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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark
One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition period from to
Commission File No. 333-49397
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FOCAL COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware 36-4167094
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
200 North LaSalle Street,
Suite 1100, Chicago, Illinois 60601
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (312) 895-8400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference on Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Based on the closing sales price on the Nasdaq National Market on February
28, 2001 of $12.8125, the aggregate market value of our voting stock held by
non-affiliates on such date was approximately $382,153,082. Shares of common
stock held by each director and executive officer and by each person who owns
or may be deemed to own 10% or more of our outstanding common stock have been
excluded, since such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes. As of that date, Focal Communications
Corporation had 61,537,117 shares of common stock issued and outstanding.
Documents Incorporated by Reference: None.
Index of Exhibits is located on page 50.
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
We make statements in this Annual Report on Form 10-K that are not
historical facts. These "forward-looking statements" can be identified by the
use of terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or comparable terminology. These forward-looking statements
include, among others, statements concerning:
. Our business strategy and competitive advantages
. Our anticipation of potential revenues from designated markets or
customers
. Statements regarding the growth of the telecommunications industry and
our business
. The markets for our services and products
. Forecasts of when we will enter particular markets or begin offering
particular services
. Our anticipated capital expenditures and funding requirements
. Anticipated regulatory developments
These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial and regulatory developments and industry growth and trend
projections, that could cause actual events or results to differ materially
from those expressed or implied by the statements. The most important factors
that could prevent us from achieving our stated goals include, but are not
limited to, our failure to:
. Successfully expand our operations into new geographic markets on a
timely and cost-effective basis
. Successfully introduce and expand our data and voice service offerings on
a timely and cost-effective basis
. Design and install our Internet services infrastructure
. Respond to competitors in our existing and planned markets
. Execute and renew interconnection agreements with incumbent carriers on
terms satisfactory to us
. Enter into and maintain our agreements for transport facilities and
services, including Internet transit services
. Maintain acceptance of our services by new and existing customers
. Receive full and timely payments from customers
. Attract and retain talented employees
. Prevail in legal and regulatory proceedings regarding reciprocal
compensation for Internet-related calls or changes to laws and
regulations that govern reciprocal compensation
. Obtain and maintain any required governmental authorizations, franchises
and permits, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions
. Respond effectively to regulatory, legislative and judicial developments,
including developments relating to reciprocal compensation
. Manage administrative, technical and operational issues presented by our
expansion plans
. Raise sufficient capital on acceptable terms and on a timely basis
. Successfully provision digital subscriber line, or DSL services
2
PART I
ITEM 1. BUSINESS
Except as otherwise required by the context, references in this report to
the "Company," "Focal," "we," "us," or "our" refer to the combined business of
Focal Communications Corporation and all of its subsidiaries. Unless otherwise
indicated, the information in this Annual Report on Form 10-K gives effect to
a recapitalization pursuant to which our Class A common stock, Class B common
stock and Class C common stock were converted into a single class of common
stock and a 500-for-1 stock split. Both the recapitalization and the stock
split were effected on July 30, 1999.
This report contains trademarks of Focal, and may contain trademarks,
tradenames and service marks of other parties.
Introduction
We are a national broadband communications provider that offers voice,
data, and Internet infrastructure services to large communications-intensive
users in major cities. We began operations in 1996, initiated service first in
May 1997 and as of December 31, 2000 offered services in the following 20
markets:
Atlanta Houston Orange County, California
Boston Los Angeles Philadelphia
Chicago Minneapolis San Francisco
Cleveland New York San Jose
Dallas Northern New Jersey Seattle
Detroit Northern Virginia Washington, D.C.
Fort Worth Oakland
As part of our expansion, we plan to offer services in four additional
markets in 2001.
When we complete our expansion, the 24 markets in service will encompass a
total of 56 metropolitan statistical areas. As of December 31, 2000, we had
435,272 lines installed and in service. This compares to 181,103 lines
installed and in service as of December 31, 1999.
Our primary objective is to become the provider of choice to
communications-intensive customers in our target markets for voice, data and
Internet infrastructure services. Our sales and marketing efforts principally
target Fortune 1000 companies and we had successfully penetrated approximately
40% of the Fortune 100 as of December 31, 2000. We also provide services to
many of the leading network service providers in the nation.
We compete primarily on diversity, reliability, service, and price. Our
primary competition is the Incumbent Local Exchange Carrier ("ILEC").
Our customers tend to be the largest, most sophisticated communications
users in the country. We meet their demanding needs through our unique network
architecture, the experience of our operations team, and our award winning
back office systems. The superior performance of our network stems, in part,
to our extensive interconnections with the ILEC in each of our markets. As of
December 31, 2000, we had approximately 2,000 interconnections points. Our
customers recognize the advantages of this design in assuring them the high
throughput they need.
Most of our revenue is derived from the provision of switched voice and
data services. Our customers have also asked for Internet access services that
are as reliable as our local dial tone. To meet this demand, we launched a
suite of services in 2000 based on a high speed Internet switching platform
called the Focal Internet eXchange. These services take advantage of our
current infrastructure and customer base to provide dedicated Internet access,
colocation and private peering. These services are primarily targeted to both
corporate accounts and network service providers.
We believe we were the first communications provider to employ the "smart-
build" approach to network design. As such, we own and operate our switches,
and initially lease, rather than own, transport capacity. As our customer
traffic increases, it becomes economically attractive to own transport
capacity in select markets. Accordingly, we signed agreements to acquire 9,730
local fiber transport miles in nine cities as of December 31, 2000. To support
our service offerings, we have also leased approximately 23,000 DS-3 miles of
long haul fiber transport capacity connecting each of our markets. Using these
facilities, we are developing a nationwide ATM network to carry voice and data
traffic.
3
Market Potential
We believe communications-intensive users in large metropolitan markets are
not adequately supplied with highly reliable, local voice and data services. We
also believe that these types of users will increasingly demand diversity in
communications providers. As a result, we have chosen to initially do business
only in large metropolitan markets with a high concentration of communications-
intensive customers. We select our target geographical markets using several
criteria:
. Sufficient market size
. Supportive state regulatory environment
. The existence of multiple fiber transport providers with extensive
networks
We currently offer circuit-switched voice and data services, packet-switched
data services, and high-speed Internet services. We believe the market
potential in our target markets for these services is substantial.
The table below summarizes estimates from our market study regarding our
current and planned markets. You should be aware that, with the exception of
the "Operational Markets," the launch period shown in the second column is our
current estimate of when we will begin providing services in our planned
markets. These estimates are subject to change based upon numerous factors,
including timely performance by third party suppliers and receipt of required
regulatory approvals. You should also be aware that the markets targeted for
launch in 2001 are preliminary and each may be replaced by other markets.
Estimated Addressable
2000 Market Data(1)
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Number of Business
and Residential
Launch Period Switched Access Lines
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(in thousands)
Operational Markets:
Chicago, IL........................... May 1997 5,762
New York, NY.......................... January 1998 8,063
Philadelphia, PA...................... September 1998 2,795
San Francisco, CA..................... September 1998 1,631
San Jose, CA.......................... September 1998 1,359
Oakland, CA........................... September 1998 1,880
Washington, D.C....................... December 1998 4,257(2)
Northern Virginia, VA................. December 1998 --
Los Angeles, CA....................... December 1998 6,281
Orange County, CA..................... December 1998 4,131
Northern New Jersey................... January 1999 4,804
Boston, MA............................ January 1999 4,300
Detroit, MI........................... June 1999 3,553
Seattle, WA........................... September 1999 2,272
Dallas, TX............................ December 1999 2,238
Fort Worth, TX........................ December 1999 998
Atlanta, GA........................... First Quarter 2000 2,513
Houston, TX........................... First Quarter 2000 2,927
Cleveland, OH......................... Second Quarter 2000 1,808
Minneapolis, MN....................... Third Quarter 2000 1,700
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Planned Markets:
Baltimore, MD......................... First Quarter 2001 1,733
San Diego, CA......................... Second Quarter 2001 1,861
Miami, FL............................. Second Quarter 2001 3,048
St. Louis, MO......................... Third Quarter 2001 1,745
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Total:.............................. 71,659
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(1) This addressable market data does not include information for non-switched
data and voice services.
(2) Data for Northern Virginia are included in the data for Washington, D.C.
4
Strategy
Our objective is to become the provider of choice for broadband voice and
data services to communication intensive users in our target markets. Our
customer base already includes many leading companies such as:
Akamai Genuity Motorola Sony
Compuserve IBM Nortel Networks United
Earthlink Kraft Sears Stationers
Wyeth
In total, Focal served approximately 40% of the Fortune 100 as of December
31, 2000.
We believe that our success is based on our superior network reliability,
customer service, and sales force among other factors. The majority of our
sales people bring significant industry experience and long standing customer
relationships to the Company. Our back office support systems have won
numerous awards including CIO Magazine's Top 100, which recognizes the
companies with the leading information systems in the country.
Perhaps the best measure of customer satisfaction is our exceptional
customer loyalty. We have had virtually zero customer related churn during the
past several years. In fact, sales to the "same customer" grew by over 50% on
a year over year basis. We also added a significant number of new customers
during 2000 with the number of Telecom customers growing from 495 at the
beginning of 2000 to 1,225 at the end of the year.
Our primary source of competition is the ILEC usually a Regional Bell
Operating Company ("RBOC"). In addition to the above strengths, we also
differentiate Focal from the competition by offering customers the ability to
manage their local service on a national basis much like they do their long
distance services. Despite our success, we still have a very low share of the
local telecommunications market in the cities we serve, providing us with
significant growth opportunities for the future.
Develop New Markets, Expand Geographic Coverage
Our six most established markets, accounted for 68% of our installed lines
and 75% of our revenue for the three months ended December 31, 2000. This
means that the remaining 14 markets, 70% of our current markets, have
tremendous growth potential as they develop and perform more like our older
markets. In addition to developing these more recent markets, Focal plans to
expand into four new Tier 1 markets in 2001. This will bring our total markets
served to 24 and our metropolitan statistical areas served to 56. Our first
customers in a new market are usually existing customers that we serve in
other locations.
Expand Service Offerings
We have responded to our customers' requests for additional services by
offering new services that build on and leverage our existing infrastructure.
This strategy reduces our start-up costs and required capital investment. The
best example of this strategy is our high speed Internet access services based
on the Focal Internet eXchange which was launched in September of 2000. This
suite of services includes dedicated Internet access, colocation, private
peering, and managed modems. As a result of our network architecture, our
Internet access service provides measurably better performance than
competitive offerings. We believe our strong presence in both the corporate
and network services markets makes us a natural aggregation point for content
providers, aggregators, and end-users.
Design a Capital-Efficient Network
By utilizing the "smart-build" approach to network design we believe we
have optimized our return on invested capital. We do this by initially
leasing, rather than owning, fiber capacity, concentrating our capital
expenditures on switching facilities and information systems and acquiring
fiber transport capacity as the volume and demands of our customer traffic
warrants. Because of increased customer traffic volume in some of our
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markets, we began acquiring our own fiber transport capacity in 1999. By
continuing to use the "smart-build" approach to network and service
deployment, we expect to reduce the time and money required to launch new
markets and services, minimize the financial risk associated with
underutilized networks and generate revenue and cash flow more quickly. We
employ this same strategy for our suite of data services.
Maximize Network Utilization
We supplement our direct sales efforts with indirect sales to maximize the
utilization of our network assets and systems infrastructure. To achieve this
goal we actively utilize our VAR distribution channel. We provide services to
VARs, such as managers of multi-dwelling units and companies that market
bundled communications services to small- and medium-sized businesses. This
enables us to increase the number of access lines served by our networks,
driving network utilization. We also intend to pursue ways to maximize
utilization rates for our Internet backbone. For example, we plan to sell
unused upstream capacity to network service providers, content providers and
application service providers as a way to maximize the utilization and
efficiency of our network.
Networks
We utilize Nortel DMS-500 SuperNode digital central office switches for our
existing markets, and currently plan to deploy similar switches in our
additional markets. As we add customers in a market, it has generally been
most cost-effective for us to use leased fiber transport capacity to connect
our customers to our network. We have initially leased local network trunking
facilities from the ILECs and metropolitan network providers in each of our
markets in order to connect our switches to major ILEC central offices serving
the central business district and outlying areas of business concentrations.
Given the large volume of traffic that we generally carry, we are able to
negotiate favorable transport rates and still offer our customers redundancy
and diversity. In addition, we have designed our networks to maximize call
completion and significantly reduce the likelihood of blocked calls, which
helps us satisfy the needs of our high-volume customers. This "smart-build"
approach is possible because there are multiple vendors of local fiber
transport facilities in each of our large metropolitan markets, both current
and planned. Our switch-based, leased transport network architecture has
allowed us to:
. Reduce the time and money required to launch a new market
. Minimize financial risk associated with under-utilized networks
. Generate revenue and cash flow more quickly
We believe that the quantity of existing and planned fiber transport
facilities available from numerous carriers will be sufficient to satisfy our
need for local leased transport facilities and permit us to obtain these
facilities at competitive prices for the foreseeable future. The fiber
transport providers in our current and planned markets compete with each other
for our business in order to maximize the return on their fixed-asset
networks, which enables us to obtain competitive pricing. In addition, because
each of our fiber transport capacity providers is a common carrier, they are
required to make their transport services available to us on terms no less
favorable than those provided to similar customers.
We own a portion of our local transport capacity because of increased
volumes of customer traffic between our switches and specific ILEC central
offices in some of our markets. We are a party to agreements for the
acquisition of local fiber transport capacity covering a combined minimum of
10,800 fiber miles. As of December 31, 2000, we had activated our transport
network in nine cities, comprising 9,730 fiber miles.
We have also employed a "smart-build" approach in developing our inter-city
strategy. Initially, we resold long distance transmission service by buying
minutes on a wholesale basis. We currently lease fiber optic transport
capacity connecting our switches between each of our existing and planned
markets that transports our calls from market to market over our own network
and terminates the calls either directly at our customer's location or at the
ILEC switch. For international calls, we have negotiated agreements with
various international carriers for termination of our international calls
throughout the world.
6
To implement our inter-city network, we have signed agreements with a
number of carriers under which we have leased approximately 23,000 DS-3 miles
of transport capacity connecting each of our existing and planned markets.
This inter-city, DS-3 backbone network will initially be based on time
division multiplexing technology and then we will transition the inter-city
backbone to ATM technology. We believe the use of ATM switches will provide
greater flexibility in creating and managing both data and voice services over
the same physical network. We are currently able to price inter-city calls
that remain on our network as if they were local calls--a service we call
FocaLINC.
We are a party to a three year private line service agreement with MCI
WorldCom providing for the lease of fiber transport capacity that will be used
to connect our existing and planned markets. Under this agreement, we have
agreed to pay total charges of at least $70 million for private line services,
including existing private lines used within our markets to provide local
service.
In order to support high-speed access to corporate LANs, we began in 1999
to deploy DSL technology in our key markets. We have obtained colocation space
from the ILECs and we are installing DSL access multiplexers, or DSLAMs, in
colocation cages in ILEC central offices located in densely populated regions.
We had 292 ILEC central office colocations in service or under development as
of December 31, 2000. Once installed, the DSLAMs terminate into an ATM switch,
which transports high-speed data from end-users to Focal's corporate
customers. These customers then manage the flow of this traffic onto their
corporate LANs.
In connection with our data services, which include managed high-speed
Internet access, colocation and peering services, we:
. Built a new Internet platform, called a Focal Internet eXchange. Each
Focal Internet eXchange consists of a state-of-the art, fully-redundant,
powerful Internet routing and switching infrastructure that enables us
to provide high quality Internet access services to our customers. The
local facilities are monitored by a centralized data network operations
center, staffed 24 hours a day, seven days a week, and supported by
trained technical resources in the field.
. Purchased transit services from multiple Tier-1 backbone providers in
each of our markets. The transit services terminate in routers in our
Focal Internet eXchanges, giving our customers direct access to multiple
Internet backbones and allowing them to bypass congested, public
interconnection points.
Products and Services
Voice Services
Inbound Services. Our basic, inbound service allows for the completion of
calls to a new phone number we supply to our customer. Alternatively, local
number portability, or LNP, allows us to provide inbound services using a
customer's existing phone number. While LNP is occasionally unavailable and
cumbersome to implement, it permits us to serve customers without altering
their existing phone numbers. Consequently, we expect LNP to become
increasingly useful to us in taking existing business from our primary
competitors, the ILECs.
Direct inward dial service allows inbound calls to reach a particular
station on a customer's phone system without operator intervention. We market
direct inward dial service to our corporate customers as both a primary and
backup service. As a primary service, the customer uses Focal numbers where a
new line and number are needed, as when a customer hires a new employee. As a
backup service, we can implement an alternative numbering plan for the
customer in case the customer's primary service from the ILEC or another CLEC
is interrupted.
Outbound Services. Our basic outbound services allow local and toll calls
to be completed within a metropolitan region and long distance calls to be
completed worldwide. This direct outward dial service is utilized by end-users
in several ways. As a primary service, a customer uses Focal as a replacement
for the ILEC
7
in placing calls to destinations within the region. In our least cost routing
application, a customer can utilize our service in conjunction with its
existing ILEC service to route calls using whichever carrier is least
expensive for that particular type of call or time of day.
Other outbound applications include long distance overflow service in which
we act as a backup to the customer's existing long distance carrier in order
to optimize the number of direct, special access lines installed from the
customer's premises to the long distance carrier's network.
Our FocaLINC service is designed to price inter-city calls that remain on
our network as if they were local calls. This product provides a cost-
effective way for our customers in one market to make calls to their offices
in other Focal markets.
All of the services described above are commonly provisioned over a high-
speed digital communications circuit called a T-1 facility and interface
directly with our customers' private branch exchange or other customer-owned
equipment. Direct interfacing averts our need to provide multiplexing
equipment, which combines a number of communications paths onto one path, at
the customer's location. This is possible due to the high call volume
generated by the large communications-intensive customers we target. Our
ability to directly interface with existing customer equipment further
minimizes our capital investment and maximizes our overall return on capital.
Data Services
Access Services. Focal Virtual Office is designed to allow a corporate
customer's employees to dial-in to the corporate customer's local area network
using a telephone number in the employee's local calling area. This allows the
employee to access the local area network for the price of a local call and
enables our corporate customer to avoid the higher cost of maintaining region-
wide 800 service for local area network access. In addition, our Virtual
Office customers are able to use the Focal FinderTM service, an interactive
tool placed on the customer's web site that automatically provides a
telecommuting employee with the local calling number to be used for server
access.
Focal Multi-Exchange Service, a variant of the Focal Virtual Office service
marketed to network service providers, allows an network service provider's
customers to cost-effectively access the network service provider's remote
access servers. The combination of the multi-exchange service capacity and our
high level of customer care has resulted in strong demand for our Multi-
Exchange Service.
We are currently deploying DSL access services to provide high-speed,
dedicated access to corporate LANs and the Internet. This service is being
marketed to each of our targeted customer segments--large corporations, ISPs
and VARs. DSL service is or will be available in a variety of speeds ranging
from 144 kilobits per second to up to seven megabits per second. We believe
DSL access service is a natural extension of the switched data services that
we have provided since inception.
We offer our customers the ability to colocate equipment in our switching
centers. Equipment colocation benefits the customer by allowing it to
inexpensively house its data equipment without having to maintain secure,
environmentally controlled space. We also offer them equipment maintenance
services. These services are particularly well-suited to our network service
provider customers, who frequently operate remote access servers and routers
in conjunction with our switched services. As of December 31, 2000, we had
over 138,000 square feet of customer colocation space available or under
development.
Internet Services. As overall Internet usage has grown, it has placed
tremendous demands on public networks and peering points. As traffic moves
from one Internet backbone to another, it passes through a variety of
interconnection points. Users frequently complain about delays, lost packets
and other deterioration in service at these congested exchange points. At the
same time, access speeds available to consumers and businesses continue to
increase. New technology and faster modems are accelerating the speed at which
users can access the Internet.
8
With these greater access speeds and as more and more companies begin to
distribute content and applications over the Internet, demand for larger-sized
files and more complex applications has increased. As a result, reliable
Internet network performance has become essential to businesses and consumers.
Erratic performance and lengthy delays, once an acceptable norm, have become
unacceptable. For most, this means that fast, reliable and stable delivery of
content and applications will become the new standard.
Our data services respond to the increased demand for high-speed Internet
access and improved Internet content and services delivery. These services
include managed high-speed Internet access, colocation and peering services.
By building on our reputation as a premier provider of local access services
data, we intend to expand the value proposition to our customers while
satisfying their demand for additional data services.
Our managed high-speed Internet access services are principally targeted to
our corporate and network service provider customer segments. These services
provide high-quality access optimally routed over multiple Tier-1 Internet
backbone networks. We buy Internet transit services from multiple Tier-1
backbone providers, terminating those connections on our routers in our
switching centers. We believe that our aggregation of different providers and
control over these routers allows us to provide a higher quality of service
than our customers could otherwise afford. The service allows direct access to
the leading global backbones with private peering connections to reach most of
the Internet's top destinations, with availability of other backbones in case
of a network failure or outage. We expect that this solution will continue to
reduce many of the problems, namely packet loss and latency, that slow
Internet services today, and continue to provide faster download speeds and
increased reliability.
Our colocation services are targeted to customers who need to reach a high
concentration of end-users. Following the installation of a Focal Internet
eXchange, we will be able to offer an enhanced colocation environment to our
customers. By colocating in a Focal facility, our colocation customers have
the ability to improve the performance of content and application delivery by
situating as close to the edge of the network as possible and reach customers
of multiple network service providers from one location. Potential customers
for this service include content replication and distribution services,
streaming media hosting services, application service providers, unified
messaging providers and companies providing downloads of software and other
large files.
We believe that our private peering points facilitate a more reliable
exchange of traffic than is currently available. The current peering option
for most of our network service provider customers is to exchange traffic at
the public exchange points. These public exchange points are major bottlenecks
in the transfer of data as congestion causes lost packets and delays. By
managing a private peering environment for the exclusive use of our customers,
we will be able to facilitate smoother exchanges of Internet traffic.
While we expect that each of our Internet services will stand on its own,
the services are highly complementary. We believe that we will attract
colocation customers because we offer convenient access to end-users of
multiple network service providers. We believe we will attract network service
provider and corporate customers not only because of our more reliable
connectivity services, but also because of the ready access to content and
applications that our customers may host in our facilities.
Advanced Services
CDR Express provides our VAR customers with automated delivery of daily
call detail records, or CDRs, via the Internet. This system enables these
customers to accurately bill their customers in a secure environment. CDR
Express, as well as some other Focal products, are located in Your Domain--a
section of our web site specifically dedicated to each customer. Your Domain
enables our customers to access their most recent invoices, call detail
records and the customer order entry forms. Your Domain is protected by a
customer's user name and password. Your Domain can also inform customers of
new product offerings being developed by us. Our Form View product, located in
Your Domain, allows our customers to download order forms and other important
documents through the Internet at their convenience.
9
Focal FLOW is an outbound service marketed to VARs that need to be able to
switch outbound traffic among multiple long distance or international
carriers. We partition our central office switch so VARs can utilize the core
switching capability of our equipment at reasonable per minute or per port
cost.
Sales and Marketing
Our primary objective is to satisfy the need for highly reliable
communications services for communications-intensive users in the large
metropolitan markets in which we operate by providing diverse, reliable and
sophisticated services. We believe that we have a competitive advantage in
satisfying this need since we are focused on delivering a specific set of
innovative services to our target customers.
Diversity. Focal provides diversity to communications-intensive users by
delivering highly reliable, local communications services as an alternative to
the ILEC. This type of diversity already exists in other areas of
communications services, such as long distance. Communications-intensive
customers clearly embrace the benefits of diversity, particularly because
redundancy minimizes the effects of facilities failures and maximizes
competitive pricing. As a result, most of our target customers typically have
multiple long distance providers, multiple equipment vendors and multiple
local private-line providers. Because of our focused strategy, we believe that
we are uniquely positioned to become the provider of choice for data and voice
communications services for large, communications-intensive corporate users,
VARs and network service providers. Our focused strategy is based on our
ability to deliver the superior level of diverse, reliable and sophisticated
services that our customers require.
Reliability. We provide reliable service to communications-intensive users,
who are highly sensitive to the potential effects of facilities failures, by
designing our networks around the same theme of diversity that we advocate for
our customers. Although local services are perceived as simple, basic
services, the delivery of highly reliable, local services requires
sophisticated systems. We have engineered our switching and transport networks
to meet the demanding traffic and reliability requirements of our target
customers. Our network strategy is based on developing and operating a robust,
reliable, high-throughput local network relative to the ILECs and other CLECs.
Because we are a relatively new entrant to the markets we serve, we must meet
or exceed the performance quality of the existing local networks in order to
attract communications-intensive users to our networks. Unlike smaller users
that tend to pre-qualify vendors based on price, we believe that
communications-intensive users choose vendors based on the performance of
their networks, and specifically, their reliability. As a result, the design
and operation of our network are key success factors in our business
development process.
We conducted extensive research to identify the best hardware for the high-
volume users that we serve. As a result of this research, we selected Nortel
DMS-500 SuperNode central office switches, which we have engineered to reduce
significantly the likelihood of blocked calls and to maximize call completion.
As such, our customers are unlikely to find themselves unable to complete or
receive calls due to limitations inherent in our switches. We typically
connect to a large number of switches in the ILEC's network. As of December
31, 2000, we had connected to a total of 1,975 ILEC switches. We believe this
is a competitive advantage because it increases call completion even if a
portion of the ILEC's trunking network becomes blocked. We optimize the
configuration of our network by implementing overflow routing between the
ILEC's network and ours, where available. Because the customer base of the
ILECs and other CLECs is not typically as communications-intensive as ours, we
specifically engineered our network to accommodate traffic volumes per
customer far in excess of that which the ILECs or other CLECs typically
experience. We believe that our design is unique among ILECs and CLECs and is
attractive to our target customer base of communications-intensive users. In
addition, we enhance our reliability by delivering service from our switches
to customers over multiple fiber transport systems.
We have also implemented safeguards in our network design to maximize
reliability. The DMS-500 SuperNode switch allows us to distribute customer
traffic across multiple bays of equipment, thus minimizing the effects of any
customer outage. In addition, these switches were engineered by Nortel
Networks with fully redundant processors and memory in the event of a
temporary failure. Similarly, we design our Focal Internet
10
eXchanges to achieve high levels of reliability by connecting each Focal
Internet eXchange to at least three Internet backbone providers and by
building two levels of redundancy into our switching and routing
infrastructure at each Focal Internet eXchange. Our disaster prevention
strategy includes service from multiple power sources where available, on-site
battery backup and diesel generator power at each switching facility to
protect against failures of our electrical service.
Sophistication. Our target customers are knowledgeable, sophisticated
buyers of communications services that demand a high level of professionalism
throughout a vendor's organization. We believe that the technical
sophistication of our management and operations team has been a critical
factor in our initial success and will continue to differentiate us from our
competitors. Execution of our strategy of penetrating communications-intensive
accounts requires a well-experienced team of sales professionals. As a result,
attracting and retaining experienced sales professionals is important to our
overall success. Our sales professionals' compensation is structured to retain
these valuable employees through the grant of stock options and cash
compensation incentives.
We divide our direct sales force into four groups:
. The corporate services group
. The data services group
. The network solutions group
. The government services group
The corporate services group is responsible for selling to large corporate
users. Our sales strategy for these corporate customers is to initially
complement the customer's service from the ILEC. After we build the service
relationship, we anticipate increasing our overall penetration of the
customer's local service. Over a period of time, we hope to dominate a
corporate customer's local switched traffic. We emphasize the diversity,
reliability and sophistication of our services in order to earn our place as
the local provider of choice for our corporate customers.
The data services group is responsible for selling to network services
providers, DSL providers and other data carriers, including ISPs. We are able
to offer several innovative services such as environmentally conditioned
colocation space, virtually non-blocking switching, transport facilities, firm
installation times and high speed Internet access services based on our Focal
Internet eXchange.
The network solutions group markets directly to VARs and other carriers by
positioning us as a highly-reliable, responsive and cost-effective source of
wholesale local communications services. We believe a wide array of
communications service providers, including long distance companies, will seek
to provide bundled communications services in the large metropolitan markets
we target. We are well-positioned to be the provider of choice for re-bundled
local service. Because we do not intend to directly distribute our services to
residential or small- and medium-sized business customers, we believe that
VARs and other carriers looking to purchase the local service portion of their
bundled service offerings are more likely to purchase service from us rather
than from other ILECs or CLECs that compete with them.
The government services group is a dedicated group of telecommunications
professionals focused solely on meeting the demanding needs of telecom-
intensive government customers. Our teams are highly experienced in the
communications industry and understand the special requirements of the
government sector.
Information Systems
Superior customer service is critical to achieving our goal of capturing
market share. We are continually enhancing our service approach, which
utilizes a trained team of customer sales and service representatives to
coordinate customer installation, billing and service. Comprehensive support
systems are also a critical
11
component of our service delivery. We have installed systems designed to
address all aspects of our business, including service order, network
provisioning, end-user and carrier billing, and trouble reporting. The
efficiency of our operating processes contributes to our ability to rapidly
initiate service to new accounts. Our installation desk follows a customer's
order, ensuring the installation date is met. Additionally, our customer sales
representatives respond to all other customer service inquiries, including
billing questions and repair calls.
We are enhancing our systems and procedures for operations support, order
provisioning and other back office systems in order to facilitate and
streamline the processing of large order volumes and customer service. These
systems are required to enter, schedule, provision and track a customer's
order from the point of sale to the installation and testing of service. The
existing systems currently employed by most ILECs, CLECs and long distance
carriers generally require multiple entries of customer information to
accomplish order management, provisioning, switch administration and billing.
This process is not only labor intensive, but it creates numerous
opportunities for errors in provisioning service and billing, delays in
installing orders, service interruptions, poor customer service, increased
customer turnover and significant added expenses due to duplicated efforts and
decreased customer satisfaction.
We are currently using order management software to develop processes that
allow us not only to enter customer orders onsite, via computer and/or over
the Internet, but also to monitor the status of an order as it progresses
through the service initiation process. This software supports the process by
which we convert a customer to our network from the local exchange network of
an ILEC or other carrier, including circuit design and work flow management.
Electronic Bonding with ILECs. In an effort to make the initiation of
service for a customer more efficient, we have electronically bonded with
several ILECs and third party service providers. Electronic bonding has
improved our productivity by decreasing the period between the time of sale
and the time a customer's line is installed. Electronic bonding allows us to
access data from the ILEC, submit service requests electronically, and more
quickly attend to errors in the local service request form because an order is
bounced back if the ILEC determines that there is a mistake. As a result, we
expect to be able to eventually substantially reduce the time required to
switch service to us. Electronic bonding should also enable us to improve our
ability to provide better customer care since we will more readily be able to
pinpoint problems with a customer's order.
Electronic Bonding with Customers. We are also working toward the
electronic bonding of that portion of the billing process in which we gather
customer specific information, including their current service options, and
the process of identifying and resolving customer service problems.
We believe automation of internal processes contributes to the overall
success of a service provider and that billing is a critical element of any
telephone company's operation. We deliver billing information in a number of
media besides paper, including electronic files and Internet inquiry. Our
Invoice Domain service allows customers to securely access and view their
monthly invoices over the Internet. In addition, this service allows customers
to download call detail records. Similarly, our VAR customers can download
call records on a daily basis through our secure web site. This allows them to
efficiently process invoices for their end-user customers.
Significant Relationships
We have no customers that accounted for more than 10% of our revenues
during the three years ended December 31, 2000.
Competition
Portions of our industry are highly competitive. We face a variety of
existing and potential competitors, including:
. The ILECs in our current and target markets
. Other voice and data CLECs
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. Long distance carriers
. Potential market entrants, including cable television companies, VARs,
electric utilities, microwave carriers, wireless telephone system
operators and private networks built by large end-users
. Foreign carriers
. Internet infrastructure companies
Our primary competitor in each of our existing and planned markets is the
ILEC. Examples include BellSouth, Verizon, Qwest, and SBC. These ILECs are
generally required to file their prices with the state regulatory agencies in
their service areas. Any price changes must be reflected in these filings. The
ILECs have also generally been given the flexibility to respond to competition
with lower pricing. In most cases, proposals for lower pricing must also be
filed with the state utility commissions and the pricing must be made
available to similarly situated customers. We believe this provides a
disincentive for the ILECs to significantly vary or discount prices even in
competitive situations. However, as a CLEC, similar obligations apply to us.
See "--Regulation--State Regulation."
The ILECs offer a wider variety of services in a broader geographic area
than ours and have much greater resources than we do. This may encourage an
ILEC to subsidize the pricing for services with which we compete with the
profits of other services in which the ILEC remains the dominant provider. We
believe competition has limited the number of services dominated by ILECs. In
addition, state regulators have exercised their enforcement powers in a way
that makes it unlikely the ILECs would be able to successfully pursue this
type of protective pricing strategy for an extended period.
In addition to competition from ILECs, we also face competition from a
growing number of other CLECs. Although CLECs overall have only captured
approximately 5% of total revenue of the U.S. local telecommunications market,
we nevertheless compete to some extent with other CLECs in our customer
segments. There are typically several other CLECs competing in each
metropolitan market we serve or plan to enter. Examples of data and voice
CLECs in our markets include Allegiance Telecom, Covad Communications Group,
MCI WorldCom, XO Communications (formerly NEXTLINK Communications), Rhythms
NetConnections and Teleport Communications Group, now a part of AT&T. In some
instances, these CLECs have resources greater than ours and offer a wider
range of services. Many of the CLECs in our markets target small- and medium-
sized business customers, which differs from our target customer base of
large, communications-intensive users.
The data services market is also extremely competitive. Our principal
competitors in this market include Internet connectivity providers such as
UUNET Technologies and Verio, private peering companies, such as InterNAP
Network Services and Equinix, RBOCs that offer Internet access, global,
national and local ISPs and companies that offer colocation services, such as
Exodus Communications and AboveNet Communications. We also believe that new
competitors will enter the data services market.
Some of the ILECs recently requested, among other things, that the FCC
relax regulation of their provision of advanced data networks, which may also
be used for voice traffic. While the FCC has denied those requests, it has
initiated a rule-making that is intended to establish the procedures and
safeguards necessary before these ILECs could, through separate subsidiary
companies, provide these services on a largely deregulated basis. If adopted,
these rules may provide additional opportunities for competition from these
ILECs. SBC and Ameritech received authority from the FCC to create such a
subsidiary in the FCC's approval of their merger. Bell Atlantic New York also
received similar authority with the recent grant of its application to provide
long-distance service in New York. The FCC recently released an order
addressing, among other things, colocation rights of carriers offering
advanced data services, but deferred action on the separate subsidiary issue.
Bills have been introduced in Congress that would grant RBOCs permission to
provide data services in areas where they are currently restricted from doing
so. Although we cannot predict the outcome of any proposed or pending
legislation, the
13
ability of RBOCs to provide data services on a broader basis could have a
material adverse effect on us. In addition, the FCC recently acted to enable
ISPs to buy DSL services in bulk from ILECs, which could result in additional
competition for ISP business.
In addition to ILECs and other CLECs, we are competing with long distance
carriers. A number of long distance carriers have introduced local
telecommunications services to compete with us and the ILECs. These services
include toll calling and other local calling services, which are often
packaged with the carrier's long distance service. While we do not believe the
packaging aspect of the service is particularly attractive to the
communications-intensive customers we target, large long distance carriers
enjoy certain competitive advantages due to their vast financial resources and
brand name recognition. In addition, we believe there is a risk the long
distance carriers may subsidize the pricing of their local services with
profits from long distance services. We anticipate that the entry of some of
the ILECs into the long distance market will reduce the risk of this type of
activity by reducing the profitability of the long distance carrier's long
distance minutes. Further, to the extent the long distance carrier purchases
our service on a wholesale basis and rebundles it at a subsidized rate, we may
benefit as the subsidized, wholesale service could result in higher market
penetration than we would otherwise have achieved. In addition, we have
displaced long distance carriers where the customer was dissatisfied with the
quality of the long distance carrier's local service. We expect our reputation
for exceptional service quality and customer care will continue to result in
us displacing the long distance carrier as the primary alternative to the ILEC
in competitive situations. In addition, we expect that some of our recent and
proposed service offerings, which enable long distance calls to be priced like
local calls, will increase our competitiveness.
We compete principally on the basis of the quality, sophistication and
reliability of our service. See "--Sales and Marketing." We believe that the
principal competitive factors in our markets are speed and reliability of
service, quality of facilities, level of customer care and technical support,
and the timing and market acceptance of new services and enhancements to
existing services.
Regulation
The following summary of regulatory developments and legislation is not
complete. It does not describe all present and proposed federal, state and
local regulation and legislation affecting the telecommunications industry.
Existing federal and state regulations are currently subject to judicial
proceedings, legislative hearings and administrative proposals that could
change, in varying degrees, the manner in which our industry operates. We
cannot predict the outcome of these proceedings or their impact on the
telecommunications industry or us.
Overview. Our services are subject to varying degrees of federal, state and
local regulation. The decisions of regulatory bodies such as the FCC and state
agencies are often subject to judicial review, which makes it difficult for us
to predict outcomes in this area.
Federal Regulation. We must comply with the requirements of common carriage
under the Communications Act of 1934. Comprehensive amendments to the
Communications Act of 1934 were made by the Telecommunications Act of 1996,
referred to as the Telecom Act, which substantially altered both federal and
state regulation of the telecommunications industry. The purpose of this
legislation was to foster increased competition in the telecommunications
industry. Because implementation of the Telecom Act is subject to numerous
federal and state policy rule-making and judicial review, we cannot predict
with certainty what its ultimate effect on us will be.
Under the Telecom Act, any entity may enter a telecommunications market,
subject to reasonable state safety, quality and consumer protection
regulations. The Telecom Act makes local markets accessible by requiring the
ILEC to permit interconnection to its network and establishing ILEC
obligations with respect to:
. Colocation of equipment. This allows companies like us to install and
maintain our own network equipment, including DSLAMs, ATM switches, and
fiber optic equipment, in ILEC central offices.
14
. Interconnection. This requires the ILECs to permit their competitors to
interconnect with ILEC facilities at any technically feasible point in
the ILECs' networks.
. Reciprocal compensation. This requires the ILECs and CLECs to compensate
each other for telecommunications traffic that originates on the network
of one carrier and is sent to the network of the other.
. Resale of service offerings. This requires the ILEC to establish
wholesale rates for services it provides to end-users at retail rates to
promote resale by CLECs.
. Access to unbundled network elements. This requires the ILECs to
unbundle and provide access to some components of their local service
network to other local service providers. Unbundled network elements are
portions of an ILEC's network, such as copper lines or "loops," that
CLECs can lease in order to create their own facilities networks.
. Number portability. This requires the ILECs and CLECs to allow a
customer to retain an existing phone number within the same local area
even if the customer changes telecommunications services providers. All
telecommunications carriers are required to contribute to the shared
industry costs of number portability.
. Dialing parity. This requires the ILECs and CLECs to establish dialing
parity so that all customers must dial the same number of digits to
place the same type of call.
. Access to rights-of-way. This requires the ILECs and CLECs to establish
non-discriminatory access to telephone poles, ducts, conduits and
rights-of-way.
ILECs are required to negotiate in good faith with other carriers that
request any or all of the arrangements discussed above. If a requesting
carrier is unable to reach agreement with the ILEC within a prescribed time,
either carrier may request arbitration by the applicable state commission. If
an agreement still cannot be reached, carriers are forced to abide by the
obligations established by the FCC and the applicable state commission.
We have entered into a number of interconnection agreements with the ILECs
in our markets. We have existing interconnection agreements in each of our
existing markets and in several of our planned markets. Several of the
original interconnection agreements covering our existing markets, including
the agreements covering Chicago and New York, have already expired. The
expiration of these agreements has required us either to negotiate and
arbitrate new interconnection terms with the ILECs, or to opt-in to other
agreements. Pending conclusion of these negotiations and arbitrations, several
existing interconnection agreements should continue to govern the payment of
reciprocal compensation and other interconnection terms, while other
renegotiated or arbitrated agreements may be given retroactive effect from the
expiration date of the superceded agreement following the conclusion of
negotiations and arbitrations.
The FCC is charged with establishing guidelines to implement the Telecom
Act. In August 1996, the FCC released a decision, known as the Interconnection
Decision, that established rules for the interconnection requirements outlined
above and provided guidelines for interconnection agreements by state
commissions. The U.S. Court of Appeals for the Eighth Circuit vacated portions
of the Interconnection Decision. On January 25, 1999, the U.S. Supreme Court
reversed the Eighth Circuit and upheld the FCC's authority to issue
regulations governing pricing of unbundled network elements provided by the
ILECs in interconnection agreements, including regulations governing
reciprocal compensation, which are discussed in more detail below. In
addition, the Supreme Court affirmed an FCC rule that allows requesting
carriers to "pick and choose" the most attractive portions of existing
interconnection agreements with other carriers. The Supreme Court did not,
however, address other challenges raised about the FCC's rules at the Eighth
Circuit because those challenges had not first been decided by the Eighth
Circuit. In addition, the Supreme Court disagreed with the standard applied by
the FCC for determining whether an ILEC should be required to provide a
competitor with particular unbundled network elements.
15
The FCC adopted a new standard in November 1999 for analyzing unbundled
network elements as required by the Supreme Court's order. Applying this
standard to the existing network elements, the FCC concluded that ILECs would
no longer be required to provide directory assistance and operator services as
network elements, though they will continue to be available pursuant to tariff
at different prices. The FCC also removed unbundled switching as an element in
urban areas where the incumbents are also providing certain other combinations
of elements in a non-discriminatory fashion. However the FCC declined, except
in limited circumstances, to require ILECs to unbundle certain facilities used
to provide high speed Internet access and other data services.
On July 18, 2000, the Eighth Circuit issued its order concerning the issues
left unresolved by the Supreme Court. It vacated the FCC's rules regarding the
discount on retail services that ILECs must provide to CLECs, the costing
rules that must be applied in determining the price of unbundled network
elements from ILECs, and the requirement that ILECs must provision
combinations of UNEs that are not already combined. The Supreme Court will
hear the latter two issues in its coming term. It is not possible to predict
the outcome of that decision.
The Supreme Court's 1999 decision and the FCC's order on remand do not
remove all uncertainty concerning the pricing terms and conditions of
interconnection agreements. In particular, the Supreme Court's further review
and ILEC appeals of the FCC's order on remand create contingencies. The
resulting uncertainty makes it difficult to predict whether we will be able to
continue to rely on our existing interconnection agreements or have the
ability to negotiate acceptable interconnection agreements in the future.
In addition to requiring the ILECs to open their networks to competitors
and reducing the level of regulation applicable to CLECs, the Telecom Act also
reduces the level of regulation that applies to the ILECs, thereby increasing
their ability to respond quickly in a competitive market. For example, the FCC
has applied "streamlined" tariff regulation of the ILECs, which shortens the
requisite waiting period before which tariff changes may take effect. These
developments enable the ILECs to change rates more quickly in response to
competitive pressures. The FCC has also adopted heightened price flexibility
for the ILECs, subject to specified caps. If exercised by the ILECs, this
flexibility may decrease our ability to effectively compete with the ILECs in
our markets.
The Telecom Act also gives the FCC authority to determine not to regulate
carriers if it believes regulation would not serve the public interest. The
FCC is charged with reviewing its regulations for continued relevance on a
regular basis. As a result of this mandate, a number of regulations that apply
to CLECs have been and may in the future continue to be eliminated. We cannot,
however, guarantee that any regulations that are now or will in the future be
applicable to us will be eliminated.
In March 1999, the FCC issued an order requiring ILECs to provide unbundled
loops and colocation on more favorable terms than had previously been
available. The order permits colocation of equipment that could be used to
more efficiently provide advanced data services such as high-speed DSL
service, and requires less expensive "cageless" colocation. In the March
order, the FCC deferred action on its previous proposal to permit ILECs to
offer advanced data services through separate affiliates, free from some of
the obligations of the Telecom Act. The D.C. Circuit vacated the FCC's rules
regarding the colocation of equipment providing functionalities in addition to
interconnection and access to UNEs, connections between colocating CLECs, and
selection of colocation space. The FCC has not yet issued its order on remand
from this decision.
In an August 1999 order, the FCC determined that advanced services are
telecommunication services subject to regulation under Sections 251 and 252 of
the Telecom Act. In the same order the FCC issued a notice of proposed rule
making on terms for the provision of such services on a separate subsidiary
basis. Permitting ILECs to provision data services through separate affiliates
with fewer regulatory requirements could have a material adverse impact on our
ability to compete in the data services sector. The FCC imposed conditions on
the merger of SBC with Ameritech in October 1999 that permit the provisioning
of advanced data services via separate subsidiaries pursuant to various
requirements, some of which expire in the near term. The D.C. Circuit vacated
the separate subsidiary requirement on January 29, 2001. We cannot predict
whether these requirements will ultimately prove enforceable, nor whether they
will deter anticompetitive behavior if they are enforceable.
16
Bell Atlantic's application for long distance service in New York has been
approved subject to similar separate subsidiary provisions. These areas of
regulation are subject to change through additional proceedings at the FCC or
judicial challenge.
On December 9, 1999, the FCC released its line sharing order that requires
ILECs to offer line sharing as an unbundled network element by June 6, 2000.
Line sharing permits CLECs to use a customer's existing line to provide DSL
services while the ILEC continues to use the same line to provide voice
service. Prices for line sharing will be set by the states.
Reciprocal Compensation. Reciprocal compensation is the compensation paid
by one carrier to complete particular calls on another local exchange
carrier's network. Because a significant portion of our customers typically
receive more calls than they make, we expect to receive more reciprocal
compensation than we pay for calls that originate on our networks. As a result
of the current regulatory environment and several trends in our business,
which are discussed below, we expect our revenues from reciprocal compensation
to decline significantly.
Some ILECs have refused to pay reciprocal compensation charges that they
estimate are the result of inbound ISP traffic because they believe that this
type of traffic is outside the scope of existing interconnection agreements.
For example, Ameritech disputed a portion of the reciprocal compensation
charges billed to it by us, which it believed were related to Internet
charges. In March of 1998, the Illinois Commerce Commission ruled in favor of
Focal and other CLECs regarding this dispute. In October 1998, Ameritech
complied with the ruling and we received payment for past reciprocal
compensation charges that represents substantially all of the disputed
amounts. On June 18, 1999, the Seventh Circuit affirmed the Illinois Commerce
Commission's order requiring the payment of reciprocal compensation for ISP-
bound traffic. On August 19, 1999, the Seventh Circuit modified its prior
order by providing that Ameritech is free to raise in state courts any state
claims concerning reciprocal compensation, and by deferring any ruling on the
petitions for rehearing pending the Court's resolution in other cases of
procedural issues concerning the participation of state commissioners.
Ameritech had previously filed such a state complaint which at its request had
been held in abeyance pending the outcome of the federal case. On March 5,
2001, the Supreme Court granted certiorari to hear the issues pertaining to
the participation of the state commissioners, and whether interconnection
agreement enforcement actions may be appealed in federal court. We cannot
predict the Supreme Court's ultimate order.
Some states in which our current and planned markets are located have
ordered the ILECs to pay reciprocal compensation for Internet-related calls.
The majority of states that have addressed the question have ruled that
compensation is owed for this traffic. However, these states and other states
that have not considered the issue to date may yet determine that no
compensation is owed. A finding that reciprocal compensation is not payable
for ISP traffic in California, Illinois, New York or Pennsylvania would have a
material adverse effect on us.
In addition, on February 26, 1999, the FCC issued a declaratory ruling and
Notice of Proposed Rulemaking concerning inbound ISP traffic. The FCC
concluded in its ruling that ISP traffic is jurisdictionally mixed and largely
interstate in nature, and also concluded that this traffic is not subject to
the reciprocal compensation provisions of the Telecom Act. The FCC has
requested comment as to what reciprocal compensation rules should govern this
traffic upon expiration of existing interconnection agreements. The FCC also
determined that no federal rule existed that governed reciprocal compensation
for ISP traffic at the time existing interconnection agreements were
negotiated and concluded that it would permit states to determine whether
reciprocal compensation should be paid for calls to ISPs under existing
interconnection agreements. On March 24, 2000, the D.C. Circuit vacated the
FCC's finding that this traffic is not subject to reciprocal compensation
provisions of the Telecom Act, and remanded this issue to the FCC for further
examination. The Court did not address the jurisdictional issue, nor the
authority of the states.
In light of the FCC's order and the court decision, state commissions,
which previously addressed this issue and required reciprocal compensation to
be paid for ISP traffic, may reconsider and may modify their prior
17
rulings. Several ILECs, including Ameritech, are seeking to overturn prior
orders that they claim are inconsistent with the FCC's February 26, 1999
order. Relief sought could include repayment of reciprocal compensation
amounts previously paid by the ILECs. Of the 32 state commissions that have
considered the issue since the FCC's February 26, 1999 order, 25 of these
states have upheld the requirement to pay reciprocal compensation for ISP-
bound traffic. Only Massachusetts, New Jersey, South Carolina, Louisiana,
Arizona, Colorado, and Iowa are not requiring reciprocal compensation for this
traffic, at least pending negotiations and a further FCC decision. Missouri
and Ohio are not requiring current payment, but are requiring a true-up based
on the FCC's future decision. In addition, of the seven Federal District
Courts and the three Courts of Appeals that have reviewed this issue on the
merits to date, all have upheld state decisions requiring that reciprocal
compensation be paid for ISP-bound traffic.
The New York Public Service Commission (the "NYPSC") determined that in
certain circumstances, Verizon can pay a lower reciprocal compensation for
calls terminated by a CLEC in excess of a ratio of three terminating minutes
to each originating minute. The NYPSC also provided an opportunity to a CLEC
having a ratio in excess of three-to-one, such as Focal, to demonstrate that
its network is such that the higher rate should be applied. The NYPSC also
permitted Verizon to file a tariff seeking to reduce the end office rate by
thirty percent from its current level of $0.0034/MOU. Focal and other CLECs
have protested this filing. Verizon has unilaterally reduced the reciprocal
compensation rate in the New York market from July 1, 1999 on a going forward
basis, which we have vigorously challenged in connection with the NYPSC
proceeding described above. Verizon has also informed us that it intends to
unilaterally escrow these payments in two smaller markets, New Jersey and
Delaware.
Upon expiration of our existing interconnection agreements, we must
negotiate new rates for reciprocal compensation with each carrier. Pending
conclusion of these negotiations, the existing interconnection agreements are
expected to continue to govern the payment of reciprocal compensation. We
expect rates for reciprocal compensation will be lower under new
interconnection agreements than under our existing agreements. A reduction in
rates payable for reciprocal compensation could have a material adverse effect
on us, as could any requirement to refund reciprocal compensation paid to
date.
In addition to charging other carriers reciprocal compensation for
terminating local traffic, Focal also collects access charges from carriers
for originating and terminating interexchange traffic. Two interexchange
carriers, AT&T and WorldCom, have stated that they will not pay the portion of
Focal's traffic-sensitive access charges that exceed ILEC traffic-sensitive
access charges. The Company is currently suing AT&T to recover these amounts.
In May 1997, the FCC released an order establishing a significantly
expanded universal service regime to subsidize the cost of telecommunications
service to high cost areas, as well as to low-income customers and qualifying
schools, libraries, and rural health care providers. Providers of interstate
telecommunications services, like us, as well as certain other entities, must
pay for these programs. We are also eligible to receive funding from these
programs if we meet certain requirements, but we are not currently planning to
do so. Our share of the payments into these subsidy funds will be based on our
share of certain defined telecommunications end-user revenues. Currently, the
FCC is assessing such payments on the basis of a provider's revenue for the
previous year. Various states are also in the process of implementing their
own universal service programs. We are currently unable to quantify the amount
of subsidy payments that we will be required to make and the effect that these
required payments will have on our financial condition. Moreover, some of the
FCC's universal service rules remain subject to judicial appeal and further
FCC review including the FCC's 8% rule. The FCC's 8% rule provides that a
carrier's international revenue is exempt from universal service assessment
when its total interstate revenue represents 8% or less of its combined
interstate and international revenue. Any court decision that has the effect
of reducing the entities subject to universal service contributions could
increase the contributions of the remaining entities that are subject to the
rules. The FCC currently assesses universal service contributions based on
prior year revenues; however, the FCC has initiated a rulemaking to reconsider
this approach. Additional changes to the universal service program could
increase our costs.
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The FCC has made and is continuing to consider various reforms to the
existing rate structure for charges assessed on long distance carriers for
allowing them to connect to local networks. These reforms are designed to move
these "access charges," over time, to lower, cost-based rate levels and
structures. These changes will reduce access charges and will shift charges,
which had historically been based on minutes-of-use, to flat-rate, monthly per
line charges on end-user customers rather than long distance carriers. On
August 5, 1999, the FCC adopted an order granting price cap local exchange
carriers additional pricing flexibility, implementing certain access charge
reforms, and seeking comment on others. The order provides certain immediate
regulatory relief to price cap carriers and sets a framework of "triggers" to
provide these companies with greater flexibility to set interstate access
rates as competition increases. The order also initiated rulemaking to
determine whether the FCC should regulate competitive local exchange carriers
access charges. On February 2, 2001, the D.C. Circuit upheld the FCC rules
regarding pricing flexibility. The FCC has recently granted pricing
flexibility applications for switched access services provided by BellSouth in
a number of cities in its service territory. The FCC also granted flexible
pricing authority for dedicated transport and special access services provided
by SBC entities in certain cities, and for dedicated transport and special
access services provided by Verizon entities in certain cities. The manner in
which the FCC continues to implement its approach to lowering access charge
levels and a decision to regulate competitive local exchange carrier access
rates could have a material effect on our ability to compete in providing
interstate access services.
On May 31, 2000 the FCC adopted the proposal of the Coalition for
Affordable Long Distance Service ("CALLS") that significantly restructures
and, reduces in some respects, the interstate access charges of the RBOCs,
AT&T, and Sprint. Among the more significant regulatory changes established by
the CALLS Order, the RBOCs are required to reduce switched access charges to
an average of $0.0055/minute. Price cap ILECs are additionally required to
eliminate the presubscribed interexchange carrier charge ("PICC") as a
separate charge and fold it into an increased subscriber line charge. AT&T and
Sprint have committed in this proceeding to pass on access charge reductions
to consumers, and to eliminate minimum monthly usage charges. Although the
CALLS Order will not apply directly to CLECs, ILEC reductions in switched
access charges may place some downward pressure on CLEC's to reduce their own
switched access charges. In addition, IXCs other than AT&T and Sprint are not
subject to the CALLS Order, but may seek to alter their offerings to conform
to AT&T's and Sprint's commitments in this proceeding. A Petition for
Reconsideration of the CALLS Order is currently before the FCC.
Tariff and Filing Requirements. Non-dominant carriers, including Focal,
must file tariffs with the FCC listing the rates, terms and conditions of
interstate and international services provided by the carrier. On October 29,
1996, the FCC adopted an order in which it eliminated the requirement that
non-dominant interstate carriers maintain tariffs on file with the FCC for
domestic interstate services. Accordingly, non-dominant interstate carriers,
including Focal, no longer file interstate tariffs with the FCC for these
services.
In addition, periodic reports concerning carriers' interstate circuits and
deployment of network facilities also are required to be filed with the FCC.
The FCC generally does not exercise direct oversight over cost justification
and the level of charges for services of non-dominant carriers, although it
has the power to do so. The FCC may also impose prior approval requirements on
transfers of control and assignments of operating authorizations.
Fines or other penalties also may be imposed for violations of FCC rules or
regulations. The FCC also requires that certified carriers like Focal notify
the FCC of foreign carrier affiliations and secure a determination that such
affiliations, if in excess of a specified amount, are in the public interest.
State Regulation. Most states regulate entry into the markets for local
exchange and other intrastate services, and states' regulation of CLECs vary
in their regulatory intensity. The majority of states require that companies
seeking to provide local exchange and other intrastate services to apply for
and obtain the requisite authorization from a state regulatory body, such as a
state commission. This authorization process generally requires the carrier to
demonstrate that it has sufficient financial, technical and managerial
capabilities and that granting the
19
authorization will serve the public interest. As of December 31, 2000, we had
obtained local exchange certification or were otherwise authorized to provide
local exchange service in:
California Illinois Minnesota Pennsylvania
Delaware Indiana Missouri Texas
District of Maryland New Jersey Virginia
Columbia Massachusetts New York Washington
Florida Michigan Ohio
Georgia
To the extent that an area within a state in which we provide service is
served by a small or rural exchange carrier not currently subject to
competition, we may not currently have authority to provide service in those
areas at this time.
As a CLEC, we are and will continue to be subject to the regulatory
directives of each state in which we are and will be certified. Most states
require that CLECs charge just and reasonable rates and not discriminate among
similarly situated customers. Some other state requirements include:
. The filing of periodic reports
. The payment of various regulatory fees and surcharges
. Compliance with service standards and consumer protection rules
States also often require prior approvals or notifications for certain
transfers of assets, customers, or ownership of a CLEC and for issuances by
certified carriers of equity securities, notes or indebtedness, although the
terms of this offering do not require any prior approval. States generally
retain the right to sanction a carrier or to revoke certifications if a
carrier violates relevant laws and/or regulations. Delays in receiving
required regulatory approvals could also have a material adverse effect on us.
We cannot assure you that regulators or third parties will not raise material
issues with regard to our compliance or non-compliance with applicable laws or
regulations.
In most states, certificated carriers like us are required to file tariffs
setting forth the terms, conditions, and prices for services which are
classified as intrastate. In some states, the required tariff may list a range
of prices for particular services, and in others, such prices can be set on an
individual customer basis. We may, however, be required to file tariff addenda
of the contract terms.
Under the Telecom Act, implementation of our plans to compete in local
markets is and will continue to be, to a certain extent, controlled by the
individual states. The states in which we operate or intend to operate have
taken regulatory and legislative action to open local communications markets
to various degrees of local exchange competition.
Local Regulation. We are also subject to numerous local regulations, such
as building code requirements, franchise and local public rights of way. These
regulations may vary greatly from state to state and from city to city.
Employees
As of December 31, 2000, we employed 1,130 full-time employees, none of
whom were covered by a collective bargaining agreement. We believe that our
future success will depend on our continued ability to attract and retain
highly skilled and qualified employees. We believe that our relations with our
employees are good.
ITEM 2. DESCRIPTION OF PROPERTY
We are headquartered in Chicago, Illinois and lease office space in a
number of locations, primarily for network equipment installations and sales
and administrative offices and cover approximately 796,000 square feet of
leased space. These leases expire in years ranging from 2002 to 2015 and have
varying renewal options. We also own approximately 13 acres of real property
in Arlington Heights, Illinois. This property, which includes a 52,000 square
foot building, houses our second Chicago-area switching center, national data
center and national network operations center.
20
ITEM 3. LEGAL PROCEEDINGS
With the exception of the matters discussed below, we are not aware of any
material litigation against us. In the ordinary course of our business, we are
involved in a number of regulatory proceedings before various state
commissions and the FCC.
On September 16, 1997, we filed a complaint and request for temporary
injunction against Ameritech Illinois with the Illinois Commerce Commission.
The complaint claimed breach of the terms of the interconnection agreement
between us and Ameritech Illinois because Ameritech Illinois refused to pay
reciprocal compensation for our transport and termination of calls to our end-
users that Ameritech Illinois believed were ISPs. In the interests of
obtaining a more timely judgment, we withdrew our complaint without prejudice
on October 17, 1997 and filed to intervene in a consolidated suit that
included similar complaints against Ameritech Illinois by several other CLECs.
On March 11, 1998, the Illinois Commerce Commission issued an order that
required Ameritech Illinois to pay reciprocal compensation for calls made to
ISPs. On March 15, 1998, Ameritech Illinois filed a motion with the Illinois
Commerce Commission to stay the order pending an appeal, which was denied on
March 23, 1998. On March 27, 1998, Ameritech Illinois filed suit in the United
States District Court for the Northern District of Illinois seeking reversal
of the Illinois Commerce Commission order. Ameritech Illinois also sought a
stay of this order from the District Court, which was granted while the case
was decided. On July 21, 1998, the District Court upheld the Illinois Commerce
Commission's order, finding that calls to ISPs are local calls and therefore
subject to the reciprocal compensation rules contained in the Telecom Act. The
District Court stayed the decision to permit any party to appeal. Ameritech
Illinois then appealed the decision to the U.S. Court of Appeals for the
Seventh Circuit on August 25, 1998, and was denied a stay while the appeal is
pending. In October 1998, Ameritech Illinois complied with the order and we
received payment for past reciprocal compensation charges that represent
substantially all of the disputed amounts. On June 18, 1999, the Seventh
Circuit affirmed the Illinois Commerce Commission's order requiring the
payment of reciprocal compensation for ISP-bound traffic. On August 19, 1999,
the Seventh Circuit modified its prior order to permit Ameritech to raise in
state courts any state claims concerning reciprocal compensation. On March 5,
2001, the Supreme Court agreed to hear the appeal pertaining to the
participation of the state commissioners, and whether interconnection
agreement enforcement actions may be appealed in federal court. We cannot
predict the Supreme Court's ultimate order or its effect on our business or
financial condition. See "Business--Regulation" for a description of federal
rule-making and other developments affecting reciprocal compensation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Focal did not submit any matter to a vote of its stockholders during the
fourth quarter of 2000.
21
PART II
ITEM 5. MARKET FOR FOCAL'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS AND
MARKET INFORMATION
Focal's common stock is traded on the Nasdaq National Market. Focal's
ticker symbol is "FCOM." Focal completed the initial public offering of its
common stock in August 1999. Prior to August 1, 1999, no established public
trading market for the common stock existed.
The following table sets forth on a per share basis, the high and low bid
information per share for our common stock as reported on the Nasdaq National
Market for the periods indicated:
High Low
------ ------
Year ended December 31, 1999:
Third quarter (from July 28, 1999)....................... $29.75 $15.50
Fourth quarter........................................... $26.88 $18.50
Year ended December 31, 2000:
First quarter............................................ $77.75 $26.00
Second quarter........................................... $46.00 $20.00
Third quarter............................................ $43.63 $13.88
Fourth quarter........................................... $20.75 $ 6.94
There were approximately 161 owners of record of Focal common stock as of
February 28, 2001. This number excludes stockholders whose stock is held in
nominee or street name by brokers and Focal believes that it has a
significantly larger number of beneficial holders of common stock. A recently
reported sale price of our common stock on the Nasdaq National Market is set
forth on the front cover of this report.
Dividends
We have not paid any cash dividends on our common stock in the past and do
not anticipate paying any cash dividends on our common stock in the
foreseeable future. Any future determination to pay dividends will be at the
discretion of our board of directors and will be dependent upon then existing
conditions, including our financial condition, results of operations,
contractual restrictions, capital requirements, business prospects, and other
factors our board of directors deems relevant. In addition, our current
financing arrangements effectively prohibit us from paying cash dividends for
the foreseeable future.
Recent Sales of Unregistered Securities
Focal did not sell any equity securities during the period covered by this
report that were not registered under the Securities Act of 1933 and that were
not previously reported on Form 10-Q.
22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected consolidated financial data presented below for the three
years ended December 31, 2000, have been derived from our Consolidated
Financial Statements and the accompanying notes related thereto. Our
Consolidated Financial Statements for the three years ended December 31, 2000
have been audited by Arthur Andersen LLP, our independent public accountants.
The balance sheet data as of December 31, 1996, 1997 and 1998 has been derived
from our audited consolidated financial statements not included in this
report. You should read the information in this table in conjunction with Item
7A, "Quantitative and Qualitative Disclosures About Market Risk", Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and our Consolidated Financial Statements and the accompanying
notes related thereto appearing elsewhere in this report.
Period from
Commencement
of Operations
Years Ended December 31, (May 31, 1996)
---------------------------------------------- to December 31,
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ---------------
(Dollars in thousands, except share data)
Statement of Operations
Data:
Data services........... $ 158,968 $ 96,856 $ -- $ -- $ --
Telecom services........ 75,152 30,005 -- -- --
---------- ---------- ---------- ---------- ---------
Total revenues...... $ 234,120 $ 126,861 $ 43,532 $ 4,024 $ --
Expenses:
Network expenses...... 89,741 29,941 5,098 2,155 --
Selling, general and
administrative....... 155,498 73,455 22,396 2,887 422
Depreciation and
amortization......... 56,985 23,763 6,671 616 1
Non-cash compensation
expense.............. 6,360 7,186 3,070 1,300 108
---------- ---------- ---------- ---------- ---------
Operating income (loss). (74,464) (7,484) 6,297 (2,934) (531)
Other income (expense),
net.................... (35,598) (14,302) (9,606) 68 17
Income tax benefit
(expense).............. 4,205 (600) (4,660) -- --
Accretion to redemption
value of Class A common
Stock -- -- -- (104) --
---------- ---------- ---------- ---------- ---------
Net loss applicable to
common stockholders.... $ (105,857) $ (22,386) $ (7,969) $ (2,970) $ (514)
========== ========== ========== ========== =========
Basic and diluted net
loss per share......... $ (1.75) $ (0.45) $ (0.18) $ (0.07) $ (0.06)
========== ========== ========== ========== =========
Basic weighted average
common stock
outstanding............ 60,456,245 50,066,315 43,763,000 42,186,500 8,498,000
========== ========== ========== ========== =========
Other Financial Data:
EBITDA.................. $ (11,119) $ 23,465 $ 16,038 $ (1,018) $ (422)
Capital expenditures.... 309,617 128,550 64,229 11,655 82
Summary Cash Flow Data:
Net cash provided by
(used in) operating
activities............. $ 52,196 $ 18,549 $ 22,507 $ (1,634) $ (153)
Net cash used in
investing activities... (309,937) (130,590) (72,189) (11,655) (82)
Net cash provided by
financing activities... 251,016 164,142 173,466 11,756 4,025
Operating Data:
Access lines in service. 435,272 181,103 52,011 7,394 --
Minutes of use
(millions)............. 27,569 13,362 3,568 282 --
23
As of December 31,
-----------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- ------ ------
Balance Sheet Data:
Cash, cash equivalents and short-
term investments................... $181,737 $188,142 $134,001 $2,257 $3,790
Current assets...................... 249,629 219,932 144,637 4,738 3,807
Property, plant and equipment, net.. 451,272 196,301 69,973 11,177 81
Total assets........................ 723,685 420,986 219,574 15,915 3,888
Long-term debt, including current
portion............................ 544,750 253,786 185,296 3,537 --
Total stockholders' equity
(deficit).......................... 44,789 142,487 19,328 (2,075) (405)
You should not assume that the results of operations above are indicative
of the financial results we can achieve in the future. You should also keep
the following matters in mind when you read this information:
. Non-cash compensation expense consists of:
-- charges totaling $0.1 million for 1996, $1.3 million for each of 1997
and 1998 and $2.5 million for 1999, which resulted from the vesting
over time of shares of common stock issued to some of our executive
officers in November 1996
-- charges of $1.8 million, $0.3 million, and $0.3 million for 1998,
1999 and 2000, respectively, which resulted from the vesting and
cancellation of shares of common stock in connection with the
September 30, 1998 amendment of vesting agreements with some of our
executive officers
-- charges of $4.4 million in 1999 and $6.1 million in 2000, which
resulted from our 1999 stock option grants to employees, directors
and an outside consultant, and common stock issued to a director
. EBITDA represents earnings before interest, income taxes, depreciation
and amortization and other non-cash charges, including non-cash
compensation expense. EBITDA is not a measurement of financial
performance under generally accepted accounting principles, is not
intended to represent cash flow from operations, and should not be
considered as an alternative to net loss applicable to common
stockholders as an indicator of our operating performance or to cash
flows as a measure of liquidity. We believe that EBITDA is widely used
by analysts, investors and other interested parties in the
telecommunications industry. EBITDA is not necessarily comparable to
similarly titled measures for other companies.
. We count access lines as of the end of the period indicated and on a
one-for-one basis using DS-0 equivalents.
. Data and Telecom services revenue information is not available for 1996,
1997 and 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
General. We provide voice, data and Internet infrastructure services to
large, communications-intensive users in major cities. We began operations in
1996 and initiated service first in Chicago in May 1997. As of December 31,
2000 we offered service in a total of 20 markets, which encompass a total of
49 metropolitan statistical areas, or MSAs, and plan to serve 24 markets, or
56 MSAs, by the end of 2001. We believe our market expansion will allow us to
reach a critical mass of geographic coverage and service capability for our
target customer base of communications-intensive users. As of December 31,
2000, we had 435,272 lines in service.
In September 2000, we announced the launch of our first Focal Internet
eXchange platform in our Chicago market. Our state-of-the-art Internet
eXchange platforms provide high-speed, managed Internet access, colocation,
and private peering services to large corporations, value-added resellers,
network service providers, and content and application service providers.
During the fourth quarter of 2000, we deployed Focal Internet
24
eXchanges in seven additional markets: New York; Northern New Jersey;
Philadelphia; Washington D.C.; San Francisco; Oakland and San Jose. At the end
of 2000, our Focal Internet eXchanges served eight markets. We intend to
deploy a total of 36 Focal Internet eXchanges across our 24 planned markets.
Revenue. Data services revenue includes revenues from circuit switched
lines sold to network service providers, DSL, colocation, and Internet
infrastructure services. Telecom services revenue includes circuit switched
lines sold to corporate and VAR customers. Our data and telecom services
revenue is composed of monthly recurring charges, usage charges, and initial
non-recurring charges. Monthly recurring charges include the fees paid by our
customers for lines in service, additional features on those lines, and
colocation space. Monthly recurring charges are derived only from end user
customers. Usage charges consist of fees paid by end-users for each call made,
fees paid by the ILEC and other CLECs as reciprocal compensation, and access
charges paid by the IXCs for long distance traffic that we originate and
terminate. Non-recurring revenues are typically derived from fees charged to
install new customer lines and are deferred and amortized over estimated
customer lives.
We earn reciprocal compensation revenue for calls made by customers of
another local exchange carrier to our customers. Conversely, we incur
reciprocal compensation expense to other local exchange carriers for calls by
our customers to their customers. We expect the proportion of revenues
represented by reciprocal compensation to decrease in the future as a result
of the expiration and subsequent renegotiation of our existing interconnection
agreements with the ILECs and the impact of recent and future regulatory
developments.
Expenses. Our expenses are categorized as network expenses; selling,
general and administrative; depreciation and amortization; and non-cash
compensation expense. Network expenses are composed of leased transport
charges, the cost of leasing space in ILEC central offices for colocating our
transmission equipment, the costs of leasing our nationwide Internet network,
reciprocal compensation payments and the cost of completing local and long
distance calls. Leased transport charges are the lease payments we make for
the use of fiber transport facilities connecting our customers to our switches
and for our connection to the ILECs' and other CLECs' networks. Generally, we
have been successful in negotiating lease agreements that match the duration
of our customer contracts, thereby allowing us to avoid the risk of incurring
expenses associated with transport facilities that are not being used by
revenue generating customers.
Our strategy of initially leasing rather than building our own fiber
transport facilities has resulted in our cost of service being a significant
component of total cost. Accordingly, our network expenses may be higher on a
relative basis compared to CLECs who own a higher percentage of their
transport network. However, compared to these same companies, our capital
expenditures will be significantly lower.
A key aspect of our "smart-build" strategy is that we only operate in Tier
1 markets which are served by multiple fiber providers. When traffic volumes
grow sufficiently to justify investing in our own network, we have purchased
our own fiber. As of December 31, 2000 we were operating our own fiber
networks in nine of our markets with approximately 9,730 fiber miles in
operation.
Selling, general and administrative expense ("SG&A") consists of network
and customer care personnel costs, sales force compensation and promotional
expenses as well as the cost of corporate activities related to regulatory,
finance, human resources, legal, executive, and other administrative
activities. We expect our sales expense to be lower as a percentage of revenue
than that of our competitors because we have relatively high sales
productivity associated with our strategy of serving communications-intensive
customers. These customers generally utilize a large number of switched access
lines relative to the average business customer, resulting in more revenue per
sale. Further, fewer sales representatives are required to service the
relatively smaller number of communications-intensive customers in a given
region.
We record monthly non-cash compensation expense related to shares issued to
some of our executive officers in November 1996, in connection with the
September 30, 1998 amendments to vesting agreements with some of our executive
officers, in connection with stock options granted to employees, an outside
consultant,
25
and directors during 1999 and shares issued to a director during the first
quarter of 1999. We will continue to record non-cash compensation expense in
future periods relating to these events through the third quarter of 2003. See
the notes to our Consolidated Financial Statements.
Quarterly Operating Results
The following table sets forth unaudited financial, operating and
statistical data for each of the specified quarters of 2000 and 1999. The
unaudited quarterly financial information has been prepared on the same basis
as our Consolidated Financial Statements and, in our opinion, contains all
normal recurring adjustments necessary to fairly state this information. The
operating results for any quarter are not necessarily indicative of results
for any future period.
2000
---------------------------------- 1999
Fourth Third Second First Fourth
Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- -------
Data Services Revenue ($ mil)..... $43,567 $40,573 $42,638 $32,190 $26,306
Telecom Services Revenue ($ mil).. $23,784 $20,179 $18,050 $13,139 $ 9,740
Switched Lines Sold to Date....... 526,356 427,641 356,918 291,443 237,167
Switched Lines Installed to Date.. 435,272 365,016 298,983 238,697 181,103
Estimated Data Lines (% of
Installed Lines)................. 61% 65% 68% 71% 72%
Lines on Switch (%)............... 100% 100% 100% 100% 100%
ILEC Switches Interconnected...... 1,975 1,823 1,677 1,447 1,209
ILEC Central Office DSL
Colocations in Service or Under
Development...................... 292 275 270 223 221
ILEC Central Office DSL
Colocations Market Ready......... 178 127 -- -- --
Quarterly Minutes of Use (mil).... 7,396 7,112 6,640 6,421 5,158
Markets in Operation.............. 20 20 19 18 16
Markets Under Development......... 4 4 5 6 4
MSAs Served....................... 49 49 48 47 40
MSAs Under Development............ 7 7 8 9 10
Circuit Switches Operational...... 20 19 16 14 12
Circuit Switches Under
Development...................... 5 6 8 7 7
ATM Switches Deployed............. 28 22 16 6 2
Fiber Miles Operational........... 9,730 7,914 4,488 864 --
Focal Customer Colocation Space in
Service (Sq. Ft.) 107,201 107,201 80,096 73,840 70,105
Focal Customer Colocation Space
Under Development (Sq. Ft.)...... 31,503 27,830 54,802 36,549 24,654
Capital Expenditures ($ mil)...... $ 82 $ 99 $ 77 $ 52 $ 34
Employees......................... 1,130 1,089 935 747 592
Sales Force(1).................... 184 180 166 124 116
- --------
(1) Quota bearing sales professionals. Does not include sales engineers or
customers support personnel.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Our data services revenue increased 64% for the year ended December 31,
2000 to $159.0 million. Telecom services revenue increased 150% to $75.2
million for the year ended December 31, 2000. The increase in our data and
telecom services revenue is primarily due to the generation of revenues from
new markets that went into operation during 2000 and from a sequential
increase in revenue from our more mature markets. In addition, we installed
254,169 lines during 2000, which exceeded the lines installed during the
comparable period of 1999 by approximately 97% or 125,077 lines.
26
Network expenses totaled $89.7 million for the year ended December 31, 2000
compared to $29.9 million for the year ended December 31, 1999. This $59.8
million increase resulted from our expansion into new markets during 2000 and
related costs for leased transport facilities, usage settlements, colocation
and Internet network costs related to our Focal Internet eXchange platforms.
Our gross margin was approximately 62% and 76% for the years ended December
31, 2000 and 1999, respectively. This decrease in our gross margin is a direct
result of our market expansion, our effective reciprocal compensation per
minute of use rate having declined between periods and due to initial network
costs related to our Focal Internet eXchange platforms. SG&A expenses
increased by $82.0 million to $155.5 million for the year ended December 31,
2000. This increase is the result of our expansion into new markets, the
rollout of our Focal Internet eXchange platforms, and due to a corresponding
increase in our employee base by 538 employees.
Depreciation and amortization increased from $23.8 million to $57.0 million
in the comparative year to year periods. This $33.2 million increase is a
result of our expansion into new markets, an increase in our fixed asset base
for our existing markets, and due to the build-out of our nationwide network
and Focal Internet eXchange platforms. Interest income was $20.3 million and
$7.9 million for the years ended December 31, 2000 and 1999, respectively.
This $12.4 million increase is primarily due to the receipt of $265.7 million
in net proceeds from our 11 7/8% senior notes ("2000 Notes") offering
completed in January 2000. Our net interest expense increased from $21.6
million during 1999 to $56.2 million for 2000. This net increase of $34.6
million is primarily due to an additional $31.8 million of interest expense
charged relating to our outstanding 2000 notes which was partially offset by
interest capitalized during the year ended December 31, 2000 totaling $9.4
million.
We incurred U.S. income tax expense of $0.6 million for 1999 compared to a
tax benefit of $4.2 million in 2000. The tax benefit recorded for 2000 is the
result of a net operating loss carryback for a refund of federal and state
taxes paid.
Our six most established markets had $186.8 million in revenue, EBITDA of
$94.0 million, and an EBITDA margin of 50% during 2000. We provide market
specific information to provide insight into the life cycle performance of our
older markets which are comprised of Chicago, New York, San Francisco, San
Jose, Oakland, and Philadelphia.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Our total revenue for the year ended 1999 was $126.9 million compared to
$43.5 million for the year ended 1998. This increase of 192% is primarily due
to the generation of revenue from numerous markets during 1999 compared to
revenues from primarily two markets, Chicago and New York, in the comparable
period of 1998. We installed approximately 129,000 access lines during 1999,
which exceeded the lines installed in the comparable period of 1998 by
approximately 187% or 84,000 lines.
Network expenses totaled $29.9 million for the year ended December 31, 1999
compared to $5.1 million for the year ended December 31, 1998. This $24.8
million increase resulted from our rapid expansion into six new markets and
related costs for leased transport facilities and usage settlements. Our gross
margin was approximately 76% and 88% for the years ended December 31, 1999 and
1998, respectively. This decrease in our gross margin is a direct result of
our effective reciprocal compensation per minute of use rate having declined
between periods. SG&A expenses increased by $51.1 million to $73.5 million
during the year ended December 31, 1999. This increase is the result of our
planned expansion and due to a corresponding increase in our employee base by
359 employees.
Depreciation and amortization increased from $6.7 million to $23.8 million
in the comparative year to year periods. This increase of $17.1 million is a
result of our 1999 expansion into six new markets and due to our fixed asset
base increase for our existing markets. Our 1999 capital expenditures of
approximately $128.5 million (excluding $21.0 million of assets acquired under
capital lease) were $64.3 million greater than that of the comparable period
of 1998. Non-cash compensation expense was $7.2 million for the year ended
December 31,
27
1999 compared to $3.1 million for comparable period in 1998. This $4.1 million
increase in non-cash compensation expense is the result of September 30, 1998
amendments of vesting agreements with some of our executive officers, stock
options granted to employees, an outside consultant, and directors during
1999, and stock issued to a director during the first quarter of 1999.
Interest income was $7.9 million and $6.5 million for the years ended 1999
and 1998, respectively. This increase of $1.4 million is primarily due to our
cash, cash equivalents, and short-term investments increasing from $134.0
million at the end of 1998 to $188.1 million at the end of 1999. This increase
is the result of our net proceeds of approximately $137 million raised in our
August 1999 initial public offering. Interest expense increased from $16.1
million during 1998 to $21.6 million for 1999. This net increase of $5.5
million is due to an additional $4.6 million of amortization of our
outstanding senior discount notes, $3.4 million of interest expense on our
secured equipment term loan, and $1.1 million of non-cash interest expense
relating to our capital lease obligation for dark fiber transport capacity.
This increase of $9.1 million was partially offset by approximately $3.6
million of interest capitalized during 1999 in connection with the
construction of our major facilities and networks.
We incurred U.S. income tax expense of $0.6 million for the year ended 1999
compared to $4.7 million in the same period of 1998. This decrease of $4.1
million in our tax expense between years is primarily due to the $18.5 million
of additional pre-tax losses incurred during 1999 and the realization of a net
operating loss at the end of 1999. We are obligated to pay federal and state
income taxes due to the application of the alternative minimum tax.
Liquidity and Capital Resources
Our current business plan anticipates that we expand our existing networks
and services, expand into four new markets in 2001, deploy our own fiber
capacity in a majority of our markets, construct 36 Focal Internet eXchange
platforms across our 24 planned markets, construct expanded colocation
centers, and fund operating losses. We will require significant capital to
fund this plan including the purchase and installation of voice and data
switches, routers, equipment, infrastructure and fiber facilities and/or long-
term rights to use fiber transport capacity. The implementation of this plan
requires significant capital expenditures, a substantial portion of which will
be incurred before significant related revenues from our new markets are
expected to be realized. These expenditures, together with associated
operating expenses, may result in our having substantial negative operating
cash flow and substantial net operating losses for the foreseeable future,
including 2001. Our current plan indicates we will turn EBITDA positive during
2001. In addition, our cash on hand and funds available under our Credit
Facility (see below) provides over $300 million in liquidity as of December
31, 2000. Although we believe that our current plan, cost estimates and the
scope and timing of our planned network build-out are reasonable, we cannot
assure that actual costs or the timing of the expenditures, or that the scope
and timing of our build-out, will be consistent with current estimates.
Our capital expenditures were approximately $309.6 million in 2000 compared
to $128.5 million in 1999 (excluding $21.0 million of assets acquired under
capital lease). This increase of $181.1 million primarily reflects capital
spending for the build-out of our new and existing markets and for the
construction of our nationwide network and Focal Internet eXchange platforms.
We estimate that our capital expenditures in connection with our current
business plan will be approximately $175 million to $200 million during 2001.
The 2001 capital expenditures are expected to be made primarily for the build-
out of four additional markets, the construction of Focal Internet eXchange
platforms, the expansion of our existing markets and the activation of local
dark fiber transport capacity in a number of our markets.
Our expectations of future capital requirements and cash flows from
operations are based on current estimates. If our plans or assumptions change
or prove to be inaccurate, we may be required to seek additional sources of
capital or seek additional capital sooner than currently anticipated.
28
Net cash provided by operating activities for 2000 was $52.2 million, an
increase of $33.6 million from the same period in 1999. This increase is
primarily the result of a $33.2 million increase in depreciation and
amortization, a $97.2 million increase in accounts payable and accrued
liabilities, and an additional $2.8 million of amortization of our senior
discount notes, which was offset by additional net losses of $83.5 million.
Net cash provided by operating activities for 1999 was $18.6 million, a
decrease of $3.9 million from the same period in 1998. This decrease is
primarily the result of a $17.1 million increase in depreciation and
amortization, a $4.1 million increase in non-cash compensation expense, and an
additional $4.6 million of amortization of our senior discount notes, which
was offset by additional net losses of $14.4 million and the increase in our
1999 accounts receivable exceeded 1998 by approximately $16.4 million.
Net cash used in investing activities was $309.9 million for 2000 compared
to $130.6 million in 1999. This increase of $179.3 million is primarily the
result of our 2000 expansion into four new markets and the continued expansion
of our existing markets. Our capital expenditures of $309.6 million in 2000
exceeded 1999 by $181.0 million. Short-term investments primarily consist of
debt securities, which typically mature between three months and one year. Net
cash used in investing activities was $130.6 million for 1999 compared to
$72.2 million in 1998. This increase of $58.4 million is primarily the result
of our 1999 expansion into six new markets and the continued expansion of our
existing markets. Our capital expenditures of $128.5 million in 1999 exceeded
1998 by $64.3 million. Short-term investments primarily consist of debt
securities, which typically mature between three months and one year.
Net cash provided by financing activities for 2000 was $251.0 million, an
increase of $86.9 million from 1999. This increase is primarily the net result
of our proceeds from the issuance of our 2000 Notes in January 2000. Net cash
provided by financing activities for 1999 was $164.1 million, a decrease of
$9.3 million from 1998. This decrease is primarily the net result of our debt
and equity proceeds between comparable periods.
On February 18, 1998, we received $150 million in gross proceeds from the
sale of our 1998 Notes. The 1998 Notes will accrete to an aggregate stated
principal amount of $270 million by February 15, 2003. As of December 31,
2000, the principal amount of the 1998 Notes had accreted to approximately
$210.1 million. No interest is payable on the 1998 Notes prior to August 15,
2003. Thereafter, cash interest will be payable semiannually on August 15 and
February 15 of each year. On August 2, 1999, we raised net proceeds of
approximately $137 million in our initial public offering in which we sold
11,442,500 shares of our common stock at a price of $13 per share, which
includes the underwriter's exercise of their over-allotment option to purchase
1,492,500 common shares at $13 per share. On January 12, 2000, we received
approximately $265.7 million in net proceeds from our 2000 Notes offering
completed in January 2000.
Our secured equipment term loans are solely for the purchase of
telecommunications equipment and related software licenses and must be repaid
over a five-year period from the date of the borrowing. As of December 31,
2000, there are no borrowings available to us under this facility and we had
$35.5 million outstanding under this term loan facility. On August 25, 2000,
we completed our $300 million Senior Secured Credit Facility (the Credit
Facility). The Credit Facility consists of a seven year $150 million revolving
credit facility and a seven year $150 million delayed draw term loan facility.
The Credit Facility will be available, subject to certain financial and
operating terms and conditions, and is intended to provide purchase money
financing for the construction, acquisition, or improvements of
telecommunications assets. The interest on amounts drawn is variable based on
our leverage ratio, as defined in our Credit Facility. The initial commitment
fee on the unused portion of the Credit Facility is 1.5% and will step down
based on usage. We had not drawn down against the Credit Facility as of
December 31, 2000. During February 2001, we borrowed approximately $8.0
million under the Credit Facility.
We have historically incurred net losses and have an accumulated deficit of
$139.6 million and $33.7 million as of December 31, 2000 and 1999
respectively. The aggregate net proceeds totaling approximately $602.7 million
that we received from the offering of our 1998 Notes, the August 1999 equity
offering, the 2000 Notes and certain other financings, have funded a large
portion of our operating losses and capital expenditures through December 31,
2000. We expect that our existing cash and investment balances, a portion of
our Credit Facility, flexible "smart-build" success-based operating plans, and
future cash flows (expected to be provided
29
from ongoing operations) will be sufficient to fund our operations and capital
expenditure requirements into the second quarter of 2002. Our expectations of
future capital requirements and cash flows from operations are based on
current estimates. If plans or assumptions change or prove to be inaccurate,
we may be required to seek additional sources of capital, seek additional
capital sooner than currently anticipated, or modify our expansion plans.
The discussions under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contain forward-looking statements. These
statements are subject to a number of risks and uncertainties that could cause
actual results to differ substantially from our projections. See "Information
Regarding Forward-looking Statements" on page 2 of this report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to minimal market risks. We manage sensitivity of our
results of operations to these risks by maintaining a conservative investment
portfolio, which primarily consists of debt securities, typically maturing
within one year, and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other financial instruments for trading purposes. Financial instruments held
for other than trading purposes do not impose a material market risk on us.
We are exposed to interest rate risk, as additional debt financing is
periodically needed due to the large operating losses and capital expenditures
associated with establishing and expanding our network coverage. The interest
rate that we will be able to obtain on debt financing will depend on market
conditions at that time, and may differ from the rates we have secured on our
current debt.
While all of Focal's long-term debt bears fixed interest rates, the fair
market value of our fixed rate long-term debt is sensitive to changes in
interest rates. We have no cash flow or earnings exposure due to market
interest rate changes for our fixed long-term debt obligations. The table
below provides additional information about our 1998 Notes and 2000 Notes. For
additional information about our long-term debt obligations, see our
Consolidated Financial Statements and accompanying notes related thereto
appearing elsewhere in this report.
As of December 31,
2000 (in thousands)
----------------------
Fixed Average
Expected Maturity Debt Interest Rate
----------------- -------- -------------
1999............................................... $ -- --
2000............................................... -- --
2001............................................... -- --
2002............................................... -- --
2003............................................... -- --
Thereafter......................................... 545,000 12%
-------- ---
$545,000 12%
======== ===
Fair Market Value.................................. $295,000
========
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements required by Item 8,
together with the notes thereto and the report thereon of the independent
public accountants dated February 9, 2000, are set forth on pages F-1-F-19 of
this report. The financial statement schedule listed under Item 14(a) 2,
together with the report thereon of the independent public accountants dated
February 9, 2001, are set forth on pages F-20 and F-21 of this report and
should be read in conjunction with our Consolidated Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below contains information about the ages and positions of
Focal's executive officers, selected key employees, and directors, as of
February 28, 2001.
Name Age Position(s)
---- --- ----------
Robert C. Taylor, Jr.................. 41 Director, President and Chief
Executive Officer
John R. Barnicle...................... 36 Director, Executive Vice President
and Chief Operating Officer
Ronald Reising........................ 40 Executive Vice President and Chief
Financial Officer
Renee M. Martin....................... 45 Senior Vice President, General
Counsel and Secretary
Anthony J. Leggio..................... 43 Executive Vice President and
President, Telecom Services Group
Michael L. Mael....................... 44 Executive Vice President and
President, Focal Data
Communications Group
Marie Allen........................... 47 Senior Vice President, Human
Resources
Robert M. Junkroski................... 37 Vice President and Treasurer
Gregory J. Swanson.................... 33 Controller
James E. Crawford, III................ 55 Director
John A. Edwardson..................... 51 Director
Todd A. Dagres........................ 40 Director
Andrew E. Sinwell..................... 36 Director
Kathleen A. Perone.................... 47 Director
James N. Perry, Jr.................... 40 Director
Paul G. Yovovich...................... 47 Director
Robert C. Taylor, Jr. Robert Taylor is Chief Executive Officer and
President for Focal Communications Corporation. He was appointed to this
position in August 1996. Taylor is also Focal's co-founder and a director.
Taylor is the Chairman of the Association for Local Telecommunications
Services (ALTS), the nation's leading organization representing facilities-
based competitive local exchange carriers (CLECs). In addition, Taylor sits on
the board of directors for IPLAN Networks, a CLEC based in Argentina and
Madison River Communications, an ILEC. With over 15 years of
telecommunications experience, Taylor has held positions with MFS
Communications, most recently as Vice President of Global Accounts, where he
worked with the company's 50 largest customers and executed market development
activities in Mexico and Canada. Prior to joining MFS in 1994, Taylor was one
of the original senior executives at McLeod Communications Group. Taylor has
also held management positions with MCI, Bellcore and Ameritech. Taylor
received his M.B.A. from the University of Chicago Graduate School of Business
and holds a Bachelor of Science degree in Mechanical Engineering.
John R. Barnicle. Mr. Barnicle has been Executive Vice President, Chief
Operating Officer and a director since June 1996. Mr. Barnicle is a co-founder
of Focal and is responsible for day-to-day operations, engineering, marketing
and long-term planning. In 1996, Mr. Barnicle was Vice President of Marketing
for MFS Telecom Companies, a subsidiary of MFS Communications. From 1994 to
1996, Mr. Barnicle was a Vice President of Duff & Phelps Credit Rating Company
and before that held various marketing, operations and engineering positions
with MFS Telecom (1992-1994) and Centel Corporation, a local exchange carrier
(1986-1992). Mr. Barnicle received his M.B.A. with Distinction from DePaul
University and holds a Bachelor of Science degree in Electrical Engineering.
Ronald Reising. Mr. Reising joined Focal in 2001 as Executive Vice
President and Chief Financial Officer of Focal. He is responsible for the
financial management of Focal and overseeing the finance, treasury and
accounting functions. From 2000-2001, Mr. Reising was the chief financial
officer of Derivion, a privately held electronic bill presentment and payment
company based in Atlanta, Georgia. From 1991-2000, he held various
international and domestic positions with Ameritech. His most recent
appointment at Ameritech was in 1999 as
32
Chief Financial Officer of Bell Canada. In 1997, he was the Chief Financial
Officer of Matav, the $1 billion national Hungarian telecommunications company
in which Ameritech held a one-third-equity stake. Mr. Reising is a graduate of
the Kellogg School of Management at Northwestern University and holds a
bachelor's degree in economics from Lawrence University (Appleton, WI). Mr.
Reising is also a Certified Public Accountant.
Renee M. Martin. Ms. Martin has been Senior Vice President, General Counsel
and Secretary since March 1998. Ms. Martin is responsible for our legal and
regulatory functions. From 1984 to 1998, Ms. Martin held various executive
positions at Ameritech, most recently as Vice President and General Counsel
Small Business Services, where she directed corporate legal resources to
address contract negotiations, employment issues, regulatory affairs and
litigation, and managed outside legal counsel. From 1982 to 1984, Ms. Martin
was an attorney at the law firm of Cook and Franke, S.C. where she
concentrated on general business and corporate law. Ms. Martin received her
J.D. from the University of Wisconsin and holds a Bachelor of Arts degree in
Journalism.
Anthony J. Leggio. Mr. Leggio, an Executive Vice President and President of
Focal's Telecom Services Group, is responsible for the sales for Focal's
business services organization, which includes corporate services, network
solutions and the government services groups. Before joining Focal in 1997 as
Regional Vice President Eastern Region, Mr. Leggio spent ten years, 1988 to
1997, with Sprint Corporation, holding a number of increasingly responsible
sales management positions. Most recently, he served as Vice President of
Sales, Eastern Region for Sprint PCS, where he led the planning, development,
organization and implementation of the Fortune 1000 sales and support
organization for Sprint's new wireless venture. Mr. Leggio received his MBA
from St. Joseph's University and a B.S. in Marketing from Rowan College.
Michael L. Mael. Mr. Mael has been Executive Vice President and President,
Focal Data Communications Group, since January 2000. Mr. Mael is responsible
for developing and managing Focal's data services business. From 1997 until
January 2000, he was Vice President, Applications and Web Services, at PSINet,
where he developed and managed the company's global Web hosting business. From
1992 until 1997, Mr. Mael held various management positions at MCI
Communications in finance, marketing, and business development, and was a
member of the team that created MCI's Internet initiative. Mr. Mael received
his BA from Brown University and his MBA from Stanford University.
Marie Allen. Ms. Allen is Senior Vice President of Human Resources. Ms.
Allen is responsible for directing the strategic issues of employee retention
and attraction for the company. She also is charged with maintaining Focal's
valued corporate culture as the company moves into its next phase of growth.
During her 15-year career, Ms. Allen has held senior management positions
across various industries. From 1998 to 2000, she was Senior Vice President of
Human Resources for Technology Solutions, Inc., a publicly traded, Chicago-
based technology consulting firm. From 1996 to 1997, she was Vice President of
Human Resources/Operations for NovaMed Eyecare Management, LLC, where she
established a human resources function, and managed all aspects of
recruitment, retention and issues related to organizational growth. In 1987
she founded The Allen Group, a human resource, training and organization
development consulting firm, which she led until 1996.
Robert M. Junkroski. Mr. Junkroski has been Vice President and Treasurer
since January 1999 and was Controller from January 1997 to January 1999. He is
responsible for all our revenue assurance, audit, cash and risk management,
customer credit, banking relationship and capital raising functions. From 1995
to 1997, Mr. Junkroski was Controller for Brambles Equipment Services, Inc.,
an equipment leasing company, where he was responsible for establishing and
maintaining the divisional accounting, financial reporting and budgeting
functions. From 1987 to 1995, Mr. Junkroski was Controller for Focus Leasing
Corporation, an equipment leasing company, where he was responsible for the
development and implementation of the accounting and financial reporting
functions of several emerging companies. Mr. Junkroski is a Certified Public
Accountant, received his M.B.A. with honors from Roosevelt University
concentrating in Finance and Accounting and holds a Bachelor of Business
Administration degree.
33
Gregory J. Swanson. Mr. Swanson has been Controller since January 1999 and
is our principal accounting officer. He is responsible for all internal and
external accounting and reporting functions. From June 1998 to December 1998,
Mr. Swanson was Director of External Reporting for Allegiance Corporation, a
health care manufacturing and distribution company. Before that he spent
approximately nine years at Arthur Andersen LLP, a public accounting firm,
where he was responsible for audit and business advisory services to
technology and manufacturing companies. Mr. Swanson is a Certified Public
Accountant and holds a Bachelor of Science degree in Accounting from the
University of Southern California.
James E. Crawford, III. Mr. Crawford has served as a director of Focal
since November 1996. From August 1992 to September 2000, he has been a general
partner and then since September of 2000 a managing partner of Frontenac
Company, a venture capital firm and stockholder of Focal. From February 1984
to August 1992, Mr. Crawford was a general partner of William Blair Venture
Management Co., a venture capital fund. He was also a general partner of
William Blair & Company, an investment bank and brokerage firm affiliated with
William Blair Venture Management Co., from January 1987 to August 1992. Mr.
Crawford serves as a director of Optika, Inc., ActionPoint, Inc., Allegiance
Telecom and several private companies.
Todd A. Dagres. Mr. Dagres has been a general partner of Battery Ventures,
a stockholder of Focal, since 1996. From 1994 to 1996, Mr. Dagres was a
Principal and Senior Technology Analyst at Montgomery Securities focusing on
the networking industry. Mr. Dagres serves on the Board of Trustees of Akamai
Technologies, Convergent Networks, Inc., Edgix Corporation, Equipe
Communications Corporation, Inventa Corporation, Alphion Corporation,
Predictive Networks, Inc., RiverDelta Networks, Inc., and Storability, Inc.
John A. Edwardson. Mr. Edwardson has served as a director of Focal since
February 1999. He became President and Chief Executive Officer of CDW Computer
Services, Inc. in February 2001. Formerly, he was Chairman of Burns
International Services Corp., a security services company, since June 1999,
and President and Chief Executive Officer of Burns International since March
1999. From 1994 to 1998, Mr. Edwardson was President of UAL Corporation, the
holding company for United Airlines, and also served as UAL's Chief Operating
Officer from April 1995 through September 1998. He previously was Executive
Vice President and Chief Financial Officer of Ameritech and held executive
positions with Northwest Airlines. Mr. Edwardson also serves as a director of
CDW and Household International, Inc.
Kathleen A. Perone. Ms. Perone is a founding partner and managing director
of Acappella Ventures L.L.C, a New Jersey-based venture capital firm that
focuses on early stage telecom and technology infrastructure companies. From
January 1998 to March 2000, Ms. Perone served as president of the North
American division of Level 3 Communications, Inc., a leading communications
and information services company, where she remains a consultant. From 1990 to
1998, Perone held a series of positions at MFS Communications: vice president
and general manager; COO of MFS International; and president of two MFS
divisions. Ms. Perone also is a director of Desktop News Corporation, REALTECH
Systems, LighTrade and INFOCROSSING. She also serves on the advisory boards of
TELLIUM and REALTECH.
James N. Perry, Jr. Mr. Perry has been a director of Focal since November
1996. From January 1993 to January 1999, he served as Vice President of
Madison Dearborn Partners, Inc., and since January of 1999 has served as
Managing Director of Madison Dearborn Partners, Inc. Previously, Mr. Perry
served in various positions at First Capital Corporation of Chicago and its
affiliates. Mr. Perry currently serves as a director or manager, as
applicable, of Voicestream Wireless, CompleTel Holdings and Allegiance
Telecom.
Andrew E. Sinwell. Mr. Sinwell has been a director of Focal since June
2000. He is a Managing Director of Madison Dearborn Partners, Inc., the
general partner of Madison Dearborn Capital Partners, L.P., a stockholder of
Focal. From 1994 to 1996, Mr. Sinwell was a Senior Policy Advisor at the
Federal Communications Commission. Mr. Sinwell serves on the Board of
Directors of Nextel Partners, Inc. and several privately-held companies.
34
Paul G. Yovovich. Mr. Yovovich has served as a director of Focal since
March 1997. He is a private investor. Mr. Yovovich served as President of
Advance Ross Corporation, an international transaction services and
manufacturing company, from 1993 to 1996. He served in several executive
positions with Centel Corporation from 1982 to 1992, where his last position
was that of President of its Central Telephone Company unit. Mr. Yovovich also
serves as a director of 3Com Corporation, APAC Customer Services, Inc.,
American Media Operations, Inc., and Lante Corporation.
How Our Directors Are Elected
The Board of Directors currently consists of nine members. The Board of
Directors is divided into three classes of three members each. Each director
serves a three-year term and one class is elected at each year's annual
meeting of stockholders. Messrs. Barnicle, Crawford, and Yovovich are in the
class of directors whose term will expire at our 2001 annual meeting of
stockholders. Messrs. Edwardson, Perry, and Taylor are in the class of
directors whose term will expire at our 2002 annual meeting of stockholders.
Messrs. Dagres and Sinwell and Ms. Perone are in the class of directors whose
term will expire at our 2003 annual meeting of stockholders. At each annual
meeting of stockholders, successors to the class of directors whose terms
expire at the meeting are elected to serve for three-year terms and until
their successors are elected and qualified.
Our Board Committees
The Board has established four committees. They are the:
. Compensation Committee
. Stock Option Committee
. Audit Committee
. Nominating Committee
The Compensation Committee establishes salaries, incentives and other forms
of compensation (except to the extent delegated to the Stock Option Committee)
for our directors, executive officers and key employees and administers our
equity incentive plans and other incentive and benefit plans. The members of
the Compensation Committee are Mr. Crawford, Mr. Edwardson, Mr. Perry and Mr.
Yovovich.
The Stock Option Committee grants stock options under the Company's 1998
Equity and Performance Incentive Plan (the "Plan") to employees who are not:
(a) "covered employees" within the meaning of Section 162(m) of the Internal
Revenue Code or who, in the Committee's judgment, are likely to be a covered
employee at any time during the period a grant or award under the Plan to such
person would be outstanding, (b) an officer or other person subject to Section
16 of the Securities Exchange Act of 1934, or (c) a vice president, senior
vice president, or executive vice president. The members of the Stock Option
Committee are Mr. Taylor and Mr. Barnicle.
The Audit Committee oversees the work of our independent auditors, reviews
internal audit controls and evaluates conflict of interest issues. The members
of the Audit Committee are Mr. Edwardson, Ms. Perone and Mr. Yovovich.
The Nominating Committee identifies nominees to stand for election to our
Board of Directors. The members of the Nominating Committee are Mr. Taylor,
Mr. Perry, Mr. Crawford and Mr. Yovovich.
Compensation of Our Directors
We currently pay our non-employee directors, other than designees of our
institutional investors, in lieu of a cash retainer, annual director
compensation in the form of an annual grant of stock options. The number of
shares subject to each stock option granted to each of these directors on an
annual basis is, as of 2001, equal to $120,000 divided by the option exercise
price, which will be the fair market value per share on the date of grant. All
directors are reimbursed for expenses incurred to attend Board of Directors or
committee meetings.
35
In April 1997, Mr. Yovovich was granted an option to purchase 130,000
shares of our common stock under our 1997 Nonqualified Stock Option Plan (the
"1997 Plan"). Ten percent of the shares covered by the option vested
immediately and an additional 15% of the shares vest every six months
thereafter. In January 1999, Mr. Yovovich was granted an additional option to
purchase 20,000 shares of common stock under the 1997 Plan, which has the same
vesting terms as his earlier grant. In February 2000, Mr. Yovovich was granted
an additional option to purchase 1,349 shares of common stock under the 1997
Plan, which has the same vesting terms as his earlier grant. In February 1999,
Mr. Edwardson was granted an option under our 1997 Plan to purchase 130,000
shares of our common stock on the same vesting terms as the options previously
granted to Mr. Yovovich. In February 2000, Mr. Edwardson was granted an option
to purchase 1,349 shares of common stock under the same vesting terms as the
options previously granted. In August 2000, Ms. Perone was granted an option
under our 1998 Plan to purchase 10,000 shares of our common stock on the same
vesting terms as the options previously granted to Mr. Yovovich and Mr.
Edwardson.
Potential Conflicts of Interest of Some of Our Directors
In addition to serving as members of our Board of Directors, Mr. Crawford,
Mr. Sinwell, Mr. Dagres and Mr. Perry each serve as directors of other
telecommunications services companies and other private companies. As a
result, these four directors may be subject to conflicts of interest during
their tenure on our Board of Directors. Accordingly, they may be periodically
required to inform us and the other companies to which they owe fiduciary
duties of financial or business opportunities. We do not currently have any
standard procedures for resolving potential conflicts of interest relating to
corporate opportunities or otherwise. Conflict of interest issues are reviewed
by our Audit Committee.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our directors
and officers and persons who own more than 10 percent of a registered class of
our equity securities to file with the Securities and Exchange Commission
initial reports of ownership and reports in changes in ownership in our common
stock, and to furnish us with copies of all the reports they file. To our
knowledge, based solely on a review of the copies of such reports furnished to
us and written representations that no other Forms 5 were required, during the
fiscal year ended December 31, 2000, all Section 16(a) filing requirements
applicable to our directors, officers and greater than 10 percent beneficial
owners were complied with, except that Mr. Crawford, a director, inadvertently
failed to report acquisitions of our common stock on Forms 4 during May 2000,
which acquisitions were subsequently reported on Forms 5.
36
ITEM 11. EXECUTIVE COMPENSATION
The table below presents information about compensation earned by our Chief
Executive Officer and each of our four other most highly compensated executive
officers whose combined salary and bonus for 2000 exceeded $100,000 for
services rendered in all capacities for our last three fiscal years. The
officers listed in the following table are referred to as the Named Executive
Officers:
Long-term
Compensation
------------
Awards(1)
------------
Securities
Annual Compensation Underlying
-------------------- ------------
Name and Principal All Other
Position Year Salary ($) Bonus ($) Options (#) Compensation($)
- ------------------ ---- ---------- --------- ------------ ---------------
Robert C. Taylor, Jr.... 1998 $150,000 $100,000 $-- $ --
Chief Executive Officer. 1999 191,923 200,000 -- --
2000 246,934 125,000 -- --
John R. Barnicle........ 1998 $140,000 $ 75,000 $-- $ --
Chief Operating Officer. 1999 178,269 144,000 -- --
2000 225,000 125,000 -- --
Joseph A. Beatty(2)..... 1998 $140,000 $ 75,000 $-- $25,000(3)
Chief Financial Officer. 1999 175,577 138,000 -- --
2000 215,000 100,000 -- --
Michael L. Mael......... 1998 $ -- $ -- $-- $ --
President, Data
Communications Group... 1999 -- -- -- --
2000 199,039 115,000 -- --
Anthony J. Leggio....... 1998 $ -- $ -- $-- $ --
President, Telecom
Services Group......... 1999 -- -- -- --
2000 193,460 115,000 -- --
- --------
(1) Does not include 2,500,000 shares of common stock issued to each of Mr.
Taylor, Mr. Barnicle and Mr. Beatty in 1996 that were subject to time-
vesting requirements set forth in their Employment Agreements, of which
500,000 shares vested in 1996, 1997 and 1998 and 1,000,000 shares vested
in 1999. See "--Employment Agreements." Also does not include 1,838,943
shares of common stock issued to each of Mr. Taylor, Mr. Barnicle and Mr.
Beatty in 1996 that were subject to performance-vesting requirements set
forth in their Vesting Agreements with some of our institutional
investors. Of these shares, 1,588,943 were canceled in connection with
the September 30, 1998 amendments to the Vesting Agreements. The
remaining 250,000 shares were subject to time-vesting requirements set
forth in Restricted Stock Agreements signed at the time of the September
30, 1998 amendments to these Vesting Agreements. Of these shares, 137,500
held by Messrs. Taylor, Barnicle and Beatty remain subject to future
vesting requirements. Based upon the closing price of our Common Stock on
February 28, 2001, these 137,500 shares have an aggregate market value of
$1,761,719. See "--Vesting Agreements." We do not anticipate paying any
dividends on any of these shares.
(2) Mr. Beatty resigned from Focal in February 2001.
(3) Represents reimbursement of moving expenses.
37
Stock Option Grants
The table below provides information regarding stock options granted to the
Named Executive Officers during the year ended December 31, 2000. None of the
Named Executive Officers received stock appreciation rights, or SARs.
Potential Realizable
Value at Assumed
Annual Rates
of Stock Price
Appreciation
Individual Grants for Option Term(5)
--------------------------------------------------- ----------------------
Number of % of Total
Securities Options
Underlying Granted to Exercise or
Options Employees in Base Price
Name Granted Fiscal Year (per share) Expiration Date 5% 10%
- ---- ---------- ------------ ----------- --------------- ---------- -----------
Robert C. Taylor,
Jr.(1)................. 250,000 4.8% $29.88 June 2010 $4,697,500 $11,905,000
John R. Barnicle(2)..... 250,000 4.8% $29.88 June 2010 $4,697,500 $11,905,000
Anthony J. Leggio(3).... 50,000 1.0% $29.88 June 2010 $ 939,500 $ 2,381,000
7,500 0.1% $ 6.94 December 2010 32,700 82,950
Michael L. Mael(4)...... 50,000 1.0% $40.63 February 2010 $1,277,500 $ 3,237,500
15,000 0.3% $29.88 June 2010 281,850 714,300
7,500 0.1% $ 6.94 December 2010 32,700 82,950
- --------
(1) The options granted to Mr. Taylor were granted under the 1998 Plan (as
defined below). The 250,000 options were granted on June 1, 2000 and are
comprised of 125,000 options that vest monthly over the 48 month vesting
period; and 125,000 options that vest 25% per year based on Focal's common
stock price meeting certain performance criteria.
(2) The options granted to Mr. Barnicle were granted under the 1998 Plan. The
250,000 options were granted on June 1, 2000 and are comprised of 125,000
options that vest monthly over the 48 month vesting period; and 125,000
options that vest 25% per year based on Focal's common stock price meeting
certain performance criteria.
(3) The options granted to Mr. Leggio were granted under the 1998 Plan. The
50,000 options were granted on June 1, 2000 and are comprised of 25,000
options that vest 25% on the first anniversary date of the grant and 12.5%
every six months thereafter; and 25,000 options that vest 25% per year
based on Focal's common stock price meeting certain performance criteria.
The remaining 7,500 options were granted on December 21, 2000 and vest 25%
on December 21, 2002 and 12.5% every six months thereafter.
(4) The options granted to Mr. Mael were granted under the 1998 Plan. The
50,000 options were granted on February 4, 2000 and vest 25% on the first
anniversary date of the grant and 12.5% every six months thereafter. The
15,000 options were granted on June 1, 2000 and are comprised of 7,500
options that vest 25% on the first anniversary date of the grant and 12.5%
every six months thereafter; and 7,500 options that vest 25% per year
based on Focal's common stock price meeting certain performance criteria.
The remaining 7,500 options were granted on December 21, 2000 and vest 25%
on December 21, 2002 and 12.5% every six months thereafter.
(5) Based on a ten-year option term and annual compounding, the 5% and 10%
calculations are set forth in compliance with the rules of the Securities
and Exchange Commission. The appreciation calculations do not take into
account any appreciation in the price of the common stock to date and are
not necessarily indicative of future values of stock options or the common
stock.
38
Exercise of Stock Options and Year-End Values
The following table sets forth information regarding the number and value
of unexercised stock options held by each of the Named Executive Officers as
of December 31, 2000. None of the Named Executive Officers holds SARs.
Value of
Unexercised
Number of In-the-Money
Unexercised Options ($) at
Options at Fiscal Year
Number of Shares Value Fiscal Year End End(2)
Acquired Upon Realized Exercisable/ Exercisable/
Name Exercise of Option Upon Exercise Unexercisable(1) Unexercisable
- ---- ------------------ ------------- ---------------- ----------------
Robert C. Taylor, Jr. .. -- -- 18,229/231,771 --
John R. Barnicle........ -- -- 18,229/231,771 --
Anthony J. Leggio....... 32,187 $1,084,519 10,938/140,625 $55,799/$355,719
Michael L. Mael......... -- -- 0/ 72,500 --
- --------
(1) These shares represent shares issuable pursuant to stock options granted
under our 1997 and 1998 Plan. See "the 1997 and 1998 Plan" below.
(2) In accordance with the SEC's rules, values are calculated by subtracting
the exercise price from the fair market value of the underlying common
stock. For purposes of this table, fair market value is deemed to be
$7.00, the closing price of our common stock reported for Nasdaq National
Market on December 31, 2000. Based upon the closing price of our Common
Stock on February 28, 20001, the exercisable and unexercisable options
would have aggregate values equal to $119,376 and $977,146, respectively.
We established the Focal Communications Corporation 1997 Non Qualified
Stock Option Plan (the "1997 Plan") effective February 27, 1997. The 1997 Plan
is administered by the compensation committee of our Board of Directors (the
"Board"). Options to purchase 6,927,650 shares were issued under the 1997 Plan
and no further options will be granted under the 1997 Plan.
We adopted the Focal Communications Corporation 1998 Equity and Performance
Incentive Plan (the "1998 Plan") on August 21, 1998. The total number of
shares available under the 1998 Plan shall not exceed 12,050,000 shares. The
Board and, with respect to non-executive employees, the stock option committee
of our Board of Directors, has sole and complete authority to select
participants and grant options, and other equity-based instruments for our
common stock.
On August 21, 1998, we also adopted the 1998 Equity Plan for Non-Employee
Directors of Focal Communications Corporation (the "1998 Non-Employee Plan").
The total number of shares available under the 1998 Non-Employee Plan shall
not exceed 150,000 shares. The Board has sole and complete authority to select
participants and grant options for our common stock, as defined in the 1998
Non-Employee Plan.
Employment Agreements
Focal is a party to identical Executive Stock Agreement and Employment
Agreements ("Employment Agreements") with each of Mr. Taylor and Mr. Barnicle
(the "Executive Investors"). The Employment Agreements provide that each
Executive Investor will receive a minimum base salary of $120,000 (or any
greater amount approved by a majority of the Board of Directors, including the
Madison Dearborn designee and one of the Frontenac or Battery Ventures
designees) and bonuses determined by the Board of Directors and based upon our
achievement of performance goals set in advance of each year in the sole
discretion of the Board of Directors. Unless he is terminated for cause, each
Executive Investor is entitled for a period of between six and 12 months
following termination of his employment with us (depending on the basis for
termination) to continue to receive his salary and medical benefits, less any
amounts the Executive Investor receives as compensation for other employment.
39
Pursuant to the Employment Agreements and in exchange for shares of common
stock held by the Executive Investors prior to November 27, 1996:
. 2,500,000 shares of common stock subject to time-vesting requirements
set forth in the Employment Agreements were issued to each of the
Executive Investors on November 27, 1996
and
. 1,838,943 shares of common stock subject to performance-vesting
requirements set forth in the Vesting Agreements (as defined below) were
issued to each of the Executive Investors on November 27, 1996. Of these
shares, 1,588,943 were canceled in connection with the September 30,
1998 amendments to the Vesting Agreements. The remaining 250,000 shares
are subject to time-vesting requirements set forth in Restricted Stock
Agreements signed on September 30, 1998. Of these shares, 137,500 shares
issued to Messrs. Taylor, Barnicle and Beatty remained subject to future
vesting requirements. See "--Vesting Agreements."
All of the 2,500,000 shares issued on November 27, 1996 that were subject
to time-vesting requirements under the Employment Agreements have vested.
We entered into employment agreements with Mr. Mael and Mr. Leggio on
substantially the same employment terms as the Executive Investors.
Each employment agreement requires the Executive Investor, or Mr. Mael or
Mr. Leggio, as applicable, to assign to us all inventions developed in the
course of employment, maintain the confidentiality of our proprietary
information and refrain from competing with and soliciting employees from
Focal during his or her employment and for a period of up to eighteen months
after his or her termination. During this period, after any applicable
severance pay period has expired, the Executive Investor, or Mr. Mael or Mr.
Leggio, as applicable, is entitled to receive noncompetition compensation
equal to his salary and medical benefits (net of any amounts he receives as
compensation for other employment), unless he breaches his non-disclosure,
non-compete or non-solicitation obligations.
Vesting Agreements
Pursuant to the original terms of three separate Vesting Agreements (the
"Vesting Agreements"), each dated November 27, 1996, among Focal, the
Executive Investors and each of our Institutional Investors, each of the
Executive Investors was entitled to earn 1,838,943 shares of common stock if
specified financial performance criteria were satisfied. If any of these
shares of common stock vested, an equal number of shares of common stock held
by the institutional investors would be forfeited by the Institutional
Investors.
Pursuant to amendments to the Vesting Agreements, on September 30, 1998,
the Vesting Agreements terminated and:
. The Institutional Investors collectively forfeited 2,500,000 shares of
common stock
. The Executive Investors each forfeited 1,588,943 shares of common stock
held by them (or a total of 6,355,770 shares for all Executive
Investors)
. 250,000 shares of common stock held by each Executive Investor were
vested and became subject to new time-vesting requirements based on
periods of continuous service with us (the "Restricted Shares").
Twenty percent of the Restricted Shares immediately vested and the
remaining Restricted Shares vest 10% on September 30, 1999, 15% on September
30, 2000, 20% on September 30, 2001 and 35% on September 30, 2002. The
Executive Investors are entitled to voting, dividend and other ownership
rights with respect to the Restricted Shares, but the Restricted Shares are
subject to restrictions on transfer until they vest. Vesting of the Restricted
Shares is accelerated under specified circumstances, including upon a Change
in Control or the Executive Investor's death or disability. Change in Control
has the same definition as in the 1997 Plan.
40
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board of Directors consists of four
directors, Messrs. Crawford, Edwardson, Perry and Yovovich. None of our
executive officers served as a member of the compensation committee of any
other entity.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth information regarding beneficial ownership of
our common stock as of February 28, 2001 for:
. Each of the Named Executive Officers
. Each of our directors
. All of our executive officers and directors as a group
. Each other person who we know beneficially owns 5% or more of our common
stock
Unless otherwise noted, the address of each Named Executive Officer and
director of Focal is 200 North LaSalle Street, Suite 1100, Chicago, Illinois
60601.
Number of Shares
Beneficially Percent
Name Owned(1) Beneficially Owned
- ---- ---------------- ------------------
Named Executive Officers
Robert C. Taylor, Jr.(2)................... 2,751,225 4.5%
John R. Barnicle(3)........................ 2,800,925 4.6%
Ronald Reising(4).......................... -- --
Anthony J. Leggio(5)....................... 28,118 *
Michael L. Mael(6)......................... 162,500 *
Directors
James N. Perry, Jr.(7)..................... 21,606,425 35.1%
Andrew E. Sinwell(8)....................... 21,606,425 35.1%
James E. Crawford III(9)................... 10,104,110 16.4%
Todd A. Dagres(10)......................... 5,041,365 8.2%
Paul G. Yovovich(11)....................... 307,029 *
John A. Edwardson(12)...................... 252,313 *
Kathleen A. Perone(13)..................... 9,274 *
All Executive Officers and Directors as a
Group (14 persons)(14).................... 45,665,812 74.2%
Other Owners
Madison Dearborn Capital Partners, L.P.
(15)...................................... 21,606,425 35.1%
Frontenac VI, L.P.(16)..................... 10,082,980 16.4%
Battery Ventures III, L.P.(17)............. 5,041,365 8.2%
Joseph A. Beatty(18)....................... 2,516,217 4.1%
- --------
* Less than 1% of the issued and outstanding shares of our common stock.
(1) In accordance with the rules of the Securities and Exchange Commission,
each beneficial owner's holding has been calculated assuming full
exercise of outstanding warrants and options exercisable by the holder
within 60 days after February 28, 2001, but no exercise of outstanding
warrants and options held by any other person. Unless otherwise
indicated below, the persons and entities named in the table have sole
voting and sole investment power with respect to all shares beneficially
owned by them, subject to applicable community property laws.
(2) Includes 137,500 shares of common stock subject to vesting provisions
contained in the executive's Restricted Stock Agreement. Also includes
965,385 shares of common stock held by Mistral Partner, L.P.,
41
a family limited partnership. Mr. Taylor exercises sole voting and
investment power over shares held by this partnership. Also includes
79,000 shares of common stock held by Hylas Blind Selling Program Trust.
Also includes 97,000 shares of common stock held by Mistral Blind Selling
Program #1. Also includes 97,000 shares of common stock held by Mistral
Blind Selling Program #2. Also includes 26,040 shares of common stock
subject to options, which are exercisable within 60 days of February 28,
2001.
(3) Includes 137,500 shares of common stock subject to vesting provisions
contained in the executive's Restricted Stock Agreement. Also includes
350,000 shares of common stock held by JRB Partners, L.P., a family
limited partnership. Mr. Barnicle exercises sole voting and investment
power over shares held by this partnership. Also includes 48,000 shares
of common stock held by John R. Barnicle Blind Selling Program Trust.
Also includes 36,000 shares of common stock held by JRB Blind Program
Selling Trust. Also includes 26,040 shares of common stock subject to
options, which are exercisable within 60 days of February 28, 2001.
(4) Mr. Reising joined Focal in February 2001 as Executive Vice President
and Chief Financial Officer.
(5) Consists of 17,180 shares of common stock and an additional 10,938
shares of common stock subject to options which are exercisable within
60 days of February 28, 2001.
(6) Includes 150,000 shares of common stock subject to vesting provisions
contained in the executive's Restricted Stock Agreement respectively.
Also, consists of 12,500 shares of common stock subject to options which
are exercisable within 60 days of February 28, 2001.
(7) Mr. Perry, a director, owns no shares in his own name. Consists of
shares of common stock owned by Madison Dearborn. See footnote 15 below.
Mr. Perry's address is c/o Madison Dearborn Partners, Inc., Three First
National Plaza, Suite 3800, Chicago, IL 60602.
(8) Mr. Sinwell, a director, owns no shares in his own name. Consists of
shares of common stock owned by Madison Dearborn. See footnote 15 below.
Mr. Sinwell's address is c/o Madison Dearborn Partners, Inc., Three
First National Plaza, Suite 3800, Chicago, IL 60602.
(9) Mr. Crawford, a director, owns no shares in his own name. Consists of
shares of common stock owned by Frontenac and 21,130 shares of common
stock owned by Mr. Crawford's son. See footnote 16 below. Mr. Crawford's
address is c/o Frontenac Company, 135 S. LaSalle Street, Suite 3800,
Chicago, IL 60603.
(10) Mr. Dagres, a director, owns no shares in his own name. Consists of
shares of common stock owned by Battery Ventures. See footnote 17 below.
Mr. Dagres's address is c/o Battery Ventures, 20 William Street,
Wellesley, MA 02481.
(11) Includes 161,716 shares of common stock and an additional 145,313 shares
of common stock subject to options which are exercisable within 60 days
of February 28, 2001.
(12) Includes 160,000 shares of common stock and an additional 92,313 shares
of common stock subject to options which are exercisable within 60 days
of February 28, 2001.
(13) Includes 6,000 shares of common stock and an additional 3,274 shares of
common stock subject to options which are exercisable wihtin 60 days of
February 28, 2001.
(14) Includes 45,275,251 shares of common stock and an additional 390,561
shares of common stock subject to options which are exercisable within
60 days of February 28, 2001.
(15) Consists of shares of common stock owned by Madison Dearborn. Messrs.
Perry and Sinwell, directors of Focal, are principals of Madison
Dearborn Capital Partners, Inc., the ultimate general partner of Madison
Dearborn. Because of these positions, Messrs. Perry and Sinwell share
voting and investment power with respect to the shares owned by Madison
Dearborn. The address of Madison Dearborn is Three First National Plaza,
Suite 3800, Chicago, IL 60602. See "Directors and Executive Officers of
the Registrant--Potential Conflicts of Interest of Some of Our
Directors."
(16) Consists of shares of common stock owned by Frontenac. Mr. Crawford, a
director, is a general partner of Frontenac Company, the general partner
of Frontenac. Because of this position, Mr. Crawford shares voting and
investment power with respect to the shares owned by Frontenac. The
address of Frontenac is 135 S. LaSalle Street, Suite 3800, Chicago, IL
60603. See "Directors and Executive Officers of the Registrant--
Potential Conflicts of Interest of Some of Our Directors."
42
(17) Consists of shares of common stock owned by Battery Ventures. Mr.
Dagres, a director, is a managing general partner of Battery Ventures.
Because of this position, Mr. Dagres shares voting and investment power
with respect to the shares owned by Battery Ventures. The address of
Battery Ventures is 20 William Street, Wellesley, MA 02481. See
"Directors and Executive Officers of the Registrant--Potential Conflicts
of Interest of Some of Our Directors."
(18) Mr. Beatty is a Named Executive Officer. He resigned from Focal in
February 2001. Includes 137,500 shares of common stock subject to
vesting provisions contained in the executive's Restricted Stock
Agreement. Also includes 815,000 shares of common stock held by Coventry
Court Partners, L.P., a family limited partnership. Mr. Beatty exercises
sole voting and investment power over shares held by this partnership.
Also includes 95,000 shares of common stock held by Coventry Court
Partners Blind Selling Trust. Also includes 20,832 shares of common
stock subject to options, which are exercisable within 60 days of
February 28, 2001.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
The Stock Purchase Agreement and Stockholders' Agreement
We have entered into a Stock Purchase Agreement with some of our
stockholders, dated as of November 27, 1996 and amended after that date.
Pursuant to the Stock Purchase Agreement and additional related agreements,
our existing stockholders were granted registration rights described below.
The Stock Purchase Agreement also requires us to:
. Deliver financial information to our institutional investors and certain
of their transferees in a private sale of shares of common stock
. Provide access by our institutional investors, and certain of their
transferees in a private sale of shares of common stock, to our physical
properties, books and records
. Comply with the periodic reporting requirements under the Exchange Act
to enable holders of "restricted shares" of common stock to sell those
shares of common stock pursuant to Rule 144 under the Securities Act of
1933 or a short-form registration statement under the Securities Act of
1933.
See "Executive Compensation--Employment Agreements" and "--Vesting
Agreements" for a more detailed discussion of the various provisions of the
Employment Agreements and Vesting Agreements.
Registration Rights
Focal has granted registration rights to some holders of its common stock.
These holders of common stock have the benefit of the following demand
registration:
. Subject to minimum dollar amounts, Madison Dearborn may demand two
registrations on Form S-1
. Frontenac and Battery may each demand one registration on Form S-1
. The holders of 8% of all shares of common stock subject to the
registration agreement may demand an unlimited number of registrations
on Form S-2 or Form S-3
In addition, stockholders that have been granted registration rights have
unlimited "piggyback" registration rights under which they have the right to
request that we register their shares of common stock whenever we register any
of our securities under the Securities Act of 1933 and the registration form
to be used may be used for the registration of their shares of common stock.
These piggyback registration rights will not, however, be available:
. If the piggyback registration is in connection with an underwritten
registration and the managing underwriter concludes that including
shares of common stock owned by holders of "piggyback" registration
rights would have an adverse impact on the marketing of the securities
to be sold in the underwritten offering
. For registrations undertaken because of a demand registration
43
Some of Our Directors are also Directors of our Competitors
Some of our directors, who serve as representatives of the Institutional
Investors, also serve on the boards of directors of companies with which we
may compete or enter into agreements. Specifically, Mr. Crawford, and Mr.
Perry are directors of Allegiance Telecom, a Dallas-based CLEC. Allegiance
Telecom is one of our competitors. See "Directors and Executive Officers of
the Registrant--Potential Conflicts of Interest of Some of Our Directors."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The consolidated financial statements of Focal Communications
Corporation and Subsidiaries for the year ended December 31, 2000, together
with the Report of Independent Public Accountants, are set forth on pages
F-1 through F-19 of this report. The supplemental financial information
listed and appearing hereafter should be read in conjunction with the
consolidated financial statements included in the report.
(2) Financial Statement Schedules
The following are included in Part IV of this report for each of the
years ended December 31, 1998, 1999 and 2000 as applicable:
Report of Independent Public Accountants F-20
Schedule II--Valuation and Qualifying Accounts F-21
Financial statement schedules not included in this report have been omitted
either because they are not applicable or because the required information is
shown in the consolidated financial statements or notes thereto, included in
this report.
(3) The exhibits listed below are filed as part of this report:
EXHIBIT INDEX
Exhibit
Number Exhibit Description
------- -------------------
3.1 Form of Amended and Restated Certificate of Incorporation.
(Incorporated by reference to Exhibit No. 3.3 of Focal's Registration
Statement on Form S-1, originally filed with the Securities and
Exchange Commission on May 7, 1999, as amended (Registration No. 333-
77995) (the "S-1"))
3.2 Certificate of Amendment of Amended and Restated Certificate of
Incorporation. (Incorporated by reference to Exhibit No. 3.1 of
Focal's Quarterly Report on Form 10-Q for the period ending June 30,
2000, originally filed with the Securities and Exchange Commission on
August 14, 2000)
3.3 Form of Amended and Restated By-Laws. (Incorporated by reference to
Exhibit No. 3.5 of the S-1)
4.1 Indenture with Harris Trust and Savings Bank, dated February 18, 1998.
(Incorporated by reference to Exhibit No. 4.1 of Focal's Registration
Statement on Form S-4, originally filed with the Securities and
Exchange Commission on August 13, 1998 (Registration No. 333-49397)
(the "1998 S-4"))
4.2 Initial Global 12.125% Senior Discount Note Due February 15, 2008,
dated February 18, 1998. (Incorporated by reference to Exhibit No. 4.2
of the 1998 S-4)
4.3 Stock Purchase Agreement with Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated November 27,
1996. (Incorporated by reference to Exhibit No. 4.5 of the 1998 S-4)
44
Exhibit
Number Exhibit Description
------- -------------------
4.4 Amendment No. 1 to Stock Purchase Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated January 23, 1998. (Incorporated by reference to
Exhibit No. 4.6 of the 1998 S-4)
4.5 Amendment No. 2 to Stock Purchase Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.8 of Focal's Quarterly Report on Form 10-Q for the
period ending September 30, 1998, originally filed with the Securities
and Exchange Commission on November 16, 1998 (the "3rd Quarter 1998
10-Q"))
4.6 Vesting Agreement with Madison Dearborn Capital Partners, L.P., Brian
F. Addy, John R. Barnicle, Joseph Beatty, and Robert C. Taylor, Jr.,
dated as of November 27, 1996. (Incorporated by reference to Exhibit
No. 4.1 of the 3rd Quarter 1998 10-Q)
4.7 Vesting Agreement with Frontenac VI, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated as of
November 27, 1996. (Incorporated by reference to Exhibit No. 4.2 of
the 3rd Quarter 1998 10-Q)
4.8 Vesting Agreement with Battery Ventures III, L.P., Brian F. Addy, John
R. Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated as of
November 27, 1996. (Incorporated by reference to Exhibit No. 4.3 of
the 3rd Quarter 1998 10-Q)
4.9 Amendment No. 1 to Vesting Agreement and Consent with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.4 of the 3rd Quarter 1998 10-Q)
4.10 Amendment No. 1 to Vesting Agreement and Consent with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.5 of the 3rd Quarter 1998 10-Q)
4.11 Amendment No. 1 to Vesting Agreement and Consent with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.6 of the 3rd Quarter 1998 10-Q)
4.12 Form of Restricted Stock Agreement with each of Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated as of
September 30, 1998 (Incorporated by reference to Exhibit No. 4.7 of
the 3rd Quarter 1998 10-Q)
4.13 Stockholders Agreement with Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated November 27,
1996. (Incorporated by reference to Exhibit No. 4.11 of the 1998 S-4)
4.14 Amendment No. 1 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of July 7, 1998. (Incorporated by reference to
Exhibit No. 4.9 of the 3rd Quarter 1998 10-Q)
4.15 Amendment No. 2 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.10 of the 3rd Quarter 1998 10-Q)
45
Exhibit
Number Exhibit Description
------- -------------------
4.16 Amendment No. 3 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated February 16, 1999. (Incorporated by reference to
Exhibit 4.16 of Focal's Annual Report on Form 10-K for the year ended
December 31, 1999, originally filed with the Securities and Exchange
Commission on March 31, 1999 (the "1998 10-K"))
4.17 Amendment No. 4 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated May 21, 1999. (Incorporated by reference to Exhibit
No. 4.27 of the S-1)
4.18 Executive Stock Agreement and Employment Agreement with Brian F. Addy,
dated November 27, 1996. (Incorporated by reference to Exhibit
No. 4.12 of the 1998 S-4)+
4.19 Executive Stock Agreement and Employment Agreement with John R.
Barnicle, dated November 27, 1996. (Incorporated by reference to
Exhibit No. 4.13 of the 1998 S-4)+
4.20 Executive Stock Agreement and Employment Agreement with Joseph A.
Beatty, dated November 27, 1996. (Incorporated by reference to Exhibit
No. 4.14 of the 1998 S-4)+
4.21 Executive Stock Agreement and Employment Agreement with Robert C.
Taylor, Jr., dated November 27, 1996. (Incorporated by reference to
Exhibit No. 4.15 of the 1998 S-4)+
4.22 Amendment No. 1 to Executive Employment Agreement and Consent with
Brian F. Addy, dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.11 of the 3rd Quarter 1998 10-Q)+
4.23 Amendment No. 1 to Executive Employment Agreement and Consent with
John R. Barnicle, dated as of August 21, 1998. (Incorporated by
reference to Exhibit No. 4.12 of the 3rd Quarter 1998 10-Q)+
4.24 Amendment No. 1 to Executive Employment Agreement and Consent with
Joseph Beatty, dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.13 of the 3rd Quarter 1998 10-Q)+
4.25 Amendment No. 1 to Executive Employment Agreement and Consent with
Robert C. Taylor, Jr., dated as of August 21, 1998. (Incorporated by
reference to Exhibit No. 4.14 of the 3rd Quarter 1998 10-Q)+
4.26 Registration Agreement with Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C. Taylor, Jr., dated November 27,
1996. (Incorporated by reference to Exhibit No. 4.16 of the 1998 S-4)
4.27 Amendment No. 1 to Registration Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 4.15 of the 3rd Quarter 1998 10-Q)
4.28 Amendment No. 2 to Registration Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 2, 2000. (Incorporated by reference to
Exhibit No. 4.2 of Focal's Quarterly Report on Form 10-Q for the
period ending September 30, 2000, originally filed with the Securities
and Exchange Commission on November 14, 2000 (the "3rd Quarter 2000
10-Q"))
4.29 Restricted Shares Agreement with Michael L. Mael, effective as of
January 31, 2000. (Incorporated by reference to Exhibit No. 4.1 of
Focal's Quarterly Report on Form 10-Q for the period ending March 31,
2000, originally filed with the Securities and Exchange Commission on
May 12, 2000 (the "1st Quarter 2000 10-Q"))+
4.30 Indenture with Harris Trust and Savings Bank, dated January 12, 2000.
(Incorporated by reference to Exhibit No. 4.28 of Focal's Registration
Statement on Form S-4, originally filed with the Securities and
Exchange Commission on April 10, 2000, as amended (Registration No.
333-34480) (the "2000 S-4"))
4.31 Form of 11 7/8% Senior Notes due January 15, 2010, Series B (CUSIP No.
344155AE6). (Incorporated by reference to Exhibit No. 4.34 of the 2000
S-4)
46
Exhibit
Number Exhibit Description
------- -------------------
4.32 Tag Along Agreement with Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III, L.P., Robert C. Taylor, Jr.,
Mistral Partners, L.P., John R. Barnicle, JRB Partners, L.P., Joseph
A. Beatty, and Coventry Court Partners, L.P. (Incorporated by
reference to Exhibit 4.3 of the 3rd Quarter 2000 10-Q)
10.1 Executive Employment Agreement with Michael L. Mael, dated as of
January 8, 2000. (Incorporated by reference to Exhibit No. 10.1 of the
1st Quarter 2000 10-Q)
10.2 $300 Million Senior Secured Credit Facility Agreement with Focal
Financial Services, Inc., certain subsidiaries of Focal, as
guarantors, and various lenders, dated as of August 25, 2000.
(Incorporated by reference to Exhibit No. 10.1 of the 3rd Quarter 2000
10-Q)
10.3 Network Products Purchase Agreement with Northern Telecom Inc., dated
January 21, 1997. (Incorporated by reference to Exhibit No. 10.5 of
the 1998 S-4)
10.4 Amendments No. 1 and No. 2 to Network Products Purchase Agreement with
Northern Telecom Inc., both dated March 6, 1998. (Incorporated by
reference to Exhibit No. 10.6 of the 1998 S-4)*
10.5 Amendment No. 3 to Network Products Purchase Agreement with Northern
Telecom Inc., dated March 25, 1999. (Incorporated by reference to
Exhibit No. 10.7 to Focal's Quarterly Report on Form 10-Q for the
period ended March 31, 1999, originally filed with the Securities and
Exchange Commission on May 7, 1999, as amended)*
10.6 Loan and Security Agreement with NTFC Capital Corporation dated
December 30, 1998. (Incorporated by reference to Exhibit No. 10.17 of
the 1998 10-K)*
10.7 Amendment No. 1 to Loan and Security Agreement with NTFC Capital
Corporation dated as of April 15, 1999. (Incorporated by reference to
Exhibit No. 10.25 of the S-1)
10.8 Second Amendment to Loan and Security Agreement with NTFC Capital
Corporation, dated as of November 30, 2000.*
10.9 Employment Agreement with Renee M. Martin, dated March 20, 1998.
(Incorporated by reference to Exhibit No. 10.16 of the 1998 S-4)+
10.10 Amendment No. 1 to Executive Employment Agreement with Renee M.
Martin, dated as of August 21, 1998. (Incorporated by reference to
Exhibit No. 10.10 of the 3rd Quarter 1998 10-Q)+
10.11 1997 Nonqualified Stock Option Plan, amended and restated as of
August 21, 1998. (Incorporated by reference to Exhibit No. 10.7 of the
3rd Quarter 1998 10-Q)+
10.12 Amendment to 1997 Nonqualified Stock Option Plan (amended and restated
as of August 21, 1998), dated as of May 21, 1999. (Incorporated by
reference to Exhibit No. 10.58 of the S-1)+
10.13 Form of Amended and Restated Stock Option Agreement. (Incorporated by
reference to Exhibit No. 10.33 of the 1998 10-K)+
10.14 Amended and Restated 1998 Equity and Performance Incentive Plan.
(Incorporated by reference to Exhibit No. 4.39 of Focal's Registration
Statement on Form S-8, originally filed with the Securities and
Exchange Commission on September 22, 2000)+
10.15 Form of Non-Qualified Stock Option Agreement. (Incorporated by
reference to Exhibit No. 4.1 of the 3rd Quarter 2000 10-Q)+
10.16 1998 Equity Plan for Non-Employee Directors. (Incorporated by
reference to Exhibit No. 10.9 of the 3rd Quarter 1998 10-Q)+
10.17 Agreement for Sale of Real Property between Focal Communications
Corporation and United Air Lines, Inc. dated August 13, 1998.
(Incorporated by reference to Exhibit No. 10.36 of the 1998 10-K)
10.18 IRU Agreement dated April 28, 1999, by and between Focal Financial
Services, Inc. and Level 3 Communications, LLC. (Incorporated by
reference to Exhibit No. 10.55 of the S-1)*
47
Exhibit
Number Exhibit Description
------- -------------------
10.19 Private Line Service Agreement, dated May 4, 1999, by and between
Focal Communications Corporation and WorldCom Technologies, Inc.
(Incorporated by reference to Exhibit No. 10.56 of the S-1)*
10.20 Fiber Optic Network leased Fiber Agreement between Metromedia Fiber
Network Services, Inc. and Focal Financial Services, Inc., dated as of
May 24, 1999. (Incorporated by reference to Exhibit No. 10.57 of the
S-1)*
10.21 2000 Employee Stock Purchase Plan. (Incorporated by reference to
Exhibit No. 4.39 of Focal's Registration Statement on Form S-8 (ESPP),
originally filed with the Securities and Exchange Commission on
September 21, 2000 (the "ESPP S-8"))
10.22 Form of Stock Purchase Agreement. (Incorporated by reference to
Exhibit No. 4.40 of the ESPP S-8)
10.23 401(k) Profit Sharing Plan. (Incorporated by reference to Exhibit 4.39
of Focal's Registration Statement on Form S-8 (401(k) Profit Sharing
Plan), originally filed with the Securities and Exchange Commission on
September 21, 2000)
21.1 Subsidiaries of Focal. (Incorporated by reference to Exhibit No. 21.1
of the 2000 S-4
23.1 Consent of Arthur Andersen LLP.
- --------
* Portions of this exhibit have been omitted pursuant to a request for
confidential treatment, and the omitted portions have been filed
separately with the Securities and Exchange Commission.
+ Management contract or compensatory plan.
(b) Reports on Form 8-K. The Company did not file any reports on Form 8-K
during the period covered by this report.
(c) Financial Statement Schedules. The financial statement schedules filed
as part of this Annual Report on Form 10-K are as specified in item 14(a)(2)
herein.
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, there unto duly authorized.
Focal Communications Corporation
/s/ Robert C. Taylor, Jr.
By: _________________________________
Robert C. Taylor, Jr.
President and Chief Executive
Officer
March 30, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated. Each Director whose
signature appears below authorizes and appoints Robert C. Taylor, Jr., John R.
Barnicle and Renee M. Martin, or any of them, as his attorney-in-fact to sign
and file on his behalf any and all amendments to this report.
Signature Title Date
--------- ----- ----
/s/ Robert C. Taylor, Jr. President, Chief Executive March 30, 2001
______________________________________ Officer and Director
Robert C. Taylor, Jr. (Principal Executive
Officer)
/s/ John R. Barnicle Executive Vice President, March 30, 2001
______________________________________ Chief Operating Officer,
John R. Barnicle and Director
/s/ Ronald Reising Executive Vice President March 30, 2001
______________________________________ and Chief Financial
Ronald Reising Officer (Principal
Financial Officer)
/s/ Gregory J. Swanson Controller (Principal March 30, 2001
______________________________________ Accounting Officer)
Gregory J. Swanson
/s/ John A. Edwardson Director March 30, 2001
______________________________________
John A. Edwardson
/s/ Andrew E. Sinwell Director March 30, 2001
______________________________________
Andrew E. Sinwell
/s/ Todd A. Dagres Director March 30, 2001
______________________________________
Todd A. Dagres
/s/ James N. Perry, Jr. Director March 30, 2001
______________________________________
James N. Perry, Jr.
/s/ Paul G. Yovovich Director March 30, 2001
______________________________________
Paul G. Yovovich
/s/ Kathleen A. Perone Director March 30, 2001
______________________________________
Kathleen A. Perone
/s/ James E. Crawford III Director March 30, 2001
______________________________________
James E. Crawford III
49
EXHIBIT INDEX
Exhibit
Number Exhibit Description Location
------- ------------------- --------
3.1 Form of Amended and Restated Certificate Incorporated by reference
of Incorporation. (Incorporated by
reference to Exhibit No. 3.3 of Focal's
Registration Statement on Form S-1,
originally filed with the Securities and
Exchange Commission on May 7, 1999, as
amended (Registration No. 333-77995) (the
"S-1"))
3.2 Certificate of Amendment of Amended and Incorporated by reference
Restated Certificate of Incorporation.
(Incorporated by reference to Exhibit No.
3.1 of Focal's Quarterly Report on Form
10-Q for the period ending June 30, 2000,
originally filed with the Securities and
Exchange Commission on August 14, 2000)
3.3 Form of Amended and Restated By-Laws. Incorporated by reference
(Incorporated by reference to Exhibit No.
3.5 of the S-1)
4.1 Indenture with Harris Trust and Savings Incorporated by reference
Bank, dated February 18, 1998.
(Incorporated by reference to Exhibit No.
4.1 of Focal's Registration Statement on
Form S-4, originally filed with the
Securities and Exchange Commission on
August 13, 1998 (Registration No. 333-
49397) (the "1998 S-4"))
4.2 Initial Global 12.125% Senior Discount Incorporated by reference
Note Due February 15, 2008, dated February
18, 1998. (Incorporated by reference to
Exhibit No. 4.2 of the 1998 S-4)
4.3 Stock Purchase Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P.,
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor, Jr., dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.5 of the 1998
S-4)
4.4 Amendment No. 1 to Stock Purchase Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated January 23,
1998. (Incorporated by reference to
Exhibit No. 4.6 of the 1998 S-4)
4.5 Amendment No. 2 to Stock Purchase Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated as of August
21, 1998. (Incorporated by reference to
Exhibit No. 4.8 of Focal's Quarterly
Report on Form 10-Q for the period ending
September 30, 1998, originally filed with
the Securities and Exchange Commission on
November 16, 1998 (the "3rd Quarter 1998
10-Q"))
4.6 Vesting Agreement with Madison Dearborn Incorporated by reference
Capital Partners, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated as of
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.1 of the 3rd
Quarter 1998 10-Q)
4.7 Vesting Agreement with Frontenac VI, L.P., Incorporated by reference
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor, Jr., dated
as of November 27, 1996. (Incorporated by
reference to Exhibit No. 4.2 of the 3rd
Quarter 1998 10-Q)
50
Exhibit
Number Exhibit Description Location
------- ------------------- --------
4.8 Vesting Agreement with Battery Ventures Incorporated by reference
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of November 27,
1996. (Incorporated by reference to
Exhibit No. 4.3 of the 3rd Quarter 1998
10-Q)
4.9 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated as of August
21, 1998. (Incorporated by reference to
Exhibit No. 4.4 of the 3rd Quarter 1998
10-Q)
4.10 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated as of August
21, 1998. (Incorporated by reference to
Exhibit No. 4.5 of the 3rd Quarter 1998
10-Q)
4.11 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated as of August
21, 1998. (Incorporated by reference to
Exhibit No. 4.6 of the 3rd Quarter 1998
10-Q)
4.12 Form of Restricted Stock Agreement with Incorporated by reference
each of Brian F. Addy, John R. Barnicle,
Joseph Beatty, and Robert C. Taylor, Jr.,
dated as of September 30, 1998
(Incorporated by reference to Exhibit No.
4.7 of the 3rd Quarter 1998 10-Q)
4.13 Stockholders Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P.,
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor, Jr., dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.11 of the 1998
S-4)
4.14 Amendment No. 1 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of July 7, 1998.
(Incorporated by reference to Exhibit No.
4.9 of the 3rd Quarter 1998 10-Q)
4.15 Amendment No. 2 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.10 of the 3rd Quarter 1998 10-Q)
4.16 Amendment No. 3 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated February 16, 1999.
(Incorporated by reference to Exhibit 4.16
of Focal's Annual Report on Form 10-K for
the year ended December 31, 1999,
originally filed with the Securities and
Exchange Commission on March 31, 1999 (the
"1998 10-K"))
4.17 Amendment No. 4 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated May 21, 1999.
(Incorporated by reference to Exhibit No.
4.27 of the S-1)
51
Exhibit
Number Exhibit Description Location
------- ------------------- --------
4.18 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Brian F. Addy, dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.12 of the 1998
S-4)+
4.19 Executive Stock Agreement and Employment Incorporated by reference
Agreement with John R. Barnicle, dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.13 of the 1998
S-4)+
4.20 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Joseph A. Beatty, dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.14 of the 1998
S-4)+
4.21 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Robert C. Taylor, Jr.,
dated November 27, 1996. (Incorporated by
reference to Exhibit No. 4.15 of the 1998
S-4)+
4.22 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Brian F. Addy,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.11 of the
3rd Quarter 1998 10-Q)+
4.23 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with John R.
Barnicle, dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.12 of the 3rd Quarter 1998 10-Q)+
4.24 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Joseph Beatty,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.13 of the
3rd Quarter 1998 10-Q)+
4.25 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Robert C.
Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.14 of the 3rd Quarter 1998 10-Q)+
4.26 Registration Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P.,
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor, Jr., dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.16 of the 1998
S-4)
4.27 Amendment No. 1 to Registration Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.15 of the 3rd Quarter 1998 10-Q)
4.28 Amendment No. 2 to Registration Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated as of August 2, 2000.
(Incorporated by reference to Exhibit No.
4.2 of Focal's Quarterly Report on Form
10-Q for the period ending September 30,
2000, originally filed with the Securities
and Exchange Commission on November 14,
2000 (the "3rd Quarter 2000 10-Q"))
4.29 Restricted Shares Agreement with Michael Incorporated by reference
L. Mael, effective as of January 31, 2000.
(Incorporated by reference to Exhibit No.
4.1 of Focal's Quarterly Report on Form
10-Q for the period ending March 31, 2000,
originally filed with the Securities and
Exchange Commission on May 12, 2000 (the
"1st Quarter 2000 10-Q"))+
52
Exhibit
Number Exhibit Description Location
------- ------------------- --------
4.30 Indenture with Harris Trust and Savings Incorporated by reference
Bank, dated January 12, 2000.
(Incorporated by reference to Exhibit No.
4.28 of Focal's Registration Statement on
Form S-4, originally filed with the
Securities and Exchange Commission on
April 10, 2000, as amended (Registration
No. 333-34480) (the "2000 S-4"))
4.31 Form of 11 7/8% Senior Note due January Incorporated by reference
15, 2010, Series B (CUSIP No. 344155AE6).
(Incorporated by reference to Exhibit No.
4.34 of the 2000 S-4)
4.32 Tag Along Agreement with Madison Dearborn Incorporated by reference
Capital Partners, L.P., Frontenac VI,
L.P., Battery Ventures III, L.P., Robert
C. Taylor, Jr., Mistral Partners, L.P.,
John R. Barnicle, JRB Partners, L.P.,
Joseph A. Beatty, and Coventry Court
Partners, L.P. (Incorporated by reference
to Exhibit 4.3 of the 3rd Quarter 2000 10-
Q)
10.1 Executive Employment Agreement with Incorporated by reference
Michael L. Mael, dated as of January 8,
2000. (Incorporated by reference to
Exhibit No. 10.1 of the 1st Quarter 2000
10-Q)
10.2 $300 Million Senior Secured Credit Incorporated by reference
Facility Agreement with Focal Financial
Services, Inc., certain subsidiaries of
Focal, as guarantors, and various lenders,
dated as of August 25, 2000. (Incorporated
by reference to Exhibit No. 10.1 of the
3rd Quarter 2000 10-Q)
10.3 Network Products Purchase Agreement with Incorporated by reference
Northern Telecom Inc., dated January 21,
1997. (Incorporated by reference to
Exhibit No. 10.5 of the 1998 S-4)
10.4 Amendments No. 1 and No. 2 to Network Incorporated by reference
Products Purchase Agreement with Northern
Telecom Inc., both dated March 6, 1998.
(Incorporated by reference to Exhibit No.
10.6 of the 1998 S-4)*
10.5 Amendment No. 3 to Network Products Incorporated by reference
Purchase Agreement with Northern Telecom
Inc., dated March 25, 1999. (Incorporated
by reference to Exhibit No. 10.7 to
Focal's Quarterly Report on Form 10-Q for
the period ended March 31, 1999,
originally filed with the Securities and
Exchange Commission on May 7, 1999, as
amended)*
10.6 Loan and Security Agreement with NTFC Incorporated by reference
Capital Corporation dated December 30,
1998 (Incorporated by reference to Exhibit
No. 10.17 of the 1998 10-K).*
10.7 Amendment No. 1 to Loan and Security Incorporated by reference
Agreement with NTFC Capital Corporation
dated as of April 15, 1999. (Incorporated
by reference to Exhibit No. 10.25 of the
S-1)
10.8 Second Amendment to Loan and Security Filed herewith
Agreement with NTFC Capital Corporation,
dated as of November 30, 2000.*
10.9 Employment Agreement with Renee M. Martin, Incorporated by reference
dated March 20, 1998. (Incorporated by
reference to Exhibit No. 10.16 of the 1998
S-4)+
10.10 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement with Renee M. Martin, dated as
of August 21, 1998. (Incorporated by
reference to Exhibit No. 10.10 of the 3rd
Quarter 1998 10-Q)+
10.11 1997 Nonqualified Stock Option Plan, Incorporated by reference
amended and restated as of August 21,
1998. (Incorporated by reference to
Exhibit No. 10.7 of the 3rd Quarter 1998
10-Q)+
53
Exhibit
Number Exhibit Description Location
------- ------------------- --------
10.12 Amendment to 1997 Nonqualified Stock Incorporated by reference
Option Plan (amended and restated as of
August 21, 1998), dated as of May 21,
1999. (Incorporated by reference to
Exhibit No. 10.58 of the S-1)+
10.13 Form of Amended and Restated Stock Option Incorporated by reference
Agreement. (Incorporated by reference to
Exhibit No. 10.33 of the 1998 10-K)+
10.14 Amended and Restated 1998 Equity and Incorporated by reference
Performance Incentive Plan. (Incorporated
by reference to Exhibit No. 4.39 of
Focal's Registration Statement on Form S-
8, originally filed with the Securities
and Exchange Commission on September 22,
2000)+
10.15 Form of Non-Qualified Stock Option Incorporated by reference
Agreement. (Incorporated by reference to
Exhibit No. 4.1 of the 3rd Quarter 2000
10-Q)+
10.16 1998 Equity Plan for Non-Employee Incorporated by reference
Directors. (Incorporated by reference to
Exhibit No. 10.9 of the 3rd Quarter 1998
10-Q)+
10.17 Agreement for Sale of Real Property Incorporated by reference
between Focal Communications Corporation
and United Air Lines, Inc. dated August
13, 1998. (Incorporated by reference to
Exhibit No. 10.36 of the 1998 10-K)
10.18 IRU Agreement dated April 28, 1999, by and Incorporated by reference
between Focal Financial Services, Inc. and
Level 3 Communications, LLC. (Incorporated
by reference to Exhibit No. 10.55 of the
S-1)*
10.19 Private Line Service Agreement, dated May Incorporated by reference
4, 1999, by and between Focal
Communications Corporation and WorldCom
Technologies, Inc. (Incorporated by
reference to Exhibit No. 10.56 of the S-
1)*
10.20 Fiber Optic Network leased Fiber Agreement Incorporated by reference
between Metromedia Fiber Network Services,
Inc. and Focal Financial Services, Inc.,
dated as of May 24, 1999. (Incorporated by
reference to Exhibit No. 10.57 of the S-
1)*
10.21 2000 Employee Stock Purchase Plan. Incorporated by reference
(Incorporated by reference to Exhibit No.
4.39 of Focal's Registration Statement on
Form S-8 (ESPP), originally filed with the
Securities and Exchange Commission on
September 21, 2000 (the "ESPP S-8"))
10.22 Form of Stock Purchase Agreement. Incorporated by reference
(Incorporated by reference to Exhibit No.
4.40 of the ESPP S-8)
10.23 401(k) Profit Sharing Plan. (Incorporated Incorporated by reference
by reference to Exhibit 4.39 of Focal's
Registration Statement on Form S-8 (401(k)
Profit Sharing Plan), originally filed
with the Securities and Exchange
Commission on September 21, 2000)
21.1 Subsidiaries of Focal. (Incorporated by Incorporated by reference
reference to Exhibit No. 21.1 of the 2000
S-4)
23.1 Consent of Arthur Andersen LLP. Filed herewith
- --------
* Portions of this exhibit have been omitted pursuant to a request for
confidential treatment, and the omitted portions have been filed
separately with the Securities and Exchange Commission.
+ Management contract or compensatory plan.
54
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2000 and 1999............ F-3
Consolidated Statements of Operations for the Three Years Ended December
31, 2000............................................................... F-4
Consolidated Statements of Stockholders' Equity for the Three Years
Ended December 31, 2000................................................ F-5
Consolidated Statements of Cash Flows for the Three Years Ended December
31, 2000................................................................. F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................ F-7
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-21
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS............................. F-22
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Focal Communications Corporation:
We have audited the accompanying consolidated balance sheets of FOCAL
COMMUNICATIONS CORPORATION AND SUBSIDIARIES (a Delaware corporation) as of
December 31, 2000 and 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Focal
Communications Corporation and Subsidiaries as of December 31, 2000 and 1999,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 9, 2001
F-2
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 2000 and 1999
(Dollars in thousands, except share amounts)
ASSETS 2000 1999
------ -------- --------
Current assets:
Cash and cash equivalents................................ $171,417 $178,142
Short-term investments................................... 10,320 10,000
Accounts receivable, net of allowance for doubtful
accounts of $9,600 and $7,700 at December 31, 2000 and
1999, respectively...................................... 46,823 27,247
Other current assets..................................... 21,069 4,543
-------- --------
Total current assets................................... 249,629 219,932
-------- --------
Property, Plant and Equipment, at cost..................... 536,355 224,470
Less--Accumulated depreciation and amortization.......... (85,083) (28,169)
-------- --------
Property, Plant and Equipment, net......................... 451,272 196,301
-------- --------
Other noncurrent assets.................................... 22,784 4,753
-------- --------
$723,685 $420,986
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable......................................... $ 99,909 $ 15,324
Accrued liabilities...................................... 28,730 7,560
Current maturities of long-term debt..................... 9,909 9,252
-------- --------
Total current liabilities.............................. 138,548 32,136
-------- --------
Long-term debt, net of current maturities.................. 534,841 244,534
-------- --------
Other noncurrent liabilities............................... 5,507 1,829
-------- --------
Stockholders' equity:
Common Stock, $.01 par value; 100,000,000 shares
authorized; 61,454,594 and 60,748,981 shares issued and
outstanding at December 31, 2000 and 1999, respectively. 615 607
Additional paid-in capital............................... 184,953 177,535
Deferred compensation.................................... (1,186) (1,919)
Accumulated deficit...................................... (139,593) (33,736)
-------- --------
Total stockholders' equity............................. 44,789 142,487
-------- --------
$723,685 $420,986
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Years Ended December 31, 2000
(Dollars in thousands, except share amounts)
2000 1999 1998
---------- ---------- ----------
REVENUES:
Data services............................ $ 158,968 $ 96,856 $ --
Telecom services ........................ 75,152 30,005 --
---------- ---------- ----------
Total revenues ........................ 234,120 126,861 43,532
---------- ---------- ----------
EXPENSES:
Network expenses......................... 89,741 29,941 5,098
Selling, general and administrative...... 155,498 73,455 22,396
Depreciation and amortization............ 56,985 23,763 6,671
Non-cash compensation expense............ 6,360 7,186 3,070
---------- ---------- ----------
Total expenses......................... 308,584 134,345 37,235
---------- ---------- ----------
OPERATING INCOME (LOSS).................... (74,464) (7,484) 6,297
---------- ---------- ----------
OTHER INCOME (EXPENSE):
Interest income.......................... 20,339 7,946 6,528
Interest expense, net.................... (56,179) (21,639) (16,134)
Other income (expense)................... 242 (609) --
---------- ---------- ----------
Total other expense.................... (35,598) (14,302) (9,606)
---------- ---------- ----------
LOSS BEFORE INCOME TAXES................... (110,062) (21,786) (3,309)
BENEFIT (PROVISION) FOR INCOME TAXES....... 4,205 (600) (4,660)
---------- ---------- ----------
NET LOSS................................... $ (105,857) $ (22,386) $ (7,969)
========== ========== ==========
BASIC AND DILUTED NET LOSS PER SHARE
OF COMMON STOCK........................... $ (1.75) $ (0.45) $ (0.18)
========== ========== ==========
BASIC WEIGHTED AVERAGE NUMBER OF SHARES OF
COMMON STOCK OUTSTANDING.................. 60,456,245 50,066,315 43,763,000
========== ========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Three Years Ended December 31, 2000
(Dollars in thousands, except common shares)
Additional
Common paid-in Deferred Accumulated
Shares Amount Capital Compensation Deficit Total
---------- ------ ---------- ------------ ----------- --------
BALANCE, December 31,
1997................... 17,355,500 $174 $ 4,923 $(3,792) $ (3,381) $ (2,076)
Reclassification
resulting from
amendment to stock
purchase agreement..... 40,153,500 401 12,002 -- -- 12,403
Issuance of Common
Stock.................. 33,500 -- 13,900 -- -- 13,900
Cancellation and
conversion of Common
Stock.................. (8,855,500) (88) 4,102 (4,014) -- --
Amortization of deferred
compensation........... -- -- -- 3,070 -- 3,070
Net loss................ -- -- -- -- (7,969) (7,969)
---------- ---- -------- ------- --------- --------
BALANCE, December 31,
1998................... 48,687,000 487 34,927 (4,736) (11,350) 19,328
Issuance of Common
Stock.................. 11,592,500 116 137,377 -- -- 137,493
Stock options exercised. 469,481 4 862 -- -- 866
Non-cash compensation... -- -- 4,369 -- -- 4,369
Amortization of deferred
compensation........... -- -- -- 2,817 -- 2,817
Net loss................ -- -- -- -- (22,386) (22,386)
---------- ---- -------- ------- --------- --------
BALANCE, December 31,
1999................... 60,748,981 607 177,535 (1,919) (33,736) 142,487
Issuance of Common
Stock.................. 150,000 2 -- -- -- 2
Cancellation of Common
Stock.................. (175,000) (2) -- -- -- (2)
Stock options exercised. 730,613 8 1,791 -- -- 1,799
Non-cash compensation... -- -- 5,627 -- -- 5,627
Amortization of deferred
compensation........... -- -- -- 733 -- 733
Net loss................ -- -- -- -- (105,857) (105,857)
---------- ---- -------- ------- --------- --------
BALANCE, December 31,
2000................... 61,454,594 $615 $184,953 $(1,186) $(139,593) $ 44,789
========== ==== ======== ======= ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Years Ended December 31, 2000
(Dollars in thousands, except share amounts)
2000 1999 1998
--------- --------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss..................................... $(105,857) $( 22,386) $ (7,969)
Adjustments to reconcile net loss to net cash
provided by operating activities--
Depreciation and amortization.............. 56,985 23,763 6,671
Amortization of obligation under capital
lease..................................... 2,275 1,077 --
Non-cash compensation expense.............. 6,360 7,186 3,070
Amortization of discount on senior discount
notes..................................... 23,487 20,713 16,080
Loss on disposal of fixed assets........... -- 609 --
Gain on sale of investment affiliate....... (199) -- --
Provision for losses on accounts
receivable................................ 6,987 7,090 720
Changes in operating assets and
liabilities--
Accounts receivable...................... (26,563) (24,545) (8,157)
Other current assets..................... (16,526) (3,699) (718)
Accounts payable and accrued liabilities. 105,755 8,522 12,491
Other non-current assets and liabilities,
net..................................... (508) 219 319
--------- --------- --------
Net cash provided by operating
activities............................ 52,196 18,549 22,507
--------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures......................... (309,617) (128,550) (64,229)
Change in short-term investments............. (320) (2,040) (7,960)
--------- --------- --------
Net cash used in investing activities.. (309,937) (130,590) (72,189)
--------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Deferred debt issuance cost.................. (14,549) -- --
Proceeds from issuance of long-term debt..... 273,020 31,768 163,103
Payments on long-term debt................... (9,254) (5,985) (3,537)
Net proceeds from the issuance of Common
Stock....................................... 1,799 138,359 13,900
--------- --------- --------
Net cash provided by financing
activities............................ 251,016 164,142 173,466
--------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS................................... (6,725) 52,101 123,784
CASH AND CASH EQUIVALENTS
Beginning of period.......................... 178,142 126,041 2,257
--------- --------- --------
CASH AND CASH EQUIVALENTS
End of period................................ $ 171,417 $ 178,142 $126,041
========= ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share amounts)
1. ORGANIZATION AND OPERATIONS
Focal Communications Corporation began operations on May 31, 1996. Focal
Communications Corporation and Subsidiaries is a national broadband
communications provider in the United States and offers a range of voice, data
and Internet infrastructure services to larger, communications-intensive users
in major cities.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The 2000 and 1999 consolidated financial statements include the accounts of
all our wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation.
Basis of Accounting
The accompanying consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles ("GAAP").
Use of Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
Concentration of Suppliers
We currently lease our transport capacity from a limited number of
suppliers and are dependent upon the availability of fiber transmission
facilities owned by those suppliers. We are currently vulnerable to the risk
of renewing favorable supplier contracts, timeliness of the supplier in
processing our orders for customers and we are at risk to regulatory
agreements that govern the rates to be charged to us.
Financial Instruments
We consider all liquid interest-earning investments with a maturity of
three months or less at the date of purchase to be cash equivalents. Short-
term investments primarily consist of debt securities, which typically mature
between three months and one year from the purchase date and are held to
maturity and valued at amortized cost, which approximates fair value. The
carrying value for current assets and current liabilities as of December 31,
2000 and 1999 reasonably approximates fair value due to the nature of the
financial instrument and the short maturity of these items. Fair value for our
long-term debt is based on market quotes, where available or by discounting
expected cash flows at the rates currently offered to us for debt of the same
remaining maturities. The fair value of our long-term debt is approximately
$295,000 and $176,850 as of December 31, 2000 and 1999, respectively.
F-7
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Revenue Recognition
Revenue is recognized as we provide services to our customers. Monthly
recurring charges include fees paid by customers for lines in service,
additional features on those lines and colocation space. These charges are
billed monthly, in advance, and are fully earned during the month. Usage
charges and reciprocal compensation charges are billed in arrears and are
fully earned when billed. Initial, non-recurring fees are deferred and
amortized over estimated customer lives.
Depreciation and Amortization
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:
Asset Description Useful Life
----------------- -----------
Buildings and improvements......... 20 years
Communications network............. 3-20 years
Computer equipment................. 3 years
Leasehold improvements............. Shorter of asset life or life of lease
Furniture and fixtures............. 2-5 years
Motor vehicles..................... 2-3 years
When depreciable assets are replaced or retired, the amounts at which such
assets were carried are removed from the respective accounts and charged to
accumulated depreciation and any gains or losses on disposition are recorded
currently in the consolidated statements of operations.
Maintenance and repairs are charged to expense as incurred, while major
replacements and improvements are capitalized.
Impairment of Long-Lived Assets
We periodically assess the recoverability of the carrying cost of our long-
lived assets based on a review of projected undiscounted cash flows related to
the asset held for use. If assets are determined to be impaired, then the
asset is written down to its fair value based on the present value of the
discounted cash flows of the related asset or other relevant measures (quoted
market prices, third-party offers, etc.). Based on our review, management does
not believe that an impairment of the long-lived assets has occurred.
Income Taxes
We account for income taxes using the liability approach pursuant to which
deferred income tax assets and liabilities are determined based on the
difference between the financial statement and tax bases of assets and
liabilities, using enacted tax rates currently in effect. State and local
taxes may be based on factors other than income.
Segment Information
In 1998, we adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information which requires a "management approach"" to
segment information. The management approach designates the internal reporting
that is used by management for making operating decisions and assessing
performance as the source of our reportable segments. We operate in a single
industry segment, "Communication Services." Operations are managed and
financial performance is evaluated based on the delivery of multiple
communications services to customers over fiber networks.
F-8
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Software Costs
Certain costs incurred in the development of internal use software are
capitalized and amortized over their appropriate useful lives.
Reclassifications
Certain prior-year amounts have been reclassified to conform to the 2000
and 1999 presentation. These changes had no impact on our previously reported
financial position or our results of operations.
3. PROPERTY, PLANT AND EQUIPMENT
Long-lived assets are stated at cost, which includes direct costs and
capitalized interest, and are depreciated once placed in service using the
straight line method. Interest capitalized in 2000 and 1999 amounted to $9,374
and $3,633, respectively.
Property, plant and equipment consists of the following:
December 31,
------------------
2000 1999
-------- --------
Building and improvements............................. $ 8,444 $ 8,365
Communications network................................ 254,860 106,723
Computer equipment.................................... 34,172 11,646
Leasehold improvements................................ 55,527 24,756
Furniture and fixtures................................ 10,166 5,020
Motor vehicles........................................ 488 152
Assets under capital lease............................ 22,354 20,917
Construction in progress.............................. 150,344 46,891
-------- --------
536,355 224,470
Less--Accumulated depreciation and amortization....... (85,083) (28,169)
-------- --------
Total............................................... $451,272 $196,301
======== ========
4. LONG-TERM DEBT
In February 1998, we completed our offering of $270 million stated
principal amount at maturity of our 12.125% senior discount notes due 2008
(the 1998 "Notes"), resulting in gross proceeds of $150,028. The 1998 Notes
bear interest at the rate of 12.125% per annum (computed on a semi-annual Note
equivalent basis) with an effective interest rate of approximately 11.09% and
11.81% for 2000 and 1999, respectively. Prior to February 15, 2003, interest
accrues but is not payable in cash.
From February 15, 2003, interest on the stated principal amount at maturity
of the 1998 Notes will be payable in cash semiannually on August 15 and
February 15 of each year, beginning on August 15, 2003. Total interest expense
for the 1998 Notes was $23,296 in 2000 and $20,713 in 1999.
F-9
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The 1998 Notes are senior unsecured obligations of Focal's ranking pari
passu in right of payment with all other existing and future senior
indebtedness of ours, if any, and will rank senior in right of payment to all
existing and future subordinated indebtedness of Focal's, if any. Holders of
secured indebtedness of Focal's, however, will have claims that are prior to
the claims of the holders of the 1998 Notes with respect to the assets
securing such other indebtedness. The 1998 Notes will be effectively
subordinated to all existing and future indebtedness and other liabilities of
our subsidiaries (including accounts payable).
The 1998 Notes are redeemable, at our option, in whole or in part, at any
time or from time to time, on or after February 15, 2003, at 106.063% of their
stated principal amount at maturity, plus accrued and unpaid current interest,
declining ratably to 100% of their stated principal amount at maturity, plus
accrued and unpaid current interest, on or after February 15, 2006.
The Notes indenture contains certain covenants which, among other things,
restrict our ability and certain of our subsidiaries to incur additional
indebtedness (and, in the case of certain subsidiaries, issue preferred
stock), pay dividends or make distributions in respect of Focal's or such
subsidiaries' capital stock, make other restricted payments, enter into sale
and leaseback transactions, incur liens, cause encumbrances or restrictions to
exist on the ability of certain subsidiaries to pay dividends or make
distributions in respect of their capital stock, issue and sell capital stock
of certain subsidiaries, enter into transactions with affiliates, sell assets,
or amalgamate, consolidate, merge or sell or otherwise dispose of all or
substantially all of their property and assets. These covenants are subject to
exceptions and qualifications. We were in compliance with these covenants as
of December 31, 2000.
On January 12, 2000, we received net proceeds of approximately $265,700
from the issuance of our $275,000 11 7/8% senior notes due 2010 ("2000
Notes"). The 2000 Notes bear interest at a rate of 11.875% per annum payable
on July 15 and January 15, commencing July 15, 2000 with an effective interest
rate of 11.71% for 2000. The 2000 Notes are not secured by any of our assets
and rank equally in right of payment with all our unsubordinated and unsecured
indebtedness. The 2000 Notes are senior in right of payment to all of our
future subordinated indebtedness. We may elect to redeem all or part of the
2000 Notes at any time from time to time, on or after January 15, 2005 at
specified redemption prices. In addition, at any time and from time to time
prior to January 15, 2003 we may redeem in the aggregate up to 35% of the
initially outstanding aggregate principal amount of the 2000 Notes with the
proceeds from one or more registered underwritten primary public offerings of
common stock at a price of 111.875% of the principal amount of the 2000 Notes.
On August 25, 2000, we completed our $300,000 Senior Secured Credit
Facility (the Credit Facility). The Credit Facility consists of a seven year
$150,000 revolving credit facility and a seven year $150,000 delayed draw term
loan facility. The Credit Facility will be available, subject to certain
financial and operating terms and conditions, and is intended to provide
purchase money financing for the construction, acquisition, or improvements of
telecommunications assets. The interest on amounts drawn is variable based on
our leverage ratio, as defined in the Credit Facility. The initial commitment
fee on the unused portion of the Credit Facility is 1.5% and will step down
based on usage. We have not drawn down against the Credit Facility as of
December 31, 2000.
We utilized a secured equipment term loan (the "Facility") from a third
party with a maximum borrowing level of $50,000. The Facility provided for,
among other things, equipment drawdowns through December 30, 1999, and
requires repayment based on 60 equal monthly installments of principal and
interest for each drawdown. All drawdowns under the Facility bear interest at
the five-year swap rate percent plus additional basis points, as defined in
the Facility. The effective interest rate for the drawdowns under the Facility
was approximately 9.82% and 9.68% for 2000 and 1999, respectively. The
Facility provides for certain restrictive
F-10
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
financial and non-financial covenants. Among other things, these covenants
require the maintenance of minimum cash flow and revenue levels. We were in
compliance with these covenants as of December 31, 2000. Total interest
expense was $ 3,958 for 2000 and $3,374 for 1999.
Long-term debt at December 31, 2000 and 1999, consists of the following:
December 31,
-----------------
2000 1999
-------- --------
12.125% senior discount notes due 2008, net of unamortized
discount of $ 59,888 and $83,184 at December 31, 2000 and
1999, respectively ......................................... $210,112 $186,816
11.875% senior notes due 2010, net of unamortized discount of
$1,789 at December 31, 2000................................. 273,211 --
Secured equipment term loan.................................. 35,462 44,214
$300,000 Senior Secured Credit Facility...................... -- --
Obligations under capital lease (Note 10).................... 25,705 21,994
Term loan payable in monthly installments through June 2001
at an interest rate of 6.5%................................. 260 762
-------- --------
544,750 253,786
Less--Current maturities..................................... 9,909 9,252
-------- --------
Total...................................................... $534,841 $244,534
======== ========
Aggregate maturities of long-term debt outstanding, excluding obligations
under capital lease, as of December 31, 2000, are as follows:
2001............................................................. $ 9,909
2002............................................................. 10,638
2003............................................................. 11,728
2004............................................................. 3,447
2005............................................................. --
Thereafter....................................................... 483,323
--------
Total.......................................................... $519,045
========
5. STOCK OPTIONS/STOCK PURCHASE PLAN
We established the Focal Communications Corporation 1997 Non Qualified
Stock Option Plan (the "1997 Plan") effective February 27, 1997. The 1997 Plan
is administered by the compensation committee of our Board of Directors (the
"Board"). Options to purchase 6,927,650 shares were issued under the 1997 Plan
and no further options will be granted under the 1997 Plan.
We adopted the Focal Communications Corporation 1998 Equity and Performance
Incentive Plan (the "1998 Plan") on August 21, 1998. The total number of
shares available under the 1998 Plan shall not exceed 12,050,000 shares. The
Board and, with respect to non-executive employees, the stock option committee
of our Board of Directors, has sole and complete authority to select
participants and grant options, and other equity-based instruments for our
common stock.
F-11
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On August 21, 1998, we also adopted the 1998 Equity Plan for Non-Employee
Directors of Focal Communications Corporation (the "1998 Non-Employee Plan").
The total number of shares available under the 1998 Non-Employee Plan shall
not exceed 150,000 shares. The Board has sole and complete authority to select
participants and grant options for our common stock, as defined in the 1998
Non-Employee Plan.
Under our stock option plans, the Board has complete discretion in
determining vesting periods and terms of each participant's options granted.
The options granted to participants under our stock option plans typically
vest at 25% on the first-year anniversary from grant date and vesting at 12.5%
every six months for the remainder of vesting years. The term of each option
has a life of 10 years. In addition, the plans provide for accelerated vesting
upon certain events, as defined.
On October 1, 2000, we established the Focal Communications Corporation
2000 Employee Stock Purchase Plan ("ESPP"). The ESPP is intended to give
employees a convenient means of purchasing shares of Focal Common Stock
through payroll deductions. Each participating employee's contributions will
be used to purchase shares for the employee's share account as promptly as
practicable after each 6 month period. The cost per share will be 85% of the
lower of the closing price of our Common Stock on the Nasdaq National Market
on the first or the last day of the 6 month period. We began the Stock
Purchase Plan October 1, 2000. We have 375,000 shares of Common Stock reserved
for issuance under the Stock Purchase Plan at December 31, 2000. As of
December 31, 2000, participants have contributed $1,932, which will be used to
purchase approximately 152,831 shares at March 31, 2001.
The following summarizes option activity:
Weighted
Shares of Exercise Average
Common Stock Prices Exercise Price
------------ ------------ --------------
Outstanding at December 31, 1997....... 611,000 $0.58-$ 0.64 $ 0.59
Activity for 1998:
Options Granted...................... 3,055,000 0.67- 3.00 2.46
Options Canceled..................... (71,000) 0.63- 3.00 1.28
---------- ------------ ------
Outstanding at December 31, 1998....... 3,595,000 $0.58-$ 3.00 $ 2.18
Activity for the year 1999:
Options Granted...................... 3,570,775 $3.15-$25.00 $ 5.83
Options Exercised.................... (469,481) 0.58- 3.73 1.85
Options Canceled..................... (342,474) 2.21- 25.00 4.25
---------- ------------ ------
Outstanding at December 31, 1999....... 6,353,820 $0.58-$25.00 $ 4.14
========== ============ ======
Activity for the year 2000:
Options Granted...................... 5,224,010 $6.94-$45.06 $29.41
Options Exercised.................... (730,613) 0.58- 4.32 2.55
Options Canceled..................... (709,909) 0.67- 45.06 22.50
---------- ------------ ------
Outstanding at December 31, 2000....... 10,137,308 $0.58-$45.06 $16.00
========== ============ ======
F-12
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about fixed stock options
outstanding at December 31, 1998, 1999 and 2000:
Options Outstanding Options Exercisable
----------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Options Contractual Exercise Options Exercise
Range of Exercise Prices Outstanding Life Price Exercisable Price
------------------------ ----------- ----------- -------- ----------- --------
$0.58-$0.67.............. 899,500 8.6 $ 0.62 284,500 $0.60
$2.10-$3.00.............. 2,695,500 9.6 2.70 252,000 3.00
---------- --- ------ --------- -----
At December 31, 1998..... 3,595,000 9.3 $ 2.18 536,500 $1.73
========== === ====== ========= =====
$0.58-$2.50.............. 1,550,873 7.9 $ 1.45 507,205 $1.25
$2.51-$5.00.............. 4,466,447 9.0 3.50 435,818 3.14
$22.00-$25.00............ 336,500 9.2 25.00 -- --
---------- --- ------ --------- -----
At December 31, 1999..... 6,353,820 8.7 $ 4.14 943,023 $2.12
========== === ====== ========= =====
$0.00-$4.51.............. 5,038,130 7.8 $ 3.01 1,636,171 $2.57
$4.52-$9.01.............. 605,694 9.7 6.94 -- --
$9.02-$13.52............. 73,150 9.9 9.06 -- --
$13.52-$18.03............ 143,525 9.2 15.56 -- --
$18.03-$27.04............ 919,061 8.6 25.91 69,653 25.01
$27.05-$31.54............ 1,833,875 8.0 29.87 47,872 29.86
$31.55-$36.05............ 357,050 9.0 32.47 -- --
$36.06-$40.56............ 351,500 8.7 37.57 -- --
$40.57-$45.06............ 815,323 8.9 44.79 674 44.50
---------- --- ------ --------- -----
At December 31, 2000..... 10,137,308 8.2 $16.00 1,754,370 $4.22
========== === ====== ========= =====
We have chosen to account for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees." Under APB No. 25, the exercise
price of the employee stock options equals the fair value of the underlying
stock on the date of grant and no compensation expense is recorded. We have
adopted the disclosure only provisions of the SFAS No. 123, "Accounting for
Stock-Based Compensation."
We utilized the Black-Scholes option pricing model to estimate the fair
value of options at the date of grant during 2000, 1999 and 1998. Had we
adopted SFAS No. 123, pro forma net loss and basic and diluted net loss per
share of Common Stock would have been approximately $(131,204) and $(2.17),
$(27,487) and $(.55), $(8,603) and $(.20), for the three years ended December
31, 2000, respectively. The pro forma disclosure is not likely to be
indicative of pro forma results which may be expected in future years because
of the fact that options vest over several years, compensation expense is
recognized over the vesting period and additional awards may also be granted.
The Black-Scholes option model estimated the weighted average fair value at
the date of grant of options granted in 2000, 1999, and 1998 to be
approximately $24.99, $5.76, and $2.23 per option, respectively. The remaining
contractual life of all options was approximately nine years. Principal
assumptions used in applying the Black-Scholes model were as follows:
2000 1999 1998
--------- --------- ---------
Risk-free interest rates.................... 4.9%-6.3% 5.6%-6.3% 4.4%-5.6%
Expected life............................... 5 years 5 years 5 years
Expected volatility......................... 133.53% 92.3% 142.0%
Expected dividend yield..................... -- -- --
F-13
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. EQUITY TRANSACTIONS
During 1999, we granted 3,570,775 stock options to employees, directors,
and an outside consultant. Giving effect to our initial public offering, the
fair market value of our common stock exceeded the exercise price for
3,192,500 of the total stock options granted. In addition, we also sold
150,000 shares of common stock to a director during 1999, which was
retrospectively determined to be at a price below the fair market value. Total
non-cash compensation related to these 1999 transactions of approximately
$20,776 will be recognized, of which $1,505 was initially recorded during 1999
on the dates of each respective transaction and the remaining $19,271 will be
ratably charged to operations over the respective vesting periods for the
stock option grants. Total non-cash compensation related to the grant to a
consultant was charged to operations over the consultant's service period
through November 1999 in accordance with SFAS No. 123.
On August 2, 1999, we sold 9,950,000 shares of our common stock in an IPO
at a price of $13 per share, which resulted in net proceeds of approximately
$119 million. In connection with the IPO, our Board of Directors and
stockholders authorized: (1) a recapitalization of our existing Class A common
stock, Class B common stock, and Class C common stock into a single class of
common stock; (2) an increase in the number of authorized shares of common
stock to 100,000,000 and the authorization of 2,000,000 shares of preferred
stock; and (3) a 500 for-one stock split.
On August 19, 1999 pursuant to the terms of the underwriting agreement,
among us and our underwriters, our underwriters elected their option to
purchase an additional 1,492,500 shares of our common stock at $13 per share
which resulted in additional net proceeds to us of approximately $18 million.
During January 2000, we granted 150,000 shares of restricted stock to an
executive in connection with an employment agreement. The restricted stock
granted resulted in total non-cash compensation of approximately $6,000 which
will be ratably charged to operations over a three year vesting period.
7. INCOME TAXES
For the year ended December 31, 2000 we recorded an income tax benefit of
$4,205. For the year ended December 31, 1999 and 1998, we recorded an income
tax provision of $600 and $4,660, respectively. The deferred tax consequences
related to the original issue discount interest accrued and other temporary
differences in reporting items for financial statement and income tax purposes
are recognized, if appropriate. Realization of future tax benefits related to
the deferred tax assets is dependent on many factors, including our ability to
generate future taxable income. Management has considered these factors and
has concluded that a full valuation allowance for financial reporting purposes
is required for the deferred tax assets for these periods.
F-14
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The income tax provision (benefit) for the three years ended December 31,
2000, consists of the following:
2000 1999 1998
------- ------ ------
Current taxes--
Federal............................................... $ -- $1,386 $4,100
State and local....................................... -- 114 560
------- ------ ------
-- 1,500 4,660
Deferred taxes--
Federal............................................... (4,205) 900 --
State and local....................................... -- -- --
------- ------ ------
Income tax provision (benefit)...................... $(4,205) $ 600 $4,660
======= ====== ======
Our federal income tax provision (benefit) at the statutory tax rate is
reconciled below to our overall provision (benefit) for income taxes for the
year ended December 31, 2000 and 1999:
2000 1999 1998
-------- ------- -------
Benefit at U.S. statutory rate..................... $(38,522) $(7,625) $(1,125)
State and local taxes, net of U.S. federal tax
benefit........................................... (6,604) (1,170) 560
Compensation....................................... (5,421) 1,071 --
Utilization of net operating loss carryback........ 4,205 (900) --
Increase in valuation allowance.................... 39,816 7,019 4,005
Alternative minimum tax............................ -- 1,364 --
Other, net......................................... 2,321 841 1,220
-------- ------- -------
Provision (benefit) for income taxes............... $ (4,205) $ 600 $ 4,660
======== ======= =======
The income tax effect of temporary differences comprising the net deferred
tax assets and tax liabilities as of December 31, 2000 and 1999 consists of the
following:
2000 1999
------- --------
Deferred income tax liabilities--
Depreciation.............................................. $(3,951) $ (4,009)
Other..................................................... (6,465) (3,778)
------- --------
(10,416) (7,787)
Deferred income tax assets--
Net operating loss carryforward........................... 39,487 900
Interest on 12.125% discount notes........................ 24,034 14,715
Allowance for doubtful accounts........................... 760 3,080
Employment related accruals............................... 458 525
Other..................................................... 945 1,193
------- --------
65,684 20,413
Less--Valuation allowance................................... (51,542) (11,726)
------- --------
Net deferred tax assets..................................... $ 3,726 $ 900
======= ========
As of December 31, 2000, we had a net operating loss carryforward ("NOL") of
approximately $98,000 for tax purposes which will be available to offset future
taxable income. This NOL will expire in 2015. We have recognized $3,726 of this
NOL as of December 31, 2000 due to the realization of a federal and state tax
refund.
F-15
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. LOSS PER SHARE
We compute basic earnings per common share based on the weighted average
number of shares of common stock outstanding for the period. This calculation
excludes certain unvested shares of common stock held by our executives.
Diluted earnings per common share are adjusted for the assumed exercise of
dilutive stock options and unvested shares of common stock. Since the
adjustments required for the calculation of diluted weighted average common
shares outstanding are anti-dilutive, this calculation has been excluded from
the loss per share calculation for the three years ended December 31, 2000.
Our basic and diluted weighted average number of shares outstanding at
December 31, 2000, 1999, and 1998 are as follows:
2000 1999 1998
---------- ---------- ----------
Basic Weighted Average Number of Common
Shares Outstanding..................... 60,456,245 50,066,315 43,763,000
Dilutive Stock Options and Unvested
Common Shares.......................... 4,646,435 4,735,604 5,521,500
---------- ---------- ----------
Dilutive Weighted Average Number of
Common Shares Outstanding.............. 65,102,680 54,801,919 49,284,500
========== ========== ==========
9. EMPLOYEE BENEFIT PLAN
We have a 401(k) Plan (the "Plan") covering substantially all eligible
employees. Under the Plan, participants may make pretax contributions from 1%
to 15% of eligible earnings, as defined. We may elect to contribute to the
Plan at our discretion. In February, 1998, we elected to match 30% of the
first 10% that an employee contributes to the Plan. Our matching contributions
totaled approximately $1,059, $430 and $145 for 2000, 1999, and 1998,
respectively.
10. COMMITMENTS AND CONTINGENCIES
Under the terms of various short- and long-term contracts, we are obligated
to make payments for office rents and for leasing components of our
communications network through 2021. The office rent contracts provide for
certain scheduled increases and for possible escalation of basic rentals based
on a change in the cost of living or on other factors. We expect to enter into
other contracts for additional components of our communications network,
office space, other facilities, equipment and maintenance services in the
future.
A summary of such fixed commitments at December 31, 2000, are as follows:
Year Amount
---- --------
2001............................................................. $ 30,840
2002............................................................. 32,964
2003............................................................. 33,815
2004............................................................. 26,155
2005............................................................. 17,637
Thereafter....................................................... 160,629
--------
Total.......................................................... $302,040
========
F-16
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Rent expense under operating leases for office rent and rent for leasing
components of our communications network was approximately $12,184, $5,093,
$1,522 for 2000, 1999, and 1998, respectively.
During 1999, we entered into agreements with carriers for the acquisition
of indefeasible rights of use for dark fiber transport capacity for a minimum
of 10,800 fiber miles. The terms of the agreements are for 20 years with a
total minimum commitment of approximately $71 million. One of these agreements
has been accounted for as a capital lease (Note 4). We also signed an
agreement with a carrier for the lease of fiber transport capacity for a five
year term and a minimum commitment of $70 million. We have committed to $10
million in year one; $13.2 million in year two; and $15.6 million for each of
the remaining three years of the agreement.
We are party to a products purchase agreement with a vendor that expires
December 31, 2002. This agreement requires us to place orders for certain
network products in a minimum aggregate amount over the term of the agreement
of $75 million.
11. STOCK PURCHASE AGREEMENT
On November 27, 1996, we entered into a Stock Purchase Agreement (the
"Agreement") with Institutional Investors and Executives ("Investors"), as
defined. The Agreement resulted in 39,692,000 shares of Class A Common Stock,
par value $.01 per share being issued for an aggregate purchase price of
$25,800. Subsequent to the closing of the Agreement, we sold 461,500 shares of
Class A Common shares for a purchase price of $300 to Designees (as defined in
the Agreement) of the Institutional Investors.
As part of the Agreement, the existing Common Stock held by the Executives
was converted into newly issued Class B Common and Class C Common shares (the
"Exchange"). The closing of the Exchange and issuance of Class B Common and
Class C Common shares took place simultaneously with the initial closing of
the issuance of Class A Common shares under the Agreement. In connection with
this transaction, compensation expense totaling approximately $5,200 will be
charged to income over the vesting period of the Class B Common shares issued
that did not vest immediately. Total non-cash compensation expense of $1,300,
and $2,492 was recorded for 1998 and 1999, respectively.
We amended certain vesting agreements of the Executives and Institutional
Investors on September 30, 1998, which effected the cancellation of 6,355,500
shares of our Class C Common Stock then outstanding, cancellation of 2,500,000
shares of the Company's Class A Common Stock held by certain institutional
shareholders and the conversion of 1,000,000 shares of the Company's Class C
Common Stock into Class B Common Stock. The new converted Class B Common Stock
is subject to certain restrictions, and was issued to our executives (founding
shareholders) in satisfaction of the obligations of Focal and such
shareholders set forth in certain vesting agreements as defined in the
Agreement. In connection with such transactions, non-cash compensation expense
totaling approximately $4,000 will be charged to income over the vesting
period of the restricted Class B Common shares issued. Total non-cash
compensation expense relating to this matter of $1,770, $326 and $272 was
recorded for the three years ended December 31, 2000, respectively. During
2000, a total of 175,000 shares of our common stock (new Class B shares prior
to recapitalization) were cancelled as a result of the resignation of an
Executive.
In connection with our IPO that was completed on August 2, 1999 (Note 6),
our Board of Directors and stockholders authorized, among other things, a
recapitalization of our existing Class A common stock, Class B common stock,
and Class C common stock into a single class of common stock.
A summary of the Company's Class A and B Common Stock before our
recapitalization on August 2, 1999 is as follows:
Class A Common--A total of 50,000,000 shares are authorized, of which
37,687,000 were issued and outstanding as of December 31, 1998.
Institutional Investors, as defined, who hold Class A Common shares
F-17
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
had the right to put the shares to us at fair market value but the
Agreement was amended and the put right was replaced by a provision which
would require us to voluntarily liquidate. The Class A Common Stock held by
Institutional Investors have demand registration rights; all Class A Common
stockholders have voting rights, piggyback registration rights, participate
in earnings and dividends and other preference features, as defined.
Class B Common--A total of 17,500,000 shares have been authorized and
11,000,000 shares are issued and outstanding as of December 31, 1998. Class
B Common stockholders have demand registration rights, voting rights,
piggyback registration rights, participate in earnings and dividends and
other preference features, as defined. The Class B Common issued upon the
Exchange will vest 20% on the closing of the Agreement and 20% on each of
the four anniversaries of the closing date of the Agreement. Accelerated
vesting will occur on the dates of certain (as defined) events: (a)
qualified sale of the Company; (b) qualified reorganization; and (c) public
offering of the Company's stock. The vesting of the Class B Common
accelerated by an additional 20% in connection with our IPO on August 2,
1999 (Note 6). For the Class B Common converted from Class C Common, the
Restricted Stock Agreement ("RSA") provides, among other things, vesting of
20% at the closing of the RSA (September 30, 1998), 10%, 15%, 20% and 35%
on each of the consecutive anniversaries of the closing of the RSA,
respectively, with immediate vesting upon a Change in Control, as defined
in the RSA.
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest and non-cash investing and financing activities for
the three years ended December 31, 2000 was as follows:
2000 1999 1998
------- ------- ----
Cash paid during the year for interest.............. $20,595 $ 3,398 $ 69
Fixed assets acquired under capital leases.......... $22,354 $20,917 $ --
Payments made under capital leases.................. $ 266 $ -- $ 52
Cash paid for income taxes.......................... $ -- $ 3,217 $605
13. SEGMENT INFORMATION
We currently operate solely in the United States and are organized
primarily on the basis of strategic geographic operating segments that provide
communications services in each respective geographic region. All of our
geographic operating segments have been aggregated into one reportable
segment, "Communications Services," for the year end as of December 31, 2000
and 1999.
The accounting policies of the segments are the same as those described in
the "Summary of Significant Accounting Policies." Our chief operating decision
maker views earnings before interest, taxes, depreciation and amortization
("EBITDA") as the primary measure of profit and loss. The following represents
information about revenues and EBITDA which excludes non-cash compensation,
total assets and capital expenditures for the Communications Services
reportable segment as of and for the years ended December 31, 2000, 1999 and
1998:
2000 1999 1998
-------- -------- -------
Revenues....................................... $234,120 $126,861 $43,532
EBITDA......................................... (11,119) 23,465 16,038
Total assets................................... 452,733 202,324 73,437
Capital expenditures........................... 309,617 128,550 64,229
======== ======== =======
F-18
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following reconciles total segment EBITDA to our consolidated net loss
before income taxes for the three years ended December 31, 2000:
2000 1999 1998
--------- -------- -------
Total EBITDA for reportable segment........ $ (11,119) $ 23,465 $16,038
Depreciation and amortization.............. (56,985) (23,763) (6,671)
Interest expense........................... (56,179) (21,639) (16,134)
Interest income............................ 20,339 7,946 6,528
Other income (expense)..................... 242 (609) --
Non-cash compensation...................... (6,360) (7,186) (3,070)
--------- -------- -------
Net loss before income
Taxes................................... $(110,062) $(21,786) $(3,309)
========= ======== =======
The following reconciles our total segment assets to our consolidated total
assets as of December 31, 2000 and 1999:
2000 1999
-------- --------
Total assets for reportable segment..................... $452,733 $202,324
Cash, cash equivalents and short-term investments....... 181,737 188,142
Other current assets.................................... 16,790 3,745
Fixed assets, net....................................... 49,641 22,022
Other noncurrent assets................................. 22,784 4,753
-------- --------
Total consolidated assets............................. $723,685 $420,986
======== ========
14. SELECTED QUARTERLY INFORMATION (UNAUDITED)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
1998--
Revenues..................... $ 5,103 $ 8,078 $12,755 $17,596
Income from operations....... 753 1,886 419 3,239
Net loss..................... (341) (583) (4,654) (2,391)
======= ======= ======= =======
Basic and diluted net loss
per share................... $ (0.01) $ (0.01) $ (0.11) $ (0.06)
======= ======= ======= =======
1999--
Revenues..................... $26,004 $30,327 $34,484 $36,046
Income (loss) from
operations.................. 4,381 2,673 (4,123) (10,415)
Net income (loss)............ 284 ( 2,302) (10,834) (9,534)
======= ======= ======= =======
Basic and diluted net income
(loss) per share............ $ 0.01 $ (0.05) $ (0.20) $ (0.16)
======= ======= ======= =======
2000--
Revenues..................... $45,329 $60,688 $60,752 $67,351
Loss from operations......... (14,331) (14,992) (22,781) (22,360)
Net loss..................... (20,825) (21,385) (29,472) (34,175)
======= ======= ======= =======
Basic and diluted net loss
per share................... $ (0.35) $ (0.35) $ (0.49) $ (0.56)
======= ======= ======= =======
F-19
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Focal Communications Corporation:
Our audits were made for the purpose of forming an opinion on the
consolidated financial statements taken as a whole. The schedule of Valuation
and Qualifying Accounts as of and for the three years ended December 31, 2000,
is presented for purposes of additional analysis and is not a required part of
the consolidated financial statements of Focal Communications Corporation and
Subsidiaries. Such information has been subjected to the auditing procedures
applied in the audits of the consolidated financial statements and, in our
opinion, is fairly stated in all material respects in relation to the
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 9, 2001
F-20
Schedule II
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Balance at Charged to Balance at
the Beginning Cost and the End of
Accounts of the Period Expense Deductions the Period
- -------- ------------- ---------- ---------- ----------
1998:
Allowance for Doubtful
Accounts..................... $ 469 $1,348 $ 628 $1,189
1999:
Allowance for Doubtful
Accounts..................... $1,189 $7,090 $ 579 $7,700
2000:
Allowance for Doubtful
Accounts..................... $7,700 $6,987 $5,087 $9,600
F-21