UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------------------------------------------------
AMENDMENT NO. 1
TO
SCHEDULE TO
TENDER OFFER STATEMENT UNDER SECTION 14(D)(1) OR SECTION 13(E)(1)
OF THE SECURITIES EXCHANGE ACT OF 1934
Z-TEL TECHNOLOGIES, INC.
(Name of Subject Company)
Z-TEL TECHNOLOGIES, INC.
(Name of Filing Person)
Series D Convertible Preferred Stock,
8% Convertible Preferred Stock, Series E, and
12% Junior Redeemable Convertible Preferred Stock, Series G
(Title of Class of Securities)
N/A
(CUSIP Number of Class of Securities)
Andrew L. Graham, Esq.
Corporate Counsel
Z-Tel Technologies, Inc.
601 South Harbour Island Boulevard, Suite 220
Tampa, Florida 33602
(813) 273-6261
(Name, Address and Telephone Number of Person
Authorized to Receive Notices and Communications on Behalf of Filing Person)
With a copy to:
Gary A. Brooks, Esq.
Cahill Gordon & Reindel LLP
80 Pine Street
New York, New York 10005
(212) 701-3000
CALCULATION OF FILING FEE
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Transaction Valuation Amount of Filing Fee
------------------------------------------------------------------------------
$115,142,180* $14,589**
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* Estimated solely for the purpose of calculating the registration fee and based
on the product of (a) the average of the high and low prices of the Company's
common stock as reported on the Nasdaq SmallCap Market on September 28, 2004
($0.49) and (b) the maximum number shares of common stock, assuming all
outstanding shares of preferred stock are tendered and accepted, to be issued in
the exchange offer (234,984,041 shares).
** The amount of the filing fee was calculated in accordance with Rule 0-11 of
the Securities Exchange Act of 1934 and equals $126.70 for each $1,000,000 of
the value of the transaction.
|X| Check the box if any part of the fee is offset as provided by Rule
0-11(a)(2) and identify the filing with which the offsetting fee was
previously paid. Identify the previous filing by registration statement
number or the Form or Schedule and the date of its filing.
Amount Previous Paid: $23,029 Filing Party: Z-Tel Technologies, Inc.
Form or Registration No.: Schedule TO (File No. 005-57653) Date Filed: September 30, 2004
|_| Check the box if the filing relates solely to preliminary communications
made before the commencement of a tender offer.
Check the appropriate boxes below to designate any transactions to which the
statement relates:
|_| third-party tender offer subject to Rule 14d-1.
|X| issuer tender offer subject to Rule 13e-4.
|_| going-private transaction subject to Rule 13e-3.
[ ] amendment to Schedule 13D under Rule 13d-2.
Check the following box if the filing is a final amendment reporting the results
of the tender offer: [ ]
This Amendment No. 1 to the Tender Offer Statement on Schedule TO
("Schedule TO") amends and supplements the Tender Offer Statement on Schedule TO
filed with the Securities and Exchange Commission on September 30, 2004 by Z-Tel
Technologies, Inc., a Delaware corporation (the "Company"), and relates to an
offer by the Company to exchange (the "Exchange Offer") shares of its common
stock for shares of its outstanding series of preferred stock as set forth
herein on the terms and subject to the conditions described in the offer to
exchange (as amended, the "Offer to Exchange"). The terms and conditions of the
Exchange Offer are set forth in the Offer to Exchange and the accompanying
Letter of Transmittal, which are exhibits (a)(1)(A) and (a)(2)(B) hereto.
The information set forth in the Offer to Exchange, including the exhibits
thereto, the accompanying Letter of Transmittal and the Preliminary Proxy
Statement, is hereby expressly incorporated herein by reference in response to
all items required in this Schedule TO.
Item 1. Summary Term Sheet.
See the section of the Offer to Exchange, dated October 21, 2004, attached
hereto as Exhibit a(1)(A) (the "Offer to Exchange"), captioned "Summary."
Item 2. Subject Company Information.
(a) The name of the Company to which this Schedule TO relates is Z-Tel
Technologies, Inc., a company organized under the laws of the State of Delaware
(the "Company"). The address of the principal office of the Company is 601 South
Harbour Island Boulevard, Suite 220, Tampa, Florida 33602 and its telephone
number is (813) 273-6261.
(b) The titles of the classes of equity securities to which this Schedule
TO relates are:
i. Series D Convertible Preferred Stock (the "Series D Preferred
Stock"),
ii. 8% Convertible Preferred Stock, Series E (the "Series E Preferred
Stock"), and
iii. 12% Junior Redeemable Convertible Preferred Stock, Series G (the
"Series G Preferred Stock").
As of September 27, 2004, there were 3,976,723 shares of Series D Preferred
Stock, 4,166,667 shares of Series E Preferred Stock, and 171.214286 shares of
Series G Preferred Stock outstanding.
(c) See the section of the Offer to Exchange captioned "Market for Common
Stock and Preferred Stock."
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Item 3. Identity and Background of Filing Person.
(a) This Schedule TO is being filed by Z-Tel Technologies, Inc. The address
of the Company's principal office is 601 South Harbour Island Boulevard, Suite
220, Tampa, Florida 33602 and its telephone number is (813) 273-6261. For the
executive officers and directors of the Company, see the section of the Offer to
Exchange captioned "Management." The business address and telephone numbers of
each executive officer and director are the same as are listed above for the
Company.
Item 4. Terms of the Transaction.
(a) See the sections of the Offer to Exchange captioned "Summary," "Risk
Factors," "The Offer to Exchange," "Description of Our Preferred Stock,"
"Description of Our Common Stock," "Material United States Federal Income Tax
Consequences," and "Certain Securities Laws Considerations."
(b) See the section of the Offer to Exchange captioned "Interests of
Directors and Officers."
Item 5. Past Contacts, Transactions, Negotiations and Agreements.
(a) See the section of the Offer to Exchange captioned "Agreements
Involving Our Securities."
Item 6. Purposes of the Transaction and Plans or Proposals.
(a) See the sections of the Offer to Exchange captioned "Summary" and
"Reasons for the Offer to Exchange."
(b) See the section of the Offer to Exchange captioned "Use of Proceeds."
(c) See the sections of the Offer to Exchange captioned "Summary," "Reasons
for the Offer to Exchange," "Risk Factors," "Business Overview," and "Use of
Proceeds."
Item 7. Source and Amount of Funds or Other Consideration.
(a) See the sections of the Offer to Exchange captioned "Summary" and "The
Offer to Exchange."
(b) See the section of the Offer to Exchange captioned "The Offer to
Exchange-Conditions."
(d) Not Applicable.
Item 8. Interest in Securities of the Subject Company.
(a) See the sections of the Offer to Exchange captioned "Interests of
Directors and Officers" and "Security Ownership."
(b) See the sections of the Offer to Exchange captioned "Interests of
Directors and Officers" and "Security Ownership of Certain Beneficial Owners and
Management."
Item 9. Persons/Assets Retained, Employed, Compensated or Used.
(a) See the section of the Offer to Exchange captioned "Fees and Expenses."
Item 10. Financial Statements.
(a) Incorporated by reference from the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2003; Quarterly Report on Form 10-Q for
the quarter ended March 31, 2004; and Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004.
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(b) See the section of the Offer to Exchange captioned "Financial
Information."
Item 11. Additional Information.
(a) See the sections of the Offer to Exchange captioned "Interest of
Directors and Officers," "Agreements Involving our Securities" and "Certain
Legal Matters; Regulatory Approvals."
(b) Not applicable.
Item 12. Exhibits.
Exhibit No. Description
----------- -----------
(a)(1)(A) Amended Offer to Exchange, dated October 21, 2004.
(a)(1)(B) Form of Letter of Transmittal, dated October 21, 2004, relating to the
Amended Offer to Exchange.
(a)(2) Preliminary Proxy Statement, filed with the Securities and Exchange
Commission on October 21, 2004.
Item 13. Information Required by Schedule 13E-3.
Not applicable.
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SIGNATURE
After due inquiry and to the best of my knowledge and belief, I certify
that the information set forth in this statement is true, complete and correct.
Z-TEL TECHNOLOGIES, INC.
By: /s/ Horace J. Davis, III
----------------------------------
Name: Horace J. Davis, III
Title: Acting Chief Executive Officer
Dated: October 21, 2004
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Exhibit (a)(1)(A)
Z-TEL TECHNOLOGIES, INC.
AMENDED OFFER TO EXCHANGE
SHARES OF
SERIES D CONVERTIBLE PREFERRED STOCK,
8% CONVERTIBLE PREFERRED STOCK, SERIES E, AND
12% JUNIOR REDEEMABLE CONVERTIBLE PREFERRED STOCK, SERIES G,
FOR SHARES OF COMMON STOCK
____________________________________________
THIS AMENDED OFFER TO EXCHANGE WILL EXPIRE AT 5:00 P.M., NEW
YORK CITY TIME, ON TUESDAY, NOVEMBER 23, 2004, UNLESS EXTENDED PURSUANT
TO THE TERMS HEREOF (THE "EXPIRATION DATE"). HOLDERS OF SHARES OF
PREFERRED STOCK MUST VALIDLY TENDER THOSE SHARES ON OR PRIOR TO THE
EXPIRATION DATE IN ORDER TO BE ELIGIBLE TO RECEIVE THE EXCHANGE OFFER
CONSIDERATION.
___________________________________________
We are offering you the opportunity to voluntarily exchange any or all of
your shares of our outstanding preferred stock as follows (subject in each case
to the impact of any reverse stock split):
o for shares of our Series D Convertible Preferred Stock (the "Series D
Preferred Stock"), which as of September 27, 2004 have a liquidation
preference (representing original investment plus accrued and unpaid
dividends) of $16.55 per share and conversion price of $8.47 per
share, to exchange 25.69030 shares of our common stock, par value
$0.01 per share (the "Common Stock"), for each share of our Series D
Preferred Stock (representing an exchange price of approximately
$0.644 per share);
o for shares of our 8% Convertible Preferred Stock, Series E (the
"Series E Preferred Stock"), which as of September 27, 2004 have a
liquidation preference of $16.26 per share and conversion price of
$8.08 per share, to exchange 25.24216 shares of our Common Stock for
each share of our Series E Preferred Stock (representing an exchange
price of approximately $0.644 per share); and
o for shares of our 12% Junior Redeemable Convertible Preferred Stock,
Series G (the "Series G Preferred Stock" and, together with the Series
D Preferred Stock and the Series E Preferred Stock, the "Preferred
Stock"), which as of September 27, 2004 have a liquidation preference
of $144,975.90 per share and conversion price of $1.28 per share, to
exchange 161,469.4 shares of our Common Stock for each share of our
Series G Preferred Stock (representing an exchange price of
approximately $0.898 per share).
On October 20, 2004, the closing price for the Common Stock on the Nasdaq
SmallCap Market was $0.39 per share.
We intend to call a special meeting (the "Special Meeting") of our
stockholders to be held on November 16, 2004 to approve consummation of this
offer to exchange, as amended (the "Exchange Offer") and certain related
matters. We expect to promptly commence a proxy solicitation of our
stockholders, including holders of Preferred Stock, by means of a separate proxy
statement in connection the Special Meeting. At the special meeting we will ask
our stockholders to, among other things, (1) approve consummation of this
Exchange Offer, (2) amend the terms of the Series D Preferred Stock to remove
certain restrictive provisions provided for in the certificate of designation
governing the Series D Preferred Stock, (3) amend our charter to terminate the
certificate of designation governing the Series D Preferred Stock if all of the
outstanding Series D Preferred Stock is tendered for exchange in this Exchange
Offer, (4) amend our charter to terminate the certificate of designation
governing the Series E Preferred Stock, (5) amend the terms of the Series G
Preferred Stock to remove certain restrictive provisions provided for in the
certificate of designation governing the Series G Preferred Stock, (6) amend our
charter to terminate the certificate of designation governing the Series G
Preferred Stock if all of the outstanding Series G Preferred Stock is tendered
for exchange in this Exchange Offer, (7) authorize our board of directors to
adopt one of several reverse stock split proposals with respect to the Common
Stock, within their discretion, and (8) approve a new management equity
incentive plan and the reservation of shares of Common Stock for issuance
thereunder (collectively, the "Special Meeting Matters"). We intend to file a
press release immediately following the Special Meeting to advise our
stockholders of the result of the votes on the Special Meeting Matters. If we
decide to postpone the Special Meeting and proceed with the Exchange Offer, we
will extend the Exchange Offer to the close of business on the fifth business
day following the Special Meeting date.
CONSUMMATION OF THE EXCHANGE OFFER IS CONDITIONED UPON THE APPROVAL BY OUR
STOCKHOLDERS OF THE SPECIAL MEETING MATTERS AND UPON THE TENDER BY THE 1818 FUND
III, L.P. ("THE 1818 FUND") OF ALL PREFERRED STOCK THAT IT OWNS (AND THE
ACCEPTANCE BY US OF SUCH SHARES) IN THE EXCHANGE OFFER. REPRESENTATIVES OF THE
1818 FUND HAVE INDICATED THAT THEY INTEND TO TENDER ALL OF THE 1818 FUND'S
SHARES OF PREFERRED STOCK IN THE OFFER IF SUBSTANTIALLY ALL OF THE SHARES OF
PREFERRED STOCK OWNED BY OTHER HOLDERS ARE TENDERED IN THE OFFER. CONSUMMATION
OF THE EXCHANGE OFFER IS ALSO SUBJECT TO THE OTHER CONDITIONS DESCRIBED HEREIN.
We will announce, by means of a press release, the amount of each series of
Preferred Stock tendered as of the close of business (1) on the second business
day preceding the date of the Special Meeting and (2) on the second business day
prior to expiration of the Exchange Offer. We will also announce, by means of a
press release, when The 1818 Fund has tendered its shares of Preferred Stock. If
necessary, we will extend the Exchange Offer to the close of business on the
fifth business day following the date upon which The 1818 Fund tenders its
shares of Preferred Stock.
We will accept shares of Preferred Stock ("Preferred Shares") validly
tendered for exchange and not withdrawn as of the Expiration Date, upon the
terms and conditions set forth
herein and in the Letter of Transmittal (the "Letter of Transmittal") attached
hereto as Exhibit A. This Offer to Exchange and the Letter of Transmittal
together constitute the "Offer."
THE ACTUAL NUMBER OF SHARES OF COMMON STOCK TO BE ISSUED IN EXCHANGE FOR
THE PREFERRED STOCK TENDERED IN THE EXCHANGE OFFER WILL AUTOMATICALLY BE
ADJUSTED BY A REVERSE STOCK SPLIT TO BE EFFECTED PRIOR TO THE CONSUMMATION OF
THE EXCHANGE OFFER. FOR ADDITIONAL INFORMATION ON THE REVERSE STOCK SPLIT, SEE
"THE OFFER TO EXCHANGE--NUMBER OF SHARES."
See "Risk Factors" beginning on page 9 and "Material United States Federal
Income Tax Consequences" beginning on page 40 for a discussion of certain
factors that you should consider in connection with the Offer.
You may direct questions and requests for assistance or additional copies
of this Offer to Exchange, the Letter of Transmittal, the Notice of Guaranteed
Delivery and other related documents to Andrew L. Graham, the Exchange and
Information Agent, at the address and telephone numbers set forth on the last
printed page of this Offer to Exchange.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved this transaction or determined if this
document is accurate or complete.
We are not, and our Board of Directors, our employees and the Exchange and
Information Agent are not, making any recommendation to you as to whether you
should tender or refrain from tendering your Preferred Shares. You must make the
decision whether to tender your Preferred Shares and, if so, how many Preferred
Shares to tender.
THE DATE OF THIS AMENDED OFFER TO EXCHANGE IS OCTOBER 21, 2004.
IMPORTANT INFORMATION REGARDING THE OFFER
We are making this Offer in reliance upon the exemption from registration
provided by Section 3(a)(9) of the Securities Act of 1933, as amended (the
"Securities Act"). We are not aware of any jurisdiction where making the Offer
to Exchange is not in compliance with applicable law. If we become aware that
the Offer to Exchange is not in compliance with any jurisdiction's applicable
law, we will make a good faith effort to comply with such law. If with our good
faith efforts, we cannot comply with such law, the Offer to Exchange will not be
made to (nor will tenders be accepted from or on behalf of) the holders of
Preferred Shares residing in such jurisdiction.
You should rely only on the information incorporated by reference or
provided in this Offer to Exchange. We have not authorized anyone to provide you
with different information or to solicit or seek tenders of Preferred Stock
pursuant to the Offer. You should not assume that the information in this Offer
to Exchange or any supplement is accurate as of any date other than the date on
the cover of this Offer to Exchange.
As described on the cover of this Exchange Offer, we expect to commence a
proxy solicitation providing for, among other things, alternative reverse stock
splits of our Common Stock. The information included in and incorporated by
reference into this Offer to Exchange does not give effect to any such reverse
stock split. For additional information on the reverse stock split, see "The
Offer to Exchange--Number of Shares."
The contents of this Offer to Exchange should not be construed as legal,
business or tax advice. You should consult your own attorney, business advisor
and tax advisor as to such matters.
CAUTION AS TO UNAUTHORIZED STATEMENTS
WE HAVE NOT AUTHORIZED ANY PERSON TO MAKE ANY RECOMMENDATION ON OUR BEHALF
AS TO WHETHER YOU SHOULD TENDER OR REFRAIN FROM TENDERING PREFERRED SHARES UNDER
THE OFFER TO EXCHANGE. WE HAVE NOT AUTHORIZED ANYONE TO GIVE ANY INFORMATION, TO
MAKE ANY REPRESENTATION OR TO SOLICIT ANY TENDERS IN CONNECTION WITH THE OFFER
TO EXCHANGE OTHER THAN WHAT IS CONTAINED IN THIS OFFER TO EXCHANGE OR IN THE
LETTER OF TRANSMITTAL.
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TABLE OF CONTENTS
Page
----
Summary.......................................................................1
Reasons for the Offer to Exchange.............................................5
Business Overview.............................................................6
Financial Information.........................................................6
Risk Factors..................................................................9
Special Factors Relating to the Offer to Exchange............................20
Management...................................................................22
Use of Proceeds..............................................................23
The Offer to Exchange........................................................23
Description of Our Preferred Stock...........................................32
Description of Our Common Stock..............................................39
Market for Common Stock and Preferred Stock..................................39
Material United States Federal Income Tax Consequences.......................41
Certain Securities Laws Considerations.......................................42
Interests of Directors and Officers..........................................42
Security Ownership...........................................................43
Agreements Involving Our Securities..........................................45
Certain Legal Matters; Regulatory Approvals..................................45
Fees and Expenses............................................................46
Independent Auditors.........................................................46
Incorporation of Certain Documents by Reference..............................46
Miscellaneous................................................................47
Where You Can Find More Information..........................................48
Exhibits
Exhibit A Letter of Transmittal
-ii-
SUMMARY
This general summary is provided solely for your convenience. You
should read the entire Offer to Exchange and the related Letter of Transmittal
before you decide whether to participate in the Offer.
Shares Eligible for Exchange................... The Offer applies to all
shares of our outstanding
Preferred Stock, which is
comprised of the following
three series:
o Series D Convertible
Preferred Stock, par value
$.01 per share,
o 8% Convertible Preferred
Stock, Series E, par value
$.01 per share, and
o 12% Junior Redeemable
Convertible Preferred Stock,
Series G, par value $.01 per
share.
Reason for the Offer........................... The purpose of the Offer is
(i) to improve and simplify
our capital structure,
thereby enabling us to
potentially attract
necessary additional
financing for our business
plan, (ii) to provide
holders of Preferred Stock
with a means to gain greater
liquidity by issuing to them
Common Stock and (iii) to
increase the aggregate
market value of our Common
Stock to maintain our
listing on the Nasdaq
SmallCap Market.
Overview of the Offer to Exchange.............. We are offering to all
holders of our Preferred
Shares the right to tender
those shares in exchange for
newly issued shares of our
Common Stock (the "Common
Shares"). The exchange ratio
(the "Exchange Ratio") and
consideration (the "Exchange
Consideration") for each
series of Preferred Stock
will be as follows (subject
in each case to the impact
of any reverse stock
split):
o For each share of our
Series D Preferred Stock, we
will issue 25.69030 Common
Shares (representing an
effective conversion price
of approximately $0.644 per
share);
o For each share of our
Series E Preferred Stock, we
will issue 25.24216 Common
Shares (representing an
effective conversion price
of approximately $0.644 per
share); and
o For each share of our
Series G Preferred Stock, we
will issue 161,494.4 Common
Shares (representing an
effective conversion price
of approximately $0.898 per
share).
As of September 27, 2004
there were approximately
38.8 million shares of
Common Stock outstanding.
The actual number of shares
of Common Stock to be issued
in exchange for the
Preferred Stock tendered in
the Exchange Offer will
automatically be adjusted by
a reverse stock split to be
effected prior to the
consummation of the Exchange
Offer. For additional
information on the reverse
stock split, see "The Offer
to Exchange--Number of
Shares."
Assuming the tender of all
outstanding Preferred Stock
in the Exchange Offer, the
exercise of all outstanding
options (other than
management options
outstanding prior to the
Exchange Offer), warrants
and other rights to acquire
Common Stock and the
inclusion of all shares of
Common Stock expected to be
reserved for issuance under
the new management equity
incentive plan (a "Fully
Diluted Basis"), after
giving effect to the
Exchange Offer:
o the former holders of
Series D Preferred Stock
would own approximately
34.0% of the Common Stock on
a Fully Diluted Basis;
o the former holders of
Series E Preferred Stock
would own approximately
35.0% of the Common Stock on
a Fully Diluted Basis;
o the former holders of
Series G Preferred Stock
would own approximately 9.2%
of the Common Stock on a
Fully Diluted Basis;
o the current holders of
Common Stock would own
approximately 13.8% of the
Common Stock on a Fully
Diluted Basis; and
o approximately 8.0% of
Common Stock, on a Fully
Diluted Basis, would have
been available for issuance
under the new management
equity incentive plan.
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Expiration Date................................ The Offer will expire on
Tuesday, November 23, 2004,
at 5:00 p.m., New York City
time, unless we extend the
Offer.
Number of Shares to Be Exchanged............... The Offer applies to all our
outstanding Preferred
Shares. As of September 27,
2004, there were:
o 3,976,723 shares of Series
D Preferred Stock
outstanding;
o 4,166,667 shares of Series
E Preferred Stock
outstanding; and
o 171.214286 shares of
Series G Preferred Stock
outstanding.
There is no minimum number
of shares that must be
tendered in the Offer. You
may tender some, all, or
none of your Preferred
Shares. However,
consummation of the Offer is
conditioned upon the tender
by The 1818 Fund of all
Preferred Shares that it
owns (and the acceptance by
us of such shares) in the
Offer. Representatives of
The 1818 Fund have indicated
that they intend to tender
all of The 1818 Fund's
Preferred Shares in the
Offer if substantially all
of the Preferred Shares
owned by other holders are
tendered in the Offer. We
will announce, by means of a
press release, the number of
shares of each series of
Preferred Stock tendered as
of the close of business (1)
on the second business day
preceding the date of the
Special Meeting and (2) on
the second business day
prior to expiration of the
Exchange Offer. We will also
announce, by means of a
press release, when The 1818
Fund has tendered its shares
of Preferred Stock. If
necessary, we will extend
the Exchange Offer to the
close of business on the
fifth business day following
the date upon which The 1818
Fund tenders its shares of
Preferred Stock.
Fractional shares will not
be issued. In the event that
a fraction of a Common Share
becomes issuable upon
consummation of the Offer to
Exchange, we will pay you an
amount in cash equal to the
closing price of our Common
Stock on the business day
preceding such consummation
(as adjusted to reflect the
impact of any reverse stock
split), multiplied by such
fraction of a Common Share.
-3-
Conditions..................................... Consummation of the Exchange
Offer is conditioned upon
the approval by stockholders
of the Special Meeting
Matters and upon the tender
by The 1818 Fund of all
Preferred Stock that it owns
in the Exchange Offer and
the acceptance by us of such
shares. In addition, we will
not be required to accept
the tender of any Preferred
Shares, and may terminate,
postpone, or amend the
Offer, if, among other
things, any action or
proceeding is commenced that
threatens the Offer or if
the other conditions
described under the heading
"The Offer to
Exchange--Conditions" are
not met.
Exchange Date.................................. We will exchange your
Preferred Shares for the
Exchange Consideration (or
return your Preferred Shares
to you if the Offer is not
consummated or such shares
are not accepted) promptly
after the Expiration Date.
Exchange and Information Agent................. Andrew L. Graham, our
Corporate Counsel
Withdrawal Rights.............................. You may withdraw tendered
Preferred Shares at any time
prior to the Expiration
Date.
Federal Income Tax Consequences................ Based upon discussions with
our tax counsel, we believe
the Offer will qualify as a
reorganization for federal
income tax purposes.
However, we did not seek or
obtain any tax opinion with
respect to the tax
consequences of the Offer.
Assuming the Offer qualifies
as a reorganization for
federal income tax purposes,
you will not recognize gain
or loss on the receipt of
the Exchange Consideration,
in exchange for the face
amount of your Preferred
Shares. However, to the
extent that Common Shares
are received for accrued but
unpaid dividends on
Preferred Shares, this
portion will be treated as
the payment of a dividend
distribution, but only to
the extent that the fair
market value of the
aggregate Common Shares
received in the exchange
exceeds the aggregate issue
price of the Preferred
Shares surrendered. For
additional information on
certain of the U.S. federal
income tax consequences of
the Exchange Offer, see
"Material United States
Federal Income Tax
Consequences."
For a complete description of the rights and preferences of the Preferred
Shares and the Common Shares, see "Description of Our Preferred Stock,"
"Description of Our Common Stock" and "Certain Securities Laws Considerations."
-4-
REASONS FOR THE OFFER TO EXCHANGE
Our business has been adversely affected by a number of factors in recent
years that have also adversely affected the trading price of our Common Stock.
We have developed a business plan that we believe can create long-term
opportunities for our business, but the execution of that business plan requires
us to obtain additional financing. We have had difficulty in attracting the
financing we will need in part due to the existence of the Preferred Stock
(particularly the mandatory redemption features thereof). Management believes
that the conversion of the Preferred Stock into Common Stock is essential for it
to be able to implement its business plan.
We are making this Offer because we believe that it will:
o Improve and simplify our capital structure by eliminating all or
substantially all of the approximately $158.4 million aggregate
liquidation preference of Preferred Stock in exchange for Common
Stock, thereby enabling us to potentially attract necessary additional
financing for our business plan.
o Eliminate all or substantially all of the dividends payable to holders
of Preferred Stock and the related dilutive effect on holders of
Common Stock (and increase the equity and earnings attributable to
Common Stock).
o Reduce or eliminate the mandatory redemption payments on our Preferred
Stock, which will be due in 2006 on the Series G Preferred Stock and
in 2008 on the Series D Preferred Stock and Series E Preferred Stock.
o Give the holders of Preferred Stock a means to gain greater liquidity
by issuing Common Shares, which subject to securities law restrictions
applicable to our affiliates, will be freely tradable and eligible for
listing or quotation on the stock market or quotation system on which
our Common Stock is then listed or quoted. The Preferred Stock does
not currently trade on any exchange or stock market.
o Give the holders of Preferred Stock an opportunity to receive more
shares of Common Stock than they would be entitled to receive under
the existing conversion provisions of the Preferred Stock. Each share
of Series D Preferred Stock is currently convertible into 1.95 shares
of Common Stock, each share of Series E Preferred Stock is currently
convertible into 2.01 shares of Common Stock, and each share of Series
G Preferred Stock is currently convertible into 113,262 shares of
Common Stock.
o Increase the aggregate market value of our Common Stock, which is
currently below the $35 million minimum amount required to maintain
listing on the Nasdaq SmallCap Market, to an amount substantially in
excess of the minimum amount required to maintain listing of the
Common Stock on the Nasdaq SmallCap Market.
Notwithstanding the fact that the Exchange Offer is conditioned upon the
approval by our stockholders of the Special Meeting Matters we are distributing
the Offer to Exchange to holders of our Preferred Stock prior to the Special
Meeting because under applicable law the Offer is re-
-5-
quired to be kept open for a minimum of 20 business days and we believe we
should attempt to synchronize the Exchange Offer period and the notice period
for the Special Meeting so that they run concurrently, with an overall view
towards most expeditiously and efficiently consummating the Offer and
transactions contemplated by the Special Meeting Matters.
BUSINESS OVERVIEW
Z-Tel Technologies, Inc. is a communications service provider. We provide
innovative and cost effective telecommunications services to consumers, business
and other communications companies by integrating our own enhanced
communications systems and advanced operational support systems with access to
communication networks. Our systems have the capability to integrate with
wireline, wireless, cable, Internet and other communications transport networks.
Our current generation of services relies primarily on access to local and long
distance telephone networks. A recent court ruling has created legal uncertainty
regarding our access to local telephone networks. See "Risk Factors--Risks
Related to Our Business and Financial Condition." We recently launched a new
generation of services using voice over Internet protocol ("VoIP").
We provide services on both a retail and wholesale basis. Our principal
retail services are Z-LineHOME(R), Z-LineBUSINESS(R) and Touch 1 Long Distance.
Z-LineHOME and Z-LineBUSINESS are residential and business versions,
respectively, of our flagship offering, the Z-Line(R). The Z-Line is local
telephone service, typically bundled with long distance and enhanced features,
including a suite of our proprietary Internet-accessible and voice-activated
functions. The enhanced features include voicemail, "Find Me" call forwarding
and our recently introduced Personal Voice Assistant(TM), or "PVA," which
utilizes voice-recognition technology so that users can access secure, online
address books from any phone using simple voice commands in order to send voice
emails, find contact information and dial numbers, among other things. Touch 1
Long Distance is a residential long distance telephone service.
Our principal executive offices are located at 601 South Harbour Island
Boulevard, Suite 220, Tampa, Florida, 33602, and our telephone number at that
address is (813) 273-6261. Our website address is www.ztel.com. Information on
our website does not constitute part of this Offer to Exchange.
For additional information about us, see "Financial Information" and the
documents incorporated by reference into this Offer to Exchange.
FINANCIAL INFORMATION
Our Summary Historical Consolidated Financial Information
The following table sets forth summary historical consolidated financial
and operating information of Z-Tel. Except for the six months ended June 30,
2004 and 2003, and the property information, the summary historical financial
information is derived from audited consolidated financial statements of Z-Tel
for each period presented. The summary historical data are only a summary, and
should be read in conjunction with the historical financial statements and
related notes contained in the annual and quarterly reports of Z-Tel
incorporated herein by reference.
-6-
Six Months Ended
Years Ended December 31, June 30,
------------------------------------------------------- ---------------------
2003 2002 2001 2000 (1) 1999 2004 2003
--------- --------- --------- ----------- --------- --------- ----------
(In thousands, except share and per share data)
Revenues........................ $289,180 $238,397 $280,350 $177,668 $6,615 $132,264 $131,975
Operating expenses:
Network operations (2)........ 135,097 94,474 159,617 107,077 6,518 65,271 58,852
Sales and marketing........... 18,753 12,327 31,243 45,018 8,898 8,971 11,111
General and administrative (3) 127,018 122,579 156,107 99,606 20,055 66,229 58,850
Asset impairment charge (4)... -- 1,129 59,247 -- -- -- --
Wholesale development costs (5) -- 1,018 -- -- -- -- --
Restructuring charge (6)...... -- 1,861 -- -- -- 807 --
Depreciation and amortization. 23,449 23,936 23,277 17,166 4,372 10,420 12,029
---------- --------- --------- ---------- --------- --------- ---------
Total operating expenses.... (304,317) 257,324 429,491 268,867 39,843 151,698 140,842
---------- --------- --------- ---------- --------- --------- ---------
Operating loss............ (15,137) (18,927) (149,141) (91,199) (33,228) (19,434) (8,867)
---------- --------- --------- ---------- --------- --------- ---------
Non-operating income (loss):
Interest and other income..... 2,086 3,509 6,862 5,475 608 1,352 1,164
Interest and other expense.... (3,076) (4,137) (3,789) (2,313) (3,351) (3,412) (1,410)
---------- --------- --------- ---------- --------- --------- ---------
Total non-operating income
(loss).................... (990) (628) 3,073 3,162 (2,743) (2,060) (246)
---------- --------- --------- ---------- --------- --------- ---------
Net loss.................. (16,127) (19,555) (146,068) (88,037) (35,971) (21,494) (9,113)
Less mandatorily redeemable
convertible preferred stock
dividends and accretion...... (17,480) (15,589) (15,059) (3,644) (1,654) (7,991) (8,904)
Less deemed dividend related to
beneficial conversion feature (186) (186) (9,356) (20,027) -- (93) (92)
Net loss attributable to
common stockholders....... $(33,793) $(35,330) $(170,483) $(111,708) $(37,625) $(29,578) $(18,109)
========== ========== ========== ========== ========== ========== ==========
Weighted average common shares
outstanding.................. 35,396,922 34,951,720 33,908,374 33,066,538 15,099,359 36,337,804 35,286,953
---------- --------- --------- ---------- --------- --------- ---------
Basic and diluted net loss per
share........................ $(0.95) $(1.01) $(5.03) $(3.38) $(2.49) $(0.81) $(0.51)
========== ========== ========== ========== ========== ========== ==========
Consolidated Balance Sheet Data
Cash and cash equivalents (7)(8) $12,013 $16,037 $18,892 $46,650 $101,657 $8,196 $14,204
Working capital (deficit)....... (31,038) (19,380) (11,983) 59,245 95,315 (45,127) (24,032)
Total assets.................... 89,453 106,711 116,737 246,461 137,677 $80,569 $104,901
Total debt...................... 5,531 10,144 15,766 20,417 14,134 2,283 7,389
Mandatorily convertible
redeemable preferred stock (8) 144,282 127,631 112,570 84,585 -- 152,366 136,132
Total stockholder's equity 159,022) (116,372)
(deficit).................... (131,019) (99,284) (67,172) 89,100 114,378 (
Other Financial Data
Net cash provided by (used in)
operating activities......... 11,956 18,399 (21,846) (96,862) (32,681) (9,183) 6,149
Net cash used in investing (4,692) (5,756)
activities................... (10,996) (15,600) (15,615) (40,602) (5,182)
Net cash provided by (used in)
financing activities......... (4,984) (5,654) 9,701) 82,455 131,547 10,058 (2,226)
______________________
(1) We completed the acquisition of Touch 1 on April 14, 2000. We used the
purchase accounting method for our acquisition of Touch 1. Therefore, our
discussions of the results of operations and liquidity and capital
resources do not include any discussions regarding Touch 1 prior to our
acquisition of Touch 1, which is treated as being closed for accounting
purposes, on April 1, 2000.
(2) During 2002, we received a $9.0 million retroactive rate reduction for the
unbundled network elements we acquired from Verizon as a result of a
settlement approved by the New York Public Service Commission.
(3) Included in the 2001 general and administrative expense was a write-off of
accounts receivable that resulted in $29.9 million of additional bad debt
expense.
-7-
(4) We recorded a $1.1 and $59.2 million expense related to impaired assets in
2002 and 2001, respectively. This expense was the result of management's
decision to reduce various customer growth initiatives, most notably
telemarketing activity levels. In 2001, a majority of the operations and
assets of telemarketing centers acquired from Touch 1 was either
voluntarily closed or sold. In addition to the goodwill impairment of $54.9
million, we recorded a $4.3 million charge associated with the impairment
of assets, composed of $3.0 million relating to unrealizable software and
development projects, $0.9 million of a worthless telemarketing property
and equipment, and $0.4 million of securities deemed to be worthless. As a
result of management's decision in the second quarter of 2002 to enhance
future cash flow and operating earnings, we closed the remaining call
centers in North Dakota and recorded a $1.1 million asset impairment. We
also incurred restructuring charges as a result of this decision during
2002 as discussed in note (1).
(5) During 2002, we began to provide our services on a wholesale basis. We
recorded start-up costs for developing this new service offering of
approximately $1.0 million. All wholesale related costs after our initial
wholesale services contract signed on March 20, 2002 are included in the
operating expenses line items, rather than being segregated.
(6) During 2002, we closed two call centers in North Dakota and our New York
sales office. As discussed in note (4) above, these expenses consisted
primarily of termination benefits, lease abandonment and lease settlement
costs.
(7) Included in the December 31, 1999 cash balance was approximately $109.1
million of net proceeds from our December 15, 1999 initial public offering.
This cash was obtained through the sale of 6,900,000 shares (including the
underwriters' over-allotment option) of our common stock at $17.00 per
share.
(8) During 2000, we issued series D and E preferred stock for approximately
$56.3 and $50.0 million, respectively. During 2001, we issued series G
preferred stock for approximately $17.5 million.
Summary Pro Forma Consolidated Financial Information of Z-Tel
The following unaudited pro forma information presents the effects of the
Offer assuming all of our outstanding Preferred Shares are exchanged for the
Exchange Consideration as if the exchange occurred as of June 30, 2004 for the
unaudited balance sheet data. There would be no pro forma adjustments to our
income statement data for either the year ended December 31, 2003 or the six
months ended June 30, 2004 if the exchange occurred as of the first day of such
periods. In the quarter in which the exchange is approved, a dividend charge
will be recorded that will impact net earnings. It is expected that this
dividend will reduce net earnings, assuming our Common Stock price remains below
the effective exchange price. Earnings per share attributable to Common Stock
will be adjusted due to the dividend and will show an even greater loss per
Common Share outstanding. The pro forma information does not include costs of
this Offer or a dividend charge that we will incur as a result of the Offer.
Consolidated Pro Forma Balance Sheets
(In thousands, except share and per share data)
(Unaudited)
-------------------------------------------------------------------------------------------------------------------
June 30, Pro Forma
2004 Adjustments Pro Forma
----------- ----------- ----------
Assets
Current assets:
Cash and cash equivalents $ 8,196 $ -- $ 8,196
Accounts receivable, net of allowance for doubtful 28,672 28,672
accounts
Prepaid expenses and other current assets 4,804 4,804
----------- ----------- ----------
Total current assets 41,672 -- 41,672
Property and equipment, net 34,298 34,298
Intangible assets, net 1,372 1,372
Other assets 3,227 3,227
----------- ----------- ----------
Total assets $ 80,569 $ -- $ 80,569
=========== =========== ==========
-8-
Consolidated Pro Forma Balance Sheets
(In thousands, except share and per share data)
(Unaudited)
June 30, Pro Forma
2004 Adjustments Pro Forma
----------- ----------- ----------
Liabilities, preferred stock and deficit
Current liabilities:
Accounts payable and accrued liabilities $ 63,745 $ -- $ 63,745
Deferred revenue 8,357 8,357
Current portion of long-term debt and capital lease
obligations 14,697 14,697
----------- ----------- ----------
Total current liabilities 86,799 86,799
Long-term deferred revenue 221 221
Long-term debt and capital lease obligations 205 -- 205
----------- ----------- ----------
Total liabilities 87,225 -- 87,225
----------- ----------- ----------
Mandatorily redeemable convertible preferred stock 152,366 (152,366) --
Stockholders' deficit:
Common stock 373 2,538 2,911
Notes receivable from stockholders (930) (930)
Additional paid-in capital 183,281 149,828 333,109
Accumulated deficit (341,358) -- (341,358)
Treasury stock (388) -- (388)
----------- ----------- ----------
Total stockholders' deficit (159,022) 152,366 (6,656)
Total liabilities, preferred stock and deficit $ 80,569 $ -- $ 80,569
=========== =========== ==========
Risk Factors
You should carefully consider the risks described below, in addition to the
other information in this Offer to Exchange, before making a decision to tender.
Each of these risk factors could adversely affect our business, financial
condition and operating results as well as adversely affecting the value of an
investment in our Common Stock.
Risks Related to the Offer
By participating in the Offer, you will give up the special rights of a holder
of Preferred Stock.
The holders of Preferred Shares have various rights which are better than
the rights of holders of Common Stock. Those rights include:
o the right to receive dividends at the rate of 8% per year (or 12% per
year, in the case of the Series G Preferred Stock);
o the right to have the Preferred Stock redeemed in 2008 at $12.00 per
share (or $100,000.00 per share in the case of Series G Preferred
Stock) plus all accrued and unpaid dividends;
o in the case of the Series E Preferred Stock, the right to vote as a
separate class on mergers and certain other transactions;
-9-
o the right to receive a preferential payment of $12.00 per share (or
$100,000.00 per share in the case of Series G Preferred Stock) plus
accrued and unpaid dividends if we liquidate; and
o the right to vote, as a class, to block the issuance of any series of
stock having preferential dividend or liquidation rights.
You will lose these rights if your Preferred Shares are exchanged in the Offer.
The Common Stock does not have any special rights.
By participating in the Offer, you will give up the seniority that you have over
holders of Common Stock or any other class of stock which is junior to your
Preferred Stock.
Holders of Preferred Shares are entitled to receive dividends and other
distributions before holders of Common Stock are entitled to receive them,
including any distributions that might be made in liquidation or bankruptcy. If
you exchange your Preferred Shares in the Offer, you will no longer have that
seniority over holders of Common Stock. Holders of Series D Preferred Stock and
Series E Preferred Stock are entitled to receive dividends and other
distributions before holders of Series G Preferred Stock are entitled to receive
them, including any distributions that might be made in liquidation or
bankruptcy. If you exchange your shares of Series D Preferred Stock or Series E
Preferred Stock in the Offer, you will no longer have that seniority over
holders of the Series G Preferred Stock.
Prior to the consummation of the Exchange Offer certain of the terms of the
Preferred Stock may be amended.
If the proposed amendments contemplated in the Special Meeting Matters that
will be described in the proxy statement to be prepared for the Special Meeting
are adopted, the terms of those series of Preferred Stock will change
significantly and holders of such Preferred Stock that is not tendered in the
Offer will cease to have certain preferential rights that they had prior to the
Offer.
If you do not participate in the Offer, your ownership percentage and voting
power may be diluted.
Consummation of the Offer will result in holders of Preferred Shares
acquiring a higher percentage of our ownership than they possessed prior to the
Offer, resulting in the dilution of the ownership of the preferred stockholders
who do not participate. In the case of the holders of Series D Preferred Stock
and Series E Preferred Stock, consummation of the Offer will result in holders
of Series D Preferred Stock and Series E Preferred Stock acquiring a higher
percentage of voting power than they possessed prior to the Offer, resulting in
the dilution of the voting power of the holders of Series D Preferred Stock and
Series E Preferred Stock who do not participate.
-10-
Risks Related to Our Business and Financial Condition
Our business depends on the availability and favorable pricing of unbundled
network components.
Our current generation of local telephone services, which produces
approximately 95% of our revenue, relies on access to local telephone networks.
Our access to these networks is based upon the Telecommunications Act of 1996
(the "Telecommunications Act"), which imposes a variety of duties upon the
traditional local telephone companies ("incumbent local exchange carriers" or
"ILECs"), including the duty to provide competitive local exchange companies,
like us, with access to the individual components of their networks. Our
business strategy depends on a continued availability of ILEC unbundled network
components and on states maintaining and adopting favorable pricing rules for
ILEC unbundled network components. The FCC has issued rules regarding access to
key components of the ILEC networks, including transport and switching. A recent
court ruling, however, has created considerable legal uncertainty regarding this
access. In United States Telecom Ass'n v. FCC, Nos. 00-1012, 00-1015, 03-1310 et
al. (D.C. Cir. March 2, 2004) ("USTA II"), the D.C. Circuit Court ordered that
the FCC's unbundled transport and switching rules be vacated after sixty days or
upon denial of a petition for rehearing, whichever occurs later. Both the U.S.
Solicitor General and the FCC have declined to appeal the case. U.S. Supreme
Court Chief Justice William Rehnquist on June 14, 2004 refused to issue a stay
of the decision.
On August 20, 2004, the Federal Communications Commission issued a Notice
of Proposed Rulemaking ("NPRM") seeking comment on unbundling rules to implement
obligations under section 251(c)(3) of the Telecommunications Act and to respond
to the D.C. Circuit's vacatur in USTA II of the rules that the FCC adopted in
the Triennial Review Order. The FCC also released an order setting forth a
two-phase plan to govern the provision of unbundled network elements ("UNEs")
while the FCC considers permanent rules. Under the first phase of the interim
plan, ILECs must continue to make available dedicated transport, mass market
switching and enterprise loops in accordance with the rates, terms and
conditions set forth in their interconnection agreements as of June 15, 2004.
Under the second phase of the plan, ILECs would be required for an additional
six months to continue to provide such UNEs to requesting carriers for the
embedded customer base subject to the rate increases specified in the FCC's
order. We do not believe these rate increases will impede our short-term
business plans. In its NPRM, the FCC seeks comment on how to establish
sustainable new unbundling rules in response to the D.C. Circuit's decision.
Specifically, the FCC seeks comment on how various ILEC offerings and
obligations fit into the unbundling framework, how best to define the relevant
markets to develop unbundling rules and how to make determinations on access to
individual network elements.
The uncertainty the ruling and the order have created could have material
adverse effects upon us and our operations. Certain potential adverse effects
from this ruling and the uncertainty it has created are set forth below. This
list is not exhaustive as a listing of all the potential adverse effects would
be impossible.
-11-
o ILECs, after some period of time, could deny us access to their
networks in violation of interconnection agreements and essentially
destroy our ability to provide our services.
o ILECs could refuse new service orders, including repair and change
orders. We would not be able to add new customers. Our business would
diminish because of normal customer churn -- that is, the normal loss
of existing customers over time.
o Our customer churn could increase as our customers return to ILEC
services in response to the uncertainty.
o ILECs could significantly raise the prices they charge for access to
their networks. We would be forced to raise our rates to
non-competitive levels.
o Vendors, including long distance companies, could alter the terms
under which they do business with us, such as credit terms, thereby
increasing our costs and diminishing our cash flow and liquidity.
o We may be unable to obtain new financing at acceptable rates. We have
already encountered difficulty in attempting to obtain financing from
one particular lender.
o We may lose prospective customers that otherwise would have become our
customers. We believe we have already lost at least one large
prospective customer (over 5,000 lines) because of the uncertainty.
o Our wholesale customers may decline to expend marketing resources to
increase their customer bases.
o We could lose major marketing partners and potential marketing
partners as they decline to expend resources in marketing our
services.
o We could lose key personnel, as they seek security in offers from
other prospective employers.
o The cost of litigation and of participation in administrative
proceedings relating to interconnection agreements and new regulations
could be excessively burdensome.
The availability of favorable pricing rules for unbundled network components is
another key element of our business strategy.
The public utilities commissions of certain states have adopted pricing
rules for unbundled network components. In general, ILECs are required to
provide us with access to their networks at forward-looking, long-run
incremental cost-based prices. However, we cannot be certain that unbundled
network components will continue to be available at favorable prices in those
states or that other states will ever adopt favorable pricing, particularly in
light of the recent D.C. Circuit Court ruling referred to above.
-12-
Because we are in an emerging industry sector, we could encounter unforeseen
issues that may adversely affect our operations.
VoIP is a new, emerging sector of the telecommunications industry. Our
experience, as well as the experience of others, in this sector is limited. As a
result we will likely encounter numerous unforeseen difficulties and challenges.
We will almost certainly need to raise additional capital.
We will need to raise additional capital from debt or equity sources in
order to finance our operations and our VoIP rollout and may need additional
capital if we enter into other lines of business. On April 22, 2004, we obtained
a $25 million credit facility pursuant to a Loan and Security Agreement with
Textron Financial Corporation. The facility has a three-year term and as of
September 27, 2004 we had borrowings of approximately $15.4 million outstanding;
this is the maximum amount permitted to be outstanding thereunder based on our
current borrowing base availability. It replaced our previous accounts
receivable facility with RFC Corporation. In addition, we have also obtained a
facility from The 1818 Fund, an affiliate of one of our stockholders, providing
for borrowings of up to $15 million. We have borrowed $5 million under this
facility, but additional borrowings thereunder are at the discretion of The 1818
Fund. Representatives of The 1818 Fund have told us that, in any event, they do
not intend to make additional loans unless the Exchange Offer is successfully
completed. There cannot, however, be any assurance that we will be able to meet
the conditions to borrowing under either of these facilities. If we cannot
obtain required financing on acceptable terms or at all, we may be required to
modify, delay or abandon our current business plan, which is likely to
materially and adversely affect our business and, as a result, the value of our
Common Stock.
We may not be able to efficiently expand our network infrastructure.
We must continue to develop, expand and adapt our network infrastructure as
the number of our users and the amount of information they wish to access and
transfer increases and as our customers' demands change. We cannot be sure that
we will be able to develop, expand or adapt the network infrastructure to meet
additional demand or our customers' changing requirements on a timely basis, at
a commercially reasonable cost, or at all. If we fail to expand our network
infrastructure on a timely basis or adapt it to either changing customer
requirements or evolving industry standards, these failures could cause our
business to perform poorly.
Our business is dependent upon our ability to resell long distance services.
We offer long distance telephone services as part of our service packages.
We currently have agreements with various long distance carriers to provide
transmission and termination services for all of our long distance traffic.
Recently, several long distance carriers have encountered financial
difficulties, including both carriers utilized by us. Financial difficulties
encountered by any of our carriers could cause disruption of service to our
customers and could diminish the value of any receivables or credits that may be
due to us from such carriers. Our agreements with long distance carriers
generally provide for the resale of long distance services on a per-minute basis
and contain minimum volume commitments. In cases in which we have agreed to
minimum volume commitments and fail to meet them, we will be obligated to pay
underutili-
-13-
zation charges. In some instances, if we incur underutilization charges, our
basic rate will increase, which could further adversely affect our operating
results. We recently settled a dispute by agreeing to a higher rate. In
addition, if our sales fall from their historical levels, our business could be
materially and adversely affected. We cannot guarantee you that we will be able
to maintain these historical sales levels.
Software failures and errors may have a material adverse impact on our business.
The software that we use and the software that we have developed internally
and are continuing to develop may contain undetected errors. Although we have
extensively tested our software, errors may be discovered in the software during
the course of its use. Any errors may result in partial or total failure of our
network, loss or diminution in service delivery performance, additional and
unexpected expenses to fund further product development or to add programming
personnel to complete or correct development, and loss of revenue because of the
inability of customers to use our products or services, which could adversely
affect our business condition.
Our inability to protect our proprietary technology could adversely affect our
revenues.
We currently rely on a combination of copyright, trademark and trade secret
laws and contractual confidentiality provisions to protect the proprietary
information that we have developed. Our ability to protect our proprietary
technology is limited, and we cannot assure you that our means of protecting our
proprietary rights will be adequate or that our competitors will not
independently develop similar technology. Also, we cannot be certain that the
intellectual property that incumbent local exchange carriers or others claim to
hold and that may be necessary for us to provide our services will be available
on commercially reasonable terms. If we were found to be infringing upon the
intellectual property rights of others, we might be required to enter into
royalty or licensing agreements, which may be costly or not available on
commercially reasonable terms. If successful, a claim of infringement against us
and our inability to license the infringed or similar technology on terms
acceptable to us could adversely affect our business.
We depend on certain information systems, which if failed, may have a material
adverse affect on our business.
Our billing, customer service and management information systems are newly
developed and we may face unexpected system difficulties, which would adversely
affect our service levels and, consequently, our business. Sophisticated
information and processing systems are vital to our ability to monitor costs,
render monthly invoices for services, process customer orders and achieve
operating efficiencies. We rely on internal systems and third party vendors,
some of which have a limited operating history, to provide our information and
processing systems. If our systems fail to perform in a timely and effective
manner and at acceptable costs, or if we fail to adequately identify all of our
information and processing needs or if our related processing or information
systems fail, these failures could have a material adverse effect on our
business.
In addition, our right to use third party systems is dependent upon license
agreements. Some of these agreements are cancelable by the vendor, and the
cancellation or nonrenewal of these agreements could seriously impair our
ability to process orders or bill our customers. As
-14-
we continue to provide local telephone service, the need for sophisticated
billing and information systems will also increase significantly and we will
have significant additional requirements for data interface with incumbent local
exchange carriers and others. We cannot be certain that we will be able to meet
these additional requirements.
Our business could be adversely affected in the event of a network failure.
The successful operation of our network will depend on a continuous supply
of electricity at multiple points. Our system is dependent on the availability
of electrical power to manage data and calls and to offer enhanced services,
such as voicemail and call forwarding, and although it has been designed to
operate under extreme weather conditions (including hurricanes, tropical storms,
heavy rain, wind and snow), like all other telecommunications systems, our
network could be adversely affected by such conditions. Our network, however, is
equipped with a back-up power supply and our existing network operations center
is equipped with both a battery backup and an on-site emergency generator.
Certain of our back-up systems, however, have failed in the past. We are working
to correct those failures. However, a power failure could negatively impact our
operations and damage our systems.
Our network also may be subject to physical damage, sabotage, tampering or
other breaches of security (by computer virus, break-ins or otherwise) that
could impair its functionality. In addition, our network is subject to unknown
capacity limitations that may cause interruptions in service or reduced capacity
for our customers. Any interruptions in service resulting from physical damage
or capacity limitations could cause our systems to fail.
We depend on local exchange carriers as a key component for our business.
We rely on incumbent local exchange carriers to supply key unbundled
components of their network infrastructure to us on a timely and accurate basis,
and in the quantities and quality demanded by us. We may from time to time
experience delays or other problems in receiving unbundled services or
facilities which we request, and there can be no assurance that we will be able
to obtain such unbundled elements on the scale and within the time frames
required by us. Any failure to obtain these components, services or additional
capacity on a timely and accurate basis could adversely affect us.
We depend on third party vendors to supply our telecommunications equipment, and
any interruption in such supply could adversely affect our business.
We currently purchase the majority of our telecommunications equipment as
needed from third party vendors, including Lucent Technologies, Inc., Sonus
Networks, Inc., Dialogic Communications Corporation, Hewlett-Packard Company,
Compaq Computer Corporation, Sun Microsystems, Inc., EMC Corporation, and Cisco
Systems, Inc. In addition, we currently license our software from third party
vendors, including Oracle Corporation, INPRISE Corporation, Mercator Software,
Inc., Microsoft Corporation, Nuance Communications, Inc., SpeechWorks
International, Inc., Telution, Inc., AMS, Inc., Netscape Communications, Inc.
and Accenture. We typically do not enter into any long-term agreements with our
telecommunications equipment or software suppliers. Any reduction or
interruption in supply from our equipment suppli-
-15-
ers or failure to obtain suitable software licensing terms could have a
disruptive effect on our business and could adversely affect our results of
operations.
Our business is dependent on our management and key personnel.
We depend on a limited number of key personnel who would be difficult to
replace. If we lose the services of some of our key personnel, our business
could suffer. We also depend on a limited number of key management, sales,
marketing and product development personnel to manage and operate our business.
In particular, we believe that our success depends to a significant degree upon
our ability to attract and retain highly skilled personnel, including our
engineering and technical staff. In the last several months we have experienced
significant employee attrition and some of those employees who have departed are
among our key personnel. If we are unable to replace the employees who have
departed and attract and retain our key employees, the value of our Common Stock
could suffer.
We are subject to government regulation and legal uncertainties that could
adversely affect our business.
We are subject to varying degrees of federal, state, and local regulation.
We must also comply with various state and federal obligations that are subject
to change, such as the duty to contribute to universal service subsidies, the
impact of which we cannot assess on a going-forward basis as the rates change
periodically. Our failure to comply with regulatory requirements may result in
fines or other penalties being imposed on us, including loss of certification to
provide services.
Decisions of the FCC and state regulatory commissions providing incumbent
local exchange carriers with increased flexibility in how they price their
services and with other regulatory relief, could have a material adverse effect
on our business and that of other competitive local exchange carriers. Future
regulatory provisions may be less favorable to competitive local exchange
carriers and more favorable to their competitors. If incumbent local exchange
carriers are allowed by regulators to engage in substantial volume and term
discount pricing practices for their end-user customers, or charge competitive
local exchange carriers higher fees for interconnection to the incumbent local
exchange carriers' networks, our business, operating results and financial
condition could be materially, adversely affected. Incumbent local exchange
carriers may also seek to delay competitors through legal or regulatory
challenges, or by recalcitrant responses to requirements that they open their
markets through interconnection and unbundling of network elements. Our legal
and administrative expenses may be increased because of our having to actively
participate in rate cases filed by incumbent local exchange carriers, in which
they seek to increase the rates they can charge for the unbundled network
element platform components. Our profitability may be adversely affected if
those carriers prevail in those cases. Pending court cases in which certain
provisions of the Telecommunications Act will be conclusively interpreted may
result in an increase in our cost of obtaining unbundled network elements.
We are also subject to federal and state laws and regulations prohibiting
"slamming," which occurs when specific procedures are not followed when a
customer changes telecommunications services. Although we attempt to diligently
comply with all such laws and regulations and have procedures in place to
prevent "slamming," if violations of such laws and regulations
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occur, we could become subject to significant fines and penalties, legal fees
and costs, and our business reputation could be harmed.
Our inability to successfully compete within our industry could adversely affect
our business.
The telecommunications and information services markets are intensely
competitive and rapidly evolving. We expect competition to increase in the
future. Many of our potential competitors have longer operating histories,
greater name recognition, larger customer bases and substantially greater
financial, personnel, marketing, engineering, technical and other resources than
us. We believe the principal competitive factors affecting our business
operations will be price, the desirability of our service offering, quality and
reliability of our services, innovation and customer service. Our ability to
compete effectively will depend upon our ability to maintain high quality,
market-driven services at prices generally equal to or below those charged by
our competitors. Competitor actions and responses to our actions could,
therefore, materially and adversely affect our business, financial condition and
results of operations.
We face competition from a variety of participants in the
telecommunications market. The largest competitor for local service in each
market in which we compete is the incumbent local exchange carrier serving that
market. Incumbent local exchange carriers have established networks,
long-standing relationships with their customers, strong political and
regulatory influence, and the benefit of state and federal regulations that
favor incumbent local exchange carriers. In the local exchange market, the
incumbent local exchange carriers continue to hold near-monopoly positions. The
long distance telecommunications market in which we compete has numerous
entities competing for the same customers and a high average churn 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 will face competition from
large interexchange carriers. Other competitors are likely to include incumbent
local exchange carriers providing out-of-region (and, with the removal of
regulatory barriers, in-region) long distance services, other incumbent local
exchange carriers, other competitive local exchange carriers, cable television
companies, electric utilities, wireless telephone system operators, microwave
and satellite carriers and private networks owned by large end users.
The Telecommunications Act facilitates such entry by requiring incumbent
local exchange carriers to allow competing providers to acquire local services
at wholesale prices for resale and to purchase unbundled network elements at
cost-based prices. A continuing trend toward combinations and strategic
alliances in the telecommunications industry, including potential consolidation
among incumbent local exchange carriers or competitive local exchange carriers,
or transactions between telephone companies and cable companies outside of the
telephone company's service area, or between interexchange carriers and
competitive local exchange carriers, could give rise to significant new
competitors.
The enhanced and information services markets are also highly competitive
and we expect that competition will continue to intensify. Our competitors in
these markets will include
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information service providers, telecommunications companies, on-line service
providers and Internet service providers.
We face risks associated with unauthorized transactions and the theft or abuse
of our services.
We may be the victim of fraud or theft or abuse of services. From time to
time, callers have obtained our services without rendering payment by unlawfully
using our access numbers and personal identification numbers. We attempt to
manage these theft and fraud risks through our internal controls and our
monitoring and blocking systems. If these efforts are not successful, the theft
of our services may cause our revenue to decline significantly. To date, we have
not encountered material fraud or theft of our service. From time to time, we
encounter users that exploit provisions of our tariffs or terms of service for
their own profit. As a regulated common carrier we are required to offer our
services on a non-discriminatory manner. Such use of our services may not be
fraudulent but is abusive. We manage the risks of abuse through our internal
controls and our monitoring and blocking systems and by rapid reaction.
Risks Related to Our Common Stock
Future sales of our Common Stock could depress our stock price.
We cannot predict the effect that future sales of our Common Stock will
have on the market price of our Common Stock. As of September 27, 2004, we had
38,776,343 shares of Common Stock outstanding. Shares of Common Stock that we
issue in the Offer or other shares of our Common Stock that we issue in the
future may become available for resale in the public market from time to time.
Sales of substantial amounts of our Common Stock, or the perception that such
sales may occur, could adversely affect the market price of our Common Stock or
our ability to raise capital by offering equity securities.
Our Common Stock may be delisted from the Nasdaq SmallCap Market.
By letter dated July 28, 2004, the Nasdaq Stock Market, Inc. notified us
that for 10 consecutive days, the market value of our Common Stock on the Nasdaq
Small Cap Market was not $35 million or more, as required for continued
inclusion on the Nasdaq Small Cap Market by the Nasdaq rules. The market value
of our Common Stock remained below the minimum market value, and as a result the
Nasdaq staff provided us with written notification that our Common Stock will be
delisted. Currently we are appealing the staff's decision to a Listing
Qualifications Panel primarily on the basis that we believe, following
consummation of the Exchange Offer, that the market value of our Common Stock
will substantially exceed the minimum required amount. The Listing
Qualifications Panel may not grant our request to defer a determination of
delisting until after the Exchange Offer is consummated. In that event our
Common Stock will be delisted, our Common Stock will only be traded over the
counter on the Nasdaq Bulletin Board and the liquidity and price of our Common
Stock may be negatively affected. Even if our request is granted, we cannot
assure you that we will achieve the necessary market value for our Common Stock
following the Exchange Offer or that our Common Stock will maintain the
necessary market value for any length of time. If we fail to achieve and
maintain the market value for our Common Stock above that required by the Nasdaq
rules, our Common Stock will ultimately be delisted from the Nasdaq SmallCap
Market.
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We have also been advised by the Nasdaq staff that our Common Stock does
not currently meet the minimum bid price per share of $1.00 necessary to
maintain listing on the Nasdaq SmallCap Market as required by the Nasdaq rules.
Although we believe that the reverse stock split proposal, if adopted at the
Special Meeting, will allow us to regain compliance, we cannot assure you that
the Common Stock will achieve the necessary bid price per share following the
reverse stock split or that our Common Stock will maintain the necessary minimum
bid price for any length of time. If we fail to achieve and maintain a bid price
for our Common Stock above that required by the Nasdaq rules, our Common Stock
will ultimately be delisted from the Nasdaq SmallCap Market.
We may experience volatility in our stock price that could affect your
investment.
The price of our Common Stock has been, and may continue to be, highly
volatile in response to various factors, many of which are beyond our control,
including:
o developments in the industries in which we operate;
o actual or anticipated variations in quarterly or annual operating
results;
o speculation in the press or investment community; and
o announcements of technological innovations or new products by us or
our competitors.
Our Common Stock's market price may also be affected by our inability to
meet analyst and investor expectations and failure to achieve projected
financial results, including those set forth in this Offer to Exchange, or as a
result of the issuance of the shares of Common Stock in the Offer and the
dilution of the currently outstanding shares of Common Stock. Any failure to
meet such expectations or projected financial results, even if minor, could
cause the market price of our Common Stock to decline.
In addition, assuming the tender of all outstanding Preferred Stock in the
Offer, The 1818 Fund, will own approximately 47% of our Common Stock which may
reduce the amount of shares of our Common Stock that are traded on a daily basis
and potentially increase the volatility of the price thereof.
Furthermore, stock markets have generally experienced a high level of price
and volume volatility, and the market prices of equity securities of many
companies have experienced wide price fluctuations not necessarily related to
the operating performance of such companies. These broad market fluctuations may
adversely affect our Common Stock's market price. In the past, securities class
action lawsuits frequently have been instituted against such companies following
periods of volatility in the market price of such companies' securities. If any
such litigation is instigated against us, it could result in substantial costs
and a diversion of management's attention and resources, which could have a
material adverse effect on our business, results of operations, and financial
condition.
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After completion of the Exchange Offer one stockholder who is represented on our
board of directors will control a significant percentage of our Common Stock and
may cause us to take actions that are adverse to your interests.
If all the Preferred Shares are tendered in the Exchange Offer, after the
completion thereof, The 1818 Fund, which is represented on our board of
directors, in the aggregate will beneficially own approximately 47% of our
Common Stock. As a result, The 1818 Fund can significantly influence all matters
requiring stockholder approval, including the election and removal of directors
and approval of significant corporate transactions such as mergers,
consolidations, and sales of assets. It also could dictate the management of our
business and affairs. This concentration of ownership could have the effect of
delaying, deferring, or preventing a change in control or impeding a merger or
consolidation, takeover, or other business combination, which could cause the
market price of our Common Stock to fall or prevent you from receiving a premium
in such a transaction.
Anti-takeover provisions in our certificate of incorporation and bylaws and
provisions of Delaware law could delay or prevent a change of control that you
may favor.
Certain provisions of our certificate of incorporation and bylaws may
inhibit changes in control of us not approved by the board of directors. These
provisions include: (i) a prohibition on stockholder action through written
consents; (ii) a requirement that special meetings of stockholders be called
only by the board of directors; (iii) advance notice requirements for
stockholder proposals and nominations; (iv) limitations on the ability of
stockholders to amend, alter or repeal the bylaws; and (v) the authority of the
board of directors to issue, without stockholder approval, preferred stock with
such terms as the board of directors may determine. We will also be afforded the
protections of Section 203 of the Delaware General Corporation Law, which could
have similar effects. The foregoing provisions could delay or make more
difficult transactions involving a change in control of us or our management.
SPECIAL FACTORS RELATING TO THE OFFER TO EXCHANGE
In addition to the other information set forth herein, holders of Preferred
Shares should carefully consider the following information:
Special Committee of the Board of Directors
Because certain members of our Board of Directors either hold or are
affiliated with holders of Preferred Stock, our Board of Directors formed a
special committee (the "Special Committee") of its independent directors
comprised of Messrs. John K. Aurell, W. Andrew Krusen, Jr. and Richard F.
LaRoche, Jr., to evaluate the fairness, from a financial point of view, of the
Exchange Offer to the holders of Common Stock. The Special Committee retained
the services of a financial advisor, Morgan Keegan & Company, Inc. ("Morgan
Keegan"). Morgan Keegan has rendered an opinion to the Special Committee as to
the fairness, from a financial point of view, of the Exchange Offer to the
holders of Common Stock. NONE OF THE SPECIAL COMMITTEE, MORGAN KEEGAN OR THE
BOARD OF DIRECTORS HAS EVALUATED THE FAIRNESS OF THE EXCHANGE OFFER TO THE
HOLDERS OF PREFERRED STOCK. ACCORDINGLY, NEITHER THE SPECIAL COMMITTEE
-20-
NOR THE BOARD OF DIRECTORS IS MAKING ANY RECOMMENDATION WHATSOEVER AS TO WHETHER
HOLDERS OF PREFERRED STOCK SHOULD PARTICIPATE IN THE EXCHANGE OFFER.
Prior to this Offer, members of the Special Committee discussed the
possibility of the Exchange Offer with The 1818 Fund to ascertain its interest
in participating in the transaction. The 1818 Fund is our largest holder of
Preferred Stock and owns all of our outstanding Series E Preferred Stock, and
approximately 73% of our outstanding Series G Preferred Stock. We have been
advised by The 1818 Fund that it currently intends to tender all of its
Preferred Stock in the Exchange Offer and to vote in favor of the Special
Meeting Matters, subject to our receiving tenders of substantially all of the
Preferred Stock in the Exchange Offer, in its sole judgment. The 1818 Fund has
not advised us what level of tenders would, in its judgment, constitute
"substantially all" of the Preferred Stock. The 1818 Fund is not obligated to
participate in the Exchange Offer or to vote in favor of the Special Meeting
Matters and may decide not to do so at any time for any reason. However, because
this Offer is contingent upon The 1818 Fund tendering all of its Preferred Stock
and because The 1818 Fund will determine the vote of holders of Series E
Preferred Stock and Series G Preferred Stock at the Special Meeting, the
Exchange Offer will not occur unless The 1818 Fund tenders, and we accept, all
of its Preferred Stock in the Exchange Offer and votes in favor of the Special
Meeting Matters.
Two of our directors are associated with The 1818 Fund: Andrew C. Cowen is
a Senior Vice President of and Lawrence C. Tucker is a General Partner of Brown
Brothers Harriman & Co., a private investment banking firm that manages The 1818
Fund. In addition, Mr. Charles D. Hyman, one of our directors, owns
approximately 0.5% of the outstanding Series D Preferred Stock.
On the basis of its discussions with The 1818 Fund and the opinion of
Morgan Keegan as to the fairness of the Exchange Offer, from a financial point
of view, to the holders of Common Stock, and the potential failure to be able
raise additional financing required for our new business plan as long as the
Preferred Stock remains outstanding, the Special Committee recommended to the
Board of Directors that we pursue the Exchange Offer. In structuring the terms
of the Exchange Offer, the Special Committee considered the rights and
preferences of the Preferred Shares, including the dividend rate; the relative
preferences and other terms relative to the Common Shares; the fact that
acceptance of the Offer is not mandatory and that each holder of the Preferred
Stock may participate in its sole discretion; recent market prices for our
Common Stock; the lack of attractive alternatives available to us in lieu of the
Exchange Offer; the assumed pro forma effect of the Offer to Exchange on our
consolidated capitalization; the United States federal income tax consequences
of the Offer to Exchange on us and on the holders of our Preferred Stock; and
the fairness opinion of Morgan Keegan.
For the following reasons our Board of Directors determined to accept the
recommendation of the Special Committee and proceed with the Exchange Offer: it
will improve and simplify our capital structure and increase our net book value;
it will reduce or eliminate the dividends and mandatory redemption obligation on
our Preferred Stock; it is within the discretion of each holder of Preferred
Stock to determine whether it should participate in the Exchange Offer; it will
give holders of our Preferred Stock an opportunity to effectively convert their
Preferred
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Stock to Common Stock at a substantial premium to the conversion rates presently
in effect for the Preferred Stock; it will give holders of our Preferred Stock
an opportunity to obtain greater liquidity on their investment; it should
significantly increase the aggregate market value of our Common Stock and
facilitate our continued listing on the Nasdaq SmallCap Market; and the failure
to convert the Preferred Stock into Common Stock will continue to be an
impediment to financing our new business plan.
Determining Whether or Not to Tender
NONE OF THE SPECIAL COMMITTEE, MORGAN KEEGAN OR THE BOARD OF DIRECTORS HAS
EVALUATED THE FAIRNESS OF THE EXCHANGE OFFER TO THE HOLDERS OF PREFERRED STOCK.
ACCORDINGLY, NEITHER THE SPECIAL COMMITTEE NOR THE BOARD OF DIRECTORS IS MAKING
ANY RECOMMENDATION WHATSOEVER AS TO WHETHER HOLDERS OF PREFERRED STOCK SHOULD
PARTICIPATE IN THE EXCHANGE OFFER.
The decision to tender Preferred Shares pursuant to the Offer to Exchange
should be made by holders of Preferred Shares after considering the value of the
Preferred Shares they are tendering, the value of the Common Shares they are
ultimately receiving, individual investment objectives and other factors
affecting such holders individually, including any federal, state, local or
foreign tax consequences of tendering Preferred Stock. Holders of Preferred
Stock should consider the current market price of the Common Shares as well as
their view of the future market price of the Common Shares. Holders of Preferred
Stock are urged to evaluate carefully all information contained or incorporated
by reference in this Offer to Exchange and to consult their own financial and
tax advisors to make their own decisions concerning whether to tender Preferred
Shares in the Offer to Exchange. See "Risk Factors," "Description of Our
Preferred Stock," "Description of Our Common Stock," "Market for Common Stock"
and "Material United States Federal Income Tax Consequences."
MANAGEMENT
The following table sets forth information about our directors and
executive officers as of the date of this Offer to Exchange:
Name Position
Horace J. Davis, III Acting Chief Executive Officer,
Treasurer and Senior Vice President --
Chief Financial Officer
Frank Grillo Chief Operating Officer
Paul Kohler Chief Technology Officer
Doug Jackson Senior Vice President Consumer Services
Mike Slauson Senior Vice President Customer Service
and Support Operations
John Tomljanovic Senior Vice President Business Operations
John K. Aurell Director
Andrew C. Cowen Director
Charles D. Hyman Director
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Name Position
W. Andrew Krusen, Jr. Director
Richard F. LaRoche, Jr. Director
Lawrence C. Tucker Director
For additional information regarding our directors and officers, reference
is hereby made to our definitive Proxy Statement on Schedule 14A filed on April
29, 2004.
USE OF PROCEEDS
We will not receive any cash proceeds from this Offer. Preferred Shares
surrendered in exchange for Common Shares will be retired and returned to the
pool of authorized but unissued Preferred Shares.
THE OFFER TO EXCHANGE
This Offer to Exchange and the related Letter of Transmittal are being
mailed to record holders of Preferred Shares and will be furnished to brokers,
banks and similar persons whose names, or the names of whose nominees, appear on
our stockholder lists or, if applicable, who are listed as participants in a
clearing agency's security position listing for subsequent transmittal to
beneficial owners of Preferred Shares.
Number of Shares
Upon the terms and subject to the conditions of this Offer to Exchange, we
will exchange all of the Preferred Shares outstanding, or such lesser number of
Preferred Shares as are validly tendered and not withdrawn prior to the
Expiration Date, for Common Shares as follows (subject in each case to the
impact of any reverse stock split):
o We will exchange 25.69030 shares of our Common Stock for each share of
our Series D Preferred Stock, of which there were 3,976,723 shares
outstanding as of September 27, 2004 (representing an exchange price
of approximately $0.644 per share);
o We will exchange 25.24216 shares of our Common Stock for each share of
our Series E Preferred Stock, of which there were 4,166,667 shares
outstanding as of September 27, 2004 (representing an exchange price
of approximately $0.644 per share); and
o We will exchange 161,469.4 shares of our Common Stock for each share
of our Series G Preferred Stock, of which there were 171.214286 shares
outstanding as of September 27, 2004 (representing an exchange price
of approximately $0.898 per share).
The actual number of shares of Common Stock to be issued in exchange for
the Preferred Stock tendered in the Exchange Offer may be adjusted by the
reverse stock split which is part of the Special Meeting Matters. Subject to the
approval by our stockholders, our Board of Direc-
-23-
tors will be authorized to amend our certificate of incorporation to effect a 3
for 1, 4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock split of the
outstanding shares of our Common Stock, with the actual implemented ratio to be
determined by our Board of Directors in its discretion. If approved by our
stockholders, the reverse stock split would become effective shortly before
consummation of the Exchange Offer or on any other date selected by our Board of
Directors prior to our next annual meeting of stockholders. Our Board of
Directors may effect only one reverse stock split. In determining the reverse
stock split ratio, our Board of Directors will consider numerous factors
including the historical and projected performance of our Common Stock, the
requirements for continued listing on the Nasdaq SmallCap Market, prevailing
market conditions and general economic trends, and will place emphasis on the
expected closing price of our Common Stock in the period following the
effectiveness of the reverse stock split. The purpose of selecting a range is to
give our Board of Directors the flexibility to provide for a post reverse stock
split market price that may allow us to maximize our ability to support future
growth. Even if the stockholders approve the reverse stock split, our Board of
Directors will reserve the right not to effect the reverse stock split if the
Board of Directors does not deem it to be in our or our stockholders' best
interest to effect the reverse stock split. Accordingly, the actual number of
shares of Common Stock outstanding will be adjusted by dividing such number of
shares by the split ratio, if any, approved by our stockholders and ultimately
effected.
As of September 27, 2004, if all of the outstanding Preferred Stock was
converted into Common Stock at the then prevailing conversion rates:
o the former holders of Series D Preferred Stock would own approximately
10.4% of our Common Stock on a fully diluted basis;
o the former holders of Series E Preferred Stock would own approximately
11.3% of our Common Stock on a fully diluted basis;
o the former holders of Series G Preferred Stock would own approximately
26.1% of our Common Stock on a fully diluted basis; and
o the current holders of Common Stock would own approximately 52.2% of
our Common Stock on a fully diluted basis.
As of the same date, if all of the outstanding Preferred Stock is exchanged
in the Exchange Offer:
o the former holders of Series D Preferred Stock would own approximately
34.0% of the Common Stock on a Fully Diluted Basis;
o the former holders of Series E Preferred Stock would own approximately
35.0% of the Common Stock on a Fully Diluted Basis;
o the former holders of Series G Preferred Stock would own approximately
9.2% of the Common Stock on a Fully Diluted Basis;
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o the current holders of Common Stock would own approximately 13.8% of
the Common Stock on a Fully Diluted Basis; and
o approximately 8.0% of the Fully Diluted Common Stock would have been
reserved for issuance under the new management equity incentive plan.
We will not issue fractional shares. In the event that a fraction of a
Common Share becomes issuable upon consummation of the Offer to Exchange, we
will pay you an amount in cash equal to the closing price of our Common Stock on
the business day preceding such consummation (as adjusted to reflect the impact
of any reverse stock split), multiplied by such fraction of a Common Share.
Expiration Date
The term "Expiration Date" means 5:00 p.m., New York City time, on Tuesday,
November 23, 2004, unless and until we, in our sole discretion, extend the
period of time during which the Offer to Exchange will remain open, in which
event the term "Expiration Date" shall refer to the latest time and date at
which the Offer to Exchange shall expire. See "--Extension of the Tender Period;
Termination; Amendment" below.
Procedures for Tendering Preferred Shares
A holder who wishes to tender Preferred Shares for exchange pursuant to the
Offer to Exchange must transmit a properly completed and duly executed Letter of
Transmittal, or a facsimile thereof, together with certificates for such
Preferred Shares and any other required documents, to the Exchange and
Information Agent prior to 5:00 p.m., New York City time, on the Expiration
Date.
To be effectively tendered, Preferred Shares, the Letter of Transmittal and
other required documents must be received by the Exchange and Information Agent
at the address set forth on the last printed page of this Offer to Exchange
prior to 5:00 p.m., New York City time, on the Expiration Date.
The tender by a stockholder will constitute an agreement between that
stockholder and us in accordance with the terms and subject to the conditions
contained in this Offer to Exchange and in the Letter of Transmittal.
The method of delivery of Preferred Shares and all other required documents
is at your election. If you deliver your Preferred Shares by mail, we recommend
registered mail, properly insured, with return receipt requested. In all cases,
you should allow sufficient time to assure timely delivery. Please send all
certificates representing Preferred Shares and Letters of Transmittal to the
Exchange and Information Agent for the Offer to Exchange, at the address set
forth on the last printed page of this Offer to Exchange. Please do not send
these materials to us.
If the Letter of Transmittal is signed by a person other than the
registered holder of any Preferred Shares listed therein, these Preferred Shares
must be endorsed or accompanied by a properly completed stock power and signed
by the registered holder as the registered holder's name appears on the
Preferred Share certificates.
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If the Letter of Transmittal or Preferred Shares or stock powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity,
these persons should so indicate when signing, unless waived by us. If we waive
any condition or matter with respect to any holder of Preferred Stock, we will
similarly waive such condition or matter for all holders of Preferred Stock.
Evidence satisfactory to us of their authority so to act must be submitted with
the Letter of Transmittal.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed by an Eligible Institution unless the Preferred
Shares tendered pursuant thereto are tendered:
o by a registered holder who has not completed the box entitled "Special
Issuance Instructions" or "Special Delivery Instructions" on the
Letter of Transmittal, or
o for the account of an Eligible Institution.
In the event that signatures on a Letter of Transmittal or a notice of
withdrawal, as the case may be, are required to be guaranteed, such guarantee
must be by a member firm of a registered national securities exchange or of the
National Association of Securities Dealers, Inc., a commercial bank or trust
company having an office or correspondent in the United States or an "eligible
guarantor institution" within the meaning of Rule 17Ad-5 under the Exchange Act
(an "Eligible Institution").
We will determine all questions as to the validity, form, eligibility,
including time of receipt, acceptance and withdrawal of tendered Preferred
Shares in our sole discretion, which determination shall be final and binding.
We reserve the absolute right to reject any and all Preferred Shares not
properly tendered or any Preferred Shares, our acceptance of which would, in the
opinion of our counsel, be unlawful. We also reserve the right to waive any
defects, irregularities or conditions of tender as to particular Preferred
Shares; provided that any such waiver shall similarly apply to all holders of
Preferred Stock. Our interpretation of the terms and conditions of the Offer to
Exchange, including the instructions in the Letter of Transmittal, shall be
final and binding on all parties. Unless waived, any defects or irregularities
in connection with the tender of Preferred Shares must be cured within the time
as we shall determine. Neither we, the Exchange and Information Agent nor any
other person shall incur any liability for failure to give notice of any defect
or irregularity with respect to any tender of Preferred Shares. Tenders of
Preferred Shares will not be deemed to have been made until such defects or
irregularities have been cured or waived. Any Preferred Shares received by the
Exchange and Information Agent that are not properly tendered and as to which
the defects or irregularities have not been cured or waived will not be deemed
to have been properly tendered. Any Preferred Shares received by the Exchange
and Information Agent that are not properly tendered and as to which the defects
or irregularities have not been cured or waived will be returned by the Exchange
and Information Agent to the tendering stockholder, unless otherwise provided in
the Letter of Transmittal, promptly following the Expiration Date.
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Conditions
Consummation of the Exchange Offer is conditioned upon the approval of
stockholders of the Special Meeting Matters and upon the tender by The 1818 Fund
of all Preferred Stock that it owns in the Exchange Offer and our acceptance of
those shares. In addition, notwithstanding any other provision of this Offer to
Exchange, we shall not be required to accept for exchange any Preferred Shares
tendered, and may terminate or amend the Offer or may postpone the acceptance
for exchange of any Preferred Shares tendered, if at any time on or before the
expiration of the Offer, any of the following events shall have occurred which,
in our reasonable judgment, makes it inadvisable to proceed with the Offer to
Exchange or with such exchange:
o any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Offer, or any
material adverse development has occurred in any existing action or
proceeding with respect to us or any of our subsidiaries, which, in
our reasonable judgment, might materially impair our ability to
proceed with the Offer;
o any law, statute, rule or regulation is proposed, adopted or enacted
which, in our reasonable judgment, might materially impair our ability
to proceed with the Offer; or
o any governmental approval has not been obtained, which approval we, in
our reasonable judgment, shall deem necessary for the consummation of
the Offer as contemplated hereby.
The foregoing conditions may be asserted by us regardless of the
circumstances giving rise to any such condition or may be waived by us in whole
or in part. With the exception of those dependent on the receipt of necessary
governmental approvals, all of the foregoing conditions must be satisfied or
waived on or before the Expiration Date. We will promptly terminate the Offer or
issue a press release stating our intentions upon becoming aware of any
condition that may not be satisfied. Any determination by us concerning the
foregoing conditions shall be final and binding on all parties.
If we determine in our reasonable discretion that any of the conditions are
not satisfied, we may:
o refuse to accept the Preferred Shares and return all tendered shares
to the tendering holders;
o extend the Offer and retain all Preferred Shares tendered prior to the
expiration of the Offer, subject, however, to the rights of holders to
withdraw their tendered shares (see "--Withdrawal of Tenders"); or
o waive the unsatisfied conditions with respect to the Offer and accept
all properly tendered Preferred Shares that have not been withdrawn.
If such a waiver constitutes a material change to the Offer, we will
promptly disclose this waiver by means of an Offer supplement that
will be distributed to the record holders of Preferred Shares. We will
also extend the Offer for a period of five to ten business days,
depending
-27-
upon the significance of the waiver and the manner of disclosure to
the record holders, if the Offer would otherwise expire during such
five to ten business day period.
Acceptance of Preferred Shares for Exchange; Delivery of Common Shares
For purposes of the Offer, we shall be deemed to have accepted properly
tendered Preferred Shares for exchange when, as and if we have given oral or
written notice thereof to the Exchange and Information Agent.
In all cases, the issuance of Common Shares for Preferred Shares that are
accepted for exchange pursuant to the Offer will be made only after timely
receipt by the Exchange and Information Agent of certificates for the Preferred
Shares, a properly completed and duly executed Letter of Transmittal and all
other required documents. If any tendered Preferred Shares are not accepted for
any reason set forth in the terms and conditions of the Offer, or if Preferred
Shares are submitted for a greater principal amount than the stockholder desires
to exchange, these unaccepted or non-exchanged Preferred Shares will be promptly
returned without expense to the tendering stockholder of these Preferred Shares.
All tendered Preferred Shares will promptly be either (1) exchanged for
shares of Common Stock or (2) returned to the tendering stockholder following
the Expiration Date.
Guaranteed Delivery Procedures
Stockholders who wish to tender their Preferred Shares and whose Preferred
Shares are not immediately available, or who cannot deliver their Preferred
Shares, the Letter of Transmittal or any other required documents to the
Exchange and Information Agent prior to the Expiration Date, may effect a tender
if:
o the tender is made through an Eligible Institution;
o prior to the Expiration Date, the Exchange and Information Agent
receives from such Eligible Institution a properly completed and duly
executed notice of guaranteed delivery, by facsimile transmission,
mail or hand delivery, setting forth the name and address of the
stockholder, the certificate number(s) of the Preferred Shares and the
principal amount of Preferred Shares tendered, stating that the tender
is being made thereby and guaranteeing that, within three (3) Nasdaq
Stock Market trading days after the Expiration Date, the Letter of
Transmittal (or facsimile thereof) together with the certificate(s)
representing the Preferred Shares and any other documents required by
the Letter of Transmittal will be deposited by the Eligible
Institution with the Exchange and Information Agent; and
o such properly completed and executed Letter of Transmittal (or
facsimile thereof) as well as the certificate(s) representing all
tendered Preferred Shares in proper form for transfer and all other
documents required by the Letter of Transmittal are received by the
Exchange and Information Agent within three Nasdaq Stock Market
trading days after the Expiration Date.
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Lost or Missing Certificate
If you desire to tender Preferred Shares pursuant to this Offer to
Exchange, but the certificates representing such Preferred Shares have been
mutilated, lost, stolen or destroyed, you should write to or telephone the
Exchange and Information Agent at the addresses or telephone numbers listed on
the last printed page of this Offer to Exchange, about procedures for obtaining
replacement certificates for such Preferred Shares, arranging for
indemnification or about any other matter that requires handling by the Exchange
and Information Agent.
Withdrawal of Tenders
Except as otherwise provided herein, tenders of Preferred Shares may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the Expiration
Date.
To withdraw a tender of Preferred Shares in the Offer to Exchange, a
written or facsimile transmission notice of withdrawal must be received by the
Exchange and Information Agent at its address set forth herein prior to 5:00
p.m., New York City time, on the Expiration Date.
You also have the right to withdraw your tendered Preferred Shares at any
time after the expiration of 40 business days from the commencement of the Offer
to Exchange, which is November 24, 2004, if we have not yet accepted your
Preferred Shares for exchange at that time.
Any notice of withdrawal must:
o specify the name of the person having deposited the Preferred Shares
to be withdrawn (the "Depositor");
o identify the Preferred Shares to be withdrawn (including the
certificate numbers and principal amounts of such Preferred Shares);
o be signed by the stockholder in the same manner as the original
signature on the Letter of Transmittal by which such Preferred Shares
were tendered (including any required signature guarantees) or be
accompanied by documents of transfer sufficient to have the trustee
with respect to the Preferred Shares register the transfer of these
Preferred Shares into the name of the person withdrawing the tender;
and
o specify the name in which any of the Preferred Shares are to be
registered, if different from that of the Depositor.
If certificates representing Preferred Shares have been delivered or
otherwise identified to the Exchange and Information Agent, then, prior to the
release of such certificates, the withdrawing stockholder must also submit the
serial numbers of the particular certificates to be withdrawn and a signed
notice of withdrawal. We will determine in our sole discretion all questions as
to the validity, form and eligibility (including time of receipt) of those
notices, which determination shall be final and binding on all parties. Any
Preferred Shares so withdrawn will be deemed not to have been validly tendered
for purposes of the Offer and no Common Stock will be issued with respect
thereto unless the Preferred Shares so withdrawn are validly retendered.
Properly
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withdrawn Preferred Shares may be retendered by following one of the procedures
described above.
Any Preferred Shares that have been tendered but that are not accepted for
exchange due to withdrawal, rejection of tender or termination of the Offer will
be returned promptly after withdrawal, rejection of tender or termination of the
Offer to the holder of the Preferred Shares, without cost to the stockholder.
Exchange and Information Agent
We have appointed Andrew L. Graham as the Exchange and Information Agent
for the Offer. All completed Letters of Transmittal should be directed to the
Exchange and Information Agent at the address set forth on the last printed page
of this Offer to Exchange.
Delivery of a Letter of Transmittal to an address other than the address
listed herein or transmission of instructions by facsimile other than as set
forth herein is not valid delivery of the Letter of Transmittal.
All questions regarding the procedures for tendering in the Offer and
requests for assistance in tendering your Preferred Shares can be directed to
the Exchange and Information Agent at the telephone number or the address on the
last printed page of this Offer to Exchange.
Requests for additional copies of this Offer to Exchange, the Letter of
Transmittal or other exchange offer materials, our Quarterly Report on Form 10-Q
for the quarter ended June 30, 2004, our Quarterly Report on Form 10-Q for the
quarter ended March 31, 2004, our 2003 Annual Report on Form 10-K and our 2002
Annual Report on Form 10-K, or any of the other documents incorporated by
reference herein, may be directed to the Exchange and Information Agent at the
telephone number and address listed on the last printed page of this Offer to
Exchange.
All deliveries, correspondence and questions sent or presented to the
Exchange and Information Agent relating to the Offer should be directed to the
address or telephone number set forth on the last printed page of this Offer to
Exchange.
Extension of the Tender Period; Termination; Amendment
We expressly reserve the absolute right, in our sole discretion:
o to delay accepting any Preferred Shares, to extend the Offer or, if in
our reasonable judgment, any of the conditions described above under
the caption "--Conditions" are not satisfied, to terminate the Offer
or waive any condition set forth in the Offer, by giving oral or
written notice of this delay, extension, termination or waiver to the
Exchange and Information Agent;
o to amend the terms of the Offer in any manner, any such amendment to
be followed promptly by a public announcement thereof; and
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o to terminate the Offer and not accept for exchange Preferred Shares
tendered pursuant thereto.
Our reservation of the right to delay the exchange of Preferred Shares is
limited by Rule 13e-4(f)(5) promulgated under the Exchange Act, which requires
that we must pay the consideration offered or return the Preferred Shares
tendered promptly after termination or withdrawal of the Offer. Any waiver,
amendment or modification will apply to all Preferred Shares tendered,
regardless of when or in what order such Preferred Shares were tendered. Any
extension or termination of the Offer or any amendment or modification of the
terms set forth in the Offer will be followed promptly by public announcement
thereof, such announcement in the case of an extension to be issued no later
than 9:00 a.m., New York City time, on the next business day after the
previously scheduled Expiration Date, unless otherwise required by applicable
law or regulation.
If we materially change the terms of the Offer or the information
concerning the Offer, we will extend the Offer to the extent required by Rules
13e-4(d)(2) and 13e-4(e)(3) promulgated under the Exchange Act. These rules
provide certain minimum periods during which an offer must remain open following
material changes in the terms of the Offer or information concerning the Offer.
We will promptly disclose such amendment by means of an Offer supplement that
will be distributed to record holders of Preferred Shares, and extend the Offer
for a period of five to ten business days, depending upon the significance of
the amendment and the manner of disclosure to the registered holders, if the
Offer would otherwise expire during such five to ten business day period.
Without limiting the manner in which we may choose to make a public
announcement of any delay, extension, termination or amendment of the Offer,
except as required by applicable law, we have no obligation to publish,
advertise or otherwise communicate any such public announcement, other than by
making a timely release to Business Wire, for further dissemination to leading
financial and general news organizations, including Associated Press, Dow Jones
and Reuters.
Accounting Treatment
The exchange of Common Stock for Preferred Stock will be treated as an
induced conversion for accounting purposes per Financial Accounting Standards
Board ("FASB") Statement No. 84, "Induced Conversions of Convertible Debt." An
"induced conversion" is considered to occur when the conversion privileges,
pursuant to the original terms of the instrument, are changed or additional
consideration is offered to security holders for the purpose of inducing prompt
conversion of the security. Per Topic D-42 and FASB 84, a dividend charge will
be incurred representing the difference between the value of the Common Stock
issued in the Offer, and the value of the shares that were issuable under the
original conversion terms of the Preferred Stock. The dividend charge will
result in an adjustment to net earnings in the quarter in which the conversion
is approved. This adjustment is expected to be a reduction to net earnings,
assuming our Common Stock price remains below the Preferred Stock effective
exchange price on the day the conversion is approved. Earnings per share
attributable to Common Stock will be adjusted due to the dividend and will show
an even greater loss per Common Share outstanding.
Regulatory Approvals
We do not believe that the receipt of any material federal or state
regulatory approvals will be necessary in connection with the Offer.
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Voluntary Exchange
Participation in the Offer is voluntary and holders of Preferred Shares
should carefully consider whether to accept the terms and conditions of the
Offer. Holders of the Preferred Shares are urged to consult their financial and
tax advisors in making their own decisions on what action to take with respect
to the Offer.
Description of Our Preferred Stock
The following are summaries of the principal terms and conditions of each
series of our outstanding Preferred Stock, as provided in our Amended and
Restated Certificate of Incorporation, as amended (the "Certificate of
Incorporation"). The following summaries are subject to, and qualified in their
entirety by reference to, all of the provisions of the Certificate of
Incorporation. In addition, as described above, if the proposed amendments
contemplated in the Special Meeting Matters that will be described in the proxy
statement to be prepared for the Special Meeting are adopted, the terms of the
Series D Preferred Stock and Series G Preferred Stock will change significantly
and will cease to have certain preferential rights that they had prior to the
Offer.
Series D Preferred Stock
Series D Preferred Shares Outstanding.............. 3,976,723 preferred shares
(as of September 27, 2004)
Parity with Series E Preferred Stock............... The Series D Preferred Stock
ranks on a parity with the
Series E Preferred Stock
with respect to dividend
rights and rights on
liquidation, dissolution or
winding up.
Dividends.......................................... Dividends equal to 8% per
annum of the Liquidation
Preference (as defined
below), are payable at the
option of the Board of
Directors in cash,
additional shares of Series
D Preferred Stock or in any
combination thereof.
Dividends automatically
accrue and are added to the
Liquidation Preference of
the Series D Preferred Stock
in the absence of a payment
election by the Board of
Directors.
Restriction on Dividends on Common Stock........... No dividends may be declared
or paid on shares of Common
Stock while there are any
shares of Series D Preferred
Stock outstanding, nor may
we redeem, purchase or
acquire stock that is junior
in rights and preferences to
the Series D Preferred Stock
("Junior Stock") in excess
of 1 million shares of
Common Stock in any 12-month
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period, unless all accrued
and unpaid dividends on the
Series D Preferred Stock
have been paid or set aside
for payment and sufficient
funds for payment of current
dividends on the Series D
Preferred have been paid or
set aside for payment. We
may declare and pay
dividends on Junior Stock
which are payable in
additional shares, or an
increase in the liquidation
value of, Junior Stock.
Optional Redemption................................ The Series D Preferred Stock
is redeemable at our option
at any time at a price per
share equal to the
Liquidation Preference, plus
a premium ranging from 5% in
the year following the third
anniversary of the original
issue date thereof to 0%
from and after the eighth
anniversary of such original
issue date, plus accrued and
unpaid dividends, whether or
not declared, to the
redemption date. The premium
for a redemption at our
option in effect from the
date of this Offer to
Exchange to June 30, 2005 is
4%.
Mandatory Redemption............................... The Series D Preferred Stock
is mandatorily redeemable by
us in 2008, at a price per
share equal to the
Liquidation Preference plus
all accrued but unpaid
dividends, whether or not
declared, to the redemption
date.
Liquidation Preference............................. $12.00 per share, plus
accrued and unpaid
dividends, prior to any
payment in respect of Junior
Stock. The Series D
Preferred Stock has parity
with the Series E Preferred
Stock ("Parity Stock"). In
the event that the proceeds
available on liquidation are
insufficient to satisfy the
Liquidation Preference of
the Series D Preferred Stock
and the Parity Stock, the
proceeds shall be
distributed among the
holders of the Series D
Preferred Stock and the
Parity Stock ratably in
proportion to the total
amounts to which all holders
of Series D Preferred Stock
and the Parity Stock are
entitled upon liquidation.
Conversion Rights.................................. Holders may convert each
share of Series D Preferred
Stock into 1.3905 shares of
Common Stock at any time,
subject to adjustment.
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Forced Conversion.................................. We have the right to convert
all (and not less than all)
shares of Series D Preferred
Stock each time the Common
Stock trades at a price per
share exceeding two times
the then-applicable
Conversion Price for twenty
consecutive trading days.
Based upon a Conversion
Price of $8.47 (as of
September 27, 2004), we have
the right to convert all
(and not less than all)
shares of Series D Preferred
Stock each time that the
Common Stock trades at a
price per share exceeding
$16.94 for twenty
consecutive trading days.
Voting Rights...................................... Each holder of Series D
Preferred Stock is entitled
to a number of votes equal
to the number of shares of
Common Stock into which that
holder's shares of Series D
Preferred Stock are then
convertible. The Series D
Preferred Stock votes as a
single class with the Common
Stock on all matters
submitted to stockholders.
The approval of seventy
percent (70%) of the
outstanding voting power of
the Series D Preferred Stock
is necessary to authorize or
issue any stock that is
senior to or on parity with
the Preferred Stock.
Accumulated Unpaid Dividends and Interest.......... $4.55 in the aggregate per
share of Series D Preferred
Stock (as of September 27,
2004). Total accumulated
unpaid dividends and
interest on all issued and
outstanding shares of Series
D Preferred Stock are
$65,809,802 as of September
27, 2004.
Series E Preferred Stock
Series E Preferred Shares Outstanding.............. 4,166,667 preferred shares
(as of September 27, 2004)
Parity with Series D Preferred Stock............... The Series E Preferred Stock
ranks on a parity with the
Series D Preferred Stock
with respect to dividend
rights and rights on
liquidation, dissolution or
winding up.
Dividends.......................................... Cumulative dividends equal
to 8% per annum of the
Liquidation Preference (as
defined below). At our
option, no dividends are
payable in cash until the
earlier of redemption or
liquidation. If
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we do not pay dividends,
they automatically accrue
and are added to the
Liquidation Preference of
the Series E Preferred
Stock. In the event of
conversion of shares of
Series E Preferred Stock,
accrued and unpaid dividends
shall be applied to increase
the number of shares of
Common Stock into which
shares of Series E Preferred
Stock are convertible.
Restriction on Redemption of Junior Stock.......... If dividends payable on
Shares of Series E Preferred
Stock are not paid in full
in cash, we may not redeem,
purchase or acquire stock
that is junior in rights and
preferences to the Series E
Preferred Stock ("Junior
Stock") in excess of 1
million shares of Common
Stock in any 12-month period
unless all accrued and
unpaid dividends on the
Series E Preferred Stock
have been paid or set aside
for payment and sufficient
funds for payment of current
dividends on the Series E
Preferred have been paid or
set aside for payment.
Participation with Dividends on Common Stock....... In the event that we declare
and pay any dividends or
make any distributions on
Common Stock (whether in
cash, stock, or pursuant to
a stockholder rights plan),
each holder of Series E
Preferred Stock shall be
entitled to receive the
dividend which is payable to
the number of shares of
Common Stock into which that
holder's shares of Series E
Preferred Stock are then
convertible.
Optional Redemption................................ The Series E Preferred Stock
is not redeemable at our
option prior to July 2,
2006. From and after July 2,
2006, the Series E Preferred
Stock is redeemable at our
option at any time at a
price per share equal to the
Liquidation Preference, plus
a premium equal to 2% in the
year beginning July 2, 2006,
1% on the year beginning
July 2, 2007, and 0% from
and after October 19, 2008,
plus accrued and unpaid
dividends, whether or not
declared, to the redemption
date.
Mandatory Redemption............................... The Series E Preferred Stock
is mandatorily redeemable by
us on October 19, 2008, at a
price
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per share equal to the
Liquidation Preference plus
all accrued but unpaid
dividends, whether or not
declared, to the redemption
date.
Liquidation Preference............................. $12.00 per share, plus
accrued and unpaid
dividends, prior to any
payment in respect of Junior
Stock. The Series E
Preferred Stock has parity
with the Series D Preferred
Stock ("Parity Stock"). In
the event that the proceeds
available on liquidation are
insufficient to satisfy the
Liquidation Preference of
the Series E Preferred Stock
and the Parity Stock, the
proceeds shall be
distributed among the
holders of the Series E
Preferred Stock and the
Parity Stock ratably in
proportion to the total
amounts to which all holders
of Series E Preferred Stock
and the Parity Stock are
entitled upon liquidation.
Conversion Rights.................................. Holders may convert each
share of Series E Preferred
Stock into 2.5737 shares of
Common Stock at any time,
subject to adjustment.
Forced Conversion.................................. From and after July 2, 2006,
we have the right to convert
all (and not less than all)
shares of Series E Preferred
Stock each time the Common
Stock trades at a price per
share exceeding 250% of the
then-applicable Conversion
Price for twenty consecutive
trading days. Based upon a
Conversion Price of $8.08
(as of September 27, 2004),
from and after July 2, 2006,
we would have the right to
convert all (and not less
than all) shares of Series E
Preferred Stock each time
that the Common Stock trades
at a price per share
exceeding $20.20 for twenty
consecutive trading days.
Voting Rights...................................... Each holder of Series E
Preferred Stock is entitled
to a number of votes equal
to the number of shares of
Common Stock into which that
holder's shares of Series E
Preferred Stock are then
convertible. The Series E
Preferred Stock votes as a
single class with the Common
Stock on all matters
submitted to stockholders.
The approval of at least
fifty percent (50%) of the
outstanding voting power of
the Series E Preferred Stock
is necessary to authorize or
issue any stock that is
senior to or on parity with
the Series E Preferred
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Stock, or effect certain
mergers or acquisitions
involving material
subsidiaries, sales of
assets in excess of $50
million, incurrence of
indebtedness for borrowed
money in excess of $100
million.
Accumulated Unpaid Dividends and Interest.......... $4.26 in the aggregate per
share of Series E Preferred
Stock (as of September 27,
2004). Total accumulated
unpaid dividends and
interest on all issued and
outstanding shares of Series
E Preferred Stock are
$67,750,315 as of September
27, 2004.
Series G Preferred Stock
Series G Preferred Shares Outstanding.............. 171.214286 preferred shares
(as of September 27, 2004)
Junior to Series D Preferred Stock and Series E
Preferred Stock................................. The Series G Preferred Stock
ranks junior to the Series D
Preferred Stock and the
Series E Preferred Stock
with respect to dividend
rights and rights on
liquidation, dissolution or
winding up.
Dividends.......................................... Cumulative dividends equal
to 12% per annum of the
Liquidation Preference (as
defined below). At our
option, no dividends are
payable in cash until the
earlier of redemption or
liquidation. If we do not
pay dividends, they
automatically accrue and are
added to the Liquidation
Preference of the Series G
Preferred Stock. In the
event of conversion of
Series G Preferred Stock
into Common Stock, accrued
and unpaid dividends are
applied to increase the
number of shares of Common
Stock into which the Series
G Preferred Stock is
convertible.
Restriction on Dividends on Common Stock........... If dividends payable on the
shares of Series G Preferred
Stock are not paid in full
in cash, we may not redeem,
purchase or acquire stock
that is junior in rights and
preferences to the Series G
Preferred Stock ("Junior
Stock") in excess of 1
million shares of Common
Stock in any 12-month period
unless all accrued and
unpaid dividends on the
Series G Preferred Stock
have been
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paid or set aside for
payment and sufficient funds
for payment of dividends on
the Series G Preferred have
been paid or set aside for
payment.
Optional Redemption................................ Subject to the rights and
privileges of the holders of
the Series D Preferred Stock
and the Series E Preferred
Stock, the Series G
Preferred Stock is
redeemable at our option at
any time after September 18,
2002 at a price per share
equal to the Liquidation
Preference, plus accrued and
unpaid dividends, whether or
not declared, to the
redemption date.
Right to Put Series G Preferred Stock on Change in
Control......................................... Subject to the rights and
privileges of the holders of
the Series D Preferred Stock
and the Series E Preferred
Stock, in the event that on
or prior to July 2, 2006, a
Change in Control occurs,
each holder of shares of
Series G Preferred Stock has
the option to require us to
redeem all of such holder's
Series G Preferred Stock for
a price equal to 125% of the
sum of the Liquidation
Preference and accrued and
unpaid dividends through the
redemption date.
Mandatory Redemption............................... Subject to the rights and
privileges of the holders of
the Series D Preferred Stock
and the Series E Preferred
Stock, the Series G
Preferred Stock is
mandatorily redeemable by us
on September 18, 2006, at a
price per share equal to the
Liquidation Preference plus
all accrued but unpaid
dividends, whether or not
declared, to the redemption
date.
Liquidation Preference............................. Subject to the rights and
privileges of the holders of
the Series D Preferred Stock
and the Series E Preferred
Stock, $100,000.00 per
share, plus accrued and
unpaid dividends, prior to
any payment in respect of
Junior Stock.
Conversion Rights.................................. Holders may convert each
share of Series G Preferred
Stock into 113,262 shares of
Common Stock at any time
(based upon a Conversion
Price of $1.28, as of
September 27, 2004).
Automatic Conversion............................... If at any time the Common
Stock trades at a price per
share of $10.00 for twenty
consecutive trading days.
Based upon a Conversion
Price of
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$1.28 (as of September 27,
2004), each share of Series
G Preferred Stock is
convertible into
118,901.6174 shares of
Common Stock.
Voting Rights...................................... The holders of the Series G
Preferred Stock are not
entitled to any voting
rights, except as required
by law.
Accumulated Unpaid Dividends and Interest.......... $44,974.90 in the aggregate
per share of Series G
Preferred Stock (as of
September 27, 2004). Total
accumulated unpaid dividends
and interest on all issued
and outstanding shares of
Series G Preferred Stock are
$24,821,153 as of September
27, 2004.
DESCRIPTION OF OUR COMMON STOCK
We are authorized to issue 150,000,000 shares of Common Stock, of which
38,776,343 shares were outstanding on September 27, 2004. All shares of Common
Stock have equal rights to participate in the distribution of assets in the
event of a liquidation of Z-Tel, subject to the preferences established on the
Preferred Stock. Each holder of Common Stock is entitled to one vote for each
share held on all matters submitted to a vote of the stockholders. Common Stock
carries no conversion, preemptive or subscription rights and is not subject to
redemption. All outstanding shares of Common Stock are fully paid and
nonassessable. Although holders of Common Stock are entitled to receive any
dividends declared thereon by the Board of Directors out of legally available
funds, we have never paid a cash dividend on our Common Stock and are prohibited
from doing so by the terms of the agreements governing our indebtedness. As a
result, we do not anticipate paying any dividends in the foreseeable future.
In addition, in our proxy statement to be prepared in connection with the
Special Meeting Matters we intend to request that our stockholders authorize our
Board of Directors to adopt one of several reverse stock split proposals. If the
reverse stock split is approved, the number of outstanding shares of Common
Stock outstanding will be reduced, but the number of authorized shares of Common
Stock under our charter will not change.
MARKET FOR COMMON STOCK AND PREFERRED STOCK
Our Common Stock currently trades on the Nasdaq SmallCap Market under the
symbol "ZTEL." Our Preferred Stock does not trade on an exchange, nor is it
listed or quoted on an inter-dealer quotation system. The price ranges presented
below for Common Stock represent high and low sale prices for each quarter, as
reported by the Nasdaq SmallCap Market. There is no established trading market
for the Preferred Stock.
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HIGH LOW
2002 (1):
First Quarter $2.98 $1.25
Second Quarter $2.25 $0.35
Third Quarter $1.55 $0.41
Fourth Quarter $1.37 $0.70
2003:
First Quarter $1.60 $0.60
Second quarter $2.99 $1.58
Third Quarter $3.25 $1.70
Fourth Quarter $3.08 $1.40
2004:
First Quarter $4.79 $2.00
Second Quarter $3.19 $1.25
Third Quarter $1.41 $0.29
October 1, 2004 through October 20, 2004 $0.56 $0.37
(1) Prices for our Common Stock for periods prior to September
10, 2002 represent stock prices on the Nasdaq National Market,
the exchange on which our Common Stock was listed prior to such
date.
As of September 27, 2004, there were 229 record holders of Common Shares,
36 record holders of Series D Preferred Shares, 1 record holder of Series E
Preferred Shares, and 7 record holders of Series G Preferred Shares.
By letter dated July 28, 2004, the Nasdaq Stock Market, Inc. notified us
that for 10 consecutive days, the market value of our Common Stock on the Nasdaq
SmallCap Market was not $35 million or more, as required for continued inclusion
on the Nasdaq SmallCap Market by the Nasdaq rules. The market value of our
Common Stock remained below the minimum market value, and as a result the Nasdaq
staff provided us with written notification that our Common Stock will be
delisted. Currently we are appealing the staff's decision to a Listing
Qualifications Panel primarily on the basis that we believe, following
consummation of the Exchange Offer, that the market value of our Common Stock
will substantially exceed the minimum required amount. The Listing
Qualifications Panel may not grant our request to defer a determination of
delisting until after the Exchange Offer is consummated. In that event our
Common Stock will be delisted, our Common Stock will only be traded over the
counter on the Nasdaq Bulletin Board and the liquidity and price of our Common
Stock may be negatively affected. Even if our request is granted, we may not
achieve the necessary market value for our Common Stock following the Exchange
Offer or our Common Stock may not maintain the necessary market value for any
length of time. If we fail to achieve and maintain the market value for our
Common Stock above that required by the Nasdaq rules, our Common Stock will
ultimately be delisted from the Nasdaq SmallCap Market.
We have also been advised by the Nasdaq staff that our Common Stock does
not currently meet the minimum bid price per share of $1.00 necessary to
maintain listing on the
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Nasdaq SmallCap Market as required by the Nasdaq rules. Although we believe that
the reverse stock split proposal, if adopted at the Special Meeting, will allow
us to regain compliance, we may not achieve the necessary bid price per share
following the reverse stock split or our Common Stock may not maintain the
necessary minimum bid price for any length of time. If we fail to achieve and
maintain a bid price for our Common Stock above that required by the Nasdaq
rules, our Common Stock will ultimately be delisted from the Nasdaq SmallCap
Market
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes certain material United States ("U.S.")
federal income tax consequences to U.S. holders of Preferred Shares who exchange
their Preferred Shares for the Exchange Consideration pursuant to the Offer to
Exchange. This discussion is based upon the Internal Revenue Code of 1986, as
amended (the "Code"), Treasury Regulations promulgated thereunder, and
administrative and judicial interpretations thereof, all as in effect on the
date hereof and all of which are subject to change, possibly with retroactive
effect, or different interpretations. Tax consequences that are different from
or in addition to those described herein may apply to holders of Preferred
Shares who are subject to special treatment under the U.S. federal income tax
laws, such as non-U.S. persons, tax-exempt organizations, financial
institutions, insurance companies, broker-dealers, U.S. holders whose functional
currency is not the U.S. dollar, holders who hold their Preferred Shares as part
of a hedge, straddle, wash sale, synthetic security, conversion transaction or
other integrated investment comprised of Preferred Shares and one or more other
investments, and persons who acquired their shares in compensatory transactions.
This discussion does not address non-U.S. or state or local tax considerations.
The summary of U.S. federal income tax consequences below is for general
information only. This discussion is not a substitute for an individual analysis
of the tax consequences of the exchange to a particular holder of Preferred
Shares. Each holder of Preferred Shares should consult a tax adviser regarding
the particular federal, state, local and non-U.S. tax consequences of the
exchange in light of such holder's own situation.
Based upon discussions with our tax counsel, we believe that the Offer will
qualify as a reorganization under Section 368(a)(1)(E) of the Code. However, we
did not seek or obtain any tax opinion with respect to the tax consequences of
the Offer. Assuming the Offer qualifies as a reorganization for federal income
tax purposes, the following U.S. federal income tax consequences will occur:
o you will not recognize gain or loss upon the receipt of Common Stock
solely in exchange for the face amount of your Preferred Shares
pursuant to the Offer to Exchange. However, you will be treated as
having received a distribution with respect to your Preferred Shares
to the extent Common Stock is received for accrued but unpaid
dividends on the Preferred Shares. Common Stock is deemed received for
accrued and unpaid dividends only to the extent of the lesser of: 1)
the amount by which the fair market value of the aggregate Common
Stock received in the exchange exceeds the aggregate issue price of
the Preferred Shares surrendered; or 2) the amount of dividends in
arrears. Any deemed distribution for accrued dividends will be treated
as a taxable dividend (to the extent of our accumulated or current
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earnings and profits, if any), then as a tax-free return of capital to
the extent of your basis in your Preferred Shares, and thereafter as
capital gain;
o the aggregate tax basis of the Common Shares received by you in
exchange for your Preferred Shares will be the same as the aggregate
tax basis of the Preferred Shares surrendered in exchange, increased
by any taxable amounts realized for accrued and unpaid dividends on
the Preferred Shares; and
o the holding period of the Common Shares received tax free by you in
exchange for your Preferred Shares will include the holding period of
the Preferred Shares surrendered by you, provided that you held such
Preferred Shares as capital assets at the effective time of the
exchange. The Common Shares received for accrued and unpaid dividends
will have a new holding period commencing on the date of the exchange.
CERTAIN SECURITIES LAWS CONSIDERATIONS
All of the Preferred Shares were issued by us in private transactions that
were not registered pursuant to the Securities Act, or any state securities
laws. The Common Shares to be issued in the Offer to Exchange are being offered
pursuant to an exemption from the registration requirements of the Securities
Act under Section 3(a)(9) of the Securities Act. Section 3(a)(9) provides for an
exemption from registration for any security exchanged by an issuer with its
existing security holders exclusively where no commission or other remuneration
is paid or given directly or indirectly for soliciting such exchange.
When securities are exchanged for other securities of an issuer under
Section 3(a)(9), the securities received in essence assume the character of the
exchanged securities for purposes of the Securities Act. Accordingly, so long as
you are not an "affiliate" of Z-Tel within the meaning of Rule 144 under the
Securities Act, if the Preferred Shares that you are tendering are no longer
"restricted securities" within the meaning of Rule 144, then the Common Shares
issued to you in the Offer to Exchange will not be "restricted shares" within
the meaning of Rule 144 under the Securities Act, and such shares will therefore
be freely tradeable by you. However, if you tender Preferred Shares that are
"restricted securities" within the meaning of Rule 144, the Common Shares you
receive in the Offer to Exchange will not be freely tradeable, and any resale
would have to comply with applicable exemptions under the securities laws,
including without limitation, the provisions of Rule 144(k). If you are an
"affiliate" of Z-Tel within the meaning of Rule 144, your Common Stock received
in the Offer to Exchange will be subject to certain provisions of Rule 144, even
if the Preferred Shares that you are tendering are no longer deemed to be
restricted securities, and therefore the Common Stock received by you will not
be freely tradeable.
INTERESTS OF DIRECTORS AND OFFICERS
Our officers, directors, and affiliates who are also holders of Preferred
Shares will receive the Offer to Exchange and will be eligible to tender their
Preferred Shares on the same basis as any other holder of Preferred Shares. Each
of The 1818 Fund and Charles D. Hyman have indicated to us that they currently
intend to tender all of their Preferred Shares in the Offer to Ex-
-42-
change. See "Special Factors Relating to the Offer to Exchange--Special
Committee of the Board of Directors" and "Security Ownership of Certain
Beneficial Owners and Management."
We are not otherwise aware of any intention to tender or consideration of
tendering Preferred Shares on the part of directors, officers or affiliates.
Neither we, nor any subsidiary of ours nor, to the best of our knowledge, any of
our directors or executive officers, nor any affiliates of any of the foregoing,
had any transactions in Preferred Shares during the 60 business days prior to
the date hereof.
SECURITY OWNERSHIP
The following table sets forth as of September 27, 2004 (unless otherwise
stated and based on 38,776,343 shares of Common Stock outstanding on that date),
the number of shares of our Common Stock, our Series D Preferred Stock, our
Series E Preferred Stock and our Series G Preferred Stock beneficially owned by:
o each person who we know to be a beneficial owner of 5% or more of that
class or series of stock (based, in part, upon copies of all Schedules
13D and 13G filed with the SEC);
o each of our directors;
o each of our Named Executive Officers; and
o all executive officers and directors as a group.
Each share of Series D Preferred Stock is currently convertible by its
holder into 1.95 shares of Common Stock, each share of Series E Preferred Stock
is currently convertible by its holder into 2.01 shares of Common Stock, and
each shares of Series G Preferred Stock is currently convertible by its holder
into 113,262 shares of Common Stock. Under the rules of the SEC, beneficial
ownership of Preferred Stock constitutes beneficial ownership of the amount of
Common Stock into which the shares of Preferred Stock are convertible.
Beneficial ownership of Common Stock is shown in the table and the portion of
that beneficial ownership traceable to beneficial ownership of Preferred Stock
is set forth in the footnotes to the table. Shares of Preferred Stock, shown
unconverted, are also shown in the table itself.
Shares Beneficially Owned and Percentage of Class
Series D Series E Series G Pro Forma Pro
Common Preferred Preferred Preferred Common Forma
Beneficial Owner (1) Stock % Stock % Stock % Stock % Stock (19) %
------------------------ ---------- ----- ---------- ------- ----------- --- --------- ---- ----------- ------
D. Gregory Smith(3) 12,834,566 29.25 416,667 10.48 -- -- 28.0 16.35 24,687,830 8.96
Carol Jane Smith(3) 5,500,000 14.32 -- -- -- -- -- -- 5,500,000 2.01
G/CJ Investments, L.P.(3) 5,500,000 14.32 -- -- -- -- -- -- 5,500,000 2.01
Charles D. Hyman(2)(4) 381,376 * 20,833 * -- -- 1.5 * 978,840 *
Buford H. Ortale(5) 2,249,917 5.76 252,667 6.35 -- -- -- -- 8,496,449 3.10
Lawrence C. Tucker(6) 28,717,781 42.79 -- -- 4,166,667 100 125.0 73.01 133,047,840 47.00
Brown Brothers Harriman &
Co.(6) 28,639,482 42.72 -- -- 4,166,667 100 125.0 73.01 132,969,814 46.98
Andrew C. Cowen(2)(7) 76,926 * -- -- -- -- -- -- 76,926 *
John K. Aurell(2)(8) 112,368 * -- -- -- -- -- -- 112,368 *
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Series D Series E Series G Pro Forma Pro
Common Preferred Preferred Preferred Common Forma
Beneficial Owner (1) Stock % Stock % Stock % Stock % Stock (19) %
------------------------ ---------- ----- ---------- ------- ----------- --- --------- ---- ----------- ------
Richard F.LaRoche, Jr.(2)(9) 59,984 * -- -- -- -- -- -- 59,984 *
W. Andrew Krusen, Jr.(2) 16,000 * -- -- -- -- -- -- 16,000 *
Douglas W. Jackson(2)(10) 346,094 * -- -- -- -- -- -- 346,094 *
Frank M. Grillo(2)(11) 52,777 * -- -- -- -- -- -- 52,777 *
Horace J. Davis III(2)(12) 365,277 * -- -- -- -- -- -- 365,277 *
John Tomlijanovic(2)(13) 82,498 * -- -- -- -- 82,498 *
Michael Slauson(2)(14) 257,753 * -- -- -- -- 257,753 *
Fulmead Ventures
Limited(15) 1,794,359 4.46 250,000 6.29 -- -- 10.0 5.84 8,491,216 3.10
Richland Ventures III,
L.P.(16) 3,308,860 7.93 1,250,000 27.36 -- -- -- -- 34,382,611 12.47
Gramercy Z-Tel LLC(17) 2,250,483 5.53 782,225 19.67 -- -- -- -- 21,987,040 7.98
-------------------------------------------------------------------------------------------------------------------------------
All directors and officers 30,468,834 44.35 20,833 * 4,166,667 100 126.5 73.88 135,396,357 47.60
as a group(18)
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the aggregate number of
shares beneficially owned by the individual stockholders and groups of
stockholders described above and the percentage ownership of such
individuals and groups, shares of common stock subject to convertible
securities currently convertible or convertible within 60 days and shares
of common stock subject to options or warrants that are currently
exercisable or exercisable within 60 days of the date of this chart are
deemed outstanding. Such shares, however, are not deemed outstanding for
the purposes of computing the percentage ownership of the other
stockholders or groups of stockholders.
(2) The stockholder's address is c/o Z-Tel Technologies, Inc., 601 South
Harbour Island Boulevard, Suite 220, Tampa, Florida 33602.
(3) D. Gregory Smith and Carol Jane Smith are husband and wife. The number of
shares shown for D. Gregory Smith and for Carol Jane Smith each includes
all of the shares held by G/ CJ Investments, L.P., a Delaware limited
partnership. G/CJ Investments, Inc., a Delaware corporation established and
controlled by Mr. and Mrs. Smith, is the sole general partner of G/CJ
Investments, L.P. The share amount also includes 2,051,387 shares for Mr.
Smith that are deemed to be beneficially owned by him by virtue of certain
stock options that are currently exercisable or become exercisable within
60 days and certain stock purchase warrants. The address of D. Gregory
Smith, Carol Jane Smith and G/CJ Investments, L.P. is 300 Delaware Avenue,
Suite 900, Wilmington, Delaware 19801.
(4) Common Stock includes 153,313 shares deemed beneficially owned by Mr. Hyman
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days and certain stock purchase warrants.
(5) Common Stock includes 402,955 shares deemed beneficially owned by Mr.
Ortale by virtue of certain stock purchase warrants. Ownership deemed owned
by Mr. Ortale includes shares owned by Sewanee Ventures and the Ortale
Family Foundation over which he has investment power. Mr. Ortale's address
is 4410 Gerald Place, Nashville, Tennessee 37205.
(6) According to a Schedule 13D dated November 20, 2000, as amended July 12,
2001, August 3, 2001 and August 26, 2004, filed jointly by Brown Brothers
Harriman & Co., The 1818 Fund III, L.P., T. Michael Long and Lawrence C.
Tucker, each of the joint filers has shared voting and dispositive power
with respect to all of the shares shown, except that Mr. Tucker's shares
include 78,026 shares deemed beneficially owned by him by virtue of certain
stock options currently exercisable or which become exercisable within 60
days. Of the shares of common stock shown for Mr. Tucker and Brown Brothers
Harriman & Co., 9,610,116 shares are deemed to be beneficially owned by
virtue of certain stock purchase warrants (excluding the 78,026 additional
shares beneficially owned by Mr. Tucker). The address of Brown Brothers
Harriman & Co., The 1818 Fund III, L.P., T. Michael Long and Lawrence C.
Tucker is 140 Broadway, New York, New York 10005.
(7) Common Stock includes 76,926 shares deemed beneficially owed by Mr. Cowen
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(8) Common Stock includes 76,095 shares deemed beneficially owned by Mr. Aurell
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(9) Common Stock includes 28,049 shares deemed beneficially owned by Mr.
LaRoche by virtue of certain stock options that are currently exercisable
or which become exercisable within 60 days.
(10) Common Stock includes 320,444 shares deemed beneficially owned by Mr.
Jackson by virtue of certain stock options that are currently exercisable
or which become exercisable within 60 days.
(11) Common Stock includes 52,777 shares deemed beneficially owned by Mr. Grillo
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
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(12) Common Stock includes 340,277 shares deemed beneficially owned by Mr. Davis
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(13) Common Stock includes 57,498 shares deemed beneficially owned by Mr.
Tomljanovic by virtue of certain stock options that are currently
exercisable or which become exercisable within 60 days.
(14) Common Stock includes 216,944 shares deemed beneficially owned by Mr.
Slauson by virtue of certain stock options that are currently exercisable
or which become exercisable within 60 days.
(15) This information is derived in part from a Schedule 13D dated February 8,
2000, as amended February 15, 2002, July 9, 2003, February 18, 2004 and
September 13, 2004, filed jointly by Professional Holdings Limited, The
Mayer Trust, Mutual Trust Management (Jersey) Limited, MTM Trustees
Limited, MTM Nominees Limited, MTM Investments Limited, Michael Cordwell
and Fulmead Ventures Limited. Each of these parties reports to have shared
voting and dispositive power with respect to all of the shares shown.
Eduard J. Mayer, beneficiary of The Mayer Trust disclaims beneficial
ownership of the shares shown. The common shares shown include 453,947
shares deemed beneficially owned by virtue of certain stock purchase
warrants. The address of the foregoing persons is 36 Hilgrove Street, St.
Helier, Jersey JE4 8TR Channel Islands.
(16) Of the shares of Common Stock shown, 2,269,736 are deemed to be
beneficially owned by virtue of warrants exercisable into shares of our
Common Stock. The address of Richland Ventures III, L.P. is 200 31st Avenue
North, Suite 200, Nashville, TN 37203.
(17) Of the shares of Common Stock shown, 1,891,446 shares are deemed to be
beneficially owned by virtue of warrants exercisable convertible into
shares of our Common Stock. The address of Gramercy is c/o Onex
Corporation, 161 Bay Street, P.O. Box 700, Toronto, Ontario CANADA M5J 2S1.
(18) Common Stock includes 11,010,738 shares deemed beneficially owned by virtue
of certain stock options that are currently exercisable or which become
exercisable within 60 days and certain stock purchase warrants.
(19) The pro forma share ownership data presents the effect of the Exchange
Offer assuming all of our outstanding Preferred Shares are exchanged for
the Exchange Consideration, after giving effect to which we would have no
shares of Preferred Stock outstanding.
AGREEMENTS INVOLVING OUR SECURITIES
On November 10, 2000, we entered into a registration rights agreement with
The 1818 Fund. Under the registration rights agreement, we agreed that, upon the
request of The 1818 Fund, we would file on one occasion a shelf registration
statement under the Securities Act registering the resale of (i) all Common
Shares issued to The 1818 Fund upon the conversion of the Series E Preferred
Stock and Series G Preferred Stock, (ii) all Common Shares issued to The 1818
Fund pursuant to previously issued warrants, and (iii) any other Common Shares
otherwise owned by The 1818 Fund. The Registration Rights Agreements also give
The 1818 Fund piggyback registration rights with respect to other registrations
of Z-Tel's Common Stock. Because The 1818 Fund has not yet exercised its rights
under the registration rights agreement, The 1818 Fund will, following the
Offer, continue to have the right to request that a shelf registration statement
be filed by us.
CERTAIN LEGAL MATTERS; REGULATORY APPROVALS
We are not aware of any license or regulatory permit that appears to be
material to our business that might be adversely affected by our repurchase of
the Preferred Stock as contemplated herein or of any approval or other action by
any government or governmental, administrative, or regulatory authority or
agency, domestic or foreign, that would be required for the repurchase of
Preferred Stock by us as contemplated herein. Should any such approval or other
action be required, we presently contemplate that such approval or other action
will be sought. We are unable to predict whether we will be required to delay
the acceptance for exchange of or exchange of Preferred Stock tendered pursuant
to the Offer to Exchange pending the outcome of
-45-
any such matter. There can be no assurance that any such approval or other
action, if needed, would be obtained or would be obtained without substantial
conditions, or that the failure to obtain any such approval or other action
might not result in adverse consequences to our business. Our obligations under
the Offer to accept for exchange and exchange Preferred Shares are subject to
certain conditions. See "The Offer to Exchange--Conditions."
FEES AND EXPENSES
Under the terms of an engagement letter dated July 6, 2004, we paid Morgan
Keegan a $50,000 retainer and have agreed to pay Morgan Keegan an additional
$25,000 in connection with the delivery of its fairness opinion. We expect that
payments to Morgan Keegan for other financial advisory services contemplated by
the engagement letter will not exceed $100,000. We have also agreed to reimburse
Morgan Keegan for its reasonable out-of-pocket expenses incurred in connection
with the engagement, including attorneys' fees, and to indemnify Morgan Keegan
and its respective related parties from and against certain liabilities,
including liabilities under the federal securities laws.
We will not pay fees or commissions to any broker, dealer or other person
for soliciting tenders of Preferred Stock pursuant to the Offer. We will,
however, upon request, reimburse brokers, dealers and commercial banks for
customary mailing and handling expenses incurred by such persons in forwarding
the Offer to Exchange and related materials to the beneficial owners of
Preferred Stock held by any such person as a nominee or in a fiduciary capacity.
No broker, dealer, commercial bank or trust company has been authorized to act
as our agent for purposes of the Offer.
We will pay or cause to be paid all stock transfer taxes, if any, on the
exchange of Preferred Stock except as otherwise provided in Instruction 6 in the
Letter of Transmittal. All fees and expenses attributable to the Offer will be
paid by us.
INDEPENDENT AUDITORS
Our annual consolidated financial statements incorporated by reference
hereto from our Annual Reports of Form 10-K for the years ended December 31,
2002 and 2003, have been audited by PricewaterhouseCoopers LLP, an independent
registered certified public accounting firm, as stated in their reports also
incorporated by reference herein.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
We are incorporating by reference into this Offer to Exchange the following
documents filed by us with the SEC:
o Annual Report on Form 10-K for the fiscal year ended December 31,
2003;
o Quarterly Report on Form 10-Q for the quarter ended March 31, 2004;
o Quarterly Report on Form 10-Q for the quarter ended June 30, 2004;
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o Quarterly Report on Form 10-Q for the quarter ended June 30, 2004;
o Definitive Proxy Statement on Schedule 14A filed on April 29, 2004;
o Current Report on Form 8-K filed on February 20, 2004 (including
amendment filed on same date);
o Current Report on Form 8-K filed on May 13, 2004;
o Current Report on Form 8-K filed on June 14, 2004;
o Current Report on Form 8-K filed on July 2, 2004;
o Current Report on Form 8-K filed on August 2, 2004;
o Current Report on Form 8-K filed on August 10, 2004;
o Current Report on Form 8-K filed on August 26, 2004;
o Current Report on Form 8-K filed on September 1, 2004;
o Current Report on Form 8-K filed on September 7, 2004;
o Current Report on Form 8-KA filed on October 6, 2004;
o Current Report on Form 8-K filed on October 12, 2004; and
o Current Report on Form 8-K filed on October 13, 2004.
The information incorporated herein by reference is considered to be part
of this Offer to Exchange and later information that we file with the SEC will
automatically update and supersede this information.
You may obtain a copy of these filings at no cost by writing or telephoning
us at:
Z-Tel Technologies, Inc.
Attention: Andrew L. Graham, Esq.
601 South Harbour Island Boulevard,
Suite 220, Tampa, Florida 33602
(813) 273-6261
MISCELLANEOUS
We are not aware of any jurisdiction where the making of the Offer is not
in compliance with applicable law. If we become aware of any jurisdiction where
the making of the Offer is not in compliance with any valid applicable law, we
will make a good faith effort to comply with such law. If, after such good faith
effort, we cannot comply with such law, the Offer will not be
-47-
made to (nor will tenders be accepted from or on behalf of) the holders of
Preferred Stock residing in such jurisdiction. In any jurisdiction where the
securities or blue sky laws of which require the Offer to be made by a licensed
broker or dealer, the Offer shall be deemed to be made on our behalf by one or
more registered brokers or dealers licensed under the laws of such jurisdiction.
Pursuant to Rule 13e-4 of the General Rules and Regulations under the
Exchange Act, we have filed with the SEC an Issuer Tender Offer Statement on
Schedule TO that contains additional information with respect to the Offer. Such
Schedule TO, including the exhibits and any amendments thereto, may be examined,
and copies may be obtained, at the same places and in the same manner as is set
forth under the caption "Where You Can Find More Information."
No person has been authorized to give any information or make any
representation on our behalf in connection with the offer other than those
contained in this Offer to Exchange or in the Letter of Transmittal. If given or
made, such information or representation must not be relied upon as having been
authorized by us.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. You may read and copy any document we file with the
SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington,
D.C. 20549. You may obtain further information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. Our filings are also
available to the public over the Internet at the SEC's website at
http://www.sec.gov.
The Exchange and Information Agent for the Offer to Exchange is:
Andrew L. Graham
Corporate Counsel
Z-Tel Technologies, Inc.
601 South Harbour Island Blvd.
Suite 220
Tampa, FL 33602
Telephone: (813) 233-4567
Facsimile: (813) 233-4623
Additional copies of the Offer to Exchange, the Letter of Transmittal or other
tender offer materials may be obtained from the Exchange and Information Agent
and will be furnished at our expense. Questions and requests for assistance may
be directed to the Exchange and Information Agent as set forth above. Holders
also may contact their local broker, dealer, commercial bank, trust company or
other nominee for assistance concerning the Offer.
-48-
Exhibit (a)(1)(B)
LETTER OF TRANSMITTAL
To Tender Preferred Shares of
Series D Convertible Preferred Stock (the "Series D Preferred Stock")
8% Convertible Preferred Stock, Series E (the "Series E Preferred Stock")
12% Junior Redeemable Convertible Preferred Stock, Series G
(the "Series G Preferred Stock" and, together with the Series D Preferred Stock
and the Series E Preferred Stock, the "Preferred Shares")
for shares of common stock
of
Z-Tel Technologies, Inc.
Pursuant to the Amended Offer to Exchange
Dated October 21, 2004
by
Z-Tel Technologies, Inc.
--------------------------------------------------------------------------------
THE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P. M., NEW YORK CITY TIME,
ON TUESDAY, NOVEMBER 23, 2004, UNLESS
THE OFFER IS EXTENDED
(THE "EXPIRATION DATE").
--------------------------------------------------------------------------------
The Exchange and Information Agent for the Offer is
Andrew L. Graham
Corporate Counsel
Z-Tel Communications, Inc.
601 South Harbour Island Blvd.
Suite 220
Tampa, FL 33602
Telephone: (813) 233-4567
Facsimile: (813) 233-4623
--------------------
DELIVERY OF THIS LETTER OF TRANSMITTAL (THE "LETTER OF TRANSMITTAL") TO AN
ADDRESS OTHER THAN AS SET FORTH ABOVE, OR TRANSMISSION OF INSTRUCTIONS VIA
FACSIMILE OTHER THAN AS SET FORTH ABOVE, DOES NOT CONSTITUTE A VALID DELIVERY TO
THE EXCHANGE AGENT. YOU MUST SIGN THIS LETTER OF TRANSMITTAL WHERE INDICATED
BELOW AND COMPLETE THE SUBSTITUTE FORM W-9 BELOW.
THE INSTRUCTIONS CONTAINED WITHIN THIS LETTER OF TRANSMITTAL SHOULD BE READ
CAREFULLY BEFORE THIS LETTER OF TRANSMITTAL IS COMPLETED. TO THE EXTENT THERE
ARE ANY CONFLICTS BETWEEN THE TERMS AND CONDITIONS OF THIS LETTER OF TRANSMITTAL
AND THE TERMS AND CONDITIONS OF THE AMENDED OFFER TO EXCHANGE, THE TERMS AND
CONDITIONS OF THE AMENDED OFFER TO EXCHANGE SHALL CONTROL.
DESCRIPTION OF PREFERRED SHARES TENDERED
----------------------------------------------------------------------------------------------------------------------
Name(s) and Addresses(es) of Registered Holder(s)
(Please fill in, if blank, exactly as name(s) appear(s) Certificate(s) and Preferred Share(s) Tendered
on the Preferred Shares Certificate(s)) (Attach additional list if necessary)
---------------------------------------------------------- -----------------------------------------------------------
Number of
Preferred Shares Number of
Certificate Represented by Preferred Shares
Number(s)* Certificate(s) Tendered*
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
---------------------------------------------------------- --------------------- ------------------ ------------------
Total Preferred
Shares
----------------------------------------------------------------------------------------------------------------------
* Unless otherwise indicated, it will be assumed that all Preferred Shares
represented by any Certificates delivered to the Exchange and Information
Agent are being tendered. See Instruction 4.
----------------------------------------------------------------------------------------------------------------------
IF CERTIFICATES HAVE BEEN LOST OR DESTROYED, SEE INSTRUCTION 11.
This Letter of Transmittal is to be completed by holders of Preferred
Shares of Z-Tel Technologies, Inc., (the "Stockholders") and certificates
evidencing its Series D Preferred Stock, Series E Preferred Stock or, Series G
Preferred Stock are to be forwarded herewith.
Stockholders whose Certificates are not immediately available or who
cannot deliver their Certificates and all other required documents to the
Exchange and Information Agent prior to the Expiration Date (as defined in the
Amended Offer to Exchange) must tender their Preferred Shares according to the
guaranteed delivery procedures set forth in "The Offer to Exchange - Guaranteed
Delivery Procedures" of the Offer to Exchange. See Instruction 2 hereof.
NOTE: SIGNATURES MUST BE PROVIDED BELOW.
PLEASE READ THE INSTRUCTIONS CAREFULLY.
-2-
Ladies and Gentlemen:
The undersigned hereby tenders to Z-Tel Technologies, Inc., a Delaware
corporation ("Z-Tel"), the above-described Preferred Shares, each in exchange
for consideration ("Exchange Consideration"), consisting of shares of Common
Stock, $0.01 par value per share (the "Common Shares"), pursuant to and as
described in the Amended Offer to Exchange, dated October 21, 2004 (the "Offer
to Exchange") and this Letter of Transmittal (which together with the Offer to
Exchange constitute the "Offer"). Receipt of the Offer to Exchange is hereby
acknowledged.
Subject to, and effective upon, acceptance for exchange of all or any
portion of the Preferred Shares tendered herewith in accordance with the terms
and subject to the conditions of the Offer (including, if the Offer is extended
or amended, the terms or conditions of any such extension or amendment), the
undersigned hereby sells, assigns and transfers to, or upon the order of, Z-Tel
all right, title and interest in and to all of the Preferred Shares that are
being tendered hereby and irrevocably constitutes and appoints the Exchange and
Information Agent the true and lawful agent and attorney-in-fact of the
undersigned with respect to such Preferred Shares, with full power of
substitution (such power of attorney being deemed to be an irrevocable power
coupled with an interest), to (i) deliver Certificates evidencing such Preferred
Shares, with all accompanying evidences of transfer and authenticity to, or upon
the order of Z-Tel, (ii) present such Preferred Shares for transfer on the books
of Z-Tel and (iii) receive all benefits and otherwise exercise all rights of
beneficial ownership of such Preferred Shares, all in accordance with the terms
and subject to the conditions of the Offer.
The undersigned hereby represents and warrants that the undersigned has
full power and authority to tender, sell, assign and transfer the Preferred
Shares tendered hereby, that the undersigned owns the Preferred Shares tendered
hereby within the meaning of Rule 14e-4 promulgated under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), that the tender of the
tendered Preferred Shares complies with Rule 14e-4 under the Exchange Act, and
that when the same are accepted for exchange by Z-Tel, Z-Tel will acquire good,
marketable and unencumbered title thereto, free and clear of all liens,
restrictions, charges and encumbrances and the same will not be subject to any
adverse claims. The undersigned will, upon request, execute and deliver any
additional documents deemed by the Exchange and Information Agent or Z-Tel to be
necessary or desirable to complete the sale, assignment and transfer of the
Preferred Shares tendered.
All authority conferred or agreed to be conferred in this Letter of
Transmittal shall be binding upon the successors, assigns, heirs, executors,
administrators and legal representatives of the undersigned and shall not be
affected by, and shall survive, the death or incapacity of the undersigned.
Except as stated in the Offer to Exchange, this tender is irrevocable.
The undersigned understands that the valid tender of the Preferred Shares
pursuant to any one of the procedures described in "The Offer to Exchange" of
the Offer to Exchange and in the Instructions hereto will constitute a binding
agreement between the undersigned and Z-Tel upon the terms and subject to the
conditions of the Offer to Exchange (and if the Offer to Exchange is extended or
amended, the terms or conditions of any such extension or amendment). Without
limiting the foregoing, if the Exchange Ratio (as defined in the Offer to
Exchange) to be offered in the Offer to Exchange is amended, the Exchange Ratio
to be given to the undersigned will be the amended Exchange Ratio
notwithstanding the fact that a different Exchange Ratio is stated in this
Letter of Transmittal. The undersigned recognizes that under certain
circumstances set forth in the Offer to Exchange, Z-Tel may not be required to
accept for exchange any of the Preferred Shares tendered hereby.
Unless otherwise indicated under "Special Issuance Instructions," please
issue the Exchange Consideration exchanged for pursuant to the Offer to Exchange
and/or return any certificates for Preferred Shares not tendered or accepted for
exchange in the name(s) of the registered holder(s) appearing above under
"Description of Preferred Shares Tendered." Similarly, unless otherwise
indicated under "Special Delivery Instructions," please mail the Exchange
Consideration exchanged for pursuant to the Offer to Exchange and/or return any
certificates for Preferred Shares not tendered or not accepted for exchange (and
any accompanying documents, as appropriate) to the address(es) of the registered
holder(s) appearing above under "Description of Preferred Shares Tendered." In
the event that the boxes entitled "Special Issuance Instructions" and "Special
Delivery Instructions" below are both completed, please issue the Exchange
Consideration exchanged for pursuant to the Offer to Exchange and/or return any
certificates evidencing Preferred Shares not tendered or not accepted for
-3-
exchange (and any accompanying documents, as appropriate) in the name(s) of, and
deliver such check and/or return any such certificates (and any accompanying
documents, as appropriate) to, the person(s) so indicated. The undersigned
recognizes that Z-Tel has no obligation, pursuant to the "Special Issuance
Instructions," to transfer any Preferred Shares from the name of the registered
holder thereof if Z-Tel does not accept for exchange any of the Preferred Shares
so tendered.
Dividends on the Preferred Shares accrue at the rate of 8% per annum in
the case of the Series D Preferred Stock and the Series E Preferred Stock and
12% per annum in the case of the Series G Preferred Stock. If you exchange your
Preferred Shares in the Offer to Exchange, you will forfeit the dividend that
has accrued on your Preferred Shares since September 30, 2004, the last payment
date for dividends on the Preferred Shares.
-4-
---------------------------------------------------------- -- -------------------------------------------------------
SPECIAL PAYMENT INSTRUCTIONS SPECIAL DELIVERY INSTRUCTIONS
(See Instructions 1, 5, 6 and 7) (See Instructions 1, 5, 6 and 7)
To be completed ONLY if Certificates for Pre- To be completed ONLY if Certificates for Preferred
ferred Shares not tendered or not accepted for ex- Shares not tendered or not accepted for exchange, or
change, or Exchange Consideration if issued pursuant Consideration if issued pursuant to the to Exchange,
to the Offer Exchange, are to be issued in the name are to be sent to someone other than the undersigned
of someone other than the undersigned. or to the undersigned at an address other than that
shown above.
Issue: |_| Exchange Consideration
and/or |_| Preferred Stock Mail: |_| Exchange Consideration
Certificate(s) to: and/or |_| Preferred Stock
Certificate(s) to:
Name________________________________________________ Name__________________________________________________
(Please Print) (Please Print)
Address_____________________________________________ Address_______________________________________________
____________________________________________________ ______________________________________________________
____________________________________________________ ______________________________________________________
(Zip Code) (Zip Code)
____________________________________________________ ______________________________________________________
(Taxpayer Identification or Social Security No.) (Taxpayer Identification or Social Security No.)
(Also Complete Substitute Form W-9) (Also Complete Substitute Form W-9)
---------------------------------------------------------- -- -------------------------------------------------------
-5-
--------------------------------------------------------------------------------
SIGN HERE
(Also Complete Substitute Form W-9 Below)
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Signature(s) of Stockholder(s)
Name(s):
------------------------------------------------------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
(Please Print)
Capacity (Full Title):
----------------------------------------------------------
Address:
------------------------------------------------------------------------
------------------------------------------------------------------------
(Include Zip Code)
Area Code and Telephone Number:_________________________________________________
Taxpayer Identification or Social Security Number:______________________________
(See Substitute Form W-9)
Dated:______________________________
Must be signed by the registered holder(s) exactly as name(s) appear(s) on the
stock certificate(s) or on a security position listing or by person(s)
authorized to become registered holder(s) by certificates and documents
transmitted herewith. If signature is by a trustee, executor, administrator,
guardian, attorney-in-fact, agent, officer of a corporation or other person
acting in a fiduciary or representative capacity, please set forth full title
and see Instruction 5.)
GUARANTEE OF SIGNATURE(S)
(See Instructions 1 and 5)
FOR USE BY FINANCIAL INSTITUTIONS ONLY. PLEASE PLACE MEDALLION GUARANTEE BELOW.
Authorized Signature(s):________________________________________________________
Name:___________________________________________________________________________
________________________________________________________________________________
(Please Print)
Name of Firm:___________________________________________________________________
(Include Zip Code)
Area Code and Telephone Number:_________________________________________________
Dated:_________________________________
--------------------------------------------------------------------------------
-6-
INSTRUCTIONS
FORMING PART OF THE TERMS AND CONDITIONS OF THE OFFER
1. Guarantee of Signatures. No signature guarantee is required on this
Letter of Transmittal if (a) this Letter of Transmittal is signed by the
registered holder(s) of Preferred Shares tendered herewith, unless such
registered holder(s) has completed either the box entitled "Special Issuance
Instructions" or the box entitled "Special Delivery Instructions" on the Letter
of Transmittal; or (b) if such Preferred Shares are tendered for the account of
a financial institution (including most commercial banks, savings and loan
associations and brokerage houses) that is a participant in the Security
Transfer Agents Medallion Program, the New York Stock Exchange Medallion
Signature Guarantee Program or the Stock Exchange Medallion Program (each, an
"Eligible Institution"). In all other cases, all signatures on this Letter of
Transmittal must be guaranteed by an Eligible Institution. See Instruction 5.
2. Delivery of Letter of Transmittal and Preferred Shares; Guaranteed
Delivery Procedures. This Letter of Transmittal is to be completed by
stockholders of Z-Tel in order to participate in the Offer to Exchange. For a
stockholder to validly tender Preferred Shares pursuant to the Offer to
Exchange, either (a) a properly completed and duly executed Letter of
Transmittal (or facsimile thereof), together with any required signature
guarantees and any other required documents, must be received by the Exchange
and Information Agent at one of its addresses set forth herein prior to the
Expiration Date and certificates for tendered Preferred Shares must be received
by the Exchange and Information Agent at one of such addresses prior to the
Expiration Date; or (b) the tendering stockholder must comply with the
guaranteed delivery procedures set forth herein and in "The Offer to Exchange -
Guaranteed Delivery Procedures" of the Offer to Exchange.
Stockholders whose certificates for Preferred Shares are not immediately
available or who cannot deliver their certificates and all other required
documents to the Exchange and Information Agent prior to the Expiration Date may
tender their Preferred Shares by properly completing and duly executing the
Notice of Guaranteed Delivery pursuant to the guaranteed delivery procedure set
forth herein and in "The Offer to Exchange - Guaranteed Delivery Procedures" of
the Offer to Exchange.
Pursuant to such guaranteed delivery procedures, (a) such tender must be
made by or through an Eligible Institution; (b) a properly completed and duly
executed Notice of Guaranteed Delivery, substantially in the form provided by
Z-Tel, must be received by the Exchange and Information Agent prior to the
Expiration Date; and (c) the certificates for all tendered Preferred Shares, in
proper form for transfer, together with a properly completed and duly executed
Letter of Transmittal (or a facsimile thereof), with any required signature
guarantees and any other required documents must be received by the Exchange and
Information Agent within three trading days after the date of execution of such
Notice of Guaranteed Delivery. A "trading day" is any day on which the Nasdaq
Stock Market is open for business.
The signatures on this Letter of Transmittal cover the Preferred Shares
tendered hereby.
THE METHOD OF DELIVERY OF THE PREFERRED SHARES, THIS LETTER OF TRANSMITTAL
AND ALL OTHER REQUIRED DOCUMENTS, IS AT THE ELECTION AND RISK OF THE TENDERING
STOCKHOLDER. THE PREFERRED SHARES WILL BE DEEMED DELIVERED ONLY WHEN ACTUALLY
RECEIVED BY THE EXCHANGE AGENT. IF DELIVERY IS BY MAIL, REGISTERED MAIL WITH
RETURN RECEIPT REQUESTED, PROPERLY INSURED, IS RECOMMENDED. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ENSURE TIMELY DELIVERY.
No alternative, conditional or contingent tenders will be accepted. All
tendering stockholders, by executing this Letter of Transmittal (or facsimile
thereof), waive any right to receive any notice of acceptance of their Preferred
Shares for exchange.
3. Inadequate Space. If the space provided herein is inadequate, the
information required under "Description of Preferred Shares Tendered" should be
listed on a separate signed schedule and attached hereto.
-7-
4. Partial Tenders. If less than all of the Preferred Shares represented by
any Certificates delivered to the Exchange and Information Agent herewith are to
be tendered hereby, fill in the number of Preferred Shares which are to be
tendered in the box entitled "Number of Preferred Shares Tendered." In such
case, a new Certificate(s) for the remainder of the Preferred Shares that were
evidenced by the old Certificates will be sent, without expense, to the
person(s) signing this Letter of Transmittal, unless otherwise provided in the
box entitled "Special Payment Instructions" or the box entitled "Special
Delivery Instructions" on this Letter of Transmittal, as soon as practicable
after the Expiration Date. All Preferred Shares represented by Certificate(s)
delivered to the Exchange and Information Agent will be deemed to have been
tendered unless otherwise indicated.
5. Signatures on Letter of Transmittal, Instruments of Transfer and
Endorsements. If this Letter of Transmittal is signed by the registered
holder(s) of the Preferred Shares tendered hereby, the signature(s) must
correspond exactly with the name(s) as written on the face of the Certificate(s)
without alteration, enlargement or any change whatsoever.
If any of the Preferred Shares tendered hereby are owned of record by two
or more joint owners, all such owners must sign this Letter of Transmittal.
If any of the tendered Preferred Shares are registered in different names
on several Certificates, it will be necessary to complete, sign and submit as
many separate Letters of Transmittal as there are different registrations of
Certificates.
If this Letter of Transmittal is signed by the registered holder(s) of the
Preferred Shares listed and transmitted hereby, no endorsements of Certificates
or separate instruments of transfer are required unless payment is to be made,
or Certificates not tendered or not purchased are to be issued or returned, to a
person other than the registered holder(s).
If this Letter of Transmittal or any certificates or instruments of
transfer are signed by a trustee, executor, administrator, guardian,
attorney-in-fact, officer of a corporation or other person acting in a fiduciary
or representative capacity, such person should so indicate when signing, and
proper evidence satisfactory to Z-Tel of such person's authority to so act must
be submitted.
If this Letter of Transmittal is signed by a person other than the
registered holder(s) of the Preferred Shares evidenced by the Certificate(s)
listed and transmitted hereby, or if payment is to be made, or any
Certificate(s) not tendered or not purchased are to be issued or returned, to a
person other than the registered holder(s), the Certificate(s) must be endorsed
or accompanied by appropriate instruments of transfer, in either case signed
exactly as the name(s) of the registered holder(s) appear(s) on the
Certificates. Signature(s) on such Certificate(s) and such endorsements or
instruments of transfer must be guaranteed by an Eligible Institution.
6. Transfer Taxes. Except as set forth in this Instruction 6, Z-Tel will
pay or cause to be paid any transfer taxes required to be paid by it with
respect to the transfer and sale of purchased Preferred Shares to it or its
order pursuant to the Offer. If, however, payment of the purchase price is to be
made to, or (in the circumstances permitted hereby) if Certificate(s) for
Preferred Shares not tendered or not purchased are to be registered in the name
of, any person other than the registered holder(s), or if tendered
Certificate(s) are registered in the name of any person other than the person(s)
signing this Letter of Transmittal, the amount of any transfer taxes (whether
imposed on the registered holder(s) or such persons) payable on account of the
transfer to such person will not be the responsibility of Z-Tel and may be
deducted from the purchase price unless satisfactory evidence of the payment of
such taxes or exemption therefrom is submitted herewith.
Except as provided in this Instruction 6, it will not be necessary for
transfer tax stamps to be affixed to the Certificates listed in this Letter of
Transmittal.
7. Special Payment and Delivery Instructions. If any Exchange Consideration
exchanged for any Preferred Shares tendered are to be issued in the name of,
and/or Preferred Share certificates for Preferred Shares not accepted for
payment or not tendered are to be issued in the name of and/or returned to, a
person other than the signer of this Letter of Transmittal, and/or such
certificates are to be returned to a person other than the signer of this Letter
-8-
of Transmittal, or to an address other than that shown above, the appropriate
boxes on this Letter of Transmittal should be completed.
8. Requests for Assistance or Additional Copies. Questions and requests for
assistance may be directed to the Exchange and Information Agent at its address
or telephone number set forth below. Requests for additional copies of the Offer
to Exchange, this Letter of Transmittal and the Notice of Guaranteed Delivery
may be directed to the Exchange and Information Agent or brokers, dealers,
commercial banks and trust companies.
9. Waiver of Conditions. The conditions of the Offer may be waived by
Z-Tel, in whole or in part, at any time or from time to time, at Z-Tel's sole
discretion, subject to the terms of the Offer.
10. Backup Withholding Tax. In order to avoid "backup withholding" of
federal income tax on payments of cash pursuant to the Offer to Exchange, a
stockholder surrendering Preferred Shares in the Offer to Exchange must, unless
an exemption applies, provide the Exchange and Information Agent with such
stockholder's correct taxpayer identification number ("TIN") on Substitute Form
W-9 in this Letter of Transmittal and certify, under penalties of perjury, that
such TIN is correct and that such stockholder is not subject to backup
withholding.
Backup withholding is not an additional income tax. Rather, the amount of
the backup withholding can be credited against the federal income tax liability
of the person subject to the backup withholding, provided that the required
information is given to the IRS. If backup withholding results in an overpayment
of tax, a refund can be obtained by the stockholder upon filing an income tax
return.
The stockholder is required to give the Exchange and Information Agent the
TIN (i.e., social security number or employer identification number) of the
record owner of the Preferred Shares. If the Preferred Shares are held in more
than one name or are not in the name of the actual owner, consult the enclosed
"Guidelines for Certification of Taxpayer Identification Number on Substitute
Form W-9" for additional guidance on which number to report.
If the tendering stockholder has not been issued a TIN and has applied for
a TIN or intends to apply for a TIN in the near future, the stockholder or other
payee must also complete the Certificate of Awaiting Taxpayer Identification
Number below in order to avoid backup withholding. Notwithstanding that the
Certificate of Awaiting Taxpayer Identification Number is completed, the
Exchange and Information Agent will withhold 28% on all payments made prior to
the time a properly certified TIN is provided to the Exchange and Information
Agent. However, such amounts will be refunded to such stockholder if a TIN is
provided to the Exchange and Information Agent within 60 days.
Certain stockholders (including, among others, all corporations and certain
foreign individuals and entities) are not subject to backup withholding.
Noncorporate foreign stockholders should complete and sign the main signature
form and a Form W-8, Certificate of Foreign Status, a copy of which may be
obtained from the Exchange and Information Agent, in order to avoid backup
withholding. See the enclosed "Guidelines for Certification of Taxpayer
Identification Number on Substitute Form W-9" for more instructions.
11. Lost or Destroyed Certificates. If any Certificate has been lost or
destroyed, the holder should promptly notify the Exchange and Information Agent.
The holder will then be instructed as to the procedure to be followed in order
to replace the Certificate. This Letter of Transmittal and related documents
cannot be processed until the procedures for replacing lost or destroyed
Certificate have been followed.
IMPORTANT: THIS LETTER OF TRANSMITTAL (OR FACSIMILE HEREOF) TOGETHER WITH ANY
REQUIRED SIGNATURE GUARANTEES, AND ANY OTHER REQUIRED DOCUMENTS, MUST BE
RECEIVED BY THE EXCHANGE AGENT PRIOR TO THE EXPIRATION DATE AND EITHER
CERTIFICATES FOR TENDERED PREFERRED SHARES MUST BE RECEIVED BY THE EXCHANGE
AGENT PRIOR TO THE EXPIRATION DATE, OR THE TENDERING STOCKHOLDER MUST COMPLY
WITH THE PROCEDURES FOR GUARANTEED DELIVERY.
-9-
IMPORTANT TAX INFORMATION
Under Federal income tax law, a stockholder whose tendered Preferred Shares
are accepted for payment is required to provide the Exchange and Information
Agent with such stockholder's correct TIN on Substitute Form W-9 below. If such
stockholder is an individual, the TIN is his social security number. If a
tendering stockholder is subject to backup withholding, such stockholder must
cross out item (2) of the Certification box on the Substitute Form W-9. If the
Exchange and Information Agent is not provided with the correct TIN, the
stockholder may be subject to a $50 penalty imposed by the Internal Revenue
Service. In addition, any payments that are made to such stockholder with
respect to Preferred Shares exchanged pursuant to the Offer to Exchange may be
subject to backup withholding.
Certain stockholders (including, among others, all corporations, and
certain foreign individuals) are not subject to these backup withholding and
reporting requirements. In order for a foreign individual to qualify as an
exempt recipient, that stockholder must submit a statement, signed under
penalties of perjury, attesting to that individual's exempt status. Such
statements can be obtained from the Exchange and Information Agent. Exempt
stockholders, other than foreign individuals, should furnish their TIN, write
"Exempt" on the face of the Substitute Form W-9 below, and sign, date and return
the Substitute Form W-9 to the Exchange and Information Agent. See the enclosed
Guidelines for Certification of Taxpayer Identification Number on Substitute
Form W-9 for additional instructions.
If backup withholding applies, the Exchange and Information Agent is
required to withhold 28% of any payments made to the stockholder. Backup
withholding is not an additional tax. Rather, the tax liability of persons
subject to backup withholding will be reduced by the amount of tax withheld. If
withholding results in an overpayment of taxes, a refund may be obtained from
the Internal Revenue Service.
Purpose of Substitute Form W-9
To prevent backup withholding on any payments that are made to a
stockholder with respect to Preferred Shares exchanged pursuant to the Offer to
Exchange, the stockholder is required to notify the Exchange and Information
Agent of such stockholder's correct taxpayer identification number by completing
the form contained herein certifying that the TIN provided on Substitute Form
W-9 is correct (or that such stockholder is awaiting a TIN).
What Number to Give the Exchange and Information Agent
The stockholder is required to give the Exchange and Information Agent the
social security number or employer identification number of the record owner of
the Preferred Shares. If the Preferred Shares are in more than one name or are
not in the name of the actual owner, consult the enclosed Guidelines for
Certification of Taxpayer Identification Number on Substitute Form W-9 for
additional guidance on which number to report. If the tendering stockholder has
not been issued a TIN and has applied for a number or intends to apply for a
number in the near future, such stockholder should write "Applied For" in the
space provided for in the TIN in Part I, and sign and date the Substitute Form
W-9. If "Applied For" is written in Part I and the Exchange and Information
Agent is not provided with a TIN within 60 days, the Exchange and Information
Agent will withhold 28% on all payments of the purchase price until a TIN is
provided to the Exchange and Information Agent.
-10-
PAYER'S NAME: [Depositary]
-------------------------------- ---------------------------------------------- --------------------------------------
Part I--PLEASE PROVIDE YOUR TIN IN THE BOX AT TIN:
-------------------------------
SUBSTITUTE RIGHT AND CERTIFY BY SIGNING AND DATING Social Security Number
Form W-9 BELOW. or Employer Identification Number
Department of the Part II--For Payees exempt from backup
Treasury Internal withholding, see the enclosed Guidelines for
Revenue Service Certification of Taxpayer Identification Number
on Substitute Form W-9 and complete as
Payor's Request instructed therein.
for Taxpayer
Identification Certification--UNDER THE PENALTIES OF PERJURY, I CERTIFY THAT:
Number ("TIN") Part III--
and Certification (1) The number shown on this form is my correct TIN
(or I am waiting for a number
to be issued to me); and
(2) I am not subject to backup withholding
because (a) I am exempt from backup
withholding, (b) I have not been notified
by the Internal Revenue Service (the
"IRS") that I am subject to backup
withholding as a result of a failure to
report all interest or dividends or (c)
the IRS has notified me that I am no
longer subject to backup withholding.
SIGNATURE: DATE: , 1997
---------------------------------------- ---------------
-------------------------------- -------------------------------------------------------------------------------------
Certification Instructions -- You must cross out item (2) of Part III above
if you have been notified by the IRS that you are subject to backup withholding
because of underreporting interest or dividends on your tax return. However, if
after being notified by the IRS that you were subject to backup withholding, you
received another notification from the IRS that you were no longer subject to
backup withholding, do not cross out item (2) of Part III. (Also see the
instructions in the enclosed Guidelines.)
NOTE: FAILURE TO COMPLETE AND RETURN THIS SUBSTITUTE FORM W-9 MAY RESULT
IN BACKUP WITHHOLDING OF 28% OF ANY PAYMENTS MADE TO YOU PURSUANT TO
THE OFFER. PLEASE REVIEW THE ENCLOSED GUIDELINES FOR CERTIFICATION
OF TAXPAYER IDENTIFICATION NUMBER ON SUBSTITUTE FORM W-9 FOR
ADDITIONAL DETAILS.
YOU MUST COMPLETE THE FOLLOWING CERTIFICATE IF YOU ARE AWAITING YOUR
TIN.
--------------------------------------------------------------------------------
CERTIFICATE OF AWAITING TAXPAYER IDENTIFICATION NUMBER
I certify under penalties of perjury that a TIN has not been issued to me,
and either (1) I have mailed or delivered an application to receive a TIN to the
appropriate IRS Center or Social Security Administration Officer or (2) I intend
to mail or deliver an application in the near future. I understand that if I do
not provide a TIN by the time of payment, 28% of all payments pursuant to the
Offer made to me thereafter will be withheld until I provide a number.
SIGNATURE: DATE:
------------------------------------------- -------------
-11-
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of
the Securities Exchange Act of 1934
(AMENDMENT NO. 1)
Filed by the Registrant /X/
Filed by a Party Other than the Registrant / /
Check the appropriate box:
/X/ Preliminary Proxy Statement
/ / Confidential, for Use of the Commission Only (as permitted
by Rule 14a-6(e)(2))
/ / Definitive Proxy Statement
/ / Definitive Additional Materials
/ / Soliciting Material Pursuant to ss. 240.14a-12
Z-TEL TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
Payment of filing fee (Check the appropriate box):
/X/ No fee required.
/ / Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and
0-11.
(1) Title of each class of securities to which transaction applies:
-----------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
-----------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction
computed pursuant to Exchange Act Rule 0-11 (set forth the
amount on which filing fee is calculated and state how it was
determined):
-----------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
-----------------------------------------------------------------------
(5) Total fee paid:
-----------------------------------------------------------------------
Fee paid previously with preliminary materials.
/ / Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11 (a) (2) and identify the filing for which the offsetting fee
was paid previously. Identify the previous filing by registration
statement number, or the Form or Schedule and the date of its filing.
(1) Amount previously paid:
-----------------------------------------------------------------------
(2) Form, Schedule or Registration No.:
-----------------------------------------------------------------------
(3) Filing Party:
-----------------------------------------------------------------------
(4) Date Filed:
-----------------------------------------------------------------------
-2-
2004
NOTICE OF SPECIAL MEETING
AND
PROXY STATEMENT
Z-TEL TECHNOLOGIES, INC.
601 South Harbour Island Boulevard, Suite 220
Tampa, Florida 33602
October 26, 2004
Dear Stockholder:
It is my pleasure to invite you to a Special Meeting of Stockholders of
Z-Tel Technologies, Inc. The meeting will be held on Tuesday, November 16, 2004
at , Eastern time at our offices located at ,
. Your board of directors and management look forward to meeting with you
at this time.
At the special meeting, you will be asked to approve a number of items that
will permit Z-Tel to proceed with an exchange offer for its outstanding
convertible preferred stock, and certain related transactions that are aimed at
simplifying and improving Z-Tel's capital structure and maintaining its
qualification for listing on the Nasdaq SmallCap Market. The transactions have
the following components:
o subject to the impact of any reverse stock split, an offer made to the
holders of Z-Tel's outstanding preferred stock to exchange their
preferred stock into common stock of Z-Tel,
o subject to approval and consummation of the exchange offer, an
amendment to the terms of the series D preferred stock to eliminate
certain restrictive provisions contained therein,
o subject to approval and consummation of the exchange offer, an
amendment to the certificate of incorporation to eliminate the series
E preferred stock,
o subject to approval and consummation of the exchange offer, an
amendment to the terms of the series G preferred stock to eliminate
certain restrictive provisions contained therein,
o subject to approval and consummation of the exchange offer, and
subject to all of the Series D preferred stock being exchanged in the
exchange offer, an amendment of the certificate of incorporation to
eliminate the series D preferred stock,
o subject to approval and consummation of the exchange offer, and
subject to all of the Series G preferred stock being exchanged in the
exchange offer, an amendment of the certificate of incorporation to
eliminate the series G preferred stock,
o subject to approval and consummation of the exchange offer, an
amendment of Z-Tel's certificate of incorporation to effect a 3 for 1,
4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock split of
the common stock, as determined at the discretion of the board of
directors, which reverse stock split at any or all of the foregoing
ratios may be abandoned at any time prior to effectiveness at the
discretion of the board of directors notwithstanding Z-Tel
stockholders authorization thereof, and
o subject to approval and consummation of the exchange offer, adoption
of a new management equity incentive plan and reservation of shares
for issuance thereunder representing 8% of the fully diluted common
stock of Z-Tel (excluding out of the money options and warrants to
acquire common stock, but including shares reserved for issuance under
the plan), after giving effect to any reverse stock split described
above.
You will also be asked to approve an amendment to Z-Tel's certificate of
incorporation changing its name to "Trinsic, Inc." The name change amendment is
not related to or contingent upon the exchange offer or any of the other
proposals set forth in this proxy statement. We intend to promptly announce, by
means of a press release, the results of the votes on the Special Meeting
Matters.
Z-Tel commenced the exchange offer which currently expires on November 23,
2004. Consummation of the exchange offer is contingent upon, among other things,
the approval of the matters set forth above (other than the name change
proposal) and the tender in the exchange offer of all series E and series G
preferred stock owned by The 1818 Fund III, L.P. If the matters set forth above
are approved at the special meeting, the exchange offer is expected to close
within 5 business days following the meeting.
We will announce, by means of a press release, the amount of each series of
Preferred Stock tendered as of the close of business (1) on the second business
day preceding the date of the Special Meeting and (2) on the second business day
prior to expiration of the Exchange Offer. We will also announce, by means of a
press release, when The 1818 Fund has tendered its shares of Preferred Stock. If
necessary, we will extend the Exchange Offer to the close of business on the
fifth business day following the date upon which The 1818 Fund tenders its
shares of Preferred Stock.
A special committee composed of independent directors of Z-Tel's board has
determined that the exchange offer is in the best interests of Z-Tel's common
stockholders. In making its determination, the special committee retained the
services of a financial advisor, Morgan Keegan & Company, Inc. Morgan Keegan
delivered a written opinion, dated September 28, 2004, to the effect that, based
upon and subject to the factors and assumptions described in the opinion, the
exchange offer was fair, from a financial point of view, to Z-Tel's common
stockholders. On the basis of the determination of the special committee, the
board of directors recommends that Z-Tel's common stockholders vote in favor of
the exchange offer. The board of directors is not making any recommendation to
Z-Tel's preferred stockholders with respect to the exchange offer.
The board of directors has determined that, subject to approval and
consummation of the exchange offer, each of the amendments to the series d and
series g preferred stock certificates of designation are in the best interests
of common stockholders and recommends that common stockholders vote in favor of
such proposals. the board of directors is not making any recommendation to
preferred stockholders as to how they should vote on
-2-
the proposal to amend the series d and series g preferred stock certificates of
designation.
The board of directors has determined that, subject to approval and
consummation of the exchange offer, the several amendments TO THE CERTIFICATE OF
INCORPORATION to ELIMINATE EACH preferred stock certificate of designation
RELATING TO A SERIES THAT IS NO LONGER OUTSTANDING, the reverse stock split
alternatives, and the NEW MANAGEMENT EQUITY INCENTIVE Plan are all in the best
interests of stockholders and recommends that Z-Tel's stockholders vote in favor
of such proposals.
THE BOARD OF DIRECTORS ALSO HAS DETERMINED THAT THE NAME CHANGE AMENDMENT
IS IN THE BEST INTERESTs OF STOCKHOLDERS AND RECOMMENDS THAT STOCKHOLDERS VOTE
IN FAVOR OF THE NAME CHANGE AMENDMENT PROPOSAL.
THE BOARD OF DIRECTORS RESERVES THE RIGHT TO ABANDON ANY OR ALL OF THE
SEVERAL AMENDMENTS TO AND ELIMINATIONS OF THE PREFERRED STOCK CERTIFICATES OF
DESIGNATION, ANY OR ALL OF THE REVERSE STOCK SPLIT ALTERNATIVES OR THE NAME
CHANGE AMENDMENT AT ANY TIME PRIOR TO THEIR EFFECTIVENESS NOTWITHSTANDING
AUTHORIZATION THEREOF BY Z-TEL'S STOCKHOLDERS.
Information about the special meeting and the business to be considered and
voted upon at the special meeting is included in the accompanying notice of
special meeting and proxy statement. Your vote is important regardless of the
number of shares you own. I urge you to complete, sign, date and return the
enclosed proxy card as soon as possible, even if you currently plan to attend
the meeting. Returning the proxy card will not prevent you from attending the
meeting and voting in person, but will ensure that your vote is counted if you
are unable to attend the meeting. I also urge you to review and consider
carefully the matters presented in the attached proxy statement. Thank you for
your interest and participation. I look forward to seeing you at the special
meeting.
Sincerely,
Horace J. Davis, III
Acting Chief Executive Officer, Treasurer and
Executive Vice President -- Chief Financial
Officer
The proxy statement is dated October 21, 2004 and is
expected to be first mailed to stockholders on
or about October 26, 2004.
-3-
Z-TEL TECHNOLOGIES, INC.
601 South Harbour Island Boulevard
Tampa, Florida 33602
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
To the Stockholders of Z-Tel Technologies, Inc.:
Notice is hereby given that a Special Meeting of Stockholders of Z-Tel
Technologies, Inc. will be held at our offices located at ,
on Tuesday, November 16, 2004, at , Eastern time, for
the following purposes:
I. To approve an offer to exchange, at the election of the holders
thereof (subject in each case to the impact of any reverse stock
split):
o shares of common stock for each outstanding share of Z-Tel's
series D convertible preferred stock;
o shares of common stock for each outstanding share of Z-Tel's
series E convertible preferred stock; and
o shares of common stock for each outstanding share of Z-Tel's
series G convertible preferred stock.
II. To approve, subject to approval and consummation of the exchange
offer, an amendment to the terms of the series D preferred stock to
eliminate certain restrictive provisions contained therein.
III. To approve, subject to approval and consummation of the exchange
offer, and subject to all of the Series D preferred stock being
exchanged in the exchange offer, an amendment of the certificate of
incorporation to eliminate the series D preferred stock.
IV. To approve, subject to approval and consummation of the exchange
offer, an amendment to the certificate of incorporation to eliminate
the series E preferred stock.
V. To approve, subject to approval and consummation of the exchange
offer, an amendment to the terms of the series G preferred stock to
eliminate certain restrictive provisions contained therein.
VI. To approve, subject to approval and consummation of the exchange
offer, and subject to all of the Series G preferred stock being
exchanged in the exchange offer, an amendment of the certificate of
incorporation to eliminate the series G preferred stock.
VII. To approve, subject to approval and consummation of the exchange
offer, an amendment of Z-Tel's certificate of incorporation to effect
a 3 for 1, 4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock
split of the common stock, as determined at the discretion of the
board of directors, which reverse stock split at any or all of the
foregoing ratios may be abandoned at any time prior to effectiveness
at the discretion of the board of directors, notwithstanding Z-Tel
stockholders authorization thereof.
VIII. To approve, subject to approval and consummation of the exchange
offer, adoption of the 2004 Stock Incentive Plan and reservation of
shares for issuance thereunder representing 8% of the fully diluted
common stock of Z-Tel (excluding out of the money options and warrants
to acquire common stock, but including shares reserved for issuance
under the plan), after giving effect to any reverse stock split
described above.
IX. To approve an amendment of Z-Tel's certificate of incorporation to
change its name to "Trinsic, Inc."
These proposals are more fully described in the proxy statement that
accompanies this notice. Please read the proxy statement carefully when
determining how to vote on these proposals.
These proposals will be submitted for approval to the holders of Z-Tel's
common stock, series D preferred stock and series E preferred stock, all voting
together as a single class. For such purpose, each share of common stock is
entitled to one vote, each share of series D preferred stock is entitled, as of
the special meeting date, to approximately votes per share which is the number
of votes equal to the series D liquidation value per share divided by the series
D conversion price, each as of the record date for the special meeting, and each
share of series E preferred stock is entitled, as of the special meeting date,
to votes per share which is the number of votes equal to the series E
liquidation value per share (together with an amount equal to accrued and unpaid
dividends thereon) divided by the series E conversion price, each as of the
record date for the special meeting.
In addition to the approval described in the preceding paragraph, proposals
II and III will be submitted for approval to the holders of Z-Tel's series D
preferred stock voting as a separate class, proposal IV will be submitted for
approval to the holders of Z-Tel's series E preferred stock voting as a separate
class, proposals V and VI will be submitted for approval to the holders of
Z-Tel's series G preferred stock, voting as a separate class.
After careful consideration and after receiving a written opinion from
Morgan Keegan & Company, Inc. as to the fairness, from a financial point of
view, to Z-Tel's common stockholders of the exchange offer, a special committee
of Z-Tel's board of directors determined that the exchange offer is in the best
interests of Z-Tel's common stockholders. On the basis of such determination,
the board of directors directed that the exchange offer be submitted to Z-Tel's
stockholders for their approval. The board of directors recommends that Z-Tel's
common stockholders vote in favor of the exchange offer. The board of directors
is not making any recommendation to Z-Tel's preferred stockholders with respect
to the exchange offer.
The board of directors also directed that the several amendments to and the
elimination of the preferred stock certificates of designation, the reverse
stock split alternatives, and the 2004 Stock Incentive Plan be submitted to
Z-Tel's stockholders for approval, subject to approval and consummation of the
exchange offer and that the name change amendment be submitted to Z-Tel's
stockholders for approval.
The board of directors has determined that, subject to approval and
consummation of the exchange offer, each of the amendments to the series D and
series G preferred stock certificates of designation are in the best interests
of common stockholders and recommends that common stockholders vote in favor of
such proposals. The board of directors is not making any recommendation to
preferred stockholders as to how they should vote on the proposal to amend the
series D and series G preferred stock certificates of designation.
The board of directors determined that, subject to approval and
consummation of the exchange offer, the several amendments to the certificate of
incorporation to eliminate each preferred stock certificates of designation
relating to a series that is no longer outstanding, the reverse stock split
alternatives, and the 2004 Stock Incentive Plan are all in the best interests of
stockholders and recommends that Z-Tel's stockholders vote in favor of such
proposals.
The Board of Directors also has determined that the name change amendment
is in the best interests of stockholders and recommends that stockholders vote
in favor of the name change amendment proposal.
THE BOARD OF DIRECTORS RESERVES THE RIGHT TO ABANDON ANY OR ALL OF THE
SEVERAL AMENDMENTS TO AND ELIMINATIONS OF THE PREFERRED STOCK CERTIFICATES OF
DESIGNATION, ANY OR ALL OF THE REVERSE STOCK SPLIT ALTERNATIVES OR THE NAME
CHANGE AMENDMENT AT ANY TIME PRIOR TO THEIR EFFECTIVENESS NOTWITHSTANDING
AUTHORIZATION THEREOF BY Z-TEL'S STOCKHOLDERS.
-2-
The board of directors has fixed the close of business on October 25, 2004
as the record date for the determination of stockholders entitled to notice of
and to vote at the special meeting and at any adjournment or postponement
thereof.
Accompanying this notice of special meeting and the proxy statement is a
proxy. Whether or not you expect to attend the special meeting, please complete,
sign and date the enclosed proxy and return it promptly. If you plan to attend
the special meeting and wish to vote your shares personally, you may do so at
any time before the proxy is voted.
All stockholders are cordially invited to attend the meeting.
By Order of the Board of Directors
Horace J. Davis, III
Acting Chief Executive Officer, Treasurer and
Executive Vice President -- Chief Financial
Officer
Tampa, Florida
, 2004
-3-
SUMMARY TERM SHEET
This summary term sheet highlights selected material information from this
proxy statement, but may not contain all of the information that is important to
you. Z-Tel urges you to carefully review the entire proxy statement before you
decide how to vote.
Summary of Exchange Offer and Related Transactions (Pages 29-45)
At the special meeting, Z-Tel's Common Stockholders ("Common
Stockholders"), holders of series D preferred stock ("Series D Preferred
Stockholders") and holders of series E preferred stock ("Series E Preferred
Stockholders) will be asked to approve the exchange offer and related
transactions (subject in each case to the impact of any reverse stock split).
Holders of series G preferred stock ("Series G Preferred Stockholders" and
together with Series D Preferred Stockholders and Series E Preferred
Stockholders, "Preferred Stockholders" and further together with Common
Stockholders, "Stockholders") will be asked to approve related transactions
affecting the series G preferred stock and its certificate of designation. The
exchange offer and related transactions consist of:
o an offer made to Preferred Stockholders to exchange Z-Tel's series D
preferred stock ("Series D Preferred Stock"), series E preferred stock
("Series E Preferred Stock") and series G preferred stock ("Series G
Preferred Stock" and together with the Series D Preferred Stock and
Series E Preferred Stock, the "Preferred Stock") stock for common
stock, par value $.01 per share ("Common Stock") of Z-Tel (the
"Exchange Offer"),
o an amendment to the terms of the Series D Preferred Stock to eliminate
certain restrictive provisions contained therein, subject to approval
and consummation of the Exchange Offer,
o an amendment to the certificate of incorporation to eliminate the
Series D Preferred Stock, subject to approval and consummation of the
Exchange Offer, and subject to all of the Series D Preferred Stock
being exchanged in the Exchange Offer,
o an amendment to the certificate of incorporation to eliminate the
Series E Preferred Stock, subject to approval and consummation of the
Exchange Offer,
o an amendment to the terms of the Series G Preferred Stock to eliminate
certain restrictive provisions contained therein, subject to approval
and consummation of the Exchange Offer,
o an amendment to the certificate of incorporation to eliminate the
Series G Preferred Stock, subject to approval and consummation of the
Exchange Offer, and subject to all of the Series G Preferred Stock
being exchanged in the Exchange Offer,
o an amendment of Z-Tel's certificate of incorporation to effect a 3 for
1, 4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock split
of the Common Stock, as determined at the direction of the board of
directors and subject to approval and consummation of the Exchange
Offer, which reverse stock split at any or all of the foregoing ratios
may be abandoned at any time prior to effectiveness at the discretion
of the board of directors notwithstanding Z-Tel Stockholder
authorization thereof, and
o adoption of the 2004 Stock Incentive Plan (the "Plan") and reservation
of shares for issuance thereunder representing 8% of the Common Stock
on a fully diluted basis (excluding out of the money options and
warrants to acquire common stock, but including shares reserved for
issuance under the Plan), after giving effect to any reverse stock
split described above ("Fully Diluted Common Stock"), subject to
approval and consummation of the Exchange Offer.
You will also be asked to approve an amendment to Z-Tel's certificate of
incorporation changing its name to "Trinsic, Inc." The name change amendment is
not related to or contingent upon the Exchange Offer or any of the other
proposals set forth in this proxy statement.
S-1
In this proxy statement, whenever we refer to the "related transactions" or
the "related proposals," we are only referring to the Exchange Offer, the
Preferred Stock amendments and certificate of designation eliminations, the
reverse stock split authorization and the Plan and reservation of shares for
issuance thereunder and not to the name change amendment. The Exchange Offer and
related transactions will be implemented only if they are all approved at the
special meeting by the Stockholders entitled to vote thereon. If the Exchange
Offer is not approved and consummated, none of the series of Preferred Stock
will be amended, the reverse stock split will not be implemented and the Plan
will not be adopted. However, if the name change amendment is approved, it will
be implemented (subject to the right of the board of directors to abandon it in
its discretion) regardless of whether the Exchange Offer and related
transactions are implemented.
Terms of the Exchange Offer (Pages 29-34)
In the proposed Exchange Offer, Z-Tel is offering to exchange any or all of
the shares of its outstanding Preferred Stock as follows (subject in each case
to the impact of any reverse stock split):
o to exchange 25.69030 shares of its Common Stock for each share of its
Series D Preferred Stock, which as of September 27, 2004 has a
liquidation value of $16.55 per share and conversion price of $8.47
per share (representing an exchange price of approximately $0.644 per
share);
o to exchange 25.24216 shares of its Common Stock for each share of its
Series E Preferred Stock, which as of September 27, 2004 has a
liquidation value of $16.26 per share and conversion price of $8.08
per share (representing an exchange price of approximately $0.644 per
share); and
o to exchange 161,469.4 shares of its Common Stock for each share of its
Series G Preferred Stock, which as of September 27, 2004 has a
liquidation value of $144,975.90 per share and conversion price of
$1.28 per share (representing an exchange price of approximately
$0.898 per share).
Reasons for the Exchange Offer and Related Transactions (Page 24)
Z-Tel is proposing the Exchange Offer at this time:
o to improve and simplify our capital structure by eliminating all or
substantially all of the approximately $158.4 million aggregate
liquidation value of Preferred Stock, as of September 27, 2004, in
exchange for Common Stock, thereby enabling us to potentially attract
necessary additional financing for our business plan;
o to eliminate all or substantially all of the dividends payable to
holders of Preferred Stock and the related dilutive effect on Common
Stockholders (and increase the equity and earnings attributable to
Common Stock);
o to reduce or eliminate the mandatory redemption payments on our
Preferred Stock, which will be due in 2006 on the Series G Preferred
Stock and in 2008 on the Series D Preferred Stock and Series E
Preferred Stock;
o to increase the aggregate market value of our Common Stock, which is
currently below the $35 million minimum amount required to maintain
listing on the Nasdaq SmallCap Market, to an amount substantially in
excess of the minimum amount required to maintain listing of the
Common Stock on the Nasdaq SmallCap Market;
o to increase our net book value by eliminating or reducing from our
balance sheet the long-term liability associated with the Preferred
Stock;
o because failure to convert the Preferred Stock to Common Stock would
prevent Z-Tel from being able to execute its business plan and most
likely result in Z-Tel's need to downsize significantly or liquidate;
and
S-2
o because the effective conversion prices for the Preferred Stock are
significantly higher than the trading prices of the Common Stock prior
to the commencement of the Exchange Offer.
Z-Tel is proposing the amendments to the Preferred Stock certificates of
designation at this time because it believes the amendments will reduce the
impact of restrictive certificate of incorporation provisions imposed by any
small amount of Series D Preferred Stock or Series G Preferred Stock not
participating in the Exchange Offer and will otherwise eliminate certificate of
incorporation provisions relating to Preferred Stock that is no longer
outstanding.
Z-Tel is proposing the reverse stock split at this time because it
believes:
o the reverse stock split will facilitate the Exchange Offer by ensuring
that enough Common Stock is available to consummate the Exchange
Offer; and
o the reverse stock split will increase the bid price per share of
Common Stock, which is currently below the $1.00 minimum amount
required to maintain listing on the Nasdaq SmallCap Market, to an
amount substantially in excess of the minimum amount required to
maintain listing of the Common Stock on the Nasdaq SmallCap Market.
Z-Tel is proposing the Plan and reservation of shares for issuance
thereunder to provide incentives to attract, retain and motivate employees,
consultants and directors and to provide for competitive compensation
opportunities, to encourage long term service, to recognize individual
contributions and reward achievement of performance goals, and to promote the
creation of long term value for stockholders by aligning the interests of such
persons with those of stockholders.
Notwithstanding the fact that the Exchange Offer and related transactions
are conditioned upon approval by stockholders, we commenced the Exchange Offer
because under applicable law the Exchange Offer is required to be kept open for
a minimum of 20 business days and we believe we should attempt to synchronize
the Exchange Offer period and the notice period for the special meeting so that
they run concurrently, with an overall view towards most expeditiously and
efficiently consummating the Exchange Offer and related transactions.
Impact of the Exchange Offer and Related Transactions
on the Holders of Z-Tel's Capital Stock (Page 27)
If the Exchange Offer and related transactions are approved by Z-Tel's
Stockholders at the special meeting, Z-Tel intends to complete such transactions
within 10 business days following the special meeting. If the Exchange Offer was
completed, following the Exchange Offer and related transactions:
o Z-Tel's Common Stock will remain outstanding. However, each share of
Common Stock will be converted into 1/3, 1/4, 1/5, 1/6, 1/7 or 1/8 of
a share of Common Stock, as a result of the reverse stock split, and
will vote with any remaining holders of Series D Preferred Stock (to
the extent any shares of Series D Preferred Stock remain outstanding
following the Exchange Offer) to elect directors to Z-Tel's board of
directors;
o shares of Series D Preferred Stock and Series G Preferred Stock
tendered in the Exchange Offer will be retired, shares of Series D
Preferred Stock and Series G Preferred Stock not tendered in the
Exchange Offer will remain outstanding, and the remaining holders of
Series D Preferred Stock and Series G Preferred Stock will no longer
have the benefit of certain restrictive provisions contained in the
certificates of designation relating to the Series D Preferred Stock
and Series G Preferred Stock, respectively;
o if all of the Series D Preferred Stock or Series G Preferred Stock is
tendered in the Exchange Offer, such series will be retired, the
former Stockholders of such retired series will receive, in exchange
for that Preferred Stock outstanding immediately prior to the Exchange
Offer, shares of
S-3
Common Stock, and Z-Tel's certificate of incorporation will be amended
to eliminate the certificate of designation relating to such series;
o Z-Tel's Series E Preferred Stock will be retired, the Series E
Preferred Stockholders will receive, in exchange for the Series E
Preferred Stock outstanding immediately prior to the Exchange Offer,
shares of Common Stock, and Z-Tel's certificate of incorporation will
be amended to eliminate the Series E Preferred Stock certificate of
designation; and
o assuming all outstanding shares of Preferred Stock are exchanged for
Common Stock, immediately following the Exchange Offer and related
transactions:
o Z-Tel's pre-existing Common Stockholders and in-the-money warrant
holders will own or have the right to acquire an aggregate of 13.8% of
the Fully Diluted Common Stock,
o Z-Tel's former Series D Preferred Stockholders will own an aggregate
of 34.0% of the Fully Diluted Common Stock,
o Z-Tel's former Series E Preferred Stockholders will own an aggregate
of 35.0% of the Fully Diluted Common Stock, and
o Z-Tel's former Series G Preferred Stockholders will own an aggregate
of 9.2% of the Fully Diluted Common Stock.
Conditions to the Exchange Offer and Related Transactions (Page 29)
Z-Tel will not consummate the Exchange Offer or any of the related
transactions unless (1) the Exchange Offer and related transactions are approved
by the stockholders entitled to vote thereon and (2) all of the Preferred Stock
owned by The 1818 Fund III, L.P. ("The 1818 Fund") is tendered for exchange in
the Exchange Offer. In addition, because The 1818 Fund owns all of the Series E
Preferred Stock and more than a majority of the Series G Preferred Stock, the
Exchange Offer and related transactions cannot be approved unless The 1818 Fund
votes in favor of such proposals at the special meeting. We will announce, by
means of a press release, the number of shares of each series of Preferred Stock
tendered as of the close of business (1) on the second business day preceding
the date of the special meeting and (2) on the second business day prior to
expiration of the Exchange Offer. We will also announce, by means of a press
release, when The 1818 Fund has tendered its shares of Preferred Stock. If
necessary, we will extend the Exchange Offer to the close of business on the
fifth business day following the date upon which The 1818 Fund tenders its
shares of Preferred Stock.
In addition, Z-Tel may terminate, amend or postpone consummation of the
Exchange Offer if at any time prior to its expiration:
o any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Exchange
Offer, or any material adverse development has occurred in any
existing action or proceeding with respect to us or any of our
subsidiaries, which, in Z-Tel's reasonable judgment, might materially
impair our ability to proceed with the Exchange Offer;
o any law, statute, rule or regulation is proposed, adopted or enacted
which, in Z-Tel's reasonable judgment, might materially impair its
ability to proceed with the Exchange Offer; or
o any governmental approval has not been obtained, which approval Z-Tel,
in its reasonable judgment, shall deem necessary for the consummation
of the Exchange Offer as contemplated hereby.
S-4
Recommendation of the Board of Directors (Page 33)
After careful consideration and after receiving a written opinion from
Morgan Keegan & Company, Inc. as to the fairness, from a financial point of
view, to Common Stockholders of the Exchange Offer, a special committee of
Z-Tel's board of directors determined that the Exchange Offer is in the best
interests of Common Stockholders. On the basis of such determination, the board
of directors directed that the Exchange Offer be submitted to Stockholders for
their approval. The board of directors recommends that Common Stockholders vote
in favor of the Exchange Offer. The board of directors is not making any
recommendation to Preferred Stockholders with respect to the Exchange Offer.
The board of directors also directed that the several amendments to the
certificate of incorporation, the amendments to eliminate the Preferred Stock
certificates of designation, the reverse stock split alternatives, and the Plan
be submitted to Stockholders for approval, subject to approval and consummation
of the Exchange Offer and that the name change amendment be submitted to
Stockholders for approval.
The board of directors has determined that, subject to approval and
consummation of the Exchange Offer, each of the amendments to the Series D
Preferred Stock and Series G Preferred Stock certificates of designation are in
the best interests of Common Stockholders and recommends that Common
Stockholders vote in favor of such proposals. The board of directors is not
making any recommendation to Preferred Stockholders as to how they should vote
on the proposal to amend the Series D Preferred Stock and Series G Preferred
Stock certificates of designation.
The board of directors determined that, subject to approval and
consummation of the Exchange Offer, the several amendments to the certificate of
incorporation to eliminate each Preferred Stock certificate of designation
relating to a series that is no longer outstanding, the reverse stock split
alternatives, and the Plan are all in the best interests of Stockholders and
recommends that Stockholders vote in favor of such proposals.
The board of directors also has determined that the name change
amendment is in the best interests of Stockholders and recommends that
Stockholders vote in favor of the name change amendment proposal.
The board of directors reserves the right to abandon any or all of the
several amendments to and eliminations of the Preferred Stock certificates of
designation, any or all of the reverse stock split alternatives or the name
change amendment at any time prior to their effectiveness notwithstanding
authorization thereof by Stockholders.
S-5
PROXY STATEMENT
TABLE OF CONTENTS
Page
SUMMARY TERM SHEET ..........................................................S-1
QUESTIONS AND ANSWERS ABOUT THE PROXY MATERIALS,
THE EXCHANGE OFFER AND THE RELATED
PROPOSED TRANSACTIONS......................................................1
QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING................................8
SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA AND
OTHER INFORMATION.........................................................13
Market for the Common Stock and the Preferred Stock...........................15
SPECIAL FACTORS...............................................................16
Background of the Exchange Offer......................................16
Opinion of Financial Advisor to the Special Committee.................18
Z-Tel's Reasons for the Exchange Offer................................23
Special Committee of the Board of Directors...........................24
Recommendation of Z-Tel's Board of Directors..........................24
Interests of Directors and Officers...................................24
Security Ownership of Certain Beneficial Owners
and Officers and Directors........................................25
Agreements Involving Our Securities...................................27
Effect of the Exchange Offer and Related Transactions.................27
PROPOSAL I: EXCHANGE OFFER...................................................29
PROPOSAL II: AMENDMENT TO Z-TEL'S SERIES D PREFERRED
STOCK CERTIFICATE OF DESIGNATION
TO ELIMINATE CERTAIN RESTRICTIVE PROVISIONS CONTAINED THEREIN............34
PROPOSAL III: AMENDMENT TO Z-TEL'S CERTIFICATE OF
INCORPORATION TO ELIMINATE THE
SERIES D PREFERRED STOCK..................................................36
PROPOSAL IV: AMENDMENT TO Z-TEL'S CERTIFICATE OF
INCORPORATION TO ELIMINATE THE SERIES
E PREFERRED STOCK.........................................................37
PROPOSAL V: AMENDMENT TO Z-TEL'S SERIES G PREFERRED
STOCK CERTIFICATE OF DESIGNATION
TO ELIMINATE CERTAIN RESTRICTIVE PROVISIONS CONTAINED THEREIN.............38
PROPOSAL VI: AMENDMENT TO Z-TEL'S CERTIFICATE OF
INCORPORATION TO ELIMINATE THE SERIES
G PREFERRED STOCK.........................................................40
PROPOSAL VII: AMENDMENT TO Z-TEL'S CERTIFICATE OF
INCORPORATION TO EFFECT THE REVERSE
STOCK SPLIT...............................................................41
PROPOSAL VIII: 2004 STOCK INCENTIVE PLAN.....................................45
PROPOSAL IX: AMENDMENT TO Z-TEL'S CERTIFICATE OF
INCORPORATION TO CHANGE ITS NAME TO
"TRINSIC, INC."...........................................................50
DESCRIPTION OF OUR PREFERRED STOCK............................................51
DESCRIPTION OF OUR COMMON STOCK...............................................55
OTHER BUSINESS................................................................56
FINANCIAL AND OTHER INFORMATION INCLUDED HEREIN...............................56
Annexes:
Annex A-1 Amended Certificate of Designations of Series D Preferred Stock
Annex A-2 Certificate of Amendment of the Amended and Restated Certificate
of Incorporation of Z-Tel Technologies, Inc. eliminating
Series D Preferred Stock Certificate of Designation
Annex B Certificate of Amendment of the Amended and Restated Certificate
of Incorporation of Z-Tel Technologies, Inc. eliminating Series
E Preferred Stock Certificate of Designation
Annex C-1 Amended Certificate of Designation of Series G Convertible
Preferred Stock
-i-
Annex C-2 Certificate of Amendment of the Amended and Restated Certificate
of Incorporation of Z-Tel Technologies, Inc. eliminating Series
G Preferred Stock Certificate of Designation
Annex D Form of Certificate of Amendment of the Amended and Restated
Certificate of Incorporation of Z-Tel Technologies, Inc.
implementing one of the reserve stock split proposals
Annex E Certificate of Amendment to the Amended and Restated Certificate
of Incorporation of Z-Tel Technologies, Inc. changing name to
"Trinsic, Inc."
Annex F Opinion of Morgan Keegan & Company, Inc.
Annex G 2004 Stock Incentive Plan
Annex H-1 Recent Developments
Annex H-2 Unaudited Interim Financial Statements and Related Management's
Discussion
Annex H-3 Report of PricewaterhouseCoopers LLP; Audited Annual Financial
Statements and Related Management's Discussion and Analysis
Proxy
-ii-
Z-TEL TECHNOLOGIES, INC.
601 South Harbour Island Boulevard, Suite 220
Tampa, Florida 33602
------------------------------------------------------------------------
PROXY STATEMENT
------------------------------------------------------------------------
This proxy statement is being furnished to the stockholders of Z-Tel
Technologies, Inc. (collectively, "Stockholders"), a Delaware corporation, in
connection with the solicitation of proxies by Z-Tel's board of directors from
the holders of outstanding shares of Common Stock ("Common Stockholders"),
Series D Preferred Stock ("Series D Preferred Stockholders"), Series E Preferred
Stock ("Series E Preferred Stockholders") and Series G Preferred Stock ("Series
G Preferred Stockholders") for use at the special meeting of Stockholders of
Z-Tel to be held on Tuesday, November 16, 2004, and any adjournments or
postponements thereof.
All Stockholders who find it convenient to do so are cordially invited to
attend the meeting in person. In any event, please complete, sign, date and
return the proxy in the enclosed envelope.
QUESTIONS AND ANSWERS ABOUT THE PROXY MATERIALS, THE EXCHANGE OFFER
AND THE RELATED PROPOSED TRANSACTIONS
Why am I receiving this proxy statement?
You have received this proxy statement and the enclosed proxy from Z-Tel
because you hold shares of Common Stock, Series D Preferred Stock, Series E
Preferred Stock and/or Series G Preferred Stock. The board of directors of Z-Tel
is soliciting your proxy to vote on the Exchange Offer and related proposed
transactions and the name change amendment to be considered at the special
meeting, as applicable. As a stockholder, you are invited to attend the special
meeting and are entitled to and requested to vote on the proposals described in
this proxy statement.
What information is contained in this proxy statement?
The information included in this proxy statement relates to the proposals
to be voted on at the special meeting, the board of directors' recommendations
regarding the proposals, procedures for voting at the special meeting and other
information required by federal securities laws.
What are the proposed Exchange Offer and related transactions?
The proposals to be voted on at the special meeting include proposals
relating to an Exchange Offer being made to holders of Z-Tel's several series of
outstanding Preferred Stock. In the proposed Exchange Offer, Z-Tel has offered
to exchange any or all of shares of its outstanding Preferred Stock as follows
(subject in each case to the impact of any reverse stock split):
o to exchange 25.69030 shares of its Common Stock for each share of its
Series D Preferred Stock, which as of September 27, 2004 has a
liquidation value (representing original investment plus accrued and
unpaid dividends) of $16.55 per share and conversion price of $8.47
per share (representing an exchange price of approximately $0.644 per
share);
o to exchange 25.24216 shares of its Common Stock for each share of its
Series E Preferred Stock, which as of September 27, 2004 has a
liquidation value of $16.26 per share and conversion price of $8.08
per share (representing an exchange price of approximately $0.644 per
share); and
o to exchange 161,469.4 shares of its Common Stock for each share of its
Series G Preferred Stock, which as of September 27, 2004 has a
liquidation value of $144,975.90 per share and conversion price of
$1.28 per share (representing an exchange price of approximately
$0.898 per share).
Subject to approval and consummation of the Exchange Offer, Z-Tel proposes
to
o amend the terms of the several series of Preferred Stock to eliminate
certain restrictive provisions contained therein, unless all of any
particular series of Preferred Stock is exchanged in the Exchange
Offer, in which case the certificate of incorporation also will be
amended to eliminate each fully exchanged series of Preferred Stock,
o amend Z-Tel's certificate of incorporation to effect a 3 for 1, 4 for
1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock split of the
Common Stock, as determined at the direction of the board of
directors, which reverse stock split at any or all of the foregoing
ratios may be abandoned at any time prior to effectiveness at the
discretion of the board of directors, notwithstanding Z-Tel
Stockholder authorization thereof, and
o adopt the Plan and reservation of shares for issuance thereunder
representing 8% of the Fully Diluted Common Stock.
If all of any particular series of Preferred Stock is exchanged in the
Exchange Offer, Z-Tel proposes to amend the certificate of incorporation to
eliminate each such fully exchanged series of Preferred Stock.
If the Exchange Offer is not approved and consummated, none of the series
of Preferred Stock will be amended, the reverse stock split will not be
implemented and the Plan will not be adopted.
What is the name change amendment?
Z-Tel has been doing business for some time under the brand name "Trinsic."
The difference between Z-Tel's name as a legal entity and its brand name can be
a source of confusion for Z-Tel's vendors and customers. Accordingly, Z-Tel is
seeking an amendment to its certificate of incorporation to change its legal
entity name to "Trinsic, Inc."
How would the Exchange Offer and related transactions affect the holders of
Z-Tel's capital stock?
If the Exchange Offer was completed, following the Exchange Offer and
related transactions:
o Z-Tel's Common Stock will remain outstanding. However, each share of
Common Stock will be converted into 1/3, 1/4, 1/5, 1/6, 1/7 or 1/8 of
a share of Common Stock, as a result of the reverse stock split, and
will vote with any remaining holders of Series D Preferred Stock (to
the extent any shares of Series D Preferred Stock remain outstanding
following the Exchange Offer) to elect directors to Z-Tel's board of
directors;
o shares of Series D Preferred Stock and Series G Preferred Stock
tendered in the Exchange Offer will be retired, shares of Series D
Preferred Stock and Series G Preferred Stock not tendered in the
Exchange Offer will remain outstanding, and the remaining holders of
Series D Preferred Stock and Series G Preferred Stock will no longer
have the benefit of certain restrictive provisions contained in the
certificates of designation relating to the Series D Preferred Stock
and Series G Preferred Stock, respectively;
o Z-Tel's Series E Preferred Stock will be retired, the Series E
Preferred Stockholders will receive, in exchange for the Series E
Preferred Stock outstanding immediately prior to the Exchange Offer,
shares of Common Stock, and Z-Tel's certificate of incorporation will
be amended to eliminate the Series E Preferred Stock certificate of
designation;
o assuming all outstanding shares of Preferred Stock are exchanged for
Common Stock, immediately following the Exchange Offer and related
transactions:
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o Z-Tel's pre-existing Common Stockholders and in-the-money warrant
holders will own or have the right to acquire an aggregate of 13.8% of
the Fully Diluted Common Stock,
o Z-Tel's former Series D Preferred Stockholders will own an aggregate
of 34.0% of the Fully Diluted Common Stock (including Common Stock
available to be issued under the Plan),
o Z-Tel's former Series E Preferred Stockholders will own an aggregate
of 35.0% of the Fully Diluted Common Stock (including Common Stock
available to be issued under the Plan), and
o Z-Tel's former Series G Preferred Stockholders will own an aggregate
of 9.2% of the Fully Diluted Common Stock (including Common Stock
available to be issued under the Plan).
What are the conditions to the Exchange Offer and related transactions?
Z-Tel will not consummate the Exchange Offer or any of the related
transactions unless (1) the Exchange Offer and related transactions are approved
by the Stockholders entitled to vote thereon and (2) all of the Preferred Stock
owned by The 1818 Fund is tendered for exchange in the Exchange Offer. In
addition, because The 1818 Fund owns all of the Series E Preferred Stock and
more than a majority of the Series G Preferred Stock, the Exchange Offer and
related transactions cannot be approved unless The 1818 Fund votes in favor of
such proposals at the special meeting. We will announce, by means of a press
release, the number of shares of each series of Preferred Stock tendered as of
the close of business (1) on the second business day preceding the date of the
special meeting and (2) on the second business day prior to expiration of the
Exchange Offer. We will also announce, by means of a press release, when The
1818 Fund has tendered its shares of Preferred Stock. If necessary, we will
extend the Exchange Offer to the close of business on the fifth business day
following the date upon which The 1818 Fund tenders its shares of Preferred
Stock.
In addition, Z-Tel may terminate, amend or postpone consummation of the
Exchange Offer if at any time prior to its expiration:
o any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Exchange
Offer, or any material adverse development has occurred in any
existing action or proceeding with respect to us or any of our
subsidiaries, which, in Z-Tel's reasonable judgment, might materially
impair our ability to proceed with the Exchange Offer;
o any law, statute, rule or regulation is proposed, adopted or enacted
which, in Z-Tel's reasonable judgment, might materially impair its
ability to proceed with the Exchange Offer; or
o any governmental approval has not been obtained, which approval Z-Tel,
in its reasonable judgment, shall deem necessary for the consummation
of the Exchange Offer as contemplated hereby.
Why is Z-Tel proposing the Exchange Offer and related transactions?
Z-Tel is proposing the Exchange Offer at this time:
o to improve and simplify our capital structure by eliminating all or
substantially all of the approximately $158.4 million aggregate
liquidation value of Preferred Stock, as of September 27, 2004, in
exchange for Common Stock, thereby enabling us to potentially attract
necessary additional financing for our business plan;
o to eliminate all or substantially all of the dividends payable to
holders of Preferred Stock and the related dilutive effect on Common
Stockholders (and increase the equity and earnings attributable to
Common Stock);
-3-
o to reduce or eliminate the mandatory redemption payments on our
Preferred Stock, which will be due in 2006 on the Series G Preferred
Stock and in 2008 on the Series D Preferred Stock and Series E
Preferred Stock;
o to increase the aggregate market value of our Common Stock, which is
currently below the $35 million minimum amount required to maintain
listing on the Nasdaq SmallCap Market, to an amount substantially in
excess of the minimum amount required to maintain listing of the
Common Stock on the Nasdaq SmallCap Market;
o to increase our net book value by eliminating or reducing from our
balance sheet the long-term liability associated with the Preferred
Stock;
o because failure to convert the Preferred Stock to Common Stock would
prevent Z-Tel from being able to execute its business plan and most
likely result in Z-Tel's need to downsize significantly or liquidate;
and
o because the effective conversion prices for the Preferred Stock were
significantly higher than the trading prices of the Common Stock prior
to the commencement of the Exchange Offer.
Z-Tel is proposing the amendments to the Preferred Stock certificates of
designation at this time because it believes the amendments will reduce the
impact of restrictive certificate of incorporation provisions imposed by any
small amount of Series D Preferred Stock or Series G Preferred Stock not
participating in the Exchange Offer and will otherwise eliminate certificate of
incorporation provisions relating to Preferred Stock that is no longer
outstanding.
Z-Tel is proposing the reverse stock split at this time because it
believes:
o the reverse stock split will facilitate the Exchange Offer by ensuring
that enough Common Stock is available to consummate the Exchange
Offer; and
o the reverse stock split will increase the bid price per share of
Common Stock, which is currently below the $1.00 minimum amount
required to maintain listing on the Nasdaq SmallCap Market, to an
amount substantially in excess of the minimum amount required to
maintain listing of the Common Stock on the Nasdaq SmallCap Market.
Z-Tel is proposing the Plan and reservation of shares for issuance
thereunder to provide incentives to attract, retain and motivate employees,
consultants and directors and to provide for competitive compensation
opportunities, to encourage long-term service to recognize individual
contributions and reward achievement of performance goals, and to promote the
creation of long term value for Stockholders by aligning the interests of such
persons with those of Stockholders.
Why is Z-Tel asking Stockholders to vote upon the Exchange Offer?
The Exchange Offer is a transaction which may require Stockholder approval
pursuant to the rules of the Nasdaq SmallCap Market. As discussed elsewhere in
this proxy statement, the Common Stock may be delisted from the Nasdaq SmallCap
Market. Notwithstanding any such delisting, the board of directors has
determined that the Exchange Offer is a transaction of sufficient significance
and consequence that it should be submitted for approval to the Stockholders of
Z-Tel. Z-Tel will not consummate the Exchange Offer unless it and the related
transactions are approved by Stockholders.
Notwithstanding the fact that the Exchange Offer and related transactions
are conditioned upon approval by stockholders, we commenced the Exchange Offer
because under applicable law the Exchange Offer is required to be kept open for
a minimum of 20 business days and we believe we should attempt to synchronize
the Exchange Offer period and the notice period for the special meeting so that
they run concurrently, with an overall view towards most expeditiously and
efficiently consummating the Exchange Offer and related transactions.
-4-
Did Z-Tel consider any negative factors that could or do arise from the Exchange
Offer and related transactions?
Z-Tel considered several negative factors that could or will arise from the
Exchange Offer and related transactions, including:
o the anticipated aggregate costs of the Exchange Offer and related
transactions, which are estimated to be approximately $1.0 million,
that will be incurred,
o the risk that the anticipated benefits of the Exchange Offer and
related transactions might not be fully realized, and
o the Common Stockholders will have their percentage ownership in the
outstanding Common Stock substantially diluted due to the additional
shares of Common Stock to be issued in the Exchange Offer.
Did Z-Tel's independent directors make a determination that the Exchange Offer
is in the best interests of the Common Stockholders?
Because certain members of Z-Tel's board of directors either hold or are
affiliated with holders of Preferred Stock, Z-Tel's board of directors formed a
special committee of its independent directors comprised of Messrs. John K.
Aurell, W. Andrew Krusen, Jr. and Richard F. LaRoche, Jr., to evaluate the
fairness, from a financial point of view, of the Exchange Offer to the Common
Stockholders. The special committee retained the services of a financial
advisor, Morgan Keegan & Company, Inc. Morgan Keegan has delivered a written
opinion to the special committee as to the fairness, from a financial point of
view, of the Exchange Offer to the Common Stockholders. The full text of Morgan
Keegan's written opinion is attached to this proxy statement as Annex F. Z-Tel
encourages you to read this opinion carefully in its entirety for a description
of the procedures followed, assumptions made, matters considered and limitations
on the review undertaken. Morgan Keegan's opinion is directed to the special
committee and does not constitute a recommendation to any stockholder as to any
matter relating to the Exchange Offer or any related transactions.
In addition to the opinion of Morgan Keegan, the special committee
considered other factors:
o the conversion of the Preferred Stock into Common Stock is essential
for Z-Tel to be able to attract the financing necessary for the
business plan, and
o if the Exchange Offer is not successful and the business plan is not
financed, the likely value of the Common Stock would be zero.
What conflicts of interest might Z-Tel's directors and officers have in the
Exchange Offer and related transactions?
When considering the recommendation of Z-Tel's board of directors, you
should be aware that some Z-Tel directors and officers have interests in the
Exchange Offer and related transactions that may be different from, or in
addition to, yours. These interests include:
o Messrs. Lawrence C. Tucker and Andrew C. Cowen, directors of Z-Tel,
are affiliates of The 1818 Fund, which owns all of the outstanding
Series E Preferred Stock and approximately 73% of the outstanding
Series G Preferred Stock.
o Mr. Charles D. Hyman, a director of Z-Tel, owns approximately 0.5% of
the outstanding Series D Preferred Stock and approximately 0.9% of the
outstanding Series G Preferred Stock.
o Directors and Officers of Z-Tel generally will be eligible to receive
equity incentives pursuant to the Plan.
-5-
Other than as described above and payments made to directors and officers in
their capacities as such, no payments or benefits will be paid to Z-Tel's
current directors or officers as a result of the Exchange Offer and related
transactions.
Has Z-Tel been advised that any of its Stockholders intend to vote in favor of
the Exchange Offer and related transactions?
Z-Tel has been advised by The 1818 Fund that it currently intends to vote
in favor of the Exchange Offer and related transactions, subject to Z-Tel
receiving tenders of substantially all of the Preferred Stock in the Exchange
Offer, in its sole judgment. The 1818 Fund has not advised Z-Tel what level of
tenders would, in its judgment, constitute "substantially all" of the Preferred
Stock. The 1818 Fund is not obligated to vote in favor of the Exchange Offer or
any of the related transactions and may decide not to do so at any time for any
reason. However, because The 1818 Fund owns all of the Series E Preferred Stock
and more than a majority of the Series G Preferred Stock, the Exchange Offer and
related transactions cannot be approved unless The 1818 Fund votes in favor of
such proposals at the special meeting. We will announce, by means of a press
release, the number of shares of each series of Preferred Stock tendered as of
the close of business (1) on the second business day preceding the date of the
special meeting and (2) on the second business day prior to expiration of the
Exchange Offer. We will also announce, by means of a press release, when The
1818 Fund has tendered its shares of Preferred Stock. If necessary, we will
extend the Exchange Offer to the close of business on the fifth business day
following the date upon which The 1818 Fund tenders its shares of Preferred
Stock.
Will I have appraisal rights as a result of the recapitalization?
Stockholders will not have appraisal rights as a result of the Exchange
Offer or related transactions.
Are any regulatory approvals required in connection with the Exchange Offer or
related transactions?
Z-Tel is not aware of any federal or state regulatory approvals that must
be obtained in connection with the Exchange Offer or related transactions.
What are the principal trading markets of the Z-Tel capital stock?
The Common Stock is currently traded on the Nasdaq SmallCap Market under
the symbol "ZTEL." However, the Common Stock does not currently meet the
following two criteria necessary for continued listing: (1) the aggregate market
value of the Common Stock is less than $35 million and (2) the closing bid price
per share of the Common Stock is less than $1.00. Z-Tel has asked for temporary
approval from the Nasdaq SmallCap Market to continue listing the Common Stock
through November 30, 2004. However, such temporary approval may not be granted
and the Common Stock may be delisted from the Nasdaq SmallCap Market in the near
future.
If Z-Tel is able to consummate the Exchange Offer and related transactions
Z-Tel believes that the Common Stock will have an aggregate market value
substantially in excess of $35 million and a bid price per share substantially
in excess of $1.00. However, there can be no assurance that the Exchange Offer
and related transactions will be consummated prior to November 30, 2004 or that
the Common Stock will meet Nasdaq SmallCap Market listing requirements following
consummation of Exchange Offer and related transactions. If not successful,
Z-Tel expects that the Common Stock will be eligible for quotation on the OTC
Bulletin Board. However, although Z-Tel would in such circumstance attempt to
have the Common Stock quoted on the OTC Bulletin Board, there can be no
assurance that it will be able to do so. Z-Tel believes that the failure to
maintain the listing of its Common Stock on the Nasdaq SmallCap Market could
have an adverse effect on the liquidity and price of the Common Stock and that
this effect would be exacerbated if the Common Stock is not quoted on the OTC
Bulletin Board.
The Preferred Stock is not currently traded in any trading market.
-6-
What are the material federal income tax considerations of the Exchange Offer
and the related transactions?
The tax consequences of the Exchange Offer to holders of Preferred Stock
are explained in the offering circular sent to Preferred Stockholders.
The reverse stock split, other than cash paid for fractional shares, will
generally be tax-free to Common Stockholders for United States federal income
tax purposes. However, tax matters are very complicated and the tax consequences
of the reverse stock split to you will depend on your own personal
circumstances. You should consult your tax advisors for a full understanding of
all of the tax consequences of the reverse stock split to you.
What is the anticipated accounting treatment of the transaction?
The exchange of Common Stock for Preferred Stock will be treated as an
induced conversion for accounting purposes per Financial Accounting Standards
Board ("FASB") Statement No. 84, "Induced Conversions of Convertible Debt." An
"induced conversion" is considered to occur when the conversion privileges,
pursuant to the original terms of the instrument, are changed or additional
consideration is offered to security holders for the purpose of inducing prompt
conversion of the security. Per Topic D-42 and FASB 84, a dividend charge will
be incurred representing the difference between the value of the Common Stock
issued in the Exchange Offer, and the value of the shares that were issuable
under the original conversion terms of the Preferred Stock. The dividend charge
will result in an adjustment to net earnings in the quarter in which the
conversion is approved. This adjustment is expected to be a reduction to net
earnings, assuming Z-Tel's common stock price remains below the preferred stock
effective exchange price on the day the conversion is approved. Earnings per
share attributable to common stock will be adjusted due to the dividend and will
show an even greater loss per common share outstanding.
A reverse stock split will not affect Z Tel's results of operations.
Because the number of outstanding shares of Common Stock will be reduced, the
per share values of operation and value per share will be increased.
What will be the sources and uses of funds in the transaction?
The Common Stock issued in the Exchange Offer is being issued in exchange
for outstanding securities of Z-Tel. No funds will be required for the Exchange
Offer and related transactions other than cash payments for fractional shares as
a consequence of a reverse stock split and transaction costs, which will be paid
from working capital. Z-Tel will not receive any cash proceeds from the issuance
of Common Stock in the exchanges.
-7-
QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING
Where and when is the special meeting being held?
The special meeting will be held at the our offices located at
, on Tuesday, November 16, 2004, at ,
Eastern time.
What is the purpose of the special meeting?
The special meeting is being held to consider and vote upon:
o an Exchange Offer, at the election of the holders thereof (subject in
each case to the impact of any reverse stock split):
o 25.69030 shares of its Common Stock, for each share of its Series D
Preferred Stock (representing an exchange price of approximately
$0.644 per share);
o 25.24216 shares of its Common Stock for each share of its Series E
Preferred Stock (representing an exchange price of approximately
$0.644 per share); and
o 161,469.4 shares of its Common Stock for each share of its Series G
Preferred Stock (representing an exchange price of approximately
$0.898 per share);
o subject to approval and consummation of the Exchange Offer, an
amendment to the terms of the Series D Preferred Stock to eliminate
certain restrictive provisions contained therein;
o subject to approval and consummation of the Exchange Offer, an
amendment to the certificate of incorporation to eliminate the Series
E Preferred Stock;
o subject to approval and consummation of the Exchange Offer, an
amendment to the terms of the Series G Preferred Stock to eliminate
certain restrictive provisions contained therein;
o subject to approval and consummation of the Exchange Offer, and
subject to all of the Series D Preferred Stock being exchanged in the
Exchange Offer, an amendment of the certificate of incorporation to
eliminate the Series D Preferred Stock;
o subject to approval and consummation of the Exchange Offer, and
subject to all of the Series G Preferred Stock being exchanged in the
Exchange Offer, an amendment of the certificate of incorporation to
eliminate the Series G Preferred Stock;
o subject to approval and consummation of the Exchange Offer, an
amendment of Z-Tel's certificate of incorporation to effect a 3 for 1,
4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock split of
the Common Stock, as determined at the direction of the board of
directors, which reverse stock split may be abandoned at the
discretion of the board of directors; and
o subject to approval and consummation of the Exchange Offer, adoption
of the Plan and reservation of shares for issuance thereunder
representing 8% of the Fully Diluted Common Stock.
At the special meeting, Stockholders will also be asked to approve an
amendment to Z-Tel's certificate of incorporation to change its name to
"Trinsic, Inc."
The board of directors knows of no other business that will be presented
for consideration at the special meeting. However, if any matters are properly
presented at the special meeting or any adjournment or postponement of the
special meeting (including any motion to adjourn the special meeting to permit
the Company to solicit addi-
-8-
tional votes in favor of the Exchange Offer and related transactions) the proxy
holders will be granted discretionary authority with respect to any such matter.
Who is entitled to vote at the special meeting?
These proposals will be submitted for approval to the record holders of
Z-Tel's Common Stock, Series D Preferred Stock and Series E Preferred Stock as
of October 25, 2004, the record date established by the board of directors for
determining Stockholders entitled to vote at the special meeting, all voting
together as a single class.
In addition to the votes described in the preceding paragraph, proposals II
and III will be submitted for approval to the record holders of Z-Tel's Series D
Preferred Stock as of October 25, 2004, voting as a separate class, proposal IV
will be submitted for approval to the record holders of Z-Tel's Series E
Preferred Stock as of October 25, 2004, voting as a separate class and proposals
V and VI will be submitted for approval to the record holders of Z-Tel's Series
G Preferred Stock as of October 25, 2004, voting as a separate class.
As of the record date, there were shares of Common Stock issued,
outstanding and entitled to be voted at the special meeting, shares of
Series D Preferred Stock issued, outstanding and entitled to be voted at the
special meeting with a Common Stock voting strength equal to shares of Common
Stock, shares of Series E Preferred Stock issued, outstanding and entitled
to be voted at the special meeting with a Common Stock voting strength equal to
shares of Common Stock, and shares of Series G Preferred Stock
issued, outstanding and entitled to be voted at the special meeting with no
Common Stock voting rights.
How many votes do I have?
For the purposes of each vote of the Common Stock, Series D Preferred Stock
and Series E Preferred Stock as a single class, each share of Common Stock is
entitled to one vote, each share of Series D Preferred Stock is entitled to
votes per share, which is the number of votes equal to the Series D Preferred
Stock liquidation value per share divided by the Series D Preferred Stock
conversion price, each as of the record date for the special meeting, and each
share of Series E Preferred Stock is entitled to votes per share, which is
the number of votes equal to the Series E Preferred Stock liquidation value per
share divided by the Series E Preferred Stock conversion price, each as of the
record date for the special meeting.
For the purpose of the Series D Preferred Stock class vote on proposals II
and III, each share of Series D Preferred Stock is entitled to one vote.
For the purpose of the Series E Preferred Stock class vote on proposal IV,
each share of Series E Preferred Stock is entitled to one vote.
For the purpose of the Series G Preferred Stock class vote on proposals V
and VI, each share of Series G Preferred Stock is entitled to one vote.
How do I vote by proxy?
If you complete and properly sign the accompanying proxy card and return it
to Z-Tel, and if it is received in time and not revoked, it will be voted at the
special meeting in accordance with the instructions indicated in such proxy. If
you are a registered stockholder and attend the meeting, you may deliver your
completed proxy card at that time or vote in person. If your shares of Z-Tel
stock are held in "street name" and you wish to vote at the meeting, you must
obtain a proxy card from the broker, bank or other nominee that holds your
shares. If no instructions are indicated on a proxy card returned to Z-Tel, the
shares represented by that proxy will be voted "FOR" the Exchange Offer and each
of the other proposals and in the discretion of the proxy holder as to any other
matter that may properly come before the special meeting or any adjournment or
postponement thereof. No proxy voted against the Exchange Offer or any of the
other proposals will be voted in favor of any adjournment or postponement of the
meeting.
-9-
Can I vote in person at the special meeting?
If you plan to attend the special meeting and vote in person, you will
receive a ballot when you arrive. If your shares are held in the name of a
broker, bank or other nominee, you must follow instructions received from that
broker, bank or nominee with this proxy statement in order to vote at the
special meeting or to change your vote.
Can I revoke my vote after I return my proxy card?
Yes. If you are a registered holder, you may revoke your proxy at any time
prior to its exercise at the special meeting by:
o filing with corporate secretary of Z-Tel, at or before the taking of
the vote at the special meeting, a written notice of revocation
bearing a later date than the proxy being revoked,
o duly executing a later-dated proxy relating to the same shares and
delivering it to corporate secretary of Z-Tel before the taking of the
vote at the special meeting, or
o attending and voting in person at the special meeting.
All written notices of revocation or other communications with respect to
revocation of proxies should be sent to Z-Tel Corporation, 601 South Harbour
Island Boulevard, Tampa, Florida 33602, Attention: corporate secretary, or hand
delivered to the corporate secretary of Z-Tel at or before the taking of the
vote at the special meeting.
If your shares are held in the name of a broker, bank or other nominee, you
must follow instructions received from such broker, bank or nominee with this
proxy statement in order to revoke your vote or to vote at the special meeting.
What constitutes a quorum?
The presence, in person or by proxy, of holders of (1) a majority of the
combined voting power of the outstanding shares of Common Stock, the Series D
Preferred Stock and the Series E Preferred Stock, (2) a majority of the
outstanding shares of the Series D Preferred Stock as a separate class, (3) a
majority of the outstanding shares of the Series E Preferred Stock as a separate
class and (4) a majority of the outstanding shares of the Series G Preferred
Stock as a separate class will constitute a quorum to conduct business at the
special meeting. Proxies received but marked as abstentions or "broker
non-votes" (which occur when shares held by brokers or nominees for beneficial
owners are voted on some matters but not on others) will be included in the
calculation of the number of shares present and entitled to vote at the special
meeting for purposes of determining whether a quorum exists, but will not
constitute a vote "for" or "against" any matter and thus will be disregarded in
the calculation of "votes cast."
What are the recommendations of the board of directors?
Exchange Offer
After careful consideration and after receiving a written opinion from
Morgan Keegan & Company, Inc. as to the fairness, from a financial point of
view, to Common Stockholders of the exchange offer, a special committee of
Z-Tel's board of directors determined that the exchange offer is in the best
interests of Common Stockholders. On the basis of such determination,
o The board of directors recommends that Common Stockholders vote FOR
the Exchange Offer proposal.
o The board of directors is not making any recommendation to Preferred
Stockholders with respect to the Exchange Offer proposal.
-10-
Amendments to Certificates of Designation, subject to Approval
and Consummation of the Exchange Offer
o The board of directors recommends that Common Stockholders vote FOR
the proposals to amend the Series D and Series G Preferred Stock
certificates of designation.
o The board of directors is not making any recommendation to Preferred
Stockholders as to how they should vote on the proposal to amend the
Series D Preferred Stock and Series G Preferred Stock certificates of
designation.
Charter Amendments to Eliminate Certificates of Designation
of Preferred Stock Series No Longer Outstanding,
Authorization of Reverse Stock Split Alternatives, and
Adoption of 2004 Stock Incentive Plan, subject to Approval
and Consummation of the Exchange Offer
o The board of directors recommends that Stockholders vote FOR the
proposals to eliminate from Z-Tel's certificate of incorporation
certificates of designation relating to series of Preferred Stock no
longer outstanding, to authorize the board of directors to adopt, in
its discretion, one of the reverse stock split alternatives and to
adopt the Plan.
Name Change Amendment
o The board of directors recommends that Stockholders vote FOR the
proposal to change Z-Tel's name to "Trinsic, Inc."
The board of directors reserves the right to abandon any or all of the
several amendments to and elimination of the Preferred Stock certificates of
designation, any or all of the reverse stock split alternatives or the name
change amendment at any time prior to their effectiveness notwithstanding
authorization thereof by Stockholders.
What vote is required to approve the Exchange Offer, the related transactions
and the name change?
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, cast at the special meeting is
required to approve the Exchange Offer and the Plan. The affirmative vote of a
majority of the voting power of the outstanding shares of the Common Stock,
Series D Preferred Stock and Series E Preferred Stock, voting together as a
single class, is required to approve the several amendments to the certificates
of designation, the reverse stock split and the name change proposal. In
addition, an amendment to or termination of the certificate of designation
relating to the Series D Preferred Stock requires the affirmative class vote of
70% of the outstanding shares of the Series D Preferred Stock, the termination
of the certificate of designation relating to the Series E Preferred Stock
requires the affirmative class vote of a majority of the Series E Preferred
Stock outstanding and the amendment to the certificate of designation relating
to the Series G Preferred Stock requires the affirmative class vote of a
majority of the outstanding shares of the Series G Preferred Stock. The failure
to vote, a vote to abstain and any "broker non-votes" will have no direct effect
on the approval of either of the Exchange Offer or the Plan so long as a quorum
is present at the special meeting. However, the failure to vote, a vote to
abstain and any "broker non-votes" will effectively be counted as a vote against
the several amendments to the certificates of designation, the reverse stock
split and the name change proposal. Because the Exchange Offer is conditioned
upon the approval of all of the related transactions being submitted to
Stockholders for approval, including the several amendments to the certificates
of designation and the reverse stock split proposal, the failure to vote, a vote
to abstain and any "broker non-votes" with respect to the several amendments to
the certificates of designation or the reverse stock split proposal will
effectively be counted as a vote against the Exchange Offer and the related
transactions.
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What does it mean if I get more than one proxy card?
You should vote on each proxy card you receive. You will receive separate
proxy cards for all shares you hold in different ways, such as jointly with
another person or in trust, or in different brokerage accounts. If you hold
shares in a stock brokerage account, you will receive a proxy card or
information about other methods of voting from each broker, and you must send
your vote to your broker according to the broker's instructions.
Who will count the votes?
All votes will be tabulated by employees of Corporate Communications, Inc.,
one or more of whom will serve also as inspectors of election.
How will the costs of soliciting proxies be paid and in what manner will proxies
be solicited?
Z-Tel will pay all of the costs associated with soliciting the proxies,
including the cost of preparing, assembling and mailing the notice of special
meeting, proxy statement and proxy. In addition to soliciting proxies by mail,
Z-Tel's officers, directors and other regular employees, without additional
compensation, may solicit proxies personally or by telephone or facsimile. It is
anticipated that banks, brokers, fiduciaries, other custodians and nominees will
forward proxy soliciting materials to their principals. Z-Tel will reimburse
such persons' out-of-pocket expenses.
-12-
SELECTED HISTORICAL AND PRO FORMA FINANCIAL DATA AND OTHER INFORMATION
The following tables present summary historical consolidated financial and
operating information and summary pro forma consolidated financial information
of Z-Tel reflecting completion of the Exchange Offer.
Summary Historical Consolidated Financial Information of Z-Tel
The following table sets forth summary historical consolidated financial
and operating information of Z-Tel. Except for the six months ended June 30,
2004 and 2003, and the property information, the summary historical financial
information is derived from audited consolidated financial statements of Z-Tel
for each period presented. The summary historical data are only a summary, and
should be read in conjunction with the historical annual audited and interim
unaudited financial statements of Z-Tel included in Annex H-2 and H-3 hereto.
Six Months Ended
Years Ended December 31, June 30,
2003 2002 2001 2000 (1) 1999 2004 2003
(In thousands, except share and per share data)
Revenues........................ $289,180 $238,397 $280,350 $177,668 $6,615 $132,264 $131,975
Operating expenses:
Network operations (2)........ 135,097 94,474 159,617 107,077 6,518 65,271 58,852
Sales and marketing........... 18,753 12,327 31,243 45,018 8,898 8,971 11,111
General and administrative (3) 127,018 122,579 156,107 99,606 20,055 66,229 58,850
Asset impairment charge (4)... -- 1,129 59,247 -- -- -- --
Wholesale development costs (5) -- 1,018 -- -- -- -- --
Restructuring charge (6)...... -- 1,861 -- -- -- 807 --
Depreciation and amortization. 23,449 23,936 23,277 17,166 4,372 10,420 12,029
Total operating expenses.... (304,317) 257,324 429,491 268,867 39,843 151,698 140,842
Operating loss............ (15,137) (18,927) (149,141) (91,199) (33,228) (19,434) (8,867)
Non-operating income (loss):
Interest and other income..... 2,086 3,509 6,862 5,475 608 1,352 1,164
Interest and other expense.... (3,076) (4,137) (3,789) (2,313) (3,351) (3,412) (1,410)
Total non-operating income (990) (628) 3,073 3,162 (2,743) (2,060) (246)
(loss)......................
Net loss.................. (16,127) (19,555) (146,068) (88,037) (35,971) (21,494) (9,113)
Less mandatorily redeemable
convertible preferred stock
dividends and accretion...... (17,480) (15,589) (15,059) (3,644) (1,654) (7,991) (8,904)
Less deemed dividend related to
beneficial conversion feature (186) (186) (9,356) (20,027) -- (93) (92)
Net loss attributable to
Common Stockholders....... $(33,793) $(35,330) $(170,483) $(111,708) $(37,625) $(29,578) $(18,109)
Weighted average common shares
outstanding.................. 35,396,922 34,951,720 33,908,374 33,066,538 15,099,359 36,337,804 35,286,953
Basic and diluted net loss per $(0.95) $(1.01) $(5.03) $(3.38) $(2.49) $(0.81) $(0.51)
share........................ Consolidated Balance Sheet Data
Cash and cash equivalents (7)(8) $12,013 $16,037 $18,892 $46,650 $101,657 $8,196 $14,204
Working capital (deficit)....... (31,038) (19,380) (11,983) 59,245 95,315 (45,127) (24,032)
Total assets.................... 89,453 106,711 116,737 246,461 137,677 $80,569 $104,901
Total debt...................... 5,531 10,144 15,766 20,417 14,134 2,283 7,389
Mandatorily convertible
redeemable preferred stock (8) 144,282 127,631 112,570 84,585 -- 152,366 136,132
Total stockholder's equity 159,022) (116,372)
(deficit).................... (131,019) (99,284) (67,172) 89,100 114,378 (
-13-
Six Months Ended
Years Ended December 31, June 30,
2003 2002 2001 2000 (1) 1999 2004 2003
(In thousands, except share and per share data)
Other Financial Data
Net cash provided by (used in)
operating activities......... 11,956 18,399 (21,846) (96,862) (32,681) (9,183) 6,149
Net cash used in investing (4,692) (5,756)
activities................... (10,996) (15,600) (15,615) (40,602) (5,182)
Net cash provided by (used in)
financing activities......... (4,984) (5,654) 9,701) 82,455 131,547 10,058 (2,226)
----------------------
(1) We completed the acquisition of Touch 1 on April 14, 2000. We used the
purchase accounting method for our acquisition of Touch 1. Therefore, our
discussions of the results of operations and liquidity and capital
resources do not include any discussions regarding Touch 1 prior to our
acquisition of Touch 1, which is treated as being closed for accounting
purposes, on April 1, 2000.
(2) During 2002, we received a $9.0 million retroactive rate reduction for the
unbundled network elements we acquired from Verizon as a result of a
settlement approved by the New York Public Service Commission.
(3) Included in the 2001 general and administrative expense was a write-off of
accounts receivable that resulted in $29.9 million of additional bad debt
expense.
(4) We recorded a $1.1 and $59.2 million expense related to impaired assets in
2002 and 2001, respectively. This expense was the result of management's
decision to reduce various customer growth initiatives, most notably
telemarketing activity levels. In 2001, a majority of the operations and
assets of telemarketing centers acquired from Touch 1 was either
voluntarily closed or sold. In addition to the goodwill impairment of $54.9
million, we recorded a $4.3 million charge associated with the impairment
of assets, composed of $3.0 million relating to unrealizable software and
development projects, $0.9 million of a worthless telemarketing property
and equipment, and $0.4 million of securities deemed to be worthless. As a
result of management's decision in the second quarter of 2002 to enhance
future cash flow and operating earnings, we closed the remaining call
centers in North Dakota and recorded a $1.1 million asset impairment. We
also incurred restructuring charges as a result of this decision during
2002 as discussed in note (1).
(5) During 2002, we began to provide our services on a wholesale basis. We
recorded start-up costs for developing this new service offering of
approximately $1.0 million. All wholesale related costs after our initial
wholesale services contract signed on March 20, 2002 are included in the
operating expenses line items, rather than being segregated.
(6) During 2002, we closed two call centers in North Dakota and our New York
sales office. As discussed in note (4) above, these expenses consisted
primarily of termination benefits, lease abandonment and lease
settlement costs.
(7) Included in the December 31, 1999 cash balance was approximately $109.1
million of net proceeds from our December 15, 1999 initial public
offering. This cash was obtained through the sale of 6,900,000 shares
(including the underwriters' over-allotment option) of our Common Stock
at $17.00 per share.
(8) During 2000, we issued Series D Preferred Stock and Series E Preferred
Stock for approximately $56.3 and $50.0 million, respectively. During
2001, we issued Series G Preferred Stock for approximately $17.5
million.
Summary Pro Forma Consolidated Financial Information of Z-Tel
The following unaudited pro forma information presents the effects of the
Exchange Offer assuming all of Z-Tel's outstanding Preferred Stock is exchanged
as if the exchange occurred as of June 30, 2004 for the unaudited balance sheet
data. There would be no pro forma adjustments to our income statement data for
either the year ended December 31, 2003 or the six months ended June 30, 2004 if
the exchange occurred as of the first day of such periods. In the quarter in
which the exchange is approved, a dividend charge will be recorded that will
impact net earnings. It is expected that this dividend will reduce net earnings,
assuming Z-Tel's common stock price remains below the effective exchange price.
Earnings per share attributable to common stock will be adjusted due to the
dividend and will show an even greater loss per common share outstanding. The
pro forma information does not include costs of the Exchange Offer or a dividend
charge that Z-Tel will incur as a result of the Exchange Offer.
-14-
Consolidated Pro Forma Balance Sheet
(In thousands, except share and per share data)
(Unaudited)
June 30, Pro Forma
2004 Adjustments Pro Forma
Assets
Current assets:
Cash and cash equivalents $ 8,196 $ -- $ 8,196
Accounts receivable, net of allowance for doubtful 28,672 28,672
accounts
Prepaid expenses and other current assets 4,804 4,804
Total current assets 41,672 -- 41,672
Property and equipment, net 34,298 34,298
Intangible assets, net 1,372 1,372
Other assets 3,227 3,227
Total assets $ 80,569 $ -- $ 80,569
Liabilities, preferred stock and deficit
Current liabilities:
Accounts payable and accrued liabilities $ 63,745 $ -- $ 63,745
Deferred revenue 8,357 8,357
Current portion of long-term debt and capital lease 14,697 14,697
obligations
Total current liabilities 86,799 86,799
Long-term deferred revenue 221 221
Long-term debt and capital lease obligations 205 -- 205
Total liabilities 87,225 -- 87,225
Mandatorily redeemable convertible preferred stock 152,366 (152,366) --
Stockholders' deficit:
Common stock 373 2,538 2,911
Notes receivable from Stockholders (930) (930)
Additional paid-in capital 183,281 149,828 333,109
Accumulated deficit (341,358) -- (341,358)
Treasury stock (388) -- (388)
Total Stockholders' deficit (159,022) 152,366 (6,656)
Total liabilities, preferred stock and deficit $ 80,569 $ -- $ 80,569
Market for the Common Stock and the Preferred Stock
Our Common Stock currently trades on the Nasdaq SmallCap Market under the
symbol "ZTEL." Our Preferred Stock does not trade on an exchange, nor is it
listed or quoted on an inter-dealer quotation system. The price ranges presented
below for Common Stock represent high and low sale prices for each quarter, as
reported by the Nasdaq SmallCap Market. There is no established trading market
for the Preferred Stock.
HIGH LOW
FISCAL YEAR 2002:
First Quarter ............ $ 2.98 $ 1.25
Second Quarter ........... $ 2.25 $ 0.35
Third Quarter ............ $ 1.55 $ 0.41
Fourth Quarter ........... $ 1.37 $ 0.70
FISCAL YEAR 2003:
First Quarter ............ $ 1.60 $ 0.60
-15-
Second Quarter ........... $ 2.99 $ 1.58
Third Quarter ............ $ 3.25 $ 1.70
Fourth Quarter ........... $ 3.08 $ 1.40
FISCAL YEAR 2004
First Quarter ............ $ 4.79 $ 2.00
Second Quarter ........... $ 3.19 $ 1.25
Third Quarter ............ $ 1.41 $ 0.29
October 1, 2004 through
October 20, 2004.......... $ 0.56 $ 0.37
(1) Prices for our Common Stock for periods prior to September
10, 2002 represent stock prices on the Nasdaq National
Market, the exchange on which our Common Stock was listed
prior to such date.
You are urged to obtain current market quotations for your shares.
As of September 27, 2004, there were 229 record holders of Common Shares,
36 record holders of Series D Preferred Stock, 1 record holder of Series E
Preferred Stock, and 7 record holders of Series G Preferred Stock.
By letter dated July 28, 2004, the Nasdaq Stock Market, Inc. notified us
that for 10 consecutive days, the market value of our Common Stock on the Nasdaq
SmallCap Market was not $35 million or more, as required for continued inclusion
on the Nasdaq SmallCap Market by the Nasdaq rules. The market value of our
Common Stock remained below the minimum market value, and as a result the Nasdaq
staff provided us with written notification that our Common Stock will be
delisted. Currently we are appealing the staff's decision to a Listing
Qualifications Panel primarily on the basis that we believe, following
consummation of the Exchange Offer, that the market value of our Common Stock
will substantially exceed the minimum required amount. The Listing
Qualifications Panel may not grant our request to defer a determination of
delisting until after the Exchange Offer is consummated. In that event our
Common Stock is delisted, we expect that our Common Stock will be eligible for
quotation on the OTC Bulletin Board, however, although Z-Tel would in such
circumstance attempt to have the Common Stock quoted on the OTC Bulletin Board,
there can be no assurance that it will be able to do so. Z-Tel believes that the
failure to maintain the listing of its Common Stock on the Nasdaq SmallCap
Market could have an adverse effect on the liquidity and price of the Common
Stock and that this effect would be exacerbated if the Common Stock is not
quoted on the OTC Bulletin Board. Even if our request is granted, we may not
achieve the necessary market value for our Common Stock following the Exchange
Offer or our Common Stock may not maintain the necessary market value for any
length of time. If we fail to achieve and maintain the market value for our
Common Stock above that required by the Nasdaq rules, our Common Stock will
ultimately be delisted from the Nasdaq SmallCap Market.
We have also been advised by the Nasdaq staff that our Common Stock does
not currently meet the minimum bid price per share of $1.00 necessary to
maintain listing on the Nasdaq SmallCap Market as required by the Nasdaq rules.
Although we believe that the reverse stock split proposal, if adopted at the
special meeting, will allow us to regain compliance, we may not achieve the
necessary bid price per share following the reverse stock split or our Common
Stock may not maintain the necessary minimum bid price for any length of time.
If we fail to achieve and maintain a bid price for our Common Stock above that
required by the Nasdaq rules, our Common Stock will ultimately be delisted from
the Nasdaq SmallCap Market.
SPECIAL FACTORS
Background of the Exchange Offer
Shortly after a March 2004 federal court decision vacating certain Federal
Communications Commission rules related to UNE-P pricing, management of Z-Tel
expedited implementation of a new business plan that revolved around Z-Tel
becoming a voice over Internet Protocol ("VoIP") based telecommunications
provider to reduce or eliminate the uncertainty of UNE-P. As part of this
process, the then chief executive officer of Z-Tel, D. Gregory Smith, began
having informal discussions with various parties about raising financing that
would be neces-
-16-
sary to pursue the VoIP initiative. It became clear fairly quickly to Mr. Smith
that the existence of the Preferred Stock, particularly the mandatory redemption
features thereof, would be a serious impediment to Z-Tel's ability to attract
additional financing.
During April and May of 2004, Mr. Smith began having discussions with
representatives of The 1818 Fund, the largest holder of the Series G Preferred
Stock and the only holder of the Series E Preferred Stock, and representatives
of Richland Ventures III, L.P. ("Richland"), the largest holder of Series D
Preferred Stock, about possibly converting their Preferred Stock into Common
Stock. Representatives of The 1818 Fund indicated a willingness to possibly
convert their Preferred Stock on a negotiated basis but only if substantially
all of the other holders of Preferred Stock also agreed to convert. Mr. Smith
informed the board that the representatives of Richland were not interested in
converting their Preferred Stock into Common Stock. Mr. Smith continued
discussing the proposed conversion with representatives of The 1818 Fund in June
2004 and reached a tentative agreement whereby The 1818 Fund would agree to
consider a conversion of their Preferred Stock (with the continued condition
that substantially all holders of Preferred Stock would similarly convert) at an
effective conversion price of $2.28 for the Series D Preferred Stock, $2.27 for
the Series E Preferred Stock and $0.68 for the Series G Preferred Stock.
In late June 2004, the board determined that it was advisable for a special
committee comprised solely of independent directors be formed in order to
recommend to the board the advisability of any exchange offer. The members of
the special committee were John K. Aurell, Richard F. LaRoche, Jr., and W.
Andrew Krusen, Jr., who was to serve as Chairman. The committee retained the law
firm of Cahill Gordon & Reindel LLP to act as its counsel and Morgan, Keegan &
Co. to act as its financial advisor.
In July 2004, Mr. Smith had additional conversations with representatives
of Richland regarding Richland's willingness to convert the Series D Preferred
Stock owned by them on the same basis he had negotiated with The 1818 Fund. Mr.
Smith informed the board of directors that the representatives of Richland said
they were not interested in the proposed terms of the exchange offer, although
they would consider exchanging their Preferred Stock for a combination of notes
and equity.
During June and July 2004, Mr. Smith and representatives of The 1818 Fund
discussed the possibility of The 1818 Fund providing a "bridge loan" to Z-Tel to
enable Z-Tel to meet current operating expenses. In late July 2004, The 1818
Fund and Z-Tel tentatively agreed on terms whereby The 1818 Fund would lend
Z-Tel $5 million with an additional $10 million potentially to be available for
future loans at the discretion of The 1818 Fund. Representatives of The 1818
Fund indicated that the additional $10 million would only be made available if
substantially all of the Preferred Stock was converted to Common Stock. The 1818
Fund also indicated that, if the Preferred Stock conversion was successful, they
would consider converting their outstanding loan to Z-Tel into Common Stock on a
negotiated basis if Z-Tel so desired.
On August 12, 2004, the special committee determined that the proposed
exchange offer negotiated with representatives of The 1818 Fund was in the best
interests of the Stockholders of Z-Tel and unanimously voted to recommend to
Z-Tel's board of directors that they make such exchange offer to the holders of
the Preferred Stock. Soon after such meeting, Mr. Smith again asked Richland if
they would support the proposed terms of the offer and Mr. Smith reported to the
board of directors that representatives of Richland declined to support such
terms. On August 16, 2004, Mr. Smith notified the board of directors that he was
not confident that The 1818 Fund would provide the $5 million of bridge loan
financing (the loan was subsequently made on August 25, 2004) and that he would
be unable to negotiate a mutually satisfactory Preferred Stock conversion with
the holders, and instructed management to hire a bankruptcy counsel and consider
a potential bankruptcy filing by Z-Tel. On August 24, 2004, Mr. Smith tendered
his resignation as chief executive officer and together with Charles W.
McDonough, our former chief technology officer, commenced discussions with us to
purchase certain assets of our Atlanta technology center, which resulted in an
agreement between us entered into on September 29, 2004. Trey Davis was
appointed as successor chief executive officer on August 29, 2004. During the
late August and early September time period, representatives of The 1818 Fund
began direct discussions with representatives of Richland to see whether a
mutually acceptable Preferred Stock conversion plan could be negotiated.
Following Mr. Smith's resignation, representatives of Richland indicated to
representatives of The 1818 Fund that, while Richland would not agree to the
previously proposed exchange rate, Richland could potentially agree to
participate in a Common Stock for Preferred Stock exchange offer that (1)
provided for a greater rate of
-17-
exchange to Series D Preferred Stock Holders and Series E Preferred Stockholders
and (2) accounted for the junior ranking of the Series G Preferred Stock by
providing for a significantly less favorable exchange rate than the rate of
exchange applicable to the Series D Preferred Stock and the Series E Preferred
Stock. In mid-September, The 1818 Fund reported to Z-Tel that they and Richland
had reached a potential agreement on modified exchange offer terms which are the
same terms as those contained in the Exchange Offer.
At meetings held on September 23 and September 28, 2004, the special
committee together with its advisors considered the revised terms of the
proposed Exchange Offer. At the September 28, 2004 meeting Morgan, Keegan
presented its analysis of the Exchange Offer terms to the special committee and
rendered their opinion that the terms of the proposed offer were fair to the
holders of the Common Stock from a financial point of view.
After discussion, members of the special committee voted to recommend to
the Z-Tel board of directors that they authorize and commence the Exchange Offer
and at a meeting on September 28, 2004 the board of directors authorized the
commencement of the Exchange Offer.
Opinion of Financial Advisor to the Special Committee
At a meeting of the special committee on September 28, 2004, Morgan Keegan
presented orally its financial analysis of the Exchange Offer. Morgan Keegan
confirmed its oral presentation in a written opinion that the Exchange Offer was
fair, from a financial point of view to Common Stockholders. The complete text
of the Morgan Keegan opinion described above, dated September 28, 2004, which
sets forth the assumptions made, procedures followed, matters considered and
limitations on the review undertaken in connection with the opinion, is attached
to this proxy statement as Annex F. The advisory services and opinion of Morgan
Keegan were provided for the information and assistance of the special committee
in connection with their consideration of the Exchange Offer and do not
constitute a recommendation as to how any Stockholder should vote with respect
to the Exchange Offer. The summary of the opinion set forth below is qualified
in its entirety by reference to such opinion.
In connection with its opinion, Morgan Keegan has made such reviews,
analyses and inquiries as it deemed necessary and appropriate under the
circumstances. Among other things, Morgan Keegan:
o reviewed the proposed terms of the Exchange Offer;
o reviewed certain publicly available business and financial information
relating to Z-Tel;
o reviewed a series of internal presentations and correspondence
prepared by Z-Tel's management regarding Z-Tel's business plan and
capital structure among others;
o reviewed certain other information provided to Morgan Keegan by Z-Tel
and discussed the business prospects and financial position of Z-Tel
with its management and independent auditors;
o visited Z-Tel's office facilities located in Atmore, Alabama;
o reviewed audited financial results of Z-Tel for fiscal years ended
December 2001 through 2003 as well as for the latest twelve months
ended June 30, 2004 and the latest unaudited interim results of Z-Tel;
o reviewed financial forecasts provided by Z-Tel's management;
o reviewed the reported historical prices and historical trading
activity of the Common Stock;
o compared and considered the financial performance of Z-Tel with that
of certain other publicly traded companies and their securities; and
o performed such other analyses and considered such other factors as
Morgan Keegan deemed appropriate.
-18-
Morgan Keegan assumed and relied upon, without independent verification,
the accuracy and completeness of the information it reviewed in arriving at its
opinion and did not independently verify any of such information. With respect
to internal financial statements, financial and operational forecasts and other
financial and operating data, Morgan Keegan assumed that such financial
statements, forecasts and data had been reasonably prepared on bases reflecting
the best currently available estimates and judgments of the management of Z-Tel.
Morgan Keegan also assumed that there had been no material changes in Z-Tel's
assets, financial condition, results of operations, business or prospects since
the respective dates of the last financial statements made available to it.
Morgan Keegan did not make any independent valuation, inspection or appraisal of
the assets or liabilities of Z-Tel, nor was it furnished with any such
appraisals or valuations. Morgan Keegan's opinion is necessarily based on
financial, economic, market and other conditions as in effect on, and the
information made available to it as of, the date of its opinion.
The following is a summary of the material financial analyses used by
Morgan Keegan in reaching its opinion and does not purport to be a complete
description of the analyses performed by Morgan Keegan. The following
quantitative information, to the extent it is based on market data, is based on
market data as it existed at or about September 27, 2004, and is not necessarily
indicative of current or future market conditions. You should understand that
the order of analyses and the results derived from these analyses described
below do not represent relative importance or weight given to these analyses by
Morgan Keegan.
Financial Condition of Z-Tel
Morgan Keegan reviewed relevant considerations associated with Z-Tel's
financial condition:
o Z-Tel is in financial distress and is running out of money to fund
operations;
o Cash levels are critical and in the absence of additional funding,
Z-Tel's management projects that cash will be exhausted in the first
quarter of 2005;
o Z-Tel has accumulated a Stockholders' deficit of $159.0 million as of
June 30, 2004;
o Z-Tel projects annual operating losses through December 31, 2004;
o The Common Stock may be de-listed from the Nasdaq SmallCap Market
(currently under appeal);
o Z-Tel's Preferred Stock is entitled to the first $158.4 million (as of
September 27, 2004) in the event of liquidation of Z-Tel; and
o Z-Tel was not in compliance with the financial covenants under its
existing bank facility.
Stock Trading Analysis
Using publicly available market data Morgan Keegan reviewed the reported
historical prices and historical trading activity for the Common Stock over the
time period beginning September 27, 2001 and ending September 27, 2004. In
addition, Morgan Keegan reviewed the amount of active equity analyst coverage
Z-Tel received and examined Z-Tel's historical trading index over a one-year
period beginning September 29, 2003 and ending September 27, 2004 as compared to
the S&P 500 index, the Nasdaq index and an index of competitive local exchange
carrier companies.
Morgan Keegan noted that the Common Stock traded between a range of $0.29
and $4.79 for the 52-week period ended September 27, 2004 with a three-month
average daily volume of approximately 1.0 million shares. The closing price of
the Common Stock on September 27, 2004 was $0.51. Morgan Keegan noted that Z-Tel
had received notice that it was being de-listed from the Nasdaq SmallCap Market
because the Common Stock did not meet the minimum listing standards. Z-Tel was
in the process of appealing the de-listing decision. Morgan Keegan concluded
that the Common Stock received virtually no analyst coverage.
-19-
Exchange Offer Analysis
Morgan Keegan reviewed the dilutive effects that the Exchange Offer would
have on Common Stockholders. Morgan Keegan found that the Exchange Offer would
be highly dilutive to existing Common Stockholders. Pre-Exchange Offer, Z-Tel
had approximately 77.0 million Common Stock equivalent shares outstanding
(including shares issuable upon exercise of in the money warrants or conversion
of Preferred Stock and restricted Common Stock, but excluding out of the money
options and warrants to acquire Common Stock), of which outstanding shares of
Common Stock (including restricted Common Stock) and in the money warrants
represent approximately 41.5 million shares, or 53.8%. Immediately following the
conversion of the Series D Preferred Stock, Series E Preferred Stock and Series
G Preferred Stock into Common Stock, Z-Tel will have approximately 276.5 million
Common Stock equivalent shares issued and outstanding (including shares issuable
upon exercise of in the money warrants and restricted Common Stock, but
excluding out of the money options and warrants to acquire Common Stock). Of the
276.5 million Common Stock equivalent shares outstanding post-Exchange Offer,
15.0% will be held by the existing Common Stockholders (including holders of
restricted Common Stock) and in the money warrant holders. Former Series D
Preferred Stock, Series E Preferred Stock and Series G Preferred Stock will hold
approximately 235.0 million shares representing 85.0% of Common Stock equivalent
shares outstanding.
Morgan Keegan noted that the Exchange Offer price with respect to the
Series D Preferred Stock of $0.644 per share of Common Stock represents a 92.4%
discount to its current conversion price and a 26.3% premium to the per share
Common Stock price as of September 27, 2004; that the Exchange Offer price with
respect to the Series E Preferred Stock of $0.644 per share of Common Stock
represents a 92.0% discount to its current conversion price and a 26.3% premium
to the per share Common Stock price as of September 27, 2004; and that the
Exchange Offer price with respect to the Series G Preferred Stock of $0.898 per
share of Common Stock represents a 29.8% discount to its current conversion
price and a 76.1% premium to the per share Common Stock price as of September
27, 2004.
Upon the completion of the Exchange Offer, significant additional dilution
to existing Common Stockholders may occur if (1) newly issued shares of Common
Stock are sold, (2) The 1818 Fund converts the aggregate amount due under its
note receivable into shares of Common Stock and (3) The 1818 Fund exercises its
warrant to purchase 2.7 million shares of Common Stock at $0.01 per share.
Peer Group Analysis
Morgan Keegan compared financial, market and operating information of Z-Tel
with corresponding data for selected publicly traded companies selected on the
basis of operational and economic similarity with the principal business
operations of Z-Tel, taking into account the risks specific to Z-Tel. Morgan
Keegan reviewed the following companies in the telecommunications industry:
Choice One Communications, ITC^Deltacom, Talk America Holdings, Time Warner
Telecom and US LEC Corporation (the "Peer Group").
Specifically, Morgan Keegan:
o compared Z-Tel's historical financial performance for the latest
twelve months ending June 30, 2004 ("LTM") and projected financial
results for the year ending December 31, 2008 with the performance of
the Peer Group for the latest twelve months of publicly available
data;
o derived valuation multiples by analyzing the Peer Group's financial
information; and
o applied these valuation multiples to Z-Tel's LTM results.
In addition, because forward looking multiples could not be derived based on
available information, Morgan Keegan applied a range of estimated market
multiples to imply theoretical equity values based on Z-Tel's projected results.
Implied equity values were discounted at 14.1%, Z-Tel's assumed weighted average
cost of capital ("WACC"). A range of discounts was applied to current market
multiples to take into consideration risks, if any, associated with Z-Tel's
business plan.
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Morgan Keegan concluded that no company analyzed in the Peer Group was
identical to Z-Tel and that given the uncertain regulatory environment and
impending price increases facing CLECs, the Peer Group as a whole has been under
significant pressure from investors. All companies in the Peer Group were
trading at or near their respective 52-week lows. In addition, all companies in
the Peer Group, except for one, had reported a net loss for the latest twelve
month period.
Morgan Keegan applied the valuation multiples derived from the Peer Group
to Z-Tel's LTM revenues, EBITDA, EBIT, Net Income and Book Value. Due to Z-Tel's
negative EBITDA, EBIT, Net Income and Book Value for the LTM period, Morgan
Keegan was unable to calculate an implied equity value. Based on Z-Tel's LTM
Revenue, however, Morgan Keegan did calculate an implied Common Stock share
price on a post "Exchange Offer" basis of $1.58, on a post Exchange Offer basis.
Morgan Keegan did not believe that this implied share price represents a fair
estimate of value to the Common Stockholders as the current revenue base is
largely dependent on the legacy UNE-P business model.
Morgan Keegan then calculated an implied equity value by applying current
median market multiples of the Peer Group to Z-Tel's projected results for the
year ending December 31, 2008. Due to limited forward estimates and multiples
for the Peer Group, Morgan Keegan applied a range of discounts to the current
median market multiples. This analysis resulted in a range of implied equity
value to existing Common Stockholders from $29.5 million to $39.5 million. This
range excluded the results implied from the EBIT and Net Income multiples, which
Morgan Keegan did not find meaningful. While Morgan Keegan noted that this range
of value was not necessarily an accurate measure of Z-Tel's current equity
value, this analysis provided a representative evaluation of the potential value
to the Common Stockholders should Z-Tel successfully implement it VoIP business
strategy.
Discounted Cash Flow Analysis
Morgan Keegan performed a discounted cash flow analysis on the projected
cash flows of Z-Tel for the fiscal years ending December 31, 2004 through 2008.
Morgan Keegan analyzed future cash flows as projected by Z-Tel's management.
Morgan Keegan used a range of discount rates (14.0% - 17.0%), terminal multiples
(8.0x - 10.0x) based on forecasted EBITDA and terminal multiples (1.1x - 2.1x)
based on forecasted revenue for the fiscal year ending December 31, 2008 to
calculate a range of implied equity values per share of Common Stock. Projected
cash flows were discounted back to September 27, 2004.
The discounted cash flow analysis implied total equity value to existing
Common Stockholders of between $21.4 million and $48.8 million. This represents
the theoretical value to existing Common Stockholders based on the Z-Tel's
successful execution of its VoIP strategy and is dependent upon the Z-Tel's
ability to obtain additional invested capital to fund working capital
requirements and vendor financing. Should the Z-Tel fail to complete the
Exchange Offer, The 1818 Fund may be reluctant to loan additional capital beyond
the $5.0 million required to fund immediate working capital needs and Morgan
Keegan believes that the Z-Tel's ability to continue as a going concern will be
in substantial doubt.
Conclusion
In determining the fairness of the Exchange Offer, from a financial point
of view, Morgan Keegan considered the various characteristics of the Exchange
Offer to the current position of Common Stockholders:
o Z-Tel requires additional funding to provide working capital to fund
its business operations.
o Z-Tel will require capital investment in addition to the $5.0 million
advanced by The 1818 Fund in the near term to fund working capital and
its network conversion. There is no mandatory obligation for The 1818
Fund to provide additional loans.
o The 1818 Fund's willingness to provide additional capital to Z-Tel is
contingent upon certain conditions including the conversion of all
outstanding Series D Preferred Stock.
-21-
o Without the conversion of the Preferred Stock and the elimination of
the existing liquidation value, it will be extremely difficult for
Z-Tel to raise additional equity.
o Funding of the network conversion is highly reliant on vendor
financing which will be difficult to obtain if Z-Tel does not obtain
additional capital and its financial condition worsens.
o Z-Tel may be delisted from the Nasdaq SmallCap Market which will make
it more difficult to raise additional capital.
o Based on discussions with Z-Tel's management and independent auditors,
if Z-Tel is unsuccessful in raising additional funding in the near
term, its ability to continue as a going concern will be in
substantial doubt.
o Z-Tel unsuccessfully attempted to raise additional funding in the
first quarter of 2004 with the assistance of an investment banking
firm.
o Given the negative EBITDA of Z-Tel, the uncertain regulatory
environment surrounding Z-Tel's business operations, the risk
associated with Z-Tel's conversion plan and the complex nature of
Z-Tel's capital structure, it would be extremely difficult for Z-Tel
to raise equity or debt financing from sources other than The 1818
Fund at this time.
o In the event of liquidation or bankruptcy, Z-Tel's Preferred
Stockholders hold a preference of approximately $158.4 million as of
September 27, 2004. The Common Stockholders would receive no value
upon liquidation based on Z-Tel's management estimates. The removal of
the liquidation value in favor of the Preferred Stock enhances the
position of the Common Stockholders to recognize some benefit in the
upside potential of Z-Tel in the event of its sale, and at least the
possibility of some recovery in the event of bankruptcy.
o The Exchange Offer is highly dilutive to existing Common Stockholders;
however, Z-Tel management's ability to successfully achieve its
strategy to convert to a VoIP network platform could create
significant Common Stockholder value in the future.
o Morgan Keegan analyzed Z-Tel management's projections and concluded
that they are reasonable under the assumptions provided.
o The conversion of the Series D Preferred Stock, Series E Preferred
Stock and Series G Preferred Stock is critical to creating this value
for existing Common Stockholders.
The preparation of a fairness opinion is a complex process involving
various determinations as to the most appropriate and relevant methods of
financial analysis and the application of these methods to the particular
circumstances and, therefore, is not necessarily susceptible to partial analysis
or summary description. Selecting portions of the analyses or of the summary set
forth above, without considering the analysis as a whole, could create an
incomplete view of the processes underlying the opinion of Morgan Keegan. In
arriving at its fairness determination, Morgan Keegan considered the results of
all such analyses and did not attribute any particular weight to any factor or
analysis considered by it; rather, Morgan Keegan made its determination as to
fairness on the basis of its experience and professional judgment after
considering the results of all such analyses. No company used in the above
analyses is directly comparable to Z-Tel. In addition, mathematical analysis
such as determining the mean or median is not in itself a meaningful method of
using selected data. The analyses were prepared solely for purposes of Morgan
Keegan providing its opinion to the special committee as to the fairness, from a
financial point of view, of the Exchange Offer to Common Stockholders. Analyses
based on forecasts of future results are not necessarily indicative of actual
future results, which may be significantly more or less favorable than suggested
by such analyses. Because such analyses are inherently subject to uncertainty,
being based upon numerous factors or events beyond the control of the parties or
their respective advisors, none of Z-Tel, Morgan Keegan or any other person
assumes responsibility if future results are materially different from those
forecast. As described below, the opinion of Mor-
-22-
gan Keegan to the special committee was among several factors taken into
consideration by the board of directors in making its recommendation that Common
Stockholders approve the Exchange Offer.
Morgan Keegan, as part of its investment banking business, is continually
engaged in the valuation of businesses and their securities in connection with
mergers and acquisitions, negotiated underwritings, competitive biddings,
secondary distributions of listed and unlisted securities, private placements
and valuations for estate, corporate and other purposes.
Morgan Keegan provides a full range of financial advisory and securities
services and, in the course of its normal trading activities, may from time to
time effect transactions and hold securities, including derivative securities,
of Z-Tel for its own account or for the accounts of customers. Morgan Keegan may
provide investment banking services to Z-Tel and its subsidiaries in the future.
Under the terms of an engagement letter dated July 6, 2004, Z-Tel paid
Morgan Keegan a $50,000 retainer and has agreed to pay Morgan Keegan an
additional $25,000 in connection with the delivery of its fairness opinion.
Z-Tel expects that payments to Morgan Keegan for other financial advisory
services contemplated by the engagement letter will not exceed $100,000. Z-Tel
has also agreed to reimburse Morgan Keegan for its reasonable out-of-pocket
expenses incurred in connection with the engagement, including attorneys' fees,
and to indemnify Morgan Keegan and its respective related parties from and
against certain liabilities, including liabilities under the federal securities
laws.
Z-Tel's Reasons for the Exchange Offer
Z-Tel is proposing the Exchange Offer at this time:
o to improve and simplify our capital structure by eliminating all or
substantially all of the approximately $158.4 million aggregate
liquidation value of Preferred Stock, as of September 27, 2004, in
exchange for Common Stock, thereby enabling us to potentially attract
necessary additional financing for our business plan;
o to eliminate all or substantially all of the dividends payable to
holders of Preferred Stock and the related dilutive effect on Common
Stockholders (and increase the equity and earnings attributable to
Common Stock);
o to reduce or eliminate the mandatory redemption payments on our
Preferred Stock, which will be due in 2006 on the Series G Preferred
Stock and in 2008 on the Series D Preferred Stock and Series E
Preferred Stock;
o to increase the aggregate market value of our Common Stock, which is
currently below the $35 million minimum amount required to maintain
listing on the Nasdaq SmallCap Market, to an amount substantially in
excess of the minimum amount required to maintain listing of the
Common Stock on the Nasdaq SmallCap Market;
o to increase our net book value by eliminating or reducing from our
balance sheet the long-term liability associated with the Preferred
Stock;
o because failure to convert the Preferred Stock to Common Stock would
prevent Z-Tel from being able to execute its business plan and most
likely result in Z-Tel's need to downsize significantly or liquidate;
and
o because the effective conversion prices for the Preferred Stock are
significantly higher than the trading prices of the Common Stock prior
to the commencement of the Exchange Offer.
Notwithstanding the fact that the Exchange Offer and related transactions are
conditioned upon approval by stockholders, we commenced the Exchange Offer
because under applicable law the Exchange Offer is required to be kept open for
a minimum of 20 business days and we believe we should attempt to synchronize
the Exchange Offer period and the notice period for the special meeting so that
they run concurrently, with an overall view towards most expeditiously and
efficiently consummating the Exchange Offer and related transactions.
-23-
Special Committee of the Board of Directors
Because certain members of our of directors either hold or are affiliated
with holders of Preferred Stock, our board of directors formed a special
committee of its independent directors comprised of Messrs. John K. Aurell, W.
Andrew Krusen, Jr. and Richard F. LaRoche, Jr., to consider the advisability of
the Exchange Offer. The special committee retained the services of a financial
advisor, Morgan Keegan & Company, Inc ("Morgan Keegan"), and a legal counsel,
Cahill Gordon & Reindel LLP. Morgan Keegan has delivered a written opinion to
the special committee as to the fairness, from a financial point of view, of the
Exchange Offer to the Common Stockholders. A copy of the Morgan Keegan opinion
is attached hereto as Annex F. None of the Special Committee, Morgan Keegan or
the Board of Directors has evaluated the fairness of the Exchange Offer to the
holders of Preferred Stock. Accordingly, neither the Special Committee nor the
Board of Directors is making any recommendation whatsoever as to whether holders
of Preferred Stock should participate in the Exchange Offer.
On the basis of discussions with The 1818 Fund and the opinion of Morgan
Keegan as to the fairness of the Exchange Offer, from a financial point of view,
to the Common Stockholders, the special committee recommended to our board of
directors that we pursue the Exchange Offer. In structuring the terms of the
Exchange Offer, the special committee considered the rights and preferences of
the Preferred Stock, including the dividend rate; the relative preferences and
other terms relative to the Common Stock; the fact that acceptance of the
Exchange Offer is not mandatory and that each holder of the Preferred Stock may
participate in its sole discretion; recent market prices for our Common Stock;
the assumed pro forma effect of the Exchange Offer on our consolidated
capitalization; the United States federal income tax consequences of the
Exchange Offer on us and on the holders of our Preferred Stock; and the lack of
effective alternatives available to Z-Tel in lieu of the Exchange Offer.
Recommendation of Z-Tel's Board of Directors
For the reasons stated above, our board of directors determined to accept
the recommendation of the special committee and recommend to the Common
Stockholders that they vote in favor of the Exchange Offer. THE BOARD OF
DIRECTORS IS NOT MAKING ANY RECOMMENDATION TO HOLDERS OF PREFERRED STOCK WITH
RESPECT TO HOW THEY SHOULD VOTE ON THE EXCHANGE OFFER PROPOSAL.
Interests of Directors and Officers
Our officers, directors and affiliates who are also holders of Preferred
Stock will receive the Exchange Offer and will be eligible to tender their
Preferred Stock on the same basis as any other holder of Preferred Stock. Two of
our directors are associated with The 1818 Fund: Andrew C. Cowen is a senior
vice president at, and Lawrence C. Tucker is a general partner of, Brown
Brothers Harriman & Co., a private investment banking firm that manages The 1818
Fund. In addition, Mr. Charles D. Hyman, one of our directors, owns
approximately 0.5% of the outstanding Series D Preferred Stock and approximately
0.9% of the outstanding Series G Preferred Stock. The 1818 Fund and Charles D.
Hyman have indicated to us that they currently intend to tender all of their
Preferred Stock in the Exchange Offer if substantially all of the Preferred
Stock owned by other holders are tendered in the Exchange Offer. See "Special
Factors Relating to the Exchange Offer--Special Committee of the Board of
Directors" and "Security Ownership of Certain Beneficial Owners and Management."
We will announce, by means of a press release, the number of shares of each
series of Preferred Stock tendered as of the close of business (1) on the second
business day preceding the date of the Special Meeting and (2) on the second
business day prior to expiration of the Exchange Offer. We will also announce,
by means of a press release, when The 1818 Fund has tendered its shares of
Preferred Stock. If necessary, we will extend the Exchange Offer to the close of
business on the fifth business day following the date upon which The 1818 Fund
tenders its shares of Preferred Stock.
We are not otherwise aware of any intention to tender or consideration of
tendering Preferred Stock on the part of directors, officers or affiliates.
Neither we, nor any subsidiary of ours nor, to the best of our knowledge, any of
our directors or executive officers, nor any affiliates of any of the foregoing,
had any transactions in Preferred Stock during the 60 business days prior to the
date hereof.
-24-
Security Ownership of Certain Beneficial Owners and Officers and Directors
The following table sets forth as of September 27, 2004 (unless otherwise
stated and based on 38,776,343 shares of Common Stock outstanding on that date),
the number of shares of our Common Stock, our Series D Preferred Stock, our
Series E Preferred Stock and our Series G Preferred Stock beneficially owned by:
o each person who we know to be a beneficial owner of 5% or more of that
class or series of stock (based, in part, upon copies of all Schedules
13D and 13G filed with the SEC);
o each of our directors;
o each of our Named Executive Officers; and
o all executive officers and directors as a group.
Each share of Series D Preferred Stock is currently convertible by its
holder into 1.95 shares of Common Stock, each share of Series E Preferred Stock
is currently convertible by its holder into 2.01 shares of Common Stock, and
each shares of Series G Preferred Stock is currently convertible by its holder
into 113,262 shares of Common Stock. Under the rules of the SEC, beneficial
ownership of Preferred Stock constitutes beneficial ownership of the amount of
Common Stock into which the shares of Preferred Stock are convertible.
Beneficial ownership of Common Stock is shown in the table and the portion of
that beneficial ownership traceable to beneficial ownership of Preferred Stock
is set forth in the footnotes to the table. Shares of Preferred Stock, shown
unconverted, are also shown in the table itself.
Shares Beneficially Owned and Percentage of Class
Series D Series E Series G Pro Forma Pro
Common Preferred Preferred Preferred Common Forma
Beneficial Owner (1) Stock % Stock % Stock % Stock % Stock (19) %
D. Gregory Smith(3) 12,834,566 29.25 416,667 10.48 -- -- 28.0 16.35 24,687,830 8.96
Carol Jane Smith(3) 5,500,000 14.32 -- -- -- -- -- -- 5,500,000 2.01
G/CJ Investments, L.P.(3) 5,500,000 14.32 -- -- -- -- -- -- 5,500,000 2.01
Charles D. Hyman(2)(4) 381,376 * 20,833 * -- -- 1.5 * 978,840 *
Buford H. Ortale(5) 2,249,917 5.76 252,667 6.35 -- -- -- -- 8,496,449 3.10
Lawrence C. Tucker(6) 28,717,781 42.79 -- -- 4,166,667 100 125.0 73.01 133,047,840 47.00
Brown Brothers Harriman &
Co.(6) 28,639,482 42.72 -- -- 4,166,667 100 125.0 73.01 132,969,814 46.98
Andrew C. Cowen(2)(7) 76,926 * -- -- -- -- -- -- 76,926 *
John K. Aurell(2)(8) 112,368 * -- -- -- -- -- -- 112,368 *
Richard F.
LaRoche, Jr.(2)(9) 59,984 * -- -- -- -- -- -- 59,984 *
W. Andrew Krusen, Jr.(2) 16,000 * -- -- -- -- -- -- 16,000 *
Douglas W. Jackson(2)(10) 346,094 * -- -- -- -- -- -- 346,094 *
Frank M. Grillo(2)(11) 52,777 * -- -- -- -- -- -- 52,777 *
Horace J. Davis III(2)(12) 365,277 * -- -- -- -- -- -- 365,277 *
John Tomlijanovic(2)(13) 82,498 * -- -- -- -- 82,498 *
Michael Slauson(2)(14) 257,753 * -- -- -- -- 257,753 *
Fulmead Ventures
Limited(15) 1,794,359 4.46 250,000 6.29 -- -- 10.0 5.84 8,491,216 3.10
Richland Ventures III,
L.P.(16) 3,308,860 7.93 1,250,000 27.36 -- -- -- -- 34,382,611 12.47
Gramercy Z-Tel LLC(17) 2,250,483 5.53 782,225 19.67 -- -- -- -- 21,987,040 7.98
All directors and officers
as a group(18) 30,468,834 44.35 20,833 * 4,166,667 100 126.5 73.88 135,396,357 47.60
--------------------------------------------------------------------------------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the aggregate number of
shares beneficially owned by the individual Stockholders and groups of
Stockholders described above and the percentage ownership of such
individuals and groups, shares of common stock subject to convertible
securities currently convertible or convertible within 60 days and shares
of common stock subject to options or warrants that are currently
exercisable or exercisable within 60 days of the date of this chart are
deemed outstanding. Such shares, however, are not deemed outstanding for
the purposes of computing the percentage ownership of the other
Stockholders or groups of Stockholders.
(2) The stockholder's address is c/o Z-Tel Technologies, Inc., 601 South
Harbour Island Boulevard, Suite 220, Tampa, Florida 33602.
-25-
(3) D. Gregory Smith and Carol Jane Smith are husband and wife. The number of
shares shown for D. Gregory Smith and for Carol Jane Smith each includes
all of the shares held by G/ CJ Investments, L.P., a Delaware limited
partnership. G/CJ Investments, Inc., a Delaware corporation established and
controlled by Mr. and Mrs. Smith, is the sole general partner of G/CJ
Investments, L.P. The share amount also includes 2,051,387 shares for Mr.
Smith that are deemed to be beneficially owned by him by virtue of certain
stock options that are currently exercisable or become exercisable within
60 days and certain stock purchase warrants. The address of D. Gregory
Smith, Carol Jane Smith and G/CJ Investments, L.P. is 300 Delaware Avenue,
Suite 900, Wilmington, Delaware 19801.
(4) Common Stock includes 153,313 shares deemed beneficially owned by Mr. Hyman
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days and certain stock purchase warrants.
(5) Common Stock includes 402,955 shares deemed beneficially owned by Mr.
Ortale by virtue of certain stock purchase warrants. Ownership deemed owned
by Mr. Ortale includes shares owned by Sewanee Ventures and the Ortale
Family Foundation over which he has investment power. Mr. Ortale's address
is 4410 Gerald Place, Nashville, Tennessee 37205.
(6) According to a Schedule 13D dated November 20, 2000, as amended July 12,
2001, August 3, 2001 and August 26, 2004, filed jointly by Brown Brothers
Harriman & Co., The 1818 Fund III, L.P., T. Michael Long and Lawrence C.
Tucker, each of the joint filers has shared voting and dispositive power
with respect to all of the shares shown, except that Mr. Tucker's shares
include 78,026 shares deemed beneficially owned by him by virtue of certain
stock options currently exercisable or which become exercisable within 60
days. Of the shares of common stock shown for Mr. Tucker and Brown Brothers
Harriman & Co., 9,610,116 shares are deemed to be beneficially owned by
virtue of certain stock purchase warrants (excluding the 78,026 additional
shares beneficially owned by Mr. Tucker). The address of Brown Brothers
Harriman & Co., The 1818 Fund III, L.P., T. Michael Long and Lawrence C.
Tucker is 140 Broadway, New York, New York 10005.
(7) Common Stock includes 76,926 shares deemed beneficially owed by Mr. Cowen
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(8) Common Stock includes 76,095 shares deemed beneficially owned by Mr. Aurell
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(9) Common Stock includes 28,049 shares deemed beneficially owned by Mr.
LaRoche by virtue of certain stock options that are currently exercisable
or which become exercisable within 60 days.
(10) Common Stock includes 320,444 shares deemed beneficially owned by Mr.
Jackson by virtue of certain stock options that are currently exercisable
or which become exercisable within 60 days.
(11) Common Stock includes 52,777 shares deemed beneficially owned by Mr. Grillo
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(12) Common Stock includes 340,277 shares deemed beneficially owned by Mr. Davis
by virtue of certain stock options that are currently exercisable or which
become exercisable within 60 days.
(13) Common Stock includes 57,498 shares deemed beneficially owned by Mr.
Tomljanovic by virtue of certain stock options that are currently
exercisable or which become exercisable within 60 days.
(14) Common Stock includes 216,944 shares deemed beneficially owned by Mr.
Slauson by virtue of certain stock options that are currently exercisable
or which become exercisable within 60 days.
(15) This information is derived in part from a Schedule 13D dated February 8,
2000, as amended February 15, 2002, July 9, 2003, February 18, 2004 and
September 13, 2004, filed jointly by Professional Holdings Limited, The
Mayer Trust, Mutual Trust Management (Jersey) Limited, MTM Trustees
Limited, MTM Nominees Limited, MTM Investments Limited, Michael Cordwell
and Fulmead Ventures Limited. Each of these parties reports to have shared
voting and dispositive power with respect to all of the shares shown.
Eduard J. Mayer, beneficiary of The Mayer Trust disclaims beneficial
ownership of the shares shown. The common shares shown include 453,947
shares deemed beneficially owned by virtue of certain stock purchase
warrants. The address of the foregoing persons is 36 Hilgrove Street, St.
Helier, Jersey JE4 8TR Channel Islands.
(16) Of the shares of common stock shown, 2,269,736 are deemed to be
beneficially owned by virtue of warrants exercisable into shares of our
common stock. The address of Richland Ventures III, L.P. is 200 31st Avenue
North, Suite 200, Nashville, TN 37203.
(17) Of the shares of common stock shown, 1,891,446 shares are deemed to be
beneficially owned by virtue of warrants exercisable convertible into
shares of our common stock. The address of Gramercy is c/o Onex
Corporation, 161 Bay Street, P.O. Box 700, Toronto, Ontario CANADA M5J 2S1.
(18) Common Stock includes 11,010,738 shares deemed beneficially owned by virtue
of certain stock options that are currently exercisable or which become
exercisable within 60 days and certain stock purchase warrants.
-26-
(19) The pro forma share ownership data presents the effect of the Exchange
Offer assuming all of our outstanding Preferred Stock is exchanged for the
Exchange Consideration, after giving effect to which we would have no
shares of Preferred Stock outstanding.
Agreements Involving Our Securities
On November 10, 2000, we entered into a registration rights agreement with
The 1818 Fund. Under the registration rights agreement, we agreed that, upon the
request of The 1818 Fund, we would file on one occasion a shelf registration
statement under the Securities Act registering the resale of (i) all Common
Stock issued to The 1818 Fund upon the conversion of the Series E Preferred
Stock and Series G Preferred Stock, (ii) all Common Stock issued to The 1818
Fund pursuant to previously issued warrants, and (iii) any other Common Stock
otherwise owned by The 1818 Fund. The registration rights agreements also give
The 1818 Fund piggyback registration rights with respect to other registrations
of Z-Tel's Common Stock. Because The 1818 Fund has not yet exercised its rights
under the registration rights agreement, The 1818 Fund will, following the
consummation of the Exchange Offer, continue to have the right to request that a
shelf registration statement be filed by us.
Effect of the Exchange Offer and Related Transactions
If the Exchange Offer and related transactions are approved by Z-Tel's
Stockholders at the special meeting, Z-Tel intends to complete such transactions
within 10 business days following the special meeting. If the Exchange Offer was
completed, following the Exchange Offer and related transactions:
o Z-Tel's Common Stock will remain outstanding. However, each share of
Common Stock will be converted into 1/3, 1/4, 1/5, 1/6, 1/7 or 1/8 of
a share of Common Stock, as a result of the reverse stock split, and
will vote with any remaining holders of Series D Preferred Stock (to
the extent any shares of Series D Preferred Stock remain outstanding
following the Exchange Offer) to elect directors to Z-Tel's board of
directors;
o shares of Series D Preferred Stock and Series G Preferred Stock
tendered in the Exchange Offer will be retired, shares of Series D
Preferred Stock and Series G Preferred Stock not tendered in the
Exchange Offer will remain outstanding, and the remaining holders of
Series D Preferred Stock and Series G Preferred Stock will no longer
have the benefit of certain restrictive provisions contained in the
certificates of designation relating to the Series D Preferred Stock
and Series G Preferred Stock, respectively;
o if all of the Series E Preferred Stock is tendered in the Exchange
Offer, Z-Tel's Series E Preferred Stock will be retired, the Series E
Preferred Stockholders will receive, in exchange for the Series E
Preferred Stock outstanding immediately prior to the Exchange Offer,
shares of Common Stock, and Z-Tel's certificate of incorporation will
be amended to eliminate the Series E Preferred Stock certificate of
designation; and
o assuming all outstanding shares of Preferred Stock are exchanged for
Common Stock, immediately following the Exchange Offer and related
transactions:
o Z-Tel's pre-existing Common Stockholders and in-the-money warrant
holders will own or have the right to acquire an aggregate of
13.8% of the Fully Diluted Common Stock;
o Z-Tel's former Series D Preferred Stockholders will own an
aggregate of 34.0% of the Fully Diluted Common Stock;
o Z-Tel's former Series E Preferred Stockholders will own an
aggregate of 35.0% of the Fully Diluted Common Stock;
o Z-Tel's former Series G Preferred Stockholders will own an
aggregate of 9.2% of the Fully Diluted Common Stock; and
-27-
o 8% of the Fully Diluted Common Stock will be reserved for
issuance under the Plan.
-28-
PROPOSAL I:
EXCHANGE OFFER
General
On September 30, 2004, Z-Tel commenced an offer to the holders of the
Preferred Stock, at the election of the holders thereof (subject to the impact
of any reverse stock split).
Reasons for the Exchange Offer
Z-Tel's reasons for the Exchange Offer and the factors considered by the
special committee, Morgan Keegan and the board of directors in evaluating the
Exchange Offer are set forth above under "Special Factors - Opinion Financial
Advisor to the Special Committee," "- Z-Tel's Reasons for the Exchange Offer,"
"Special Committee of the Board of Directors" and "Recommendation of Z-Tel's
Board of Directors."
Conditions of the Exchange Offer
Z-Tel will not consummate the Exchange Offer or any of the related
transactions unless (1) the Exchange Offer and related transactions are approved
by the Stockholders entitled to vote thereon and (2) all of the Preferred Stock
owned by The 1818 Fund is tendered for exchange in the Exchange Offer.
Z-Tel may terminate, amend or postpone consummation of the Exchange Offer
if at any time prior to its expiration:
o any action or proceeding is instituted or threatened in any court or
by or before any governmental agency with respect to the Exchange
Offer, or any material adverse development has occurred in any
existing action or proceeding with respect to us or any of our
subsidiaries, which, in Z-Tel's reasonable judgment, might materially
impair our ability to proceed with the Exchange Offer;
o any law, statute, rule or regulation is proposed, adopted or enacted,
which, in Z-Tel's reasonable judgment, might materially impair its
ability to proceed with the Exchange Offer; or
o any governmental approval has not been obtained, which approval Z-Tel,
in its reasonable judgment, shall deem necessary for the consummation
of the Exchange Offer as contemplated hereby.
Risks of the Exchange Offer
Z-Tel considered several negative factors that could or will arise from the
Exchange Offer and related transactions, including:
o the anticipated aggregate costs of the Exchange Offer and related
transactions, which are estimated to be approximately $1.0 million,
that will be incurred,
o the risk that the anticipated benefits of the Exchange Offer and
related transactions might not be fully realized, including the risk
that the Common Stock may be delisted from the Nasdaq SmallCap Market,
and
o the Common Stockholders will have their percentage ownership in the
outstanding Common Stock substantially diluted due to the additional
shares of Common Stock to be issued in the Exchange Offer.
-29-
Effects on the Capital Stock of Z-Tel
The principal effects of the exchange of Common Stock for shares of
Preferred Stock are described above under "Special Factors--Effect of the
Exchange Offer and the Related Transactions."
Material Differences Between the Preferred Stock and the Common Stock
The information set forth below is a summary of the material differences
between the Series D Preferred Stock, the Series E Preferred Stock, the Series G
Preferred Stock and the Common Stock. This description is qualified in its
entirety by reference to Z-Tel's amended certificate of incorporation, which
contains the terms of Z-Tel's Common Stock and Preferred Stock.
Series D Preferred Series E Preferred Series G Preferred
Stock Stock Stock Common Stock
Dividends Dividends equal to 8% Cumulative dividends Cumulative dividends Although Common
per annum of the equal to 8% per annum equal to 12% per Stockholders are
liquidation value (as of the liquidation annum of the entitled to
defined below), are value (as defined liquidation value (as receive any
payable at the option below). At our defined below). At dividends
of the board of option, no dividends our option, no declared thereon
directors in cash, are payable in cash dividends are payable by the board of
additional shares of until the earlier of in cash until the directors out of
Series D Preferred redemption or earlier of redemption legally
Stock or in any liquidation. If we do or liquidation. If available funds,
combination thereof. not pay dividends, we do not pay we have never
Dividends they automatically dividends, they paid a cash
automatically accrue accrue and are added automatically accrue dividend on our
and are added to the to the liquidation and are added to the Common Stock and
liquidation value of value of the Series E liquidation value of are prohibited
the Series D Preferred Stock. In the Series G from doing so by
Preferred Stock in the event of Preferred Stock. In the terms of the
the absence of a conversion of shares the event of agreements
payment election by of Series E Preferred conversion of Series governing our
the board of Stock, accrued and G Preferred Stock indebtedness.
directors. unpaid dividends shall into Common Stock,
be applied to increase accrued and unpaid
the number of shares dividends are applied
of Common Stock into to increase the
which shares of Series number of shares of
E Preferred Stock are Common Stock into
convertible. which the Series G
Preferred Stock is
convertible.
Liquidation $12.00 per share, $12.00 per share, plus Subject to the rights All shares of
plus accrued and accrued and unpaid and privileges of the Common Stock
unpaid dividends, dividends, prior to holders of the Series have equal
prior to any payment any payment in respect D Preferred Stock and rights to
in respect of junior of Junior Stock. The the Series E participate in
stock. The Series D Series E Preferred Preferred Stock, the distribution
Preferred Stock has Stock has parity with $100,000.00 per of assets in the
parity with the the Series D Preferred share, plus accrued event of a
Series E Preferred Stock ("Parity and unpaid dividends, liquidation of
Stock ("Parity Stock"). In the event prior to any payment Z-Tel, subject
Stock"). In the that the proceeds in respect of junior to the
event that the available on stock. preferences
proceeds available on liquidation are established on
-30-
Series D Preferred Series E Preferred Series G Preferred
Stock Stock Stock Common Stock
liquidation are insufficient to the Preferred
insufficient to satisfy the Stock.
satisfy the liquidation value of
liquidation value of the Series E Preferred
the Series D Stock and the Parity
Preferred Stock and Stock, the proceeds
the Parity Stock, the shall be distributed
proceeds shall be among the holders of
distributed among the the Series E Preferred
holders of the Series Stock and the Parity
D Preferred Stock and Stock ratably in
the Parity Stock proportion to the
ratably in proportion total amounts to which
to the total amounts all holders of Series
to which all holders E Preferred Stock and
of Series D Preferred the Parity Stock are
Stock and the Parity entitled upon
Stock are entitled liquidation.
upon liquidation.
Optional The Series D The Series E Preferred Subject to the rights N/A
Redemption Preferred Stock is Stock is not and privileges of the
redeemable at our redeemable at our holders of the Series
option at any time at option prior to July D Preferred Stock and
a price per share 2, 2006. From and the Series E
equal to the after July 2, 2006, Preferred Stock, the
liquidation value, the Series E Preferred Series G Preferred
plus a premium Stock is redeemable at Stock is redeemable
ranging from 5% in our option at any time at our option at any
the year following at a price per share time after September
the third anniversary equal to the 18, 2002 at a price
of the original issue liquidation value, per share equal to
date thereof to 0% plus a premium equal the liquidation
from and after the to 2% in the year value, plus accrued
eighth anniversary of beginning July 2, and unpaid dividends,
such original issue 2006, 1% on the year whether or not
date, plus accrued beginning July 2, declared, to the
and unpaid dividends, 2007, and 0% from and redemption date.
whether or not after October 19,
declared, to the 2008, plus accrued and
redemption date. The unpaid dividends,
premium for a whether or not
redemption at our declared, to the
option in effect from redemption date.
the date of the Offer
to Exchange to June
30, 2005 is 4%.
Mandatory The Series D The Series E Preferred Subject to the rights N/A
Redemption Preferred Stock is Stock is mandatorily and privileges of the
mandatorily redeemable by us on holders of the Series
redeemable by us in October 19, 2008, at a D Preferred Stock and
2008, at a price per price per share equal the Series E
share equal to the to the liquidation Preferred Stock, the
liquidation value value plus all accrued Series G Preferred
plus all accrued but but unpaid dividends, Stock is mandatorily
unpaid dividends, whether or not redeemable by us on
-31-
Series D Preferred Series E Preferred Series G Preferred
Stock Stock Stock Common Stock
whether or not declared, to the September 18, 2006,
declared, to the redemption date. at a price per share
redemption date. equal to the liquida-
tion value plus all
accrued but unpaid
dividends, whether
or not declared,
to the redemption
date.
Voting Rights Each holder of Series Each holder of Series The holders of the Each holder of
D Preferred Stock is E Preferred Stock is Series G Preferred Common Stock is
entitled to a number entitled to a number Stock are not entitled to one
of votes equal to the of votes equal to the entitled to any vote for each
number of shares of number of shares of voting rights, except share held on
Common Stock into Common Stock into as required by law. all matters
which that holder's which that holder's submitted to a
shares of Series D shares of Series E vote of the
Preferred Stock are Preferred Stock are Stockholders.
then convertible. then convertible. The
The Series D Series E Preferred
Preferred Stock votes Stock votes as a
as a single class single class with the
with the Common Stock Common Stock on all
on all matters matters submitted to
submitted to Stockholders. The
Stockholders. The approval of at least
approval of seventy fifty percent (50%) of
percent (70%) of the the outstanding voting
outstanding voting power of the Series E
power of the Series D Preferred Stock is
Preferred Stock is necessary to authorize
necessary to or issue any stock
authorize or issue that is senior to or
any stock that is on parity with the
senior to or on Series E Preferred
parity with the Stock, or effect
Series D Preferred certain mergers or
Stock. acquisitions involving
material subsidiaries, sales
of assets in excess of $50
million, incurrence of
indebtedness for borrowed
money in excess of $100
million.
Material Federal Income Tax Considerations Related to the Exchange Offer
The tax consequences of the Exchange Offer to holders of Preferred Stock
are explained in the offering circular sent to Preferred Stockholders. There are
no material tax consequences of the Exchange Offer to Common Stockholders.
-32-
No Appraisal Rights
No appraisal rights are available to Z-Tel's Stockholders under the
Delaware General Corporation Law, or "DGCL", with respect to the Exchange Offer,
and Z-Tel will not independently provide Stockholders with any such rights.
Vote Required
The Exchange Offer is a transaction which may require Stockholder approval
pursuant to the rules of the Nasdaq SmallCap Market. As discussed elsewhere in
this proxy statement, the Common Stock may be delisted from the Nasdaq SmallCap
Market. Notwithstanding any such delisting, the board of directors has
determined that the Exchange Offer is a transaction of sufficient significance
and consequence that it should be submitted for approval to the Stockholders of
Z-Tel. Z-Tel will not consummate the Exchange Offer unless it and the related
transactions are approved by Stockholders.
The affirmative vote of a majority of the voting power of the outstanding
shares of Common Stock, Series D Preferred Stock and Series E Preferred Stock,
voting together as a single class, cast at the special meeting is required to
approve the Exchange Offer. The failure to vote, a vote to abstain and any
"broker non-votes" will have no direct effect on the approval of the Exchange
Offer so long as a quorum is present at the special meeting.
The failure to vote, a vote to abstain and any "broker non-votes" with
respect to the several amendments to the certificates of designation and the
reverse stock split proposal discussed in proposals II through VII below will
effectively be counted as a vote against such proposals. Because the Exchange
Offer is conditioned upon the approval of all of the related transactions being
submitted to Stockholders for approval, including the several amendments to the
certificates of designation and the reverse stock split proposal, the failure to
vote, a vote to abstain and any "broker non-votes" with respect to the several
amendments to the certificates of designation and the reverse stock split
proposal will effectively be counted as a vote against the Exchange Offer.
Board Recommendation
ON THE BASIS OF THE DETERMINATION OF THE SPECIAL COMMITTEE, THE BOARD OF
DIRECTORS HAS DETERMINED THAT THE EXCHANGE OFFER IS ADVISABLE TO COMMON
STOCKHOLDERS AND THAT IT SHOULD BE SUBMITTED TO STOCKHOLDERS FOR APPROVAL. ON
THE BASIS OF THE DETERMINATION OF THE SPECIAL COMMITTEE, THE BOARD OF DIRECTORS
RECOMMENDS THAT COMMON STOCKHOLDERS VOTE "FOR" THE EXCHANGE OFFER. THE BOARD OF
DIRECTORS IS NOT MAKING ANY RECOMMENDATION TO PREFERRED STOCKHOLDERS WITH
RESPECT TO THE EXCHANGE OFFER.
-33-
PROPOSAL II:
AMENDMENT TO Z-TEL'S SERIES D PREFERRED STOCK CERTIFICATE OF
DESIGNATION TO ELIMINATE CERTAIN RESTRICTIVE PROVISIONS
CONTAINED THEREIN
General
In connection with the Exchange Offer, Z-Tel has determined to amend its
Series D Preferred Stock certificate of designation to eliminate certain
restrictive provisions contained therein. If all of the Series D Preferred Stock
is exchanged in the Exchange offer, Z-Tel's certificate of incorporation also
would be amended to eliminate the Series D Preferred Stock certificate of
designation as set forth in Proposal III.
Z-Tel's proposed Amended and Restated Certificate of Designation for its
Series D Preferred Stock attached to this proxy statement as Annex A-1
implements the specific amendments. The following description, which summarizes
the amendments to Z-Tel's Certificate Of Designation for its Series D Preferred
Stock, is qualified in its entirety by reference to Annex A-1.
Proposed Series D Amendments
Series D Preferred Stock Certificate of Designation. Subject to Stockholder
approval and consummation of the Exchange Offer the certificate of designations
will be amended by (section references are to the relevant sections of the
certificate of designations prior to the amendments):
(1) eliminating the restrictions on payments of dividends on and
redemptions of parity and junior stock (Sections 2(a), 2(c) and 2(d));
(2) eliminating the liquidation rights associated with events deemed a
liquidation (Section 3(b));
(3) amending the provisions relating to adjustments to the conversion
price to limit the circumstances pursuant to which the conversion price is
adjusted and certain other amendments related thereto (Sections 4(c) and
4(g)(ii)); and
(4) eliminating the special voting rights related to certain
transactions (Section 8).
We refer to the amendments described above and more fully set forth in Annex A-1
as the "Proposed Series D Amendments."
The Proposed Series D Amendments, if approved, will be filed with the
Secretary of State of the State of Delaware and will become operative with
respect to the Series D Preferred Stock shortly before consummation of the
Exchange Offer.
Risk Related to the Proposed Series D Amendments
If the Proposed Series D Amendments are approved, the amendments will be
filed with the Secretary of State of the State of Delaware and will become
operative with respect to the Series D Preferred Stock shortly before
consummation of the Exchange Offer. Such Proposed Series D Amendments will be
binding on all non-tendering holders of Series D Preferred Stock. Accordingly,
the adoption of the Proposed Series D Amendments may have adverse consequences
for holders of Series D Preferred Stock who elect not to tender in the Exchange
Offer. One immediate consequence of the Proposed Series D Amendments would be
that no antidilution adjustment will be made to the Series D Preferred Stock as
a consequence of the Exchange Offer.
-34-
Reasons for the Proposed Amendments
Z-Tel is proposing the amendments to the Preferred Stock certificates of
designation at this time because it believes the amendments will reduce the
impact of restrictive certificate of incorporation provisions imposed by any
small amount of Series D Preferred Stock not participating in the Exchange
Offer.
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of Common Stock, Series D Preferred Stock and Series E Preferred Stock,
voting together as a single class, is required to approve the several amendments
to the Series D Preferred Stock certificate of designation. In addition, the
amendment to the Series D Preferred Stock certificate of designation requires
the affirmative class vote of 70% of the outstanding shares of Series D
Preferred Stock. The failure to vote, a vote to abstain and any "broker
non-votes" will effectively be counted as a vote against the Proposed Series D
Amendments.
Because the Exchange Offer is conditioned upon the approval of all of the
related transactions being submitted to Stockholders for approval, including the
Proposed Series D Amendments, the failure to vote, a vote to abstain and any
"broker non-votes" will effectively be counted as a vote against the Exchange
Offer and the related transactions.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE PROPOSED SERIES D AMENDMENTS
ARE ADVISABLE TO COMMON STOCKHOLDERS AND THAT THEY SHOULD BE SUBMITTED TO
STOCKHOLDERS FOR APPROVAL. THE BOARD OF DIRECTORS RECOMMENDS THAT COMMON
STOCKHOLDERS VOTE "FOR" THE PROPOSED SERIES D AMENDMENTS. THE BOARD OF DIRECTORS
IS NOT MAKING ANY RECOMMENDATION TO PREFERRED STOCKHOLDERS AS TO HOW THEY SHOULD
VOTE ON THE PROPOSED SERIES D AMENDMENTS.
-35-
PROPOSAL III:
AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO ELIMINATE
THE SERIES D PREFERRED STOCK
General
If the Exchange Offer is approved by Stockholders and consummated and as a
result all of the outstanding Series D Preferred Stock is exchanged, Z-Tel has
determined to amend its certificate of incorporation to eliminate the Series D
Preferred Stock certificate of designation. The proposed certificate of
incorporation amendment attached to this proxy statement as Annex A-2 implements
such an amendment by deleting from Z-Tel's existing certificate of incorporation
all references and the terms applicable to the Series D Preferred Stock. The
preceding description, which summarizes the amendment to Z-Tel's certificate of
incorporation to eliminate the Series D Preferred Stock, is qualified in its
entirety by reference to Annex A-2.
Reason for Elimination of Series D Preferred Stock
Following the consummation of the Exchange Offer, if all of the Series D
Preferred Stock is exchanged, none of the Series D Preferred Stock will be
outstanding. In such case Z-Tel's board of directors has determined that the
Series D Preferred Stock certificate of designation would no longer serve any
useful purpose and that it would be advisable to simplify Z-Tel's certificate of
incorporation by eliminating the Series D Preferred Stock certificate of
designation.
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, is required to approve the elimination
of the Series D Preferred Stock certificate of designation from Z-Tel's
certificate of incorporation. In addition, the elimination of the outstanding
shares of the Series D Preferred Stock certificate of designation requires the
affirmative class vote of 70% of the outstanding shares of Series D Preferred
Stock. The failure to vote, a vote to abstain and any "broker non-votes" will
effectively be counted as a vote against the elimination of the Series D
Preferred Stock certificate of designation from Z-Tel's certificate of
incorporation.
Because the Exchange Offer is conditioned upon the approval of all of the
related transactions being submitted to Stockholders for approval, including the
elimination of the Series D Preferred Stock certificate of designation from
Z-Tel's certificate of incorporation if no Series D Preferred Stock is
outstanding after the Exchange Offer is consummated, the failure to vote, a vote
to abstain and any "broker non-votes" will effectively be counted as a vote
against the Exchange Offer and the related transactions.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE AMENDMENT TO Z-TEL'S
CERTIFICATE OF INCORPORATION TO ELIMINATE THE SERIES D PREFERRED STOCK IF NO
SERIES D PREFERRED STOCK IS OUTSTANDING AFTER THE EXCHANGE OFFER IS APPROVED BY
STOCKHOLDERS AND CONSUMMATED IS ADVISABLE TO STOCKHOLDERS AND THAT IT SHOULD BE
SUBMITTED TO STOCKHOLDERS FOR APPROVAL. THE BOARD OF DIRECTORS RECOMMENDS THAT
STOCKHOLDERS VOTE "FOR" THE AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO
ELIMINATE THE SERIES D PREFERRED STOCK IF NO SERIES D PREFERRED STOCK IS
OUTSTANDING AFTER THE EXCHANGE OFFER IS APPROVED BY STOCKHOLDERS AND
CONSUMMATED.
-36-
PROPOSAL IV:
AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO ELIMINATE
THE SERIES E PREFERRED STOCK
General
The Exchange Offer is conditioned upon The 1818 Fund tendering all of its
Preferred Stock for exchange, which includes all of the outstanding Series E
Preferred Stock. As a result, if the Exchange Offer is approved by Stockholders
and consummated, Z-Tel has determined to amend its certificate of incorporation
to eliminate the Series E Preferred Stock certificate of designation. The
proposed certificate of incorporation amendment attached to this proxy statement
as Annex B implements such an amendment by deleting from Z-Tel's existing
certificate of incorporation all references and the terms applicable to the
Series E Preferred Stock. The preceding description, which summarizes the
amendment to Z-Tel's certificate of incorporation to eliminate the Series E
Preferred Stock, is qualified in its entirety by reference to Annex B.
Reason for Elimination of Series E Preferred Stock
Following the consummation of the Exchange Offer, none of the Series E
Preferred Stock will be outstanding. As such Z-Tel's board of directors has
determined that the Series E Preferred Stock certificate of designation would no
longer serve any useful purpose and that it would be advisable to simplify
Z-Tel's certificate of incorporation by eliminating the Series E Preferred Stock
certificate of designation.
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, is required to approve the elimination
of the Series E Preferred Stock certificate of designation from Z-Tel's
certificate of incorporation. In addition, the elimination of the outstanding
shares of the Series E Preferred Stock certificate of designation requires the
affirmative class vote of a majority of the outstanding shares of Series E
Preferred Stock. The failure to vote, a vote to abstain and any "broker
non-votes" will effectively be counted as a vote against the elimination of the
Series E Preferred Stock certificate of designation from Z-Tel's certificate of
incorporation.
Because the Exchange Offer is conditioned upon the approval of all of the
related transactions being submitted to Stockholders for approval, including the
elimination of the Series E Preferred Stock certificate of designation from
Z-Tel's certificate of incorporation if no Series E Preferred Stock is
outstanding after the Exchange Offer is consummated, the failure to vote, a vote
to abstain and any "broker non-votes" will effectively be counted as a vote
against the Exchange Offer and the related transactions.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE AMENDMENT TO Z-TEL'S
CERTIFICATE OF INCORPORATION TO ELIMINATE THE SERIES E PREFERRED STOCK IF THE
EXCHANGE OFFER IS APPROVED BY STOCKHOLDERS AND CONSUMMATED IS ADVISABLE TO
STOCKHOLDERS AND THAT IT SHOULD BE SUBMITTED TO STOCKHOLDERS FOR APPROVAL. THE
BOARD OF DIRECTORS RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" THE AMENDMENT TO
Z-TEL'S CERTIFICATE OF INCORPORATION TO ELIMINATE THE SERIES E PREFERRED STOCK
IF THE EXCHANGE OFFER IS APPROVED BY STOCKHOLDERS AND CONSUMMATED.
-37-
PROPOSAL V:
AMENDMENT TO Z-TEL'S SERIES G PREFERRED STOCK CERTIFICATE OF DESIGNATION
TO ELIMINATE CERTAIN RESTRICTIVE PROVISIONS CONTAINED THEREIN.
General
In connection with the Exchange Offer, Z-Tel has determined to amend its
Series G Preferred Stock certificate of designation to eliminate certain
restrictive provisions contained therein. If all of the Series G Preferred Stock
is exchanged in the Exchange Offer, Z-Tel's certificate of incorporation also
would be amended to eliminate the Series G Preferred Stock certificate of
designation as set forth in proposal VI.
Z-Tel's proposed Amended and Restated Certificate of Designation for its
Series G Preferred Stock attached to this proxy statement as Annex C-1
implements the specific amendments. The following description, which summarizes
the amendments to Z-Tel's Certificate of Designation for its Series G Preferred
Stock, is qualified in its entirety by reference to Annex C-1.
Proposed Amendments
Series G Preferred Stock Certificate of Designation. Subject to Stockholder
approval and consummation of the Exchange Offer, the certificate of designations
will be amended by (section references are to the relevant sections of the
certificate of designations prior to the amendments):
(1) eliminating the restrictions on payments of dividends on and
redemptions of parity and junior stock (Sections 1(a) and 2(a));
(2) eliminating certain restrictions applicable if dividends on Series
G Preferred Stock are not paid (Section 4);
(3) eliminating provisions related to changes of control (Sections
5(a), 5(c), 5(d)(i), 5(d)(ii) and 11);
(4) eliminating certain provisions related to liquidation rights
(Section 7(a)); and
(4) amending the provisions relating to adjustments to the conversion
price to limit the circumstances pursuant to which the conversion price is
adjusted and certain other amendments related thereto (Sections 4(e) and
8(c)).
We refer to the amendments described above and more fully set forth in Annex C-1
as the "Proposed Series G Amendments."
The Proposed Series G Amendments, if approved, will be filed with the
Secretary of State of the State of Delaware and will become operative with
respect to the Series G Preferred Stock shortly before consummation of the
Exchange Offer.
Risk Related to the Proposed Series G Amendments
If the Proposed Series G Amendments are approved, the amendments will be
filed with the Secretary of State of the State of Delaware and will become
operative with respect to the Series G Preferred Stock shortly before
consummation of the Exchange Offer. Such Proposed Series G Amendments will be
binding on all non-tendering holders of Series G Preferred Stock. Accordingly,
the adoption of the Proposed Series G Amendments may have adverse consequences
for holders of Series G Preferred Stock who elect not to tender in the Exchange
Offer. One immediate consequence of the Proposed Series G Amendments would be
that no antidilution adjustment will be made to the Series G Preferred Stock as
a consequence of the Exchange Offer.
-38-
Reasons for the Proposed Amendments
Z-Tel is proposing the amendments to the Preferred Stock certificates of
designation at this time because it believes the amendments will reduce the
impact of restrictive certificate of incorporation provisions imposed by any
small amount of Series G Preferred Stock not participating in the Exchange
Offer.
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, is required to approve the several
amendments to the Series G Preferred Stock certificate of designation. In
addition, the amendment to the Series G Preferred Stock certificate of
designation requires the affirmative class vote of a majority of the outstanding
shares of the Series G Preferred Stock. The failure to vote, a vote to abstain
and any "broker non-votes" will effectively be counted as a vote against the
Proposed Series G Amendments.
Because the Exchange Offer is conditioned upon the approval of all of the
related transactions being submitted to Stockholders for approval, including the
Proposed Series G Amendments, the failure to vote, a vote to abstain and any
"broker non-votes" will effectively be counted as a vote against the Exchange
Offer and the related transactions.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE PROPOSED SERIES G AMENDMENTS
ARE ADVISABLE TO COMMON STOCKHOLDERS AND THAT THEY SHOULD BE SUBMITTED TO
STOCKHOLDERS FOR APPROVAL. THE BOARD OF DIRECTORS RECOMMENDS THAT COMMON
STOCKHOLDERS VOTE "FOR" THE PROPOSED SERIES G AMENDMENTS. THE BOARD OF DIRECTORS
IS NOT MAKING ANY RECOMMENDATION TO PREFERRED STOCKHOLDERS AS TO HOW THEY SHOULD
VOTE ON THE PROPOSED SERIES G AMENDMENTS.
-39-
PROPOSAL VI:
AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO ELIMINATE
THE SERIES G PREFERRED STOCK
General
If the Exchange Offer is approved by Stockholders and consummated and as a
result all of the outstanding Series G Preferred Stock is exchanged, Z-Tel has
determined to amend its certificate of incorporation to eliminate the Series G
Preferred Stock certificate of designation. The proposed certificate of
incorporation amendment attached to this proxy statement as Annex C-2 implements
such an amendment by deleting from Z-Tel's existing certificate of incorporation
all references and the terms applicable to the Series G Preferred Stock. The
preceding description, which summarizes the amendment to Z-Tel's certificate of
incorporation to eliminate the Series G Preferred Stock, is qualified in its
entirety by reference to Annex C-2.
Elimination of Series G Preferred Stock
Following the consummation of the Exchange Offer, if all of the Series G
Preferred Stock is exchanged, none of the Series G Preferred Stock will be
outstanding. In such case Z-Tel's board of directors has determined that the
Series G Preferred Stock certificate of designation would no longer serve any
useful purpose and that it would be advisable to simplify Z-Tel's certificate of
incorporation by eliminating the Series G Preferred Stock certificate of
designation.
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, is required to approve the elimination
of the Series G Preferred Stock certificate of designation from Z-Tel's
certificate of incorporation. In addition, the elimination of the Series G
Preferred Stock certificate of designation requires the affirmative class vote
of a majority of the outstanding shares of the Series G Preferred Stock. The
failure to vote, a vote to abstain and any "broker non-votes" will effectively
be counted as a vote against the Proposed Series G Amendments.
Because the Exchange Offer is conditioned upon the approval of all of the
related transactions being submitted to Stockholders for approval, including the
Proposed Series G Amendments, the failure to vote, a vote to abstain and any
"broker non-votes" will effectively be counted as a vote against the Exchange
Offer and the related transactions.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE AMENDMENT TO Z-TEL'S
CERTIFICATE OF INCORPORATION TO ELIMINATE THE SERIES G PREFERRED STOCK IF NO
SERIES D PREFERRED STOCK IS OUTSTANDING AFTER THE EXCHANGE OFFER IS APPROVED BY
STOCKHOLDERS AND CONSUMMATED IS ADVISABLE TO STOCKHOLDERS AND THAT IT SHOULD BE
SUBMITTED TO STOCKHOLDERS FOR APPROVAL. THE BOARD OF DIRECTORS RECOMMENDS THAT
STOCKHOLDERS VOTE "FOR" THE AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO
ELIMINATE THE SERIES G PREFERRED STOCK IF NO SERIES G PREFERRED STOCK IS
OUTSTANDING AFTER THE EXCHANGE OFFER IS APPROVED BY STOCKHOLDERS AND
CONSUMMATED.
-40-
PROPOSAL VII:
AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO EFFECT
THE REVERSE STOCK SPLIT
General
Our board of directors has unanimously adopted a resolution approving,
declaring advisable and recommending to the Stockholders for their approval, a
proposal, subject to the approval by Stockholders and consummation of the
Exchange Offer, authorizing the board of directors to amend Z-Tel's certificate
of incorporation to effect a 3 for 1, 4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8
for 1 reverse stock split of the outstanding shares of Common Stock, with the
actual implemented ratio to be determined by the board of directors in its
discretion. If approved by our Stockholders, the reverse stock split would
become effective shortly before consummation of the Exchange Offer or on any
other date selected by our board of directors prior to our next annual meeting
of Stockholders. Our board of directors may effect only one reverse stock split.
In determining the reverse stock split ratio, our board of directors will
consider numerous factors including the historical and projected performance of
our Common Stock, the requirements for continued listing on the Nasdaq SmallCap
Market, prevailing market conditions and general economic trends, and will place
emphasis on the expected closing price of our Common Stock in the period
following the effectiveness of the reverse stock split. The purpose of selecting
a range is to give our board of directors the flexibility to provide for a post
reverse stock split market price that may allow us to maximize Z-Tel's ability
to support future growth. Even if the Stockholders approve the reverse stock
split, the board of directors reserves the right not to effect the reverse stock
split if the board of directors does not deem it to be in the best interests of
Z-Tel and its Stockholders to effect the reverse stock split.
The preceding description, which summarizes the amendment to Z-Tel's
certificate of incorporation to effect the reverse stock split is qualified in
its entirety by reference to the form of certificate of amendment attached as
Annex D.
Reasons for the Reverse Stock Split
Z-Tel is proposing the reverse stock split at this time because it believes
the reverse stock split will facilitate the Exchange Offer by ensuring that
enough Common Stock is available to consummate the Exchange Offer, and the
reverse stock split will increase the bid price per share of Common Stock, which
is currently below the $1.00 minimum amount required to maintain listing on the
Nasdaq SmallCap Market, to an amount substantially in excess of the minimum
amount required to maintain listing of the Common Stock on the Nasdaq SmallCap
Market.
Conditions to the reverse stock split
Z-Tel will not consummate the reverse stock split unless the Exchange Offer
is approved by Stockholders and consummated and the board of directors
determines to proceed in implementing it.
Risks associated with the reverse stock split
We cannot predict whether the reverse stock split will increase the market
price for our Common Stock. There can be no assurance that
o the market price per share of our Common Stock after the reverse stock
split will rise in proportion to the reduction in the number of shares
of our Common Stock outstanding before the reverse stock split; or
o the market price per share of our Common Stock after the reverse stock
split will either exceed or remain in excess of the $1.00 minimum bid
price required to maintain listing on the Nasdaq SmallCap Market.
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The market price of our Common Stock will also be based on our performance
and other factors, some of which are unrelated to the number of shares
outstanding. If the reverse stock split is effected and the market price of our
Common Stock declines, the percentage decline as an absolute number and as a
percentage of our overall market capitalization may be greater than would occur
in the absence of a reverse stock split.
Determination of Ratio
The ratio of the reverse stock split will be 3 for 1, 4 for 1, 5 for 1, 6
for 1, 7 for 1 or 8 for 1 as determined by our board of directors, in its sole
discretion. In determining the reverse stock split ratio, our board of directors
will consider numerous factors including the historical and projected
performance of our Common Stock, the requirements for continued listing on the
Nasdaq SmallCap Market, prevailing market conditions and general economic
trends, and will place emphasis on the expected closing price of our Common
Stock in the period following the effectiveness of the reverse stock split. Our
board of directors will also consider the impact of the reverse stock split
ratio on investor interest and our ability to attract and retain employees. The
purpose of asking for authorization to implement one of several alternative
reverse stock splits is to give our board of directors the flexibility to meet
business needs as they arise, to take advantage of favorable opportunities and
to respond to a changing corporate environment.
Effect of the Reverse Stock Split
The principal effect of the reverse stock split will be to decrease the
number of outstanding shares of Common Stock. A description of the other effects
of the reverse stock split is provided above under "Special Factors--Effect of
the Exchange Offer and the related transactions."
Procedure for Effecting Reverse Stock Split and Exchange of Stock Certificates
If the certificate of amendment is approved by our Stockholders, and if our
board of directors still believes that a reverse stock split is in the best
interests of Z-Tel and its Stockholders, our board of directors will determine
the ratio of the reverse stock split to be implemented.
The form of certificate of amendment is attached as Annex D to this proxy
statement and would be tailored to the specific reverse stock split ratio to be
effected. Our board of directors may delay effecting the reverse stock split
without resoliciting Stockholder approval. The reverse stock split will become
effective on the split effective date. Beginning on the split effective date,
each certificate representing old shares will be deemed for all corporate
purposes to evidence ownership of new shares.
As soon as practicable after the split effective date, Stockholders will be
notified that the reverse stock split has been effected. We expect that our
transfer agent, American Stock Transfer & Trust Company, will act as exchange
agent for purposes of implementing the exchange of stock certificates. Holders
of old shares will be asked to surrender to the exchange agent certificates
representing old shares in exchange for certificates representing new shares in
accordance with the procedures to be set forth in a letter of transmittal to be
sent by us. No new certificates will be issued to a Stockholder until such
Stockholder has surrendered such Stockholder's outstanding certificate(s)
together with the properly completed and executed letter of transmittal to the
exchange agent. Any old shares submitted for transfer, whether pursuant to a
sale or other disposition, or otherwise, will automatically be exchanged for new
shares. STOCKHOLDERS SHOULD NOT DESTROY ANY STOCK CERTIFICATE(S) AND SHOULD NOT
SUBMIT ANY CERTIFICATE(S) UNTIL REQUESTED TO DO SO.
The reverse stock split amendment to our certificate of incorporation, if
implemented, may be filed with the Secretary of State of the State of Delaware
and become operative shortly before consummation of the Exchange Offer.
Fractional Shares
No fractional shares will be issued in connection with the reverse stock
split. Stockholders of record who otherwise would be entitled to receive
fractional shares because they hold a number of old shares not evenly divisi-
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ble by the number of new shares for which each old share is to be exchanged,
will be entitled, upon surrender to the exchange agent of certificates
representing such shares, to a cash payment in lieu thereof at a price equal to
the fraction to which the Stockholder would otherwise be entitled multiplied by
the closing price of the Common Stock, as reported in the Wall Street Journal,
on the trading day after the date of the split effective date. The ownership of
a fractional interest will not give the holder thereof any voting, dividend, or
other rights except to receive payment therefor as described herein.
Stockholders should be aware that, under the escheat laws of the various
jurisdictions where Stockholders reside, where Z-Tel is domiciled, and where the
funds will be deposited, sums due for fractional interests that are not timely
claimed after the split effective date may be required to be paid to the
designated agent for each such jurisdiction, unless correspondence has been
received by Z-Tel or the exchange agent concerning ownership of such funds
within the time permitted in such jurisdiction. Thereafter, Stockholders
otherwise entitled to receive such funds will have to seek to obtain them
directly from the state to which they were paid.
Accounting Matters
The reverse stock split will not affect total Stockholders' equity on our
balance sheet. However, because the par value of our Common Stock will remain
unchanged on the split effective date, the components that make up total
Stockholders' equity will change by offsetting amounts. Depending on the size of
the reverse stock split our board of directors decides to implement, the stated
capital component will be reduced to an amount between one-third (1/3) and
one-eighth (1/8) of its present amount, and the additional paid-in capital
component will be increased with the amount by which the stated capital is
reduced. The per share net income or loss and net book value of our Common Stock
will be increased because there will be fewer shares of our Common Stock
outstanding. Prior periods' per share amounts will be restated to reflect the
reverse stock split.
No Appraisal Rights
Under the Delaware General Corporation Law, our Stockholders are not
entitled to appraisal rights with respect to the reverse stock split, and we
will not independently provide Stockholders with any such right.
Material Federal Income Tax Consequences
The following is a summary of certain material federal income tax
consequences of the reverse stock split and does not purport to be a complete
discussion of all of the possible federal income tax consequences of the reverse
stock split and is included for general information only. Further, it does not
address any state, local or foreign income or other tax consequences. For
example, the state and local tax consequences of the reverse stock split may
vary significantly as to each Stockholder, depending upon the state in which
such Stockholder resides. Also, it does not address the tax consequences to
holders that are subject to special tax rules, such as banks, insurance
companies, regulated investment companies, personal holding companies, foreign
entities, nonresident alien individuals, broker-dealers and tax-exempt entities.
The discussion is based on the provisions of the United States federal income
tax law as of the date hereof, which is subject to change retroactively as well
as prospectively. The tax treatment of a Stockholder may vary depending upon the
particular facts and circumstances of such Stockholder.
Based upon discussions with our tax counsel, we believe that, other than
the cash payments for fractional shares discussed below, no gain or loss should
be recognized by a Stockholder upon such Stockholder's exchange of old shares
for new shares pursuant to the reverse stock split. We did not, however, seek or
obtain any tax opinion with respect to the tax consequences of the Offer.
Assuming the Offer qualifies as a reorganization for federal income tax
purposes, the aggregate tax basis of the new shares received in the reverse
stock split will be the same as the Stockholder's aggregate tax basis in the old
shares exchanged therefor. In general, Stockholders who receive cash upon
redemption of their fractional share interests in the new shares as a result of
the reverse stock split will recognize gain or loss based on their adjusted
basis in the fractional share interests redeemed. The federal income tax
liability, if any, generated by the receipt of cash in lieu of a fractional
interest should be minimal in view of the low value of the fractional interest.
The Stockholder's holding period for the new shares will include the period
during which the Stockholder held the old shares surrendered in the reverse
stock split.
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Our view regarding the tax consequence of the reverse stock split is not
binding on the Internal Revenue Service or the courts. Accordingly, each
Stockholder should consult with such Stockholder's own tax advisor with respect
to all of the potential tax consequences to such Stockholder of the reverse
stock split.
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, is required to approve the
authorization of the board of directors to implement one of the reverse stock
split alternatives, in its discretion, by amending our certificate of
incorporation. The failure to vote, a vote to abstain and any "broker non-votes"
will effectively be counted as a vote against the authorization of the board of
directors to implement one of the reverse stock split alternatives.
Because the Exchange Offer is conditioned upon the approval of all of the
related transactions being submitted to Stockholders for approval, including the
authorization of the board of directors to implement one of the reverse stock
split alternatives, the failure to vote, a vote to abstain and any "broker
non-votes" will effectively be counted as a vote against the Exchange Offer and
the related transactions.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE AUTHORIZATION OF THE BOARD
OF DIRECTORS TO AMEND Z-TEL'S CERTIFICATE OF INCORPORATION TO IMPLEMENT ONE OF
THE REVERSE STOCK SPLIT ALTERNATIVES IF THE EXCHANGE OFFER IS APPROVED BY
STOCKHOLDERS AND CONSUMMATED IS ADVISABLE TO STOCKHOLDERS AND THAT IT SHOULD BE
SUBMITTED TO STOCKHOLDERS FOR APPROVAL. THE BOARD OF DIRECTORS RECOMMENDS THAT
STOCKHOLDERS VOTE "FOR" THE AUTHORIZATION OF THE BOARD OF DIRECTORS TO AMEND
Z-TEL'S CERTIFICATE OF INCORPORATION TO IMPLEMENT ONE OF THE REVERSE STOCK SPLIT
ALTERNATIVES IF THE EXCHANGE OFFER IS APPROVED BY STOCKHOLDERS AND CONSUMMATED.
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PROPOSAL VIII:
2004 STOCK INCENTIVE PLAN
The board of directors has adopted the Plan, subject to approval by
Stockholders of and consummation of the Exchange Offer and Stockholder approval
of the Plan and the reservation of Common Stock for issuance thereunder. Z-Tel
now asks the Stockholders to approve the adoption of the Plan and reservation of
8% of the Fully Diluted Common Stock following the consummation of the Exchange
Offer for issuance thereunder, subject to the approval by Stockholders and
consummation of the Exchange Offer. The following summary of the Plan is
qualified in its entirety by reference to the Plan, which is attached as Annex G
to this proxy statement.
General
The Plan is intended to provide incentives to attract, retain and motivate
employees, consultants and directors and to provide for competitive compensation
opportunities, to encourage long term service, to recognize individual
contributions and reward achievement of performance goals, and to promote the
creation of long term value for Stockholders by aligning the interests of such
persons with those of Stockholders. The Plan will provide for the grant to
eligible employees, consultants and directors of stock options, share
appreciation rights ("SARs"), restricted shares, restricted share units,
performance shares, performance units, dividend equivalents, and other
share-based awards (the "Awards"). An aggregate of 8% of the Fully Diluted
Common Stock following consummation of the Exchange Offer will be reserved for
issuance under the Plan. Those Shares can be issued as restricted shares,
restricted share units, performance shares, performance units and other "full
value" share-based awards. In addition, during a calendar year (i) the maximum
number of shares with respect to which options and SARs may be granted to a
participant under the Plan will be 15% of the number of shares originally
reserved for issuance under the Plan, and (ii) the maximum number of shares
which may be granted to a participant under the Plan with respect to other
Awards intended to qualify as performance-based compensation under the Internal
Revenue Code of 1986, as amended (the "Code") will be 15% of the number of
shares originally reserved for issuance under the Plan. These share amounts are
subject to anti-dilution adjustments in the event of certain changes in Z-Tel's
capital structure, as described below. Shares issued pursuant to the Plan will
be either authorized but unissued shares or treasury shares.
Eligibility and Administration. Officers and other employees of, and
consultants to, Z-Tel and its subsidiaries and affiliates and directors of Z-Tel
will be eligible to be granted Awards under the Plan. The Plan will be
administered by the compensation committee or such other committee of the board
of directors (or the entire board of directors) as may be designated by the
board of directors (the "Plan Committee"). Unless otherwise determined by the
board of directors, the Plan Committee will consist of two or more members of
the board of directors who are nonemployee directors within the meaning of Rule
16b-3 of the Securities Exchange Act of 1934 (the "Exchange Act") and "outside
directors" within the meaning of Section 162(m) of the Code. The Plan Committee
will determine which eligible employees, consultants and directors receive
Awards, the types of Awards to be received and the terms and conditions thereof.
The Plan Committee will have authority to waive conditions relating to an Award
or accelerate vesting of Awards.
Z-Tel's chief executive officer will have the power and authority to make
awards under the Plan to employees and consultants not subject to Section 16 of
the Exchange Act, subject to limitations imposed by the Plan Committee.
Awards. Incentive stock options ("ISOs") intended to qualify for special
tax treatment in accordance with the Code and nonqualified stock options not
intended to qualify for special tax treatment under the Code may be granted for
such number of shares of Common Stock as the Plan Committee determines. The Plan
Committee will be authorized to set the terms relating to an option, including
exercise price and the time and method of exercise.
An SAR will entitle the holder thereof to receive with respect to each
share subject thereto, an amount equal to the excess of the fair market value of
one share of Common Stock on the date of exercise (or, if the Plan Committee so
determines, at any time during a specified period before or after the date of
exercise) over the exercise price of the SAR set by the Plan Committee as of the
date of grant. Payment with respect to SARs may be made in cash or shares of
Common Stock as determined by the Plan Committee.
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Awards of restricted shares will be subject to such restrictions on
transferability and other restrictions, if any, as the Plan Committee may
impose. Such restrictions will lapse under circumstances as the Plan Committee
may determine, including based upon a specified period of continued employment
or upon the achievement of performance criteria referred to below. Except as
otherwise determined by the Plan Committee, eligible employees granted
restricted shares will have all of the rights of a Stockholder, including the
right to vote restricted shares and receive dividends thereon, and unvested
restricted shares will be forfeited upon termination of employment during the
applicable restriction period.
A restricted share unit will entitle the holder thereof to receive shares
of Common Stock or cash at the end of a specified deferral period. Restricted
share units will also be subject to such restrictions as the Plan Committee may
impose. Such restrictions will lapse under circumstances as the Plan Committee
may determine, including based upon a specified period of continued employment
or upon the achievement of performance criteria referred to below. Except as
otherwise determined by the Plan Committee, restricted share units subject to
restriction will be forfeited upon termination of employment during any
applicable restriction period.
Performance shares and performance units will provide for future issuance
of shares or payment of cash, respectively, to the recipient upon the attainment
of corporate performance goals established by the Plan Committee over specified
performance periods. Except as otherwise determined by the Plan Committee,
performance shares and performance units will be forfeited upon termination of
employment during any applicable performance period. Performance objectives may
vary from person to person and will be based upon such performance criteria as
the Plan Committee may deem appropriate. The Plan Committee may revise
performance objectives if significant events occur during the performance period
which the Plan Committee expects to have a substantial effect on such
objectives.
The Plan Committee may also grant dividend equivalent rights and it is
authorized, subject to limitations under applicable law, to grant such other
Awards that may be denominated in, valued in, or otherwise based on, shares of
Common Stock, as deemed by the Plan Committee to be consistent with the purposes
of the Plan.
If the Plan Committee determines that an Award of restricted shares,
restricted share units, performance shares, performance units or other
share-based awards should qualify under the performance-based compensation
exception to the $1 million cap on deductibility under Section 162(m) of the
Code, the grant, vesting, exercise and/or settlement of such awards shall be
contingent upon achievement of preestablished performance goals based on one or
more of the following business criteria for Z-Tel and/or for specified
subsidiaries or affiliates or other business units or lines of business of
Z-Tel: (1) earnings per share (basic or fully diluted); (2) revenues; (3)
earnings, before or after taxes, from operations (generally or specified
operations), or before or after interest expense, depreciation, amortization,
incentives, or extraordinary or special items; (4) cash flow, free cash flow,
cash flow return on investment (discounted or otherwise), net cash provided by
operations, or cash flow in excess of cost of capital; (5) return on net assets,
return on assets, return on investment, return on capital, return on equity; (6)
economic value added; (7) operating margin or operating expense; (8) net income;
(9) share price or total Stockholder return; and (10) strategic business
criteria, consisting of one or more objectives based on meeting specified market
penetration, geographic business expansion goals, cost targets, customer
satisfaction, supervision of litigation and information technology, and goals
relating to acquisitions or divestitures of subsidiaries, affiliates or joint
ventures. The targeted level or levels of performance with respect to such
business criteria may be established at such levels and in such terms as the
Plan Committee may determine, in its discretion, including in absolute terms, as
a goal relative to performance in prior periods, or as a goal compared to the
performance of one or more comparable companies or an index covering multiple
companies.
The maximum amount payable upon settlement of a cash-settled Performance
Unit (or other cash-settled Award) granted for any calendar year to any eligible
person that is intended to satisfy the requirements for "performance-based
compensation" under Section 162(m) of the Code may not exceed $1,000,000.
Nontransferability. Unless otherwise set forth by the Plan Committee in an
award agreement, Awards (except for vested shares) will generally not be
transferable by the participant other than by will or the laws of descent and
distribution and will be exercisable during the lifetime of the participant only
by such participant or his or her guardian or legal representative.
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Change of Control. In the event of a change of control (as defined in the
Plan), all Awards granted under the Plan then outstanding but not then
exercisable (or subject to restrictions) shall become immediately exercisable,
all restrictions shall lapse, and any performance criteria shall be deemed
satisfied, unless otherwise provided in the applicable Award agreement.
Capital Structure Changes. If the Plan Committee determines that any
dividend in shares, recapitalization, share split, reorganization, merger,
consolidation, spin-off, repurchase, share exchange, or other similar corporate
transaction or event affects the Common Stock such that an adjustment is
appropriate in order to prevent dilution or enlargement of the rights of
eligible participants under the Plan, then the Plan Committee shall make such
equitable changes or adjustments as it deems appropriate, including adjustments
to (i) the number and kind of shares which may thereafter be issued under the
Plan, (ii) the number and kind of shares, other securities or other
consideration issued or issuable in respect of outstanding Awards, and (iii) the
exercise price, grant price or purchase price relating to any Award.
Amendment and Termination. The Plan may be amended, suspended or terminated
by the board of directors at any time, in whole or in part. However, any
amendment for which Stockholder approval is required under the rules of any
stock exchange or automated quotation system on which the Common Stock may then
be listed or quoted will not be effective until such Stockholder approval has
been obtained. In addition, no amendment, suspension, or termination of the Plan
may materially and adversely affect the rights of a participant under any Award
theretofore granted to him or her without the consent of the affected
participant. The Plan Committee may waive any conditions or rights, amend any
terms, or amend, suspend or terminate, any Award granted, provided that, without
participant consent, such amendment, suspension or termination may not
materially and adversely affect the rights of such participant under any Award
previously granted to him or her. If we waive any condition or matter with
respect to any holder of Preferred Stock, we will similarly waive such condition
or matter for all holders of Preferred Stock.
Effective Date and Term. The Plan is effective as of consummation of the
Exchange Offer, subject to stockholder approval. Unless earlier terminated, the
Plan will expire on the tenth anniversary of the effective date and no further
awards may be granted thereunder after such date.
Market Value. The per share closing price of the Common Stock on the Nasdaq
SmallCap Market on October 20, 2004 was $0.39 per share.
Federal Income Tax Consequences.
The following is a summary of the federal income tax consequences of the
Plan, based upon current provisions of the Code, the Treasury regulations
promulgated thereunder and administrative and judicial interpretations thereof,
and does not address the consequences under any state, local or foreign tax
laws.
Stock Options
In general, the grant of an option will not be a taxable event to the
recipient and it will not result in a deduction to Z-Tel. The tax consequences
associated with the exercise of an option and the subsequent disposition of
shares of Common Stock acquired on the exercise of such option depend on whether
the option is a nonqualified stock option or an ISO.
Upon the exercise of a nonqualified stock option, the participant will
recognize ordinary taxable income equal to the excess of the fair market value
of the shares of Common Stock received upon exercise over the exercise price.
Z-Tel will generally be able to claim a deduction in an equivalent amount. Any
gain or loss upon a subsequent sale or exchange of the shares of Common Stock
will be capital gain or loss, long-term or short-term, depending on the holding
period for the shares of Common Stock.
Generally, a participant will not recognize ordinary taxable income at the
time of exercise of an ISO and no deduction will be available to Z-Tel, provided
the option is exercised while the participant is an employee or within three
months following termination of employment (longer, in the case of disability or
death). If an ISO granted under the Plan is exercised after these periods, the
exercise will be treated for federal income tax purposes as the exercise of a
nonqualified stock option. Also, an ISO granted
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under the Plan will be treated as a nonqualified stock option to the extent it
(together with other ISOs granted to the participant by Z-Tel) first becomes
exercisable in any calendar year for shares of Common Stock having a fair market
value, determined as of the date of grant, in excess of $100,000.
If shares of Common Stock acquired upon exercise of an ISO are sold or
exchanged more than one year after the date of exercise and more than two years
after the date of grant of the option, any gain or loss will be long-term
capital gain or loss. If shares of Common Stock acquired upon exercise of an ISO
are disposed of prior to the expiration of these one-year or two-year holding
periods (a "Disqualifying Disposition"), the participant will recognize ordinary
income at the time of disposition, and Z-Tel will generally be entitled to a
deduction, in an amount equal to the excess of the fair market value of the
shares of Common Stock at the date of exercise over the exercise price. Any
additional gain will be treated as capital gain, long-term or short-term,
depending on how long the shares of Common Stock have been held. Where shares of
Common Stock are sold or exchanged in a Disqualifying Disposition (other than
certain related party transactions) for an amount less than their fair market
value at the date of exercise, any ordinary income recognized in connection with
the Disqualifying Disposition will be limited to the amount of gain, if any,
recognized in the sale or exchange, and any loss will be a long-term or
short-term capital loss, depending on how long the shares of Common Stock have
been held.
If an option is exercised through the use of shares of Common Stock
previously owned by the participant, such exercise generally will not be
considered a taxable disposition of the previously owned shares and, thus, no
gain or loss will be recognized with respect to such previously owned shares
upon such exercise. The amount of any built-in gain on the previously owned
shares generally will not be recognized until the new shares acquired on the
option exercise are disposed of in a sale or other taxable transaction.
Although the exercise of an ISO as described above would not produce
ordinary taxable income to the participant, it would result in an increase in
the participant's alternative minimum taxable income and may result in an
alternative minimum tax liability.
Restricted Shares
A participant who receives restricted shares will generally recognize
ordinary income at the time that they "vest," i.e., when they are not subject to
a substantial risk of forfeiture. The amount of ordinary income so recognized
will generally be the fair market value of the Common Stock at the time the
shares vest, less the amount, if any, paid for the shares. This amount is
generally deductible for federal income tax purposes by Z-Tel. Dividends paid
with respect to Common Stock that is nonvested will be ordinary compensation
income to the participant (and generally deductible by Z-Tel). Any gain or loss
upon a subsequent sale or exchange of the shares of Common Stock, measured by
the difference between the sale price and the fair market value on the date the
shares vest, will be capital gain or loss, long-term or short-term, depending on
the holding period for the shares of Common Stock. The holding period for this
purpose will begin on the date following the date the shares vest.
In lieu of the treatment described above, a participant may elect immediate
recognition of income under Section 83(b) of the Code. In such event, the
participant will recognize as income the fair market value of the restricted
shares at the time of grant (determined without regard to any restrictions other
than restrictions which by their terms will never lapse), and Z-Tel will
generally be entitled to a corresponding deduction. Dividends paid with respect
to shares as to which a proper Section 83(b) election has been made will not be
deductible to Z-Tel. If a Section 83(b) election is made and the restricted
shares are subsequently forfeited, the participant will not be entitled to any
offsetting tax deduction.
SARs and Other Awards
With respect to SARs, restricted share units, performance shares,
performance units, dividend equivalents and other Awards under the Plan not
described above, generally, when a participant receives payment with respect to
any such Award granted to him or her under the Plan, the amount of cash and the
fair market value of any other property received will be ordinary income to such
participant and will be allowed as a deduction for federal income tax purposes
to Z-Tel.
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Payment of Withholding Taxes
Z-Tel may withhold, or require a participant to remit to it, an amount
sufficient to satisfy any federal, state, local or foreign withholding tax
requirements associated with Awards under the Plan.
Deductibility Limit on Compensation in Excess of $1 Million
Section 162(m) of the Code generally limits the deductible amount of annual
compensation paid (including, unless an exception applies, compensation
otherwise deductible in connection with Awards granted under the Plan) by a
public company to each "covered employee" (i.e., the chief executive officer and
four other most highly compensated executive officers of Z-Tel) to no more than
$1 million. Z-Tel currently intends to structure stock options and other Awards
granted under the Plan to comply with an exception to nondeductibility under
Section 162(m) of the Code.
New Plan Benefits.
No benefits have been received or allocated to any employee, consultant or
director under the Plan, and therefore a "New Plan Benefits" table has not been
included.
Vote Required
The Plan and reservation of shares for issuance thereunder is a transaction
which requires Stockholder approval pursuant to the rules of the Nasdaq SmallCap
Market. As discussed elsewhere in this proxy statement, the Common Stock may be
delisted from the Nasdaq SmallCap Market. Notwithstanding any such delisting,
the board of directors has determined that the Plan and the reservation of
shares for issuance thereunder is a transaction of sufficient significance and
consequence that it should be submitted for approval to the Stockholders of
Z-Tel. Z-Tel will not adopt the Plan or reserve shares for issuance thereunder
unless it and the Exchange Offer are approved by Stockholders.
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, cast at the special meeting is
required to approve the Plan and the reservation of shares for issuance
thereunder. The failure to vote, a vote to abstain and any "broker non-votes"
will have no direct effect on the approval of the Plan or reservation of shares
for issuance thereunder so long as a quorum is present at the special meeting.
The failure to vote, a vote to abstain and any "broker non-votes" with
respect to the several amendments to the certificates of designation and the
reverse stock split proposal discussed in Proposals II through VII above will
effectively be counted as a vote against such proposals. Because the Exchange
Offer is conditioned upon the approval of all of the related transactions being
submitted to Stockholders for approval, including the several amendments to the
certificates of designation and the reverse stock split proposal, and because
adoption of the Plan is conditioned on approval by Stockholders and consummation
of the Exchange Offer, the failure to vote, a vote to abstain and any "broker
non-votes" with respect to the several amendments to the certificates of
designation and the reverse stock split proposal will effectively be counted as
a vote against the Plan.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE PLAN AND RESERVATION OF
SHARES FOR ISSUANCE THEREUNDER, SUBJECT TO APPROVAL BY STOCKHOLDERS AND
CONSUMMATION OF THE EXCHANGE OFFER, IS ADVISABLE TO STOCKHOLDERS AND THAT THEY
SHOULD BE SUBMITTED TO STOCKHOLDERS FOR APPROVAL. THE BOARD OF DIRECTORS
RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" THE ADOPTION OF THE PLAN AND RESERVATION
OF SHARES FOR ISSUANCE THEREUNDER, SUBJECT TO APPROVAL BY STOCKHOLDERS AND
CONSUMMATION OF THE EXCHANGE OFFER.
-49-
PROPOSAL IX:
AMENDMENT TO Z-TEL'S CERTIFICATE OF INCORPORATION TO CHANGE
ITS NAME TO "TRINSIC, INC."
General
Z-Tel has been doing business for some time under the brand name "Trinsic."
The difference between Z-Tel's name as a legal entity and its brand name can be
a source of confusion for Z-Tel's vendors and customers. Accordingly, Z-Tel is
seeking an amendment to its certificate of incorporation to change its legal
entity name to "Trinsic, Inc."
The preceding description which summarizes the amendment to Z-Tel's
certificate of incorporation to change its name to "Trinsic, Inc." is qualified
in its entirety by reference to the certificate of amendment attached as Annex
E.
Conditions to the name change amendment
The name change amendment is not contingent upon the Exchange Offer or any
of the related transactions. Z-Tel will implement the name change amendment if
it is approved by Stockholders, regardless of whether the Exchange Offer and the
related transactions are approved by Stockholders or consummated. However, our
board of directors reserves the right to abandon the name change amendment at
any time prior to its implementation, notwithstanding prior approval of
Stockholders
Vote Required
The affirmative vote of a majority of the voting power of the outstanding
shares of the Common Stock, Series D Preferred Stock and Series E Preferred
Stock, voting together as a single class, is required to approve the
authorization of the name change amendment to our certificate of incorporation.
The failure to vote, a vote to abstain and any "broker non-votes" will
effectively be counted as a vote against the name change amendment.
Board Recommendation
THE BOARD OF DIRECTORS HAS DETERMINED THAT THE AMENDMENT OF Z-TEL'S
CERTIFICATE OF INCORPORATION TO CHANGE ITS NAME TO "TRINSIC, INC." IS ADVISABLE
TO STOCKHOLDERS AND THAT IT SHOULD BE SUBMITTED TO STOCKHOLDERS FOR APPROVAL.
THE BOARD OF DIRECTORS RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" THE AMEDMENT OF
Z-TEL'S CERTIFICATE OF INCORPORATION TO CHANGE ITS NAME TO "TRINSIC, INC."
-50-
DESCRIPTION OF OUR PREFERRED STOCK
The following are summaries of the principal terms and conditions of each
series of our outstanding Preferred Stock, as provided in our Amended and
Restated Certificate of Incorporation, as amended (the "Certificate of
Incorporation"). The following summaries are subject to, and qualified in their
entirety by reference to, all of the provisions of our amended certificate of
incorporation. In addition, as described above in proposals II and V, if the
proposed certificate of designation amendments are adopted, the terms of the
Series D Preferred Stock and Series G Preferred Stock will change significantly
and will cease to have certain preferential rights. Also, as described above in
proposals III, IV and VI, if the series of Preferred Stock ceases to be
outstanding as a consequence of the exchange offer, its certificate of
designation will be terminated and removed from our Amended and Restated
Certificate of Incorporation.
Series D Preferred Stock
Series D Preferred Stock Outstanding............... 3,976,723 preferred shares (as of September 27, 2004)
Parity with Series E Preferred Stock............... The Series D Preferred Stock ranks on a parity with the
Series E Preferred Stock with respect to dividend rights
and rights on liquidation, dissolution or winding up.
Dividends.......................................... Dividends equal to 8% per annum of the Liquidation
Preference (as defined below), are payable at the option
of the board of directors in cash, additional shares of
Series D Preferred Stock or in any combination thereof.
Dividends automatically accrue and are added to the
Liquidation Preference of the Series D Preferred Stock in
the absence of a payment election by the board of
directors.
Restriction on Dividends on Common Stock........... No dividends may be declared or paid on shares of Common
Stock while there are any shares of Series D Preferred
Stock outstanding, nor may we redeem, purchase or acquire
stock that is junior in rights and preferences to the
Series D Preferred Stock ("Junior Stock") in excess of 1
million shares of Common Stock in any 12-month period,
unless all accrued and unpaid dividends on the Series D
Preferred Stock have been paid or set aside for payment
and sufficient funds for payment of current dividends on
the Series D Preferred have been paid or set aside for
payment. We may declare and pay dividends on Junior Stock
which are payable in additional shares, or an increase in
the liquidation value of, Junior Stock.
Optional Redemption................................ The Series D Preferred Stock is redeemable at our option
at any time at a price per share equal to the Liquidation
Preference, plus a premium ranging from 5% in the year
following the third anniversary of the original issue date
thereof to 0% from and after the eighth anniversary of
such original issue date, plus accrued and unpaid
dividends, whether or not declared, to the redemption
date. The premium for a redemption at our option in
effect from the date of September 30, 2004 to June 30,
2005 is 4%.
Mandatory Redemption............................... The Series D Preferred Stock is mandatorily redeemable by
us in 2008, at a price per share equal to the Liquidation
Preference plus all accrued but unpaid dividends, whether
or not declared, to the redemption date.
Liquidation Preference............................. $12.00 per share, plus accrued and unpaid dividends,
prior to any payment in respect of Junior Stock. The
Series D
-51-
Preferred Stock has parity with the Series E
Preferred Stock ("Parity Stock"). In the event that the
proceeds available on liquidation are insufficient to
satisfy the Liquidation Preference of the Series D
Preferred Stock and the Parity Stock, the proceeds shall
be distributed among the holders of the Series D Preferred
Stock and the Parity Stock ratably in proportion to the
total amounts to which all holders of Series D Preferred
Stock and the Parity Stock are entitled upon liquidation.
Conversion Rights.................................. As of September 27, 2004 the adjusted conversion rate was
1.9538 shares of Common Stock per share of Series D
Preferred Stock. Holders may convert shares of Series D
Preferred Stock at any time.
Forced Conversion.................................. We have the right to convert all (and not less than all)
shares of Series D Preferred Stock each time the Common
Stock trades at a price per share exceeding two times the
then-applicable Conversion Price for twenty consecutive
trading days. Based upon a Conversion Price of $8.47 (as
of September 27, 2004), we have the right to convert all
(and not less than all) shares of Series D Preferred Stock
each time that the Common Stock trades at a price per
share exceeding $16.94 for twenty consecutive trading days.
Voting Rights...................................... Each holder of Series D Preferred Stock is entitled to a
number of votes equal to the number of shares of Common
Stock into which that holder's shares of Series D
Preferred Stock are then convertible. The Series D
Preferred Stock votes as a single class with the Common
Stock on all matters submitted to Stockholders. The
approval of seventy percent (70%) of the outstanding
voting power of the Series D Preferred Stock is necessary
to authorize or issue any stock that is senior to or on
parity with the Preferred Stock.
Accumulated Unpaid Dividends and Interest.......... $4.55 in the aggregate per share of Series D Preferred
Stock (as of September 27, 2004).
Series E Preferred Stock
Series E Preferred Stock Outstanding............... 4,166,667 preferred shares (as of September 27, 2004)
Parity with Series D Preferred Stock............... The Series E Preferred Stock ranks on a parity with the
Series D Preferred Stock with respect to dividend rights
and rights on liquidation, dissolution or winding up.
Dividends.......................................... Dividends equal to 8% per annum of the Liquidation
Preference (as defined below). At our option, no
dividends are payable in cash until the earlier of
redemption or liquidation. If we do not pay dividends,
they automatically accrue and are added to the Liquidation
Preference of the Series E Preferred Stock. In the event
of conversion of shares of Series E Preferred Stock,
accrued and unpaid dividends shall be applied to increase
the number of shares of Common Stock into which shares of
Series E Preferred Stock are convertible.
-52-
Restriction on Redemption of Junior Stock.......... If dividends payable on Shares of Series E Preferred Stock
are not paid in full in cash, we may not redeem, purchase
or acquire stock that is junior in rights and preferences
to the Series E Preferred Stock ("Junior Stock") in excess
of 1 million shares of Common Stock in any 12-month period
unless all accrued and unpaid dividends on the Series E
Preferred Stock have been paid or set aside for payment
and sufficient funds for payment of current dividends on
the Series E Preferred have been paid or set aside for
payment.
Participation with Dividends on Common Stock....... In the event that we declare and pay any dividends or make
any distributions on Common Stock (whether in cash, stock,
or pursuant to a stockholder rights plan), each holder of
Series E Preferred Stock shall be entitled to receive the
dividend which is payable to the number of shares of
Common Stock into which that holder's shares of Series E
Preferred Stock are then convertible.
Optional Redemption................................ The Series E Preferred Stock is not redeemable at our
option prior to July 2, 2006. From and after July 2,
2006, the Series E Preferred Stock is redeemable at our
option at any time at a price per share equal to the
Liquidation Preference, plus a premium equal to 2% in the
year beginning July 2, 2006, 1% in the year beginning July
2, 2007, and 0% from and after October 19, 2008, plus
accrued and unpaid dividends, whether or not declared, to
the redemption date.
Mandatory Redemption............................... The Series E Preferred Stock is mandatorily redeemable by
us on October 19, 2008, at a price per share equal to the
Liquidation Preference plus all accrued but unpaid
dividends, whether or not declared, to the redemption date.
Liquidation Preference............................. $12.00 per share, plus accrued and unpaid dividends, prior
to any payment in respect of Junior Stock. The Series E
Preferred Stock has parity with the Series D Preferred
Stock ("Parity Stock"). In the event that the proceeds
available on liquidation are insufficient to satisfy the
Liquidation Preference of the Series E Preferred Stock and
the Parity Stock, the proceeds shall be distributed among
the holders of the Series E Preferred Stock and the Parity
Stock ratably in proportion to the total amounts to which
all holders of Series E Preferred Stock and the Parity
Stock are entitled upon liquidation.
Conversion Rights.................................. As of September 27, 2004 the adjusted conversion rate was
2.0124 shares of Common Stock per share of Series E
Preferred Stock. Holders may convert shares of Series E
Preferred Stock any time.
Forced Conversion.................................. From and after July 2, 2006, we have the right to convert
all (and not less than all) shares of Series E Preferred
Stock each time the Common Stock trades at a price per
share exceeding 250% of the then-applicable Conversion
Price for twenty consecutive trading days. Based upon a
Conversion Price of $8.08 (as of September 27, 2004), from
and after July 2, 2006, we would have the right to convert
all (and not less than all) shares of Series E Preferred
Stock each time that the Common Stock trades at a price
per share
-53-
exceeding $20.20 for twenty consecutive trading days.
Voting Rights...................................... Each holder of Series E Preferred Stock is entitled to a
number of votes equal to the number of shares of Common
Stock into which that holder's shares of Series E
Preferred Stock are then convertible. The Series E
Preferred Stock votes as a single class with the Common
Stock on all matters submitted to Stockholders. The
approval of at least fifty percent (50%) of the
outstanding voting power of the Series E Preferred Stock
is necessary to authorize or issue any stock that is
senior to or on parity with the Series E Preferred Stock,
or effect certain mergers or acquisitions involving
material subsidiaries, sales of assets in excess of $50
million, incurrence of indebtedness for borrowed money in
excess of $100 million.
Accumulated Unpaid Dividends and Interest.......... $4.26 in the aggregate per share of Series E Preferred
Stock (as of September 27, 2004).
Series G Preferred Stock
Series G Preferred Stock Outstanding............... 171.214286 preferred shares (as of September 27, 2004)
Junior to Series D Preferred Stock and Series E
Preferred Stock................................. The Series G Preferred Stock ranks junior to the Series D
Preferred Stock and the Series E Preferred Stock with
respect to dividend rights and rights on liquidation,
dissolution or winding up.
Dividends.......................................... Dividends equal to 12% per annum of the Liquidation
Preference (as defined below). At our option, no
dividends are payable in cash until the earlier of
redemption or liquidation. If we do not pay dividends,
they automatically accrue and are added to the Liquidation
Preference of the Series G Preferred Stock. In the event
of conversion of Series G Preferred Stock into Common
Stock, accrued and unpaid dividends are applied to
increase the number of shares of Common Stock into which
the Series G Preferred Stock is convertible.
Restriction on Dividends on Common Stock........... If dividends payable on the shares of Series G Preferred
Stock are not paid in full in cash, we may not redeem,
purchase or acquire stock that is junior in rights and
preferences to the Series G Preferred Stock ("Junior
Stock") in excess of 1 million shares of Common Stock in
any 12-month period unless all accrued and unpaid
dividends on the Series G Preferred Stock have been paid
or set aside for payment and sufficient funds for payment
of dividends on the Series G Preferred have been paid or
set aside for payment.
Optional Redemption................................ Subject to the rights and privileges of the holders of the
Series D Preferred Stock and the Series E Preferred Stock,
the Series G Preferred Stock is redeemable at our option
at any time after September 18, 2002 at a price per share
equal to the Liquidation Preference, plus accrued and
unpaid dividends, whether or not declared, to the
redemption date.
-54-
Right to Put Series G Preferred Stock on Change in
Control......................................... Subject to the rights and privileges of the holders of the
Series D Preferred Stock and the Series E Preferred Stock,
in the event that on or prior to July 2, 2006, a Change in
Control occurs, each holder of shares of Series G
Preferred Stock has the option to require us to redeem all
of such holder's Series G Preferred Stock for a price
equal to 125% of the sum of the Liquidation Preference and
accrued and unpaid dividends through the redemption date.
Mandatory Redemption............................... Subject to the rights and privileges of the holders of the
Series D Preferred Stock and the Series E Preferred Stock,
the Series G Preferred Stock is mandatorily redeemable by
us on September 18, 2006, at a price per share equal to
the Liquidation Preference plus all accrued but unpaid
dividends, whether or not declared, to the redemption date.
Liquidation Preference............................. Subject to the rights and privileges of the holders of the
Series D Preferred Stock and the Series E Preferred Stock,
$100,000.00 per share, plus accrued and unpaid dividends,
prior to any payment in respect of Junior Stock.
Conversion Rights.................................. As of September 27, 2004 the adjusted conversion rate was
113,258.8 shares of Common Stock per share of SeriesG
Preferred Stock. Holders may convert shares of Series G
Preferred Stock at any time.
Automatic Conversion............................... If at any time the Common Stock trades at a price per
share of $10.00 for twenty consecutive trading days.
Based upon a Conversion Price of $1.28 (as of
September 27, 2004), each share of Series G Preferred
Stock is convertible into 118,901.6174 shares of Common
Stock.
Voting Rights...................................... The holders of the Series G Preferred Stock are not
entitled to any voting rights, except as required by law.
Accumulated Unpaid Dividends and Interest.......... $44,974.90 in the aggregate per share of Series G
Preferred Stock (as of September 27, 2004).
DESCRIPTION OF OUR COMMON STOCK
We are authorized to issue 150,000,000 shares of Common Stock, of which
shares were outstanding as of the record date. All shares of Common Stock have
equal rights to participate in the distribution of assets in the event of a
liquidation of Z-Tel, subject to the preferences established on the Preferred
Stock. Each holder of Common Stock is entitled to one vote for each share held
on all matters submitted to a vote of the Stockholders. Common Stock carries no
conversion, preemptive or subscription rights and is not subject to redemption.
All outstanding shares of Common Stock are fully paid and nonassessable.
Although Common Stockholders are entitled to receive any dividends declared
thereon by the board of directors out of legally available funds, we have never
paid a cash dividend on our Common Stock and are prohibited from doing so by the
terms of the agreements governing our indebtedness. As a result, we do not
anticipate paying any dividends in the foreseeable future.
If the reverse stock split is approved at the special meeting and adopted
by our board of directors, the number of outstanding shares of Common Stock
outstanding will be reduced, but the number of authorized shares of Common Stock
under our certificate of incorporation will not change.
-55-
OTHER BUSINESS
No other matters are to be presented for action at the special meeting
other than as set forth in this proxy statement. If other matters should
properly come before the special meeting, however, the persons named in the
accompanying proxy will vote all proxies in accordance with their best judgment.
FINANCIAL AND OTHER INFORMATION INCLUDED HEREIN
Attached hereto as Annex H is a discussion of recent developments affecting
Z-Tel, unaudited interim financial statements of Z-Tel and related management's
discussion and analysis, and audited annual financial statements of Z-Tel and
related management's discussion and analysis.
By Order of the Board of Directors
Horace J. Davis, III
Acting Chief Executive Officer, Treasurer and
Executive Vice President -- Chief Financial Officer
Tampa, Florida
October 21, 2004
-56-
Annex A-1
Z-TEL TECHNOLOGIES, INC.
AMENDED CERTIFICATE OF DESIGNATIONS,
PREFERENCES AND RELATIVE RIGHTS, QUALIFICATIONS,
LIMITATIONS AND RESTRICTIONS
SERIES D CONVERTIBLE PREFERRED STOCK
--------------------------------------------------------------------------------
Pursuant to the Delaware General Corporation Law, Z-Tel Technologies, Inc.,
a Delaware corporation (the "Corporation"), DOES HEREBY CERTIFY:
FIRST: That pursuant to the authority conferred upon the Board of Directors
of the Corporation by the Certificate of Incorporation of the Corporation (the
"Charter"), the Board of Directors of the Corporation on June 30, 2000 duly
adopted resolutions creating a series of Preferred Stock designated as Series D
Convertible Preferred Stock (the "Series D Preferred").
SECOND: Resolutions, setting forth a proposed Amended Certificate of
Designation of Series D Preferred (the "Amended Certificate"), declaring the
Amended Certificate to be advisable and directing that this Amended Certificate
be considered by the stockholders of the Corporation entitled to vote thereon,
were duly adopted by the Board of Directors of the Corporation.
THIRD: Thereafter, the Amended Certificate was approved at a special
meeting, duly called and convened in accordance with Section 222 of the General
Corporation Law of the State of Delaware on , 2004, by vote in respect
thereof of the requisite percentage of the stockholders of the Corporation
entitled to vote thereon.
FOURTH: The Amended Certificate was duly adopted in accordance with Section
242 of the General Corporation Law of the State of Delaware.
FIFTH: The Amended Certificate amends the Corporation's Certificate of
Designation of Series D Preferred, as amended, in its entirety and hereby
replaces it with the following:
1. General. (a) Authorization. The series of authorized preferred stock
shall have a par value of $0.01 per share, shall be designated as "Series D
Convertible Preferred Stock", and shall consist of five million (5,000,000)
shares and shall have the powers, designations, preferences and relative,
participating, optional and other special rights, qualifications, limitations
and restrictions set forth herein. (b) Certain Definitions. Unless the context
otherwise requires, in addition to the terms defined elsewhere herein, the terms
defined in this Section 1 shall have, for all purposes of this resolution, the
meanings herein specified when used herein with initial capital letters (with
terms defined in the singular having comparable meanings when used in the
plural).
"Common Stock" shall mean the common stock, $.01 par value per share, of
the Corporation.
"Stock Purchase Agreement" means the Stock Purchase Agreement, dated July
6, 2000, by and among the Corporation, the Holder and the other investors named
on Schedule I thereto.
2. Dividends and Distributions.
A-1-1
(a) Series D Dividends. The holders of record of shares of Series D
Preferred shall be entitled to receive dividends at a rate of eight percent (8%)
of the Liquidation Preference (as defined herein) per annum per share of Series
D Preferred (the "Series D Dividend"), which shall be fully cumulative. The
Series D Dividend shall accrue from the date of issuance of each share until the
earlier of (i) the conversion of such share of Series D Preferred to Common
Stock, (ii) a Liquidation (as defined herein), or (iii) the repurchase or
redemption of such share of Series D Preferred. Such dividend shall be payable
quarterly in arrears on March 31, June 30, September 30 and December 31 of each
year (each a "Series D Dividend Date") commencing on September 30, 2000, except
that if any such date is a Saturday, Sunday or legal holiday (a "Non-Business
Day"), then such dividend shall be payable on the next day that is not a
Saturday, Sunday or legal holiday on which banks in the State of Delaware are
permitted to be closed (a "Business Day") to holders of record as they appear on
the stock ledger of the Corporation on the applicable record date, which shall
be not more than sixty (60) nor less than ten (10) days preceding the payment
date for such dividends, as fixed by the Board of Directors (the "Series D
Record Date"). Series D Dividends shall be payable only when, as and if declared
by the Board of Directors out of funds legally available therefor. The dividends
shall either be payable in (i) shares of Series D Preferred or (ii) cash, as
provided in the next paragraph. The dividends shall automatically accrue in the
absence of an election by the Board of Directors within sixty (60) days after
each Series D Dividend Date to pay the dividends. The amount of dividends
payable for any period that is shorter or longer than a full annual dividend
shall be computed on the basis of a 360-day year and the actual number of days
elapsed (including the first day but excluding the last day) occurring in the
period for which such amount is payable. All accrued but unpaid dividends
(whether declared or undeclared) shall accrue interest at a rate of ten percent
(10%) per annum computed on the basis of a 360-day year and the actual number of
days elapsed (including the first day but excluding the last day) occurring in
the period for which such amount is payable, but with interest on such dividend
compounded on a quarterly basis (on each March 31, June 30, September 30 and
December 31) for the year during which such dividend was payable, and thereafter
until paid. If the Series D Dividend cannot be paid in full, dividends shall be
paid, to the maximum possible extent, to the holders of the Series D Preferred
pro rata on the basis of the amount of accrued and unpaid dividends outstanding
on each share.
(b) Cash Dividends; In-Kind Dividends. Dividends that are declared and
payable on each September 30 shall be paid in cash. Until the fifth anniversary
of July 13, 2000 (the "Original Issue Date") (or, if such day is not a business
day, on the first business day thereafter), dividends that are declared and
payable on each March 31, June 30 and December 31 shall be paid in shares of
Series D Preferred (each, a "Series D Payment-in-Kind") rather than cash,
valuing each such share issued at the Liquidation Preference. Thereafter, all
dividends that are declared and payable shall be paid in cash.
3. Liquidation Rights. In the event of any liquidation, dissolution or
winding-up of the Corporation, whether voluntary or involuntary (a
"Liquidation"), the Liquidation Preference of the Series D Preferred shall be
$12.00 per share. The Liquidation Preference shall not be subject to adjustment.
In the event of a Liquidation, the holders of the outstanding Series D
Preferred, subject to the other terms contained herein, shall be entitled to be
paid first out of the assets of the Corporation available for distribution to
holders of its capital stock an amount (the "Liquidation Value") equal to (i)
the applicable Liquidation Preference, plus (ii) all accrued but unpaid
dividends (whether declared or undeclared including any interest accrued thereon
calculated through the date of Liquidation), prior to any distribution to the
holders of any Common Stock. If the proceeds from a Liquidation are not
sufficient to pay to the holders of Series D Preferred then such holders shall
instead be entitled to receive, pro rata with the holders of all other series of
preferred stock of the Corporation, the entire assets and funds of the
Corporation legally available for distribution to the holders of capital stock,
which assets and funds shall be distributed pro rata among the holders of the
Series D Preferred on the basis of the amounts per share to be paid to each.
After payment of the full preferential amount, such holders shall not be
entitled to any further participation in any distribution of assets of the
Corporation.
4. Conversion. The Series D Preferred are subject to conversion rights as
follows (the "Conversion Rights"):
(a) Conversion at Option of the Holder; Conversion at Option of the
Company. Each share of Series D Preferred shall initially be convertible,
at the option of the holder thereof, at any time on or after the date of
issuance thereof and up to and including the day immediately preceding the
Mandatory Redemption Date, into the number of fully paid and nonassessable
shares of Common Stock which results from di-
A-1-2
viding the applicable Conversion Price (as hereinafter specified) per share
in effect at the time of conversion into the applicable per share
Liquidation Preference in effect at the time of conversion. The initial
Conversion Price of the Series D Preferred after giving effect to the
exchange offer and the amendments to the Corporation's certificate of
incorporation each as described in the Corporation's proxy statement dated
, 2004 (collectively, the "Transactions") shall be $8.47 per
share. The initial Conversion Price of the Series D Preferred shall be
subject to adjustment from time to time as provided in Section 4(c) hereof.
Upon conversion, all accrued or declared but unpaid dividends (including
any interest accrued thereon calculated as of the date of conversion) on
the Series D Preferred so converted shall be paid in Common Stock. In
making such payment, the number of shares of Common Stock will be
determined by dividing the applicable Conversion Price per share in effect
at the time of conversion into the amount of the accrued or declared but
unpaid dividends (including any interest accrued thereon calculated as of
the date of conversion). Such shares of Common Stock will be fully paid and
nonassessable.
At any time that the closing price of the Common Stock on The Nasdaq Stock
Market (or on the exchange or quotation system on which the Corporation's Common
Stock is then traded) as reported in The Wall Street Journal (such price on a
given day, referred to as the "Current Market Price" for such day) equals or
exceeds two (2) times the then-applicable Conversion Price for twenty (20) or
more consecutive trading days beginning on or after July 13, 2002, then,
beginning on the day following the 20th such consecutive trading day and ending
sixty (60) calendar days after the last such consecutive trading day, the
Corporation shall have the right to convert all, but not less than all, of the
shares of Series D Preferred into shares of Common Stock, with each share of
Series D Preferred converting into the number of fully paid and nonassessable
shares of Common Stock which results from dividing the applicable Conversion
Price per share in effect at the time of conversion into the applicable per
share Liquidation Preference in effect at the time of conversion.
(b) Mechanics of Conversion at the Option of the Holder. Before any
holder of Series D Preferred shall be entitled to convert the same into
shares of Common Stock and to receive certificates therefor, such holder
shall surrender the certificate or certificates therefor, duly endorsed, at
the principal office of the Corporation or of any transfer agent for the
Series D Preferred and shall give written notice to the Corporation at such
office that such holder elects to convert the same. The Corporation shall
as soon as practicable after such delivery issue and deliver at such office
to such holder of Series D Preferred a certificate or certificates for the
number of shares of Common Stock to which it, he or she shall be entitled
as aforesaid. Such conversion shall be deemed to have been made immediately
prior to the close of business on the date of such surrender of the shares
of Series D Preferred and the person or persons entitled to receive the
shares of Common Stock issuable upon such conversion shall be treated for
all purposes as the record holder or holders of such shares of Common Stock
on such date.
(c) Adjustments to Conversion Price. If the Corporation shall, while
shares of Series D Preferred remain outstanding, (i) pay a dividend, or
make a distribution to Common Stockholders, in either case in shares of its
Common Stock, (ii) subdivide its outstanding shares of Common Stock, (iii)
combine its outstanding shares of Common Stock into a smaller number of
shares or (iv) issue by reclassification of its shares of Common Stock any
shares of capital stock of the Corporation, in each case, at any time after
consummation of the Transactions, then thereafter the Conversion Price
shall be automatically (and without notice or further action) increased or
decreased, as the case may be, in direct proportion to the increase or
decrease in the number of shares of Common Stock by reason of such change,
so that the aggregate Conversion Price of shares of Series D Preferred
shall be unchanged by such change.
(d) Status of Converted Stock. In case any shares of Series D
Preferred shall be converted pursuant to Section 4 hereof, the shares so
converted shall be canceled, shall not be reissuable and shall cease to be
a part of the authorized capital stock of the Corporation.
(e) Fractional Shares. In lieu of any fractional shares in the
aggregate to which the holder of Series D Preferred would otherwise be
entitled upon conversion, the Corporation shall pay cash equal to such
fraction multiplied by the fair market value of one share of Common Stock.
(f) Miscellaneous.
A-1-3
(i) All calculations under this Section 4 shall be made to the nearest
cent or to the nearest one hundredth (1/100) of a share, as the case may
be.
(ii) The determination of the Board of Directors of adjustments
pursuant to this Section 4 shall, absent manifest error, be final on all
holders of Series D Preferred.
(iii) No adjustment in the applicable Conversion Price of the Series D
Preferred will be made if such adjustment would result in a change in such
Conversion Price of less than $0.01. Any adjustment of less than $0.01
which is not made shall be carried forward and shall be made at the time of
and together with any subsequent adjustment which, on a cumulative basis,
amounts to an adjustment of $0.01 or more in such Conversion Price.
(g) No Impairment. The Corporation will not through any
reorganization, recapitalization, transfer of assets, consolidation,
merger, dissolution, issue or sale of securities or any other voluntary
action, avoid or seek to avoid the observance or performance of any of the
terms to be observed or performed hereunder by the Corporation, but will at
all times in good faith assist in the carrying out of all the provisions of
this Section 4 and in the taking of all action as may be necessary or
appropriate in order to protect the conversion rights of the holders of
Series D Preferred against impairment.
(h) Reservation of Stock Issuable Upon Conversion. The Corporation
shall at all times reserve and keep available out of its authorized but
unissued shares of Common Stock, solely for the purpose of effecting the
conversion of the shares of Series D Preferred such number of its shares of
Common Stock as shall from time to time be sufficient to effect the
conversion of all outstanding shares of Series D Preferred. If at any time
the number of authorized but unissued shares of Common Stock shall not be
sufficient to effect the conversion of all then outstanding shares of
Series D Preferred the Corporation will take such corporate action as may,
in the opinion of its counsel, be necessary to increase its authorized but
unissued shares of Common Stock to such number of shares as shall be
sufficient for such purpose.
5. Voting Rights. Except as otherwise required by law, the holder of each
share of Series D Preferred will be entitled to vote on all matters with the
holders of the Common Stock as a single class, and not as a separate class or
series. Each share of Series D Preferred will entitle the holder to the number
of votes per share equal to the full number of shares of Common Stock into which
such share of Series D Preferred is convertible on the record date for such
vote. The holders of Series D Preferred shall receive notice of and shall be
entitled to attend in person or by proxy any meeting of the Common Stockholders.
6. Notices of Certain Record Dates. In the event of any taking by the
Corporation of a record of the holders of any class of securities for the
purpose of determining the holders thereof who are entitled to receive any
dividend or other distribution, any right to subscribe for, purchase or
otherwise acquire any shares of stock of any class or any other securities or
property, or to receive any other right, the Corporation shall mail to each
holder of Series D Preferred at least twenty (20) days prior to the record date
specified therein, a notice specifying the date on which any such record is to
be taken for the purpose of such dividend, distribution or right, and the
anticipated amount and character of such dividend, distribution or right.
7. Notices. Any notice required by the provisions of this Amended or
Restated Certificate to be given to the holders of Series D Preferred shall be
deemed given (i) when made, if made by hand delivery, (ii) upon confirmation, if
made by fax, or (iii) one business day after being deposited with a reputable
next-day courier, postage prepaid, and in each case, addressed to each holder of
record at such holder's address or fax number appearing on the books of the
Corporation.
A-1-4
8. Redemption.
If Redeemed on or After the Anniversary of And Redeemed Before the Anniversary of the
the Original Issue Date Occurring In Original Issue Date Percent of Liquidation
Occurring In Preference
-------------------------------------------- ------------------------------------------ -----------------------
2004 2005 104%
2005 2006 103%
2006 2007 102%
2007 2008 101%
(a) The Corporation may at its option redeem the Series D Preferred in
whole or in part, at any time or from time to time, upon at least thirty days'
prior notice, at a redemption price equal to the percentage of the Liquidation
Preference per share of Series D Preferred set forth below, plus any accumulated
unpaid dividends (whether or not declared) up to but excluding such redemption
date. Shares so redeemed shall be cancelled and upon such cancellation shall be
deemed to be authorized and unissued shares of Preferred Stock, without par
value, of the Corporation but shall not be reissued as shares of the same
series.
(b) Mandatory Redemption. To the extent permitted by law, the Corporation
shall redeem, on the eighth anniversary of the Original Issue Date (or, if such
day is not a business day, on the first business day thereafter) (the "Mandatory
Redemption Date"), all remaining shares of Series D Preferred then outstanding,
for an amount equal to the Liquidation Preference for each share outstanding,
plus an amount in cash equal to all accrued but unpaid dividends thereon to the
Mandatory Redemption Date (the "Redemption Price"). Prior to authorizing or
making such redemption with respect to the Series D Preferred, the Corporation,
by resolution of the Board of Directors shall, to the extent of funds legally
available therefor, declare a dividend on the Series D Preferred payable on the
Mandatory Redemption Date in an amount equal to any accrued and unpaid dividends
on the Series D Preferred as of such date and, if the Corporation does not have
sufficient legally available funds to declare and pay all dividends accrued at
the time of such redemption, any remaining accrued and unpaid dividends shall be
added to the redemption price. After paying any accrued and unpaid dividends
pursuant to the foregoing sentence, if the funds of the Corporation legally
available for redemption of shares of the Series D Preferred then required to be
redeemed are insufficient to redeem the total number of such shares then
outstanding, those funds which are legally available shall be used to redeem the
maximum possible number of shares of the Series D Preferred, which shares to be
redeemed shall be allocated pro rata among the holders of the Series D Preferred
based on the number of shares of Series D Preferred held by such holders. At any
time and from time to time thereafter, when additional funds of the Corporation
are legally available to discharge its obligation to redeem all of the
outstanding shares of Series D Preferred required to be redeemed pursuant to
this section (the "Mandatory Redemption obligation"), such funds shall be
immediately used to discharge such Mandatory Redemption Obligation until the
balance of such shares have been redeemed. If and so long as the Mandatory
Redemption Obligation shall not be fully discharged, dividends on any remaining
outstanding shares of Series D Preferred shall continue to accrue and be added
to the dividend payable pursuant to the second preceding sentence.
(c) Notice. The Corporation will provide notice of any redemption of shares
of Series D Preferred to holders of record of the Series D Preferred to be
redeemed not less than 30 nor more than 60 days prior to the date fixed for such
redemption. Such notice shall be provided by first-class mail postage prepaid,
to each holder of record of the Series D Preferred to be redeemed, at such
holder's address as it appears on the stock transfer books of the Corporation.
Each such mailed notice shall state, as appropriate, the following:
(i) the redemption date;
A-1-5
(ii) the number of shares of Series D Preferred to be redeemed and, if
fewer than all the shares held by any holder are to be redeemed, the number
of such shares to be redeemed from such holder;
(iii) the Redemption Price;
(iv) the place or places where certificates for such shares are to be
surrendered for redemption;
(v) the amount of full cumulative dividends per share of Series D
Preferred to be redeemed accrued and unpaid up to but excluding such
redemption date, and that dividends on shares of Series D Preferred to be
redeemed will cease to accrue on such redemption date unless the
Corporation shall default in payment of the Redemption Price plus such full
cumulative dividends accrued and unpaid thereon;
(vi) the name and location of any bank or trust company with which the
Corporation will deposit redemption funds pursuant to subsection (e) below;
(vii) the then-effective Conversion Price; and (viii) that the right of
holders to convert shares of Series D Preferred to be redeemed will
terminate at the close of business on the business day next preceding the
date fixed for redemption (unless the Corporation shall default in the
payment of the Redemption Price and such full cumulative dividends accrued
and unpaid thereon).
Any notice that is mailed as set forth above shall be conclusively presumed to
have been duly given, whether or not the holder of shares of Series D Preferred
receives such notice, and failure to give such notice by mail, or any defect in
such notice, to the holders of any shares designated for redemption shall not
affect the validity of the proceedings for the redemption of any other shares of
Series D Preferred.
(d) Mechanics of Redemption. Upon surrender in accordance with the
aforesaid notice of the certificate for any shares so redeemed (duly endorsed or
accompanied by appropriate instruments of transfer if so required by the
Corporation), the holders of record of such shares shall be entitled to receive
the redemption price, without interest, plus full cumulative dividends thereon
accrued and unpaid up to but excluding such redemption date out of funds legally
available therefor. If fewer than all the shares represented by any such
certificate are redeemed, a new certificate representing the unredeemed shares
shall be issued without cost to the holder thereof.
(e) Redemption Funds. On the date of any redemption being made pursuant to
this Section, the Corporation shall, and at any time after notice of such
redemption shall have been mailed and before the date of redemption the
Corporation may, deposit for the benefit of the holders of shares of Series D
Preferred to be redeemed the funds necessary for such redemption with a bank or
trust company having a capital and surplus of at least $1 billion, with
instructions to such bank or trust company to pay the full redemption amounts as
provided herein to the holders of shares of Series D Preferred upon surrender of
certificates for such shares; provided, however, that the making of such deposit
shall not release the Corporation from any of its obligations hereunder. Any
moneys so deposited by the Corporation and unclaimed at the end of two years
from the date designated for such redemption shall revert to the general funds
of the Corporation and, upon demand, such bank or trust company shall pay over
to the Corporation such unclaimed amounts and thereupon such bank or trust
company shall be relieved of all responsibility in respect thereof and any
holder of shares of Series D Preferred so redeemed shall look only to the
Corporation for the payment of the full redemption amounts, as provided herein.
(f) Rights After Redemption. Notice of redemption having been given as
aforesaid, upon the deposit pursuant to subsection (e) of the full redemption
amounts as provided herein in respect of all shares of Series D Preferred then
to be redeemed, notwithstanding that any certificates for such shares shall not
have been surrendered in accordance with subsection (d), from and after the date
of redemption designated in the notice of redemption: (i) the shares represented
thereby shall no longer be deemed outstanding, (ii) the rights to receive
dividends thereon shall cease to accrue, and (iii) all rights of the holders of
such shares of Series D Preferred shall cease and terminate, excepting only the
right to receive the full redemption amounts as provided herein without interest
A-1-6
thereon. If the funds deposited are not sufficient for redemption of the shares
of the Series D Preferred that were to be redeemed, then no certificates
evidencing such shares shall be deemed surrendered and such shares shall remain
outstanding and the rights of holders of shares of Series D Preferred shall
continue to be those of holders of shares of the Series D Preferred.
9. Headings and Subdivisions. The headings of the various subdivisions
hereof are for convenience of reference only and shall not affect the
interpretation of any of the provisions hereof.
10. Severability of Provisions. If any voting powers, preferences and
relative, participating, optional and other special rights of the Series D
Preferred and qualifications, limitations and restrictions thereof set forth in
this resolution (as such resolution may be amended from time to time) are
invalid, unlawful or incapable of being enforced by reason of any rule of law or
public policy, all other voting powers, preferences and relative, participating,
optional and other special rights of the Series D Preferred and qualifications,
limitations and restrictions thereof set forth in this resolution (as so
amended) which can be given effect without the invalid, unlawful or
unenforceable voting powers, preferences and relative, participating, optional
and other special rights of the Series D Preferred and qualifications,
limitations and restrictions thereof shall, nevertheless, remain in full force
and effect, and no voting powers, preferences and relative, participating,
optional or other special rights of the Series D Preferred and qualifications,
limitations and restrictions thereof herein set forth shall be deemed dependent
upon any other such powers, preferences and relative, participating, optional or
other special rights of the Series D Preferred and qualifications, limitations
and restrictions thereof unless so expressed herein.
IN WITNESS WHEREOF, Z-TEL TECHNOLOGIES, INC. has caused this Amended
Certificate of Designations, Preferences and Relative Rights, Qualifications,
Limitations and Restrictions to be signed this ____ day of _____________, 2004.
Z-TEL TECHNOLOGIES, INC.
By:
-----------------------------------
Name:
Title:
A-1-7
Annex A-2
CERTIFICATE OF AMENDMENT
OF THE AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION OF
Z-TEL TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
Pursuant to the Delaware General Corporation Law, Z-Tel Technologies, Inc.,
a Delaware corporation (the "Corporation"), DOES HEREBY CERTIFY:
FIRST: That pursuant to the authority conferred upon the Board of Directors
of the Corporation by the Certificate of Incorporation of the Corporation (the
"Charter"), the Board of Directors of the Corporation on June 30, 2000 duly
adopted resolutions creating a series of Preferred Stock designated as Series D
Convertible Preferred Stock (the "Series D Convertible Preferred Stock"), the
terms of which were subsequently amended (as amended, the "Certificate of
Designation").
SECOND: Resolutions, setting forth this proposed Certificate of Amendment
(the "Certificate of Amendment"), declaring this Certificate of Amendment to be
advisable and directing that this Certificate of Amendment be considered by the
stockholders of the Corporation entitled to vote thereon, were duly adopted by
the Board of Directors of the Corporation.
THIRD: Thereafter, this Certificate of Amendment was approved at a special
meeting, duly called and convened in accordance with Section 222 of the General
Corporation Law of the State of Delaware on , 2004, by vote in respect
thereof of the requisite percentage of the stockholders of the Corporation
entitled to vote thereon.
FOURTH: This Certificate of Amendment was duly adopted in accordance with
Section 242 of the General Corporation Law of the State of Delaware.
FIFTH: The Corporation has acquired all of the outstanding shares of the
Series D Convertible Preferred Stock through an exchange offer completed on
, 2004.
SIXTH: This Certificate of Amendment amends the Amended and Restated
Certificate of Incorporation of the Corporation by eliminating the Certificate
of Designation in its entirety.
IN WITNESS WHEREOF, Z-TEL TECHNOLOGIES, INC. has caused this Certificate of
Amendment to be signed this day of , 2004.
Z-TEL TECHNOLOGIES, INC.
By:
---------------------------------
Name:
Title:
A-2-1
Annex B
CERTIFICATE OF AMENDMENT
OF THE AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION OF
Z-TEL TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
Pursuant to the Delaware General Corporation Law, Z-Tel Technologies, Inc.,
a Delaware corporation (the "Corporation"), DOES HEREBY CERTIFY:
FIRST: That pursuant to the authority conferred upon the Board of Directors
of the Corporation by the Certificate of Incorporation of the Corporation (the
"Charter"), the Board of Directors of the Corporation on October 17, 2000, duly
adopted resolutions creating a series of Preferred Stock designated as 8%
Convertible Preferred Stock, Series E (the "Series E Convertible Preferred
Stock"), the terms of which were subsequently amended by the Amended and
Restated Certificate of Designation, dated July 2, 2001 and the Certificate of
Amendment dated March 11, 2003 (as amended, the "Certificate of Designation").
SECOND: Resolutions, setting forth this proposed Certificate of Amendment
(the "Certificate of Amendment"), declaring this Certificate of Amendment to be
advisable and directing that this Certificate of Amendment be considered by the
stockholders of the Corporation entitled to vote thereon, were duly adopted by
the Board of Directors of the Corporation.
THIRD: Thereafter, this Certificate of Amendment was approved at a special
meeting, duly called and convened in accordance with Section 222 of the General
Corporation Law of the State of Delaware on , 2004, by vote in respect
thereof of the requisite percentage of the stockholders of the Corporation
entitled to vote thereon.
FOURTH: This Certificate of Amendment was duly adopted in accordance with
Section 242 of the General Corporation Law of the State of Delaware.
FIFTH: The Corporation has acquired all of the outstanding shares of the
Series E Convertible Preferred Stock through an exchange offer completed on
, 2004.
SIXTH: This Certificate of Amendment amends the Amended and Restated
Certificate of Incorporation of the Corporation by eliminating the Certificate
of Designation in its entirety.
IN WITNESS WHEREOF, Z-TEL TECHNOLOGIES, INC. has caused this Certificate of
Amendment to be signed this day of , 2004.
Z-TEL TECHNOLOGIES, INC.
By:
---------------------------------
Name:
Title:
B-1
Annex C-1
Z-TEL TECHNOLOGIES, INC.
AMENDED CERTIFICATE OF DESIGNATION
OF 12% JUNIOR REDEEMABLE CONVERTIBLE PREFERRED
STOCK, SERIES G, SETTING FORTH THE POWERS,
PREFERENCES, RIGHTS, QUALIFICATIONS, LIMITATIONS
AND RESTRICTIONS OF SUCH SERIES OF PREFERRED STOCK
--------------------------------------------------------------------------------
Pursuant to the Delaware General Corporation Law, Z-Tel Technologies, Inc.,
a Delaware corporation (the "Corporation"), DOES HEREBY CERTIFY:
FIRST: That pursuant to the authority conferred upon the Board of Directors
of the Corporation by the Certificate of Incorporation of the Corporation (the
"Charter"), the Board of Directors of the Corporation on June 29, 2001 duly
adopted resolutions creating a series of 12% Junior Redeemable Convertible
Preferred Stock, Series G (the "Series G Preferred").
SECOND: Resolutions setting forth a proposed Amended Certificate of
Designation of Series G Preferred (the "Amended Certificate"), declaring the
Amended Certificate to be advisable and directing that this Amended Certificate
be considered by the stockholders of the Corporation entitled to vote thereon
were duly adopted by the Board of Directors of the Corporation.
THIRD: Thereafter, the Amended Certificate was approved at a special
meeting duly called and convened in accordance with Section 222 of the General
Corporation Law of the State of Delaware on , 2004 by vote in respect
thereof of the requisite percentage of the stockholders of the Corporation
entitled to vote thereon.
FOURTH: The Amended Certificate was duly adopted in accordance with Section
242 of the General Corporation Law of the State of Delaware.
FIFTH: The Amended Certificate amends the Corporation's Certificate of
Designation of Series G Preferred, as amended, in its entirety and hereby
replaces it with the following:
Section 1. Designation and Number; Ranking.
(a) The shares of such series shall be designated as 12% Junior Redeemable
Convertible Preferred Stock, Series G. The number of authorized shares of the
Series G Preferred shall be 175, which number may be decreased (but not
increased) by the Board of Directors without a vote of stockholders; provided,
however, that such number may not be decreased below the number of then
outstanding shares of Series G Preferred or shares of Series G Preferred to be
issued pursuant to the Investment Agreement.
(b) Capitalized terms used herein and not otherwise defined shall have the
meanings set forth in Section 10.
Section 2. Dividends and Distributions.
(a) Series G Dividends. The holders of shares of Series G Preferred shall
be entitled to receive, when, as and if declared by the Board of Directors, out
of the assets of the Corporation legally available therefor, cumulative cash
dividends at an annual rate per share of Series G Preferred equal to 12.00% of
the Liquidation Preference with respect to such share per annum ("Series G
Dividend Rate"), calculated on the basis of a 360-day year consisting of twelve
30-day months, accruing and payable in equal quarterly payments, in immediately
available funds, on the last day of March, June, September and December or, if
any such day is not a Business Day, the next succeeding Business Day, in each
year (each such date being referred to herein as a "Quarterly Dividend Payment
Date"),
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commencing on the first quarterly dividend date to occur after the issue date of
such shares; provided that the dividend payable on the first Quarterly Dividend
Payment Date to occur after the Issue Date of each share of Series G Preferred
shall be computed based on the number of days prior to the date that such share
has been issued and outstanding.
(b) Dividend Arrearage. If as of any Quarterly Dividend Payment Date there
is a Dividend Arrearage (as hereinafter defined), an additional dividend (the
"Additional Dividend") shall accrue on each share of the Series G Preferred for
the period from such Quarterly Dividend Payment Date through the earlier of (x)
the date on which such Dividend Arrearage is paid or converted pursuant to the
terms hereof in full and (y) the next succeeding Quarterly Dividend Payment
Date, in an amount equal to the product of (i) the Series G Dividend Rate and
(ii) the amount of such Dividend Arrearage as of such Quarterly Dividend Payment
Date. For purposes of this Section 2(b), "Dividend Arrearage" shall mean, with
respect to each share of Series G Preferred, as of any Quarterly Dividend
Payment Date, the excess, if any of (i) the sum of all dividends theretofore
accrued on such share in accordance with Section 2(a) (including those accrued
as of and including such Quarterly Dividend Payment Date) plus all Additional
Dividends, if any, theretofore accrued on such share in accordance with this
Section 2(b) (including those accrued as of and including such Quarterly
Dividend Payment Date), over (ii) all dividends actually paid or converted (but
only to the extent so paid or converted) pursuant to the terms hereof with
respect to such share on or before such Quarterly Dividend Payment Date.
(c) Accrual of Dividends. Dividends payable pursuant to Section 2(a) shall
begin to accrue and be cumulative from the Issue Date, and shall accrue on a
daily basis, in each case whether or not declared. Dividends paid on the shares
of Series G Preferred in an amount less than the total amount of such dividends
at the time accrued and payable on such shares shall be allocated pro rata on a
share-by-share basis among all such shares of Series G Preferred at the time
outstanding. The Board of Directors may fix a record date for the determination
of holders of shares of Series G Preferred entitled to receive payment of a
dividend declared thereon, which record date shall be no more than 60 days or
less than 10 days prior to the date fixed for the payment thereof. Accumulated
but unpaid dividends for any past quarterly dividend periods may be declared and
paid at any time, without reference to any regular Quarterly Dividend Payment
Date, to holders of record on such date, not more than 60 nor less than 10 days
preceding the payment date thereof, as may be fixed by the Board of Directors.
(d) Other Dividends. In addition to the dividends or distributions on the
Series G Preferred described in Section 2(a), in the event that the Corporation
shall declare a dividend or make any other distribution (including, without
limitation, in cash, in capital stock (which shall include, without limitation,
any options, warrants or other rights to acquire capital stock) of the
Corporation, whether or not pursuant to a shareholder rights plan, "poison pill"
or similar arrangement, or other property or assets)) to holders of Common
Stock, then the Board of Directors shall declare and the holder of each share of
Series G Preferred shall be entitled to receive a dividend or distribution in an
amount equal to the amount of such dividend or distribution received by a holder
of the number of shares of Common Stock for which such share of Series G
Preferred is convertible on the record date for such dividend or distribution
(without regard to the Conversion Limit). Any such amount shall be paid to the
holders of shares of Series G Preferred at the same time such dividend or
distribution is made to holders of Common Stock.
Section 3. Voting Rights.
Except for any voting rights provided by law, the holders of shares of
Series G Preferred shall not be entitled to vote.
Section 4. Redemption.
(a) Optional Redemption. Except as otherwise set forth in this Section 4,
the Corporation shall not have any right to redeem any shares of Series G
Preferred prior to the first anniversary of the Drawdown Date. On and after the
first anniversary of the Drawdown Date, the Corporation shall have the right, at
its sole option and election, to redeem the shares of Series G Preferred, in
whole but not in part, on not less than 10 days notice of the date of redemption
(any such date an "Optional Redemption Date") for cash at a price per share (the
"Optional Redemption Price") equal to the sum of (i) the Liquidation Preference
per share and (ii) any accrued and unpaid dividends thereon (including
Additional Dividends), whether or not declared or payable, to the applicable
optional Redemption Date, in immediately available funds.
C-1-2
(b) Mandatory Redemption. To the extent permitted by law, the Corporation
shall redeem, on:
(i) December 31, 2001, if the Stockholder Approval Certification Date
has not then occurred, the number of shares of Series G Preferred presented
for redemption by the holders thereof for cash, at a price per share, in
immediately available funds, equal to the sum of (x) the Liquidation
Preference per share plus (y) any accrued and unpaid dividends thereon
(including Additional Dividends), whether or not declared or payable; or
(ii) the fifth anniversary of the Drawdown Date, all remaining shares
of Series G Preferred then outstanding, for cash at a price per share equal
to the Liquidation Preference, plus an amount equal to all accrued but
unpaid dividends thereon (including Additional Dividends), whether or not
declared or payable to the Mandatory Redemption Date, in immediately
available funds
(each of the dates referred to in Sections 4(b)(i) and (ii) above, a "Mandatory
Redemption Date" and each of the redemption amounts referred to in Sections
4(b)(i) and (ii) above, a "Mandatory Redemption Price"). Prior to authorizing or
making such redemption with respect to the Series G Preferred, the Corporation,
by resolution of the Board of Directors shall, to the extent of funds legally
available therefor, declare a dividend on the Series G Preferred payable on the
Mandatory Redemption Date in an amount equal to any accrued and unpaid dividends
on the Series G Preferred as of such date (including Additional Dividends) and,
if the Corporation does not have sufficient legally available funds to declare
and pay all dividends accrued at the time of such redemption, any remaining
accrued and unpaid dividends (including Additional Dividends) shall be added to
the Mandatory Redemption Price. After paying any accrued and unpaid dividends
pursuant to the foregoing sentence, if the funds of the Corporation legally
available for redemption of shares of the Series G Preferred then required to be
redeemed are insufficient to redeem the total number of such shares then
outstanding, those funds which are legally available shall be used to redeem the
maximum possible number of shares of the Series G Preferred, which shares to be
redeemed shall be allocated pro rata among the holders of the Series G Preferred
based on the number of shares of Series G Preferred held by such holders. At any
time and from time to time thereafter, when additional funds of the Corporation
are legally available to discharge its obligation to redeem all of the
outstanding shares of Series G Preferred required to be redeemed pursuant to
this Section (the "Mandatory Redemption Obligation"), such funds shall be
immediately used to discharge such Mandatory Redemption Obligation until the
balance of such shares have been redeemed. If and so long as the Mandatory
Redemption Obligation shall not be fully discharged, dividends on any remaining
outstanding shares of Series G Preferred shall continue to accrue and be added
to the dividend payable pursuant to the second preceding sentence.
(c) Notice.
(i) The Corporation will provide notice to holders of record of the Series
G Preferred of any redemption pursuant to Section 4(a) or 4(b) not less than 10
(in the case of Section 4(a)) and 30 (in the case of Section 4(b)) nor more than
60 days prior to the date fixed for such redemption (a "Redemption Notice"). Any
Notice provided pursuant to this Section 4(c) shall be provided by first-class
mail, postage prepaid, to each holder of record of the Series G Preferred, at
such holder's address as it appears on the stock transfer books of the
Corporation.
(ii) Each Redemption Notice shall state, as appropriate: (x) the Applicable
Redemption Date; (y) the number of shares of Series G Preferred to be redeemed
and, if fewer than all the shares held by any holder are to be redeemed, the
number of such shares to be redeemed from such holder; and (z) the Optional
Redemption Price or Mandatory Redemption Price.
(iii) In addition, each Redemption Notice shall state, as appropriate: (v)
the place or places where certificates for such shares are to be surrendered for
redemption; (w) the amount of full cumulative dividends per share of Series G
Preferred to be redeemed (including Additional Dividends) up to but excluding
the Applicable Redemption Date, and that dividends on shares of Series G
Preferred to be redeemed will cease to accrue on such Redemption Date unless the
Corporation shall default in payment of the Applicable Redemption Price; (x) the
name and location of any bank or trust company with which the Corporation will
deposit redemption funds pursuant to subsection (e) below; (y) the
then-effective Conversion Price; and (z) that the right of holders to convert
shares of Series G Preferred to be redeemed will terminate at the close of
business on the Business Day next preceding the date fixed for redemption
(unless the Corporation shall default in the payment of the Applicable
Redemption Price).
C-1-3
Any Notice that is mailed pursuant to clause (i) shall be conclusively
presumed to have been duly given, whether or not the holder of shares of Series
G Preferred receives such notice, and failure to give such notice by mail, or
any defect in such notice, to the holders of any shares designated for
redemption shall not affect the validity of the proceedings for the redemption
of any other shares of Series G Preferred.
(d) Mechanics of Redemption. Upon surrender in accordance with any notice
referred to in subsection (d) above of the certificate for any shares redeemed
pursuant to Section 4(a) or (b) (duly endorsed or accompanied by appropriate
instruments of transfer if so required by the Corporation), the holders of
record of such shares shall be entitled to receive the Applicable Redemption
Price, without interest, up to but excluding such Redemption Date out of funds
legally available therefor. If fewer than all the shares represented by any such
certificate are redeemed, a new certificate representing the unredeemed shares
shall be issued without cost to the holder thereof.
(e) Redemption Funds. On the date of any redemption being made pursuant to
this Section, the Corporation shall, and at any time after mailing the
Redemption Notice and before the Applicable Redemption Date the Corporation may,
deposit for the benefit of the holders of shares of Series G Preferred to be
redeemed the funds necessary for such redemption with a bank or trust company
having a capital and surplus of at least $1 billion, with instructions to such
bank or trust company to pay the full redemption as provided herein to the
holders of shares of Series G Preferred upon surrender of certificates for such
shares; provided, however, that the making of such deposit shall not release the
Corporation from any of its obligations hereunder. Any moneys so deposited by
the Corporation and unclaimed at the end of two years from the Applicable
Redemption Date shall revert to the general funds of the Corporation and, upon
demand, such bank or trust company shall pay over to the Corporation such
unclaimed amounts and thereupon such bank or trust company shall be relieved of
all responsibility in respect thereof and any holder of shares of Series G
Preferred so redeemed shall look only to the Corporation for the payment of the
full redemption amounts, as provided herein.
(f) Rights After Redemption. Notice of redemption having been given as
provided in Section 4(c), upon the deposit pursuant to subsection (e) of the
full redemption amounts as provided herein in respect of all shares of Series G
Preferred then to be redeemed, notwithstanding that any certificates for such
shares shall not have been surrendered in accordance with subsection (d), from
and after the Applicable Redemption Date: (i) the shares represented thereby
shall no longer be deemed outstanding, (ii) the right to receive dividends
thereon shall cease to accrue, and (iii) all rights of the holders of such
shares of Series G Preferred shall cease and terminate, excepting only the right
to receive the full redemption amounts as provided herein without interest
thereon. If the funds deposited are not sufficient for redemption of the shares
of the Series G Preferred that were to be redeemed, then no certificates
evidencing such shares shall be deemed surrendered and such shares shall remain
outstanding and the rights of holders of shares of Series G Preferred shall
continue to be those of holders of shares of the Series G Preferred.
Section 5. Reacquired Shares.
Any shares of Series G Preferred converted, exchanged, redeemed, purchased
or otherwise acquired by the Corporation in any manner whatsoever shall be
retired and canceled promptly after the acquisition thereof. All such shares of
Series G Preferred shall upon their cancellation become authorized but unissued
shares of preferred stock, par value $.01 per share, of the Corporation and,
upon the filing of an appropriate Certificate of Designation with the Secretary
of State of the State of Delaware, may be reissued as part of another series of
preferred stock, par value $.01 per share, of the Corporation subject to the
conditions or restrictions on issuance set forth therein, but in any event may
not be reissued as shares of Series G Preferred unless all shares of the Series
G Preferred issued on each of the Issue Dates shall have already been redeemed,
converted or exchanged.
Section 6. Liquidation, Dissolution or Winding Up.
Upon any voluntary or involuntary dissolution, liquidation or winding up of
the Corporation, the Corporation shall pay to holders of shares of Series G
Preferred for cash, at a price per share, in immediately available funds, equal
to the sum of (x) the Liquidation Preference per share plus (y) any accrued and
unpaid dividends thereon (including Additional Dividends), whether or not
declared or payable, prior to any distribution to the holders of any Common
Stock. If the proceeds from any such event are not sufficient to pay to the
holders of Series G Preferred then such holders shall instead be entitled to
receive, pro rata with the holders of all other series of preferred stock of the
Corporation, the entire assets and funds of the Corporation legally available
for distribution to the holders of
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capital stock, which assets and funds shall be distributed pro rata among the
holders of the Series G Preferred on the basis of the amounts per share to be
paid to each. After payment of the full preferential amount, such holders shall
not be entitled to any further participation in any distribution of assets of
the Corporation.
Section 7. Voluntary Conversion.
(a) Conversion Right. Any holder of Series G Preferred shall have the
right, at its option, at any time and from time to time, to convert, subject to
the terms and provisions of this Section 7, any or all of such holder's shares
of Series G Preferred into such number of fully paid and non-assessable shares
of Common Stock as is equal, subject to Section 7(f), to the product of the
number of shares of Series G Preferred being so converted multiplied by the
quotient of (i) the sum of the Liquidation Preference and all dividends accrued
and unpaid (including Additional Dividends) on the Series G Preferred so
converted to the date of conversion, divided by (ii) the Conversion Price then
in effect, except that with respect to any shares which shall be called for
exchange or redemption, such right shall terminate at the close of business on
the date of exchange or redemption for such shares, unless in any such case the
Corporation shall default in performance or payment due upon exchange or
redemption thereof. The Conversion Price shall be calculated in accordance with
Section 7(k) and shall be subject to adjustment as set forth in Section 7(c).
Such conversion right shall be exercised by the surrender of the shares to be
converted to the Corporation at any time during usual business hours at its
principal place of business to be maintained by it, accompanied by written
notice that the holder elects to convert such Shares and, subject to Section
7(j), specifying the name or names (with address) in which a certificate or
certificates for shares of Common Stock are to be issued and (if so required by
the Corporation) by a written instrument or instruments of transfer in form
reasonably satisfactory to the Corporation duly executed by the holder or its
duly authorized legal representative and transfer tax stamps or funds therefor,
if required pursuant to Section 7(j). All shares of Series G Preferred
surrendered for conversion shall be delivered to the Corporation for
cancellation and canceled by it and no shares of Series G Preferred shall be
issued in lieu thereof.
(b) Mechanics of Conversion. As promptly as practicable after the
surrender, as herein provided, of any shares of Series G Preferred for
conversion pursuant to Section 7(a), the Corporation shall deliver to or upon
the written order of the holder of such shares so surrendered a certificate or
certificates representing the number of fully paid and non-assessable shares of
Common Stock into which such shares of Series G Preferred have been converted in
accordance with the provisions of this Section 7. Subject to the following
provisions of this paragraph and of Section 7(c), such conversion shall be
deemed to have been made immediately prior to the close of business on the date
that such shares of Series G Preferred shall have been surrendered in
satisfactory form for conversion, and the Person or Persons entitled to receive
the Common Stock deliverable upon conversion of such shares of Series G
Preferred shall be treated for all purposes as having become the record holder
or holders of such Common Stock at such time, and such conversion shall be at
the Conversion Price in effect at such time; provided, however, that no
surrender shall be effective to constitute the Person or Persons entitled to
receive the Common Stock deliverable upon such conversion as the record holder
or holders of such Common Stock while the share transfer books of the
Corporation shall be closed (but not for any period in excess of five days), but
such surrender shall be effective to constitute the Person or Persons entitled
to receive such Common Stock as the record holder or holders thereof for all
purposes immediately prior to the close of business on the next succeeding day
on which such share transfer books are open, and such conversion shall be deemed
to have been made at, and shall be made at the Conversion Price in effect at,
such time on such next succeeding day.
(c) Adjustment of Conversion Price. If the Corporation shall, while shares
of Series G Preferred remain outstanding, (i) pay a dividend, or make a
distribution to holders of Common Stock, in either case in shares of its Common
Stock, (ii) subdivide its outstanding shares of Common Stock, (iii) combine its
outstanding shares of Common Stock into a smaller number of shares or (iv) issue
by reclassification of its shares of Common Stock any shares of capital stock of
the Corporation, in each case, at any time after the consummation of the
Recapitalization Transactions (as defined below), then thereafter the Conversion
Price shall be automatically (and without notice or further action) increased or
decreased, as the case may be, in direct proportion to the increase or decrease
in the number of shares of Common Stock by reason of such change so that the
aggregate Conversion Price of shares of Series G Preferred shall be unchanged by
such change.
(d) Effect of Setting Record Date. If the Corporation shall take a record
of the holders of its Common Stock for the purpose of entitling them to receive
a dividend or other distribution, and shall thereafter and before the
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distribution to stockholders thereof legally abandon its plan to pay or deliver
such dividend or distribution, then thereafter no adjustment in the Conversion
Price then in effect shall be required by reason of the taking of such record.
(e) Determination of Adjustment. The determination of the Board of
Directors of adjustments pursuant to Section 7(c) shall, absent manifest error,
be final on all holders of Series G Preferred.
(f) No Fractional Shares. No fractional shares or scrip representing
fractional shares shall be issued upon the conversion of any shares of Series G
Preferred. If more than one share of Series G Preferred shall be surrendered for
conversion at one time by the same holder, the number of full shares of Common
Stock issuable upon conversion thereof shall be computed on the basis of the
aggregate Liquidation Preference (plus accrued and unpaid dividends, including
any Additional Dividends) of the shares of Series G Preferred so surrendered. If
the conversion of any share or shares of Series G Preferred results in a
fraction, an amount equal to such fraction multiplied by the Current Market
Price of the Common Stock on the Business Day preceding the day of conversion
shall be paid to such holder in cash by the Corporation.
(g) Transactions. In case of any capital reorganization or reclassification
or other change of outstanding shares of Common Stock (other than a change in
par value, or from par value to no par value, or from no par value to par
value), or in case of any consolidation or merger of the Corporation with or
into another Person (other than a consolidation or merger in which the
Corporation is the resulting or surviving Person and which does not result in
any reclassification or change of outstanding Common Stock) (any of the
foregoing, a "Transaction"), the Corporation, or such successor or purchasing
Person, as the case may be, shall execute and deliver to each holder of Series G
Preferred at least 10 Business Days prior to effecting any of the foregoing
Transactions a certificate that the holder of each share of Series G Preferred
then outstanding shall have the right after the Transaction to convert such
share of Series G Preferred into the kind and amount of shares of stock or other
securities (of the Corporation or another issuer) or property or cash receivable
upon such Transaction by a holder of the number of shares of Common Stock into
which such share of Series G Preferred could have been converted immediately
prior to such Transaction (without giving effect to the Conversion Limit). Such
certificate shall provide for adjustments which shall be as nearly equivalent as
may be practicable to the adjustments provided for in this Section 7. If, in the
case of any such Transaction, the stock, other securities, cash or property
receivable thereupon by a holder of Common Stock includes shares of stock or
other securities of a Person other than the successor or purchasing Person and
other than the Corporation, which controls or is controlled by the successor or
purchasing Person or which, in connection with such Transaction, issues stock,
securities, other property or cash to holders of Common Stock, then such
certificate also shall be executed by such Person, and such Person shall, in
such certificate, specifically acknowledge the obligations of such successor or
purchasing Person and acknowledge its obligations to issue such stock,
securities, other property or cash to the holders of Series G Preferred upon
conversion of the shares of Series G Preferred as provided above. The provisions
of this Section 7(g) and any equivalent thereof in any such certificate
similarly shall apply to successive Transactions.
(h) Notice. In case at any time or from time to time:
(i) the Corporation shall declare a dividend (or any other
distribution) on its common stock;
(ii) the Corporation shall authorize the granting to the holders of
its Common Stock of rights or warrants to subscribe for or purchase any
shares of stock of any class or of any other rights or warrants;
(iii) there shall be any reclassification of the Common Stock, or any
consolidation or merger to which the Corporation is a party and for which
approval of any shareholders of the Corporation is required, or any sale or
other disposition of all or substantially all of the assets of the
Corporation; or
(iv) there shall be any voluntary or involuntary dissolution,
liquidation or winding up of the Corporation;
then the Corporation shall mail to each holder of shares of Series G Preferred
at such holder's address as it appears on the transfer books of the Corporation,
as promptly as possible but in any event at least 10 days prior to the
appli-
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cable date hereinafter specified, a notice stating (x) the date on which a
record is to be taken for the purpose of such dividend, distribution or rights
or warrants or, if a record is not to be taken, the date as of which the holders
of Common Stock of record to be entitled to such dividend, distribution or
rights are to be determined, or (y) the date on which such reclassification,
consolidation, merger, sale, conveyance, dissolution, liquidation or winding up
is expected to become effective. Such notice also shall specify the date as of
which it is expected that holders of Common Stock of record shall be entitled to
exchange their Common Stock for shares of stock or other securities or property
or cash deliverable upon such reclassification, consolidation, merger, sale,
conveyance, dissolution, liquidation or winding up.
(i) Reservation of Common Stock. The Corporation shall at all times reserve
and keep available for issuance upon the conversion of the Series G Preferred
pursuant to Section 7(a) or 9(a), such number of its authorized but unissued
shares of Common Stock as will from time to time be sufficient to permit the
conversion of all outstanding shares of Series G Preferred, and shall take all
action required to increase the authorized number of shares of Common Stock if
at any time there shall be insufficient authorized but unissued shares of Common
Stock to permit such reservation or to permit the conversion of all outstanding
shares of Series G Preferred.
(j) Issuance of Certificates. The issuance or delivery of certificates for
Common Stock upon the conversion of shares of Series G Preferred pursuant to
Section 7(a) or 9(a) shall be made without charge to the converting holder of
shares of Series G Preferred for such certificates or for any tax in respect of
the issuance or delivery of such certificates or the securities represented
thereby, and such certificates shall be issued or delivered in the respective
names of, or (subject to compliance with the applicable provisions of federal
and state securities laws) in such names as may be directed by, the holders of
the shares of Series G Preferred converted; provided, however, that the
Corporation shall not be required to pay any tax which may be payable in respect
of any transfer involved in the issuance and delivery of any such certificate in
a name other than that of the holder of the shares of Series G Preferred
converted, and the Corporation shall not be required to issue or deliver such
certificate unless or until the Person or Persons requesting the issuance or
delivery thereof shall have paid to the Corporation the amount of such tax or
shall have established to the reasonable satisfaction of the Corporation that
such tax has been paid.
(k) Conversion Price. The conversion price (the "Conversion Price") for
each share of Series G Preferred after giving effect to the exchange offer and
the amendments to the Corporation's certificate of incorporation each as
described in the Corporation's proxy statement dated , 2004 (collectively, the
"Recapitalization Transactions") shall be $1.28 per share.
(l) Conversion Limit. Notwithstanding anything to the contrary, on any day
prior to the Stockholder Approval Certification Date, the maximum number of
whole or fractional shares of Series G Preferred that may be converted into
Common Stock pursuant to any provision of this Certificate of Designation shall
be the number of shares of Series G Preferred that, if converted into shares of
Common Stock at the then applicable Conversion Price, would convert into the
"Maximum Remaining Pre-Approval Shares." The "Maximum Remaining Pre-Approval
Shares" means a number of shares of Common Stock equal to (1) the
Pre-Stockholder Approval Number, minus (2) the number of shares of Common Stock,
if any, then already issued by the Corporation pursuant to the conversion of any
Series G Preferred. Thereafter, no additional shares of Series G Preferred may
be converted while the Conversion Limit is in effect. Until the Stockholder
Approval Certification Date, no Series G Preferred holder may convert pursuant
to Section 7(a) without approval of holders of a majority of the Series G
Preferred. The preceding portion of Section 7(l) is referred to in this
Certificate of Designation as the "Conversion Limit." The Conversion Limit shall
act merely to limit the number of shares of Common Stock issuable upon
conversion of the Series G Preferred prior to the Stockholder Approval
Certification Date and not to restrict any adjustments to the Conversion Price,
whether pursuant to Section 7(c) or otherwise, and shall not affect any matter
other than the conversion of shares of Series G Preferred into shares of Common
Stock. For the avoidance of doubt, the adjustments to the Conversion Price
pursuant to Section 7(c) shall be calculated regardless of whether the
Conversion Limit is in effect and the Conversion Limit shall act merely to limit
the number of shares of Common Stock issuable upon conversion of the Series G
Preferred prior to Stockholder Approval (and not to restrict any adjustments to
the Conversion Price).
Section 8. Certain Remedies.
Any registered holder of Series G Preferred shall be entitled to an
injunction or injunctions to prevent breaches of the provisions of this
Certificate of Designation and to enforce specifically the terms and provisions
of
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this Certificate of Designation in any court of the United States or any state
thereof having jurisdiction, this being in addition to any other remedy to which
such holder may be entitled at law or in equity.
Section 9. Automatic Conversion.
(a) Time of Conversion. If at any time after the first anniversary of the
Effective Date, the Market Price of the Common Stock for 20 consecutive Trading
Days exceeds $10.00 per share (as appropriately adjusted for stock splits, stock
combinations and similar events), then on the 30th Business Day following the
end of such 20-day period (the "Conversion Date"), all outstanding shares of
Series G Preferred shall automatically convert, subject to the Conversion Limit
(if any), without any action by the holders thereof, into such number of fully
paid and non-assessable shares of Common Stock as is equal, subject to Section
7(f), to the product of the number of shares of Series G Preferred being so
converted multiplied by the quotient of (i) the Liquidation Preference (plus
accrued and unpaid dividends, including any Additional Dividends to and
including the Conversion Date) divided by (ii) the Conversion Price in effect on
the Conversion Date.
(b) Officer's Certificate. The Corporation will provide notice to holders
of record of Series G Preferred of the conversion pursuant to Section 9(a) at
least 20 Business Days prior to the Conversion Date, by first-class mail postage
prepaid, to each holder of record of the Series G Preferred, at such holder's
address as it appears on the stock transfer books of the Corporation. Such
notice shall include an officer's certificate attesting to the satisfaction of
the condition precedent to optional conversion, stating the Conversion Price in
effect on the Conversion Date and the number of fully paid and non-assessable
shares of Common Stock into which such shares of Series G Preferred will be
converted in accordance with Section 7 and this Section 9.
(c) The Corporation shall deposit for the benefit of the holders of shares
of Series G Preferred the share certificates representing the shares of Common
Stock deliverable upon conversion of the shares of Series G Preferred with a
bank or trust company having a capital and surplus of at least $1 billion, with
instructions to such bank or trust company to deliver the certificates to the
holders of shares of Series G Preferred upon surrender of the certificates for
such shares; provided, however, that the making of such deposit shall not
release the Corporation from any of its obligations hereunder. Any certificates
so deposited by the Corporation and unclaimed at the end of two years from the
Conversion Date shall revert to the Corporation and the bank or trust company
shall be relieved of all responsibility in respect thereof and any holder of
shares of Series G Preferred so converted shall look only to the Corporation for
the certificate representing the Common Stock issued upon the conversion, as
provided herein.
(d) Effect of Conversion. Notice of conversion having been given as
provided in Section 9(b), upon the deposit pursuant to subsection (c) of the
certificates representing the shares of Common Stock issuable upon conversion of
the shares of Series G Preferred, notwithstanding that any certificates for such
shares shall not have been surrendered for cancellation, from and after the
Conversion Date (i) the shares represented thereby shall no longer be deemed
outstanding, (ii) the rights to receive dividends thereon shall cease to accrue,
and (iii) all rights of the holders of shares of Series G Preferred to be
converted shall cease and terminate, excepting only the right to receive the
shares of Common Stock. If the Corporation shall default in the execution and
delivery of the shares of Common Stock, then no certificates evidencing such
shares shall be deemed surrendered and such shares shall remain outstanding and
the rights of holders of Series G Preferred shall continue to be those of
holders of shares of the Series G Preferred.
Section 10. Definitions.
For the purposes of this Certificate of Designation of Series G Preferred,
the following terms shall have the meanings indicated:
"Additional Amount" means an amount equal to the amount of dividends to
accrue on a share of Series G Preferred pursuant to Section 2(a) hereof from the
date of issuance of such share to and including the fifth anniversary thereof,
assuming that on each Quarterly Dividend Date such dividends to be paid on such
date were added to the Liquidation Preference on such Quarterly Dividend Date
for purposes of Section 2(a).
C-1-8
"Affiliate" shall have the meaning ascribed to such term in Rule 12b-2 of
the General Rules and Regulations under the Exchange Act; provided, that for
purposes of this Certificate, neither the 1818 Fund III, L.P. nor any of its
Affiliates shall be considered an Affiliate of the Corporation.
"Business Day" shall mean any day other than a Saturday, Sunday or other
day on which commercial banks in the State of Delaware are authorized or
required by law or executive order to close.
"Common Stock" shall mean the common stock, par value $.01 per share, and
each other class of capital stock of the Corporation into which such stock is
reclassified or reconstituted.
"Conversion Limit" shall mean the limitation set forth in Section 7(l).
"Current Market Price" per share shall mean, on any date specified herein
for the determination thereof, (a) the average daily Market Price of the Common
Stock for those days during the period of 20 days, ending on such date, which
are Trading Days, and (b) if the Common Stock is not then listed or admitted to
trading on any national securities exchange or quoted in the over-the-counter
market, the Market Price on such date.
"Drawdown Date" shall mean September 18, 2001.
"Effective Date" shall mean July 2, 2001.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as amended,
and the rules and regulations of the Securities and Exchange Commission
thereunder.
"Fair Market Value" shall mean the amount which a willing buyer, under no
compulsion to buy, would pay a willing seller, under no compulsion to sell, in
an arm's-length transaction (assuming that the Common Stock is valued "as if
fully distributed" so that, among other things, there is no consideration given
for minority investment discounts or discounts related to illiquidity or
restrictions on transferability).
"GAAP" shall mean the generally accepted United States accounting
principles in effect from time to time.
"Investment Agreement" shall mean the Stock and Warrant Purchase Agreement,
dated July 2, 2001 between the Corporation, The 1818 Fund III, L.P. and the
other persons listed therein, as the same may be amended from time to time.
"Issue Date" shall mean, with respect to any share of Series G Preferred,
the original date of issuance of such share of Series G Preferred pursuant to
the Investment Agreement.
"Liquidation Preference" with respect to a share of Series G Preferred
shall mean $100,000.
"Market Price" shall mean, per share of Common Stock on any date specified
herein: (a) the closing price per share of the Common Stock on such date
published in The Wall Street Journal or, if no such closing price on such date
is published in The Wall Street Journal, the average of the closing bid and
asked prices on such date, as officially reported on the principal national
securities exchange on which the Common Stock is then listed or admitted to
trading; (b) if the Common Stock is not then listed or admitted to trading on
any national securities exchange but is designated as a national market system
security, the last trading price of the Common Stock on such date; or (c) if
there shall have been no trading on such date or if the Common Stock is not so
designated, the average of the reported closing bid and asked prices of the
Common Stock on such date as shown by NASDAQ and reported by any member firm of
the NYSE, selected by the Corporation. If neither (a), (b) nor (c) is
applicable, Market Price shall mean the Fair Market Value per share determined
in good faith by the Board of Directors of the Corporation which shall be deemed
to be Fair Market Value unless holders of at least 50% of the outstanding shares
of Series G Preferred request that the Corporation obtain an opinion of a
nationally recognized investment banking firm chosen by such holders and the
Corporation (at the Corporation's expense), in which event Fair Market Value
shall be as determined by such investment banking firm.
C-1-9
"NASDAQ" shall mean the National Market System of the Nasdaq Stock Market.
"NYSE" shall mean the New York Stock Exchange, Inc.
"Person" shall mean any individual, firm, corporation, partnership, limited
liability company trust, incorporated or unincorporated association, joint
venture, joint stock company, government (or an agency or political subdivision
thereof) or other entity of any kind, and shall any successor (by merger) of
such entity.
"Pre-Stockholder Approval Number" shall mean as of any date 20% of the
number of shares of Common Stock issued and outstanding prior to the Effective
Date (subject to adjustment to reflect stock splits, stock dividends, stock
combinations, recapitalizations and like occurrences), rounded down to the
nearest whole number of shares, minus the sum of (x) the number of shares of
Common Stock then issuable upon exercise of all then-outstanding warrants issued
pursuant to the Investment Agreement (the "Warrants"), plus (y) the number of
shares of Common Stock previously issued upon exercise of the Warrants, if any,
plus (z) one in the case of both (x) and (y) rounded down to the nearest whole
number.
"Stockholder Approval" shall mean the vote, by a majority of the votes cast
in the Stockholder Vote, in favor of approval of the matter considered in such
vote.
"Stockholder Approval Certification Date" shall mean earlier of (i) the
date that the Stockholder Meeting occurred and that Stockholder Approval has
been obtained, or (ii) the date of a certificate, delivered by the Corporation
to each registered holder of Series G Preferred, signed by the President or a
Vice-President and by the Secretary or an Assistant Secretary of the
Corporation, stating that the Corporation has determined that the Corporation is
not required by any Law or by any NASDAQ Rule to obtain Stockholder Approval,
the basis for such determination, and that the Corporation has then confirmed
that such determination is acceptable to Persons holding a majority of the then
outstanding shares of Series G Preferred.
"Stockholder Meeting" shall mean a special meeting of the Corporation's
stockholders, duly called and convened, at which a quorum is present throughout
and at which the Stockholder Vote is conducted.
"Stockholder Vote" shall mean a vote, by those of the Corporation's
stockholders entitled to vote thereon, on the matter of approval of the terms of
the Investment Agreement and of the Series G Preferred.
"Subsidiary" shall mean, with respect to any Person, a corporation or other
entity of which 50% or more of the voting power of the voting equity securities
or equity interest is owned, directly or indirectly, by such Person.
"Trading Days" shall mean a day on which the national securities exchanges
are open for trading.
Section 11. Modification or Amendment.
Except as specifically set forth herein, modifications or amendments to
this Certificate of Designation may be made by the Corporation with the consent
of the holders of at least 50% of the outstanding shares of Series G Preferred.
C-1-10
IN WITNESS WHEREOF, Z-Tel Technologies, Inc. has caused this Amended
Certificate to be duly executed in its corporate name on this day of , 2004.
Z-TEL TECHNOLOGIES, INC.
By:
---------------------------------
Name:
Title:
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Annex C-2
CERTIFICATE OF AMENDMENT
OF THE AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION OF
Z-TEL TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
Pursuant to the Delaware General Corporation Law, Z-Tel Technologies, Inc.,
a Delaware corporation (the "Corporation"), DOES HEREBY CERTIFY:
FIRST: That pursuant to the authority conferred upon the Board of Directors
of the Corporation by the Certificate of Incorporation of the Corporation (the
"Charter"), the Board of Directors of the Corporation on June 29, 2001, duly
adopted resolutions creating a series of 12% Junior Redeemable Convertible
Preferred Stock, Series G (the "Series G Convertible Preferred Stock"), the
terms of which were subsequently amended (as amended, the "Certificate of
Designation").
SECOND: Resolutions, setting forth this proposed Certificate of Amendment
(the "Certificate of Amendment"), declaring this Certificate of Amendment to be
advisable and directing that this Certificate of Amendment be considered by the
stockholders of the Corporation entitled to vote thereon, were duly adopted by
the Board of Directors of the Corporation.
THIRD: Thereafter, this Certificate of Amendment was approved at a special
meeting duly called and convened in accordance with Section 222 of the General
Corporation Law of the State of Delaware on , 2004 by vote in respect
thereof of the requisite percentage of the stockholders of the Corporation
entitled to vote thereon.
FOURTH: This Certificate of Amendment was duly adopted in accordance with
Section 242 of the General Corporation Law of the State of Delaware.
FIFTH: The Corporation has acquired all of the outstanding shares of the
Series G Convertible Preferred Stock through an exchange offer completed on
, 2004.
SIXTH: This Certificate of Amendment amends the Amended and Restated
Certificate of Incorporation of the Corporation by eliminating the Certificate
of Designation in its entirety.
IN WITNESS WHEREOF, Z Tel Technologies, Inc. has caused this Certificate of
Amendment to be duly executed in its corporate name on this day of , 2004.
Z-TEL TECHNOLOGIES, INC.
By:
---------------------------------
Name:
Title:
C-2-1
Annex D
CERTIFICATE OF AMENDMENT OF THE
AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION OF Z-TEL TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
Z-TEL TECHNOLOGIES, INC., a corporation organized and existing under and by
virtue of the General Corporation Law of the State of Delaware (the "DGCL"),
hereby certifies as follows:
FIRST: The name of the Corporation is Z-TEL TECHNOLOGIES, INC. (the
"Corporation").
SECOND: Article IV of the Corporation's current Restated Certificate of
Incorporation, as amended, is hereby amended to include the following text as
Subsection C to Article IV:
"C. Upon this Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of the corporation becoming effective in accordance
with the General Corporation Law of the State of Delaware (the "Effective
Time"), each three (3), four (4), five (5), six (6), seven (7) or eight (8)
shares of Common Stock, par value $.01 per share, of the corporation ("Old
Common Stock") issued and outstanding immediately prior to the Effective Time
shall be automatically reclassified as and converted into one (1) share of
Common Stock, par value $.01 per share, of the corporation ("New Common Stock")
Notwithstanding the immediately preceding sentence, no fractional shares of
New Common Stock shall be issued in connection with the foregoing
reclassification of shares of Old Common Stock. In lieu thereof, upon surrender
after the Effective Time of a certificate formerly representing shares of Old
Common Stock, the corporation shall pay to the holder of the certificate an
amount in cash at a price equal to the fraction to which the stockholder would
otherwise be entitled multiplied by the closing price of the Common Stock, as
reported in the Wall Street Journal, on the first trading date after the date on
which the Effective Time occurs.
Each stock certificate that, immediately prior to the Effective Time,
represented shares of Old Common Stock shall, from and after the Effective Time,
automatically and without the necessity of presenting the same for exchange,
represent that number of whole shares of New Common Stock into which the shares
of Old Common Stock represented by such certificate shall have been reclassified
(as well as the right to receive cash in lieu of any fractional shares of New
Common Stock), provided, however, that each holder of record of a certificate
that represented shares of Old Common Stock shall receive, upon surrender of
such certificate, a new certificate representing the number of whole shares of
New Common Stock into which the shares of Old Common Stock represented by such
certificate shall have been reclassified, as well as any cash in lieu of
fractional shares New Common Stock to which such holder may be entitled pursuant
to the immediately preceding paragraph."
THIRD: This Certificate of Amendment of the Corporation's Amended and
Restated Certificate of Incorporation has been duly adopted by the Board of
Directors and Stockholders of the Corporation in accordance with the provisions
of Section 242 of the DGCL.
IN WITNESS WHEREOF, Z-TEL TECHNOLOGIES, INC., has caused this certificate
to be duly executed in its corporate name on this day of , 2004.
Z-TEL TECHNOLOGIES, INC.
By: _____________________________
Name:
Title:
D-1
Annex E
CERTIFICATE OF AMENDMENT OF THE
AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION OF Z-TEL TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
Z-TEL TECHNOLOGIES, INC., a corporation organized and existing under and by
virtue of the General Corporation Law of the State of Delaware (the "DGCL"),
hereby certifies as follows:
FIRST: The name of the Corporation is Z-TEL TECHNOLOGIES, INC. (the
"Corporation").
SECOND: Article I of the Corporation's current Restated Certificate of
Incorporation, as amended (the "Certificate of Incorporation"), is hereby
amended in its entirety so it reads:
"ARTICLE I
Name
The name of the corporation is Trinsic, Inc."
THIRD: All other references to "Z-Tel Technologies, Inc." in the
Certificate of Incorporation shall be amended to be references to "Trinsic,
Inc."
FOURTH: This Certificate of Amendment of the Corporation's Amended and
Restated Certificate of Incorporation has been duly adopted by the Board of
Directors and Stockholders of the Corporation in accordance with the provisions
of Section 242 of the DGCL.
IN WITNESS WHEREOF, Z-TEL TECHNOLOGIES, INC., has caused this certificate
to be duly executed in its corporate name on this day of , 2004.
Z-TEL TECHNOLOGIES, INC.
By: _____________________________
Name:
Title:
E-1
Annex F
OPINION OF MORGAN KEEGAN & COMPANY, INC.
September 28, 2004
Special Committee of the Independent Directors
(the "Special Committee")
Z-Tel Technologies, Inc.
601 S. Harbour Island Blvd.
Suite 220
Tampa, FL 33602
Members of the Special Committee:
We have been engaged by Z-Tel Technologies, Inc. ("Z-Tel" or the "Company"),
pursuant to an engagement letter dated July 6, 2004, to advise and provide to
the Special Committee our opinion with respect to the fairness, from a financial
point of view, to the holders the Company's common stock ("Common Stockholders")
of a proposed offer by the Company to exchange its three outstanding series of
convertible preferred stock as follows: for its Series D Convertible Preferred
Stock, which as of September 27, 2004 3,976,723 shares with a liquidation
preference of $16.55 per share and a conversion price of $8.47 per share were
outstanding, to exchange 25.69030 shares of its common stock ("Common Stock"),
for each share of its Series D Preferred Stock (representing an exchange price
of approximately $0.644 per share); for its 8% Convertible Preferred Stock,
Series E, which as of September 27, 2004 4,166,667 shares with a liquidation
preference of $16.26 per share and a conversion price of $8.08 per share were
outstanding, to exchange 25.24216 shares of Common Stock, for each share of its
Series E Preferred Stock (representing an exchange price of approximately $0.644
per share); and for its 12% Junior Redeemable Convertible Preferred Stock,
Series G, which as of September 27, 2004 171.214286 shares outstanding with had
a liquidation preference of $144,974.90 per share and conversion price of $1.28
per share were outstanding, to exchange 161,469.4 shares of Common Stock, for
each share of its Series G Preferred Stock (representing an exchange price of
approximately $0.898 per share) (collectively "Exchange Offer").
In arriving at our opinion, we have reviewed the reviewed the proposed terms of
the Exchange Offer; reviewed certain publicly available business and financial
information relating to Z-Tel; reviewed a series of internal presentations and
correspondence prepared by Z-Tel's management regarding Z-Tel's business plan
and capital structure among others; reviewed certain other information provided
to us by Z-Tel and discussed the business prospects and financial position of
Z-Tel with its management and independent auditors; visited Z-Tel's office
facilities located in Atmore, Alabama; reviewed audited financial results of
Z-Tel for fiscal years ended December 2001 through 2003 as well as for the
latest twelve months ended June 30, 2004 and the latest unaudited interim
results of Z-Tel; reviewed financial forecasts provided by Z-Tel's management;
reviewed the reported historical prices and historical trading activity of the
Common Stock; compared and considered the financial performance of Z-Tel with
that of certain other publicly traded companies and their securities; performed
such other analyses and considered such other factors as Morgan Keegan deemed
appropriate.
In connection with our review, we have not assumed any responsibility for
independent verification of any of the foregoing information and have relied on
such information being complete and accurate in all material respects. We have
assumed with respect to financial forecasts provided to Morgan Keegan that they
had been reasonably prepared on bases reflecting the best currently available
estimates and judgments of management as to future financial performance of
Z-Tel. We also assumed that there had been no material changes in Z-Tel's
assets, financial condition, results of operations, business or prospects since
the respective dates of the last financial statements made available to us. We
have not been requested to make, and have not made, an independent evaluation or
appraisal of the assets of liabilities (contingent or otherwise) of Z-Tel, nor
have we been furnished with any such evaluation or appraisal.
F-1
Our opinion is necessarily based upon information available to us, and
financial, economic, market and other conditions as they exist and can be
evaluated, on the date hereof.
We have acted as financial advisor to the Special Committee in connection with
the Exchange Offer and will receive a fee upon delivery of this opinion. We have
not in the past provided financial and investment banking services to Z-Tel. In
the ordinary course of business, we and our affiliates may hold or actively
trade the securities of Z-Tel for our own account and for the accounts of
customers and, accordingly, may at any time hold long or short positions in such
securities.
It is understood that this letter is solely for the information of the Special
Committee in connection with its consideration of the Exchange Offer and does
not constitute a recommendation to any Common Stockholder as to whether such
stockholder should tender shares in connection with the transaction.
Based upon and subject to the foregoing, it is our opinion that, as of the date
hereof, the Exchange Offer is fair, from a financial point of view, to the
Common Stockholders of the Company.
Very truly yours,
/s/ MORGAN KEEGAN & COMPANY, INC.
F-2
Annex G
2004 STOCK INCENTIVE PLAN
Z-TEL TECHNOLOGIES, INC.
2004 STOCK INCENTIVE PLAN
1. Purposes.
The purposes of the 2004 Stock Incentive Plan are to advance the interests
of Z-Tel Technologies, Inc. and its shareholders by providing a means to
attract, retain, and motivate employees, consultants and directors of the
Company, its subsidiaries and affiliates, to provide for competitive
compensation opportunities, to encourage long term service, to recognize
individual contributions and reward achievement of performance goals, and to
promote the creation of long term value for stockholders by aligning the
interests of such persons with those of stockholders.
2. Definitions.
For purposes of the Plan, the following terms shall be defined as set forth
below:
(a) "Affiliate" means any entity other than the Company and its
Subsidiaries that is designated by the Board or the Committee as a participating
employer under the Plan; provided, however, that the Company directly or
indirectly owns at least 20% of the combined voting power of all classes of
stock of such entity or at least 20% of the ownership interests in such entity.
(b) "Award" means any Option, SAR, Restricted Share, Restricted Share Unit,
Performance Share, Performance Unit, Dividend Equivalent, or Other Share-Based
Award granted to an Eligible Person under the Plan.
(c) "Award Agreement" means any written agreement, contract, or other
instrument or document evidencing an Award.
(d) "Beneficiary" means the person, persons, trust or trusts which have
been designated by an Eligible Person in his or her most recent written
beneficiary designation filed with the Company to receive the benefits specified
under this Plan upon the death of the Eligible Person, or, if there is no
designated Beneficiary or surviving designated Beneficiary, then the person,
persons, trust or trusts entitled by will or the laws of descent and
distribution to receive such benefits.
(e) "Board" means the Board of Directors of the Company.
(f) "Code" means the Internal Revenue Code of 1986, as amended from time to
time. References to any provision of the Code shall be deemed to include
successor provisions thereto and regulations thereunder.
(g) "Committee" means the Compensation Committee of the Board, or such
other Board committee (which may include the entire Board) as may be designated
by the Board to administer the Plan; provided, however, that, unless otherwise
determined by the Board, the Committee shall consist of two or more directors of
the Company, each of whom is a "non-employee director" within the meaning of
Rule 16b-3 under the Exchange Act, to the extent applicable, and each of whom is
an "outside director" within the meaning of Section 162(m) of the Code, to the
extent applicable; provided, further, that the mere fact that the Committee
shall fail to qualify under either of the foregoing requirements shall not
invalidate any Award made by the Committee which Award is otherwise validly made
under the Plan.
(h) "Company" means Z-Tel Technologies, Inc., a corporation organized under
the laws of Delaware or any successor corporation.
(i) "Director" means a member of the Board who is not an employee of the
Company, a Subsidiary or an Affiliate.
G-1
(j) "Dividend Equivalent" means a right, granted under Section 5(g), to
receive cash, Shares, or other property equal in value to dividends paid with
respect to a specified number of Shares. Dividend Equivalents may be awarded on
a free-standing basis or in connection with another Award, and may be paid
currently or on a deferred basis.
(k) "Eligible Person" means (i) an employee or consultant of the Company, a
Subsidiary or an Affiliate, including any director who is an employee, or (ii) a
Director. Notwithstanding any provisions of this Plan to the contrary, an Award
may be granted to an employee, consultant or Director, in connection with his or
her hiring or retention prior to the date the employee, consultant or Director
first performs services for the Company, a Subsidiary or an Affiliate; provided,
however, that any such Award shall not become vested or exercisable prior to the
date the employee, consultant or Director first performs such services.
(l) "Exchange Act" means the Securities Exchange Act of 1934, as amended
from time to time. References to any provision of the Exchange Act shall be
deemed to include successor provisions thereto and regulations thereunder.
(m) "Fair Market Value" means, with respect to Shares or other property,
the fair market value of such Shares or other property determined by such
methods or procedures as shall be established from time to time by the
Committee. If the Shares are listed on any established stock exchange or a
national market system, unless otherwise determined by the Committee in good
faith, the Fair Market Value of Shares shall mean the mean between the high and
low selling prices per Share on the date (or, if the Shares were not traded on
that day, the next preceding day that the Shares were traded) on the principal
exchange or market system on which the Shares are traded, as such prices are
officially quoted on such exchange.
(n) "ISO" means any Option intended to be and designated as an incentive
stock option within the meaning of Section 422 of the Code.
(o) "NQSO" means any Option that is not an ISO.
(p) "Option" means a right, granted under Section 5(b), to purchase Shares.
(q) "Other Share-Based Award" means a right, granted under Section 5(h),
that relates to or is valued by reference to Shares.
(r) "Participant" means an Eligible Person who has been granted an Award
under the Plan.
(s) "Performance Share" means a performance share granted under Section
5(f).
(t) "Performance Unit" means a performance unit granted under Section 5(f).
(u) "Plan" means this 2004 Stock Incentive Plan.
(v) "Restricted Shares" means an Award of Shares under Section 5(d) that
may be subject to certain restrictions and to a risk of forfeiture.
(w) "Restricted Share Unit" means a right, granted under Section 5(e), to
receive Shares or cash at the end of a specified deferral period.
(x) "Rule 16b-3" means Rule 16b-3, as from time to time in effect and
applicable to the Plan and Participants, promulgated by the Securities and
Exchange Commission under Section 16 of the Exchange Act.
(y) "SAR" or "Share Appreciation Right" means the right, granted under
Section 5(c), to be paid an amount measured by the difference between the
exercise price of the right and the Fair Market Value of Shares on the date of
exercise of the right, with payment to be made in cash, Shares, or property as
specified in the Award or determined by the Committee.
G-2
(z) "Shares" means common stock, $.01 par value per share, of the Company,
and such other securities as may be substituted for Shares pursuant to Section 4
hereof.
(aa) "Subsidiary" means any corporation (other than the Company) in an
unbroken chain of corporations beginning with the Company if each of the
corporations (other than the last corporation in the unbroken chain) owns shares
possessing 50% or more of the total combined voting power of all classes of
stock in one of the other corporations in the chain.
(bb) "Termination of Service" means the termination of the Participant's
employment, consulting services or directorship with the Company, its
Subsidiaries and its Affiliates, as the case may be. A Participant employed by a
Subsidiary of the Company or one of its Affiliates shall also be deemed to incur
a Termination of Service if the Subsidiary of the Company or Affiliate ceases to
be such a Subsidiary or an Affiliate, as the case may be, and the Participant
does not immediately thereafter become an employee or director of, or a
consultant to, the Company, another Subsidiary of the Company or an Affiliate.
Temporary absences from employment because of illness, vacation or leave of
absence and transfers among the Company and its Subsidiaries and Affiliates
shall not be considered a Termination of Service.
3. Administration.
(a) Authority of the Committee. The Plan shall be administered by the
Committee, and the Committee shall have full and final authority to take the
following actions, in each case subject to and consistent with the provisions of
the Plan:
(i) to select Eligible Persons to whom Awards may be granted;
(ii) to designate Affiliates;
(iii) to determine the type or types of Awards to be granted to each
Eligible Person;
(iv) to determine the type and number of Awards to be granted, the
number of Shares to which an Award may relate, the terms and conditions of
any Award granted under the Plan (including, but not limited to, any
exercise price, grant price, or purchase price, any restriction or
condition, any schedule for lapse of restrictions or conditions relating to
transferability or forfeiture, exercisability, or settlement of an Award,
and waiver or accelerations thereof, and waivers of performance conditions
relating to an Award, based in each case on such considerations as the
Committee shall determine), and all other matters to be determined in
connection with an Award;
(v) to determine whether, to what extent, and under what circumstances
an Award may be settled, or the exercise price of an Award may be paid, in
cash, Shares, other Awards, or other property, or an Award may be canceled,
forfeited, exchanged, or surrendered;
(vi) to determine whether, to what extent, and under what
circumstances cash, Shares, other Awards, or other property payable with
respect to an Award will be deferred either automatically, at the election
of the Committee, or at the election of the Eligible Person;
(vii) to prescribe the form of each Award Agreement, which need not be
identical for each Eligible Person;
(viii) to adopt, amend, suspend, waive, and rescind such rules and
regulations and appoint such agents as the Committee may deem necessary or
advisable to administer the Plan;
(ix) to correct any defect or supply any omission or reconcile any
inconsistency in the Plan and to construe and interpret the Plan and any
Award, rules and regulations, Award Agreement, or other instrument
hereunder;
G-3
(x) to accelerate the exercisability or vesting of all or any portion
of any Award or to extend the period during which an Award is exercisable;
(xi) to determine whether uncertificated Shares may be used in
satisfying Awards and otherwise in connection with the Plan; and
(xii) to make all other decisions and determinations as may be
required under the terms of the Plan or as the Committee may deem necessary
or advisable for the administration of the Plan.
(b) Manner of Exercise of Committee Authority. The Committee shall have
sole discretion in exercising its authority under the Plan. Any action of the
Committee with respect to the Plan shall be final, conclusive, and binding on
all persons, including the Company, Subsidiaries, Affiliates, Eligible Persons,
any person claiming any rights under the Plan from or through any Eligible
Person, and shareholders. The express grant of any specific power to the
Committee, and the taking of any action by the Committee, shall not be construed
as limiting any power or authority of the Committee. The Committee may delegate
to other members of the Board or officers or managers of the Company or any
Subsidiary or Affiliate the authority, subject to such terms as the Committee
shall determine, to perform administrative functions and, with respect to Awards
granted to persons not subject to Section 16 of the Exchange Act, to perform
such other functions as the Committee may determine, to the extent permitted
under Rule 16b-3 (if applicable) and applicable law.
(c) Limitation of Liability. Each member of the Committee shall be entitled
to, in good faith, rely or act upon any report or other information furnished to
him or her by any officer or other employee of the Company or any Subsidiary or
Affiliate, the Company's independent certified public accountants, or other
professional retained by the Company to assist in the administration of the
Plan. No member of the Committee, and no officer or employee of the Company
acting on behalf of the Committee, shall be personally liable for any action,
determination, or interpretation taken or made in good faith with respect to the
Plan, and all members of the Committee and any officer or employee of the
Company acting on their behalf shall, to the extent permitted by law, be fully
indemnified and protected by the Company with respect to any such action,
determination, or interpretation.
(d) Limitation on Committee's Discretion. Anything in this Plan to the
contrary notwithstanding, in the case of any Award which is intended to qualify
as "performance-based compensation" within the meaning of Section 162(m)(4)(C)
of the Code, if the Award Agreement so provides, the Committee shall have no
discretion to increase the amount of compensation payable under the Award to the
extent such an increase would cause the Award to lose its qualification as such
performance-based compensation.
4. Shares Subject to the Plan.
(a) Subject to adjustment as provided in Section 4(c) hereof, the total
number of Shares reserved for issuance in connection with Awards under the Plan
shall be __________ (the "Initial Shares"(1)). No Award may be granted if the
number of Shares to which such Award relates, when added to the number of Shares
previously issued under the Plan, exceeds the number of Shares reserved under
the preceding sentence. If any Awards are forfeited, canceled, terminated,
exchanged or surrendered or such Award is settled in cash or otherwise
terminates without a distribution of Shares to the Participant, any Shares
counted against the number of Shares reserved and available under the Plan with
respect to such Award shall, to the extent of any such forfeiture, settlement,
termination, cancellation, exchange or surrender, again be available for Awards
under the Plan. Upon the exercise of any Award granted in tandem with any other
Awards, such related Awards shall be canceled to the extent of the number of
Shares as to which the Award is exercised.
(b) Subject to adjustment as provided in Section 4(c) hereof, the maximum
number of Shares (i) with respect to which Options or SARs may be granted during
a calendar year to any Eligible Person under this Plan shall be 15% of the
Initial Shares, and (ii) with respect to Performance Shares, Performance Units,
Restricted Shares or Restricted Share Units intended to qualify as
performance-based compensation within the meaning of Section 162(m)(4)(C) of the
Code shall be 15% of the Initial Shares during a calendar year to any Eligible
Person under this Plan.
----------
1 This number shall be equal to 8% of the common stock of Z-tel on a fully
diluted basis (excluding out of the money options and warrants to acquire
common stock, but including shares reserved for issuance under the plan),
after giving effect to any reverse stock split.
G-4
(c) In the event that the Committee shall determine that any dividend in
Shares, recapitalization, Share split, reverse split, reorganization, merger,
consolidation, spin-off, combination, repurchase, or share exchange, or other
similar corporate transaction or event, affects the Shares such that an
adjustment is appropriate in order to prevent dilution or enlargement of the
rights of Eligible Persons under the Plan, then the Committee shall make such
equitable changes or adjustments as it deems appropriate and, in such manner as
it may deem equitable, adjust any or all of (i) the number and kind of shares
which may thereafter be issued under the Plan, (ii) the number and kind of
shares, other securities or other consideration issued or issuable in respect of
outstanding Awards, and (iii) the exercise price, grant price, or purchase price
relating to any Award; provided, however, in each case that, with respect to
ISOs, such adjustment shall be made in accordance with Section 424(a) of the
Code, unless the Committee determines otherwise. In addition, the Committee is
authorized to make adjustments in the terms and conditions of, and the criteria
and performance objectives, if any, included in, Awards in recognition of
unusual or non-recurring events (including, without limitation, events described
in the preceding sentence) affecting the Company or any Subsidiary or Affiliate
or the financial statements of the Company or any Subsidiary or Affiliate, or in
response to changes in applicable laws, regulations, or accounting principles;
provided, however, that, if an Award Agreement specifically so provides, the
Committee shall not have discretion to increase the amount of compensation
payable under the Award to the extent such an increase would cause the Award to
lose its qualification as performance-based compensation for purposes of Section
162(m)(4)(C) of the Code and the regulations thereunder.
(d) In the event that the Company is a party to a merger or consolidation
or a Change of Control shall occur, outstanding Options shall be subject to the
agreement of merger or consolidation or other applicable transaction agreement.
Such agreement, without the Participants' consent, may provide for: (i)
continuation or assumption of such outstanding Option under the Plan by the
Company (if it is the surviving corporation) or by the surviving corporation or
its parent; (ii) substitution by the surviving corporation or its parent of
stock options with substantially the same terms for such outstanding Options
(and, if the Company is not a publicly traded entity, substitution of option
shares with equity of the surviving corporation or its parent with substantially
the same terms as the outstanding option shares); (iii) acceleration of the
vesting of or right to exercise such outstanding Options immediately prior to or
as of the date of the merger or consolidation or Change of Control, and the
expiration of such outstanding Options to the extent not timely exercised by the
date of the merger, consolidation, Change of Control or other date thereafter
designated by the Board; or (iv) cancellation of all or any portion of such
outstanding Options by a cash payment of the excess, if any, of the Fair Market
Value of the shares subject to such outstanding Options or portion thereof being
canceled over the aggregate purchase price with respect to such Options or
portion thereof being canceled.
(e) Any Shares distributed pursuant to an Award may consist, in whole or in
part, of authorized and unissued Shares or treasury Shares including Shares
acquired by purchase in the open market or in private transactions.
5. Specific Terms of Awards.
(a) General. Awards may be granted on the terms and conditions set forth in
this Section 5. In addition, the Committee may impose on any Award or the
exercise thereof, at the date of grant or thereafter (subject to Section 9(d)),
such additional terms and conditions, not inconsistent with the provisions of
the Plan, as the Committee shall determine, including terms regarding forfeiture
of Awards or continued exercisability of Awards in the event of Termination of
Service by the Eligible Person.
(b) Options. The Committee is authorized to grant Options, which may be
NQSOs or ISOs, to Eligible Persons on the following terms and conditions:
(i) Exercise Price. The exercise price per Share purchasable under an
Option shall be determined by the Committee. The Committee may, without
limitation, set an exercise price that is based upon achievement of
performance criteria if deemed appropriate by the Committee.
(ii) Option Term. The term of each Option shall be determined by the
Committee.
G-5
(iii) Time and Method of Exercise. The Committee shall determine at
the date of grant or thereafter the time or times at which an Option may be
exercised in whole or in part (including, without limitation, upon
achievement of performance criteria if deemed appropriate by the
Committee), the methods by which such exercise price may be paid or deemed
to be paid (including, without limitation, broker-assisted exercise
arrangements), the form of such payment (including, without limitation,
cash, Shares, notes or other property), and the methods by which Shares
will be delivered or deemed to be delivered to Eligible Persons; provided,
however, that, unless otherwise determined by the Committee, in no event
may any portion of the exercise price be paid with Shares acquired either
under an Award granted pursuant to this Plan, upon exercise of a stock
option granted under another Company plan or as a stock bonus or other
stock award granted under another Company plan unless, in any such case,
the Shares were acquired and vested more than six months in advance of the
date of exercise.
(iv) ISOs. The terms of any ISO granted under the Plan shall comply in
all respects with the provisions of Section 422 of the Code, including but
not limited to the requirement that the ISO shall be granted within ten
years from the earlier of the date of adoption or shareholder approval of
the Plan. ISOs may only be granted to employees of the Company or a
Subsidiary.
(c) SARs. The Committee is authorized to grant SARs (Share Appreciation
Rights) to Eligible Persons on the following terms and conditions:
(i) Right to Payment. A SAR shall confer on the Eligible Person to
whom it is granted a right to receive with respect to each Share subject
thereto, upon exercise thereof, the excess of (1) the Fair Market Value of
one Share on the date of exercise (or, if the Committee shall so determine
in the case of any such right, the Fair Market Value of one Share at any
time during a specified period before or after the date of exercise) over
(2) the exercise price per Share of the SAR as determined by the Committee
as of the date of grant of the SAR (which, in the case of a SAR granted in
tandem with an Option, shall be equal to the exercise price of the
underlying Option).
(ii) Other Terms. The Committee shall determine, at the time of grant
or thereafter, the time or times at which a SAR may be exercised in whole
or in part, the method of exercise, method of settlement, form of
consideration payable in settlement, method by which Shares will be
delivered or deemed to be delivered to Eligible Persons, whether or not a
SAR shall be in tandem with any other Award, and any other terms and
conditions of any SAR. Unless the Committee determines otherwise, a SAR (1)
granted in tandem with an NQSO may be granted at the time of grant of the
related NQSO or at any time thereafter and (2) granted in tandem with an
ISO may only be granted at the time of grant of the related ISO.
(d) Restricted Shares. The Committee is authorized to grant Restricted
Shares to Eligible Persons on the following terms and conditions:
(i) Issuance and Restrictions. Restricted Shares shall be subject to
such restrictions on transferability and other restrictions, if any, as the
Committee may impose at the date of grant or thereafter, which restrictions
may lapse separately or in combination at such times, under such
circumstances (including, without limitation, upon achievement of
performance criteria if deemed appropriate by the Committee), in such
installments, or otherwise, as the Committee may determine. Except to the
extent restricted under the Award Agreement relating to the Restricted
Shares, an Eligible Person granted Restricted Shares shall have all of the
rights of a shareholder including, without limitation, the right to vote
Restricted Shares and the right to receive dividends thereon.
(ii) Forfeiture. Except as otherwise determined by the Committee, at
the date of grant or thereafter, upon Termination of Service during the
applicable restriction period, Restricted Shares and any accrued but unpaid
dividends or Dividend Equivalents that are at that time subject to
restrictions shall be forfeited; provided, however, that the Committee may
provide, by rule or regulation or in any Award Agreement, or may determine
in any individual case, that restrictions or forfeiture conditions relating
to Restricted Shares will be waived in whole or in part in the event of
Termination of Service resulting from
G-6
specified causes, and the Committee may in other cases waive in whole or in
part the forfeiture of Restricted Shares.
(iii) Certificates for Shares. Restricted Shares granted under the
Plan may be evidenced in such manner as the Committee shall determine. If
certificates representing Restricted Shares are registered in the name of
the Eligible Person, such certificates shall bear an appropriate legend
referring to the terms, conditions, and restrictions applicable to such
Restricted Shares, the Company shall retain physical possession of the
certificate and the Participant shall deliver a stock power to the Company,
endorsed in blank, relating to the Restricted Shares.
(iv) Dividends. Dividends paid on Restricted Shares shall be either
paid at the dividend payment date, or deferred for payment to such date as
determined by the Committee, in cash or in unrestricted Shares having a
Fair Market Value equal to the amount of such dividends. Shares distributed
in connection with a Share split or dividend in Shares, and other property
distributed as a dividend, shall be subject to restrictions and a risk of
forfeiture to the same extent as the Restricted Shares with respect to
which such Shares or other property has been distributed.
(e) Restricted Share Units. The Committee is authorized to grant Restricted
Share Units to Eligible Persons, subject to the following terms and conditions:
(i) Award and Restrictions. Delivery of Shares or cash, as the case
may be, will occur upon expiration of the deferral period specified for
Restricted Share Units by the Committee (or, if permitted by the Committee,
as elected by the Eligible Person). In addition, Restricted Share Units
shall be subject to such restrictions as the Committee may impose, if any
(including, without limitation, the achievement of performance criteria if
deemed appropriate by the Committee), at the date of grant or thereafter,
which restrictions may lapse at the expiration of the deferral period or at
earlier or later specified times, separately or in combination, in
installments or otherwise, as the Committee may determine.
(ii) Forfeiture. Except as otherwise determined by the Committee at
date of grant or thereafter, upon Termination of Service during the
applicable deferral period or portion thereof to which forfeiture
conditions apply (as provided in the Award Agreement evidencing the
Restricted Share Units), or upon failure to satisfy any other conditions
precedent to the delivery of Shares or cash to which such Restricted Share
Units relate, all Restricted Share Units that are at that time subject to
deferral or restriction shall be forfeited; provided, however, that the
Committee may provide, by rule or regulation or in any Award Agreement, or
may determine in any individual case, that restrictions or forfeiture
conditions relating to Restricted Share Units will be waived in whole or in
part in the event of Termination of Service resulting from specified
causes, and the Committee may in other cases waive in whole or in part the
forfeiture of Restricted Share Units.
(iii) Dividend Equivalents. Unless otherwise determined by the
Committee at date of grant, Dividend Equivalents on the specified number of
Shares covered by a Restricted Share Unit shall be either (A) paid with
respect to such Restricted Share Unit at the dividend payment date in cash
or in unrestricted Shares having a Fair Market Value equal to the amount of
such dividends, or (B) deferred with respect to such Restricted Share Unit
and the amount or value thereof automatically deemed reinvested in
additional Restricted Share Units or other Awards, as the Committee shall
determine or permit the Participant to elect.
(f) Performance Shares and Performance Units. The Committee is authorized
to grant Performance Shares or Performance Units or both to Eligible Persons on
the following terms and conditions:
(i) Performance Period. The Committee shall determine a performance
period (the "Performance Period") of one or more years and shall determine
the performance objectives for grants of Performance Shares and Performance
Units. Performance objectives may vary from Eligible Person to Eligible
Person and shall be based upon the performance criteria as the Committee
may deem appropriate. The performance objectives may be determined by
reference to the performance of the Company, or of a Subsidiary or
Affiliate, or of a division or unit of any of the foregoing. Performance
Periods may overlap and
G-7
Eligible Persons may participate simultaneously with respect to Performance
Shares and Performance Units for which different Performance Periods are
prescribed.
(ii) Award Value. At the beginning of a Performance Period, the
Committee shall determine for each Eligible Person or group of Eligible
Persons with respect to that Performance Period the range of number of
Shares, if any, in the case of Performance Shares, and the range of dollar
values, if any, in the case of Performance Units, which may be fixed or may
vary in accordance with such performance or other criteria specified by the
Committee, which shall be paid to an Eligible Person as an Award if the
relevant measure of Company performance for the Performance Period is met.
(iii) Significant Events. If during the course of a Performance Period
there shall occur significant events as determined by the Committee which
the Committee expects to have a substantial effect on a performance
objective during such period, the Committee may revise such objective;
provided, however, that, if an Award Agreement so provides, the Committee
shall not have any discretion to increase the amount of compensation
payable under the Award to the extent such an increase would cause the
Award to lose its qualification as performance-based compensation for
purposes of Section 162(m)(4)(C) of the Code and the regulations
thereunder.
(iv) Forfeiture. Except as otherwise determined by the Committee, at
the date of grant or thereafter, upon Termination Service during the
applicable Performance Period, Performance Shares and Performance Units for
which the Performance Period was prescribed shall be forfeited; provided,
however, that the Committee may provide, by rule or regulation or in any
Award Agreement, or may determine in an individual case, that restrictions
or forfeiture conditions relating to Performance Shares and Performance
Units will be waived in whole or in part in the event of Terminations of
Service resulting from specified causes, and the Committee may in other
cases waive in whole or in part the forfeiture of Performance Shares and
Performance Units.
(v) Payment. Each Performance Share or Performance Unit may be paid in
whole Shares, or cash, or a combination of Shares and cash either as a lump
sum payment or in installments, all as the Committee shall determine, at
the time of grant of the Performance Share or Performance Unit or
otherwise, commencing as soon as practicable after the end of the relevant
Performance Period.
(g) Dividend Equivalents. The Committee is authorized to grant Dividend
Equivalents to Eligible Persons. The Committee may provide, at the date of grant
or thereafter, that Dividend Equivalents shall be paid or distributed when
accrued or shall be deemed to have been reinvested in additional Shares, or
other investment vehicles as the Committee may specify; provided, however, that
Dividend Equivalents (other than freestanding Dividend Equivalents) shall be
subject to all conditions and restrictions of the underlying Awards to which
they relate.
(h) Other Share-Based Awards. The Committee is authorized, subject to
limitations under applicable law, to grant to Eligible Persons such other Awards
that may be denominated or payable in, valued in whole or in part by reference
to, or otherwise based on, or related to, Shares, as deemed by the Committee to
be consistent with the purposes of the Plan, including, without limitation,
unrestricted shares awarded purely as a "bonus" and not subject to any
restrictions or conditions, other rights convertible or exchangeable into
Shares, purchase rights for Shares, Awards with value and payment contingent
upon performance of the Company or any other factors designated by the
Committee, and Awards valued by reference to the performance of specified
Subsidiaries or Affiliates. The Committee shall determine the terms and
conditions of such Awards at date of grant or thereafter. Shares delivered
pursuant to an Award in the nature of a purchase right granted under this
Section 5(h) shall be purchased for such consideration, paid for at such times,
by such methods, and in such forms, including, without limitation, cash, Shares,
notes or other property, as the Committee shall determine. Cash awards, as an
element of or supplement to any other Award under the Plan, shall also be
authorized pursuant to this Section 5(h).
6. Certain Provisions Applicable to Awards.
(a) Stand-Alone, Additional, Tandem and Substitute Awards. Awards granted
under the Plan may, in the discretion of the Committee, be granted to Eligible
Persons either alone or in addition to, in tandem with, or in
G-8
exchange or substitution for, any other Award granted under the Plan or any
award granted under any other plan or agreement of the Company, any Subsidiary
or Affiliate, or any business entity to be acquired by the Company or a
Subsidiary or Affiliate, or any other right of an Eligible Person to receive
payment from the Company or any Subsidiary or Affiliate. Awards may be granted
in addition to or in tandem with such other Awards or awards, and may be granted
either as of the same time as or a different time from the grant of such other
Awards or awards. The per Share exercise price of any Option or grant price of
any SAR which, in either case, is granted in connection with the substitution of
awards granted under any other plan or agreement of the Company or any
Subsidiary or Affiliate or any business entity to be acquired by the Company or
any Subsidiary or Affiliate shall be determined by the Committee, in its
discretion.
(b) Term of Awards. The term of each Award granted to an Eligible Person
shall be for such period as may be determined by the Committee; provided,
however, that in no event shall the term of any ISO or a SAR granted in tandem
therewith exceed a period of ten years from the date of its grant (or such
shorter period as may be applicable under Section 422 of the Code).
(c) Form of Payment Under Awards. Subject to the terms of the Plan and any
applicable Award Agreement, payments to be made by the Company or a Subsidiary
or Affiliate upon the grant, maturation, or exercise of an Award may be made in
such forms as the Committee shall determine at the date of grant or thereafter,
including, without limitation, cash, Shares, notes or other property, and may be
made in a single payment or transfer, in installments, or on a deferred basis.
The Committee may make rules relating to installment or deferred payments with
respect to Awards, including the rate of interest to be credited with respect to
such payments, and the Committee may require deferral of payment under an Award
if, in the sole judgment of the Committee, it may be necessary in order to avoid
nondeductibility of the payment under Section 162(m) of the Code.
(d) Nontransferability. Unless otherwise set forth by the Committee in an
Award Agreement, Awards shall not be transferable by an Eligible Person except
by will or the laws of descent and distribution (except pursuant to a
Beneficiary designation) and shall be exercisable during the lifetime of an
Eligible Person only by such Eligible Person or his guardian or legal
representative. An Eligible Person's rights under the Plan may not be pledged,
mortgaged, hypothecated, or otherwise encumbered, and shall not be subject to
claims of the Eligible Person's creditors.
(e) Noncompetition. The Committee may, by way of the Award Agreements or
otherwise, establish such other terms, conditions, restrictions and/or
limitations, if any, of any Award, provided they are not inconsistent with the
Plan, including, without limitation, the requirement that the Participant not
engage in competition with the Company.
7. Performance Awards.
(a) Performance Awards Granted to Covered Employees. If the Committee
determines that an Award (other than an Option or SAR) to be granted to an
Eligible Person should qualify as "performance based compensation" for purposes
of Section 162(m) of the Code, the grant, vesting, exercise and/or settlement of
such Award (each, a "Performance Award") shall be contingent upon achievement of
preestablished performance goals and other terms set forth in this Section 7(a).
(i) Performance Goals Generally. The performance goals for such
Performance Awards shall consist of one or more business criteria and a
targeted level or levels of performance with respect to each of such
criteria, as specified by the Committee consistent with this Section 7(a).
The performance goals shall be objective and shall otherwise meet the
requirements of Section 162(m) of the Code and regulations thereunder
(including Treasury Regulation 1.162 27 and successor regulations thereto),
including the requirement that the level or levels of performance targeted
by the Committee result in the achievement of performance goals being
"substantially uncertain." The Committee may determine that such
Performance Awards shall be granted, vested, exercised and/or settled upon
achievement of any one performance goal or that two or more of the
performance goals must be achieved as a condition to grant, vesting,
exercise and/or settlement of such Performance Awards. Performance goals
may differ for Performance Awards granted to any one Participant or to
different Participants.
G-9
(ii) Business Criteria. One or more of the following business criteria
for the Company, on a consolidated basis, and/or for specified Subsidiaries
or Affiliates or other business units or lines of business of the Company
shall be used by the Committee in establishing performance goals for such
Performance Awards: (1) earnings per share (basic or fully diluted); (2)
revenues; (3) earnings, before or after taxes, from operations (generally
or specified operations), or before or after interest expense,
depreciation, amortization, incentives, or extraordinary or special items;
(4) cash flow, free cash flow, cash flow return on investment (discounted
or otherwise), net cash provided by operations, or cash flow in excess of
cost of capital; (5) return on net assets, return on assets, return on
investment, return on capital, return on equity; (6) economic value added;
(7) operating margin or operating expense; (8) net income; (9) Share price
or total stockholder return; and (10) strategic business criteria,
consisting of one or more objectives based on meeting specified market
penetration, geographic business expansion goals, cost targets, customer
satisfaction, supervision of litigation and information technology, and
goals relating to acquisitions or divestitures of Subsidiaries, Affiliates
or joint ventures. The targeted level or levels of performance with respect
to such business criteria may be established at such levels and in such
terms as the Committee may determine, in its discretion, including in
absolute terms, as a goal relative to performance in prior periods, or as a
goal compared to the performance of one or more comparable companies or an
index covering multiple companies.
(iii) Performance Period; Timing for Establishing Performance Goals;
Per-Person Limit. Achievement of performance goals in respect of such
Performance Awards shall be measured over a performance period, as
specified by the Committee. A performance goal shall be established not
later than the earlier of (A) 90 days after the beginning of any
performance period applicable to such Performance Award or (B) the time 25%
of such performance period has elapsed. In all cases, the maximum
Performance Award of any Participant shall be subject to the limitation set
forth in Section 4(b).
(iv) Settlement of Performance Awards; Other Terms. Settlement of such
Performance Awards shall be in cash, Shares, other Awards or other
property, in the discretion of the Committee. The Committee may, in its
discretion, reduce the amount of a settlement otherwise to be made in
connection with such Performance Awards, but may not exercise discretion to
increase any such amount payable to the Participant in respect of a
Performance Award subject to this Section 7(a). Any settlement which
changes the form of payment from that originally specified shall be
implemented in a manner such that the Performance Award and other related
Awards do not, solely for that reason, fail to qualify as
"performance-based compensation" for purposes of Section 162(m) of the
Code. The Committee shall specify the circumstances in which such
Performance Awards shall be paid or forfeited in the event of Termination
of Service of the Participant or other event (including a Change of
Control) prior to the end of a performance period or settlement of such
Performance Awards.
(v) Maximum Annual Cash Award. The maximum amount payable upon
settlement of a cash-settled Performance Unit (or other cash-settled Award)
granted under this Plan for any calendar year to any Eligible Person that
is intended to satisfy the requirements for "performance-based
compensation" under Section 162(m) of the Code shall not exceed $1,000,000.
(b) Written Determinations. Determinations by the Committee as to the
establishment of performance goals, the amount potentially payable in respect of
Performance Awards, the level of actual achievement of the specified performance
goals relating to Performance Awards and the amount of any final Performance
Award shall be recorded in writing in the case of Performance Awards intended to
qualify under Section 162(m) of the Code. Specifically, the Committee shall
certify in writing, in a manner conforming to applicable regulations under
Section 162(m), prior to settlement of each such Award, that the performance
objective relating to the Performance Award and other material terms of the
Award upon which settlement of the Award was conditioned have been satisfied.
8. Change of Control Provisions.
(a) Acceleration of Exercisability and Lapse of Restrictions. Unless
otherwise provided by the Committee at the time of the Award grant, in the event
of a Change of Control, (i) all outstanding Awards pursuant to which the
Participant may have rights the exercise of which is restricted or limited,
shall become fully exercisable at the time of the Change of Control, and (ii)
unless the right to lapse of restrictions or limitations is waived or deferred
G-10
by a Participant prior to such lapse, all restrictions or limitations (including
risks of forfeiture and deferrals) on outstanding Awards subject to restrictions
or limitations under the Plan shall lapse, and all performance criteria and
other conditions to payment of Awards under which payments of cash, Shares or
other property are subject to conditions shall be deemed to be achieved or
fulfilled and shall be waived by the Company at the time of the Change of
Control.
(b) Definition of Change of Control. For purposes of this Plan, "Change of
Control" shall mean:
(i) the acquisition by any individual, entity or group (within the
meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act (a "Person"),
of beneficial ownership (within the meaning of Rule 13d-3 promulgated under
the Exchange Act) of more than 50% of either (1) the then outstanding
shares of common stock of the Company (the "Outstanding Company Common
Stock") or (2) the combined voting power of the then outstanding voting
securities of the Company entitled to vote generally in the election of
directors (the "Outstanding Company Voting Securities"); provided, however,
that the following acquisitions shall not constitute a Change of Control:
(i) any acquisition directly from the Company (other than by exercise of a
conversion privilege); (ii) any acquisition by the Company or any of its
Subsidiaries; (iii) any acquisition by any employee benefit plan (or
related trust) sponsored or maintained by the Company or any of its
Subsidiaries; or (iv) any acquisition by any corporation with respect to
which, following such acquisition, more than 50% of, respectively, the then
outstanding shares of common stock of such corporation and the combined
voting power of the then outstanding voting securities of such corporation
entitled to vote generally in the election of directors is then
beneficially owned, directly or indirectly, by all or substantially all of
the individuals and entities who were the beneficial owners, respectively,
of the outstanding Company Common Stock and Outstanding Company Voting
Securities immediately prior to such acquisition in substantially the same
proportions as their ownership, immediately prior to such acquisition, of
the Outstanding Company Common Stock and Outstanding Company Voting
Securities, as the case may be;
(ii) during any period of two consecutive years, individuals who, as
of the beginning of such period, constitute the Board (the "Incumbent
Board") cease for any reason to constitute at least a majority of the
Board; provided, however, that any individual becoming a director
subsequent to the beginning of such period whose election, or nomination
for election by the Company's shareholders, was approved by a vote of at
least a majority of the directors then comprising the Incumbent Board shall
be considered as though such individual were a member of the Incumbent
Board, but excluding, for this purpose, any such individual whose initial
assumption of office occurs as a result of either an actual or threatened
election contest (as such terms are used in Rule 14a-11 of Regulation 14A
promulgated under the Exchange Act);
(iii) consummation of a reorganization, merger or consolidation, in
each case, with respect to which all or substantially all of the
individuals and entities who were the beneficial owners, respectively, of
the Outstanding Company Common Stock and outstanding Company Voting
Securities immediately prior to such reorganization, merger or
consolidation, do not, following such reorganization, merger or
consolidation, beneficially own, directly or indirectly, more than 50% of,
respectively, the then outstanding shares of common stock and the combined
voting power of the then outstanding voting securities entitled to vote
generally in the election of directors, as the case may be, of the
corporation resulting from such reorganization, merger or consolidation in
substantially the same proportions as their ownership, immediately prior to
such reorganization, merger or consolidation, of the Outstanding Company
Common Stock and Outstanding Company Voting Securities, as the case may be;
(iv) consummation of a sale or other disposition of all or
substantially all of the assets of the Company, other than to a corporation
with respect to which following such sale or other disposition, more than
50% of, respectively, the then outstanding shares of common stock of such
corporation and the combined voting power of the then outstanding voting
securities of such corporation entitled to vote generally in the election
of directors is then beneficially owned, directly or indirectly, by all or
substantially all of the individuals and entities who were the beneficial
owners, respectively, of the outstanding Company Common Stock and
Outstanding Company Voting Securities immediately prior to such sale or
other disposition in substantially the same proportions as their ownership,
immediately prior to such sale or other disposition,
G-11
of the Outstanding Company Common Stock and Outstanding Company Voting
Securities, as the case may be; or
(v) approval by the shareholders of the Company of a complete
liquidation or dissolution of the Company.
9. General Provisions.
(a) Compliance with Legal and Trading Requirements. The Plan, the granting
and exercising of Awards thereunder, and the other obligations of the Company
under the Plan and any Award Agreement, shall be subject to all applicable
federal, state and foreign laws, rules and regulations, and to such approvals by
any stock exchange, regulatory or governmental agency as may be required. The
Company, in its discretion, may postpone the issuance or delivery of Shares
under any Award until completion of such stock exchange or market system listing
or registration or qualification of such Shares or other required action under
any state, federal or foreign law, rule or regulation as the Company may
consider appropriate, and may require any Participant to make such
representations and furnish such information as it may consider appropriate in
connection with the issuance or delivery of Shares in compliance with applicable
laws, rules and regulations. No provisions of the Plan shall be interpreted or
construed to obligate the Company to register any Shares under federal, state or
foreign law. The Shares issued under the Plan may be subject to such other
restrictions on transfer as determined by the Committee.
(b) No Right to Continued Employment or Service. Neither the Plan nor any
action taken thereunder shall be construed as giving any employee, consultant or
director the right to be retained in the employ or service of the Company or any
of its Subsidiaries or Affiliates, nor shall it interfere in any way with the
right of the Company or any of its Subsidiaries or Affiliates to terminate any
employee's, consultant's or director's employment or service at any time.
(c) Taxes. The Company or any Subsidiary or Affiliate is authorized to
withhold from any Award granted, any payment relating to an Award under the
Plan, including from a distribution of Shares, or any payroll or other payment
to an Eligible Person, amounts of withholding and other taxes due in connection
with any transaction involving an Award, and to take such other action as the
Committee may deem advisable to enable the Company and Eligible Persons to
satisfy obligations for the payment of withholding taxes and other tax
obligations relating to any Award. This authority shall include authority to
withhold or receive Shares or other property and to make cash payments in
respect thereof in satisfaction of an Eligible Person's tax obligations;
provided, however, that the amount of tax withholding to be satisfied by
withholding Shares shall be limited to the minimum amount of taxes, including
employment taxes, required to be withheld under applicable Federal, state and
local law.
(d) Changes to the Plan and Awards. The Board may amend, alter, suspend,
discontinue, or terminate the Plan or the Committee's authority to grant Awards
under the Plan without the consent of shareholders of the Company or
Participants, except that any such amendment or alteration shall be subject to
the approval of the Company's shareholders (i) to the extent such shareholder
approval is required under the rules of any stock exchange or automated
quotation system on which the Shares may then be listed or quoted or (ii) as it
applies to ISOs, to the extent such shareholder approval is required under
Section 422 of the Code; provided, however, that, without the consent of an
affected Participant, no amendment, alteration, suspension, discontinuation, or
termination of the Plan may materially and adversely affect the rights of such
Participant under any Award theretofore granted to him or her. The Committee may
waive any conditions or rights under, amend any terms of, or amend, alter,
suspend, discontinue or terminate, any Award theretofore granted, prospectively
or retrospectively; provided, however, that, without the consent of a
Participant, no amendment, alteration, suspension, discontinuation or
termination of any Award may materially and adversely affect the rights of such
Participant under any Award theretofore granted to him or her.
(e) No Rights to Awards; No Shareholder Rights. No Eligible Person or
employee shall have any claim to be granted any Award under the Plan, and there
is no obligation for uniformity of treatment of Eligible Persons and employees.
No Award shall confer on any Eligible Person any of the rights of a shareholder
of the Company unless and until Shares are duly issued or transferred to the
Eligible Person in accordance with the terms of the Award.
G-12
(f) Unfunded Status of Awards. The Plan is intended to constitute an
"unfunded" plan for incentive compensation. With respect to any payments not yet
made to a Participant pursuant to an Award, nothing contained in the Plan or any
Award shall give any such Participant any rights that are greater than those of
a general creditor of the Company; provided, however, that the Committee may
authorize the creation of trusts or make other arrangements to meet the
Company's obligations under the Plan to deliver cash, Shares, other Awards, or
other property pursuant to any Award, which trusts or other arrangements shall
be consistent with the "unfunded" status of the Plan unless the Committee
otherwise determines with the consent of each affected Participant.
(g) Nonexclusivity of the Plan. Neither the adoption of the Plan by the
Board nor its submission to the shareholders of the Company for approval shall
be construed as creating any limitations on the power of the Board to adopt such
other incentive arrangements as it may deem desirable, including, without
limitation, the granting of options and other awards otherwise than under the
Plan, and such arrangements may be either applicable generally or only in
specific cases.
(h) Not Compensation for Benefit Plans. No Award payable under this Plan
shall be deemed salary or compensation for the purpose of computing benefits
under any benefit plan or other arrangement of the Company for the benefit of
its employees, consultants or directors unless the Company shall determine
otherwise.
(i) No Fractional Shares. No fractional Shares shall be issued or delivered
pursuant to the Plan or any Award. The Committee shall determine whether cash,
other Awards, or other property shall be issued or paid in lieu of such
fractional Shares or whether such fractional Shares or any rights thereto shall
be forfeited or otherwise eliminated.
(j) Governing Law. The validity, construction, and effect of the Plan, any
rules and regulations relating to the Plan, and any Award Agreement shall be
determined in accordance with the laws of New York, without giving effect to
principles of conflict of laws thereof.
(k) Effective Date; Plan Termination. The Plan shall become effective as of
_________________________ (the "Effective Date"(2)), subject to approval by the
shareholders of the Companys. The Plan shall terminate as to future awards on
the date which is ten (10) years after the Effective Date.
(l) Titles and Headings. The titles and headings of the sections in the
Plan are for convenience of reference only. In the event of any conflict, the
text of the Plan, rather than such titles or headings, shall control.
----------
2 The effective date shall be the date of consummation of the exchange offer.
G-13
Annex H-1
RECENT DEVELOPMENTS
Management Changes
On August 25, 2004, chairman, president and chief executive officer D. Gregory
Smith and director and chief technology officer Charles W. McDonough resigned
from their positions to found a new company. Chief financial officer Trey Davis
has been appointed by Z-Tel's board as acting chief executive officer, and Frank
Grillo was named acting chief operating officer. Effective June 28, 2004,
Jeffrey A. Bowden, one of our founders, resigned from our Board of Directors.
Loan Agreements
At June 30, 2004, we did not meet the fixed charge coverage ratio on our asset
based loan agreement with Textron Financial Corporation. We have not yet reached
an agreement with Textron on a waiver or amendment to the original covenant
requirements for the fixed charge coverage ratio. On October 1, 2004, we
received a letter from Textron indicating that additional interest would be
charged on the outstanding revolving balance (charged monthly) since the
violation of the covenant had not been resolved within the 20 day term defined
per the contract. The interest will begin accruing on October 4, 2004. We
continue to believe that Textron will not terminate this agreement as we believe
they are adequately secured under this facility. At current collection rates, we
will collect the total amount outstanding under this facility in less than a
month.
On August 24, 2004, we entered into a $15 million Standby Credit Facility
Agreement with The 1818 Fund. On August 25, 2004, we were advanced $5 million
pursuant to the credit facility. Loans under the credit facility are represented
by a senior unsecured promissory note bearing interest at 9.95% annually. The
note matures March 31, 2006, but under certain circumstances may be extended by
the company until August, 2006.
Commitments and Contingencies
On October 1, 2004 we signed an agreement with SipStorm. SipStorm is the company
formed by our former chairman, president and chief executive officer D. Gregory
Smith and former director and chief technology officer Charles W. McDonough.
This agreement will transfer selected hardware, software and intellectual
property rights from Z-Tel to SipStorm. These assets are mainly related to next
generation PVA enhanced services. SipStorm will continue development of these
applications and will provide us with access to developed product(s) over the
course of the next 15 months.
Relative to the purchase, SipStorm has assumed responsibility for certain
accounts payable, future maintenance payments and provided a promissory note in
the amount of $3 million. We expect to incur a material loss in the third
quarter resulting from the transfer of assets to Sipstorm. We believe this loss
would have been incurred with or without the transfer as a result of our
restructuring efforts and shift in focus. The promissory note is secured by all
Preferred Stock held by Messrs. Smith and McDonough. Messrs. Smith and McDonough
each retain sole discretion with respect to all matters relating to the voting
or other disposition of their Preferred Stock, including the decisions whether
to participate in the Exchange Offer and to vote for or against the several
proposals set forth in this proxy statement. Should either of Messrs. Smith or
McDonough choose to sell his Preferred Stock or, if applicable, Common Stock
received in exchange therefore, we would be entitled to 75% of the proceeds of
such sale, capped at the then outstanding amount of the promissory note.
Restructuring Charges
The Company has implemented and is in the process of implementing a cost
restructuring. This process began in June, but most of the initiatives involved
within the restructuring were decided upon and fully committed to in
H-1-1
the August and September timeframe. These initiatives exceed $20 million in
annual recurring expense savings. The most significant component of the
restructuring program was a layoff done on September 1, 2004 involving 152
employees. In accordance with Financial Accounting Standards Board ("FASB") SFAS
No. 146 "Accounting for Costs Associated with Exit or Disposal Activities" the
restructuring costs will be considered a "One-Time Termination Benefit" and as
such we recognized the restructuring costs as a liability at the communication
date of September 1, 2004. The restructuring charge included termination
benefits in connection with the reduction in force of approximately 152
employees. The total charge taken in the third quarter of 2004 was approximately
$2.9 million.
The Company has also been amending business terms with several key vendors in an
effort to reduce operating expense. These discussions have included, but have
not been limited to, key operating vendor partners, landlords and other parties
with whom the Company has had existing financial obligations. The final outcome
of some of these discussions are still uncertain, and no assurances can be given
to the form of their final outcome.
Legal and Regulatory Proceedings
On August 20, 2004, the Federal Communications Commission issued a Notice of
Proposed Rulemaking ("NPRM") seeking comment on unbundling rules to implement
obligations under section 251(c)(3) of the Telecommunications Act of 1996 and to
respond to the D.C. Circuit's vacatur in United States Telecom Ass'n v. FCC of
the rules that the FCC adopted in the Triennial Review Order. The FCC also
released an order setting forth a two-phase plan to govern the provision of
unbundled network elements ("UNEs") while the FCC considers permanent rules.
Under the first phase of the interim plan, ILECs must continue to make available
dedicated transport, mass market switching and enterprise loops in accordance
with the rates, terms and conditions set forth in their interconnection
agreements as of June 15, 2004. Under the second phase of the plan, ILECs would
be required for an additional six months to continue to provide such UNEs to
requesting carriers for the embedded customer base subject to the rate increases
specified in the FCC's Order. In its NPRM, the FCC seeks comment on how to
establish sustainable new unbundling rules in response to the D.C. Circuit's
decision. Specifically, the FCC seeks comment on how various ILEC offerings and
obligations fit into the unbundling framework, how best to define the relevant
markets to develop unbundling rules and how to make determinations on access to
individual network elements.
H-1-2
Annex H-2
UNAUDITED INTERIM FINANCIAL STATEMENTS AND
RELATED MANAGEMENT'S DISCUSSION AND ANALYSIS
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
June 30, December 31,
2004 2003
Assets
Current assets:
Cash and cash equivalents....................................................... $ 8,196 $ 12,013
Accounts receivable, net of allowance for doubtful accounts of $9,206
and $13,804.................................................................. 28,672 24,600
Prepaid expenses and other current assets....................................... 4,804 7,664
Total current assets............................................................ 41,672 44,277
Property and equipment, net..................................................... 34,298 39,069
Intangible assets, net.......................................................... 1,372 2,287
Other assets.................................................................... 3,227 3,820
Total assets.................................................................... $ 80,569 $ 89,453
Liabilities, Mandatorily Redeemable Convertible Preferred Stock and
Stockholders' Deficit
Current liabilities:
Accounts payable and accrued liabilities........................................ $ 63,745 $ 59,230
Deferred revenue................................................................ 8,357 11,068
Current portion of long-term debt and capital lease obligations................. 2,078 5,017
Asset based loan................................................................ 12,619 --
Total current liabilities....................................................... 86,799 75,315
Long-term deferred revenue...................................................... 221 361
Long-term debt and capital lease obligations.................................... 205 514
Total liabilities............................................................... 87,225 76,190
Mandatorily redeemable convertible preferred stock, $.01 par value;
50,000,000 shares authorized; 8,855,089 issued; 8,736,337 and
8,738,422 outstanding (aggregate liquidation value of $164,998 and
$158,779).................................................................... 152,366 144,282
Commitments and contingencies (Notes 9 and 11) Stockholders' deficit:
Common stock, $.01 par value; 150,000,000 shares authorized; 37,321,257 and
36,186,686 shares issued; 36,979,707 and 35,845,136
outstanding.................................................................. 373 362
Notes receivable from stockholders.............................................. (930) (1,121)
Unearned stock compensation..................................................... (984) --
Additional paid-in capital...................................................... 183,281 189,008
Accumulated deficit............................................................. (340,374) (318,880)
Treasury stock, 341,550 shares at cost.......................................... (388) (388)
Total stockholders' deficit..................................................... (159,022) (131,019)
Total liabilities, mandatorily redeemable convertible preferred stock
and stockholders' deficit.................................................... $ 80,569 $ 89,453
H-2-1
The accompanying notes are an integral part of these consolidated financial
statements.
H-2-2
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
Revenues............................................... $ 63,797 $ 71,046 $ 132,264 $ 131,975
Operating expenses:
Network operations, exclusive of depreciation
and amortization shown below........................ 31,237 32,070 65,271 58,852
Sales and marketing.................................... 4,450 6,617 8,971 11,111
General and administrative............................. 31,658 31,944 66,229 58,850
Restructuring charge................................... 807 -- 807 --
Depreciation and amortization.......................... 5,109 6,002 10,420 12,029
Total operating expenses............................... 73,261 76,633 151,698 140,842
Operating loss......................................... (9,464) (5,587) (19,434) (8,867)
Nonoperating income (expense):
Interest and other income.............................. 491 239 1,352 1,164
Interest and other expense............................. (2,138) (660) (3,412) (1,410)
Total nonoperating expense............................. (1,647) (421) (2,060) (246)
Net loss............................................... (11,111) (6,008) (21,494) (9,113)
Less mandatorily redeemable convertible
preferred stock dividends and accretion............. (3,626) (4,667) (7,991) (8,904)
Less deemed dividend related to beneficial
conversion feature.................................. (47) (46) (93) (92)
Net loss attributable to common stockholders........... $ (14,784) $ (10,721) $ (29,578) $ (18,109)
Weighted average common shares outstanding............. 36,608,703 35,305,448 36,337,804 35,286,953
Basic and diluted net loss per share................... $ (0.40) $ (0.30) $ (0.81) $ (0.51)
The accompanying notes are an integral part of these consolidated financial
statements.
H-2-3
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPREHENSIVE INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATE)
Notes
Receiv-ableUn-earned Total
Common Stock from Stock Additional Accumulated Treasury Stock-
Par r on Paid-In holder'
Shares Value Stockholde Compensati Capital Deficit Stock Deficit
Balance, December 31, 35,845,136 $ 362 $(1,121) $ -- $189,008 $(318,880) $ (388) $(131,019)
2003....................
Exercise of stock options. 372,480 3 486 $ 489
Exercise of warrants...... 37,714 3 $ 3
Issuance of common stock
for settlement.......... 585,723 5 743 $ 748
Issue common restricted (984) 1,128 $ 144
stock................... Conversion of
mandatorily redeemable
convertible preferred 138,654 -- -- $ --
stock to common.........
Repayment of notes 191 $ 191
receivable..............
Mandatorily redeemable
convertible preferred
stock dividends and (8,084) $(8,084)
accretion...............
Net loss................ (21,494) $(21,494)
Balance, June 30, 2004.... 36,979,707 $ 373 $ (930) $ (984) $183,281 $(340,374) $ (388) $(159,022)
The accompanying notes are an integral part of these consolidated financial
statements
H-2-4
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Six Months Ended June 30,
2004 2003
Cash flows from operating activities:
Net loss................................................................ $ (21,494) $ (9,113)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization........................................... 10,418 12,029
Provision for bad debts................................................. 3,017 6,268
Expense charged for granting of restricted stock........................ 888 --
Change in operating assets and liabilities:
(Increase) decrease in accounts receivable.............................. (7,089) (13,465)
(Increase) decrease in prepaid expenses................................. 2,860 930
(Increase) decrease in other assets..................................... 553 (29)
Increase (decrease) in accounts payable and accrued liabilities......... 4,515 (1,284)
Increase (decrease) in deferred revenue................................. (2,851) 10,813
Total adjustments....................................................... 12,311 15,262
Net cash (used in) provided by operating activities..................... (9,183) 6,149
Cash flows from investing activities:
Purchases of property and equipment..................................... (4,732) (5,783)
Principal repayments received on notes receivable....................... 40 27
Net cash used in investing activities................................... (4,692) (5,756)
Cash flows from financing activities:
Payments on long-term debt and capital lease obligations................ (3,248) (2,755)
Payment of preferred stock dividends.................................... (3) --
Principal repayments received on notes receivable issued for stock......
191 469
Proceeds from asset based loan.......................................... 12,619 --
Proceeds from exercise of stock options and warrants.................... 499 60
Net cash provided by (used in) financing activities..................... 10,058 (2,226)
Net decrease in cash and cash equivalents............................... (3,817) (1,833)
Cash and cash equivalents, beginning of period.......................... 12,013 16,037
Cash and cash equivalents, end of period................................ $ 8,196 $ 14,204
The accompanying notes are an integral part of these consolidated financial
statements
H-2-5
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(ALL TABLES ARE IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE DATA)
1. NATURE OF BUSINESS
DESCRIPTION OF BUSINESS
Z-Tel Technologies, Inc. and subsidiaries ("Z-Tel" or "we" or "us")
incorporated in Delaware on January 15, 1998 as Olympus Telecommunications
Group, Inc. In March 1998, Olympus Telecommunications Group, Inc. changed its
name to Z-Tel Technologies, Inc.
We are a provider of advanced, integrated telecommunications services
targeted to consumer (residential) and business subscribers. We offer local and
long distance telephone services in combination with enhanced communications
features accessible through the telephone, the Internet and certain personal
digital assistants. We offer our Z-LineHOME and Z-LineBUSINESS services in
forty-nine states. Our customers are primarily concentrated in ten states. We
also provide long-distance telecommunications services to customers nationally.
We introduced our wholesale services during the first quarter of 2002. This
service provides other companies with the opportunity to provide local,
long-distance and enhanced telephone service to their own residential and
business end user customers on a private label basis by utilizing our telephone
exchange services, enhanced services platform, infrastructure and back-office
operations.
Historically we have utilized the unbundled network elements platform
("UNE-P") as the basis of delivering our primary services to our retail end
users and end users of our wholesale customers. Under UNE-P we utilize various
unbundled elements of the incumbent local exchange carriers to facilitate the
delivery of our services to our own end users and the end users that are
acquired and owned by our wholesale services customers. To date, UNE-P has been
the primary access method that we have utilized in delivering our services.
We introduced our voice over Internet protocol ("VoIP") service offerings
during the second quarter of 2004. This service offering provides us an
alternative method to UNE-P in delivering our services to consumer and business
customers. We have tested this delivery method in two markets and have developed
a beta customer base in each market. We intend, upon the successful completion
of this initial test phase, to pursue aggressively VoIP as the eventual
preferred method whereby we will deliver our services to our end users. We also
intend to offer this new access method to our existing and future wholesale
services partners. While this is a more capital intensive approach, this method
of delivery mitigates our reliance on the incumbent local exchange carriers.
LIQUIDITY AND CAPITAL RESOURCES
We have a limited operating history and our operations are subject to
certain risks and uncertainties, particularly related to the evolution of the
regulatory environment, which impacts our access to and cost of the network
elements that we utilize to provide services to our customers, access to
adequate financing, and competition within the industry.
We have incurred significant losses since our inception, resulting in an
accumulated deficit at June 30, 2004 of approximately $340.4 million. We also
had total liabilities recorded at June 30, 2004 of approximately $87.2 million.
We experienced positive cash flows from operations for the first time for the
year ended December 31, 2002 and again during 2003. We also had positive cash
flows from operations for the three months ended March 31, 2004, but experienced
negative cash flows from operations for the three and six months ended June 30,
2004. Prior to 2002 we had historically been dependent on financing from
investors to sustain our operating activities.
H-2-6
The company's reported cash position declined on a net basis for the three
months and six months ended June 30, 2004. The net cash declines for the three
and six months ended June 30, 2004 were $3.6 and $3.8 million respectively.
At June 30, 2004, we had cash on hand of approximately $8.2 million. In
addition, we have an asset based loan agreement, which provides us with up to
$25 million to fund operations, of which we were utilizing $12.6 million as of
June 30, 2004, which was approximately the maximum then available to us under
the loan availability calculation. We did not meet the fixed charge coverage
ratio for the quarter ended June 30, 2004. All other covenants have been met per
our agreement with Textron. Per the agreement, Textron can cancel the loan
arrangement with us; however, we believe that it is unlikely that Textron would
take such measures. We are working to resolve this issue without triggering a
cancellation of the agreement (see Footnote 5 to our financial statements in
this report).
We anticipate that we may not generate adequate cash flow over the
foreseeable future to meet all of our operating, investing and financing
requirements. We are actively exploring potential financing arrangements to help
improve our liquidity position and to give us more flexibility in pursuing our
business plan over the foreseeable future.
On June 16, 2004, the D.C. Circuit decision to USTA II became effective and
the FCC's unbundling rules that were the subject of the appeal were vacated. If
the FCC does not write adequate interim and final UNB rules, or if the USTA II
decision is not stayed or reversed, or if state commissions do not take action
under state law, there could be an immediate, significant, adverse and material
impact upon our business. ILECs might utilize the reversal of the unbundling
rules to deny us access to their local networks or sharply increase the price of
that access. We believe that in the event the vacated unbundling rules are not
replaced by either the FCC or the state commissions, we have interconnection
agreements with our principal ILEC suppliers (including Verizon, SBC, BellSouth
and Qwest) that will permit us to obtain access to local network elements during
the interviewing time period (see Footnote 11 to our financial statements in
this report).
On July 26, 2004, Sprint indicated to us that they plan on committing less
resources to the existing wholesale services arrangement under which we
currently operate. Although Sprint is not canceling the agreement, they have
indicated to us that we can expect lower sales volumes as early as August 2004
(see Footnote 13 to our financial statements in this report).
By letter dated July 28, 2004, the Nasdaq Stock Market Inc. notified us
that for 10 consecutive days the market value of our listed securities was below
$35 million as required for continued inclusion by Nasdaq Marketplace Rule
4310(c)(2)(B)(ii). Nasdaq has given us 30 calendar days or until August 27, 2004
to regain compliance (see Footnote 13 to our financial statements in this
report).
If actual results differ materially from our current plan or if expected
financing is not available, we may have the ability to curtail growth
initiatives and spending, including the reduction of certain discretionary
capital and operating costs. These plans may include, but are not be limited to,
the implementation of a workforce reduction. There can be no assurance, however,
that we will be able to implement our strategies or obtain additional financing
under favorable terms, if at all.
2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared by us in accordance with accounting principles generally accepted in
the United States of America for interim financial information and are in the
form prescribed by the Securities and Exchange Commission's ("SEC") instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes for complete financial statements as
required by accounting principles generally accepted in the United States of
America. The interim unaudited financial statements should be read in
conjunction with our audited financial statements as of and for the year ended
December 31, 2003, included in our Annual Report on Form 10-K filed with the SEC
on March 30, 2004. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included. Operating results for the
six months ended June 30, 2004 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2004.
H-2-7
RECLASSIFICATION
Certain amounts in the consolidated statements of operations for the six
months ended June 30, 2003 have been reclassified to conform to the presentation
for the six months ended June 30, 2004.
3. SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS
SIGNIFICANT ACCOUNTING POLICIES
Our significant accounting policies are included in the Notes to
Consolidated Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2003.
STOCK-BASED COMPENSATION
We account for our stock option plans in accordance with the provisions of
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations and comply with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" and SFAS No. 148. As such, we record
compensation expense on the date of grant only if the current market price of
the underlying stock exceeds the exercise price. Additionally, if a modification
is made to an existing grant, any related compensation expense is calculated on
the date both parties accept the modification and recorded on the date the
modification becomes effective.
The following table illustrates, in accordance with the provisions of SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment of SFAS 123, Accounting for Stock-Based Compensation," the effect
on net loss and earnings per share if we had applied the fair value recognition
provisions of SFAS No. 123, to stock-based employee compensation (encompassing
the impacts of both stock option and restricted stock grants).
For the three months ended For the six months ended
June 30, June 30,
2004 2003 2004 2003
Net loss attributable to common
stockholders, as reported...................... $ (14,784) $ (10,721) $ (29,578) $ (18,109)
Add: Stock based compensation included in
net loss....................................... 145 -- 145 --
Deduct: Total stock based employee
compensation determined under the fair
value based method for all awards.............. (1,043) (1,247) (1,799) (4,429)
Net loss attributable to common
stockholders, pro forma........................ $ (15,682) $ (11,968) $ (31,232) $ (22,538)
Basic and Diluted Net Loss
Per Common Share
As reported....................................... $ (0.40) $ (0.30) $ (0.81) $ (0.51)
Pro forma......................................... (0.43) (0.34) (0.86) (0.64)
We calculated the fair value of each grant on the date of grant using the
Black-Scholes option pricing model. In addition to there being no payments of
dividends on our common stock, the following assumptions were used for each
respective period:
For the three months ended For the six months ended
June 30, June 30,
H-2-8
2004 2003 2004 2003
Discount Rate..................................... 3.4% 2.5% 3.1% 2.6%
Volatility ....................................... 98.4% 97.3% 100.1% 97.0%
Average Option Expected Life ..................... 5 years 5 years 5 years 5 years
Incremental shares of common stock equivalents are not included in the
calculation of net loss per share as the inclusion of such equivalents would be
anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on EITF Issue No. 03-6, "Participating Securities and the Two-Class Method under
Financial Accounting Standards Board ("FASB") Statement No. 128, Earnings per
Share." EITF 03-6 clarifies what constitutes a participating security and
provides further guidance in applying the two-class method of calculating
earnings per share ("EPS"). The consensus reached by the Task Force in this
Issue is effective for reporting periods beginning after March 31, 2004. We
adopted EITF Issue No. 03-06 in the quarter ended June 30, 2004. There was no
impact of the adoption on the computation of EPS during the three months and six
months ended June 30, 2004, as the effect is anti-dilutive. In periods of net
income, we will utilize the two-class method of computing EPS.
4. WHOLESALE SERVICES
In February 2003, we executed an agreement providing for the resale of our
local wireline telecommunications services and for the provisioning of ancillary
services with Sprint. Under this agreement, we provide Sprint access to our
Web-integrated, enhanced communications platform and operational support
systems. We are the primary obligor for certain underlying expenses that are
incorporated into our pricing in connection with the agreement and therefore,
are recording revenues using a gross presentation. This accounting method
results in revenue being recorded for certain per-line, per-minute, and direct
costs and the corresponding expenses are recorded in the appropriate operating
expense line. As a result of this accounting treatment, increases or decreases
in pricing or volume that impact certain direct costs that are incurred in
connection with this agreement would have little or no impact on net income, as
the amount is recorded in an equivalent amount in both revenue and expense. Our
wholesale services agreement with Sprint is non-exclusive in nature.
We are deferring $1.0 million of revenues for pre-contract payments by
recognizing this amount ratably over the life of the agreement.
As of June 30, 2004, under our contract with Sprint, we had approximately
$2.2 million of deferred revenue recorded, of which $0.2 million is recorded as
long-term deferred revenue.
Sprint revenues were 32.3% of total revenues for the three months ended
June 30, 2004, as compared to 14.9% for the prior year period. Sprint revenues
were 33.1% of total revenues for the six months ended June 30, 2004, as compared
to 9.3% for the prior year period.
On July 26, 2004 Sprint indicated to us that they plan on committing less
resources to the existing wholesale services arrangement under which we
currently operate. Although Sprint is not canceling the agreement, they have
indicated to us that we can expect lower sales volumes as early as August 2004
(see Footnote 13 to our financial statements in this report).
5. ACCOUNTS RECEIVABLE AGREEMENT
In April 2004 we signed a three-year asset based loan agreement with
Textron Financial Corporation ("Textron"). This agreement eliminated our RFC
accounts receivable factoring agreement, and provides us with an availability to
borrow up to $25 million at a 6% interest rate. Our overall availability is
based on the eligibility of our accounts receivables, subject to certain
limitations and advance rates. The new asset based loan agreement is expected to
provide us with additional liquidity because it includes residential, business
and wholesale accounts receivable while our prior arrangement with RFC only
included certain portions of our accounts
H-2-9
receivable. We believe that this new agreement may provide us with additional
working capital financing flexibility to help facilitate the growth of our
business, to the extent growth materializes in our business.
This agreement has three primary financial covenants: a fixed charge
coverage ratio, accounts receivable turnover requirement and an unfunded capital
expenditures cap. The fixed charge coverage ratio requirement is measured each
quarter as of June 30, 2004. The ratio requirements begin low and increase each
quarter through December 31, 2004 and then remain constant. We did not meet the
fixed charge coverage ratio for the quarter ended June 30, 2004. All other
covenants have been met per our agreement with Textron. Per the agreement,
Textron can cancel the loan arrangement with us; however, we believe that it is
unlikely that Textron would take such measures. We are working to resolve this
issue without triggering a cancellation of the agreement. At current collection
rates, we will collect the total amount outstanding under this facility in less
than a month. We believe that Textron is adequately secured under this facility.
In addition, we have already disclosed to Textron the cost saving measures
recently implemented to make improvements that would allow us to meet the fixed
charge coverage ratio required in future quarters.
There are also disposition of asset limitations, limits on change of
control, certain notification requirements, change in management limitations and
certain other restrictions. There are also certain limitations on our ability to
access subordinated debt within the confines of the agreement; however, we
believe the agreement will provide us with flexibility for future debt financing
alternatives. Under the amended asset based loan structure with Textron, we had
an outstanding loan balance to Textron of approximately $12.6 million at June
30, 2004.
6. INTANGIBLE ASSETS
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets," we reassessed the expected useful
lives of existing intangible assets. This reassessment resulted in no changes to
the expected useful lives of our intangible assets. We only have one intangible
asset as of June 30, 2004.
Summarized below is our only recorded intangible asset that will continue
to be amortized under SFAS No. 142. It is a customer list that was acquired in
April of 2000 in connection with our acquisition of Touch 1.
June 30, 2004
Carrying Accumulated Net Intangible
Amount Amortization Assets
Intangible assets subject to amortization:
Customer list - standalone 1+................... $9,145 $7,773 $1,372
The following table presents current and expected amortization expense of
the existing intangible assets as of June 30, 2004 for each of the following
periods:
Aggregate amortization expense:
For the six months ended June 30, 2004....................... $915
Expected amortization expense for the remainder of 2004...... $914
Expected amortization expense for the year ending
December 31, 2005.......................................... $458
7. RESTRUCTURING CHARGES
In April 2002, we approved and implemented a restructuring to improve our
future cash flows and operating earnings. The restructuring included a reduction
in force coupled with the closure of our North Dakota call centers and our New
York sales office. In accordance with Emerging Issues Task Force ("EITF") 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity," the restruc-
H-2-10
turing costs were recognized as liabilities at the time management committed to
the plan. Management determined that these costs provided no future economic
benefit to us.
The restructuring charge included termination benefits in connection with
the termination of 167 employees and lease abandonment costs. In addition, we
agreed to a settlement to exit the two leases for our call centers in North
Dakota as of July 1, 2002. On May 17, 2004 a termination agreement was signed
for our New York office lease on which we had previously recorded a lease
abandonment charge in connection with the restructure. The settlement included a
$90,000 payment in lieu of the remaining balance of $299,545 previously recorded
as a lease abandonment charge. The settlement payment consisted of a one-time
payment of $30,000, paid at the time of agreement, and three promissory notes of
$20,000 payable on November 1, 2004, May 1, 2005 and August 30, 2005,
respectively. All other expenses associated with this restructuring have been
paid in full.
In June 2004, we approved and implemented another restructuring to improve
our future cash flows and operating earnings. The restructuring included a
reduction in force. In accordance with Financial Accounting Standards Board
("FASB") SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal
Activities" the restructuring costs were considered a "One-Time Termination
Benefit" and as such we recognized the restructuring costs as a liability at the
communication date of June 8, 2004. The restructuring charge included
termination benefits in connection with the reduction in force of 102 employees.
The total charge taken in the second quarter of 2004 was $806,875 of which
$40,832 was paid in the second quarter. The majority of the remainder of
termination benefits will be paid in full by the end of August 2004.
SFAS No. 146 replaces the Emerging Issues Task Force ("EITF") 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity," used with the 2002 restructuring plan.
The following table shows the restructuring charges and related accruals
recognized under the plans and the effect on our consolidated financial
position:
Employee Lease Lease
Termination Settlement Abandonment
Benefits Costs Costs Total
Balance at January 1, 2002.....................$ -- $ -- $ -- $ --
Plan Charges.................................... 913 325 623 1,861
Cash paid....................................... (913) (325) (72) (1,310)
Balance at December 31, 2002.................... -- -- 551 551
Cash paid....................................... (200) (200)
Balance at December 31, 2003.................... -- -- 351 351
Plan Charges.................................... 807 -- 807
Lease Termination Settlement.................... (210) (210)
Cash paid....................................... (41) (81) (122)
Balance at June 30, 2004.......................$ 766 $ -- $ 60 $ 826
8. STOCK BASED COMPENSATION
STOCK OPTIONS
For employee stock options, the Financial Accounting Standards Board
("FASB") issued SFAS No. 123, "Accounting for Stock-Based Compensation,"
requiring entities to recognize as an expense, over the vesting period, the fair
value of the options or utilize the accounting for employee stock options used
under Accounting Principles Board ("APB") Opinion No. 25. We apply the
provisions of APB Opinion No. 25 and consequently recognize compensation expense
over the vesting period for grants made to employees and directors only if, on
the measurement date, the market price of the underlying stock exceeds the
exercise price. We do provide the pro forma net loss and earnings per share
disclosures as required under SFAS No. 123 for grants made as if the fair value
method defined in SFAS No. 123 had been applied. We recognize expense over the
H-2-11
vesting period of the grants made to non-employees based on utilizing the
Black-Scholes stock valuation model to calculate the value of the option on the
measurement date.
RESTRICTED STOCK
In March and April 2004, our compensation committee approved the granting
of 403,000 shares of restricted stock with a then approximate value of $1.1
million to certain executive officers and key employees. Consideration paid for
this stock is par value of $0.01 and continued employment. We apply the
provisions of APB Opinion No. 25 and consequently recognize compensation expense
over the vesting period for grants made to employees because the exercise prices
are less than the market price on the date of grant. We recorded compensation
expense of $0.1 million for the three and six months ended June 30, 2004.
9. COMMITMENTS AND CONTINGENCIES
We have disputed billings and access charges from certain inter-exchange
carriers ("IXCs") and incumbent local exchange carriers ("ILECs"). We contend
that these billings are not in accordance with the interconnection, service
level, or tariff agreements between us and certain IXCs and ILECs. We have not
paid these disputed amounts and, while we can make no guarantee, management
believes that we will prevail or mostly prevail in these disputes. At June 30,
2004, the total disputed amounts were approximately $19.7 million.
We currently have agreements with two long-distance carriers to provide
transmission and termination services for all of our long distance traffic.
These agreements generally provide for the resale of long distance services on a
per-minute basis and contain minimum volume commitments. As a result of a
settlement of a billing dispute associated with minimum volume commitments
required in one of these contracts we have agreed to pay an increased per minute
charge for minutes until the achievement of certain minimum minute requirements.
All other terms of the original agreement continue in full force. We believe
that we will be in full compliance with all minimum volume commitments during
2004. We have accrued $0.2 million representing the incremental increased fees
we expect to pay in 2004, so that the expense recorded per minute is consistent
throughout the agreement.
In connection with certain of our wholesale services agreements, all or a
portion of customer lines are provisioned using a unique code for our company.
Therefore, we are the customer of record for all Regional Bell Operating
Companies' billings, including a portion actually attributable to our wholesale
services customers. It is very likely that the state commissions would require
us to continue providing services to the end user customer for at least a 90-day
period, regardless of whether our wholesale relationships continue or whether
our wholesale services customers provide payment to us.
We have agreed to certain service level agreements ("SLAs") for providing
service under our wholesale service agreements. If we were to not fulfill the
SLAs after the phase-in period there are certain remedies including but not
limited to financial compensation. We have not paid any financial compensation
to date as a result of our not meeting any SLAs.
10. COMPUTATION OF NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted average number of common shares outstanding
during the period. Incremental shares of common stock equivalents are not
included in the calculation of net loss per share as the inclusion of such
equivalents would be anti-dilutive.
Net loss per share is calculated as follows:
For the three months ended For the six months ended
June 30, June 30,
2004 2003 2004 2003
H-2-12
Basic and diluted net loss per share:
Net loss.......................................... $ (11,111) $ (6,008) $ (21,494) $ (9,113)
Less mandatorily redeemable convertible
preferred stock dividends and accretion........ (3,626) (4,667) (7,991) (8,904)
Less deemed dividend related to beneficial
conversion feature............................. (47) (46) (93) (92)
Net loss attributable to common
stockholders................................... $ (14,784) $ (10,721) $ (29,578) $ (18,109)
Weighted average common shares
outstanding.................................... 36,608,703 35,305,448 36,337,804 35,286,953
Basic and diluted net loss per share.............. $ (0.40) $ (0.30) $ (0.81) $ (0.51)
Basic and diluted net loss per share are the same for each of the periods
presented. The following table includes potentially dilutive items that were not
included in the computation of diluted net loss per share for all periods
presented because to do so would be anti-dilutive in each case:
Six Months ended
June 30,
2004 2003
Unexercised stock options........................................ 14,219,585 12,848,745
Unexercised warrants............................................. 10,841,488 10,580,985
Mandatorily redeemable preferred stock convertible into
common shares................................................ 35,702,810 24,243,545
Total potentially dilutive shares of common stock
equivalents.................................................. 60,763,883 47,673,275
11. LEGAL AND REGULATORY PROCEEDINGS
During June and July 2001, three separate class action lawsuits were filed
against us, certain of our current and former directors and officers (the
"D&Os") and firms engaged in the underwriting (the "Underwriters") of our
initial public offering of stock (the "IPO"). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising out
of initial public offering allocations, have been assigned to a Judge in the
United States District Court for the Southern District of New York for pretrial
coordination. The lawsuits against us have been consolidated into a single
action. A consolidated amended complaint was filed on April 20, 2002. A Second
Corrected Amended Complaint (the "Amended Complaint"), which is the operative
complaint, was filed on July 12, 2002.
The Amended Complaint is based on the allegations that our registration
statement on Form S-1, filed with the Securities and Exchange Commission ("SEC")
in connection with the IPO, contained untrue statements of material fact and
omitted to state facts necessary to make the statements made not misleading by
failing to disclose that the underwriters allegedly had received additional,
excessive and undisclosed commissions from, and allegedly had entered into
unlawful tie-in and other arrangements with, certain customers to whom they
allocated shares in the IPO. The plaintiffs in the Amended Complaint assert
claims against us and the D&Os pursuant to Section 11 of the Securities Act of
1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC there under. The plaintiffs in the Amended Complaint
assert claims against the D&Os pursuant to Sections 11 and 15 of the Securities
Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated by the SEC there under. The plaintiffs seek an
undisclosed amount of damages, as well as pre-judgment and post-judgment
interest, costs and expenses, including attorneys' fees, experts' fees and other
costs and disbursements. Initial discovery has begun. We believe we are entitled
to indemnification from our Underwriters.
A settlement has been reached by the respective lawyers for the plaintiffs,
the issuers and insurers of the issuers. The principal terms of the proposed
settlement are (i) a release of all claims against the issuers and their
officers and directors, (ii) the assignment by the issuers to the plaintiffs of
certain claims the issuers may have against the Underwriters and (iii) an
undertaking by the insurers to ensure the plaintiffs receive not less than $1
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billion in connection with claims against the Underwriters. Hence, under the
terms of the settlement our financial obligations will likely be covered by
insurance. Our board of directors has approved the settlement. To be binding,
the settlement must be executed by the parties and thereafter submitted to and
approved by the court. The settlement will not be binding upon any plaintiffs
electing to opt-out of the settlement.
The Metropolitan Government of Nashville and Davidson County, Tennessee, on
behalf of the Metropolitan Nashville Employee Benefit Board (collectively "Metro
Nashville"), filed the foregoing lawsuit against us on September 20, 2002. The
lawsuit asserted claims under Delaware Law, the Uniform Commercial Code, and
state law and sought actual damages of $18 million, punitive damages of $18
million, interest, and court costs. Metro Nashville alleged that we wrongfully
and improperly delayed delivery of a stock certificate, preventing Metro
Nashville from selling or taking other steps to protect the value of their
shares while the market price of our stock declined significantly. On May 18,
2004, we entered into a settlement agreement whereby we paid Metro Nashville
$800,000 in cash and delivered to Metro Nashville 585,723 shares of our Common
Stock. We also agreed to file on Metro Nashville's behalf a registration
statement on Form S-3 allowing resale of those shares. That registration
statement became effective July 15, 2004.
On October 9, 2003, Z-Tel Communications, Inc., our wholly-owned subsidiary
corporation, filed a lawsuit against SBC Communications, Inc. and several of its
subsidiaries (collectively, "SBC") in federal court in Texas, where both SBC and
Z-Tel do business. The lawsuit alleges SBC's violation of the federal antitrust
laws, the Racketeering Influenced Corrupt Organizations Act (RICO), the Lanham
Act, and other federal and state laws. The complaint seeks damages and an
injunction against SBC. On November 20, 2003, SBC filed a motion to dismiss the
complaint. On August 6, 2004, the court denied in part, and granted in part,
SBC's motion to dismiss the complaint, allowing certain antitrust, RICO, and
Lanham Act claims to proceed. Although we intend to pursue our claims against
SBC vigorously, we cannot predict the outcome of this litigation with any
certainty.
Susan Schad, on behalf of herself and all others similarly situated, filed
a class action lawsuit against Z-Tel Communications, Inc., our wholly-owned
subsidiary corporation, on May 13, 2004. The lawsuit alleges that our subsidiary
has engaged in a pattern and practice of deceiving consumers into paying amounts
in excess of their monthly rates by deceptively labeling certain line-item
charges as government-mandated taxes or fees when in fact they were not. The
complaint seeks to certify a class of plaintiffs consisting of all persons or
entities who contracted with Z-Tel for telecommunications services and were
billed for particular taxes or regulatory fees. The complaint asserts a claim
under the Illinois Consumer Fraud and Deceptive Businesses Practices Act and
seeks unspecified damages, attorneys' fees and court costs. On June 22, 2004,
our subsidiary filed a notice of removal in the state circuit court action,
removing the case to the federal district court for the Northern District of
Illinois, Eastern Division, C.A. No. 4 C 4187. On July 26, 2004, Plaintiff filed
a motion to remand the case to the state circuit court. Plaintiff's motion is
still pending. Although we believe the plaintiff's allegations are without merit
and intend to defend the lawsuit vigorously, we cannot predict the outcome of
this litigation with any certainty.
The availability to Z-Tel of unbundled network elements pursuant to section
251 of the Telecommunications Act of 1996 is currently subject to considerable
legal uncertainty and litigation. In particular, our access to unbundled analog
switching - a key component of the Unbundled Network Element Platform
combination of elements, or UNE-P - is the subject of litigation by our Bell
company competitors and other incumbent local exchange carriers. In 2003, in the
Triennial Review Order, the Federal Communications Commission ("FCC") ruled that
entrants like Z-Tel would be able to purchase analog switching and dedicated
transport on an unbundled basis, subject to state-by-state review of whether
such unbundling was needed in their states. Carriers were involved in those
state-by-state proceedings when, on March 2, 2004, the D.C. Circuit Court of
Appeals overturned the FCC's decision as an improper delegation of authority to
state public utility commissions. See Report and Order and Order on Remand and
Further Notice of Proposed Rulemaking, Review of Section 251 Unbundling
Obligations of Incumbent Local Exchange Carriers, 18 FCC Rcd 16978 (2003)
("Triennial Review Order"), rev'd in part and remanded, United States Telecom
Ass'n v. FCC, Nos. 00-1012, 00-1015, 03-1310 et al. (D.C. Cir. March 2, 2004)
("USTA II").
The D.C. Circuit ordered that the unbundled transport and switching rules
be vacated as of June 15, 2004. Both the U.S. Solicitor General and the FCC
declined to appeal the case, and U.S. Supreme Court Justice
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William Rehnquist denied the request of Z-Tel and other CLECs for a stay of the
decision. Z-Tel and a number of other competitive local exchange carriers have
filed a Petition for Writ of Certiorari before the United States Supreme Court,
as has the State of California and the California Public Utilities Commission.
Those appeals of the USTA II litigation are currently pending before the Supreme
Court, and we expect the Court to either grant or deny those petitions in the
next several months.
On June 16, 2004, the D.C. Circuit decision in USTA II became effective and
the FCC's unbundling rules that were the subject of the appeal were vacated.
Shortly thereafter, the largest four Bell operating companies (Verizon,
BellSouth, SBC and Qwest) made several statements about their intent as to
whether to continue to provide CLECs like Z-Tel access to unbundled switching (a
critical component of the Unbundled Network Element Platform, or UNE-P) in
certain circumstances, high-capacity loops, dedicated transport, and EELs. To
varying degrees, we depend upon access to UNE-P, high capacity loops, transport
and EELs to provide our services, including our new VoIP services. The National
Telecommunications and Information Administration (NTIA), has stated that in
order to avoid customer and CLEC dislocation, the FCC should implement interim
rules that would maintain the status quo in terms of UNE availability as long as
possible. It has been reported that the FCC is currently considering adopting
interim UNE rules that would maintain the status quo for a certain period of
time while the FCC attempts to write rules to replace those vacated by the D.C.
Circuit in the USTA II opinion. Z-Tel plans to be active in these FCC
proceedings, as it was during the Triennial Review proceeding in 2002 and 2003.
Several state commissions are also considering options as to whether to impose
unbundling obligations under state law, in the absence of federal requirements.
If the FCC does not write adequate interim and final UNE rules, or if the
USTA II decision is not stayed or reversed, or if state commissions do not take
action under state law, there could be an immediate, significant, adverse and
material impact upon our business. ILECs might utilize the reversal of the
unbundling rules to deny us access to their local networks or sharply increase
the price of that access. We believe that in the event the vacated unbundling
rules are not replaced by either the FCC or the state commissions, we have
interconnection agreements with our principal ILEC suppliers (including Verizon,
SBC, BellSouth and Qwest) that will permit us to obtain access to local network
elements during the intervening time period. However, several of these Bell
companies have provided us notice that they wish to renegotiate those agreements
to take into account the vacating of the unbundling rules. Negotiation and
arbitration of those terms is likely to take some time and could result in
uncertainty as to our legal rights in the interim. It is also possible that
while those negotiations are pending, any or all of those incumbent local
telephone company suppliers will refuse to abide by the terms of the existing
agreements or terminate those agreements outright. Z-Tel is currently evaluating
all of its legal options to ensure that we can continue to meet the needs of our
existing and future customers. We believe we have legal rights to purchase these
elements pursuant to state law and under section 271 of the Telecommunications
Act of 1996, which the FCC has ruled to be a separate, alternative legal
requirement for Bell companies to provide wholesale network access. However,
enforcing those rights could be costly and require simultaneous litigation
throughout our multi-state service area, and the final result of such litigation
may or may not assure us of these alternative means of access.
Therefore, there is considerable uncertainty about the rates, terms and
conditions by which we will be able to access the local networks of the ILECs at
this time. This legal uncertainty can harm our business and could affect our
ability to secure financing for our ongoing operations and our investment in new
facilities and equipment. The uncertainty also harms our business by making it
more difficult to sell our services. If ILECs attempt to impose wholesale price
increases and regulators or courts do not act to stop such action, it may become
uneconomic for Z-Tel to offer service in many, if not all, of the territories
where we currently offer services. Z-Tel is actively considering all of its
options in response to this uncertainty, which may include retail price
increases, limitation or scaling back of our current business plan, reductions
in overhead or staffing, as well as litigation or regulatory actions. We have
and will continue to communicate these challenges to regulators and policymakers
throughout the United States Government and the states.
With regard to pricing of network elements, states and the FCC are
currently re-evaluating the pricing of network elements. As a result, it is
possible that some states could increase or lower rates from existing levels.
Currently, the incumbent local exchange carriers Verizon, BellSouth, SBC and
Qwest have rate cases pending before state regulatory commissions in at least
one state in each of their respective territories. Our intent is to be an active
participant in many of these rate cases and any others that might be critical to
our operations. The
H-2-15
FCC is also currently reevaluating its prescribed methodology for calculating
unbundled network element rates. In the 2002 Verizon v. FCC decision, the U.S.
Supreme Court affirmed the FCC's current pricing methodology, called "Total
Element Long Run Incremental Cost," or "TELRIC." The current FCC rulemaking
proposes to modify the TELRIC methodology by mandating that states set prices
based upon the forward-looking costs of operating the existing network
architecture of incumbent local telephone company networks. In many instances,
modifying the TELRIC methodology in this way could increase the rates we pay for
certain elements and result in lower rates for other elements. We believe that
the FCC's proposals to modify TELRIC are inconsistent with the Supreme Court's
decision in the Verizon case, meaning that new FCC TELRIC rules may be subject
to considerable litigation if they are adopted. Finally, all four Bell companies
also have pending before the FCC petitions asking that the FCC forbear from
application of the "TELRIC" pricing rules for UNE-P access. Z-Tel has opposed
those petitions, but by operation of law, the FCC is required to address those
petitions by the end of this year.
In the ordinary course of business, we are involved in legal and regulatory
proceedings, disputes and tax audits at the federal, state and local level that
are generally incidental to our ongoing operations. In addition, from time to
time, we are the subject of customer and vendor complaints filed with the state
utility commissions of the states in which they operate or the Federal
Communications Commission. Most complaints are handled informally and at this
time there are no formal proceedings pending. While there can be no assurance of
the ultimate disposition of incidental legal proceedings or customer complaints,
we do not believe their disposition will have a material adverse effect on our
consolidated results of operations or financial position.
12. SEGMENT REPORTING
We have two reportable operating segments: Retail Services and Wholesale
Services.
The retail services segment includes our Z-LineHOME and Z-LineBUSINESS
services that offer bundled local and long-distance telephone services in
combination with enhanced communications features accessible, through the
telephone, the Internet and certain personal digital assistants. We offer
Z-LineHOME and Z-LineBUSINESS in forty-nine states. Our customers are primarily
concentrated within metropolitan areas in ten states for both our Z-LineHOME and
Z-LineBUSINESS services. This segment also includes our Touch 1 residential
long-distance 1+ offering that is available nationwide. We have also included
expenses that are associated with our VoIP offering that was launched for beta
customers in May 2004.
The wholesale services segment allows companies to offer telephone exchange
and enhanced services to residential and small business customers. This service
is currently available in forty-nine states and Sprint is our primary customer
within this line of business.
Management evaluates the performance of each business unit based on segment
results. It is also important to note that we only record directly assignable
expenses against the wholesale services business segment and therefore, all
employee benefits, occupancy, insurance, and other indirect or corporate related
expenses are reflected in the retail services business segment.
The following summarizes the financial information concerning our
reportable segments for the three months ended June 30, 2004 and 2003:
Three Months ended June 30, 2004 Three Months ended June 30, 2003
Retail Wholesale Retail Wholesale
Services Services Consolidated Services Services Consolidated
Revenues................... $ 42,814 $ 20,983 $ 63,797 $ 55,142 $ 15,904 $ 71,046
Segment results............ $ (8,856) $ 4,501 $ (4,355) $ (2,850) $ 3,265 $ 415
Depreciation and $ 5,073 $ 36 $ 5,109 $ 5,380 $ 622 $ 6,002
amortization...............
Capital expenditures....... $ 2,311 $ 12 $ 2,323 $ 2,432 $ 223 $ 2,655
H-2-16
The following summarizes the financial information concerning our
reportable segments for the six months ended June 30, 2004 and 2003:
Six Months ended June 30, 2004 Six Months ended June 30, 2003
Retail Wholesale Retail Wholesale
Services Services Consolidated Services Services Consolidated
Revenues................... $ 88,118 $ 44,146 $132,264 $103,111 $ 28,864 $131,975
Segment results............ $(18,201) $ 9,187 $ (9,014) $ (7,097) $ 10,259 $ 3,162
Depreciation and $ 9,750 $ 670 $ 10,420 $ 10,798 $ 1,231 $ 12,029
amortization...............
Capital expenditures....... $ 4,691 $ 41 $ 4,732 $ 5,297 $ 48 $ 5,783
Identifiable assets........ $ 67,344 $ 13,225 $ 80,569 $ 85,049 $ 19,852 $104,901
The following table reconciles our segment information to the consolidated
financial information for the six months ended June 30, 2004 and 2003:
All 2004 and 2003 consolidated results reconcile to the consolidated
financial information above with the exception of the segment results reconciled
below:
Three Months ended Six Months ended
Reconciliation of segment results to net loss June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
Consolidated segment operating income (loss)...... $ (4,355) $ 415 $ (9,014) $ 3,162
Depreciation and amortization..................... (5,109) (6,002) (10,420) (12,029)
Interest and other income......................... 491 239 1,352 1,164
Interest and other expense........................ (2,138) (660) (3,412) (1,410)
Net loss.......................................... $(11,111) $ (6,008) $(21,494) $ (9,113)
13. SUBSEQUENT EVENTS
On July 26, 2004 Sprint indicated to us that they plan on committing less
resources to the existing wholesale services arrangement under which we
currently operate. Although Sprint is not canceling the agreement, they have
indicated to us that we can expect lower sales volumes as early as August 2004.
We believe that it is likely that this lower monthly sales activity will lead to
an increasingly smaller wholesale subscriber base. To the extent that this
proves to be the case, we will likely reduce the workforce that is currently
dedicated to the Sprint relationship. We are compensated on a direct cost pass
through basis by Sprint for the workforce that is dedicated to servicing the
Sprint customer base. We will likely reduce this dedicated workforce in
proportion to the decline in the size of the wholesale subscriber base
attributable to Sprint. Our net fee income can be expected to decline should the
wholesale lines in service begin to decline on an approximately proportional
basis.
By letter dated July 28, 2004, the Nasdaq Stock Market, Inc. notified us
that for 10 consecutive days the market value of our listed securities was below
$35 million as required for continued inclusion by Nasdaq Marketplace Rule
4310(c)(2)(B)(ii). Nasdaq has given us 30 calendar days or until August 27, 2004
to regain compliance. If compliance cannot be demonstrated by that day, the
Nasdaq staff will provide written notification that our common stock will be
delisted. At that time we may appeal the staff's determination to a Listing
Qualifications Panel. If our shares are delisted from the Nasdaq SmallCap
Market, our ability to raise additional capital may be hampered. We are planning
efforts to regain compliance, including a recapitalization of our preferred
shares.
On July 28, 2004, we entered into a lease agreement with Cisco Systems
Capital Corporation for $1.8 million in hardware, software and professional fees
that supports our VoIP initiative. The majority of this equipment was
implemented during the second quarter and is currently being used to support our
VoIP customer
H-2-17
base. The lease terms are for two years with a 25% refundable deposit amount of
$458,137 with two monthly payments (first and last) due immediately. At the end
of the lease the equipment can be purchased for fair market value. This lease
qualifies as an operating lease under the Financial Accounting Standards Board
("FASB") No. 13, "Accounting for Leases." As such, we will record and pay
monthly lease amounts through the term of the lease in the amount of $81,177
(including taxes). For the second quarter 2004, we recorded $63,681 for
professional fees and $151,733 for leased equipment expense.
On October 9, 2003, Z-Tel Communications, Inc., our wholly-owned subsidiary
corporation, had filed a lawsuit against SBC Communications, Inc. and several of
its subsidiaries (collectively, "SBC") in federal court in Texas, where both SBC
and we do business. The lawsuit alleges SBC's violation of the federal antitrust
laws, the Racketeering Influenced Corrupt Organizations Act (RICO), the Lanham
Act, and other federal and state laws. The complaint seeks damages and an
injunction against SBC. On November 20, 2003, SBC had filed a motion to dismiss
the complaint. On August 6, 2004, the court denied in part SBC's motion to
dismiss the complaint, allowing certain antitrust, RICO, and Lanham Act claims
to proceed. Although we intend to pursue our claims against SBC vigorously, we
cannot predict the outcome of this litigation with any certainty.
H-2-18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
You should read the following discussion together with the "Selected
Consolidated Financial Data," financial statements and related notes included in
this document. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results may differ materially from those
projected in the forward-looking statements as a result of certain factors,
including, but not limited to, those discussed in "Item 1. Business," as well as
"Cautionary Statements Regarding Forward-Looking Statements," and "Risks Related
to our Financial Condition and our Business," included in our Form 10-K filed
with the Securities and Exchange Commission on March 30, 2004. Factors that may
affect our results of operations include, but are not limited to, our limited
operating history and cumulative losses, uncertainty of customer demand,
potential software failures and errors, potential network and interconnection
failure, dependence on local exchange carriers, dependence on third party
vendors, success and profitability of our wholesale services, dependence on key
personnel, uncertainty of government regulation, legal and regulatory
uncertainties, and competition. We disclaim any obligation to update information
contained in any forward-looking statement.
OVERVIEW
We are an emerging provider of advanced, integrated telecommunications
services targeted to residential and business customers. We launched our
voice-over Internet protocol ("VoIP") service to business customers in May 2004
on a beta testing basis and expect to have a residential offering available in
certain markets by the fourth quarter of 2004.
Historically we have utilized the unbundled network elements platform
("UNE-P") as the basis of delivering our primary services to our retail end
users and end users of our wholesale customers. Under UNE-P we utilize various
elements of the incumbent local exchange carriers' to facilitate the delivery of
our services to our own end users and the end users of our wholesale services
customers.
In addition to providing our services on a retail basis, we are also
providing these services on a wholesale basis. Our wholesale service offering
allows other companies to have the ability to utilize our telephone exchange
services, enhanced services platform, and even our infrastructure and
back-office operations to provide services on a retail basis to their own end
users under their own private label brand. Under such an arrangement our
wholesale services customer owns the resulting base of end users and we simply
earn a cost plus fee from our wholesale services customer typically structured
on a per month per line in service basis.
For management purposes, we are organized into two reportable operating
segments: retail services and wholesale services. The nature of our business is
rapidly evolving.
In evaluating our financial condition and operating performance the most
important matters on which we focus are lines in service, revenue per unit, cost
per unit, bad debt expense, expenses as a percentage of revenues and results by
operating segment. These measures and other analysis are discussed in detail
throughout the following paragraphs and provide insight into how we analyze and
review our business. Because of significant uncertainty in the regulatory
environment in which we operate (created by a recent court case, See Part II,
Item I, Legal Proceedings), we must monitor and respond to any negative
regulatory developments.
Our second quarter 2004 financial and operating results include our investments
to expand our business services unit and to prepare for our VoIP initiatives
that we expect to increasingly launch over the second half of 2004.
Consistent with our plan to shift away from being an unbundled element
platform ("UNE-P") only provider, we concentrated our efforts during the second
quarter on preparing for our full scale VoIP launch in the Tampa and Atlanta
markets. We have a full in-house sales force operating in Tampa and Atlanta.
We focused the balance of our resources during the second quarter of 2004
on developing additional business clients on our UNE-P platform. Retail Brand
Alliance (the parent of Brooks Brother's stores, Casual Corner Group, Carolee,
Adrienne Vittadini) and Crabtree & Evelyn stores have recently decided to take
advan-
H-2-19
tage of Z-Tel's Managed Local Services. Importantly, we are obtaining clients
within this part of our business services unit that we can potentially convert
to our VoIP platform as we turn up various markets.
We also intend to increasingly convert our residential customer base from
the UNE-P platform to the VoIP platform as we turn up more markets. By doing so,
we think we can mitigate our reliance of the ILECs and increase our operating
profitability through margin expansion. We may or may not be successful in this
endeavor.
CONSOLIDATED RESULTS OF OPERATIONS
The three and six months ended June 30, 2004 compared to the same period in the
prior year.
The following consolidated Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
results by segment. Key selected financial and operating data for the three and
six months ended June 30, 2004 and 2003 are as follows:
Amount Percentage
For the three months Change Change
ended June 30, Favorable Favorable Percentage of Revenues
2004 2003 (Unfavorable)(Unfavorable) 2004 2003
(In Millions)
Results of Operations:
Revenues............................... $63.8 $71.1 $(7.3) (10.3)% 100.0% 100.0%
Operating expenses:
Network operations..................... 31.2 32.1 0.9 2.8% 48.9% 45.1%
Sales and marketing.................... 4.5 6.6 2.1 31.8% 7.1% 9.3%
General and administrative............. 31.7 31.9 0.2 0.6% 49.7% 44.9%
Restructuring Charge................... 0.8 -- (0.8) (100.0)% 1.2% --%
Depreciation and amortization.......... 5.1 6.0 0.9 15.0% 8.0% 8.4%
Total operating expenses............... 73.3 76.6 3.3 4.3% 114.9% 107.7%
Operating loss......................... (9.5) (5.5) (4.0) (72.7)% (14.9)% (7.7)%
Nonoperating income (loss):
Interest and other income.............. 0.5 0.2 0.3 150.0% 0.8% 0.3%
Interest and other expense............. (2.1) (0.7) (1.4) (200.0)% (3.3)% (1.0)%
Total nonoperating income (loss)....... (1.6) (0.5) (1.1) 220.0% (2.5)% (0.7)%
Net loss............................... (11.1) (6.0) (5.1) (85.0)% (17.4)% (8.4)%
Less mandatorily redeemable
convertible preferred stock (3.6) (4.6) 1.0 21.7% (5.6)% (6.5)%
dividends and accretion.............
Less deemed dividend related to
beneficial conversion feature....... (0.1) (0.1) -- --% (0.2)% (0.1)%
Net loss attributable to common $(14.8) $(10.7) $(4.1) (38.3)% (23.2)% (15.0)%
stockholders........................
Cash Flow Data:
Net cash used in operating $(12.4) $1.0 $(13.4) (1,340.0)% *
activities..........................
Net cash used in investing (2.3) (2.6) 0.3 11.5% * *
activities..........................
Net cash provided by financing 11.1 (1.2) 12.3 (1,025.0)% * *
activities..........................
Net decrease in cash and cash $(3.6) $(2.8) $(0.8) 28.6% * *
equivalents.........................
H-2-20
Amount Percentage
For the three months Change Change
ended June 30, Favorable Favorable Percentage of Revenues
2004 2003 (Unfavorable)(Unfavorable) 2004 2003
(In Millions)
Results of Operations:
Revenues............................... $132.3 $132.0 $0.3 0.2% 100.0% 100.0%
Operating expenses:
Network operations..................... 65.3 58.9 (6.4) (10.9)% 49.4% 44.6%
Sales and marketing.................... 9.0 11.1 2.1 18.9% 6.8% 8.4%
General and administrative............. 66.2 58.9 (7.3) (12.4)% 50.0% 44.6%
Restructuring Charge................... 0.8 -- (0.8) (100.0)% 0.6% --%
Depreciation and amortization.......... 10.4 12.0 1.6 13.3% 7.9% 9.1%
Total operating expenses............... 151.7 140.9 (10.8) (7.7)% 114.7% 106.7%
Operating loss......................... (19.4) (8.9) (10.5) (118.0)% (14.7)% (6.7)%
Nonoperating income (loss):
Interest and other income.............. 1.3 1.2 0.1 8.3% 1.0% 0.9%
Interest and other expense............. (3.4) (1.4) (2.0) (142.9)% (2.6)% (1.1)%
Total nonoperating income (loss)....... (2.1) (0.2) (1.9) (950.0)% (1.6)% (0.2)%
Net loss............................... (21.5) (9.1) (12.4) (136.3)% (16.3)% (6.9)%
Less mandatorily redeemable
convertible preferred stock (8.0) (8.9) 0.9 10.1% (6.0)% ----------
dividends and accretion............. (6.7)%
Less deemed dividend related to
beneficial conversion feature....... (0.1) (0.1) -- --% (0.1)% (0.1)%
Net loss attributable to common $(29.6) $(18.1) $(11.5) (63.5)% (22.4)% (13.7)%
stockholders........................
Cash Flow Data:
Net cash used in operating $(9.2) $6.1 $(15.3) (250.8)% * *
activities..........................
Net cash used in investing (4.7) (5.7) 1.0 17.5% * *
activities..........................
Net cash provided by financing 10.1 (2.2) 12.3 (559.1)% * *
activities..........................
Net decrease in cash and cash
equivalents......................... $(3.8) $(1.8) $(2.0) 111.1% * *
(*) Not meaningful
Revenues. Revenues decreased by $7.3 million to $63.8 million for the three
months ended June 30, 2004, compared to $71.1 million the prior year. The
decrease in revenues was primarily a result of the decline in residential UNE-P
lines in service by approximately 58,000 lines. This decrease was in line with
our intent to make less investment in traditional consumer subscribers, instead
focusing on the growth of our business and VoIP services.
Revenues increased by $.3 million to $132.3 million for the six months
ended June 30, 2004, compared to $132.0 million the prior year. We experienced a
decrease in consumer related revenues over this period, compared to the prior
year, but this decrease was offset by a similar increase in wholesale and
business revenues over the period.
The following table provides a break-down of our revenues and changes for
the three and six months ended June 30, 2004 compared to the same period in
2003:
Amount Percentage
Revenues for the Change Change
three Favorable Favorable Percentage of Revenues
months ended June
30,
2004 2003 (Unfavorable) (Unfavorable) 2004 2003
(In Millions)
Residential Services................ $36.0 $52.0 $(16.0) (30.8)% 56.4% 73.1
Business Services .................. 4.9 0.6 4.3 716.7% 7.7% 0.8%
1+ Long Distance Services .......... 1.9 2.6 (0.7) (26.9)% 3.0% 3.7%
Wholesale Services ................. 21.0 15.9 5.1 32.1% 32.9% 22.4%
Total .............................. $63.8 $71.1 $(7.3) (10.3)% 100.0% 100.0%
H-2-21
Amount Percentage
Revenues for the six Change Change
months ended June Favorable Favorable Percentage of Revenues
30,
2004 2003 (Unfavorable) (Unfavorable) 2004 2003
(In Millions)
Residential Services................ $76.1 $96.5 $(20.4) (21.1)% 57.5% 73.1%
Business Services .................. 8.2 1.0 7.2 720.0% 6.2% 0.8%
1+ Long Distance Services .......... 3.9 5.6 (1.7) (30.4)% 3.0% 4.2%
Wholesale Services ................. 44.1 28.9 15.2 52.6% 33.3% 21.9%
Total .............................. $132.3 $132.0 $0.3 0.2% 100.0% 100.0%
Two significant drivers impact our revenues: lines in service and average
monthly revenue per unit ("ARPU"). The more significant driver impacting our
changes in revenue is the amount of lines in service. The following table
provides a break-down of our lines in service:
Average lines in service Ending lines in service
for the three months ended for the three months ended
June 30, June 30,
2004 2003 2004 2003
Residential Services....................... 185,631 244,345 181,344 256,007
Business Services.......................... 39,554 4,680 46,514 5,942
1+ Long Distance Services.................. 55,737 95,539 49,451 90,003
Wholesale Services......................... 347,821 108,201 355,912 157,800
Total...................................... 628,743 452,765 633,221 509,752
Average lines in service Ending lines in service
for the six months ended for the six months ended
June 30, June 30,
2004 2003 2004 2003
Residential Services....................... 193,051 229,730 181,344 256,007
Business Services.......................... 34,054 2,971 46,514 5,942
1+ Long Distance Services.................. 61,935 98,328 49,451 90,003
Wholesale Services......................... 326,368 106,662 355,912 157,800
Total...................................... 615,408 437,691 633,221 509,752
ARPU provides a business measure of the average monthly revenue generation
attributable to each line in service. ARPU is calculated by taking total
revenues divided by the number of months in the period and is divided by the
average lines in service during the period. We use this measure when analyzing
our retail services revenue, but not when assessing our wholesale services
revenue because of the gross accounting method used to record our wholesale
services revenue which makes ARPU for wholesale services a largely meaningless
business measure. We believe ARPU, which calculates the average revenue per
average line in service, is a useful measure to evaluate our past revenues and
to assist in forecasting our future retail revenues. We also believe that this
measure provides a gauge to compare and contrast our revenue streams and to
compare our revenues to other communication providers that have significantly
more or less subscribers than we have. The following table provides a summary of
our ARPU:
Average revenue per unit in Amount Percentage
service Change Change
for the three months ended Favorable Favorable
June 30,
2004 2003 (Unfavorable) (Unfavorable)
Residential Services....................... $64.64 $70.94 $(6.30) (8.9)%
Business Services.......................... $41.29 $42.74 $(1.45) (3.4)%
1+ Long Distance Services.................. $11.36 $9.07 $2.29 25.3%
Wholesale Services......................... * * * *
H-2-22
Average revenue per unit in Amount Percentage
service Change Change
for the six months ended Favorable Favorable
June 30,
2004 2003 (Unfavorable) (Unfavorable)
Residential Services....................... $65.70 $70.01 $(4.31) (6.2)%
Business Services.......................... $40.13 $56.10 $(15.97) (28.5)%
1+ Long Distance Services.................. $10.49 $9.49 $1.00 10.5%
Wholesale Services......................... * * * *
(*) Not meaningful
The overall change in our revenues for the three and six months ended June
30, 2004 compared to the same prior year period was largely driven by our
continued focus in 2004 on growing our wholesale and retail business services,
preparing for the launch of our VoIP services, and to reduce our investment in
the traditional consumer business. Residential UNE-P and 1+ long distance
service revenues combined to decrease $16.7 and $22.1 million for the three and
six months ended June 30, 2004, respectively. This was a result of our continued
shift away from actively investing in our residential UNE-P business, a trend
that began during mid-2003. With respect to our existing revenue streams, we
intend to focus the majority of our sales and marketing investment on our
business services segment and in marketing our emerging VoIP based services.
We also anticipate that our ARPU will continue to decline, perhaps
materially, into the foreseeable future, primarily due to the competitive
climate and planned reductions in access fees. To the extent that we are able to
develop more and/or new service offerings, such as our PVA and/or Digital
Subscriber Line ("DSL"), we may have some opportunity to mitigate any
fundamental decrease in general levels of ARPU. We intend to invest in sales and
marketing activities to attract select business customers.
Negative legal and regulatory outcomes could restrict or increase the costs
of our access to ILEC networks. We would expect to respond by substantially
curtailing or perhaps fully eliminating our marketing of UNE-P based services
and focusing primarily on offering VoIP services, thereby reducing our reliance
on the ILEC networks. We may or may not be successful in this endeavor.
As of July 21, 2004 we have approximately 43 VoIP customers in beta test
with a total of 338 lines. We continue to target companies with large existing
consumer and business customer bases for various forms of partnership
opportunities, and we are also exploring additional distribution arrangements
and delivery opportunities for our current and future services. We are also
seeking additional wholesale service relationships and expect to focus our
business sales on large national multi-locations business customers because we
believe that our service offering is most attractive to these types of
customers.
Network Operations. Network operations expense decreased by $.9 million to
$31.2 million for the three months ended June 30, 2004, compared to $32.1
million the prior year. The decrease in network operations expense was primarily
the result of having an overall smaller average number of lines in service for
the three months ended June 30, 2004 compared to the same prior year period.
Network operations expense increased by $6.4 million to $65.3 million for
the six months ended June 30, 2004, compared to $58.9 million the prior year.
The overall increase was due to wholesale line growth outstripping the
residential line falloff especially during the first quarter of 2004 as compared
to the prior year. Our network operations expense primarily consists of fixed
and variable transmission expenses for the leasing of the UNE-P components from
the ILECs, domestic and international charges from service level agreements with
IXCs, the Universal Service Fee and certain other regulatory charges to be
consistent with industry practice. The following tables provide a detailed
break-down and analysis of changes in network operations expense:
Network Operations for Amount Percentage
the Change Change Percentage of
three months ended Favorable Favorable Network Operations
June 30,
2004 2003 (Unfavorable)(Unfavorable) 2004 2003
(In Millions)
H-2-23
Residential & Business Services..... $21.3 $24.1 $2.8 11.6% 68.2% 75.1%
1+ Long Distance Services........... 0.3 0.7 0.4 57.1% 1.0% 2.2%
Wholesale Services.................. 9.6 7.3 (2.3) (31.5)% 30.8% 22.7%
Total............................... $31.2 $32.1 $0.9 2.8% 100.0% 100.0%
Network Operations for Amount Percentage
the Change Change Percentage of
six months ended Favorable Favorable Network Operations
June 30,
2004 2003 (Unfavorable)(Unfavorable) 2004 2003
(In Millions)
Residential & Business Services..... $43.5 $46.0 $2.5 5.4% 66.6% 78.1%
1+ Long Distance Services........... 0.8 1.4 0.6 42.9% 1.2% 2.4%
Wholesale Services.................. 21.0 11.5 (9.5) (82.6)% 32.2% 19.5%
Total............................... $65.3 $58.9 $(6.4) (10.9)% 100.0% 100.0%
Our network operations expense as a percentage of revenues increased to
48.9% for three months ended June 30, 2004 compared to 45.1% in the prior year.
Our network operations expense as a percentage of revenues increased to 49.4%
for the six months ended June 30, 2004 compared to 44.6% in the prior year. The
increase in network operations expense was primarily a result of the increase in
wholesale lines in service.
The following tables provide a detail of network operations expense as a
percentage of revenues by the respective revenue types.
Network operations as a Amount
% of revenues for the Change
three months ended June 30 Favorable
2004 2003 (Unfavorable)
Residential & Business Services................. 52.1% 45.8% (6.3)%
1+ Long Distance Services....................... 15.8% 26.9% 11.1%
Wholesale Services.............................. 45.7% 45.9% 0.2%
Network operations as a Amount
% of revenues for the Change
six months ended June 30 Favorable
2004 2003 (Unfavorable)
Residential & Business Services................. 51.6 47.2% (4.4)%
1+ Long Distance Services 20.5% 25.0% 4.5%
Wholesale Services 47.6% 39.8% (7.8)%
We also analyze the average expense per unit ("AEPU") for network
operations expense, similar to the ARPU calculation for revenues. AEPU is
calculated by taking total network operations expense divided by the number of
months in the period and is divided by the average lines in service during the
respective period. We believe AEPU, which calculates the average network
operations expense per average line in service, is a useful measure to evaluate
our past network operations expense and to assist in forecasting our future
retail network operations expense. We also believe that this measure provides a
gauge to compare our network operations expense to other communications
providers that have significantly more or less subscribers than we have. The
following details AEPU for retail network operations expense:
H-2-24
Average network operations
expense per unit for the Amount Percentage
three months ended Change Change
June 30, Favorable Favorable
2004 2003 (Unfavorable) (Unfavorable)
Residential & Business Services............ $31.53 $32.26 $0.73 2.3%
1+ Long Distance Services.................. $1.79 $2.44 $0.65 26.5%
Wholesale Services......................... * * * *
Average network operations
expense per unit for the Amount Percentage
six months ended Change Change
June 30, Favorable Favorable
2004 2003 (Unfavorable) (Unfavorable)
Residential & Business Services............ $31.92 $32.95 $1.03 3.1%
1+ Long Distance Services.................. $2.15 $2.37 $0.22 9.3%
Wholesale Services......................... * * * *
(*) Not meaningful
Similar to the ARPU analysis, this table excludes an analysis of wholesale
services because management does not look at this measure, given that network
expenses related to wholesale services are intended to be zero-margin direct
cost pass-through in nature.
We do expect increases to our AEPU as a result of increased end user usage,
continued geographical dispersion of customers to more expensive UNE-P pricing
zones and states, an increased proportion of business lines which have a higher
network operations expense per unit, and probable increased costs due to
uncontrollable change within the regulatory arena relative to the rules under
which we gain access to the various UNE-P elements today. We will attempt to
ensure that the pricing and availability of UNE-P is conducive to our desire to
compete; however, we recognize the wide-range of possibilities that could occur,
including the possibility of an immediate and material adverse effect upon our
business. We will also begin to experience additional fixed facility charges and
additional network operation expenses as we develop and grow our VoIP offering.
As stated above negative legal and regulatory outcomes could increase the costs
of, or restrict altogether, gaining access to ILEC networks. We would expect to
respond by substantially curtailing, or perhaps fully eliminating, our marketing
of UNE-P-based services and focusing primarily on VoIP services, thereby
mitigating our reliance on ILEC networks.
Sales and Marketing. Sales and marketing expense decreased $2.1 million to
$4.5 million for the three months ended June 30, 2004 compared to $6.6 million
the prior year. Sales and marketing expense decreased $2.1 million to $9.0
million for the six months ended June 30, 2004 compared to $11.1 million the
prior year. Sales and marketing expense primarily consists of the costs of
telemarketing, sending direct mail, advertising and independent sales
representative commissions, sales salaries and benefits. Sales and marketing
includes all salary and benefits costs paid to employees directly engaged in
sales and marketing activities.
Although the sales and marketing expense decreased for the six months ended
June 30, 2004 compared to the same prior year period there were several
significant changes in certain line items that compose this expense as detailed
below:
o $2.0 million increase in payroll and related expense as a result of
significantly growing our internal sales force to grow our business
and VoIP offerings;
o $3.5 million decrease to other discretionary marketing such as
telemarketing, direct mail, and other brand awareness items;
H-2-25
o $.5 million decrease in one-time and recurring commissions to
independent sales contractors. This is mainly due to the corresponding
decrease in residential lines.
We expect to leverage our in-house sales team in the coming months as we
have grown this team to drive growth in our business and VoIP offerings and
expect to reduce the use of our independent sales contractors to sell business
services over the coming quarters. Our business and VoIP sales efforts may
become more localized in areas in which we expect to make a substantial
investment in VoIP facilities. We believe that by focusing our investment in
certain areas we will maximize our network economies in making a transition from
a UNE-P based access delivery method to a VoIP solution. We intend to offer
additional VoIP based enhanced services, and to reduce our reliance on the
incumbent local exchange carriers. Now that we have built a core in-house sales
team we expect business sales to provide lower acquisition costs than we have
previously experienced. As stated above, legal and regulatory matters could
continue to cause us to substantially curtail or fully eliminate the marketing
of our UNE-P based services.
General and Administrative. General and administrative expense primarily
consists of employee salaries and benefits, outsourced services, bad debt
expense, billing and collection costs, occupancy costs, legal, regulatory and
provisioning costs.
General and administrative expense decreased $.2 million to $31.7 million
for the three months ended June 30, 2004, compared to $31.9 million in the prior
year period. General and administrative expense as a percentage of revenue
increased by 4.8% to 49.7% for the three months ended June 30, 2004, compared to
44.9% in the prior year period.
The decrease in our general and administrative expense for the three months
ended June 30, 2004 was primarily a result of improved collection rates that
resulted in decreases to bad debt expense of $2.8 million compared to the same
period in the prior year. These were partially offset by increases in sales and
use tax expense of $1.0 million as well as additional legal fees due of $1.1
million for outstanding legal matters and efforts to support our position on
contested regulatory issues related to UNE-P. We also had an increase in health
insurance expense of $.4 million.
General and administrative expense increased $7.3 million to $66.2 million
for the six months ended June 30, 2004, compared to $58.9 million in the prior
year period. General and administrative expense as a percentage of revenue
increased by 5.4% to 50.0% for the six months ended June 30, 2004, compared to
44.6% in the prior year period.
The specific significant changes in general and administrative expense line
items for the six months ended June 30, 2004 from the same prior year period
were as follows:
o Increase in legal and professional fees - $2.3 million
o Increase in sales and use tax expense - $1.9 million
o Increase in stock expense for issuance of restricted stock - $0.2
million
o Increase in wholesale service costs - $1.4 million
o Reduction in ILEC performance credits - $2.6 million
o Settlement for litigation related to Metro Nashville - $1.8 million
o Accrual for payroll bonus and related expenses - $1.1 million
o Increase in health insurance expense - $0.6 million
o Reduction in bad debt expense - $3.5 million
H-2-26
o Reduction in support fees (telephone & verification expense) - $0.9
million
o Reduction due to New York lease settlement - $0.2 million
The increase in general and administrative expense as a percentage of
revenue is partially the result of our continued investment in technology
personnel and the dedication of existing resources to the continued development
and expansion of our VoIP offering. We also spent significantly more on legal
and regulatory fees for the six months ended June 30, 2004 compared to the prior
year period due primarily to the Metro Nashville lawsuit against us, our
continued anti-trust lawsuit against SBC Communications and a continued
investment in supporting the legal and regulatory arguments for the continuance
of the current UNE-P rules as mandated by the 1996 Telecommunications Act.
We anticipate general and administrative expenditures will continue to
increase in total to support our planned expansion of service offerings for
VoIP. We will continue to evaluate our operations for efficiencies and our
employee staffing requirements as they relate to increased efficiencies or needs
to expand our outsource services.
As stated above legal and regulatory matters could significantly increase
the costs of our access to ILEC networks, if not fully eliminate our access. We
would likely respond with a reduction in the number of our employees to reduce
general and administrative expenses and help enable us to invest in VoIP
operations. Depending on the final resolution of these regulatory matters as
they relate to the pricing that we pay to other network providers, we may or may
not be able to reduce enough General and Administrative expense to remain a
going concern.
Restructuring Charge. We recorded a restructuring charge in the amount of
$.8 million for the three and six months ending June 30, 2004 as compared to the
prior year. The primary measure as part of a set of initiatives that we
implemented in early June 2004 was a reduction in force of 102 employees, which
in aggregate, earned a total salary of approximately $3.5 million. The reduction
in force triggered the WARN Act and therefore employees received a severance of
at least two months salary and benefits. We recorded the total charge for this
initiative in the period ended June 30, 2004 (see Footnote 7 to our financial
statements in this report).
Depreciation and Amortization. Depreciation and amortization expense
decreased $.9 million to $5.1 million for the three months ended June 30, 2004,
compared to $6.0 million the prior year period. Depreciation and amortization
expense decreased $1.6 million to $10.4 million for the six months ended June
30, 2004, compared to $12.0 million the prior year period. Depreciation expense
decreased during the three months and six months ending June 30, 2004 due to
some of our equipment reaching the end of its fully depreciable life. We have
generally been recording more depreciation expense than capital expenditures for
several years, and consequently our depreciable capital asset base is smaller
than it has been historically.
We expect to purchase additional computer equipment, switching equipment,
furniture and leasehold improvements as a result of our intended VoIP expansion.
We will also continually evaluate our depreciation policy with respect to our
current and future network plans and the associated purchases of capital
equipment. Depending on a variety of matters, including but not limited to, our
success in transitioning from UNE-P to VoIP, we may or may not write-off certain
assets in the future.
Interest and Other Income. Interest and other income was $0.5 million as
compared to $0.2 million for the three months ending June 30, 2004 and 2003,
respectively. Interest and other income was $1.3 million as compared to $1.2
million for the six months ending June 30, 2004 and 2003, respectively. Interest
and other income consists of interest charged to our bundled consumer and
business customers for not paying their bills on time and income from interest
earned from our cash balance.
Interest and Other Expense. Interest and other expense increased $1.4
million to $2.1 million for the three months ended June 30, 2004, compared to
$0.7 million the prior year period. Interest and other expense increased $2.0
million to $3.4 million for the six months ended June 30, 2004, compared to $1.4
million the prior year period. Our interest expense includes late fees for
vendor payments and charges related to our working
H-2-27
capital facility, capital leases and our other term debt obligations. The
overall increase in interest and other expense for the three and six months
ended June 30, 2004 compared to the prior year period was the result of
increased late payment charges on vendor payments. We anticipate that interest
expense may increase due to the additional availability that may be created from
our new asset based loan with Textron Financial Corporation. We also expect to
finance as much of our VoIP related capital expenditures as possible and we are
seeking and considering additional debt offerings and other financing options in
an effort to improve our liquidity in order to fund our growth initiatives for
2004.
Income Tax Benefit. No provision for federal or state income taxes has been
recorded due to the full valuation allowance recorded against the net deferred
tax asset for the six months ended June 30, 2004 and the same prior year period.
RESULTS OF OPERATIONS BY SEGMENT
Our reportable segments reflect strategic business units that offer similar
products and service. We have two reportable segments:
o Retail Services
o Wholesale Services
Management evaluates the performance of each business unit based on segment
results. See our Segment footnote to our consolidated financial statements for a
reconciliation of segmented results to the consolidated financial information.
The following discussions highlight our performance within the context of
these segments.
RETAIL SERVICES SEGMENT
Our retail services operating segment includes our consumer and business
bundled service lines of business. This segment also includes our 1+
long-distance stand-alone offering. In mid-2003 we shifted to focusing on
growing our business bundled service lines, and to only passively investing in
our consumer UNE-P business. We have continued to fully harvest the 1+
long-distance stand- alone offering for maximum cash flow since its acquisition
in April 2000. The following tables, in millions, summarize the results for our
retail services business segment for the three and six months ended June 30,
2004, respectively compared to the prior year period:
Retail Services Segment
Amount Percentage
For the three months Change Change
ended June 30, Favorable Favorable Percentage of Revenues
2004 2003 (Unfavorable) (Unfavorable) 2004 2003
Revenues
Bundled residential services...... $36.0 $52.0 $(16.0) (30.8)% 84.1% 94.2%
Bundled business services......... 4.9 0.6 4.3 716.7% 11.5% 1.1%
1+ long-distance services......... 1.9 2.6 (0.7) (26.9)% 4.4% 4.7%
Total Revenues.................... 42.8 55.2 (12.4) (22.5)% 100.0% 100.0%
Operating expenses:
Network operations................ 21.6 24.8 3.2 12.9% 50.5% 44.9%
Sales and marketing............... 4.4 6.6 2.2 33.3% 10.3% 12.0%
Restructure Charge................ 0.8 -- (0.8) (100.0)% 1.9% --%
General and administrative........ 24.8 26.7 1.9 7.1% 57.9% 48.4%
Total operating expenses.......... 51.6 58.1 6.5 11.2% 120.6% 105.3%
Segment results................... $(8.8) $(2.9) $(5.9) (203.4)% (20.6)% (5.3)%
Retail Services Segment
Amount Percentage
H-2-28
For the six months Change Change
ended June 30, Favorable Favorable Percentage of Revenues
2004 2003 (Unfavorable) (Unfavorable) 2004 2003
Revenues
Bundled residential services...... $76.0 $96.5 $(20.5) (21.2)% 86.3% 93.6%
Bundled business services......... 8.2 1.0 7.2 720.0% 9.3% 1.0%
1+ long-distance services......... 3.9 5.6 (1.7) (30.4)% 4.4% 5.4%
Total Revenues.................... 88.1 103.1 (15.0) (14.5)% 100.0% 100.0%
Operating expenses:
Network operations................ 44.3 47.4 3.1 6.5% 50.3% 46.0%
Sales and marketing............... 8.8 11.0 2.2 20.0% 10.0% 10.7%
General and administrative........ 52.4 51.8 (0.6) (1.2)% 59.5% 50.2%
Restructure Charge................ 0.8 -- (0.8) (100.0)% 0.9% --%
Total operating expenses.......... 106.3 110.2 3.9 3.5% 120.7% 106.9%
Segment results................... $(18.2) $(7.1) $(11.1) (156.3)% (20.7)% (6.9)%
Revenues. Revenues decreased by $12.4 million to $42.8 million for the
three months ended June 30, 2004, compared to $55.2 million the prior year
period. The net revenue decline in our retail business of $16.7 million is
primarily related to our reduction in residential and 1+ long distance lines,
for the three months ending June 30, 2004 as compared to the prior period. This
was partially offset by a $4.3 million increase in our business services
revenue.
Revenues decreased by $15.0 million to $88.1 million for the six months
ended June 30, 2004, compared to $103.1 million the prior year period. The net
revenue decline in our retail business of $22.2 million is primarily related to
our reduction in residential and 1+ long distance lines, for the six months
ending June 30, 2004 as compared to the prior period. This was partially offset
by a $7.2 million increase in our business services revenue.
Additionally, our ARPU per bundled consumer UNE-P line decreased by $6.30
to $64.64 for the three months ended June 30, 2004, compared to $70.94 in the
prior year period. Our ARPU per bundled consumer UNE-P line decreased by $4.31
to $65.70 for the six months ended June 30, 2004, compared to $70.01 in the
prior year period. There were two significant factors that contributed to this
change in ARPU. First, another decrease in access rates (charges that we bill to
other carriers for carrying their traffic to our customers) was effective in
June of 2003 but would not have been fully reflected in the second quarter 2003
numbers as compared to 2004. (A further decrease occurred in June of 2004.)
Secondly, in order to react to the highly competitive telecommunication market
and pricing trends we have seen significant line increases in our unlimited
bundle service offerings to consumer customers. The unlimited service has a
lower ARPU than some of our historical pricing plans because it includes for a
fixed price, unlimited domestic and local calling, in addition to all of our
enhanced services.
We expect business service lines to continue to increase throughout the
year as we leverage our in-house business sales staff. Our 1+ long-distance
revenue is expected to continually decrease and we expect to have some VoIP
revenues, although not any meaningful amounts, during 2004. Therefore, we expect
that consumer related services will continue to generate the majority of our
overall revenue and cash flow during 2004, due to the size of the embedded
customer base relative to the other lines of business and the rate at which they
may grow.
Network Operations. Network operations expense decreased by $3.2 million to
$21.6 million for the three months ended June 30, 2004, compared to $24.8
million the prior year period. Our network operations as a percentage of revenue
increased by 5.6% to 50.5% for the three months ended June 30, 2004, compared to
44.9% the prior year.
Network operations expense decreased by $3.1 million to $44.3 million for
the six months ended June 30, 2004, compared to $47.4 million the prior year
period. Our network operations as a percentage of revenue increased by 4.3% to
50.3% for the six months ended June 30, 2004, compared to 46.0% the prior year.
The increase in network operations expense as a percentage of revenue was a
result of increased long distance usage from the growth in our unlimited service
offerings and increases in certain network cost elements
H-2-29
as a result of our customer base being spread across more states and zones
within those states that have less favorable pricing when compared to the states
in which we had customers in the prior year period. These increases were offset
by reductions to network operations expense as a result of the overall decrease
in our overall retail lines in service at June 30, 2004 compared to the prior
year period.
We expect network operations expense to increase in the near term as we
begin to incur more VoIP expenditures and believe that the current regulatory
environment surrounding UNE-P will likely result in increased per unit recurring
and non-recurring costs, perhaps significantly. The expected growth across all
of our service offerings will most likely drive increases to our network
operations expense in 2004 and beyond. We believe that over the longer-term,
however, our network costs may decrease on a per unit basis as we move from a
UNE-P LEC dependent based model to a VoIP model.
Sales and Marketing. Sales and marketing expense was $4.4 million for the
three months ended June 30, 2004 compared to $6.6 million for the prior year
period. Sales and marketing expense was $8.8 million for the six months ended
June 30, 2004 compared to $11.0 for the prior year period. The changes in our
sales and marketing focus are discussed in the consolidated operations.
We expect to invest in additional headcount for our in-house business sales
force and reduce our reliance on a large independent sales contractor agreement
for some of our business services line growth which should result in reductions
to our acquisition costs for business lines. We also expect to add more sales
force related headcount in certain markets as we initiate our VoIP efforts. We
anticipate an increasingly localized sales effort in certain markets as VoIP is
utilized as the preferred delivery method of our service to end users.
General and Administrative. General and administrative expense decreased
$1.9 million to $24.8 million for the three months ended June 30, 2004, compared
to $26.7 million in the prior year. As a percentage of revenues general and
administrative expense increased by 9.5% to 57.9% of revenues for the three
months ended June 30, 2003 compared to 48.4% the prior year period.
The decrease in the general and administrative expense for the three months
ended June 20, 2004 was primarily the result of improved collection rates that
resulted in decreases to bad debt expense of $2.8 million and a decrease in ILEC
performance credits received of $1.8 million as compared to the same period in
the prior year. These were partially offset by increases in sales and use tax
expense of $1.0 million as well as additional legal fees due of $1.1 million for
outstanding legal matters and efforts to support our position on contested
regulatory issues related to UNE-P. We also had an increase in health insurance
expense of $.4 million.
General and administrative expense increased $0.6 million to $52.4 million
for the six months ended June 30, 2004, compared to $51.8 million the prior
year. As a percentage of revenues general and administrative expense increased
by 9.3% to 59.5% of revenues for the six months ended June 30, 2003 compared to
50.2% the prior year period.
The overall increase in general and administrative expense for the six
months ended June 30, 2004 mirrors the consolidated increases and decreases
except that the ILEC gateway expenses are lower as a result of less overall
residential lines which is driven by lower residential line acquisition and some
decrease in cost per transaction.
The specific significant changes in general and administrative expense line
items for the six months ended June 30, 2004 from the prior year period:
o Increase in legal and professional fees - $2.3 million
o Increase in sales and use tax expense - $1.9 million
o Increase in stock expense for issuance of restricted stock - $0.2
million
o Increase in hardware and software support - $0.8 million
H-2-30
o Reduction in ILEC performance credits - $2.6 million
o Settlement for litigation related to Metro Nashville - $1.8 million
o Accrual for payroll bonus and related expenses - $1.1 million
o Reduction in bad debt expense - $3.5 million
o Reduction in support fees related to provisioning - $5.3 million
o Reduction due to New York lease settlement - $0.2 million
o Reduction to billing and collection expense - $1.3 million
Included in the retail services general and administrative expense are all
employee benefits, occupancy, insurance, and other indirect or overhead-related
expenses, as only directly assignable costs are recorded within our wholesale
services business segment. We are in the process of reviewing and possibly
adopting a methodology for internal reporting purposes that would allocate a
portion of these indirect and overhead related expenses to the respective
operating segments or possibly separating these expenses from each segment.
We are planning for overall line and revenue growth in 2005, and therefore
expect general and administrative expense to decrease as a percentage of
revenues over the longer term as a result of the leveraging of certain elements
of our fixed cost structure, although we do expect an increase in overall
administrative expense in raw dollars as we incur more charges for provisioning
new customers and incremental administrative costs such as billing, collections,
and customer care related expenses during the latter part of 2004 and into 2005.
Our overall general and administrative expenses are somewhat dependent on
operational improvements to our retail customer economics. The most significant
improvement over the past year was in our bad debt expense, which improved due
to our improvements in our customer treatment programs which have been applied
consistently to problem accounts and by targeting higher quality customers from
a sales and marketing perspective. These improvements helped allow us to invest
more rapidly into our business services line of business. We expect to continue
focusing on growth for our business and VoIP service offerings which will likely
contribute to increased general and administrative expense.
WHOLESALE SERVICES SEGMENT
Our wholesale services operating segment includes services that we provide
to other companies giving them the ability to offer bundled telephony and
enhanced services on a private label basis to their own residential and business
customers using us as their primary platform for delivery. Our largest current
customer for this service is Sprint. The following tables, in millions,
summarizes the results for our wholesale services business segment for the three
and six months ended June 30, 2004, respectively compared to the prior year
period:
Wholesale Services Segment
Amount Percentage
For the three months Change Change
ended June 30, Favorable Favorable Percentage of Revenues
2004 2003 (Unfavorable) (Unfavorable) 2004 2003
Revenues
Sprint............................ $20.6 $10.6 $10.0 94.3% 98.1% 66.7%
MCI............................... -- 5.1 (5.1) (100.0)% --% 32.1%
Other............................. 0.4 0.2 0.2 100.0% 1.9% 1.2%
Total Revenues.................... 21.0 15.9 5.1 32.1% 100.0% 100.0%
Operating expenses:
Network operations................ 9.6 7.4 (2.2) (29.7)% 45.7% 46.6%
General and administrative........ 6.9 5.3 (1.6) (30.2)% 32.9% 33.3%
Total operating expenses.......... 16.5 12.7 (3.8) (29.9)% 78.6% 79.9%
Segment results................... $4.5 $3.2 $1.3 40.6% 21.4% 20.1%
H-2-31
Wholesale Services Segment
Amount Percentage
For the six months Change Change
ended June 30, Favorable Favorable Percentage of Revenues
2004 2003 (Unfavorable) (Unfavorable) 2004 2003
Revenues
Sprint............................ $43.7 $12.3 $31.4 255.3% 98.9% 42.6%
MCI............................... 0.1 16.2 (16.1) (99.4)% 0.2% 56.0%
Other............................. 0.4 0.4 -- --% 0.9% 1.4%
Total Revenues.................... 44.2 28.9 15.3 52.9% 100.0% 100.0%
Operating expenses:
Network operations................ 21.0 11.5 (9.5) (82.6)% 47.5% 39.8%
Sales and marketing............... 0.1 -- (0.1) 100.0% 0.3% --%
General and administrative........ 13.8 7.1 (6.7) (94.4)% 31.2% 24.6%
Total operating expenses.......... 34.9 18.6 (16.3) (87.6)% 79.0% 64.4 %
Segment results................... $9.3 $10.3 $(1.0) (9.7)% 21.0% 35.6%
Revenues. Revenues increased by $5.1 million to $21.0 million for the three
months ended June 30, 2004, compared to $15.9 million the prior year period. Our
wholesale service revenues increased to 32.9% of consolidated revenues for the
three months ended June 30, 2004, compared to 22.4% in the prior year period. We
signed our wholesale services agreement with Sprint in February of 2003. Sprint
contributed $20.6 million of revenue for the three months ended June 30, 2004
and was our primary wholesale customer during that period. MCI, a former
wholesale services customer, contributed of $5.1 million of wholesale revenues
during the three months ended June 30, 2003.
Revenues increased by $15.3 million to $44.2 million for the six months
ended June 30, 2004, compared to $28.9 million the prior year period. Our
wholesale service revenues increased to 33.4% of consolidated revenues for the
six months ended June 30, 2004, compared to 21.9% in the prior year period.
Sprint contributed $43.7 million of revenue for the six months ended June 30,
2004 and was our primary wholesale customer during that period. MCI, a former
wholesale services customer, contributed $16.2 million of wholesale revenues
during the six months ended June 30, 2003.
On July 26, 2004 Sprint indicated to us that they plan on committing fewer
resources to the existing wholesale services arrangement under which we
currently operate. Although Sprint is not canceling the agreement, they have
indicated to us that we can expect lower sales volumes as early as August 2004.
We believe that it is likely that this lower monthly sales activity will lead to
an increasingly smaller wholesale subscriber base. To the extent that this
proves to be the case, we will likely reduce the workforce that is currently
dedicated to the Sprint relationship. This workforce is currently compensated by
Sprint at approximately our cost, in proportion to the decline in the size of
the wholesale subscriber base. Our net fee income can be expected to decline
should the wholesale lines in service begin to decline on an approximately
proportional basis.
Network Operations. Network operations expense increased by $2.2 million to
$9.6 million for the three months ended June 30, 2004, compared to $7.4 million
in the prior year period. Network operations expense increased by $9.5 million
to $21.0 million for the six months ended June 30, 2004, compared to $11.5
million in the prior year period.
The increases in network operations expenses for the three and six month
periods were mostly attributable to an increase in Sprint wholesale lines in
service in the latter part of 2003 and into 2004.
In late 2003, Sprint decided to become the customer of record for billing
purposes from the ILECs for all future customers. This transition was completed
by January 2004. As churn impacts the number of lines implemented before January
2004, we will expect network operations expense, and revenue, to decrease.
Although, it should still be larger than the amounts reported during 2003 for
part of the year as a result of the increased total lines that we are still
receiving ILEC billings for. This decrease should have little to no impact on
our reported segment results.
H-2-32
General and Administrative. General and administrative expense increased by
$1.6 million to $6.9 million for the three months ended June 30, 2004, compared
to $5.3 million in the prior year period. General and administrative expense
increased by $6.7 million to $13.8 million for the six months ended June 30,
2004, compared to $7.1 million in the prior year period.
The significant components of this expense are very similar to the
administrative expenses incurred on the retail side of our business; however, we
only isolate as wholesale expenses those expenses that are directly associated
with our wholesale services activity. Therefore, we have not allocated any
indirect or corporate (i.e. traditional overhead) expenses, such as certain
employee benefits, occupancy expenses, insurance expenses or other similar
expenses to the wholesale services business segment. These expenses are all
currently included within the retail services business segment. The increase in
general and administrative expense is a result of increased wholesale lines in
service as a result of growth attributable to Sprint.
The increase in general and administrative expense is the result of
increased payroll expense, the outsourcing of certain functions to limit our
cost exposure and increased non-recurring provisioning expenses to establish
service for our wholesale customers. Due to the expectation that Sprint will
commit less resources to the existing wholesale services arrangement under which
we currently operate, we expect general and administrative expense to decrease
over the remainder of 2004. We will continue to monitor our wholesale services
and determine the appropriate bad debt methodology based on each individual
wholesale contract, but we do not expect any material changes to our current
approach.
LIQUIDITY AND CAPITAL RESOURCES
The competitive local telecommunications service business has traditionally
been considered to be a relatively capital intensive business, owing to the
significant investments required in fiber optic communication networks and in
the collocation of switching and transmission equipment in incumbent local
exchange carriers' central offices. Although we have historically utilized UNE-P
to provide our services to our own end users, we are also now developing a VoIP
initiative, an alternative access method by which we can provide our services to
end users. VoIP will likely involve more capital investment than the UNE-P based
model typically has required. We will continue providing our UNE-P based
services, but our focus will increasingly move towards utilizing VoIP as an
access method whereby we will provide service to our own end users. In the
second quarter of 2004, we launched VoIP in two markets: Tampa, Florida and
Atlanta, Georgia. We expect to significantly expand this offering over the
coming years. We expect that we will continue to devote significant amounts of
our capital resources to continued operations, software development, new service
offerings and marketing efforts in order to achieve an acceptable level of
penetration in the markets that we target.
We have incurred accumulated losses since our inception as a result of
developing our business, performing ongoing research and development, building
and maintaining our network infrastructure and technology, the sale and
promotion of our services, and ongoing administrative expenditures. As of June
30, 2004, we had an accumulated deficit of $340.4 million, a net tax operating
loss carry forward of approximately $280.8 million, and $8.2 million in cash and
cash equivalents. We have funded our expenditures primarily through operating
revenues, private securities offerings, an asset based loan agreement and an
initial public offering that raised net proceeds of $109.1 million, and working
capital facilities.
We anticipate that we may not generate adequate cash flow over the near
future to meet all of our operating, investing and financing requirements. We
are actively exploring potential financing arrangements to help improve our
liquidity position and to give us more flexibility in pursuing our business plan
over the near future. We have the ability and intent to curtail growth
initiatives and spending, including the reduction of certain discretionary
capital and marketing costs or the implementation of a workforce reduction, in
order to continue as a going-concern. There can be no assurance, however, that
we will be able to implement our strategies or obtain additional financing under
favorable terms, if at all.
Net cash used in operating activities decreased by $15.3 million to $9.2
million for the six months ended June 30, 2004, compared to $6.1 million in the
prior year period. The decrease was primarily a result of the termination of our
RFC agreement in favor of a new asset based loan obtained from Textron Financial
Cor-
H-2-33
poration in April 2004. As a result of this change, net cash from operations
decreased while net cash from financing activities increased.
Our net cash used in investing activities decreased by $1.0 million to $4.7
million for the six months ended June 30, 2004, compared to $5.7 million the
prior year period. The decrease was primarily attributable to the reduction in
property and equipment purchases for the six months ended June 30, 2004 compared
to the prior year period. We expect our capital expenditures to increase during
the last half of 2004, as we plan to increasingly transition our services to a
VoIP platform which is a more capital intensive service platform than UNE-P has
been. We will attempt to obtain financing for these purchases, but may be
unsuccessful in doing so.
Our net cash provided by financing activities increased $12.3 million to
$10.1 million for the six months ended June 30, 2004 compared to $2.2 million
the prior year period. The increase was primarily attributable to the execution
of the Textron Financial Corporation asset based loan agreement.
We expect our total debt to increase during 2004 because of our new asset
based loan that we obtained from Textron Financial in April 2004 and due to our
intent to finance as much of our capital expenditures as possible over the
balance of 2004 and into 2005. The Textron agreement replaced the factoring
agreement that we had in place with Textron's subsidiary company, RFC. This new
agreement will be a loan as opposed to a factoring facility and will therefore
be recorded as a financing transaction. The old RFC agreement had been reflected
as an operating cash flow item. The new asset based loan will include more of
our accounts receivable in the borrowing base calculation than was historically
the case with RFC, therefore, likely providing us with some additional
liquidity. This increase in financing activities will be only partially off-set
by most of our existing term debt being retired by the end of third quarter of
2004. We are also attempting to obtain some type of subordinated debt agreement
to provide additional financing to support our growth and new service
initiatives for 2004. We may or may not be successful in doing so.
We currently have agreements with two long-distance carriers to provide
transmission and termination services for all of our long distance traffic.
These agreements generally provide for the resale of long distance services on a
per-minute basis and contain minimum volume commitments. As a result of a
settlement of a billing dispute associated with minimum volume commitments
required in one of the contracts we have agreed to pay an increased per minute
charge for minutes until the achievement of certain minimum minute requirements.
Once we meet the new agreed upon minimum minutes we will revert to the terms of
our original agreement. All other terms of the original agreement continue in
full force. We believe that we will be fully in compliance with all minimum
volume commitments during 2004.
ANTICIPATED SOURCES AND USES OF CASH
When we discuss cash flow throughout this section we are referring to the
cash inflows and cash outflows, exclusive of fixed and overhead operating costs
such as administrative payroll expenses, non-operations related payroll
expenses, occupancy costs, and other costs that are of a corporate or overhead
nature. These corporate overhead expenses were $17.2 and $35.0 million for the
three and six months ended June 30, 2004, respectively. We believe that it is
appropriate to present this information in order to help the reader understand
our individual operating contribution streams, while realizing that these
contribution streams must in aggregate provide enough cash flow to fund our
corporate overhead expenditures.
Our retail residential UNE-P service currently generates the majority of
our cash from operations. We also continue to utilize the 1+ long-distance
service as a positive cash generating business, primarily because of our policy
of not actively investing in it, other than the ongoing maintenance costs
associated with this line of business. Our wholesale services business is also a
good source of cash flow. Although not as significant in terms of overall
contribution or per line operating metrics as our residential business, it
provides a healthy net cash contribution on a per line basis without causing us
to incur traditionally significant upfront sales and marketing costs as is
typically the case with most retail marketing activities.
We expect to continue actively investing in the growth of our business
services unit which could provide an increasingly positive contribution to our
company by late 2004. Finally, we are continuing our revenue and access
diversification as we roll-out our VoIP services, in an effort to ultimately
provide services that are not
H-2-34
largely dependent on the incumbent local exchange carriers as is the case with
UNE-P. We expect to invest in this business throughout 2004 and beyond, without
any significant positive net cash contribution until 2005. We believe that this
increasingly diversified business model provides us with more avenues for growth
opportunity and less dependence on any one model (service, access or end user)
for success. We also recognize the importance of managing the timing and ongoing
economics of this growth as it relates to our overall cash and financial
position.
Our ongoing capital requirements will depend on several factors, including
market acceptance of our services, the amount of resources that we devote to
investments in our networks and facilities, the build-out of additional
enterprise management centers, the ongoing development of services and brand
promotions, the resources that we devote to the sales and marketing of our
services, and many other factors including access to acceptable forms of lease
financing. We will continue to provide our back-office services and the
technology that we have developed to other companies seeking the capability of
offering residential and small business telecommunications services on a private
label basis to their own customers. As growth and opportunities arise, we expect
to make strategic investments in technology and our network architecture and
enter potential strategic alliances or partnerships with other entities. We
expect to continue to finance our capital expenditures partly from internally
generated cash flow and from existing facilities. We expect to see an overall
increase in fixed assets across nearly all categories during 2004.
We are currently under audit by the State of New York for our sales and use
and franchise taxes. In July of 2004, we received an updated summary from the
State of New York stating that we owe them $2.7 million in sales and use and
franchise taxes, before any possible interest or penalties, primarily due to
their position that 100% of the bundled services we offer are taxable. Although
this process is still on-going, we currently disagree with the State of New
York's calculation of the sales and use tax due on our bundled products and we
believe that certain portions of the bundle are not subject to sales and use
taxes. Our goal is to obtain an acceptable settlement with the state, and we
believe that our methodology is appropriate, reasonable, and in compliance with
the State of New York's sales and use taxes laws. We have made accruals based on
our best estimates of the facts, but are unable to determine the final outcome
of this matter at this time.
In May 2004 we signed a settlement agreement with Metro Nashville to settle
certain litigation, as discussed in Footnote "11. Legal and Regulatory
Proceedings".
CASH MANAGEMENT
We have a significant amount of corporate expenditures and other
non-essential headcount and related expenses which would not be necessary if we
were to reduce our operations to a purely maintenance approach. This would
include but not necessarily be limited to the termination of spending on certain
new service offerings or new business opportunities, other technological focused
initiatives and investments in legal and regulatory related activities.
Our overall cash position over the balance of 2004 will be dependent upon a
variety of factors including, but not limited to, the actual line count levels
and reported revenues over the remainder of the year, the speed with which we
deploy VoIP related capital expenditures, our ability to secure reasonable forms
of lease financing, and whether various operating initiates are implemented in
an effort to enhance cash flows. We recognize that our growth will need to be
managed very closely from a liquidity standpoint prior to achieving these
expected free cash flows, as we are operating with negative working capital and
expect to be concurrently pursuing several growth initiatives. We expect the
next six months of 2004 to be very challenging from a cash management
perspective. We currently carry a total accounts payable balance greater than we
have historically and we also expect to increase our capital expenditures over
historical levels. We may also incur a variety of front-end loaded expenses as
we increasingly transition to VoIP, and we expect that negative cash flows may
result over the short term, but should become positive during the last quarter
of 2004 or during the first quarter of 2005. We will continue to finance
significant capital expenditures internally, but we are working with certain
vendors to obtain more generous payment terms that will provide us with more
flexibility during this period. We may or may not be successful in these
endeavors. If we are able to generate free cash flow we will likely reinvest
this cash back into our business to fund our capital expenditures for VoIP, any
additional head-count requirement and any related costs for growing certain
potions of our business.
H-2-35
In September of 2003, we decided to postpone a company-wide salary
increase. This increase was scheduled to take place in April of 2004. We have
announced a plan to provide a bonus to employees that will average 5% of their
pay. We currently intend to pay this bonus in December of 2004. We have been
considering this as an alternative to a general increase in salaries to help
coincide with the expected increased cash flows available in December of 2004.
We also have used non-cash compensation such as a company-wide granting of stock
options and certain key employees have received restricted stock as a way to
assist with deferring the cash impact of increases in salary expenses.
DEBT INSTRUMENTS
Asset-Based Loan
In April 2004 we signed a three-year asset based loan agreement with
Textron Financial Corporation. This agreement eliminated the RFC accounts
receivable factoring agreement, and provides us with an availability to borrow
up to $25 million. Our overall availability is based on the eligibility of our
accounts receivables, subject to certain limitations and advance rates. The new
asset-based loan agreement is expected to provide us with additional liquidity
because it includes residential, business and wholesale accounts receivable that
were not included in our prior arrangement with RFC. The RFC factoring agreement
only considered residential accounts receivable as its collateral. We believe
that this new agreement will provide us with additional working capital
financing flexibility to help facilitate the growth of our business. This
agreement has three primary financial covenants: a fixed charge coverage ratio,
accounts receivable turnover requirement and an unfunded capital expenditures
cap. The fixed charge coverage ratio requirement begins June 30, 2004 and is
measured each quarter thereafter with various look-back time periods. The ratio
requirements begin low and increase each quarter through December 31, 2004 and
then remain constant.
We did not meet the fixed charge coverage ratio for the quarter ended June
30, 2004. All other covenants have been met per our agreement with Textron. Per
the agreement, Textron can cancel the loan arrangement with us; however, we
believe that it is unlikely that Textron would take such measures. We are
working to resolve this issue without triggering a cancellation of the
agreement. At current collection rates, we will collect the total amount
outstanding under this facility in less than a month. We believe that Textron is
adequately secured under this facility. In addition, we have already disclosed
to Textron the cost saving measures recently implemented to make improvements
that would allow us to meet the fixed charge coverage ratio required in future
quarters.
There are also common disposition of assets limitations, capital
expenditure limitations of $9.0 million per year, limits on change of control,
certain notification requirements, change in management limitations and certain
other restrictions. There are also certain limitations on our ability to access
subordinated debt within the confines of the agreement, however; we believe the
agreement provides us with flexibility for future debt financing alternatives.
We believe that this new agreement will help us to manage our short and
long-term cash needs, although we are still exploring other alternatives for
obtaining additional funding, including but not limited to subordinated debt and
certain equity transactions. We believe that this agreement may provide some
help in improving our overall working capital position. If the expected growth
in our business is realized we may still have additional liquidity needs that
would have to be obtained through additional financings. We also may need
additional funds for our VoIP initiative which will be much more capital
intensive than the UNE-P business model has been historically. The availability
of cash will somewhat dictate the speed in which we will be able to roll this
access method out to new markets, as there is an initial cost of at least $0.5
million in capital expenditures to establish service in each major metropolitan
area. After this initial cost there are the additional costs of the customer
premise equipment and installation and provisioning costs to get customers onto
the service but these costs are mostly success based and will likely move in
tandem with the addition of new customers but will require larger up-front
payments than we currently experience to get a customer successfully provisioned
under the UNE-P platform. However, in the longer-term the network costs for
these customers are much lower because of the larger capital expenditures for
network bandwidth which reduces future incremental costs.
H-2-36
Term Debt
We have $1.4 million of remaining principal term debt as of June 30, 2004,
of which all but $0.1 million is currently scheduled to be fully retired in
September 2004. This debt was assumed in the purchase of Touch 1 Communications,
Inc., our wholly owned subsidiary, in April 2000. All of this debt is paid
monthly and is at a fixed interest rate of 6.0%.
ILEC, IXC AND RELATED DISPUTED CHARGES
Since our existence we have disputed and continue to dispute significant
charges from the various ILECs, IXCs, and certain other carriers providing us
network services. We have a policy of treating all charges that we believe to be
without merit that are still being presented on a bill to as disputes,
regardless of the age of the dispute. We believe that the majority of these
charges are without merit; however, we accrue for any charges that we believe
represent valid charges against us. Our outstanding disputes at June 30, 2004
totaled $19.7 million. These disputes are summarized in the following table:
Outstanding
Disputes at
June 30, 2004
(In millions)
Alternatively billed services.......................... $8.1
MCI fixed facility charges............................. 2.3
Verizon back-billing of installation charges........... 2.4
Late fees for non-payment of disputed charges.......... 3.9
All others............................................. 3.0
$19.7
Alternatively billed services are primarily charges for certain in-collect
and information service calls. These disputes are largely historic in nature. We
settled certain of these disputes in Texas with Southwestern Bell Telephone
Company. We remit all monies collected associated with these services but do not
pay the charges unless we collect from our customers. We believe that our
liability related to these charges should be capped at the amount remitted by
our end users, however, some of our settlements have included payments in excess
of payments from our customers.
The MCI fixed facility charge dispute is over 3 years old. We have received
communications from MCI that these charges are not valid and in August 2004 we
have started to receive credits for these disputed amounts. So far, the total
amount of credit received is $1.2 million on total disputes of $2.3 million
relating to incorrect billings, taxes, surcharges and late payment fees.
We received a billing for $2.4 million from Verizon relating to the
back-billing of dispatch charges believed to relate to the period from August
2000 to February 2002 and from March 2003 to September 2003. We do not know if
this is the entire amount they will bill related to these back-billed charges.
Our policy is to dispute items that are billed without the necessary underlying
detail records and therefore, we have disputed these charges. We expect that if
any of these charges are valid, a portion of these charges may be subject to
being billed to our wholesale services customers for services that we provided
under our contracts with them. We have not received sufficient detail related to
these charges from Verizon and therefore, are unable to determine their
validity.
The late fees are accumulating from all of our disputes as we do not pay
for disputed items and therefore incur and accumulate late fees for these
disputed billings.
The remaining $3.0 million of disputes relates to various disputes
primarily with ILECs for incorrect billing rates, duplicate billing problems,
charges for customers for whom we are no longer providing service and other
various billing errors.
H-2-37
While we can make no guarantee, we believe that we are adequately reserved
for our disputes and attempt to manage our cash position to ensure that we have
the necessary availability of cash to make payments which may arise out of the
loss of disputes that we believe are at risk. Therefore, we believe our maximum
cash exposure for these charges is $19.7 million. However, we do not believe
that these charges are valid and intend to continue our dispute and non-payment
of these charges. We may or may not be successful in resolving these issues
satisfactorily.
H-2-38
Annex H-3
AUDITED ANNUAL FINANCIAL STATEMENTS AND
RELATED MANAGEMENT'S DISCUSSION AND ANALYSIS
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Z-Tel Technologies, Inc. and
Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of changes in stockholders'
equity (deficit) and comprehensive income and of cash flows present fairly, in
all material respects, the financial position of Z-Tel Technologies, Inc. and
its subsidiaries at December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America. 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 of these
statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Tampa, Florida
March 29, 2004
H-3-1
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
December 31, December 31,
2003 2002
Assets
Current assets:
Cash and cash equivalents ............................................................. $ 12,013 $ 16,037
Accounts receivable, net of allowance for doubtful accounts of $13,804 and
$17,401 ............................................................................. 24,600 26,749
Prepaid expenses and other current assets ............................................. 7,664 5,741
Total current assets .................................................................. 44,277 48,527
Property and equipment, net ........................................................... 39,069 48,320
Intangible assets, net ................................................................ 2,287 4,116
Other assets .......................................................................... 3,820 5,748
Total assets .......................................................................... $ 89,453 $ 106,711
Liabilities, Mandatorily Redeemable Convertible Preferred Stock and
Stockholders' Deficit
Current liabilities:
Accounts payable and accrued liabilities .............................................. $ 59,230 $ 51,771
Deferred revenue ...................................................................... 11,068 10,172
Current portion of long-term debt and capital lease obligations ....................... 5,017 5,964
Total current liabilities ............................................................. 75,315 67,907
Long-term deferred revenue ............................................................ 361 6,277
Long-term debt and capital lease obligations .......................................... 514 4,180
Total liabilities ..................................................................... 76,190 78,364
Mandatorily redeemable convertible preferred stock, $.01 par value; 50,000,000
shares authorized; 8,855,089 issued; 8,738,422 and 8,855,089 outstanding
(aggregate liquidation value of $158,779 and $145,503) .............................. 144,282 127,631
Commitments and contingencies (Notes 11, 16 and 21) Stockholders' deficit:
Common stock, $.01 par value; 150,000,000 shares authorized; 36,186,686 and
35,609,803 shares issued; 35,845,136 and 35,268,253 outstanding ..................... 362 356
Notes receivable from stockholders .................................................... (1,121) (1,589)
Additional paid-in capital ............................................................ 189,008 205,090
Accumulated deficit ................................................................... (318,880) (302,753)
Treasury stock, 341,550 shares at cost ................................................ (388) (388)
Total stockholders' deficit ........................................................... (131,019) (99,284)
Total liabilities, mandatorily redeemable convertible Preferred Stock and
stockholders' deficit ............................................................... $ 89,453 $ 106,711
The accompanying notes are an integral part of these consolidated financial
statements.
H-3-2
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Year Ended
December 31,
2003 2002 2001
Revenues............................................................. $ 289,180 $ 238,397 $ 280,350
Operating expenses:
Network operations, exclusive of depreciation and 135,097
amortization shown below ............................................... 94,474 159,617
Sales and marketing ....................................................... 18,753 12,327 31,243
General and administrative ................................................127,018 122,579 156,107
Depreciation and amortization ............................................. 23,449 23,936 23,277
Asset impairment charge ................................................... -- 1,129 59,247
Wholesale development costs ............................................... -- 1,018 --
Restructuring charge ...................................................... -- 1,861 --
Total operating expenses ..................................................304,317 257,324 429,491
Operating loss ............................................................(15,137) (18,927) (149,141)
Nonoperating income (expense):
Interest and other income ................................................. 2,086 3,509 6,862
Interest and other expense ................................................ (3,076) (4,137) (3,789)
Total nonoperating income (expense) ....................................... (990) (628) 3,073
Net loss ..................................................................(16,127) (19,555) (146,068)
Less mandatorily redeemable convertible preferred stock (17,480)
dividends and accretion ................................................ (15,589) (15,059)
Less deemed dividend related to beneficial conversion (186)
feature ................................................................ (186) (9,356)
Net loss attributable to common stockholders .........................$....(33,793) $ (35,330) $ (170,483)
Weighted average common shares outstanding .............................35,396,922 34,951,720 33,908,374
Basic and diluted net loss per share .................................$.... (0.95) $ (1.01) $ (5.03)
The accompanying notes are an integral part of these consolidated financial
statements.
H-3-3
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPREHENSIVE INCOME
(In thousands, except share data)
Notes
Receivable Unearned Additional
from Stock Paid-In
Common Stock Stockholders Compensation Capital
Shares Par Value
Balance, December 31, 2000.................... 33,754,235 $ 340 $ (839) $ (255) $ 227,304
Issuance of common stock for exercise of
stock options ............................. 254,731 3 (820) 1,000
Issuance of common stock for exercise of
warrants .................................. 25,714 --
Issuance of common stock for the purchase of
software .................................. 27,500 -- 155
Vesting of stock options granted below
intrinsic value ........................... 133
Accelerated vesting of stock options ......... 49
Mandatorily convertible redeemable dividends
and preferred stock accretion ............. (15,059)
Warrants issued with preferred stock ......... 4,333
Treasury stock received upon cancellation of
notes receivable from stockholder ......... (61,875) -- 70
Net loss
Foreign currency translation adjustment
Comprehensive loss
Balance, December 31, 2001 ................... 34,000,305 343 (1,589) (122) 217,782
Issuance of common stock ..................... 1,000,000 10 2,320
Issuance of common stock for exercise of
warrants .................................. 171,429 2
Issuance of common stock for exercise of
options ................................... 361 --
Conversion of mandatorily convertible
redeemable preferred stock ................ 76,158 1 679
Vesting of stock options granted below
intrinsic value ........................... 122
Accelerated vesting of stock options and
issuance of shares ........................ 20,000 -- 84
Mandatorily redeemable convertible preferred
stock dividends and accretion ............. (15,775)
Net loss
Balance, December 31, 2002 ................... 35,268,253 356 (1,589) -- 205,090
Exercise of stock options .................... 394,144 4 518
Exercise of warrants ......................... 73,714 1
Accelerated vesting of stock options ......... 123
Conversion of mandatorily redeemable
convertible preferred stock to common ..... 109,025 1 943
Repayment of notes receivable 468
Mandatorily redeemable convertible preferred
stock dividends and accretion ............. (17,666)
H-3-4
Net loss
Balance, December 31, 2003 ................... 35,845,136 $ 362 $ (1,121) $ -- $ 189,008
[Additional columns below]
H-3-5
[Continued from above table, first column(s) repeated]
Accumulated
Other Total
Accumulated Comprehensive Stockholders'
Deficit Loss Treasury Stock Deficit
Balance, December 31, 2000.......................... $ (137,130) $ (2) $ (318) $ 89,100
Issuance of common stock for exercise of stock
options .......................................... 183
Issuance of common stock for exercise of
warrants ......................................... --
Issuance of common stock for the purchase of
software ......................................... 155
Vesting of stock options granted below intrinsic
value ............................................ 133
Accelerated vesting of stock options ............... 49
Mandatorily convertible redeemable dividends and
Preferred Stock accretion ........................ (15,059)
Warrants issued with preferred stock ............... 4,333
Treasury stock received upon cancellation of
notes receivable from stockholder ................ (70) --
Net loss ........................................... (146,068) (146,068)
Foreign currency translation adjustment ............ 2 2
Comprehensive loss ................................. (146,066)
Balance, December 31, 2001 ......................... (283,198) -- (388) (67,172)
Issuance of common stock ........................... 2,330
Issuance of common stock for exercise of
warrants ......................................... 2
Issuance of common stock for exercise of options ... --
Conversion of mandatorily convertible
redeemable preferred stock ....................... 680
Vesting of stock options granted below intrinsic
value ............................................ 122
Accelerated vesting of stock options and
issuance of shares ............................... 84
Mandatorily redeemable convertible preferred
stock dividends and accretion .................... (15,775)
Net loss ........................................... (19,555) (19,555)
Balance, December 31, 2002 ......................... (302,753) -- (388) (99,284)
Exercise of stock options .......................... 522
Exercise of warrants ............................... 1
Accelerated vesting of stock options ............... 123
Conversion of mandatorily redeemable
convertible preferred stock to common ............ 944
Repayment of notes receivable ...................... 468
Mandatorily redeemable convertible preferred
stock dividends and accretion .................... (17,666)
Net loss ........................................... (16,127) (16,127)
Balance, December 31, 2003 ......................... $ (318,880) $ -- $ (388) $ (131,019)
The accompanying notes are an integral part of these consolidated financial
statements
H-3-6
Z-TEL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended
December 31,
2003 2002 2001
Cash flows from operating activities:
Net loss .................................................................... $ (16,127) $ (19,555) $ (146,068)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization ............................................... 23,449 23,936 23,277
Provision for bad debts ..................................................... 14,022 23,964 55,530
Asset impairment charge ..................................................... -- 1,129 59,247
(Gain) loss on disposal of equipment ........................................ (43) (132) (329)
Expense charged for granting of stock options ............................... 123 206 182
Change in operating assets and liabilities:
Increase in accounts receivable ............................................. (11,873) (23,671) (17,140)
(Increase) decrease in prepaid expenses ..................................... (1,923) (1,780) 1,106
Decrease (increase) in other assets ......................................... 1,888 1,655 (1,070)
Increase in accounts payable and accrued liabilities ........................ 7,460 2,149 5,138
Increase (decrease) in deferred revenue ..................................... (5,020) 10,498 (1,715)
Total adjustments ........................................................... 28,083 37,954 124,226
Net cash provided by (used in) operating activities ......................... 11,956 18,399 (21,842
Cash flows from investing activities:
Purchases of property and equipment ......................................... (11,036) (15,193) (15,426)
Principal repayments received on notes receivable ........................... 40 590 7
Issuance of note receivable ................................................. -- (997 (196
Net cash used in investing activities ....................................... (10,996) (15,600) (15,615)
Cash flows from financing activities:
Payments on long-term debt and capital lease obligations .................... (5,903 (5,622 (7,532
Proceeds from issuance of mandatorily redeemable convertible
preferred stock ........................................................... -- -- 17,500
Payments of issuance cost for mandatorily redeemable convertible
preferred stock ........................................................... -- -- (450
Payment of preferred stock dividends ........................................ (72) (34) --
Principal repayments received on notes receivable issued for stock .......... 468 -- --
Proceeds from exercise of stock options and warrants ........................ 523 2 183
Net cash provided by (used in) financing activities ......................... (4,984) (5,654) 9,701
Adjustment for foreign currency translation ................................. -- -- (2)
Net decrease in cash and cash equivalents ................................... (4,024) (2,855) (27,758)
Cash and cash equivalents, beginning of period .............................. 16,037 18,892 46,650
Cash and cash equivalents, end of period .................................... $ 12,013 $ 16,037 $ 18,892
H-3-7
Year Ended
December 31,
2003 2002 2001
Supplemental disclosure of cash flow information:
Cash paid for interest ......................................................... $ 3,070 $ 2,788 $ 2,648
Non-cash investing and financing activities:
Property and equipment acquired under capital lease obligations ................ $ 1,290 $ 222 $ 2,395
Increase in additional paid-in capital for stock options granted ............... $ 518 $ 84 $ 1,051
Common stock granted for wholesale services contract ........................... $ -- $ 2,330 $ --
Net increase in unearned stock compensation for stock options granted .......... $ -- $ 122 $ 133
Accrued dividends and accretion on preferred stock ............................. $ 17,480 $ 15,589 $ 15,059
Notes receivable issued for common stock ....................................... $ -- $ -- $ 820
Forgiveness of note receivable issued for common stock ......................... $ -- $ -- $ (70)
Common stock issued for purchase of assets ..................................... $ -- $ -- $ 155
Treasury stock received upon cancellation of note receivable for common
stock ........................................................................ -- $ -- $ (70)
Conversion of preferred stock to common stock .................................. $ 943 $ 680 $ --
Beneficial conversion associated with preferred stock issuance ................. $ 186 $ 186 $ 9,356
The accompanying notes are an integral part of these consolidated financial
statements.
H-3-8
1. NATURE OF BUSINESS
DESCRIPTION OF BUSINESS
Z-Tel Technologies, Inc. and subsidiaries ("we" or "us") incorporated in
Delaware on January 15, 1998 as Olympus Telecommunications Group, Inc. In March
1998, Olympus Telecommunications Group, Inc. changed its name to Z-Tel
Technologies, Inc.
We are an emerging provider of advanced, integrated telecommunications
services targeted to residential and small business subscribers. We offer local
and long distance telephone services in combination with enhanced communication
features accessible through the telephone, the Internet and certain personal
digital assistants. We offer our Z-LineHOME and Z-LineBUSINESS services in
forty-nine states. Our customers are primarily in ten states. We also provide
long-distance telecommunications services to customers nationally.
We introduced our wholesale services during the first quarter of 2002. This
service provides other companies with the opportunity to provide local,
long-distance and enhanced telephone service to residential and small business
customers by utilizing our telephone exchange services, enhanced services
platform, infrastructure and back-office operations.
LIQUIDITY AND CAPITAL RESOURCES
We have a limited operating history and our operations are subject to
certain risks and uncertainties, particularly related to the evolution of the
regulatory environment, which impacts our access to and cost of the network
elements used to provide services to our customers; access to adequate
financing; and competition within the industry.
We have incurred significant losses since our inception, resulting in an
accumulated deficit at December 31, 2003 of approximately $318.9 million. We
also had debt outstanding of approximately $5.5 million. We experienced positive
cash flows from operations for the first time during 2002 and also had positive
cash flows from operations for the year ended December 31, 2003. Prior to 2002,
we had historically been dependent on financing from investors to sustain our
operating activities.
At December 31, 2003, we had cash on hand of approximately $12.0 million.
In addition, we had an accounts receivable factoring agreement which provides us
with up to $25 million dollars to fund operations, of which we were utilizing
$13.9 million as of December 31, 2003. This factoring agreement expires on July
27, 2004. Currently, we anticipate obtaining an asset-based loan to replace our
current accounts receivable factoring agreement. We expect that this agreement
will provide us with $3.0 to $5.0 million of additional liquidity immediately,
up to a maximum of $25 million of total liquidity as it is currently
contemplated. The additional liquidity is a result of additional accounts
receivable being eligible under this arrangement. We anticipate generating,
through normal operations, the remaining cash flows necessary to meet our
operating, investing and financing requirements. We also are exploring potential
subordinated debt arrangements and financing of certain capital expenditures. If
actual results differ materially from our current plan or if expected financing
is not available, we have the ability and intent to curtail growth initiatives
and spending, including the reduction of certain discretionary capital and
marketing costs or the implementation of a workforce reduction, in order to
continue as a going-concern. There can be no assurance, however, that we will be
able to implement our strategies or obtain additional financing under favorable
terms, if at all.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include all our accounts and our
wholly- owned subsidiaries. All intercompany accounts and transactions have been
eliminated.
H-3-9
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments with original maturity dates of
three months or less to be cash equivalents.
PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist primarily of prepaid
maintenance and support, insurance contracts advances to suppliers and certain
disputes with vendors that require payment and filing of a dispute claim.
PROPERTY AND EQUIPMENT, NET
Property and equipment are recorded at historical cost. Depreciation and
amortization are calculated on a straight-line basis over the assets' useful
life. Maintenance and repairs are expensed as incurred, while renewals and
betterments are capitalized. Upon the sale or other disposition of property, the
cost and related accumulated depreciation are removed from the accounts and any
gain or loss is recognized in operations. Under the Statement of Position
("SOP") 98-1, "Accounting for the Cost of Computer Software Developed or
Obtained for Internal Use," we expense computer software costs related to
internal software that is incurred in the preliminary project stage. When the
capitalization criteria of SOP 98-1 have been met, costs of developing or
obtaining internal-use computer software are capitalized. We capitalized
approximately $3.1, $3.7 and $3.9 million of employee salary costs for
internally developed software for the years ended December 31, 2003, 2002 and
2001, respectively. Internal use software is included as a component of property
and equipment on the consolidated balance sheet. We also incur research and
development costs, such as employee salaries and outside consultants, that are
expensed in our general and administrative expense. We expensed approximately
$6.0, $7.4 and $8.9 million of research and development costs for the years
ended December 31, 2003, 2002 and 2001, respectively.
LONG-LIVED ASSETS
We review long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net expected
undiscounted cash flows to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the discounted cash
flows. We recognized an impairment of $59.2 million related to goodwill acquired
from the acquisition of Touch 1 Communications, Inc. ("Touch 1") as a result of
the sale of our telemarketing centers in 2001.
We adopted Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" on a
prospective basis on January 1, 2002. This statement supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." However, SFAS 144 retains the fundamental provisions of SFAS
No. 121 for the recognition and measurement of the impairment of long-lived
assets to be held and used and the measurement of long-lived assets to be
disposed of by sale. Impairment of goodwill is not included in the scope of SFAS
No. 144 and will be treated in accordance with the accounting standards
established in SFAS No. 142, Goodwill and Other Intangible Assets." According to
SFAS No. 144, long-lived assets are to be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in continuing or
discontinued operations. The statement applies to all long-lived assets,
including discontinued operations, and replaces the provisions of APB Opinion
No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of segments of a business.
INTANGIBLE ASSETS, NET
We adopted SFAS No. 141 "Business Combinations" and SFAS No. 142, "Goodwill
and Other Intangible Assets," as of January 1, 2002. SFAS 141 addresses the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. SFAS No. 142 addresses the initial
recognition and measurement of intangible assets acquired outside of a business
combination, whether acquired individually or with a group
H-3-10
of other assets, and the accounting and reporting for goodwill and other
intangible assets subsequent to their acquisition. These standards require all
future business combinations to be accounted for using the purchase method of
accounting. Certain intangible assets will no longer be amortized ratably but
instead will be subject to impairment tests at least annually.
Intangible assets on the consolidated balance sheet consist of customer
lists resulting from our acquisition of Touch 1 in 2000. The customer lists are
amortized over five years using the straight-line method and reviewed for
impairment as outlined in our long-lived assets policy above. All goodwill was
written-down to a zero value in 2001. See footnote 8, Intangible Assets, for
further discussion.
REVENUE RECOGNITION
Revenues are recognized when earned. Revenues related to long distance,
carrier access service and certain other usage driven charges are billed monthly
in arrears and the associated revenues are recognized during the month of
service. We record an estimate for this amount. Subscription services are billed
monthly in advance and we recognize revenues for this service ratably over the
service period. We defer certain installation charges and recognize this revenue
ratably over the estimated life of our customer. Our wholesale services revenues
are derived from contractual arrangements. We perform a review of each contract
and determine the appropriate timing of revenue recognition depending on the
facts and circumstances of each individual item within the contract. We are
currently deferring certain revenues over the life of our arrangements, rather
than recognizing these revenues up-front. In instances where we are the primary
obligor for costs incurred we use the gross method to record our revenues for
wholesale services. We operate in a heavily regulated industry; therefore, our
pricing is subject to both state and federal regulatory commission oversight.
Such oversight could result in changes to the amount we bill our customers in
current and future periods.
The gross accounting presentation for our wholesale services business
segment requires the understanding that certain recorded revenues are actually
direct cost pass-through. For instance, under our Sprint contract we charge to
Sprint, with a zero mark-up, certain charges that we receive from the incumbent
local exchange carriers ("ILECs") that are attributable to lines that are owned
by Sprint under the aforementioned agreement. However, late in the third quarter
of 2003 Sprint established its own billing codes with the ILECs and has been
adding all new customers to these codes. This had the effect of reducing our
gross monthly billings to Sprint, yet has no impact on the profitability of the
contract. Indeed, Sprint's lines under the wholesale services agreement were
actually increasing significantly during the period in reference. This action
also has the impact of increasing total margins, even though the profitability
of the contract on a per line basis was unchanged. This is why we chose to focus
on the net income per wholesale services line in service, as opposed to stated
revenues or margins per se.
STOCK-BASED COMPENSATION
For employee stock options, the FASB issued SFAS No. 123, "Accounting for
Stock-Based Compensation" requiring entities to recognize as an expense, over
the vesting period, the fair value of the options or utilize the accounting for
employee stock options used under Accounting Principles Board ("APB") Opinion
No. 25. We apply the provisions of APB Opinion No. 25 and consequently recognize
compensation expense over the vesting period for grants made to employees and
directors only if, on the measurement date, the market price of the underlying
stock exceeds the exercise price. We provide the pro forma net income and
earnings per share disclosures as required under SFAS No. 123 for grants made as
if the fair value method defined in SFAS No. 123 had been applied. We recognize
expense over the vesting period of the grants made to non-employees based on
utilizing the Black-Scholes stock valuation model to calculate the value of the
option on the measurement date.
The following table illustrates, in accordance with the provisions of SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment of SFAS 123, Accounting for Stock-Based Compensation," the effect
on net loss and earnings per share if we had applied the fair value recognition
provisions of SFAS No. 123, to stock-based employee compensation.
H-3-11
For the years ended
December 31,
2003 2002 2001
Net loss attributable to common stockholders, as reported........... $ (33,793) $ (35,330) $ (170,483)
Add: Stock based compensation included in net loss ................. 123 206 (182
Deduct: Total stock based employee compensation determined under
the fair value based method for all awards ....................... (5,821) (13,182) (13,0430
Net loss attributable to common stockholders, pro forma ............ $ (39,491) $ (48,306) $ (183,344)
Basic and Diluted Net Loss Per Common Share ........................
As reported ........................................................ $ (0.95) $ (1.01) $ (5.03)
Pro forma .......................................................... $ (1.12) $ (1.38) $ (5.41)
We calculated the fair value of each grant on the date of grant using the
Black-Scholes option pricing model. In addition to there being no payments of
dividends on our common stock, the following assumptions were used for each
respective period:
For the years ended
December 31,
2003 2002 2001
Discount Rate.................... 3.1% 3.1% 4.7%
Volatility ...................... 96.6% 93.0% 87.0%
Average Option Expected Life .... 5 years 5 years 5 years
Incremental shares of common stock equivalents are not included in the
calculation of net loss per share as the inclusion of such equivalents would be
anti-dilutive.
ADVERTISING
Advertising costs are expensed as incurred. Included in sales and marketing
expenses are advertising costs of approximately $5.3, $5.2 and $8.8 million for
the years ended December 31, 2003, 2002 and 2001, respectively.
INCOME TAXES
We utilize the asset and liability method of accounting for income taxes.
Under this method, deferred income taxes are recorded to reflect the tax
consequences on future years of differences between the tax basis of assets and
liabilities and their financially reported amounts at each year-end based on
enacted laws and statutory rates applicable to the periods in which differences
are expected to affect taxable income. A valuation allowance is provided against
the future benefits of deferred tax assets if it is determined that it is more
likely than not that the future tax benefits associated with the deferred tax
asset will not be realized.
FOREIGN CURRENCY TRANSLATION
We sold our only foreign subsidiary during 2001.
The assets and liabilities of our foreign subsidiary, whose functional
currency is other than the U.S. Dollar, are translated at the exchange rates in
effect on the reporting date, and income and expenses are translated at the
weighted average exchange rate during the period. The net effect of translation
gains and losses is not included in determining net income but is included in
accumulated other comprehensive income, which is reflected as a separate
component of shareholder's equity. Foreign currency transaction gains and losses
are included in determining net income. Such gains and losses are not material
for any period presented.
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CONCENTRATIONS
Financial instruments that potentially subject us to concentrations of
credit risk consist principally of cash and cash equivalents and accounts
receivable. We place our cash and cash equivalents in financial institutions
considered by management to be high quality. We maintain cash balances at
financial institutions in excess of the $100,000 insured by the Federal Deposit
Insurance Corporation ("FDIC"). We had approximately $2.4, $2.7 and $8.1 million
invested in interest bearing money market and short-term fixed income
investments that are not insured by the FDIC at December 31, 2003, 2002 and
2001, respectively. We have not experienced any losses in these accounts and
believe we are not exposed to any significant credit risk on cash balances.
During the normal course of business, we extend credit to residential and
business customers residing in the United States. Our customer base is
broken-down as follows:
Percentage of Total Bundled
Service Revenues
2003 2002
New York 33% 46%
Illinois 10% 13%
Michigan 9% 13%
Georgia 6% 4%
Texas 6% 8%
Kentucky 6% 0%
Pennsylvania 4% 6%
Maryland 3% 2%
Florida 3% 0%
California 2% 1%
Indiana 2% 0%
Tennessee 2% 0%
Alabama 2% 0%
Virginia 2% 2%
All Others 10% 5%
100% 100%
This results in a concentration of credit to residential and business
customers in these states. We believe our credit policies, collection procedures
and allowance for doubtful accounts minimize the exposure to significant credit
risk of accounts receivable balances. Additionally, as of December 31, 2003, our
wholesale services receivables are concentrated with Sprint Communications
Company L.P. ("Sprint") as they are the primary wholesale customer.
We rely upon the Regional Bell Operating Companies ("RBOCs") for
provisioning of customers and the RBOCs are the primary suppliers of local
central office switching and local telephone lines. Global Crossing Ltd and
Williams Communications Group Inc. (now WilTel Communications Group, Inc.) are
the primary suppliers for our long-distance calling. We have not incurred any
material impact to our operations or financial statements as a result of the
Chapter 11 bankruptcy filings made by these companies.
We rely upon two separate service providers for provisioning and billing
services essential to support our operations.
SEGMENT REPORTING
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires that we report financial and descriptive information
about reportable segments, and how these segments were determined. We determine
the allocation and performance of resources based on total operations. Based on
these factors, man-
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agement has determined that we operate as two segments as defined by SFAS No.
131 during 2003 and 2002, retail services and wholesale services. We did not
earn wholesale services revenue in 2001.
FINANCIAL INSTRUMENTS
The recorded amounts of cash and cash equivalents approximate fair value
due to the short-term nature of these instruments. We have determined that due
to the interest rates and short-term nature of the capital lease obligation, the
fair value approximates the value recorded. We have determined that the
long-term debt assumed through acquisition is recorded at fair value. The
interest rates were adjusted to the current market rate for purchase accounting
treatment and we believe the debt is properly recorded at fair value.
MANAGEMENT'S USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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. Estimates also affect the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached a consensus on EITF No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." EITF No. 00-21
addresses how to account for arrangements that may involve the delivery or
performance of multiple products, services and/or rights to use assets. Revenue
arrangements with multiple deliverables should be divided into separate units of
accounting if the deliverables in the arrangement meet certain criteria.
Arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values. EITF No. 00-21 also supersedes
certain guidance set forth in Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements." The final consensus is applicable
to agreements entered into in quarters beginning after June 15, 2003, with early
adoption permitted. Additionally, companies are permitted to apply the consensus
guidance to all existing arrangements as a cumulative effect of a change in
accounting principle. We adopted this new pronouncement effective July 1, 2003,
on a prospective basis. This adoption did not have a material impact on our
consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective for our quarter
beginning July 1, 2003. We reviewed this new pronouncement and concluded that
none of the mandatorily redeemable convertible preferred stock recorded in the
mezzanine section of our balance sheet is within the scope of SFAS No. 150. This
conclusion is based on the facts that no unconditional obligation requiring the
redemption of the securities exists because they are convertible into common at
the option of the holder and the conversion option is substantial. We recognize
that the FASB is in the process of possibly promulgating additional rules in the
future related to securities similar to the ones that we have in the mezzanine
section, but are unable to determine what any future rule's impact might have on
our consolidated financial statements.
In June 2003, the FASB issued SFAS 149, "An Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This statement amends and
clarifies financial accounting and reporting for hedging activities and
derivative instruments, including certain derivative instruments embedded in
other contracts. This Statement is effective for contracts entered into or
modified after June 30, 2003. We adopted SFAS 149 in the third quarter of 2003.
This adoption did not have any impact on our consolidated financial statements.
In December 2003, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 104 ("SAB 104"), Revenue Recognition. SAB 104 clarifies
existing guidance regarding revenues for contracts which
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contain multiple deliverables to make it consistent with EITF No. 00-21. The
adoption of the provisions of EITF 00-21 and SAB 104 had no effect on our
results of operations.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity to consolidate
the entity and also requires majority and significant variable interest
investors to provide certain disclosures. A variable interest entity is an
entity that has (1) equity investment at risk that is insufficient to finance
the entity's activities without receiving additional subordinated financial
support from the other parties, (2) a group of equity owners that are unable to
make substantive decisions about the entity's activities, or (3) equity that
does not absorb the entity's losses or receive the benefits of the entity. FIN
46 is effective for all new variable interest entities created or acquired after
January 31, 2003. We have evaluated our investments and other relationships and
have concluded that none qualify as a variable interest entity as defined in FIN
46.
RECLASSIFICATION
To be consistent with emerging industry practices, the revenues for all
periods presented have been changed to reflect the billing to our customers of
the Universal Service Fund ("USF") and other regulatory fees and the related
payments into the associated regulatory funds as network operations expense.
Operating income and net income for all periods presented were unaffected. The
additional revenues and expenses recorded were $4.2, $3.1 and $4.5 million for
the years ended December 31, 2003, 2002, and 2001, respectively. We also have
certain other amounts in the December 31, 2002 and 2001 financial statements
that have been reclassified to conform to the December 31, 2003 presentation.
3. WHOLESALE SERVICES
In February 2003, we executed an agreement providing for the resale of our
local wireline telecommunications services and provision of ancillary services
with Sprint. Under this agreement, we provide Sprint access to our
Web-integrated, enhanced communications platform and operational support
systems. This contract includes various per-minute, per-line, and other charges
that are being recorded as revenue as earned. We are the primary obligor for
certain underlying expenses that are incorporated into our pricing in connection
with the agreement and therefore, are recording revenues using a gross
presentation, consistent with the method used for our wholesale services
agreement with MCI WORLDCOM Communications, Inc. ("MCI"). This method results in
certain per-line, per-minute and direct costs being recorded as revenues and the
corresponding expenses being recorded in the appropriate operating expense line.
As a result of this accounting treatment, increases or decreases in pricing or
volume that impact direct costs that are incurred in connection with this
agreement would have no impact on net income, as the amount is recorded in an
equivalent amount in both revenue and expense. Our wholesale services agreement
with Sprint is non-exclusive in nature.
We are deferring $1.0 million of revenues for pre-contract payments by
recognizing this amount ratably over the life of the agreement.
As of December 31, 2003, under our contract with Sprint, we had
approximately $4.7 million of deferred revenue, of which $0.3 million is
recorded as long-term deferred revenue. As of December 31, 2002, under our
contract with MCI we had approximately $3.6 and $6.3 million of long-term and
short-term deferred revenue, respectively.
On March 20, 2002, we entered into a 48-month agreement with MCI for
wholesale telephone exchange services, ancillary services and a limited-term
technology license. The agreement was cancelable by either party after eighteen
months. This agreement was significantly amended on November 1, 2002.
Under the original terms of the agreement, MCI was to pay us a maximum of
$50 million related to the use of our network in the form of a technology
license fee, should the agreement not be terminated early. Cash flows related to
the license were to be paid based on the number of MCI customers on our network,
as defined in the contract, and were subject to monthly minimum amounts. In
addition, MCI was to pay for services provided through usage-based fees
according to certain per line and per minute calculations defined in the
agreement and MCI was to
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also pay fees to us for providing telephone exchange services, payroll costs and
certain vendor fees. We are the primary obligor for all costs incurred under
this agreement.
We recognized the $50 million license fee, and amounts received in advance
of the contract, on a straight-line basis over the four-year contract period
beginning in April 2002. In connection with the agreement, we issued MCI one
million shares of our common stock at a price of $2.33, the market price of our
stock at the date of the agreement. As a result of this transaction an asset
totaling $2.3 million was being amortized on a straight-line basis as a
reduction to revenues over the 48-month term of the agreement with the remaining
balance recorded in other non-current assets. Monthly usage-based charges and
cost reimbursements were recognized when earned.
On November 1, 2002 we significantly amended the terms or our agreement
with MCI. This amendment was made as a result of MCI's bankruptcy filing on July
21, 2002. The significant financial changes in this amendment were the
elimination of the $50 million limited-term technology license fee, increases to
various fees calculated on a per minute and per line basis, certain additional
fees for services provided, elimination of exclusivity clauses, a reduction to
the monthly minimum payments and forgiveness of certain amounts to be repaid to
MCI.
Amounts received in advance of revenues being earned were being amortized
through December 31, 2004, the amended termination date of the agreement. The
amended agreement is cancelable by MCI without cause on or after April 1, 2002,
given at least 90 days written notice to us.
On August 7, 2003, we amended our contract with MCI to terminate the
contract on December 31, 2003. On August 15, 2003, MCI provided us with notice
that they were terminating the contract effective October 15, 2003, therefore,
we recognized $4.8 million of previously deferred revenue.
4. ACCOUNTS RECEIVABLE AGREEMENT
In July 2000, we entered into an accounts receivable agreement with RFC
Capital Corporation, a division of Textron, Inc. ("RFC"), providing for the sale
of certain of our accounts receivable to RFC. The RFC agreement provides for the
purchase of up to $25.0 million of certain of our accounts receivable, subject
to selection criteria as defined in the contract. In July 2002, we extended our
agreement with RFC under substantially similar terms for an additional two
years. The purchase of the receivables is at the option of RFC and they utilize
selection criteria to determine which receivables will be purchased. We had been
selling our receivables to RFC at a 23% discount; Prior to March 2002 we sold
our receivables at a 32% discount. Our collection percentage for receivables
sold to RFC was 98.5% and 92.9% for the years ended December 31, 2003 and 2002,
respectively. We received an additional payment from RFC for servicing the
assets in an amount equal to every dollar collected over the advance rate, less
certain fees. The accounts receivable agreement did not have a minimum
receivable sales requirement.
We sold approximately $138.2 and $135.2 million of receivables to RFC, for
net proceeds of approximately $111.9 and $107.3 million, during the years ended
December 31, 2003 and 2002, respectively. A net receivable servicing asset of
approximately $13.2 and $8.5 million is included in the accounts receivable
balance at December 31, 2003 and 2002, respectively. We recorded costs related
to the agreement of approximately $1.0, $1.3 and $1.1 million for the years
ended December 31, 2003, 2002 and 2001, respectively. Included in accounts
payable and accrued liabilities are advances for unbilled receivables in the
amount of $4.2 and $3.4 million at December 31, 2003 and 2002, respectively. We
were responsible for the continued servicing of the receivables sold.
5. ACCOUNTS RECEIVABLE WRITE-OFF
During the second quarter of 2001, management performed a detailed analysis
of accounts receivable and also reviewed its credit policies relating
specifically to acceptance and provisioning of service to new customers. As a
result of the analysis and subsequent change in credit policy, we switched our
focus from collection efforts on overdue and delinquent account balances to a
stringent credit policy surrounding customer acceptance and a collection effort
focused on fewer delinquent accounts. The detailed analysis and change in credit
policy lead to a write-off of delinquent receivables of approximately $29.9
million and revisions to the estimates used to develop the allowance for
doubtful accounts in the current and future periods. We had write-offs of
accounts receivable totaling approximately $17.6, $31.6 and $43.9 million for
the years ended December 31, 2003, 2002 and 2001, respectively.
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6. PROPERTY AND EQUIPMENT
At the respective dates, property and equipment consist of the following:
Depreciable
Lives in
Years December 31,
2003 2002
Switching equipment..................................... 5-10 $ 14,489 $ 14,170
Computer equipment ..................................... 5-10 35,965 32,092
Software ............................................... 3 53,813 46,753
Furniture and office equipment ......................... 5-10 8,990 9,034
Leasehold improvements ................................. 3-15 6,247 6,244
Land and building ...................................... 20-30 4,439 4,439
Construction-in-progress ............................... 1,047
124,990 112,732
Less accumulated depreciation and amortization ......... 85,921 64,412
Property and equipment, net ............................ $ 39,069 $ 48,320
Depreciation expense related to property and equipment amounted to
approximately $9.4, $10.5 and $11.5 million for the years ended December 31,
2003, 2002 and 2001, respectively. Amortization expense related to software
amounted to approximately $11.2, $11.3 and $8.5 million for the years ended
December 31, 2003, 2002 and 2001, respectively.
At the respective dates, assets acquired under capital leases, included in
property and equipment, consist of the following:
December 31,
2003 2002
Computer equipment................................ $ 2,443 $ 1,288
Software ......................................... 912 824
3,355 2,112
Less accumulated depreciation and amortization ... 1,357 788
Capital leases, net .............................. $ 1,998 $ 1,324
7. ASSET IMPAIRMENT
In the second quarter of 2001, management decided to reduce telemarketing
efforts, resulting in a majority of the operations and assets of telemarketing
centers acquired in 2000 from Touch 1 being voluntarily closed or sold. On June
30, 2001, the telemarketing centers sold accounted for approximately $1.0
million in property, plant and equipment. For these assets, we received 270,000
shares of preferred stock of the privately held acquiring company and a note
receivable of approximately $0.5 million. The loss recorded from this
transaction was approximately $1.0 million.
As a result of the decision to reduce telemarketing efforts noted above and
the subsequent transactions, management performed an assessment of the value of
the intangible assets recorded in the Touch 1 acquisition. In the second quarter
of 2001, it was determined that undiscounted future cash flows over the
remaining amortization period of certain intangible assets indicated that the
value assigned to the intangible assets might not be recoverable. Therefore, we
undertook an effort to determine the amount of expense to be recorded relating
to the impairment.
The carrying value of the goodwill and identifiable intangibles recorded on
the books approximated $61.7 million prior to the impairment analysis. We
calculated the fair value of the intangibles by performing a discounted cash
flow analysis related to the remaining assets acquired in the Touch 1 purchase.
When we determined we would effectively cease any telemarketing efforts in the
future, the sole remaining assets from the Touch 1 pur-
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chase were certain amounts of property, plant and equipment and intangibles
(consisting of customer lists and goodwill) acquired in the Touch 1 transaction.
Assuming a monthly attrition rate of 4.5% and a discount rate of 17.5% over an
18 month period, it was determined that the remaining operations acquired from
Touch 1 had a liquidation value which approximated the carrying value of the
customer lists acquired from Touch 1. At June 30, 2001, the carrying value of
the identifiable intangibles associated with the customer lists was
approximately $6.8 million. Therefore, during the second quarter of 2001, we
recorded a loss of $54.9 million, the difference between the carrying value of
all intangibles and the carrying value of the customer lists.
For the year ended December 31, 2001, we recorded an additional $4.3
million of impaired asset charges, composed of $3.0 million relating to
unrealizable software and development projects, $0.9 million of telemarketing
property and equipment and $0.4 million of securities deemed to be worthless. As
of December 31, 2003 and 2002, we had approximately $2.3 and $4.1 million,
respectively, of net intangible assets related to customer lists.
In April of 2002, we announced a restructuring plan that included a
reduction in force and the closure of the North Dakota call centers, acquired
from Touch 1, resulting in the settlement of the leases in these locations and
an asset impairment charge totaling approximately $1.1 million being recorded in
the second quarter of 2002.
8. INTANGIBLE ASSETS
In accordance with SFAS No. 142, we reassessed the expected useful lives of
existing intangible assets. This reassessment resulted in no changes to the
expected useful lives of our customer lists. We only have one intangible asset
as of December 31, 2003 as a result of all of our goodwill being written-off
during 2001.
Summarized below are the major classes of intangible assets as a result of
our acquisition of Touch 1 in April of 2000 that will continue to be amortized
under SFAS No. 142. We do not have any intangible assets that will not be
amortized:
December 31, 2003 December 31, 2002
Net Net
Carrying Accululated Intangible Carrying Accululated Intangible
Amount Amortization Assets Amount Amortization Assets
INTANGIBLE ASSETS SUBJECT TO
AMORTIZATION:
Customer related intangible
assets ................... $ 9,145 $ 6,858 $ 2,287 $ 9,145 $ 5,029 $ 4,116
The following table presents current and expected amortization expense of
the existing intangible assets as of December 31, 2003 for each of the following
periods:
AGGREGATE AMORTIZATION EXPENSE:
For the year ended December 31, 2003............................$ 1,829
Expected amortization expense for the years ending December 31,
2004 ........................................................... 1,829
2005 ........................................................... 458
9. OTHER ASSETS
At the respective dates, other assets consist of the following:
2003 2002
Deposits..................................... $ 3,062 $ 3,166
Contract signing bonus ...................... -- 1,885
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Certificates of deposit, restricted ......... 673 573
Interest receivable ......................... 54 57
Other ....................................... 31 67
$ 3,820 $ 5,748
The certificates of deposit are pledged as collateral on outstanding
letters of credit in the amount of approximately $0.7 and $0.6 million at
December 31, 2003 and 2002, respectively, related to lease obligations on two of
the our office spaces and $0.1 million for certain surety bonds required for
regulatory purposes in 2003.
10. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
At the respective dates, accounts payable and accrued liabilities consist
of the following:
2003 2002
Trade accounts payable.................. $ 39,176 $ 24,541
Accrued sales and use tax payable ...... 6,908 13,936
Advances on accounts receivable ........ 4,181 3,425
Accrued payroll ........................ 2,560 2,038
Accrued rent ........................... 1,263 1,423
Accrued transmission ................... 845 1,256
Other accrued liabilities .............. 4,297 5,152
$ 59,230 $ 51,771
11. LONG-TERM DEBT
Long-term debt consists of the following:
2003 2002
RELATED PARTIES:
Note payable to Corman Elegre, customer base pledged as collateral payable in
monthly installments, due September, 2004, interest rate
at 6% ................................................................... $ 2,364 $ 5,070
Note payable to First Revocable Trust of W. F. Corman, unsecured
payable in monthly installments, due September 2004, interest rate
at 6% ................................................................... 132 315
Note payable to James F. Corman, unsecured, payable in monthly
installments, due September 2004, interest rate at 6% ................... 45 106
UNRELATED PARTIES:
Note payable to Franklin Investment Funds, unsecured, payable in
monthly installments, due September 2004, interest rate of 6% ........... 919 2,183
Note payable to First National Bank of Atmore, unsecured, personally
guaranteed by James F. Corman, payable in monthly installments, due
September 2004, interest rate at 6% ..................................... 123 293
Notes payable to Touch 1 pre-petition creditors (trade vendors),
unsecured, payable in monthly installments, due September 2004,
interest rate at 6% ..................................................... 409 732
Notes payable to Touch 1 pre-petition creditors (trade vendors),
priority unsecured, payable in monthly Installments, due
September 2005, interest rate at 6% ..................................... 58 245
4,050 8,944
Less: Current portion ..................................................... (3,992) (5,193)
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Total long-term debt ...................................................... $ 58 $ 3,751
OPERATING LEASES
We have entered into various non-cancelable operating leases for equipment
and office space with monthly payments through the year 2009. Included in
general and administrative expense is rental expense relating to operating
leases of approximately $2.9, $2.9 and $2.8 million for the years ended December
31, 2003, 2002, and 2001, respectively. Sales and marketing expense includes
$0.0, $0.3 and $0.6 million of rental expense relating to operating leases for
the year ended December 31, 2003, 2002 and 2001, respectively.
CAPITAL LEASES
We have entered into various capital lease obligations that have effective
interest rates ranging from 3.8% to 19.9%, with three capital leases remaining
with payments through 2006.
Future minimum lease payments under non-cancelable operating and capital
leases and long-term debt as of December 31, 2003 are as follows:
CAPITAL
OPERATING LEASE LONG-TERM
Year ending december 31, LEASES OBLIGATIONS DEBT
2004.......................................................... $ 2,939 $ 1,245 $ 3,992
2005 ......................................................... 2,035 489 58
2006 ......................................................... 1,411 41 --
2007 ......................................................... 1,461 -- --
2008 ......................................................... 1,518 -- --
Thereafter ................................................... 907 -- --
Less amount representing estimated executory costs
(taxes, etc.), including profit thereon, included in
minimum lease payments ..................................... -- 115 --
Net minimum payment .......................................... $ 10,271 $ 1,660 $ 4,050
Less amount representing Interest on obligations under
capital lease .............................................. 179
Present value of minimum lease payments (including
approximately $1,025 due within one year) .................. 1,481
12. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
In 2003, four holders of our Series D Convertible Preferred Stock ("Series
D Preferred") converted their shares to common stock. There was a total of
66,667 shares of Series D converted into 109,025 shares of common stock. We also
paid $0.1 million in cash for certain dividends. In 2002, we had one conversion
of 50,000 shares of Series D converted into 76,158 common shares.
In July 2000, we filed a Certificate of Designation authorizing the
issuance of 5.0 million shares of $.01 par value Series D Preferred. We received
aggregate proceeds of approximately $56.3 million in connection with the sale of
4,688,247 shares of Series D Preferred at a price of $12.00 per share. The costs
associated with the transaction were approximately $0.4 million. The Series D
Preferred is convertible at an original conversion price of $12.00, which price
is subject to adjustment for such items as: (i) a dividend or distribution to
common shareholders (whether such dividend or distribution is in stock,
securities or other property), (ii) a stock split, (iii) a stock combination,
(iv) a reclassification of the common stock, (v) the issuance of stock or,
securities convertible into or exercisable for our common stock at a price that
is less than the adjusted conversion price and other events that would cause
dilution of ownership to the Series D Preferred stock. As a result of certain of
these events the conversion price at December 31, 2003 is $8.63. The Series D
Preferred is convertible into common stock at the option of the
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holder (i.e., initially convertible on a one-for-one basis); however, there are
certain circumstances that provide for us to force a conversion of the stock.
Series D Preferred is mandatorily redeemable in 2008, has an 8% cumulative
dividend payable at times in cash and at times in-kind with additional Series D
Preferred and has certain, liquidation preferences and voting rights. Each
purchaser of Series D Preferred received a warrant to purchase a number of our
shares of common stock equal to one-half of the amount of Series D Preferred
purchased by such investor. Each warrant is exercisable at a price of $13.80 per
share subject to certain adjustments that have lowered the exercise price to
$9.88 per share, at December 31, 2003.
In November 2000, we filed a Certificate of Designation authorizing the
issuance of approximately 6.3 million shares of $.01 par value Series E
Convertible Preferred Stock ("Series E Preferred"). We received proceeds of
approximately $50.0 million in connection with the sale of 4,166,667 shares of
Series E Preferred at a price of $12.00 per share. The purchaser of Series E
Preferred received a warrant to purchase a number of our shares of common stock
equal to one-half of the amount of Series E Preferred purchased by such
investor. These warrants are exercisable at a price of $13.80 per share subject
to certain adjustments that have lowered the exercise price to $7.62 per share,
at December 31, 2003. Series E Preferred is convertible at an original
conversion price of $12.00, which price is subject to adjustment for such items
as (i) a dividend or distribution to common shareholders (whether such dividend
or distribution is in stock, securities or other property), (ii) a stock split,
(iii) a stock combination, (iv) a reclassification of the common stock, (v) the
issuance of stock or securities convertible into or exercisable for our common
shares at a price that is less than the adjusted conversion price, and (vi)
other events that would cause dilution in the ownership of the holders of the
Series E Preferred stock. As a result of these events the conversion price at
December 31, 2003 is $8.25. The Series E Preferred is convertible into common
stock at the option of the holder (i.e., initially convertible on a one-for-one
basis); however, there are certain circumstances that provide us the ability to
force a conversion of the stock. Series E Preferred is mandatorily redeemable 8
years from the original issue date, has an 8% cumulative dividend payable
in-kind and has certain liquidation preferences and voting rights.
In July 2001, we filed a Certificate of Designation authorizing the
issuance of 175 shares of Series G junior convertible preferred stock ("Series G
Preferred"). On July 2 and August 3, 2001, we issued an aggregate of 175 shares
of Series G Preferred for aggregate proceeds of $17.5 million, initially
convertible into 11,739,970 shares of common stock, at a conversion price of
$1.49, subject to adjustment for such items as: (i) a dividend or distribution
to common shareholders (whether such dividend or distribution is in stock,
securities or other property), (ii) a stock split, (iii) a stock combination,
(iv) a reclassification of the common stock, (v) the issuance of stock or
securities convertible into or exercisable for our common stock at a price that
is less than the adjusted conversion price and upon the occurrence of certain
other events that would cause dilution in the ownership of the holders of the
Series G Preferred. To date there has been no change in the conversion price. In
conjunction with the issuance of the Series G Preferred, we issued warrants to
purchase 3,000,000 shares of common stock at an exercise price of $0.01 per
share. Series G Preferred, becomes mandatorily redeemable September 18, 2006.
The Series G Preferred has a 12% cumulative dividend, is convertible at the
option of the holder and has certain liquidation rights; however, there are
certain circumstances that provide for an automatic conversion of the Series G
Preferred.
In accordance with generally accepted accounting principles, we recorded a
deemed dividend of approximately $2.3 million, which results from the value
assigned to the warrants and a beneficial conversion feature associated with the
Series G Preferred transaction. These deemed dividends were originally accreted
over an expected life through December 31, 2001 (the earliest redemption date).
Once shareholder approval was obtained on October 30, 2001, the remaining
balance of $1.2 million was to be accreted over the remaining 5-year redemption
period. We recorded approximately $0.2, $0.2 and $1.6 million of a deemed
dividend related to this beneficial conversion feature in 2003, 2002 and 2001,
respectively.
As a result of certain anti-dilution clauses in the Series D Preferred
stock agreement, the issuance of Series G Preferred triggered an additional
beneficial conversion feature related to the Series D Preferred agreement. The
deemed dividend of approximately $7.8 million was accreted immediately, in the
third quarter of 2001.
In accordance with EITF 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,"
APB Opinion No. 14, "Accounting for Convertible Debt and Debt Issued with Stock
Purchase Warrants," EITF 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments" and SFAS No. 128 "Earnings Per Share" we recorded
non-cash charges relating to a beneficial conversion, cumulative dividends and
preferred stock accretion. We recorded preferred stock dividends and accretion
of $17.5,
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$15.6 and $15.1 million for the years ended December 31, 2003, 2002 and 2001,
respectively. We also recorded a deemed dividend related to a beneficial
conversion feature in the amounts of approximately $0.2, $0.2 and $9.4 million
for the years ended December 31, 2003, 2002 and 2001, respectively.
The recording of the beneficial conversion feature and the resulting
preferred stock accretion is the result of calculating the accounting conversion
price through a fair value allocation of the net proceeds received in the
preferred stock offerings between the preferred stock and the warrants issued.
This required the use of the Black-Scholes valuation model to calculate the fair
value on a per share or warrant basis for the Series D, E and G Preferred. The
beneficial conversion and resulting preferred stock accretion and the cumulative
dividend are included in the calculations of the net loss attributable to common
stockholders and the net loss per share calculation.
13. COMMON STOCK
The board of directors has never declared dividends on our common stock
since January 15, 1998 (Inception).
In March 2003, our Board of Directors authorized the repurchase of up to
one million shares of our common stock for a twelve-month period. We did not
repurchase any shares.
On February 19, 2001, our Board of Directors adopted a Stockholders Rights
Agreement (the "Plan") designed to deter coercive takeover tactics and prevent
an acquirer from gaining control of us without engaging in negotiation with our
Board of Directors.
Under the terms of the plan, preferred stock purchase rights were
distributed as a dividend at the rate of one right for each share of our common
stock, par value $0.01 per share and a corresponding number of rights for each
outstanding share of our Series D and E preferred stock outstanding at the close
of business on March 7, 2001. Until the rights become exercisable, additional
common stock or Series D and E Preferred will also have one right attached.
The rights will become exercisable only upon certain triggering events
whereby certain persons or groups of persons have expressed the intent to
acquire at least 15% or more of the voting power of the outstanding common
shares.
Upon the occurrence of a triggering event, each right will entitle holders
to buy one one-thousandth of a share of our Series F Junior Participating
preferred stock, par value $0.001 per share, at an exercise price of $45 per
one-thousandth of a share, subject to adjustment. Each holder of a right will
thereafter have the right to receive, in lieu of Series F Junior Participating
preferred stock and upon payment of the exercise price, common stock (or in
certain circumstances, cash, property or other of our securities) having a value
equal to two times the exercise price of the right. Except as otherwise provided
in the plan, we will generally be able to redeem the rights at $0.001 per right
at any time on or prior to a triggering event. The rights will expire on
February 19, 2011, unless earlier redeemed by the Board of Directors.
14. RESTRUCTURING CHARGES
In April of 2002, we approved and implemented a restructuring to enhance
our future cash flows and operating earnings. The restructuring included a
reduction of force coupled with the closure of our North Dakota call centers and
our New York sales office. In accordance with EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity,"
the restructuring costs were recognized as liabilities at the time management
committed to the plan. Management determined that these costs provided no future
economic benefit to us.
The restructuring charge includes termination benefits in connection with
the termination of 167 employees and lease abandonment costs. In addition, we
agreed to a settlement to exit the two leases for our call centers in North
Dakota as of July 1, 2002. All termination benefits and settlements to exit our
leases in North Dakota are paid
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as of December 31, 2002. We have recorded a lease abandonment charge
representing the future lease payments for our New York office as a liability
and payments exist through August 2005.
The following table shows the restructuring charges and related accruals
recognized under the plan and the effect on our consolidated financial position:
Employee Lease Lease
Termination Settlement Abondonment
Benefits Costs Costs Total
Balance at January 1, 2002................ $ -- $ -- $ -- $ --
Plan Charges ............................. 913 325 623 1,861
Cash paid ................................ (913) (325) (72) (1,310)
Balance at December 31, 2002 ............. -- -- 551 551
Cash paid ................................ (200) (200)
Balance at December 31, 2003 ............. $ -- $ -- $ 351 $ 351
15. INCOME TAXES
We account for income taxes under SFAS No. 109, "Accounting for Income
Taxes." Deferred income tax assets and liabilities are determined based upon
differences between financial reporting and tax basis of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
A reconciliation of the difference between the effective income tax rate
and the statutory federal tax rate follows:
2003 2002 2001
Tax at U.S. statutory rate................. $ (5,644) $ (6,844) $ (51,145)
State taxes, net of federal benefit ........ (413) (573) (2,698)
Change in valuation allowance .............. 5,807 7,255 36,779
Goodwill amortization ...................... -- -- 19,725
Other ...................................... 250 162 (2,661)
$ -- $ -- $ --
Significant components of our deferred tax assets and liabilities are as
follows:
2003 2002
Current deferred tax assets:
Accounts receivable .................................. $ 5,246 $ 6,612
Other ................................................ 1,968 95
Noncurrent deferred tax assets:
Net operating loss carryforward ...................... 106,691 99,869
Deferred revenue ..................................... 271 2,385
Deferred compensation ................................ 181 616
Excess capital losses ................................ 133 133
Accrued expenses ..................................... 145 696
Other ................................................ 480 541
Gross deferred tax assets ............................ 115,115 110,947
Less: Valuation allowance ............................ (111,900) (106,093)
3,215 4,854
Noncurrent deferred tax liabilities:
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Property and equipment ............................... (2,346) (3,290)
Intangible assets .................................... (869) (1,564)
Net deferred tax asset ............................... $ -- $ --
Generally accepted accounting principles require a valuation allowance to
reduce the deferred tax assets reported if, based on the weight of the evidence,
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. After consideration of all of the evidence, management has
determined that a valuation allowance of approximately $111.9 and $106.1 million
is necessary at December 31, 2003 and 2002, respectively.
At December 31, 2003 and 2002, our net operating loss carryforward for
federal income tax purposes is approximately $280.8 and $262.8 million,
respectively, expiring in various amounts from 2018 through 2023. Utilization of
our net operating loss carryforwards may be subject to annual limitations due to
ownership change rules as provided by the Internal Revenue Code and similar
state provisions.
16. COMMITMENTS AND CONTINGENCIES
We have disputed billings and access charges from certain inter-exchange
carriers ("IXCs") and incumbent local exchange carriers ("ILECs"). We contend
that the invoicing and billings of access charges to us are not in accordance
with the interconnection, service level, or tariff agreements between us and
certain IXCs and ILECs. We have not paid these disputed amounts and management
believes that we will prevail in these disputes. At December 31, 2003, the total
disputed amounts were approximately $18.2 million.
In August 2000, we entered into an agreement with a service firm to
outsource customer provisioning and other ordering through electronic bonding
with the incumbent local exchange carriers. In September 2002, we renegotiated
this agreement, resulting in a lowering of our monthly minimum payments and an
increase to the fees we pay on a per transaction basis. Our annual commitment,
subject to certain adjustments, is approximately $9.6 million for the year
ending December 31, 2004. We made payments under the agreement totaling $11.8,
$9.7 and $6.3 million for the years ended December 31, 2003, 2002 and 2001,
respectively. The minimum payments are required by us, regardless of our use of
the services provided for in the contract. This contract provides, under certain
circumstances, for early termination and severance fees for such action.
We currently have agreements with two long-distance carriers to provide
transmission and termination services for all of our long distance traffic.
These agreements generally provide for the resale of long distance services on a
per-minute basis and contain minimum volume commitments. As a result of a
settlement of a billing dispute associated with minimum volume commitments
required in one of these contracts we have agreed to pay an increased per minute
charge for minutes until the achievement of certain minimum minute requirements
which we expect to meet in the first half of 2004. Once we meet the new agreed
upon minimum minutes we will revert to the terms of our original agreement. All
other terms of the original agreement continue in full force. We believe that we
will be fully in compliance with all minimum volume commitments during 2004. We
accrued amounts representing the incremental fees in 2003, so that the expense
recorded per minute is consistent throughout the agreement.
In connection with certain of our wholesale services agreements, all or a
portion of customer lines are provisioned using our company code. Therefore, we
are the customer of record for the regional bell operating companies' wholesale
billing. It is very likely that the state commissions would require us to
continue providing services to the end user customer for at least a 90-day
period, regardless of whether our wholesale relationships continue.
We have agreed to certain service level agreements ("SLA"s) for providing
service under our wholesale agreements. If we were to not fulfill the SLAs after
the phase-in period there are certain remedies including but not limited to
financial compensation. We have not had any financial compensation paid as a
result of any SLAs since our inception.
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17. RELATED PARTY TRANSACTIONS
In January 2001, we accelerated the vesting of 50,000 stock options granted
to an executive as part of his severance agreement. This acceleration resulted
in the employee being fully vested in stock options with a strike price of $3.64
when the stock was trading at $4.50. We recorded approximately $0.1 million in
general and administrative expense as a result of this transaction.
In January 2002, we accelerated the vesting of 96,471 stock options granted
to an executive as part of his severance agreement. This acceleration resulted
in the employee being fully vested in stock options with a strike price of $1.30
when the stock was trading at $1.80. The employee forfeited 76,471 of his vested
options in return for the exercise of 20,000 shares of stock. We recorded
approximately $0.1 million in general and administrative expense as a result of
this transaction.
In February 2003 we received a payment of $0.5 million from an executive
officer who is also on our Board of Directors in fulfillment of an outstanding
note receivable to us.
In August 2003, we accelerated the vesting of 122,223 stock options granted
to an executive as part of his severance agreement.
This acceleration resulted in the employee being fully vested in stock
options with a strike price of $1.30 per share and were in-the-money trading at
$2.02 per share as the time of acceleration. As a result of this transaction we
recorded approximately $0.1 million in general and administrative expense.
As of December 31, 2003 we have approximately $1.7 million of notes
receivable from employees and former employees for various reasons We have
recorded approximately $1.1 million of these loans as a contra to our equity as
the loans were for the purchase of stock. The remaining $0.6 million loans were
more of a personal nature and we have made an accrual for $0.5 million as some
of these loans are to former employees and the likelihood of collection and lack
of collateral make it likely that these amounts will not be collectable. These
notes are primarily due by December 2004 with approximately $0.8 million due by
that date. Only two notes are due beyond this date, one is a note in the amount
of approximately $0.8 million, due in June 2005, and the other is approximately
$0.1 million and is a demand note that currently has no specific due date.
We paid interest on our related party term debt in the amounts of $0.3,
$0.4 and $0.6 million for the years ended December 31, 2003, 2002 and 2001,
respectively.
18. EMPLOYEE BENEFIT PLAN
In 1999, we established a 401(k) plan covering defined employees who meet
established eligibility requirements. Under the original plan provisions, we did
not make matching contributions. Effective September 15, 2000, we merged the
plans of Touch 1 and ours and established a matching contribution for the 401(k)
plan to 50% of participating contributions to a maximum matching amount of 5% of
a participant's compensation. Our contribution was approximately $0.5 million
for each of the years ended December 31, 2003, 2002 and 2001.
19. STOCK-BASED COMPENSATION
Effective October 30, 1998, we adopted the 1998 Equity Participation Plan
("1998 Plan"), for the grant to eligible employees and eligible participants of
options to purchase up to 1,261,000 shares of our common stock. During September
and November 1999, the Board of Directors (the "Board") increased the shares
available for grant under the 1998 Plan to 6.0 and 7.5 million shares,
respectively.
Effective April 20, 2000, we adopted the 2000 Equity Participation Plan
("2000 Plan"). This plan allows for the grant to eligible employees and eligible
participants of options to purchase up to 2.0 million shares of our common
stock. The 2000 Plan automatically increases the number of shares available for
grant on the first day of our fiscal year beginning in 2001 equal to the lesser
of (i) 3.0 million shares, (ii) 6% of the outstanding shares on such date, or
(iii) a lesser amount determined by the Board.
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Our plans are administered by a committee appointed by the Board, or by the
Board. The Board or the appointed committee shall administer the 2000 Plan,
select the eligible employees and eligible participants to whom options will be
granted, the price to be paid, the exercise period and the number of shares
subject to any such options and interpret, construe and implement the provisions
of the 2000 Plan.
Stock option grants approximate the fair market value at the date of grant.
The vesting periods on these options range from immediately to four years and
have a maximum contractual life of ten years.
Prior to the adoption of the 1998 Plan, the Board awarded options (the
"Initial Plan") for the right to purchase 3,868,800 shares of common stock at a
weighted average option price per share of $2.83. The vesting periods on these
options range from immediately to four years, and have a maximum contractual
life of ten years.
A summary of the stock option activity for the years ended December 31,
2003, 2002 and 2001 is presented below:
1998 Equity 2000 Equity
Initial Plan Participation Plan Participation Plan Total
Weighted Weighted Weighted Weighted
Average Average Average Average
Number of Exercise Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price Shares Price
Outstanding,
December 31, 2000 2,888,252 $ 2.98 3,627,188 $ 13.07 1,751,640 $ 11.45 8,267,080 $ 9.20
Granted ............ 4,257,450 1.69 4,257,450 1.69
Exercised .......... (47,486) 2.32 (130,253) 3.64 -- -- (177,739) 3.29
Forfeited .......... (97,144) 2.49 (638,227) 12.70 (727,376) 9.84 (1,462,747) 10.60
Outstanding,
December 31, 2001 2,743,622 3.01 2,858,708 13.58 5,281,714 3.80 10,884,044 6.17
Granted ............ -- -- -- -- 3,370,475 1.29 3,370,475 1.29
Exercised .......... -- -- -- -- (20,361) 1.30 (20,361 1.30
Forfeited .......... (17,593) 3.31 (480,845) 19.97 (1,242,132) 3.58 (1,740,570) 8.10
Outstanding,
December 31, 2002 2,726,029 3.01 2,377,863 12.29 7,389,696 2.70 12,493,588 4.59
Granted ............ -- -- -- -- 1,712,600 1.94 1,712,600 1.94
Exercised .......... -- -- -- -- (394,144) 1.32 (394,144) 1.32
Forfeited .......... -- -- (292,237) 3.21 (437,183) 12.31 (696,420) 8.67
Expired ............ (550,000) 3.64 -- -- -- -- (550,000) 3.64
Outstanding,
December 31, 2003 2,176,029 $ 2.85 2,085,626 $ 13.56 8,270,969 $ 2.10 12,565,624 $ 4.14
We did not grant any options to non-employees during 2003, 2002 and 2001.
The following table summarizes information about stock options outstanding
at December 31, 2003:
Weighted
Average
Exercise Number Number Exercisable
Price Range Outstanding Exercisable Price
$0.00 - $1.00 159,050 73,189 $ 0.85
$1.01 - $2.00 7,613,075 4,176,775 $ 1.28
$2.01 - $3.00 658,548 184,609 $ 2.26
$3.01 - $4.00 1,731,388 1,729,691 $ 3.65
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$5.01 - $6.00 366,620 366,620 $ 5.45
$6.01 - $7.01 303,900 302,700 $ 7.00
$7.00 -$8.00 173,453 170,953 $ 7.39
$8.01 - $9.00 8,450 7,900 $ 8.96
$9.01 - $10.00 76,250 76,250 $ 10.00
$11.01 - $12.00 58,900 58,900 $ 12.00
$12.01 - $13.00 942,190 940,190 $ 13.00
$13.01 - $47.00 473,800 1,000 $ 30.59
12,565,624 8,088,777
20. COMPUTATION OF NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted average number of common shares outstanding
during the period. Incremental shares of common stock equivalents are not
included in the calculation of net loss per share as the inclusion of such
equivalents would be anti-dilutive.
Net loss per share is calculated as follows:
Year Ended December 31,
2003 2002 2003
Basic and diluted net loss per share:
Net loss .............................................................. $ (16,127) $ (19,555) $ (146,068)
Less mandatorily redeemable convertible preferred stock
dividends and accretion ............................................ (17,480) (15,589) (15,059)
Less deemed dividend related to beneficial conversion feature ......... (186) (186) (9,356)
Net loss attributable to common stockholders .......................... $ (33,793) $ (35,330) $ (170,483)
Weighted average common shares outstanding ............................ 35,396,922 34,951,720 33,908,374
Basic and diluted net loss per share .................................. $ (0.95) $ (1.01) $ (5.03)
For each of the periods presented, basic and diluted net loss per share are
the same. The following table includes potentially dilutive items that were not
included in the computation of diluted net loss per share for all periods
presented because to do so would be anti-dilutive in each case:
Year Ended December 31,
2003 2002 2001
Unexercised stock options.............................................. 12,565,624 12,493,588 10,884,044
Unexercised warrants .................................................. 10,652,769 10,443,330 10,425,982
Mandatorily redeemable preferred stock convertible into common
shares .............................................................. 31,678,795 27,901,655 25,941,982
Total potentially dilutive shares of common stock equivalents ......... 54,897,188 50,838,573 47,252,008
21. LEGAL AND REGULATORY PROCEEDINGS
During June and July 2001, three separate class action lawsuits were filed
against us, certain of our current and former directors and officers (the
"D&Os") and firms engaged in the underwriting (the "Underwriters") of our
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initial public offering of stock (the "IPO"). The lawsuits, along with
approximately 310 other similar lawsuits filed against other issuers arising out
of initial public offering allocations, have been assigned to a Judge in the
United States District Court for the Southern District of New York for pretrial
coordination. The lawsuits against us have been consolidated into a single
action. A consolidated amended complaint was filed on April 20, 2002. A Second
Corrected Amended Complaint (the "Amended Complaint"), which is the operative
complaint, was filed on July 12, 2002.
The Amended Complaint is based on the allegations that our registration
statement on Form S-1, filed with the Securities and Exchange Commission ("SEC")
in connection with the IPO, contained untrue statements of material fact and
omitted to state facts necessary to make the statements made not misleading by
failing to disclose that the underwriters allegedly had received additional,
excessive and undisclosed commissions from, and allegedly had entered into
unlawful tie-in and other arrangements with, certain customers to whom they
allocated shares in the IPO. The plaintiffs in the Amended Complaint assert
claims against us and the D&Os pursuant to Section 11 of the Securities Act of
1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5
promulgated by the SEC thereunder. The plaintiffs in the Amended Complaint
assert claims against the D&Os pursuant to Sections 11 and 15 of the Securities
Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated by the SEC thereunder. The plaintiffs seek an
undisclosed amount of damages, as well as pre-judgment and post-judgment
interest, costs and expenses, including attorneys' fees, experts' fees and other
costs and disbursements. Initial discovery has begun. We believe we are entitled
to indemnification from our Underwriters.
A memorandum of understanding has been reached by lawyers for the
plaintiffs, the issuers and insurers of the issuers. The memorandum sets forth
the terms of a proposed settlement, the principal components of which are (i) a
release of all claims against the issuers and their officers and directors, (ii)
the assignment by the issuers to the plaintiffs of certain claims the issuers
may have against the Underwriters and (iii) an undertaking by the insurers to
ensure the plaintiffs receive not less than $1 billion in connection with claims
against the Underwriters. Our board of directors has approved the memorandum of
understanding. To be binding, the settlement must be approved by substantially
all the issuers and thereafter submitted to and approved by the court. The
settlement will not be binding upon any plaintiffs electing to opt-out of the
settlement.
The Metropolitan Government of Nashville and Davidson County, Tennessee, on
behalf of the Metropolitan Nashville Employee Benefit Board (collectively "Metro
Nashville"), filed a lawsuit against us on September 20, 2002. The lawsuit
asserts claims under Delaware Law, the Uniform Commercial Code, and state law
and seeks actual damages of $18 million, punitive damages of $18 million,
interest, and court costs. Metropolitan Nashville Employee Benefit Board is our
common shareholder. Metro Nashville alleges that we wrongfully and improperly
delayed delivery of a stock certificate, preventing Metro Nashville from selling
or taking other steps to protect the value of their shares while the price of
our stock declined significantly. The court denied our motion to dismiss on
January 20, 2003 and denied our motion for summary judgment on January 21, 2004.
We filed a motion for reconsideration of the Order Denying Summary Judgment on
February 6, 2004. This motion is still pending before the court. The court has
scheduled trial to begin on May 17, 2004. We believe the lawsuit is without
merit and intend to oppose the allegations vigorously; however, we cannot
predict the outcome of this litigation with any certainty.
On August 6, 2002, we filed a complaint against Southwestern Bell Telephone
Company ("SWBT") before the Public Utility Commission of Texas ("PUCT"),
requesting that the PUCT enjoin SWBT from disconnecting our access to customers
in Texas on the basis of a billing dispute between the parties. The billing
dispute centered on whether we owed SWBT certain amounts for collect calls from
SWBT retail customers to our retail customers. On August 23, 2002, the PUCT
issued in part the injunctive relief requested by us, making clear that service
not be interrupted. Since that injunction, we and SWBT have been involved in a
dispute resolution process over these and other billing disputes between SWBT
and SBC affiliates of SWBT.
On October 9, 2003, Z-Tel Communications, Inc., our wholly-owned subsidiary
corporation, filed a lawsuit against SBC Communications, Inc. and several of its
subsidiaries (collectively, "SBC") in federal court in Texas, where both SBC and
we do business. The lawsuit alleges SBC's violation of the federal antitrust
laws, the Racketeering Influenced Corrupt Organizations Act (RICO), the Lanham
Act, and other federal and state laws. The complaint seeks damages and an
injunction against SBC. On November 20, 2003, SBC filed a motion to dismiss the
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complaint. This motion is pending before the court. We cannot predict the
outcome of this litigation with any certainty.
In September 2003, the FCC released its final decision in the Triennial
Review proceeding. In the Triennial Review Order, the FCC also ruled that
entrants would no longer be able to access network elements utilized by
incumbent local telephone companies to provide "broadband" services, such as
fiber-to-the-premises loops, high-capacity transport, packet switching,
line-sharing for DSL services, and fiber-fed "next-generation digital loop
carrier" loops. These limitations on unbundled access could have a significant
impact upon our business; if incumbent carriers deploy next-generation
architectures as a replacement for their existing local plant, there is the
significant possibility that our ability to provide services to our customers
will be eliminated or severely restricted in such situations. The FCC did
reaffirm incumbent local telephone company obligations to provide unbundled
access to Enhanced Extended Links ("EELs," a combination of loop and transport)
and the UNE-P combination in particular circumstances, subject to review by
state public utility commissions. In particular, the FCC ruled that entrants
like us would be able to purchase dedicated transport (utilized in EELs) and
analog switching (utilized in UNE-P) on an unbundled basis, subject to
state-by-state review of whether such unbundling was needed in their states.
Carriers were involved in those state-by-state proceedings when, on March
2, 2004, the D.C. Circuit Court of Appeals overturned the FCC's decision as an
improper delegation of authority to state public utility commissions. See Report
and Order on Remand and Further Notice of Proposed Rulemaking, Review of Section
251 Unbundling Obligations of Incumbent Local Exchange Carriers, 18 FCC Rcd
16978 (2003) ("Triennial Review Order"), rev'd in part and remanded, United
States Telecom Ass'n v. FCC, Nos. 00-1012, 00-1015, 03-1310 et al. (D.C. Cir.
March 2, 2004) ("USTA II"). The D.C. Circuit ordered that the unbundled
transport and switching rules be vacated after sixty days or upon denial of a
petition for rehearing, whichever occurs later. A majority of the FCC has
indicated that it will support an appeal of this decision. We are weighing our
legal options with regard to this opinion, as are other competitive carriers. If
the USTA II decision is not stayed or reversed, it could have immediate,
significant, adverse and material impact upon our business. For example, ILECs
might utilize the reversal of the unbundling rules to deny us access to their
local networks. We depend upon such access to provide our services to our
customers.
With regard to pricing, states and the FCC are currently re-evaluating the
pricing of network elements. As a result, it is possible that prices in some
states could increase or lower rates from existing levels. Currently, the
incumbent local exchange carriers Verizon, BellSouth, SBC and Qwest have rate
cases pending before state regulatory commissions in at least one state in each
of their respective territories. In particular, ongoing rate cases in Illinois,
Ohio, Indiana and Michigan could significantly raise the existing rates for some
network elements and network element combinations. Our intent is to be an active
participant in many of these rate cases and any others that might be critical to
our operations. We anticipate joining other competitive service providers in
arguing that existing rates and rates proposed by the incumbents are overstated
and do not reflect the true total element long run incremental costing
principles required by the FCC and the Telecommunications Act. The FCC, in
Docket No. 03 is currently reevaluating its prescribed methodology for
calculating unbundled network element rates. In the 2002 Verizon v. FCC
decision, the U.S. Supreme Court affirmed the FCC's current pricing methodology,
called "Total Element Long Run Incremental Cost," or "TELRIC." The current FCC
rulemaking proposes to modify the TELRIC methodology by mandating that states
set prices based upon the forward-looking costs of operating the existing
network architecture of incumbent local telephone company networks. In many
instances, modifying the TELRIC methodology in this way could increase the rates
we pay for certain elements and result in lower rates for other elements. We
believe that the FCC's proposals to modify TELRIC are inconsistent with the
Supreme Court's decision in the Verizon case, meaning that new FCC TELRIC rules
may be subject to considerable litigation if they are adopted.
While the prevailing productivity trends within the industry would predict
the adoption of lower rates in association with the provision of unbundled
network elements and network element combinations, we cannot predict the outcome
of any pending or potential rate case or judicial proceeding. Increases or
decreases in rate levels charged by incumbent local exchange carriers as a
result of regulatory and/or judicial review through rate case, court case or
arbitration proceedings could significantly impact our business plans.
We believe that in the event the rules are vacated without any replacement
by either the FCC or the state utility commissions, we have interconnection
agreements with our principal ILEC vendors that will permit us to continue to
obtain access to local network elements during any intervening time period.
However, it is possible that
H-3-29
any or all of those ILECs will refuse to abide by the terms of those agreements
or seek to terminate those agreements. We are evaluating our legal options to
ensure that we continue to meet the needs of our existing and future customers.
In the ordinary course of business, we are involved in legal and regulatory
proceedings, disputes and tax audits at the federal, state and local level that
are generally incidental to our ongoing operations. In addition, from time to
time, we are the subject of customer and vendor complaints filed with the state
utility commissions of the states in which they operate or the Federal
Communications Commission. Most complaints are handled informally, and at this
time, there are no formal proceedings pending. While there can be no assurance
of the ultimate disposition of incidental legal proceedings or customer
complaints, we do not believe their disposition will have a material adverse
effect on our consolidated results of operations or financial position.
22. SEGMENT REPORTING
We have two reportable operating segments: Retail Services and Wholesale
Services.
Prior to 2002 we had only one reportable segment: retail services.
The retail services segment includes our Z-LineHOME and Z-LineBUSINESS
services that offer bundled local and long-distance telephone services in
combination with enhanced communication features accessible, through the
telephone, the Internet and certain personal digital assistants. We offer
Z-LineHOME and Z-LineBUSINESS in 49 states. Our customers are concentrated
primarily in metropolitan areas in 10 states for both our Z-LineHOME and
Z-LineBUSINESS services. This segment also includes our Touch 1 residential
long-distance offering that is available nation-wide.
The wholesale services segment allows companies to offer telephone exchange
and enhanced services to residential and small business customers. This service
is currently available in 49 states and Sprint is our primary customer for this
offering.
Management evaluates the performance of each business unit based on segment
results, exclusive of adjustments for unusual items. Special items are
transactions or events that are included in our reported consolidated results
but are excluded from segment results due to their nonrecurring or
non-operational nature. It is also important to understand when viewing our
segment results that we only record direct expenses in our wholesale services
and therefore, all employee benefits, occupancy, insurance, and other indirect
or overhead related expenses are reflected in the retail services segment.
The following summarizes the financial information concerning our
reportable segments for the years ended December 31, 2003, 2002 and 2001:
December 31,
2003 2002 2001
Retail Services
Revenues........................................ $ 205,059 $ 208,280 $ 280,350
Depreciation and amortization .................. $ 20,956 $ 22,428 $ 23,277
Segment results ................................ $ (18,905) $ (9,975) $ (36,721)
Capital expenditures ........................... $ 10,239 $ 6,657 $ 15,426
Identifiable assets ............................ $ 77,108 $ 97,914 $ 116,737
December 31,
2003 2002 2001
Wholesale Services
Revenues............................................. $ 84,121 $ 30,774 $ --
Depreciation and amortization ....................... $ 2,493 $ 1,508 $ --
H-3-30
Segment results ..................................... $ 24,717 $ 11,315 $ --
Capital expenditures ................................ $ 797 $ 8,536 $ --
Identifiable Assets ................................. $ 12,345 $ 8,797 $ --
The following table reconciles our segment information to the consolidated
financial information for 2003, 2002 and 2001:
December 31,
Revenues 2003 2002 2001
Total segment revenues ......................................... $ 289,180 $ 239,054 $ 280,350
MCI bankruptcy revenue reversal ................................ -- (657) --
Total consolidated ............................................. $ 289,180 $ 238,397 $ 280,350
December 31,
Segment results: 2003 2002 2001
Total segment results .......................................... $ 5,812 $ 1,340 $ (36,668)
Retroactive reduction to network access rate ................... 2,500 8,981 --
MCI bankruptcy ................................................. -- (1,304) --
Write-off of accounts receivable ............................... -- -- (29,949)
Asset impairment charge ........................................ -- (1,129) (59,247)
Wholesale development costs .................................... -- (1,018) --
Restructuring charge ........................................... -- (1,861) --
Depreciation and amortization .................................. (23,449) (23,936) (23,277)
Total consolidated operating loss .............................. $ (15,137) $ (18,927) $ (149,141)
23. SUBSEQUENT EVENTS
In February 2004, we received from two employees an aggregate payment of
$0.5 million for repayment of notes receivable.
In March 2004, we signed an agreement with a large communication company
with a large embedded customer base. This agreement is a marketing arrangement
in which we would pay a monthly recurring commission and certain other fees
based on retail customers added during the agreement. We will own the end user
and will consequently be responsible for providing all services and expenses
associated with these customers, similar to our existing retail UNE-P business.
This agreement has no minimum requirements but we were provided with formal
notice for a projected launch of May 6, 2004.
In March 2004, we granted 285,000 shares of restricted stock with an
approximate value of $0.8 million to certain executive officers and key
employees. The cost of the stock is $0.01, par value, per share and vests
one-third after one year and one thirty-sixth each month thereafter.
SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
In the following summary of quarterly financial information, all
adjustments necessary for a fair presentation of each period were included.
H-3-31
Quarter ended
March 31, June 30,
2003 2003 September 30, 2003 December 31, 2003
Revenues................................ $ 60,929 $ 71,046 $ 82,716 $ 4,489
Operating loss ......................... (3,280) (5,587) (2,069) (4,201)
Net loss ............................... (3,105) (6,008) (2,553) (4,461)
Loss per share (1) ..................... $ (0.21) $ (0.30) $ (0.18) $ (0.26)
Weighted average shares outstanding .... 35,268,253 35,305,448 35,368,759 35,641,435
Quarter ended
March 31, June 30,
2002 2002 September 30, 2002 December 31, 2002
Revenues................................ $ 58,156 $ 63,039 $ 59,478 $ 57,724
Operating income (loss) ................ (11,172) 1,355 (5,127) (3,983)
Net income (loss) ...................... (10,607) 259 (4,962) (4,245)
Loss per share (1-4) ................... $ (0.42) $ (0.11) $ (0.26) $ (0.22)
Weighted average shares outstanding .... 34,307,194 35,074,936 35,191,836 35,220,240
(1) Earnings per share were calculated for each three-month period on a
stand-alone basis.
(2) We recorded start-up costs of approximately $1.0 million for the
development our new Wholesale Services offering during the first quarter of
2002.
(3) We recorded approximately $1.9 million for termination benefits, lease
abandonment and lease settlement costs in connection with the closure of
two call centers in North Dakota and our New York sales office in the
second quarter of 2002.
(4) We recorded approximately $1.2, $1.3 and $9.0 million as a result of
retroactive rate reduction for the unbundled network elements in the first
quarter 2003, second quarter 2003 and second quarter 2002, respectively.
H-3-32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with the "Selected
Consolidated Financial Data," financial statements and related notes included in
this document. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results may differ materially from those
projected in the forward-looking statements as a result of certain factors,
including, but not limited to, those discussed in "Item 1. Business," as well as
"Cautionary Statements Regarding Forward-Looking Statements," and "Risks Related
to our Financial Condition and our Business," below, and other factors relating
to our business and us that are not historical facts. Factors that may affect
our results of operations include, but are not limited to, our limited operating
history and cumulative losses, uncertainty of customer demand, anticipated rapid
expansion, potential software failures and errors, potential network and
interconnection failure, dependence on local exchange carriers, dependence on
third party vendors, success and profitability of our wholesale services,
dependence on key personnel, uncertainty of government regulation, legal and
regulatory uncertainties, and competition. We disclaim any obligation to update
information contained in any forward-looking statement.
OVERVIEW
We offer local and long distance telephone services in combination with
enhanced communication features accessible through the telephone or the
Internet. These features include Personal Voice Assistant ("PVA"), "Find-Me,"
"Notify-Me," caller identification, call waiting and speed dialing. PVA allows
users to store contacts in a virtual address book and then access and utilize
that information by voice from any telephone. PVA users can also send voice
e-mails. We are an emerging provider of advanced, integrated telecommunications
services targeted to residential and business customers. In addition to
providing our services on a retail basis, we are also providing these services
on a wholesale basis. Our wholesale services provide other companies the ability
to utilize our telephone exchange services, enhanced services platform,
infrastructure and back-office operations to provide services to retail and
business customers on a private label basis. For management purposes, we are
organized into two reportable operating segments: retail services and wholesale
services. The nature of our business is rapidly evolving, and we have a limited
operating history.
Economic and Industry-Wide Factors
The overall telecommunication industry is experiencing an enormous amount
of competition. Although telecommunications has always been relatively
competitive, it seems that competitive pressures are even further intensifying,
as incumbent and new providers continue to undercut each other in price while
offering more and new services. In order to promote new services, providers
usually provide immediate discounts and enticements. This generally makes
prospective customers more willing perhaps to switch telecommunication providers
and experiment with new service offerings. The industry is also receiving
entrants from other industries, which is creating various bundling and pricing
opportunities. Not only are end user prices generally decreasing, but customers
are also receiving more minutes, features, options, and partnering advantages
than has been typically available in the past. The industry is also experiencing
increased churn as service providers in the wireline, wireless, VoIP, cable,
internet, satellite, and other markets compete for and in some cases target
each-other's customer bases with various marketing and partnering opportunities.
The overlapping of markets is also driving the desire of companies to be the
sole provider of services across many communication markets, which provides
additional margins and an incentive to customers to stay with the provider as a
result of discounts for receiving multiple services.
The 1996 Telecommunications Act and the establishment of the unbundled
network element platform ("UNEP") and total element long run incremental cost
("TELRIC") pricing have been consumed in either regulatory uncertainty or in the
court system as the ILEC's continue to argue for the elimination of UNE-P or at
a very minimum the need to increase pricing of UNE-P. This consistent status of
flux and uncertainty has become more significant recently. The uncertainty is a
result of the D.C. Circuit decision that vacates certain Federal Communication
Commission ("FCC") rules related to UNE-P 60 days from March 2, 2004, or upon
denial of a petition for rehearing, whichever is later, primarily as a result of
what, in the court's opinion, is the mishandling of the 1996 Telecommunications
Act by the FCC. Therefore, the competitive carriers have appealed to the U.S.
Supreme Court to review the case. This uncertainty could make it extremely
difficult to operate our business as we must work even more diligently to
convince the market, customers, partners, vendors, lenders and other
constituents that this issue
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will pass and we will be able to continue to successfully pursue our business
plan. We believe that UNE-P will continue to exist into the foreseeable future,
but we do not know the exact time-frame. We will also continue to pursue our
VoIP initiatives, as this is our planned longer-term solution to mitigating or
perhaps fully eliminating our risk from the uncertainty of UNE-P.
We believe that there are significant opportunities to grow our business,
especially through marketing partnerships. We believe that the establishment of
bundled service offerings as being the "standard" will further drive the
convergence of services across all telecommunication service offerings and even
across markets. We believe that this will only increase as customers
increasingly recognize the value of bundled services. We expect further
partnering and potential consolidation in the telecommunications industry during
the coming years as competition continues, the regulatory environment becomes
clearer and the availability of service offerings expands. There is also
significant risk with these factors as the intense competition from a price and
service perspective will force continued operational and financial pressures on
operating margins and perhaps other measurements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP"). The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our critical
accounting policies and estimates, including those related to revenue
recognition, disputed payables related to network operations expense, valuation
of accounts receivable, property, plant and equipment, long-lived and intangible
assets, restructuring reserves, tax related accruals and contingencies. We base
our estimates on experience and on various other assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may materially differ
from these estimates under different assumptions or conditions. Furthermore,
accounting treatment of assets, liabilities, revenues, and expenses may differ
from telecommunication regulatory treatment of these same items.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue Recognition. Revenues are recognized when earned. Revenues related
to long distance, carrier access service and certain other usage driven charges
are billed monthly in arrears and the associated revenues are recognized during
the month of service. We record an estimate for this amount. Subscription
services are billed monthly in advance and we recognize revenues for this
service ratably over the service period. We defer certain installation charges
and recognize this revenue ratably over the estimated life of our customer. Our
wholesale services revenues are derived from contractual arrangements. We
perform a review of each contract and determine the appropriate timing of
revenue recognition depending on the facts and circumstances of each individual
item within the contract. We are currently deferring certain revenues over the
life of our arrangements, rather than recognizing these revenues up-front. In
instances where we are the primary obligor for costs incurred we use the gross
method to record our revenues for wholesale services. We operate in a heavily
regulated industry; therefore, our pricing is subject to both state and federal
regulatory commission oversight. Such oversight could result in changes to the
amount we bill our customers in current and future periods.
The gross accounting presentation for our wholesale services business
segment requires the understanding that certain recorded revenues are actually
direct cost pass-through. For instance, under our Sprint contract we charge to
Sprint, with a zero mark-up, certain charges that we receive from the incumbent
local exchange carriers ("ILECs") that are attributable to lines that are owned
by Sprint under the aforementioned agreement. However, late in the third quarter
of 2003 Sprint established its own billing codes with the ILECs and has been
adding all new customers to these codes. This had the effect of reducing our
gross monthly billings to Sprint, yet has no impact on the profitability of the
contract. Indeed, Sprint's lines under the wholesale services agreement were
actually increasing significantly during the period in reference. This action
also has the impact of increasing total margins, even though the profitability
of the contract on a per line basis was unchanged. This is why we chose to focus
on the net income per wholesale services line in service, as opposed to stated
revenues or margins per se.
H-3-34
Disputed Payables Related to Network Operations and General and
Administrative Expense. Network operations expenses are primarily charges from
the ILECs for the leasing of their lines, utilizing the UNE-P, made available to
us as a result of the Telecommunication Act of 1996, and long distance and other
charges from inter-exchange carriers ("IXCs"). We record certain charges such as
up-front set-up fees, incorrect dispatch, and change and modification charges in
the general and administrative expense line item. We typically have disputed
billings with IXCs and ILECs as a matter of normal business operations. Certain
of these disputed amounts are recorded as an expense at the time of dispute, but
we do not pay any of our disputes until they are resolved and it is determined
that we indeed owe part or all of the dispute. Our disputes are for various
reasons including but not limited to incorrect billing rates, alternatively
billed services, duplicate billing errors, and costs associated with line loss.
This pricing is subject to both state and federal oversight and therefore, our
pricing is subject to change. Any such change could have a material impact on
our business.
Management recognizes as disputes any billing that is continued to be
presented as a past-due amount on invoices that we receive. This approach
results in the disclosure of certain disputes that management does not believe
are of a significant risk to us, primarily due to the age and/or the dispute,
but believe it is appropriate to disclose the amounts as they have not been
resolved and continue to be billed to us as past-due amounts.
Valuation of Accounts Receivable. Considerable judgment is required to
assess the ultimate realization of receivables, including assessing the
probability of collection and the current credit-worthiness of our customers. We
regularly analyze our approach as we gain additional experience or new events
and information are identified to determine if any change to our methodology is
warranted. Our current allowance methodology is directly related to the age of a
customer's receivable and the belief that the older the receivable is, the less
likely a customer is to pay. Additionally, we have performed liquidation and
other collection analyses to make necessary changes in reporting our accounts
receivable in a reasonable and prudent fashion. The impact of changing the
percentages we use for each aging bucket in the calculation of our allowance for
doubtful accounts by 5% would result in a $0.5 million change to our bad debt
expense.
Property, Plant and Equipment. Changes in technology or changes in the
intended use of property, plant and equipment may cause the estimated period of
use or the value of these assets to change. We utilize straight-line
depreciation for property and equipment. We perform an annual analysis to
confirm the appropriateness of estimated economic useful lives for each category
of current property, plant and equipment. Estimates and assumptions are used in
both setting depreciable lives for various asset classes and in testing for
recoverability. These estimates and assumptions require considerable judgment.
The effect of a one year change in the useful lives of our switching and
computer equipment, software and software development would result in a change
of $5.3 million to our depreciation expense.
Tax Related Accruals. Our estimates of deferred and current income taxes
and the significant items giving rise to the deferred assets and liabilities are
shown in Footnote 15 - Income Taxes to our consolidated financial statements.
These reflect our assessment of actual current and future estimated income taxes
to be paid on items reflected in the financial statements, giving consideration
to both timing and probability of actual realization. Currently we have placed a
100% valuation allowance on all net deferred tax assets. A valuation allowance
to reduce deferred tax assets is required if the weight of evidence it is more
likely than not that the deferred tax assets will not be realized. We also are
subject to various tax audits from various federal, state, and local
jurisdictions and make estimates based on available information and after
consultation with experts, where necessary. We believe that our estimates are
reasonable based on facts known now; however, they may change materially in the
future due to new developments.
Contingencies. We are subject to proceedings, lawsuits, audits and other
claims related to lawsuits and other legal and regulatory proceedings that arise
in the ordinary course of business. We are required to assess the likelihood of
any adverse judgments or outcomes to these matters as well as potential ranges
of probable losses. A determination of the amount of loss accrual required, if
any, for these contingencies are made after careful analysis of each individual
issue. We consult with legal counsel and other experts where necessary in
connection with our assessment of any contingencies. The required accrual for
any such contingency may change materially in the future due to new developments
in each matter.
H-3-35
CONSOLIDATED RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 The
following consolidated Management's Discussion and Analysis of Financial
Condition and Results of Operations should be read in conjunction with results
by segment. Key selected financial and operating data for the years ended
December 31, 2003 and 2002 are as follows:
Amount Change Percentage Change
For the year ended Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2002 2003 2003 2002
(In Millions)
Results of Operations:
Revenues ........................... $ 289.2 $ 238.4 $ 50.8 21.3% 100.0% 100.0%
Operating expenses:
Network operations ................. 135.1 94.5 (40.6) (43.0)% 46.7% 39.6%
Sales and marketing ................ 18.8 12.3 (6.5) (52.8)% 6.5% 5.2%
General and administrative ......... 127.0 122.6 (4.4 (3.6)% 43.9% 51.4%
Asset impairment charge ............ -- 1.1 1.1 100.0% --% 0.5%
Wholesale development costs ........ -- 1.0 1.0 100.0% --% 0.4%
Restructuring expense .............. -- 1.9 1.9 100.0% --% 0.8%
Depreciation and amortization ...... 23.4 23.9 0.5 2.1% 8.1% 10.0%
Total operating expenses ........... 304.3 257.3 (47.0) (18.3)% 105.2% 107.9%
Operating loss ..................... (15.1) (18.9) 3.8 20.1% (5.2)% (7.9)%
Nonoperating income (expense):
Interest and other income .......... 2.1 3.5 (1.4) (40.0)% 0.7% 1.4%
Interest and other expense ......... (3.1) (4.1) 1.0 24.4% (1.0)% (1.7)%
Total nonoperating expense ......... (1.0) (0.6) (0.4) (66.7)% (0.3)% (0.3)%
Net loss ........................... (16.1) (19.5) 3.4 17.4% (5.5)% (8.2)%
Less mandatorily redeemable
convertible Preferred Stock
dividends and accretion ......... (17.5) (15.6) (1.9) (12.2)% (6.1)% (6.5)%
Less deemed dividend related to
beneficial conversion feature ... (0.2) (0.2) -- --% (0.1)% (0.1)%
Net loss attributable to Common
Stockholders .................... $ (33.8) $ (35.3) $ 1.5 4.2 (11.7)% (14.8)%
Cash Flow Data:
Net cash provided by operating
activities ...................... $ 12.0 $ 18.4 $ (6.4) (34.8)% * *
Net cash used in investing
activities ...................... (11.0) (15.6) 4.6 29.5% * *
Net cash used in financing
activities ...................... (5.0) (5.7) 0.7 12.3% * *
Net decrease in cash and cash
equivalents ..................... $ (4.0) $ (2.9) $ (1.1) (37.9)% * *
___________________________
(*) Not meaningful
Revenues. To be consistent with emerging industry practices, the revenues
for all periods presented have been changed to reflect the billing to our
customers of the Universal Service Fund ("USF") and other regulatory fees and
the related payments into the associated regulatory funds as network operations
expense. Operating income and
H-3-36
net income for all periods presented were unaffected. The additional revenues
and expenses recorded were $4.2 and $3.1 million for the years ended December
31, 2003 and 2002, respectively. Revenues increased by $50.8 million to $289.2
million for the year ended December 31, 2003, compared to $238.4 million the
prior year. The increase in revenues was primarily a result of an increase of
$53.3 million in our wholesale services revenue. This increase was primarily a
result of increased revenues from our wholesale contract with Sprint, signed in
February 2003, contributing an additional $60.0 million in 2003, and was
partially offset by a decrease of $6.3 million in MCI's wholesale service
revenues compared to the prior year. The below table provides a break-down of
our revenues and changes for 2003 compared to 2002:
Amount Change Percentage Change
Revenues for the years ending Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2002 2003 2003 2002
(In Millions)
Type of Revenues:
Bundled residential services........ $ 190.7 $ 190.5 $ 0.2 0.1% 65.9% 79.9%
Bundled business services .......... 3.7 0.3 3.4 1,133.3% 1.3% 0.1%
1+ long distance services .......... 10.7 16.8 (6.1) (36.3)% 3.7% 7.1%
Wholesale services ................. 84.1 30.8 53.3 173.1% 29.1% 12.9%
Total .............................. $ 289.2 $ 238.4 4 $50.8 21.3% 100.0% 100.0%
Two significant drivers impact our revenues: lines in service and average
(monthly) revenue per unit ("ARPU.") The more significant driver impacting of
our changes in revenue is the amount of lines in service. The table below
provides a detail break-down of our lines:
Average lines in service Ending lines in service
for the years ending for the years ending
December 31, December 31,
2003 2002 2003 2002
Bundled residential services.................. 232,827 224,049 204,758 203,453
Bundled business services .................... 8,017 -- 21,593 --
1+ long distance services .................... 90,584 134,000 74,419 106,652
Wholesale services ........................... 158,199 35,796 296,824 55,523
Total lines under management ................. 489,627 393,845 597,594 365,628
ARPU provides us with a business measure as to the average monthly revenue
generation attributable to each line in service, by business segment. ARPU is
calculated by taking total revenues divided by 12 to calculate the average
revenue per month and this total is divided by the average lines in service. We
use this measure when analyzing our retail services businesses, but not when
assessing our wholesale services business for reasons discussed earlier in this
section under the Critical Accounting Policies and Estimates within the Revenue
Recognition section. The following table provides a detail of our ARPU:
Average revenue per unit in Amount Change Percentage Change
service for the years ending Favorable Favorable
December 31, (Unfavorable) (Unfavorable)
2003 2002
Bundled Residential Services............... $68.26 $70.86 $(2.60) (3.7)%
Bundled Business Services ................. $38.46 N/A * *
1+ Long Distance Services ................. $9.84 $10.45 $(0.61) (5.9)%
___________________________
(*) Not meaningful
H-3-37
The overall change in our revenues in 2003 compared to the prior year was
driven by our focus on growing our wholesale and business services during the
last half of 2003. Residential services revenues grew during the first half of
2003 but with our shift in focus mid-year we ended nearly flat compared to the
prior year. We expect the trend of focusing on growing our bundled business and
wholesale services while the signing of a partnering agreement has the potential
to increase our bundled residential services in 2004. We also expect that our
ARPU will stay relatively flat to slightly lower into the foreseeable future,
primarily due to the competitive climate and due to reductions in access fees.
To the extent that we are able to develop more and/or new service offerings,
such as our PVA and/or Digital Subscriber Line ("DSL"), we may have some
opportunity to mitigate any decrease in general levels of ARPU. We expect
residential, business and wholesale lines in service to grow significantly
during 2004. We believe that the economics of our business and wholesale
services are currently more attractive for active investment than is the
traditional residential business. Therefore, we will invest in sales and
marketing activities to attract business customers and look to marketing
partnership opportunities to be the primary driver in our residential revenues.
In March 2004, we entered into a marketing partnership with a large
communication company. This new offering is expected to be launched in May 2004.
We expect to launch our Voice over Internet Protocol ("VoIP") services in
the second quarter of 2004, but we do not expect a significant amount of revenue
from this new service offering during 2004. We continue to target companies with
large existing residential and business customer bases for various forms of
partnership opportunities, and we are also exploring additional distribution and
delivery opportunities for our services. We are also seeking additional
wholesale services relationships.
Network Operations. Network operations expense increased by $40.6 million
to $135.1 million for the year ended December 31, 2003, compared to $94.5
million the prior year. Our network operations expense primarily consists of
fixed and variable transmission expenses for the leasing of the UNE-P components
from the ILECs, domestic and international charges from service level agreements
with IXCs, and the USF and certain other regulatory charges to be consistent
with industry practice. The increase in network operation expense was primarily
the result of having an overall larger average number of lines under management
in service for the year ended 2003 compared to the prior year. The following
table provides a detailed break-down and analysis of changes in network
operations expense:
Network Operations for the Percentage
years ending December 31, Amount Change Change
Favorable Favorable Percentage of Network
N (Unfavorable) (Unfavorable) Operations
2003 2002
(In Millions) 2003 2002
Bundled residential &
business services......... $95.1 $80.3 $(14.8) (18.4)% 70.4% 85.0%
1+ long distance services ... 2.6 3.5 0.9 25.7% 1.9% 3.7%
Wholesale services .......... 37.4 10.7 (26.7) (249.5)% 27.7% 11.3%
Total ....................... $135.1 $94.5 $(40.6) (43.0)% 100.0% 100.0%
Our network operations expense as a percentage of revenues, increased to
46.7% for 2003 compared to 39.6% in the prior year. We recorded a reduction to
network operations expense for certain retroactive rate reductions and billing
errors in the amounts of $2.5 million and $9.0 million recorded in 2003 and
2002, respectively. Excluding the impact of these retroactive rate reductions,
the consolidated network costs, as a percentage of revenues were 47.6 % for 2003
compared to 43.4% in the prior year. The increase in network operations is
primarily a result of the impact of the gross accounting used to account for our
wholesale service. The following table provides a detail of network operations
expense as a percentage of revenues by the respective revenue types. This table
excludes an analysis of wholesale services because management does not look at
this measure, given that network expenses related to wholesale services are
intended to be zero-margin direct cost pass-through in nature.
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Network operations as a % of Amount Change
revenues for the years ended Favorable
December 31, (Unfavorable)
2003 2002
Bundled residential & business services............. 48.9% 42.1% (6.8)%
1+ long distance services .......................... 24.3% 20.8% (3.5)%
We also analyze the average expense per unit ("AEPU") for network
operations, similar to the ARPU calculation for revenues. AEPU is calculated by
taking total network operations expense divided by 12 to calculate the average
network operations expense per month and this total is divided by the average
lines in service. The following details AEPU for network operations expense.
Average network operations Amount Change Percentage Change
expense per unit for the years Favorable Favorable
ended December 31, (Unfavorable) (Unfavorable)
2003 2002
Bundled residential & business
services............................. $ 32.91 $ 29.87 $ (3.04 ) (10.2 )%
1+ long distance services ............. $ 2.39 $ 2.18 $ (0.21 ) (9.6 )%
Excluding the $2.5 million and $9.0 million retroactive rate reductions for
2003 and 2002, respectively, the bundled residential and business services
network operations expense as a percentage of revenue would have been 50.4% for
the year ended December 31, 2003 compared to 46.8% in the prior year. Performing
this same analysis for the bundled residential & business services would have
resulted in AEPU increasing by 2.1% to $33.77 in 2003, compared to $33.21 in the
prior year.
The overall increase in network operations expense was primarily driven by
our increase in wholesale lines in service from our contract with Sprint. The
increase of approximately 8,000 lines in the average bundled residential and
business service lines also contributed to the increased expense. Our 1+ long
distance services provided a small off-set to these services. In addition to an
increase in the overall average lines in service, we also experienced a small
increase in the AEPU which also contributed to our increase in network
operations expense. This increase was primarily the net result of three
contributing factors: (1) increased usage as a result of our customer choosing
our unlimited product which generally results in increased domestic
long-distance charges; (2) increased per line costs as our customer base
continues to become more geographically diverse resulting in some small changes
to the average cost experienced as a result of having more lines in more
expensively priced UNE-P states and zones; reduced by (3) our auditing and
analysis of network operations and improving the synchronization of our billing
systems to help reduce network costs on a per unit basis.
We expect network operations expense to increase in 2004 as we plan for an
increase in the overall lines in service. We also expect continued increases to
our AEPU as a result of increased usage, continued geographical dispersion of
customers to more expensive UNE-P pricing zones and states, increased proportion
of business lines which have a higher network operations expense per unit and
possible increased costs due to the risk in the regulatory arena relative to the
costs of leasing the UNE-P elements. We will be focusing our efforts on insuring
that the pricing and availability of UNE-P is conducive to our desire to
compete; however, we recognize the wide-range of possibilities that could occur,
including the possibility of an immediate and material adverse effect upon our
business.
Sales and Marketing. Sales and marketing expense increased $6.5 million to
$18.8 million for the year ended December 31, 2003, compared to $12.3 million
the prior year. The sales and marketing expense primarily consists of
telemarketing, direct mail, brand awareness advertising and independent sales
representative commissions and salaries and benefits paid to employees engaged
in sales and marketing activities.
The increase in sales and marketing expense is directly attributable to
increased payments of one-time and recurring commissions to independent sales
contractors, which increased by $8.2 million in 2003 compared to the prior year.
This increase was partially off-set by expenses associated with our
telemarketing centers that were
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closed in 2002 but resulted in $2.3 million of expenses being recorded prior to
their closure. The remaining increase was in general advertising activities.
We continue to treat our sales and marketing expense as a discretionary
spending item in the management of our cash flow. We significantly decreased
sales and marketing activity levels during 2002 by closing our telemarketing
centers and focusing on conserving cash. During the first half of 2003, we
increased our sales and marketing efforts to attract residential lines. As a
result of intense competition and the economics of a residential customer
relative to a business customer, we elected to shift our primary focus of time
and monetary resources to the marketing of our newly introduced business
services. This was achieved primarily through the addition of an in-house sales
team. We have also recruited master independent sale contractors to assist with
growing this line of business. This focus has provided us with the ability to
leverage our national footprint by offering prospective end users a
consolidating billing solution and by providing local and long distance services
to multi-location businesses. This is also intended to further diversify our
service offerings, revenue streams and cash flow streams beyond only retail
residential services and wholesale services. Our business service has provided
lower acquisition cost on a per line basis in some cases, depending on the type
of account acquired. Fundamentally however, we believe that the limited amount
of sales and marketing dollars and resources that we have had and currently have
access to are best spent by being focused on acquiring business customers due to
lower churn rates, extended customer lives and lower ongoing services costs,
including but not limited to reduced rates of bad debt. We will continue to
invest in our residential base but in smaller amounts than we have historically,
however, our decision to enter certain partnering opportunities may result in
increased sales and marketing expense.
We continue our use of the PVA as a component of our sales strategy. We
believe that PVA is a service differentiator for our residential and business
service offerings. We continue to expand our traditional retail sales approach
of offering our services in retail electronics and recently wireless stores in
an effort to provide them with the ability to offer a complete wireless and
wireline service for customers. We believe that this approach may allow us to
reduce our total acquisition costs by creating opportunities to partner with
organizations that can provide us with attractive distribution economics.
Additionally, we have introduced new bundles and pricing points in an effort to
expand the marketability of our offerings to consumers including variations of
PVA on a stand-alone basis. We also expect to launch our VoIP initiative during
the second quarter of 2004, and have already hired a sales force to begin
supporting the sale of this new service on a pre-sale basis. We will continue to
build the overall awareness of our "Z" brand and explore alliances and ventures
with other companies. We expect sales and marketing expense to increase
significantly during 2004 as a result of a new agreement that we have signed
with a large communications provider, which likely will increase commission
payments, however, we are still assessing the final accounting for this contract
and its accounting impact on our future results. We will continue to manage
sales and marketing expense as a discretionary item to assist with managing our
overall cash position, including in determining which agreements we decide to
pursue.
General and Administrative. General and administrative expense increased
$4.4 million to $127.0 million for the year ended December 31, 2003, compared to
$122.6 million the prior year. General and administrative expense primarily
consists of employee salaries and benefits, outsourced services, bad debt
expense, billing and collection costs, occupancy costs, legal and provisioning
costs.
The increase in general and administrative expense was primarily related to
the growth of our wholesale services during 2003 and the increased cost of
maintaining and supporting lines and employees. The significant general and
administrative expense line items that increased in 2003 compared, to 2002 were
as follows:
o Payroll and related expenses - $11.8 million
o Charges from our ILEC gateway provided to establish and change
customers' services - $3.1 million
o Outsourcing of customer service and collections - $1.9 million
o Dispatch charges from the ILECs - $1.7 million
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o Contract development costs - $1.5 million
o Insurance for general coverage and employee health costs - $1.2
million
o Set-up fees from the ILECs to establish service for new customers -
$1.1 million
The decreases in general and administrative expense were a result of
improved operating and subscriber management activities which resulted in
significant decreases to bad debt expense. We also reduced various general and
tax audit accruals during 2003 compared to the accruing of such expenses in
2002. The significant general and administrative expenses that decreased in 2003
compared to 2002 were as follows:
o Bad debt expense - $9.9 million
o Sales and use tax expense - $8.4 million
o ILEC performance credits for failure to meet certain service levels -
$2.3 million
The remaining increase of $2.7 million was primarily related to the volume
driven incremental costs associated with additional employees and active lines
in service. General and administrative expense as a percentage of revenue
decreased by 7.5% to 43.9% for the year ended December 31, 2003, compared to
51.4% in the prior year. This decrease was primarily driven by the gross
accounting treatment that is applied to the wholesale services segment of our
business that results in our recording certain costs, including but not limited
to payroll, provisioning, ILEC, billing and collection costs, that are recorded
in general and administrative expense even though we are charging these costs
through with zero or very little mark-up.
We have improved our operating costs and overall operations, which has
contributed to improved per line cost factors. Additionally, as our business
services market continues to increase as a percentage of our overall retail
sales, we expect the overall general and administrative cost per total retail
line in service to continue to decrease, as the cost to maintain a business
service line is typically less than the cost to maintain a residential line. We
anticipate general and administrative expenditures will continue to increase in
total into the future to support our planned expansion of service offerings and
our expected increase in residential, business and wholesale lines during 2004.
We will continue to evaluate our operations for efficiencies and our employee
staffing requirements as they relate to increased efficiencies or needs to
expand or outsource services. We expect to see continued improvements to the
reductions of general and administrative expense as a percentage of total
reported revenue in 2004 relative to 2003.
Depreciation and Amortization. Depreciation and amortization expense
decreased $0.5 million to $23.4 million for the year ended December 31, 2003,
compared to $23.9 million the prior year. We anticipate an increase to our fixed
asset purchases in the coming year as we introduce our VoIP service which is
more capital intensive than our UNE-P offering. We also expect to purchase
additional computer equipment, switching equipment, furniture and leasehold
improvements as a result of our expected growth across all lines of service.
Interest and Other Income. Interest and other income decreased $1.4 million
to $2.1 million for the year ended December 31, 2003, compared to $3.5 million
the prior year. Interest and other income consists of interest charged to our
bundled residential and business customers for not paying their bills on time
and income from interest earned from our cash balance. The decrease in 2003 was
primarily due to having fewer late charges attributable to our increased
subscriber management activities.
Interest and Other Expense. Interest and other expense decreased $1.0
million to $3.1 million for the year ended December 31, 2003, compared to $4.1
million the prior year. Our interest expense includes late fees for vendor
payments, charges related to our RFC Capital Corporation ("RFC") accounts
receivable agreement, capital leases and our other debt obligations. The overall
decrease in interest and other expense for the year ended December 31, 2003
compared to 2002 was the result of our overall increased liquidity for part of
2003 compared to the prior year period that allowed us to make more timely
payments of our operating expenses while simultaneously reducing our reliance on
our RFC accounts receivable facility during the middle of 2003. We also have
less outstanding term debt obligations, which has contributed to lower interest
payments. We anticipate that interest ex-
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pense will increase due to the increased utilization of our RFC accounts
receivable agreement and our expectation of converting our current agreement to
an traditional asset-based loan. We also are seeking and considering additional
debt offerings and other financing options in an effort to improve our liquidity
to fund our growth initiatives for 2004.
Income Tax Benefit. No provision for federal or state income taxes has been
recorded due to the full valuation allowance recorded against the net deferred
tax asset for the years ended December 31, 2003 and 2002.
Net Loss Attributable to Common Stockholders. Our net loss attributable to
common stockholders improved $1.5 million to $33.8 million for the year ended
December 31, 2003, compared to $35.3 million the prior year. This decrease was
primarily discussed above, however, there was also an increase of $1.9 million
for the preferred stock dividends and accretion during 2003 as a result of the
additional accrual of dividends on the unpaid dividends.
RESULTS OF OPERATIONS BY SEGMENT
Our reportable segments reflect strategic business units that offer similar
products and service. We have two reportable segments:
o Retail Services
o Wholesale Services
Management evaluates the performance of each business unit based on segment
results, exclusive of adjustments for unusual items that may arise. Unusual
items are transactions or events that are included in our reported consolidated
results but are excluded from segment results due to their nonrecurring or
non-operational nature. See our Segment footnote to our consolidated financial
statements for a reconciliation of segmented results to the consolidated
financial information.
The following discussion highlights our performance in the context of these
segments.
RETAIL SERVICES SEGMENT
Our retail services segment includes our residential and business bundle
service lines of business. This segment also includes our 1+ long-distance
stand-alone offering. In 2003 we shifted to focusing on growing our business
bundled services, passively investing in our residential services and harvesting
the 1+ long-distance offering for maximum cash flow. The following table, in
millions, summarizes our retail services business segment for 2003 compared to
2002:
Retail Services Segment
Amount Change Percentage Change
For the years ended Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2003 2002 2003 2002
Revenues:
Bundled residential services . $ 190.7 $ 191.2 $ 0.5 0.3% 93.0% 91.8%
Bundled business services .... 3.7 0.3 3.4 1,133.3% 1.8% 0.1%
1+ long-distance services .... 10.7 16.8 (6.1) (36.3)% 5.2% 8.1%
Total Revenues ............... 205.1 208.3 (3.2) (1.5)% 100.0% 100.0%
Operating expenses:
Network operations ........... 100.6 92.7 (7.9) (8.5)% 49.1% 44.5%
Sales and marketing .......... 18.7 12.3 (6.4) (52.0)% 9.1% 5.9%
General and administrative ... 104.7 111.9 7.2 6.4% 51.0% 53.7%
Total operating expenses ..... 224.0 216.9 (7.1) (3.3)% 109.2% 104.1%
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Segment results .............. $ (18.9) $ (8.6) $ (10.3) (119.8)% (9.2)% (4.1)%
Revenues. Revenues decreased by $3.2 million to $205.1 million for the year
ended December 31, 2003, compared to $208.3 million the prior year. The revenue
growth in our residential and business lines was not enough to overcome the $6.1
million decrease in our 1+ long-distance services experienced in 2003, compared
to the prior year. Additionally, our ARPU decreased by $2.60 to $68.26 for the
year ended December 31, 2003, compared $70.86 in the prior year. There were two
significant factors that contributed to this change in ARPU. First, a decrease
in the access rates (charges that we bill to other carriers for carrying their
traffic to our customers) went into effect in June of 2003. (A further decrease
will occur in June of 2004.) Also, during 2003, to address pricing trends and to
react to the highly competitive telecommunication market, we actively marketed
our unlimited bundle service offering to residential customers. The unlimited
service has a lower ARPU than some of our historical pricing plans, because it
includes for a fixed price, unlimited domestic and local calling, in addition to
all of our enhanced services.
The trend in our bundled residential service during 2003 provides some
insight into the fluctuations in our revenues during the course of the year as
well as points to our plans for 2004. Our average bundled residential service
lines and ending lines were relatively the same for both the years ended
December 31, 2003 and the prior year. During the first half of 2003, we were
almost exclusively focused on growing our residential services to the exclusion
of any of our other lines of business. However, at mid year management made the
decision to redirect sales and marketing investment to the newly formed business
services line of business, as well as to the new wholesale services relationship
with Sprint, neither of which existed in a meaningful fashion during most of the
first half of 2003. Management judged that the retail business services and
wholesale services lines of business offered a superior return on investment
when compared to the traditional retail residential consumer business. In 2002,
we decided to slow our residential line growth and we were solely dependent on
our wholesale services business (primarily MCI at the time) for overall line
growth. In 2003, we had diversified into business services to provide us with
more opportunities to achieve retail line growth.
In March 2004, we signed a marketing contract with a large communications
concern that has a significant embedded base of customers. This agreement
provides our marketing partner the opportunity to market our telecommunication
services to their users under a fixed and variable commissioning structure.
There are no minimums in this contract, but the success of this relationship
could provide a significant growth in our retail lines in service. If this
contract does not provide a large amount of new customers we will continue to
focus our retail efforts primarily on business services. Residential services
will continue to generate the majority of our overall revenue and cash flow
during 2004, due to the size of the embedded customer base relative to the other
lines of business even if it stays relatively flat or decreases in line count
over the course of 2004.
Network Operations. Network operations expense increased by $7.9 million to
$100.6 million for the year ended December 31, 2003, compared to $92.7 million
the prior year. Our network operations as a percentage of revenue increased by
4.6% to 49.1% for the year ended December 31, 2003, compared to 44.5% the prior
year. Excluding a retroactive rate reduction of $2.5 million in 2003 and $9.0
million in 2002, network expense increased by $1.4 million and 1.5% as a
percentage of revenue during 2003 relative to 2002. The increase in network
operations expense after excluding retroactive rate reductions was a result of
increased long distance usage from the growth in our unlimited service offering
and the mix of our customer base being spread across more states that had less
favorable pricing when compared to the states in which we had customers in the
prior year. These increases have been partially offset by reductions to network
operations as a result of improved internal operations and processes to minimize
our network operations costs.
Sales and Marketing. Sales and marketing expense increased $6.4 million to
$18.7 million for the year ended December 31, 2003, compared to $12.3 million
the prior year. We elected to aggressively grow residential lines during the
first half of the year, and we also incurred various startup expenses related to
the introduction of our
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business services line of business during mid 2003. Although we slowed
residential line growth during the second half of 2003, the significant
investment during the first half of the year, coupled with the launch of the
business services caused overall sales and marketing expense to increase during
2003 when compared to 2002. Specifically, the increase in our sales and
marketing for the year ended December 31, 2003 compared to the prior year was a
result of increased commission payments of $8.2 million in 2003. This increase
is primarily a result of the increased use of independent sales contractors
during 2003 compared to the prior year. A large portion of our business services
lines are a result of an independent sales contractor agreement that requires
that we pre-pay the full 12 months of the commission per line sold, however, if
a customer they provided discontinues service before being a customer for 12
months we reduce their payment by the pro rata portion of the 12 month payment.
In accordance with accounting rules and industry practice the entire payment is
expensed when paid. This increase was offset by a decrease of $2.2 million in
savings in 2003 compared to 2002, as a result of closing our call centers in
North Dakota. The remaining increase in sales and marketing expense was a result
of increased advertising, primarily during the first half of 2003.
Historically, we have used advertising and independent sales contractors to
drive the growth of our retail residential lines. We have also been growing an
internal sales force to increase sales in our business services and our VoIP
offering. We also expect a recently signed agreement with a large company with
millions of existing consumer customers to drive growth for our residential
service offering. This agreement involves a commission and gross profit sharing
arrangement that is success based. We expect that this agreement could
significantly increase commission payments. We continue to explore new
opportunities of selling our service including our efforts to leverage the use
of our PVA product as a distribution medium and by pursuing partnering
opportunities. To the extent possible, we will treat sales and marketing as a
discretionary item to assist with managing our overall financial results and
cash flow. We do expect sales and marketing will increase significantly during
2004 over that reported during 2003.
General and Administrative. General and administrative expense decreased
$7.2 million to $104.7 million for the year ended December 31, 2003, compared to
$111.9 million the prior year. As a percentage of revenues general and
administrative expense decreased by 2.7% to 51.0% of revenues in 2003 compared
to 53.7% the prior year. The overall decrease in general and administrative
expense for the year ended December 31, 2003 was primarily a result of the
following items:
o $6.8 million increase in payroll expenses as a result of adding
employees to support our increased lines in service and our new
business services and less work dedicated to internally designed
software development that can be capitalized;
o $2.3 million increase in contract development for work on new products
and various improvements and updates to our retail service offerings;
o $1.3 million increase in health insurance and other general insurance,
as a result of the increased cost for employee health benefits and
insurance for being a publicly traded company;
o $1.1 million increase in incorrect dispatch charges;
o $9.9 million decrease to bad debt expense as result of our improved
customer acceptance process and subscriber management activities and
the sale of previously written-off receivables, which resulted in a
reduction to our bad debt expense of $1.0 million;
o $2.3 million decrease in ILEC credits that we received on ILEC bills
for the failure of the ILECs to meet certain regulatory requirements
for the service provided to unbundled network element platform
customers;
o $8.4 million decrease in tax expense for certain tax accruals made in
the prior year and certain reduction to these accruals during 2003;
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o $1.0 million decrease in billing expense as a result of renegotiating
various rates in our billing contracts as a result of increased
volumes and improved billing practices;
o $1.6 million decrease in provisioning expenses as a result of
renegotiating the minimums in our contract with an outside vendor; and
The remaining $4.5 million increase was primarily the result of the increases
associated with increased payroll expenses and having more average lines in
service in 2003 compared to 2002.
Included in the retail services general and administrative expense are all
employee benefits, occupancy, insurance, and other indirect or overhead-related
expenses as only direct costs are recorded in our wholesale services segment. We
are in the process of reviewing and possibly adopting a methodology for internal
reporting purposes that would allocate these indirect and overhead related
expenses to the respective segments or possibly separating these expenses from
each segment.
We are planning for overall line and revenue growth during 2004, and
therefore expect general and administrative expense to decrease as a percentage
of revenues as a result of the leveraging of certain elements of our fixed cost
structure, although we do expect an increase in overall administrative expense
in raw dollars as we incur more charges for provisioning new customers and
incremental administrative costs such as billing, collections, and customer care
related expense during 2004.
Our overall general and administrative expenses are associated with
operational and fiscal improvements to our retail customer economics. The most
significant improvement was in our bad debt expense, which improved due to our
improvements to customer treatments that have been applied consistently and by
targeting higher quality customers from a sales and marketing perspective. These
improvements allowed us to invest in our business services segment which was
primarily responsible for the increased payroll expenses in 2003. We expect to
continue focusing on our retail growth and specifically our business services.
We expect our residential services to grow rapidly if our recent marketing
agreement with a large communications concern is very successful. This agreement
has no minimums and is success based, with the partner being responsible for
providing customers, therefore, its initial success is dependent on our
partner's efforts to offer our services to its end users.
WHOLESALE SERVICES SEGMENT
Our wholesale services segment includes services that we provide to other
companies giving them the ability to offer telephone exchange and enhanced
services to their own residential and business customers on a private label
basis using us as their primary platform for delivery. Our largest customers for
this service during 2003 were MCI and Sprint. Sprint is currently our primary
wholesale services customer, as MCI cancelled their agreement in October 2003.
The following table, in millions, provides our wholesale services business
segment for 2003 compared to 2002:
Wholesale Services Segment
Amount Change Percentage Change
For the years ended Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2003 2002 2003 2002
Revenues:
Sprint ........................ $ 59.7 $ -- $ 59.7 100.0% 71.0% --%
MCI ........................... 23.9 30.2 (6.3) (20.9)% 28.4% 98.1%
Other ......................... 0.5 0.6 (0.1) (16.7)% 0.6% 1.9%
Total Revenues ................ 84.1 30.8 53.3 173.1% 100.0% 100.0%
Operating expenses:
Network operations ............ 37.0 10.8 (26.2) (242.6)% 44.0% 35.1%
Sales and marketing ........... 0.1 -- (0.1) (100.0)% 0.1% --%
General and administrative .... 22.3 8.7 (13.6) (156.3)% 26.5% 28.2%
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Total operating expenses ...... 59.4 19.5 (39.9) (204.6)% 70.6% 63.3%
Segment results ............... $ 24.7 $ 11.3 $ 13.4 118.6% 29.4% 36.7%
Revenues. Revenues increased by $53.3 million to $84.1 million for the year
ended December 31, 2003, compared to $30.8 million the prior year. Our wholesale
service revenues increased to 29.1% of consolidated revenues in 2003, compared
to 12.9% in the prior year. We signed our wholesale services agreement with
Sprint in February of 2003. Sprint contributed $59.7 million of revenue for the
year ended December 31, 2003 and was our primary wholesale customer during 2003,
replacing MCI. On August 15, 2003, MCI provided us with notice that they were
terminating the contract effective October 15, 2003. As a result of this notice
we accelerated the recognition of $4.7 million of deferred revenue due to the
new termination date of October 15, 2003. Prior to MCI's decision to terminate
the agreement early, this revenue was being recognized ratably over the life of
the agreement, in accordance with GAAP, with an original termination date of
December 31, 2005. As a result of this treatment, our revenues related to MCI
increased; however, there was no increase to our cash flow, as the cash had
already been paid in the prior year.
Our business development group is actively pursuing other potential
wholesale partners and is working to develop new wholesale services. We expect
that our wholesale lines in service will continue to steadily increase during
2004. This, however, does not automatically translate into increased revenue. We
employ the gross accounting method for recognizing revenue within the wholesale
service business segment; therefore, we record revenue for certain services that
we provide to Sprint at our cost and record the off-setting expense in one of
the respective operating cost lines within our income statement. These revenues
(and cost pass-through items) result in no contribution to operating profit.
Therefore, to the extent that Sprint decides to take over certain services that
we currently provide to them, such as becoming the customer of record for the
ILEC bills associated with their customer base, which is occurring to an
increasing extent, a decrease in reported revenues (and a decrease in the
off-setting operating expense) will result. This action will have no direct
impact on the overall profitability of the contract. Revenue per line under
management will decrease but the operating contribution generated on a per line
basis will stay the same. Also, our stated accounts payable will decrease, as we
will no longer be incurring this liability.
In February 2004, we signed a new wholesale services agreement with Working
Assets Funding Services, Inc. Although the expected growth from this
relationship will be significantly less than that with our existing Sprint
agreement, it will provide some additional growth in 2004.
While we expect wholesale lines in service to grow in a meaningful manner
during 2004, we predict wholesale revenue will be relatively flat, however this
may change appreciably given the inherent uncertainties associated with the
nature of having to apply the gross accounting treatment to the wholesale
services business segment. The primary reason for this is that the charges for
ILEC services are the largest revenue component of our wholesale services and
with Sprint becoming the customer of record for these bills our revenue will
decrease while we expect income to continue to increase during 2004.
Network Operations. Network operations expense increased by $26.2 million
to $37.0 million for the year ended December 31, 2003, compared to $10.8 million
in the prior year. As stated in the revenue paragraph, Sprint has decided to
become the customer of record for billing purposes from the ILECs, therefore, we
expect the network operations expense to decrease significantly during 2004
relative to 2003.
General and Administrative. General and administrative expense increased by
$13.6 million to $22.3 million for the year ended December 31, 2003, compared to
$8.7 million in the previous year. The significant components of this expense
are very similar to the administrative expenses incurred on the retail side of
our business; however, we only isolate as wholesale expense those expenses that
are directly associated with our wholesale services activity. Therefore, we have
not allocated any indirect or corporate (i.e. traditional overhead) expenses,
such as certain employee benefits, occupancy expenses, insurance expenses or
other similar expenses to the whole-
H-3-46
sale services business segment. These expenses are all currently included in the
retail services segment. The increase in general and administrative expense is a
result of increased wholesale lines in service as a result of growth
attributable to Sprint.
The increase in general and administrative expense is the result of
increased payroll expense, the outsourcing of certain functions to limit our
cost exposure and increased non-recurring provisioning expenses to establish
service for our wholesale customers. We expect to steadily increase headcount to
support our existing wholesale customers and the possible addition of new
wholesale customers. We may transfer existing employees from our retail services
to wholesale services. As a result of this growth, we expect general and
administrative expense to increase in total dollars and as a percentage of our
consolidated expenses. We have not recorded any bad debt expense for wholesale
services and have not had any material write-offs of receivables. We will
continue to monitor our wholesale services and determine the appropriate bad
debt methodology based on each individual wholesale contract, but we do not
expect any material changes to our current approach.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
The following consolidated Management's Discussion and Analysis of
Financial Condition and Results of Operations should be read in conjunction with
results by segment. Key selected financial and operating data for the years
ended December 31, 2002 and 2001 are as follows:
Amount Change Percentage Change
For the years ended Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2002 2002 2002 2003
(In Millions)
Results of Operations:
Revenues ..................... $ 238.4 $ 280.3 $ (41.9) (14.9)% 100.0% 100.0%
Operating expenses:
Network operations ........... 94.5 159.6 65.1 40.8% 39.6% 56.9%
Sales and marketing .......... 12.3 31.2 18.9 60.6% 5.2% 11.1%
General and administrative ... 122.6 156.1 33.5 21.5% 51.4% 55.7%
Asset impairment charge ...... 1.1 59.2 58.1 98.1% 0.5% 21.1%
Wholesale development costs .. 1.0 -- (1.0) (100.0)% 0.4% --%
Restructuring Charge ......... 1.9 -- (1.9) (100.0)% 0.8% --%
Depreciation and
amortization ............... 23.9 23.3 (0.6) (2.6)% 10.0% 8.3%
Total operating expenses ..... 257.3 429.4 172.1 40.1% 107.9% 153.1%
Operating loss ............... (18.9) (149.1) 130.2 87.3% (7.9)% (53.1)%
Nonoperating income (loss):
Interest and other income .... 3.5 6.9 (3.4) (49.3)% 1.5% 2.4%
Interest and other expense ... (4.1) (3.8) (0.3) (7.9)% (1.7)% (1.4)%
Total nonoperating income
(loss) ..................... (0.6) 3.1 (3.7) (119.4)% (0.2)% 1.0%
Net loss ..................... (19.5) (146.0 126.5 86.6% (8.1)% (52.1)%
Less mandatorily redeemable
convertible Preferred
Stock dividends and
accretion .................. (15.6) (15.1) (0.5) (3.3)% (6.6)% (5.4)%
Less deemed dividend related
to beneficial conversion
feature .................... (0.2) (9.4) 9.2 97.9% (0.1)% (3.3)%
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Net loss attributable to
Common Stockholders ........ $ (35.3) $ (170.5 $ 135.2 79.3% (14.8)% (60.8)%
Cash Flow Data:
Net cash provide by (used
in) operating activities ... $ 18.4 $ (21.8) $ 40.2 184.4% * *
Net cash used in investing
activities ................. (15.6) (15.6) -- --% * *
Net cash provided by (used
in) financing activities ... (5.7) 9.7 (15.4) (158.8)% * *
Net decrease in cash and
cash equivalents ........... $ (2.9) $ (27.7) $ 24.8 89.5% * *
______________________________
(*) Not meaningful
The following is a summary of special items that management believes are
important to be identified and discussed separately in our discussion of
comparing our results for 2002 to 2001.
- Retroactive reduction to network access rates. During 2002, we
received a $9.0 million retroactive rate reduction for the unbundled
network elements from Verizon as a result of their settlement with the
New York Public Service Commission.
- Restructuring charge. During 2002, we closed two call centers in North
Dakota and our New York sales office. We recorded $1.9 million for
termination benefits, lease abandonment and lease settlement costs.
- Asset impairment. We recorded $1.1 and $59.2 million of expenses
related to impaired assets in 2002 and 2001, respectively. This
expense was the result of management's decision to reduce
telemarketing activity levels. In 2001, a majority of the operations
and assets of telemarketing centers acquired from Touch 1 during the
prior year were either voluntarily closed or sold. In addition to the
goodwill impairment of $54.9 million, we recorded a $4.3 million
charge associated with the impairment of assets, composed of $3.0
million relating to unrealizable software and development projects,
$0.9 million of a worthless telemarketing property and equipment, and
$0.4 million of securities deemed to be worthless. As a result of
management's decision in the second quarter of 2002 to stabilize its
future operating cash flows and operating earnings, we closed the
remaining call centers in North Dakota and recorded a $1.1 million
asset impairment charge.
- MCI bankruptcy. During 2002, we recorded $1.3 million for possible bad
debt exposure to carrier receivables as a result of MCI's bankruptcy
filing. We reversed $0.6 million of previously recorded revenue and
recorded an additional $0.7 million of additional bad debt expense.
- Wholesale development costs. During 2002, we began to provide
wholesale telephone service. In connection with development
activities, we recorded start-up costs associated with this new line
of business of approximately $1.0 million.
- Write-down of accounts receivable. Included in the 2001 general and
administrative expense was a write-off of accounts receivable that
resulted in $29.9 million of additional bad debt expense.
Revenues. Revenues decreased by $41.9 million to $238.4 million for the
year ended December 31, 2002, compared to $280.3 million the prior year. The
decrease was primarily attributable to the average Z-LineHOME and Z-LineBUSINESS
customer count of 224,000 for the year ended December 31, 2002, compared to
297,000 for
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the prior year. Additionally, the decrease in Touch 1 (1+) long distance lines
in service contributed an additional decrease of $6.1 million to our 2002
revenues. The following table outlines the approximate number of subscriber
lines for Z-LineHOME and Touch 1 (1+) long distance services as of the end of
each period:
TYPE OF SERVICE DECEMBER 31, 2002 DECEMBER 31, 2001
Z-LineHOME and Z-LineBUSINESS....
203,000 254,000
Touch 1 (1+) Long Distance
Services ...................... 107,000 160,000
The reduction in lines in service was a result of our effort to slow growth
for the first three quarters of 2002, while eliminating poor paying customers
and increasing the quality of our embedded subscriber base with respect to
payment experience. These decreases were somewhat off-set by the introduction of
our wholesale services line of business which contributed $30.8 million to our
revenues for the nine-months that we offered this service during 2002.
The following table, in millions, provides a summary of our revenues for
the years ended 2002 and 2001:
TYPE OF REVENUES 2002 2001
Z-LineHOME and Z-LineBUSINESS $190.8 $257.4
Touch 1 (1+) Long Distance Services 16.8 22.9
Wholesale Services 30.8 -0-
Total $238.4 $280.3
Our service offerings, Z-LineHOME and Z-LineBUSINESS, accounted for 80.0%
of our total revenues in 2002, compared to 91.8% the prior year.
Network Operations. Network operations expense decreased by $65.1 million
to $94.5 million for the year ended December 31, 2002, compared to $159.6
million during the prior year. Our network operations as a percentage of
revenues decreased to 39.6% for the year ended December 31, 2002, compared to
56.9% the prior year. The decrease in network operation expenses was primarily
the result of having an overall lower average number of subscriber lines in
service for the year ended 2002 compared to the prior year.
In addition, in early 2002, the New York Public Service Commission (the
"Commission") approved a settlement, which reduced the prices that we and other
competitive local exchange carriers paid for unbundled network elements and
expanded the availability of those elements. Specifically, rates for the
elements comprising the unbundled network element platform were reduced by
approximately $8 to $9 per month per subscriber, on average. These rate
decreases were effective March 1, 2002. In addition, the Commission directed
Verizon to provide bill credits to us in the amount of $9.0 million to implement
retroactive rate decreases for unbundled local switching. We recorded this
credit during 2002 and had received the entire credit from Verizon as of
December 31, 2002.
Sales and Marketing. Sales and marketing expense decreased $18.9 million to
$12.3 million for the year ended December 31, 2002, compared to $31.2 million
the prior year. Our continued decrease in sales and marketing expense was
largely attributable to our primary focus on conserving cash and focusing on
improving internal operating performance and increasing the overall quality of
our subscriber base. As a component of this effort, we decreased marketing
activity levels which contributed to a decrease in active lines of 54,000, or
about 20% during 2002. Our primary source of sales in 2002 was from independent
sales representatives. It was not until the last quarter of 2002 that we amended
our approach to once again pursue line growth. At that time we began a
multi-faceted marketing campaign in Atlanta, Georgia that combined radio,
billboard, and television advertising to launch our new service offering, PVA.
In addition to our marketing campaign we also contracted with several
independent sales representatives during the latter half of 2002 that
contributed to our fourth quarter net line growth.
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General and Administrative. General and administrative expense decreased
$33.5 million to $122.6 million for the year ended December 31, 2002, compared
to $156.1 million during prior year. The decrease in general and administrative
expense was primarily related to the write-off of accounts receivables in 2001
that resulted in the recognition of $29.9 million of additional bad debt
expense. Excluding the $29.9 million of bad debt expense, general and
administrative expense decreased only $3.6 million during 2002 and represented
52.4% of revenues in 2002, compared to 45.0% in 2001. This increase as a
percentage of revenues was largely the result of our decision in 2002 to
continue focusing on improving internal operations, our product offerings and on
subscriber economics, rather than investing in line growth for most of the year.
Excluding the 2001 write-off, our decreased line count and increased focus on
internal operations resulted in lower bad debt expense, decreased billing and
collection expenses and less salary and benefit expenses, all of which
contributed to our reduced general and administrative expenses in 2002 compared
to 2001.
Asset Impairment Charge. Asset impairment charges decreased $58.1 million
to $1.1 million for the year ended December 31, 2002, compared to $59.2 million
the prior year. The decrease in asset impairment is the result of the closure of
the remaining North Dakota call centers in 2002 after closing substantially all
of the centers in 2001.
As a result of management's decision in the second quarter of 2002 to
enhance future cash flow and operating earnings, we decided to close the
remaining call centers in North Dakota acquired in our acquisition of Touch 1.
In April of 2002, we announced a restructuring plan that included a reduction in
force and the closure of the North Dakota call centers resulting in an asset
impairment charge totaling $1.1 million for property, plant, and equipment sold
in conjunction with the settlement of the leases in these locations, in the
second quarter of 2002.
Wholesale development costs. Wholesale development costs were $1.0 million
in 2002. We incurred these costs, related to the initiation of our wholesale
services offerings, during the first quarter of 2002.
Restructuring Charge. We recorded a restructuring charge of $1.9 million in
2002.
In April of 2002, we approved and implemented a restructuring to enhance
our future cash flows and operating earnings. The restructuring included a
reduction of force coupled with the closure of our North Dakota call centers and
our New York sales office. In accordance with EITF 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity,"
the restructuring costs were recognized as liabilities at the time management
committed us to the plan. Management determined that these costs provided no
future economic benefit to us.
The restructuring charge includes termination benefits and lease
abandonment costs. In addition, we agreed to a settlement to exit the two leases
for our call centers in North Dakota as of July 1, 2002. All termination
benefits and settlements to exit the leases in North Dakota were paid as of
December 31, 2002. We have recorded a lease abandonment charge representing the
future lease payments for the New York office as a liability and payments exist
through August 2005.
Depreciation and Amortization. Depreciation and amortization expense
increased $0.6 million to $23.9 million for the year ended December 31, 2002,
compared to $23.3 million the prior year. The slight increase in depreciation
and amortization is a function of the amount of capital investment that we
record relative to the amount of depreciation that we record against our
embedded fixed assets. There has been relatively little change in the amount of
capital investment that we have made over the past several years, nor have we
significantly altered our depreciation policy over this time.
Interest and Other Income. Interest and other income decreased $3.4 million
to $3.5 million for the year ended December 31, 2002, compared to $6.9 million
the prior year. Interest and other income consists of interest charged to our
Z-LineHOME customers for not paying their bills on-time and income from interest
earned from our cash balance and any gains from the sale of investments or
securities. The decrease for 2002 was primarily due to our having an overall
average of fewer customers in service in 2002 compared to 2001, and due to our
more effective treatment of poor paying customers resulting in fewer
delinquencies and more timely payments by customers.
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Interest and Other Expense. Interest and other expense increased $0.3
million to $4.1 million for the year ended December 31, 2002, compared to $3.8
million the prior year. Our interest expense is a result of late fees for vendor
payments, charges related to our RFC Capital Corporation ("RFC") accounts
receivable agreement, capital leases and other debt obligations. The overall
increase in interest expense was a result of $1.0 million of increased late
payment fees paid for network costs in 2002 compared to 2001. This increase was
offset by reduced interest expense on our debt obligations. The charges for the
utilization of our accounts receivable arrangement with RFC during 2002 remained
consistent with the prior year expenses, although we decreased our sale of
receivables during the second half of 2002
Income Tax Benefit. No provision for federal or state income taxes has been
recorded due to the full valuation allowance recorded against the deferred tax
asset for the years ended December 31, 2002 and 2001.
RESULTS OF OPERATIONS BY SEGMENT
Management evaluates the performance of each business unit based on segment
results, exclusive of adjustments for special items. Special items are
transactions or events that are included in our reported consolidated results
but are excluded from segment results due to their nonrecurring or
non-operational nature. See our Segment footnote to our consolidated financial
statements for a reconciliation of segmented results to the consolidated
financial information. In addition, when changes in our business affect the
comparability of current versus historical results, we will adjust historical
operating information to reflect the current business structure.
The following tables, in millions, provide our reportable segments in total
dollars and as a percentage of our consolidated results. These tables will
facilitate our discussion of our results by segment.
Year Ended December 31, 2002 Year Ended December 31, 2001
etail Services Wholesale Consolidated Wholesale Consolidated
R Services(1) Results Retail Services Services(1) Results
Revenues................ $ 208.3 $ 30.8 $ 239.1 $ 280.3 $ -- $ 280.3
Operating expenses:
Network operations...... 92.7 10.8 103.5 159.6 -- 159.6
Sales and marketing .... 12.3 -- 12.3 31.2 -- 31.2
General and
administrative ....... 111.9 8.7 120.6 126.2 -- 126.2
Total operating expenses 216.9 19.5 236.4 317.0 -- 317.0
Segment results ........ $ (8.6) $ 11.3 $ 2.7 $ (36.7) $ -- $ (36.7)
H-3-51
Revenues And Operating Expense As A %
of Consolidated Segment Results
Year Ended Year Ended
December 31, 2002 December 31, 2001
Retail Wholesale Wholesale Consolidated
Services Services(1) Services(1) Results
Revenues................................................. 87.1 % 12.9 % 100.0 % -- %
Operating expenses: -- %
Network operations ...................................... 89.6 % 10.4 % 100.0 % -- %
Sales and marketing ..................................... 100.0 % --% 100.0 % -- %
General and administrative .............................. 92.8 % 7.2 % 100.0 % -- %
Depreciation and amortization ........................... 93.7 % 6.3 % 100.0 % -- %
Total operating expenses ................................ 91.9 % 8.1 % 100.0 % -- %
___________________________
(1) We began our wholesale services business in April of 2002. Therefore, there
are only nine months of activity for this business segment.
(2) For a detail of the special items please refer to the Special Items
Reconciliation at the beginning of this section.
RETAIL SERVICES SEGMENT
The following table, in millions, provides our retail services segment for
2002 compared to 2001. This was the first annual discussion of our results by
business segment because prior to 2002 we had only one segment, retail services.
Therefore, the 2001 retail services segment is the same as our consolidated 2001
results, excluding special items.
Retail Services Segment
Amount Change Percentage Change
For the Years Ended Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2002 2001 2002 2001
Revenues................... $ 208.3 $ 280.3 $ (72.0) (25.7)% 100.0% 100.0%
Operating expenses:
Network operations ........ 92.7 159.6 66.9 41.9% 44.5% 56.9%
Sales and marketing ....... 12.3 31.2 18.9 60.6% 5.9% 11.1%
General and
administrative .......... 111.9 126.2 14.3 11.3% 53.7% 45.0%
Total operating expenses .. 216.9 317.0 100.1 31.6% 104.1% 113.1%
Segment results ........... $ (8.6) $ (36.7) $ 28.1 76.6% (4.1)% (13.1)%
Revenues. Revenues decreased by $72.0 million to $208.3 million for the
year ended December 31, 2002, compared to $280.3 million the prior year. The
decrease was primarily attributable to a decline in Z-LineHOME customers in 2002
compared to 2001. The decrease in Touch 1 (1+) long distance lines in service
contributed an additional decrease of $6.1 million to our 2002 revenues. These
decreases were a result of focusing our efforts primarily on establishing and
growing our wholesale services, which were launched during 2002, which partially
reduced our focus from our retail services business. Therefore, retail services
revenues decreased as a percentage of consolidated revenues to 87.1% for 2002,
compared to 100% during the prior year. We changed our focus to once again
increasing the line growth within our retail business segment during the final
quarter of 2002.
Network Operations. Network operations expense decreased by $66.9 million
to $92.7 million for the year ended December 31, 2002, compared to $159.6
million the prior year. Our gross margin percentage increased to
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55.5% for the year ended December 31, 2002, compared to 43.1% the prior year.
Excluded from this improved gross margin for 2002 is a $9.0 million retroactive
reduction to network access rates in New York; including this item, network
operations expense would have decreased by $75.9 million from 2001 and gross
margin, as a percentage of retail services revenues would have been 59.8% for
2002. Our network operations expense as a percentage of revenues decreased
primarily as a result of decreases in the unbundled network element platform
rates that we paid to lease lines from the ILECs in the states in which we were
operating and more specifically the rate reduction in New York, our then largest
market with 46% of our 2002 Z-LineHOME and Z-LineBUSINESS revenues. Other
reductions resulted from improvements we made to internal operations and
processes that mitigated our network operations costs.
Sales and Marketing. Sales and marketing expense decreased $18.9 million to
$12.3 million for the year ended December 31, 2002, compared to $31.2 million
the prior year. We continued to more actively conserve cash during 2002, which
resulted in less than historically reported sales and marketing expenses in
2002.
General and Administrative. General and administrative expense decreased
$14.3 million to $111.9 million for the year ended December 31, 2002, compared
to $126.2 million the prior year. As a percentage of revenue, general and
administrative expense increased by 8.7% to 53.7% of revenues in 2002 compared
to 45.0% the prior year. This increase excluded special items in 2002 of $0.7
million of bad debt expense related to the WorldCom bankruptcy and the 2001
accounts receivable write-down totaling $29.9 million of bad debt expense.
Including these special items, general and administrative expense decreased by
$43.5 million during 2002 and was 54.1% of revenues compared to 55.7% for the
prior year. The increase as a percentage of revenues before special items was
the result of our decision in 2002 to focus on improving internal operations,
expanding product offerings and improving subscriber economics rather than
investing in line growth for most of 2002. During 2002 retail services was 92.8%
of consolidated segment general and administrative expense. Included in the
retail services general and administrative expense is all employee benefits,
occupancy, insurance, and other indirect or overhead-related expenses, as only
direct costs are recorded in our wholesale services segment.
WHOLESALE SERVICES SEGMENT
This was the first annual discussion of our results by segment because
prior to April 1, 2002 we had only one business segment, retail services.
Therefore, the 2001 wholesale services segment has no results. The following
table, in millions, provides our wholesale services segment for 2002 compared to
2001 to facilitate our discussion of results for our wholesale services segment:
Wholesale Services Segment
Amount Change Percentage Change
For the Years Ended Favorable Favorable
December 31, (Unfavorable) (Unfavorable) Percentage of Revenues
2002 2001 2002 2001
Revenues................... $ 30.8 $ -- $ 30.8 100.0% 100.0% --%
Operating expenses:
Network operations ........ 10.8 -- (10.8) (100.0)% 35.1% --%
General and
administrative .......... 8.7 -- (8.7) (100.0)% 28.2% --%
Depreciation and
amortization ............ 1.5 -- (1.5) (100.0)% 4.9% --%
Total operating expenses .. 21.0 -- (21.0) (100.0)% 68.2% --%
Segment results ........... $ 9.8 $ -- $ 9.8 100.0% 31.8% --%
Revenues. Revenues were $30.8 million, or 12.9% of consolidated revenue for
2002. These revenues were primarily from our wholesale contract with MCI.
Network Operations. Network operations expense was $10.8 million, or 10.4%
of consolidated network operations expense. This expense will vary depending on
each individual wholesale services contract.
H-3-53
General and Administrative. General and administrative expense was $8.7
million, or 7.2% of consolidated general and administrative expense. The
significant components of this expense are similar to our consolidated expenses,
however, we only record the direct expenses associated with our wholesale
services within the wholesale business segment. Therefore, we have not allocated
any indirect or corporate (i.e. overhead related) expenses such as employee
benefits, occupancy costs , insurance expenses or other administrative expenses
to the wholesale services business segment. These expenses are all included in
the retail services segment. We received pre-prepayments from MCI for our
wholesale services as a result of their bankruptcy filing on a post petition
basis, and did not record any bad debt expense for the wholesale services
portion of our overall relationship.
LIQUIDITY AND CAPITAL RESOURCES
The competitive local telecommunications service business is traditionally
considered to be a relatively capital intensive business, owing to the
significant investments required in fiber optic communication networks and in
the collocation of switching and transmission equipment in incumbent local
exchange carriers' central offices. Although we have historically utilized UNE-P
to provide our services to our own end users, we are also now working on a VoIP
initiative which will likely involve more capital expenditures than the UNE-P
based model has typically required. We will continue providing our UNE-P based
services, but our focus will increasingly move towards utilizing VoIP as an
access method whereby we will provide service to our own end users. In 2004, we
plan to launch VoIP in at least two markets: Tampa, Florida and Atlanta,
Georgia. We expect to significantly expand this offering over the coming years.
We will continue to devote significant amounts of our capital resources to
continued operations, software development, new service offerings and the
marketing efforts that we have designed to achieve penetration of our target
markets.
We have incurred accumulated losses since our inception as a result of
developing our business, performing ongoing research and development, building
and maintaining our network infrastructure and technology, the sale and
promotion of our services, and ongoing administrative expenditures. As of
December 31, 2003, we had an accumulated deficit of $318.9 million, a net tax
operating loss carryforward of $280.8 million, and $12.0 million in cash and
cash equivalents. We have funded our expenditures primarily through operating
revenues, private securities offerings, a sale-leaseback credit facility, an
accounts receivable factoring facility and an initial public offering that
raised net proceeds of $109.1 million. We intend to continue building our
organization in anticipation of future growth and we believe that our operating
expenditures will also continue to increase.
Net cash provided by operating activities decreased by $6.4 million to
$12.0 million for the year ended December 31, 2003, compared to $18.4 million in
the prior year. The decrease was a result of our net loss after excluding
non-cash items, which increased by $8.1 million while overall working capital
only improved by $1.7 million.
Included in our net cash operating activities was the sale of $138.2 and
$135.2 million of receivables, for net proceeds of $111.9 and $107.3 million, as
of December 31, 2003 and 2002, respectively. A net receivable servicing asset of
$13.2 and $8.5 million is included in accounts receivable and $4.2 and $3.4
million of advances on unbilled receivables are included in accounts payable and
accrued liabilities as of December 31, 2003 and 2002, respectively. The costs
relating to the agreement of $1.0, $1.3 and 1.1 million is included in interest
and other expense for years ended December 31, 2003, 2002 and 2001,
respectively.
The RFC agreement allows us to sell up to $25 million of receivables,
subject to the selection criteria utilized by RFC for the receivables they agree
to purchase. There were no minimum sales requirements under this agreement. RFC
purchased our receivables from us at a discount of 23%; prior to March 2002, RFC
purchased our receivables at a 32% discount rate. Our collection percentages
during 2003 and 2002 were 98.5% and 92.9%, respectively. Under the agreement we
were responsible for the continued servicing of the receivables and any amount
collected over the discount rate was paid to us by RFC for providing the
servicing less certain fees.
Our net cash used in investing activities improved by $4.6 million to $11.0
million for the year ended December 31, 2003, compared to $15.6 million the
prior year. Nearly all the improvement was attributable to the purchasing of
less property and equipment during 2003 and the financing of $1.3 million of
equipment purchases in 2003. We expect our capital expenditures to increase
during 2004, however, we expect to obtain financing for these purchases. As we
move toward a VoIP business model from our UNE-P model our capital ex-
H-3-54
penditures are expected to increase in the coming years due to the more capital
intense requirements of VoIP. Also, the expected growth in our retail and
wholesale business will increase capital expenditures.
Our net cash used in financing activities improved by $0.7 million to $5.0
million for the year ended December 31, 2003, compared to $5.7 million the prior
year. This improvement is primarily a result of receiving the repayment of $0.5
million from an executive who is also a member of the board of directors in
fulfillment of a note payable for the issuance of common stock and $0.5 million
for the exercise of stock options. These increased financing inflows were
reduced by a $0.3 million increase to the payments on long-term debt and capital
leases.
We expect our total debt to increase during 2004 because of a new asset
based loan agreement we expect to obtain in the near term. We expect that this
agreement will replace the accounts receivable agreement that we have with RFC.
This new agreement should be reported as a loan and therefore, will be recorded
as a financing transaction, as opposed to the RFC agreement, which is recorded
as an operating cash flow (it is a factoring facility as opposed to a
traditional asset based loan). As it is currently contemplated the new asset
based loan will include more of our accounts receivable in the borrowing base
calculation than was historically the case with RFC, therefore, proving us with
some additional liquidity. We also have received payments on related party notes
receivable and additional exercises of stock options during 2004 which will
provided additional improvement to our liquidity position for 2004.
We currently have agreements with two long-distance carriers to provide
transmission and termination services for all of our long distance traffic.
These agreements generally provide for the resale of long distance services on a
per-minute basis and contain minimum volume commitments. As a result of a
settlement of a billing dispute associated with minimum volume commitments
required in one of the contracts we have agreed to pay an increased per minute
charge for minutes until the achievement of certain minimum minute requirements
which we expect to meet in the first half of 2004. Once we meet the new agreed
upon minimum minutes we will revert to the terms of our original agreement. All
other terms of the original agreement continue in full force. We believe that we
will be fully in compliance with all minimum volume commitments during 2004. As
of December 31, 2003 had recorded an accrual for $0.2 million, our estimated of
the remaining estimated payments.
ANTICIPATED SOURCES AND USES OF CASH
We diversified our sources and uses of cash during 2003 and will continue
to do so during 2004. When we discuss positive cash flow throughout this section
we are referring to the cash inflows and incremental cash outflows, exclusive of
fixed and overhead operating costs such as administrative payroll expenses,
non-operations related payroll expenses, occupancy costs, and other costs that
are of a corporate or overhead nature. These corporate overhead expenses were
$46.8 million for the year ended December 31, 2003. We believe it is appropriate
to have this discussion in order to understand our individual contribution
streams, while realizing that these streams must provide enough cash flow to
fund our corporate overhead. Our residential service provides most of our cash
from operations. We also continue to utilize the 1+ long-distance service as a
positive cash generating business, primarily because of our policy of not
actively investing in it, other than the ongoing maintenance costs associated
with this line of business. Our wholesale services business is also a good
source of cash flow. Although not as significant in volume as our residential
business, it provides a healthy net cash contribution on a per line basis
without causing us to incur traditional upfront sales and marketing costs, out
of pocket, as is typically the case with traditional retail activities.
We expect to spend most of 2004 investing in the growth of our business
services, which should provide a positive cash flow in 2004. Finally, we are
continuing our access method diversification into VoIP, in an effort to provide
services that are not largely dependent on UNE-P. We expect to invest in this
business throughout 2004, without any significant positive net cash contribution
until 2005. We believe we are well positioned for growth during 2004 because of
these diversified business models which provide us with more avenues for growth
opportunity and less dependence on any one model for success. We also recognize
the importance of managing the timing and ongoing economics of this growth as it
relates to our overall cash and financial position.
Our ongoing capital requirements will depend on several factors, including
market acceptance of our services, the amount of resources that we devote to
investments in our networks and facilities, the build-out of additional
enterprise management centers, the ongoing development of services and brand
promotions, the resources that
H-3-55
we devote to the sales and marketing of our services, and many other factors. We
will continue to provide our back-office services and the technology that we
have developed to other companies seeking the capability of offering residential
and small business telecommunications services on a private label basis to
residential and business customers. As growth and opportunities arise, we expect
to make strategic investments in technology and our network architecture and
enter potential strategic alliances or partnerships with other entities. We
expect to continue to finance our capital expenditures mostly from internally
generated cash flow and from existing facilities. We expect to see an overall
increase in fixed assets across nearly all categories during 2004.
We are currently under audit by the State of New York for our sales and use
taxes. In January of 2004, we received a preliminary summary from the State of
New York stating that we owe them $2.0 million in sales and use taxes, before
any possible interest or penalties, primarily due to their position that 100% of
the bundled services we offer are taxable. Although this process is still on
going, we currently disagree with their calculation of the sales and use tax due
on our bundled products and we believe that certain portions of the bundle are
not subject to sales and use taxes. Our goal is to obtain an acceptable
settlement with the state, but we believe that our methodology is appropriate,
reasonable, and in compliance with the State of New York's sales and use taxes
calculation. We have made accruals based on our best estimates of the facts, but
are unable to determine the final outcome at this time.
CASH MANAGEMENT
We had about $46.8 million in corporate expenditures during 2003, of which
$19.2 million relates to non-essential headcount and related expenses which
would not be necessary if we were to reduce our operations to a purely
maintenance approach and discontinued spending on any development of new service
offerings or new business opportunities, other technological focused initiatives
and investments in legal and regulatory related activities.
We believe that if the line growth materializes similar to management's
expectations over the course of 2004, we will generate overall free cash flow
without any reductions to the aforementioned corporate expenditures. We expect
to reinvest this free cash flow into the business and to fund our capital
expenditures for VoIP, any additional head-count requirement and any related
costs for growing our wholesale and retail service business segments. We expect
the next six months of 2004 to be challenging from a cash management
perspective, however the expected closing of an asset based loan agreement will
provide additional liquidity that will help us manage our payables and expected
increased capital expenditures resulting from expected growth in all lines of
our business. These expenses are primarily front-end loaded and should result in
negative cash flows over the short term, but should become positive during the
last quarter of 2004. We will continue to finance significant capital
expenditures and are working with certain vendors to obtain more generous
payment terms that will provide us with more flexibility during this period. We
may or may not be successful in these endeavors.
Looking to the future, the most significant issue we need to address is the
mandatorily redeemable preferred Stock which has a current collective
liquidation value of $154.0 million, that either will need to be redeemed or
converted in some fashion into common stock or some other type of instrument.
The redemption of this stock is not definite, as it can be converted at the
option of the holder or under certain conditions the conversion may be forced by
us. However, this would not likely occur until our common stock price increases
significantly. We recognize the importance of exploring various options and
alternatives to address a possible redemption that may occur as early as 2006
for a part of the preferred stock. We also realize that these instruments may
hinder our ability to obtain additional financing in the future, unless we have
a viable plan to convert or redeem these securities in part or in full.
In September of 2003, we decided to postpone a company-wide salary
increase. This increase was scheduled to take place in April of 2004, however,
we are still assessing if this increase will be further postponed. We are also
exploring the possibility of granting certain employees with restricted stock in
lieu of payroll increases.
H-3-56
DEBT INSTRUMENTS
Asset-Based Loan
We believe we are close to signing a three-year revolving credit agreement,
which we expect to be completed in the next 15 days. We expect that this
agreement will provide us with an availability to borrow up to $25.0 million.
Our overall availability is based on the eligibility of our accounts
receivables, subject to certain limitations and advance rates. This agreement
will replace our RFC accounts receivable agreement which terminates on July 27,
2004. This new agreement is expected to provide us with additional liquidity as
it encompasses certain accounts receivable that were not included in our prior
arrangement with RFC, which was based only on our residential accounts
receivable. We believe that this new agreement will provide us with the
necessary flexibility to grow our business and should include less restrictive
covenants during the first three quarters of 2004. We also, as the deal is
currently contemplated, have agreed to acceptable terms that we believe will
provide us with the ability to access subordinated debt within the confines of
the agreement, which we believe provide us with additional flexibility for
future debt financing alternatives. Although we expect that we will have this
agreement completed in the next 15 days we can not assure that the agreement
will be closed and that we will obtain all of the terms and conditions we
discussed, in the final agreement.
We believe that this new agreement will help us to manage our short and
long-term cash needs, although we are still exploring other alternatives for
obtaining additional funding, including but not limited to subordinated debt and
certain equity transactions. We believe that an asset based loan agreement will
immediately help to improve our overall working capital position but the
expected growth in our business may still result in additional liquidity needs
that would have to be obtained through additional financings. Specifically, our
recently signed agreement with a large communications concern with a significant
embedded customer base may result in our residential service operating at a cash
flow negative position until the fourth quarter of 2004. We also may need
additional funds for our VoIP initiative which will likely be much more capital
intensive than the UNE-P business model has been historically. The availability
of cash will somewhat dictate the speed in which we will be able to roll this
access method out to new cities, as there is an initial cost of about $0.5
million in capital expenditures to establish service in a major metropolitan
areas. After this initial cost there are the additional costs of the customer
premise equipment and installation and provisioning costs to get customers onto
the service but these costs are success based and will move in tandem with new
customers but will require larger up-front payments than we currently experience
to get a customer up and running with UNE-P services. However, in the
longer-term the network costs for these customers are much lower because of the
larger capital expenditures for network bandwidth which reduces future
incremental costs.
Term Debt
We have $4.1 million of remaining principal term debt as of December 31,
2003, of which all but $0.1 million will be paid off by September 2004. This
debt was assumed in the purchase of Touch 1 Communications, Inc., our wholly
owned subsidiary, in April 2000. All of this debt is paid monthly and is at a
fixed interest rate of 6.0%.
ILEC, IXC AND RELATED DISPUTED CHARGES
Since our existence we have disputed and continue to dispute significant
charges from the various ILECs, IXCs, and certain other carriers providing us
services. We have a policy of treating all charges, that we believe are without
merit, that are still being presented on a bill to us on a regular basis as
disputes, regardless of the age of the dispute. We believe that the majority of
these charges are without merit, however, we accrue for any the charges we
believe represent valid charges against us. Our outstanding disputes at December
31, 2003 totaling $18.2 million. These disputes are summarized in the following
table:
Outstanding
Disputes at
December 31, 2003
(In millions)
Alternatively billed services......................... $ 7.8
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MCI fixed facility charges............................ 2.8
Verizon back-billing of installation charges.......... 2.4
Late fees for non-payment of disputed charges......... 2.4
All others............................................ 2.8
Total................................................. $ 18.2
Alternatively billed services are primarily charges for certain 1-800,
collect and information service calls. These disputes are largely historic in
nature. We settled certain of these disputes in Texas with Southwestern Bell
Telephone Company. We remit all monies collected associated with these services
but do not pay the charges unless we collect from our customers. We believe that
our liability related to these charges should be capped at the amount remitted
by our end users, however, some of our settlements have included payments in
excess of payments from our customers. Therefore, we have accrued $1.7 million
for alternatively billed services as of December 31, 2003.
The MCI fixed facility charge dispute is over 3 years old. Although we have
received communications from MCI that these charges are not valid, they have
never removed these charges from their billings to us.
We received a billing for $2.3 million from Verizon relating to the
back-billing of dispatch charges believed to relate to the period from August
2000 to February 2002 and from March 2003 to September 2003. We do not know if
this is the entire amount they will bill related to these back-billed charges.
Our policy is to dispute items that are billed without the necessary underlying
detail records and therefore, we have disputed these charges. We expect that if
any of these charges are valid, a portion of these charges may be subject to
being billed to our wholesale services customers for services that we provided
under our contracts with them. We have not received sufficient detail related to
these charges from Verizon and therefore, are unable to determine their
validity.
The late fees are accumulating from all of our disputes as we do not pay
for disputed items and therefore incur and accumulate late fee for these
disputed billings.
The remaining $2.8 million of disputes relates to various disputes
primarily with ILECs for incorrect rates, duplicate billing, charges for
customers for whom we are no longer providing service and other billing errors.
We believe that we are adequately reserved for our disputes and manage our
cash position to insure that we have the necessary availability of cash to make
payments which may arise out of the loss of disputes that we believe are at
risk. Therefore, we believe our maximum cash exposure for these charges is $18.2
million. However, we do not believe that these charges are valid and intend to
continue our dispute and non-payment of these charges.
CONTRACTUAL OBLIGATIONS
The following table, in thousands, discloses aggregate information about
our contractual obligations and the periods in which payments are due:
LESS THAN AFTER 5
CONTRACTUAL OBLIGATONS TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
Long-term debt $ 4,050 $ 3,992 $ 58 $ -- $ --
Operating leases 10,271 2,939 4,907 2,452 --
Capital leases 1,660 2,939 4,907 2,425 --
Mandatorily redeemable preferred stock 17,421 14,919 141 1,154 1,207
redemption
Total contractual cash obligation $ 192,181 $ 23,095 $ 28,835 $139,044 $ 1,207
We have no other significant off-balance sheet items.
H-3-58
RELATED PARTY TRANSACTIONS
In January 2001, we accelerated the vesting of 50,000 stock options granted
to an executive as part of his severance agreement. This acceleration resulted
in the employee being fully vested in stock options with a strike price of $3.64
when the stock was trading at $4.50. We recorded approximately $0.1 million in
general and administrative expense as a result of this transaction.
In January 2002, we accelerated the vesting of 96,471 stock options granted
to an executive as part of his severance agreement. This acceleration resulted
in the employee being fully vested in stock options with a strike price of $1.30
per share when the stock was trading at $1.80 per share. The employee forfeited
76,471 of his vested options in return for the exercise of 20,000 shares of
stock. We recorded approximately $0.1 million in general and administrative
expense as a result of this transaction.
In February 2003 we received a payment to $0.5 million from an executive
officer who is also on our Board of Directors in fulfillment of an outstanding
note receivable to us.
In August 2003, we accelerated the vesting of 122,223 stock options granted
to an executive as part of his severance agreement. This acceleration resulted
in the employee being fully vested in stock options with a strike price of $1.30
per share when the stock was trading at $2.02 per share. As a result of this
transaction we recorded approximately $0.1 million in general and administrative
expense.
At December 31, 2003, we have approximately $1.7 million of notes
receivable from employees and former employees for various reasons. We have
recorded approximately $1.1 million of these loans as contra equity, as the
loans were for the purchase of stock. The remaining $0.6 million loans were more
of a personal nature and we have made an accrual for $0.5 million as some of
these loans are to former employees and the likelihood of collection and lack of
collateral make it likely that these amounts will not be collectable. These
notes are primarily due by December 2004 with approximately $0.8 million due by
that date. Only two notes are due beyond this date, one is a note in the amount
of approximately $0.8 million, due in June 2005, and the other is approximately
$0.1 million and is a demand note that currently has no specific due date.
We paid interest on our related party term debt in the amount of $0.3, $0.4
and $0.6 million for the years ended December 31, 2003, 2002 and 2001,
respectively.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached a consensus on EITF No. 00-21,
"Accounting for Revenue Arrangements with Multiple Element Deliverables." EITF
No. 00-21 addresses how to account for arrangements that may involve the
delivery or performance of multiple products, services and/or rights to use
assets. Revenue arrangements with multiple deliverables should be divided into
separate units of accounting if the deliverables in the arrangement meet certain
criteria. Arrangement consideration should be allocated among the separate units
of accounting based on their relative fair values. The Issue also supersedes
certain guidance set forth in Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements." The final consensus is applicable
to agreements entered into in quarters beginning after June 15, 2003, with early
adoption permitted. Additionally, companies are permitted to apply the consensus
guidance to all existing arrangements as a cumulative effect of a change in
accounting principle. We adopted this new pronouncement effective July 1, 2003,
on a prospective basis. This adoption did not have a material impact on our
consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity." This statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. This statement
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective for quarters beginning July 1, 2003. We
reviewed this new pronouncement and have concluded that none of our mandatorily
redeemable convertible preferred stock presented in the mezzanine section of our
balance sheet is within the scope of SFAS No. 150. This conclusion is based on
the facts that there is
H-3-59
not an unconditional obligation requiring the redemption of the securities
because they are convertible into common at the option of the holder and the
conversion option is substantial. We recognize that the FASB is in the process
of possibly promulgating additional rules in the future related to securities
similar to the ones that we have in the mezzanine section, but are unable to
determine what any future rule's impact might have on our consolidated financial
statements.
In December 2003, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 104 ("SAB 104"), Revenue Recognition. SAB 104 clarifies
existing guidance regarding revenues for contracts which contain multiple
deliverables to make it consistent with EITF No. 00-21. The adoption of the
provisions of EITF 00-21 and SAB 104 had no effect on our results of operations.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46 "). FIN 46 requires an investor with a
majority of the variable interests in a variable interest entity to consolidate
the entity and also requires majority and significant variable interest
investors to provide certain disclosures. A variable interest entity is an
entity that has (1) equity investment at risk that is insufficient to finance
the entity's activities without receiving additional subordinated financial
support from the other parties, (2) a group of equity owners that are unable to
make substantive decisions about the entity's activities, or (3) equity that
does not absorb the entity's losses or receive the benefits of the entity. FIN
46 is effective for all new variable interest entities created or acquired after
January 31, 2003. We do not have any variable interest entities and experienced
no impact from the adoption of FIN 46.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The report contains forward-looking statements relating to events
anticipated to happen in the future. These forward-looking statements are based
on the beliefs of our management, as well as assumptions made by and information
currently available to our management. Forward-looking statements also may be
included in other written and oral statements made or released by us. You can
identify forward-looking statements by the fact that they do not relate strictly
to historical or current facts. The words "believe," "anticipate," "intend,"
"expect," "estimate," "project" and similar expressions are intended to identify
forward-looking statements. Forward-looking statements describe our expectations
today of what we believe is most likely to occur or may be reasonably achievable
in the future, but they do not predict or assure any future occurrence and may
turn out to be wrong. Forward-looking statements are subject to both known and
unknown risks and uncertainties and can be affected by inaccurate assumptions we
might make. Consequently, no forward-looking statement can be guaranteed. Actual
future results may vary materially. We do not undertake any obligation to
publicly update any forward-looking statements to reflect new information or
future events or occurrences. These statements reflect our current views with
respect to future events and are subject to risks and uncertainties about us,
including, among other things:
o our reliance on ILEC local networks;
o the outcome of legal and regulatory proceedings;
o our ability to market our services successfully to new subscribers;
o our ability to retain a high percentage of our customers;
o the possibility of unforeseen capital expenditures and other upfront
investments required to deploy new technologies or to effect new business
initiatives;
o our ability to access markets and finance network developments and
operations;
o our expansion, including consumer acceptance of new price plans and bundled
offerings;
o additions or departures of key personnel;
o competition, including the introduction of new products or services by our
competitors;
H-3-60
o existing and future laws or regulations affecting our business and our
ability to comply with these laws or regulations;
o our reliance on the Regional Bell operating company's systems and
provisioning processes;
o technological innovations;
o general economic and business conditions, both nationally and in the
regions in which we operate; and
o other factors described in this document, including those described in more
detail below.
We caution you not to place undue reliance on these forward-looking
statements, which speak only as of the date of this document.
RISKS RELATED TO OUR FINANCIAL CONDITION AND OUR BUSINESS
Availability and Favorable Pricing of Unbundled Network Components. Our
business strategy depends on a continued availability of ILEC unbundled network
components and on states maintaining and adopting favorable pricing rules for
ILEC unbundled network components. Approximately 95% of our revenues are derived
from the use of ILEC networks. The FCC has issued rules regarding access to key
components of the ILEC networks, including transport and switching. A recent
court ruling, however, has created considerable legal uncertainty regarding this
access. In United States Telecom Ass'n v. FCC , Nos. 00-1012, 00-1015, 03-1310
et al. (D.C. Cir. March 2, 2004) (" USTA II "), the D.C. Circuit Court ordered
that the FCC's unbundled transport and switching rules be vacated after sixty
days or upon denial of a petition for rehearing, whichever occurs later.
Although a majority of the FCC has indicated that it will support an appeal,
this ruling and the uncertainty it has created could have material, adverse
effects upon us and our operations. Certain potential adverse effects from this
ruling and the uncertainty is has created are set forth below. This list is not
exhaustive as a listing of all the potential adverse effects would impossible.
See also the section of this report entitled "Government Regulation."
o ILECs, after some period of time, could deny us access to their networks in
violation of interconnection agreements and essentially destroy our ability
to provide our services.
o ILECs could refuse new service orders, including repair and change orders.
We would not be able to add new customers. Our business would diminish
because of normal customer churn, that is, the normal loss of existing
customers over time.
o Our customer churn could increase as our customers return to ILEC services
in response to the uncertainty.
o ILECs could significantly raise the prices they charge for access to their
networks. We would be forced to raise our rates to non-competitive levels.
o Vendors, including long distance companies, could alter the terms under
which they do business with us, such as credit terms, thereby increasing
our costs and diminishing our cash flow and liquidity.
o We may be unable to obtain new financing at acceptable rates. We have
already encountered difficulty in attempting to obtain financing from one
particular lender.
o We may lose prospective customers that otherwise would have become our
customers. We believe we have already lost at least one large prospective
customer (over 5,000 lines) because of the uncertainty.
H-3-61
o Our wholesale customers may decline to expend marketing resources to
increase their customer bases.
o We could lose major marketing partners and potential marketing partners as
they decline to expend resources in marketing our services.
o We could lose key personnel, as they see security in offers from other
prospective employers.
o The cost of litigation and of participation in administrative proceedings
relating to interconnection agreements and new regulations could be
excessively burdensome.
The availability of favorable pricing rules for unbundled network
components is another key element of our business strategy. The public utilities
commissions of certain states have adopted pricing rules for unbundled network
components. In general, ILECs are required to provide us with access to their
networks at forward-looking, long-run incremental cost-based prices. However, we
cannot be certain that unbundled network components will continue to be
available at favorable prices in those states or that other states will ever
adopt favorable pricing, particularly in light of the recent D.C. Circuit Court
ruling referred to above.
Emerging Industry Sector. We are in a new, emerging sector of the
telecommunications industry. Our experience, as well as the experience of
others, in this sector is limited. As a result we could encounter numerous
unforeseen difficulties and challenges.
Uncertainties Relating to Wholesale Initiative. Our wholesale initiative is
still developing. We believe we are the first competitive local exchange carrier
to offer wholesale local exchange services. We undoubtedly will encounter
unforeseen delays, capital expenditures and upfront costs, regulatory and legal
issues (which may include legal challenges to our wholesale strategy by
incumbent local exchange carriers), technical difficulties and other challenges.
There can be no assurance that we will overcome these challenges successfully or
without expenditure of substantial resources. Moreover, since we must pay the
incumbent local exchange carrier fees relating to local telephone usage by both
our retail and wholesale customers, we will be highly dependent upon our
wholesale customers. Their failure to pay fees to us may make it difficult or
impossible for us to pay fees to the incumbent local exchange carriers upon
which we rely.
Rapid Expansion. We are attempting to grow our business rapidly in terms of
the number of services we offer, the number of customers we serve and the
regions we serve. We are expending substantial sums in anticipation of increased
sales resulting from a new marketing partner relationship. There can be no
assurance this marketing initiative will be launched as expected or that it will
be successful, particularly in light of the legal and regulatory uncertainties
described elsewhere in this report. Furthermore, there is no assurance that we
will successfully manage our efforts to:
o expand, train, manage and retain our employee base;
o expand and improve our customer service and support systems and improve the
performance of billing systems;
o introduce and market new products and services and new pricing plans in
addition to Z-LineHOME and our other service offerings;
o enhance and upgrade the features of our software;
o capitalize on new opportunities in the competitive marketplace; or
o control our expenses.
The strains posed by these demands are magnified by the emerging nature of
our operations. If we cannot manage our growth effectively, our results of
operations could be adversely affected.
H-3-62
Difficulties in Expanding Network Infrastructure. We must continue to
develop, expand and adapt our network infrastructure as the number of our users
and the amount of information they wish to access and transfer increases and as
our customers' demands change. We cannot be sure that we will be able to
develop, expand or adapt the network infrastructure to meet additional demand or
our customers' changing requirements on a timely basis, at a commercially
reasonable cost, or at all. If we fail to expand our network infrastructure on a
timely basis or adapt it to either changing customer requirements or evolving
industry standards, these failures could cause our business to perform poorly.
Ability to Resell Long Distance Services. We offer long distance telephone
services as part of our service packages. We currently have agreements with
various long distance carriers to provide transmission and termination services
for all of our long distance traffic. Recently, several long distance carriers
have encountered financial difficulties, including both carriers utilized by us.
Financial difficulties encountered by any of our carriers could cause disruption
of service to our customers and could diminish the value of any receivables or
credits that may be due to us from such carriers. Our agreements with long
distance carriers generally provide for the resale of long distance services on
a per-minute basis and contain minimum volume commitments. In cases in which we
have agreed to minimum volume commitments and fail to meet them, we will be
obligated to pay underutilization charges. In some instances, if we incur
underutilization charges, our basic rate will increase, which could further
adversely affect our operating results. We recently settled a dispute by
agreeing to a higher rate.
Risk of Software Failures and Errors. The software that we use and the
software that we have developed internally and are continuing to develop may
contain undetected errors. Although we have extensively tested our software,
errors may be discovered in the software during the course of its use. Any
errors may result in partial or total failure of our network, loss or diminution
in service delivery performance, additional and unexpected expenses to fund
further product development or to add programming personnel to complete or
correct development, and loss of revenue because of the inability of customers
to use our products or services, which could adversely affect our business
condition.
Protection of Proprietary Technology. We currently rely on a combination of
copyright, trademark and trade secret laws and contractual confidentiality
provisions to protect the proprietary information that we have developed. Our
ability to protect our proprietary technology is limited, and we cannot assure
you that our means of protecting our proprietary rights will be adequate or that
our competitors will not independently develop similar technology. Also, we
cannot be certain that the intellectual property that incumbent local exchange
carriers or others claim to hold and that may be necessary for us to provide our
services will be available on commercially reasonable terms. If we were found to
be infringing upon the intellectual property rights of others, we might be
required to enter into royalty or licensing agreements, which may be costly or
not available on commercially reasonable terms. If successful, a claim of
infringement against us and our inability to license the infringed or similar
technology on terms acceptable to us could adversely affect our business.
Dependence on Information Systems. Our billing, customer service and
management information systems are newly developed and we may face unexpected
system difficulties, which would adversely affect our service levels and,
consequently, our business. Sophisticated information and processing systems are
vital to our ability to monitor costs, render monthly invoices for services,
process customer orders and achieve operating efficiencies. We rely on internal
systems and third party vendors, some of which have a limited operating history,
to provide our information and processing systems. If our systems fail to
perform in a timely and effective manner and at acceptable costs, or if we fail
to adequately identify all of our information and processing needs or if our
related processing or information systems fail, these failures could have a
material adverse effect on our business.
In addition, our right to use third party systems is dependent upon license
agreements. Some of these agreements are cancelable by the vendor, and the
cancellation or nonrenewal of these agreements could seriously impair our
ability to process orders or bill our customers. As we continue to provide local
telephone service, the need for sophisticated billing and information systems
will also increase significantly and we will have significant additional
requirements for data interface with incumbent local exchange carriers and
others. We cannot be certain that we will be able to meet these additional
requirements.
Network Failure. The successful operation of our network will depend on a
continuous supply of electricity at multiple points. Although the system that
carries signals has been designed to operate under extreme weather
H-3-63
conditions (including heavy rain, wind and snow), like all other
telecommunications systems, our network could be adversely affected by such
conditions. Our network, however, is equipped with a back-up power supply and
our existing network operations center is equipped with both a battery backup
and an on-site emergency generator. If a power failure causes an interruption in
our service, the interruption could negatively impact our operations.
Our network also may be subject to physical damage, sabotage, tampering or
other breaches of security (by computer virus, break-ins or otherwise) that
could impair its functionality. In addition, our network is subject to unknown
capacity limitations that may cause interruptions in service or reduced capacity
for our customers. Any interruptions in service resulting from physical damage
or capacity limitations could cause our systems to fail.
Dependence on Local Exchange Carriers. We rely on incumbent local exchange
carriers to supply key unbundled components of their network infrastructure to
us on a timely and accurate basis, and in the quantities and quality demanded by
us. We may from time to time experience delays or other problems in receiving
unbundled services or facilities which we request, and there can be no assurance
that we will able to obtain such unbundled elements on the scale and within the
time frames required by us. Any failure to obtain these components, services or
additional capacity on a timely and accurate basis could adversely affect us.
Anticipated Capital Needs. If we expand more rapidly than currently
anticipated or if our working capital needs exceed our current expectations, we
may need to raise additional capital from debt or equity sources. If we cannot
obtain financing on acceptable terms or at all, we may be required to modify,
delay or abandon our current business plan, which is likely to materially and
adversely affect our business and, as a result, the value of our common stock.
We have an accounts receivable facility with RFC Corporation that provides for
the sale of up to $25 million of our receivables to RFC. This facility expires
in July 2004. We are currently in negotiations to replace this facility.
Dependence on Third Party Vendors. We currently purchase the majority of
our telecommunications equipment as needed from third party vendors, including
Lucent Technologies, Inc., Sonus Networks, Inc., Dialogic Communications
Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Sun
Microsystems, Inc. and EMC Corporation. In addition, we currently license our
software from third party vendors, including Oracle Corporation, INPRISE
Corporation, Mercator Software, Inc., Microsoft Corporation, Nuance
Communications, Inc., SpeechWorks International, Inc., Telution, Inc., AMS,
Inc., Netscape Communications, Inc. and Accenture. We typically do not enter
into any long-term agreements with our telecommunications equipment or software
suppliers. Any reduction or interruption in supply from our equipment suppliers
or failure to obtain suitable software licensing terms could have a disruptive
effect on our business and could adversely affect our results of operations.
Dependence on Management and Key Personnel. We depend on a limited number
of key personnel who would be difficult to replace. If we lose the services of
some of our key personnel, our business could suffer. We currently maintain a
$5,000,000 key man life insurance policy on the life of Mr. D. Gregory Smith,
our president, chief executive officer and chairman of the board. We also depend
on a limited number of key management, sales, marketing and product development
personnel to manage and operate our business. In particular, we believe that our
success depends to a significant degree upon our ability to attract and retain
highly skilled personnel, including our engineering and technical staff. If we
are unable to attract and retain our key employees, the value of our common
stock could suffer.
Government Regulation and Legal Uncertainties. We are subject to varying
degrees of federal, state, and local regulation. We must also comply with
various state and federal obligations that are subject to change, such as the
duty to contribute to universal service subsidies, the impact of which we cannot
assess on a going-forward basis as the rates change periodically. Our failure to
comply with regulatory requirements may result in fines or other penalties being
imposed on us, including loss of certification to provide services.
Decisions of the FCC and state regulatory commissions providing incumbent
local exchange carriers with increased flexibility in how they price their
services and with other regulatory relief, could have a material adverse effect
on our business and that of other competitive local exchange carriers. Future
regulatory provisions may be less favorable to competitive local exchange
carriers and more favorable to their competitors. If incumbent local exchange
carriers are allowed by regulators to engage in substantial volume and term
discount pricing practices for their end-user customers, or charge competitive
local exchange carriers higher fees for interconnection to the in-
H-3-64
cumbent local exchange carriers' networks, our business, operating results and
financial condition could be materially, adversely affected. Incumbent local
exchange carriers may also seek to delay competitors through legal or regulatory
challenges, or by recalcitrant responses to requirements that they open their
markets through interconnection and unbundling of network elements. Our legal
and administrative expenses may be increased because of our having to actively
participate in rate cases filed by incumbent local exchange carriers, in which
they seek to increase the rates they can charge for the unbundled network
element platform components. Our profitability may be adversely affected if
those carriers prevail in those cases. Pending court cases, in which certain
provisions of the Telecommunications Act of 1996 will be conclusively
interpreted, may result in an increase in our cost of obtaining unbundled
network elements.
We are also subject to federal and state laws and regulations prohibiting
"slamming," which occurs when specific procedures are not followed when a
customer changes telecommunications services. Although we attempt to diligently
comply with all such laws and regulations and have procedures in place to
prevent "slamming," if violations of such laws and regulations occur, we could
become subject to significant fines and penalties, legal fees and costs, and our
business reputation could be harmed.
Competition. The telecommunications and information services markets are
intensely competitive and rapidly evolving. We expect competition to increase in
the future. Many of our potential competitors have longer operating histories,
greater name recognition, larger customer bases and substantially greater
financial, personnel, marketing, engineering, technical and other resources than
us. We believe the principal competitive factors affecting our business
operations will be price, the desirability of our service offering, quality and
reliability of our services, innovation and customer service. Our ability to
compete effectively will depend upon our ability to maintain high quality,
market-driven services at prices generally equal to or below those charged by
our competitors. Competitor actions and responses to our actions could,
therefore, materially and adversely affect our business, financial condition and
results of operations.
We face competition from a variety of participants in the
telecommunications market. The largest competitor for local service in each
market in which we compete is the incumbent local exchange carrier serving that
market. Incumbent local exchange carriers have established networks,
long-standing relationships with their customers, strong political and
regulatory influence, and the benefit of state and federal regulations that
favor incumbent local exchange carriers. In the local exchange market, the
incumbent local exchange carriers continue to hold near-monopoly positions. The
long distance telecommunications market in which we compete has numerous
entities competing for the same customers and a high average churn 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 will face competition from
large interexchange carriers. Other competitors are likely to include incumbent
local exchange carriers providing out-of-region (and, with the removal of
regulatory barriers, in-region) long distance services, other incumbent local
exchange carriers, other competitive local exchange carriers, cable television
companies, electric utilities, wireless telephone system operators, microwave
and satellite carriers and private networks owned by large end users.
The Telecommunications Act of 1996 facilitates such entry by requiring
incumbent local exchange carriers to allow competing providers to acquire local
services at wholesale prices for resale and to purchase unbundled network
elements at cost-based prices. A continuing trend toward combinations and
strategic alliances in the telecommunications industry, including potential
consolidation among incumbent local exchange carriers or competitive local
exchange carriers, or transactions between telephone companies and cable
companies outside of the telephone company's service area, or between
interexchange carriers and competitive local exchange carriers, could give rise
to significant new competitors.
The enhanced and information services markets are also highly competitive
and we expect that competition will continue to intensify. Our competitors in
these markets will include information service providers, telecommunications
companies, on-line service providers and Internet service providers.
Unauthorized Transactions; Theft of Services. We may be the victim of fraud
or theft of service. From time to time, callers have obtained our services
without rendering payment by unlawfully using our access numbers
H-3-65
and personal identification numbers. We attempt to manage these theft and fraud
risks through our internal controls and our monitoring and blocking systems. If
these efforts are not successful, the theft of our services may cause our
revenue to decline significantly. To date, we have not encountered material
fraud or theft of our service.
H-3-66
[FRONT OF PROXY CARD FOR COMMON STOCK,
SERIES D PREFERRED STOCK AND SERIES E PREFERRED STOCK]
PROXY
Z-TEL TECHNOLOGIES, INC.
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS FOR THE
SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON NOVEMBER 16, 2004
The undersigned, a stockholder of Z-Tel Technologies, Inc. ("Z-Tel"),
hereby appoints Messrs. John K. Aurell, W. Andrew Krusen, Jr. and Richard F.
LaRoche, Jr., jointly and severally, as attorney and proxy of the undersigned,
each with full powers of substitution, for and on behalf of the undersigned, to
represent the undersigned at the Special Meeting of Stockholders of Z-Tel to be
held at , at Eastern time, on Tuesday, November 16,
2004, and any adjournments or postponements thereof (the "Special Meeting"), and
to vote at the Special Meeting all the shares of capital stock of Z-Tel that the
undersigned is entitled to vote at the Special Meeting, with the same effect as
if the undersigned were personally present at the Special Meeting, all as
described in the company's Proxy Statement dated , , 2004 relating to the
Special Meeting, and the undersigned hereby authorizes and instructs the above
named proxies to vote as specified on the reverse side:
The shares represented by this Proxy will be voted in the manner directed
herein only if this Proxy is properly executed and timely returned. If the
undersigned does not specify a choice, the shares will be voted FOR the
proposals listed on the reverse side, and in the discretion of the proxies for
other matters which may properly come before the Special Meeting.
[REVERSE OF PROXY CARD FOR COMMON STOCK, SERIES D PREFERRED STOCK
AND SERIES E PREFERRED STOCK]
A. The board of directors solicits your voting in connection with the following
proposals:
I. / / FOR / / AGAINST / / ABSTAIN
Approval of the Exchange Offer,
II. / / FOR / / AGAINST / / ABSTAIN
Approval of the Proposed Series D Amendments, subject to approval and
consummation of the Exchange Offer.
III. / / FOR / / AGAINST / / ABSTAIN
Approval of an amendment to the certificate of incorporation to
eliminate the Series D Preferred Stock certificate of designation, subject to
approval and consummation of the Exchange Offer, and subject to all of the
Series D Preferred Stock being exchanged in the Exchange Offer.
IV. / / FOR / / AGAINST / / ABSTAIN
Approval of an amendment to the certificate of incorporation to
eliminate the Series E Preferred Stock certificate of designation, subject to
approval and consummation of the Exchange Offer.
V. / / FOR / / AGAINST / / ABSTAIN
Approval of the Proposed Series G Amendments, subject to approval and
consummation of the Exchange Offer.
VI. / / FOR / / AGAINST / / ABSTAIN
Approval of an amendment to the certificate of incorporation to
eliminate the Series G Preferred Stock certificate of designation, subject to
approval and consummation of the Exchange Offer, and subject to all of the
Series G Preferred Stock being exchanged in the Exchange Offer.
VII. / / FOR / / AGAINST / / ABSTAIN
Approval of an amendment of Z-Tel's certificate of incorporation to
effect a 3 for 1, 4 for 1, 5 for 1, 6 for 1, 7 for 1 or 8 for 1 reverse stock
split of the Common Stock, as determined at the direction of the board of
directors and subject to approval and consummation of the Exchange Offer.
VIII. / / FOR / / AGAINST / / ABSTAIN
Approval of the 2004 Stock Incentive Plan and reservation of 8% of the
Common Stock for issuance thereunder, subject to approval and consummation of
the Exchange Offer.
IX. / / FOR / / AGAINST / / ABSTAIN
Approval of an amendment to Z-Tel's certificate of incorporation
changing its name to "Trinsic, Inc."
B. OTHER MATTERS: Unless a line is stricken through this sentence, the proxies
herein named may in their discretion vote the shares represented by this Proxy
upon such other matters as may properly come before the Special Meeting.
The undersigned acknowledges receipt of the Z-Tel's Notice of Special
Meeting and Proxy Statement dated , , 2004 relating to the Special Meeting. The
undersigned does hereby revoke any proxy previously given with respect to the
shares represented by this Proxy.
,2004
Signature
Signature if held jointly
NOTE: Your signature should appear as your name appears hereon. As to shares
held in joint names, each joint owner should sign. If the signer is a
corporation, please sign full corporate name by a duly authorized officer. If a
partnership, please sign in partnership name by an authorized person. If signing
as attorney, executor, administrator, trustee, guardian, or in other
representative capacity, please give full title as such.
Please mark, sign and date this proxy card and promptly return it using the
enclosed envelope.
[FRONT OF PROXY CARD FOR SERIES G PREFERRED STOCK]
PROXY
Z-TEL TECHNOLOGIES, INC.
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS FOR THE
SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON NOVEMBER 16, 2004
The undersigned, a stockholder of Z-Tel Technologies, Inc. ("Z-Tel"),
hereby appoints and Messrs. John K. Aurell, W. Andrew Krusen, Jr. and Richard F.
LaRoche, Jr., jointly and severally, as attorney and proxy of the undersigned,
each with full powers of substitution, for and on behalf of the undersigned, to
represent the undersigned at the Special Meeting of Stockholders of Z-Tel to be
held at at local time, on November 16, 2004,
and any adjournments or postponements thereof (the "Special Meeting"), and
to vote at the Special Meeting all the shares of capital stock of Z-Tel that the
undersigned is entitled to vote at the Special Meeting, with the same effect as
if the undersigned were personally present at the Special Meeting, all as
described in the company's Proxy Statement dated , , 2004 relating to the
Special Meeting, and the undersigned hereby authorizes and instructs the above
named proxies to vote as specified on the reverse side:
The shares represented by this Proxy will be voted in the manner directed
herein only if this Proxy is properly executed and timely returned. If the
undersigned does not specify a choice, the shares will be voted FOR the
proposals listed on the reverse side, and in the discretion of the proxies for
other matters which may properly come before the Special Meeting.
[REVERSE OF PROXY CARD FOR SERIES G PREFERRED STOCK]
A. The board of directors solicits your voting in connection with the following
proposals:
V. / / FOR / / AGAINST / / ABSTAIN
Approval of the Proposed Series G Amendments, subject to approval and
consummation of the Exchange Offer.
VI. / / FOR / / AGAINST / / ABSTAIN
Approval of an amendment to the certificate of incorporation to eliminate
the Series G Preferred Stock certificate of designation, subject to approval and
consummation of the Exchange Offer, and subject to all of the Series G Preferred
Stock being exchanged in the Exchange Offer.
B. OTHER MATTERS: Unless a line is stricken through this sentence, the proxies
herein named may in their discretion vote the shares represented by this Proxy
upon such other matters as may properly come before the Special Meeting.
The undersigned acknowledges receipt of the Z-Tel's Notice of Special
Meeting and Proxy Statement dated , , 2004 relating to the Special Meeting. The
undersigned does hereby revoke any proxy previously given with respect to the
shares represented by this Proxy.
, 2004
Signature
Signature if held jointly
NOTE: Your signature should appear as your name appears hereon. As to shares
held in joint names, each joint owner should sign. If the signer is a
corporation, please sign full corporate name by a duly authorized officer. If a
partnership, please sign in partnership name by an authorized person. If signing
as attorney, executor, administrator, trustee, guardian, or in other
representative capacity, please give full title as such.
Please mark, sign and date this proxy card and promptly return it using the
enclosed envelope.