December 31, 2000. *11.2 Statement Regarding Computation of Per Share Earnings (Loss) for the year ended December 31, 1999. *11.3 Statement Regarding Computation of Per Share Earnings (Loss) for the year ended December 31, 1998 *21.1 Subsidiaries of Allegiance. ***23.1 Consent of Arthur Andersen LLP. 24.1 Power of Attorney (included in the signature page to this report).
--------------- * Previously filed in the Form 10-K filed with the SEC on March 30, 2001 ** Confidential treatment requested for certain portions of this agreement *** Consent filed herewith + Management contract or compensatory plan or arrangement filed as an exhibit to this report pursuant to Items 14(a) and 14(c) of Form 10-K E-2