-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CXMng79RODK0/9mr8o+iF7MUEzMad9fG1fDsdsuX9xAhNLJmjXvzzzpbEHP+xTX3 p0xrAHTHIhaIk4gM0xtolQ== 0000901309-97-000082.txt : 19971117 0000901309-97-000082.hdr.sgml : 19971117 ACCESSION NUMBER: 0000901309-97-000082 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ACC CORP CENTRAL INDEX KEY: 0000783233 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 161175232 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-14567 FILM NUMBER: 97719341 BUSINESS ADDRESS: STREET 1: 400 WEST AVENUE CITY: ROCHESTER STATE: NY ZIP: 14611 BUSINESS PHONE: 7169873000 MAIL ADDRESS: STREET 1: 400 WEST AVENUE CITY: ROCHESTER STATE: NY ZIP: 14611 FORMER COMPANY: FORMER CONFORMED NAME: AC TELECONNECT CORP DATE OF NAME CHANGE: 19870129 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997. ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ Commission file number 0-14567 ACC CORP. (Exact name of registrant as specified in its charter) Delaware 16-1175232 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 400 West Avenue, Rochester, New York 14611 (Address of principal executive offices) (716) 987-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of November 1, 1997, the Registrant had issued and outstanding 16,984,657 shares of its Class A Common Stock, par value $.015 per share. The Index of Exhibits filed with this Report is found at Page 29. PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS ACC CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Amounts in thousands, except share and per share data)
Three months ended Nine months ended September 30, September 30, 1997 1996 1997 1996 Revenue: Toll revenue $83,919 $70,226 $238,596 $206,362 Local service and other 11,205 7,059 28,681 17,865 95,124 77,285 267,277 224,227 Network costs 54,837 48,815 156,973 143,803 Gross profit 40,287 28,470 110,304 80,424 Other operating expenses: Depreciation and amortization 5,922 4,266 16,401 12,061 Selling, general and administrative 27,791 20,995 76,091 58,977 33,713 25,261 92,492 71,038 Income from operations 6,574 3,209 17,812 9,386 Other income (expense): Net Interest (601) (186) (1,941) (2,622) Foreign exchange gain (loss) 20 22 (168) (48) (581) (164) (2,109) (2,574) Income before provision for income taxes and minority interest 5,993 3,045 15,703 6,812 Provision for income taxes 1,085 543 2,379 1,396 Income before minority interest 4,908 2,502 13,324 5,416 Minority interest in (earnings) of consolidated subsidiary (303) (899) Net income 4,908 2,199 13,324 4,517 Less Series A preferred stock dividend (334) (1,022) Less Series A preferred stock accretion (872) (1,496) Income applicable to common stock $4,908 $993 $13,324 $1,999 Earnings per common and common equivalent share $0.28 $0.06 $0.76 $0.13 Average number of common and common and common equivalent shares 17,736,192 16,694,546 17,494,614 14,984,299
ACC CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands, except share and per share data) UNAUDITED September 30, December 31, 1997 1996 CURRENT ASSETS: Cash and cash equivalents $0 $2,035 Accounts receivable, net of allowance for doubtful accounts of $3,533 in 1997 and $3,795 in 1996 69,539 51,474 Other receivables 2,015 3,792 Prepaid expenses and other assets 7,908 4,632 TOTAL CURRENT ASSETS 79,462 61,933 PROPERTY, PLANT, AND EQUIPMENT At cost 153,758 119,398 Less-accumulated depreciation and amortization (49,308) (38,946) TOTAL PROPERTY, PLANT, AND EQUIPMENT 104,450 80,452 OTHER ASSETS: Goodwill and customer base, net 75,874 50,629 Deferred installation costs, net 5,277 4,312 Other 11,534 6,705 TOTAL OTHER ASSETS 92,685 61,646 TOTAL ASSETS $276,597 $204,031 September 30, December 31, 1997 1996 CURRENT LIABILITIES: Notes payable $877 $730 Current maturities of long-term debt 2,647 3,521 Accounts payable 8,341 15,351 Accrued network costs 32,042 22,908 Other accrued expenses 18,534 34,884 TOTAL CURRENT LIABILITIES 62,441 77,394 Deferred income taxes 3,398 2,767 Long-term debt 74,388 6,007 SHAREHOLDERS' EQUITY: Preferred Stock, $1.00 par value, Authorized - 1,990,000 shares; Issued - no shares - - Class A Common Stock, $.015 par value Authorized - 50,000,000 shares; Issued - 16,984,657 in 1997 and 17,684,361 in 1996 271 265 Class B Common Stock, $.015 par value, Authorized - 25,000,000 shares; Issued - no shares - - Capital in excess of par value 122,097 116,878 Cumulative translation adjustment (1,402) (1,362) Retained earnings 17,014 3,692 137,980 119,473 Less- Treasury stock, at cost (1,089,884 shares in 1997 and 1996) (1,610) (1,610) TOTAL SHAREHOLDERS' EQUITY 136,370 117,863 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $276,597 $204,031 ACC CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Amounts in 000's)
For the nine months ended September 30, 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES Net income $13,324 $4,517 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 16,401 12,061 Deferred income taxes 2,167 362 Minority interest in earnings of consolidated subsidiary 899 Unrealized foreign exchange loss 17 (137) Amortization of deferred financing costs 457 316 (INCREASE) DECREASE IN ASSETS: Accounts receivable, net (14,622) (14,225) Other receivables 684 1,653 Prepaid expenses and other assets (3,084) (1,228) Deferred installation costs (2,785) (1,943) Other (4,613) (390) INCREASE (DECREASE) IN LIABILITIES: Accounts payable (10,434) (371) Accrued network costs 6,225 (2,326) Other accrued expenses (17,979) (780) Net cash provided by (used in) operating activities (14,242) (1,592) CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures, net (34,469) (14,865) Payment for purchase of subsidiaries, net of cash acquired (22,245) 0 Acquisition of customer base (1,305) (2,226) Net cash used in investing activities (58,019) (17,091) CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings under lines of credit and notes payable 148,507 19,500 Repayments under lines of credit and notes payable (76,230) (42,999) Repayment of long-term debt, other than lines of credit (8,096) (2,841) Proceeds from issuance of common stock 5,225 68,476 Financing costs (1,294) (441) Net cash provided by financing activities 68,112 41,695 Effect of exchange rate changes on cash 2,114 (408) Net increase (decrease) in cash from operations (2,035) 22,604 Cash and cash equivalents at beginning of period 2,035 518 Cash and cash equivalents at end of period $0 $23,122 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $1,630 $2,326 Income taxes $2,646 $1,033 SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Fair Value of acquired companies assets acquired other than cash $ 34,985 0 Fair value of acquired companies liabilities assumed 12,740 0 Net cash paid $ 22,245 $ Equipment purchased through capital leases $ 1,490 $ 2,775
ACC CORP. AND SUBSIDIARIES Notes to Consolidated Financial Statements September 30, 1997 1. Statement of Management The condensed financial statements of ACC Corp. and subsidiaries (the "Company") included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the Company's latest Annual Report on Form 10-K. The interim financial statements contained herein reflect all adjustments of a normal recurring nature which are, in the opinion of management, necessary to a fair statement of the results of operations for the interim periods presented. As used herein, unless the context otherwise requires, the "Company" and "ACC" refer to ACC Corp. and its subsidiaries, including its U.S. operating subsidiaries("ACC U.S."), ACC TelEnterprises Ltd.("ACC Canada"), ACC Long Distance UK Ltd. ("ACC U.K."), and ACC Telecommunications GmbH ("ACC Germany"). In this Form 10-Q, references to "dollar" and "$" are to United States dollars, references to "Cdn. $" are to Canadian dollars, references to "pound symbol" are to English pounds sterling, references to "DM" are to German Deutchmarks, the terms "United States" and "U.S." mean the United States of America and, unless the context otherwise requires, its states, territories and possessions and all areas subject to its jurisdiction, and the terms "United Kingdom" and "U.K." mean England, Scotland and Wales. "North American Operations" includes operations in the United States and Canada, while "Europe Operations" includes operations in the United Kingdom and German operations. 2. Form 10-K Reference is made to the following footnotes included in the Company's 1996 Annual Report on Form 10-K: Principles of Consolidation Minority Interest Revenue Other Receivables Property, Plant and Equipment Deferred Costs Goodwill and Customer Base Common and Common Equivalent Shares Foreign Currency Translation Income Taxes Cash Equivalents Derivative Financial Instruments Financial Instruments Stock-Based Compensation Use of Estimates Reclassifications Description of Business Equal Access Costs Debt Senior Credit Facility and Lines of Credit Working Capital Lines of Credit Income Taxes Redeemable Preferred Stock Public Offerings Private Placement Stock-Based Compensation Employee Long-Term Incentive Plan Employee Stock Purchase Plan Non-Employee Directors' Stock Option Plan United Kingdom Sharesave Scheme Treasury Stock Operating Leases Employment and Other Agreements Purchase Commitments Defined Contribution Plans Annual Incentive Plan Legal Matters Geographic Area Information Related Party Transactions 3. Net Income Per Share Net income per common and common equivalent share is computed on the basis of the weighted average number of common and common equivalent shares outstanding during the period and net income reduced by preferred dividends and accreted costs. The average number of shares outstanding (1996 data retroactively restated for a three-for-two stock split as of August 8, 1996) is computed as follows: For the Three Months For the Nine Months Ended September 30, Ended September 30, Average Number Outstanding: 1997 1996 1997 1996 Common Shares 16,858,307 15,315,633 16,747,143 13,767,380 Common Equivalent Shares 877,885 1,378,913 747,471 1,216,919 TOTAL 17,736,192 16,694,546 17,494,614 14,984,299 Fully diluted income per share amounts are not presented for the prior period because inclusion of these amounts would be anti-dilutive. Fully diluted income per share amounts for the current period do not differ materially from primary earnings per share amounts. 4. Recently Issued Accounting Standards SFAS No. 128 In March 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 128, "Earnings per Share," which is applicable to the Company beginning in the fourth quarter of 1997. This statement, upon adoption, will require all prior-period earnings per share ("EPS") data to be restated, to conform to the provisions of the statement. The statement will eliminate the disclosure of primary earnings per share which includes the dilutive effect of stock options, warrants and other convertible securities ("Common Stock Equivalents") and instead requires reporting of "basic" earnings per share, which will exclude Common Stock Equivalents. Additionally, the statement changes the methodology for fully diluted earnings per share. In the opinion of the Company's management, the adoption of this new accounting standard will not have a material effect on the reported earnings per share of the Company. While the Statement prohibits early adoption, pro forma presentation of the impact of the Statement for the reporting periods is illustrated below: Pro Forma Earnings Per Share Computation under FAS 128 Three Months ended Nine Months ended September 30, 1997 and 1996 September 30, 1997 and 1996 (amounts in thousands except (amounts in thousands except share and per share amounts) share and per share amounts) 1997 1996 1997 1996 Income Shares Per Share Income Shares Per Share Income Shares Per Share Income Shares Per Share Basic EPS Net income $4,908 $2,199 $13,324 $4,517 Less: preferred stock dividends and preferred stock accretion - (1,206) (2,518) Income available to common shareholder $4,908 16,858,307 $.29 $ 993 15,315,633 $.06 $13,324 16,747,143 $.80 $1,999 13,767,380 $.14 Diluted EPS Add: Options and warrants 877,885 (.01) - 1,378,913 - - 747,471 (.04) - 1,216,919 (.01) Income available to common shareholders$4,908 17,736,192 $.28 $ 993 16,694,546 $.06 $13,324 17,494,614 $.76 $1,999 14,984,299 $.13
Pro forma basic earnings per common share were computed by dividing net income by weighted average number of shares of common stock outstanding during the quarter. The pro forma dilutive effect of options and warrants reflects application of the treasury stock method, utilizing average market prices during the period, and excludes any assumed exercise that would have been antidilutive. Assumed conversion of outstanding redeemable and convertible preferred stock at September 30, 1996 was excluded from the above, as the effect would have been antidilutive. SFAS No. 130 In June 1997, the FASB issued Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income", which is applicable to the Company effective January 1, 1998. This Statement establishes standards for reporting and display of comprehensive income and its components (revenue, expenses, gains and losses)in a full set of general purpose financial statements. Comprehensive income is defined as the change in the equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period (from net income and other sources) except those resulting from investments by owners and distributions to owners. Management believes that the adoption of this statement will not have a material effect on the Company's consolidated results of operations or financial position. SFAS No. 131 In June 1997, the FASB issued Statement of Financial Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is applicable to the Company effective January 1, 1998. This Statement requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Statement requires disclosure of a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It requires reconciliations of total segment revenues, total segment profit or loss, total segment assets, and other amounts disclosed for segments to corresponding amounts in the enterprise's general purpose financial statements. It requires that all public business enterprises report information about the revenues derived from the enterprise's products or services, about the countries in which the enterprise earns revenues and holds assets, and about major customers regardless of whether that information is used in making operating decisions. Management believes that the adoption of this statement will not have a material effect on the Company's consolidated results of operations or financial position. 5. Senior Credit Facility Under the terms of the five-year senior revolving credit facility agreement of July 21, 1995, the Company was obligated to pay the financial institution an aggregate contingent interest payment based on the minimum of $750,000 or the appreciation in value of 140,000 shares of the Company's Class A Common Stock over the 18 month period ending January 21, 1997, but not to exceed $2.1 million. A payment of $2.1 million was made on January 15, 1997 in conjunction with the amendment to the credit facility, and was reflected as an accrued expense on the balance sheet at December 31, 1996. On January 14, 1997, the Company signed an agreement with the same financial institution to provide a $100 million credit facility to the Company which amended and restated the previous $35 million credit facility. The amended credit facility was syndicated among five financial institutions. Borrowings can be made in U.S. dollars, Canadian dollars and British pounds, and are limited individually to $30 million for ACC Canada, $20 million for ACC U.K. and $15 million for the Company's local exchange business in the U.S., with total borrowings for the Company limited to $100 million. The amended facility will be used to finance capital expenditures, provide working capital and to provide capital for acquisitions. The maximum aggregate principal amount of the amended facility is required to be reduced by $8 million per quarter commencing on March 31, 1999 until December 31, 2000, and by $9 million per quarter commencing on March 31, 2001 until maturity of the loan in January 2002. 6. Business Combinations During the third quarter of 1997, the Company consummated several business combinations, all accounted for as purchases, as follows: ACC U.K. acquired United Telecom Ltd. ("UT"), a pre-paid calling card and long distance services provider based in London U.K. The results of operations of UT are reflected in the third quarter results of operations effective July 1, 1997. UT reported annual revenues of (pound symbol) 2.8 million (US $4.5 million) for the fiscal year ended April 30, 1997. ACC U.S. acquired VISTA International Communications Inc. ("VISTA"), a privately held, switch-based long distance provider headquartered in Mount Arlington, New Jersey. VISTA provides services to small-to-medium-sized commercial customers in the Northeastern U.S., with concentrations primarily in New Jersey and Pennsylvania. VISTA reported revenues of over $10 million in 1996. The results of operations of VISTA are included in the accompanying results of operations effective August 1, 1997. ACC Germany acquired all the interests of Telenational Communications Deutschland Limited Partnership ("TNC") a privately held telecommunications services provider headquartered in Hamburg, Germany. TNC is a supplier of prepaid calling cards, and has developed affinity programs with large commercial customers. TNC's 1997 annualized revenue is DM 9.2 million (U.S. $5.0 million). The results of operations of TNC are included in the accompanying results of operations effective July 1, 1997. The aggregate amount paid for these three acquisitions was U.S. $21.0 million. The estimated fair value of assets acquired (including Goodwill and customer base) was U.S. $31.8 million, and liabilities assumed was U.S. $10.8 million. Goodwill associated with these acquisitions was U.S. $28.6 million, and is being amortized from 20 to 40 years. Customer base intangibles associated with these acquisitions was U.S. $1.1 million, and is being amortized over 5 years. (Note: U.S. dollar equivalent amounts noted above are estimated based on the relevant month-end exchange rate). In October 1997, the Company signed a definitive merger agreement with US WATS Inc. ("US WATS") a switch-based long distance provider headquartered in Bala Cynwyd, Pennsylvania. Under the terms of the agreement, US WATS shareholders will receive .077 shares of ACC Common Stock for each share of US WATS Common Stock, subject to certain adjustments. The exchange ratio may change in the event of a change in the per share price of ACC common stock prior to closing and certain other contingencies. The transaction was valued at $46 million (before assumption of liabilities) at the date of signing the agreement, but may reach a maximum of $50.6 million based on the final exchange ratio at closing and certain other contingencies. The transaction is intended to be accounted for as a pooling, and is subject to final regulatory and US WATS shareholder approvals and certain other contingencies. US WATS provides switch-based long distance and other services to small-medium sized business, switchless resellers and other carriers principally located throughout the mid-Atlantic region. US WATS has annualized revenue of over $55 million. On November 10, 1997, Tel-Save Holdings, Inc. ("Tel-Save") filed a Schedule 13D with the Securities and Exchange Commission in which Tel-Save indicated that it had purchased more than 10 percent of the outstanding common stock of US WATS. Tel-Save stated that it believes that such stock ownership will enable Tel- Save to influence the outcome of the proposed merger and that Tel- Save does not favor the merger. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Recent Developments". 7. Derivative Financial Instruments The Company uses derivative financial instruments to reduce its exposure to market risks from changes in foreign exchange rates and interest rates. The Company does not hold or issue financial instruments for speculative purposes. The derivative instruments used are currency forward contracts and interest rate swap agreements. These derivatives are non-leveraged and involve little complexity. The Company enters into contracts to buy and sell foreign currencies in the future in order to protect the U.S. dollar value of certain currency positions and future foreign currency transactions. The fair value method is used to account for these instruments. Under the fair value method, changes in fair value are recognized in the consolidated balance sheet as a component of other accrued expenses, and in the consolidated income statement as foreign currency gain or loss. For reporting purposes, the contractual assets or liabilities of the foreign currency agreements are offset because the agreements provide for a right of offset. Any premiums or discounts related to foreign currency contracts are amortized over the life of the contracts. The Company enters into cross-currency rate swaps to hedge intercompany debt from certain subsidiaries. Under these agreements, the Company typically pays a fixed rate of interest on a foreign dollar note, and receives a variable rate of interest on a U.S. dollar receivable. The fair value method is used to account for these instruments. Under the fair value method, the amounts receivable and payable are carried at their fair value on the consolidated balance sheet as a component of other receivables. Changes in the fair value are recognized in the consolidated income statement as foreign currency gain or loss. Interest due under the fixed contracts and interest receivable under the variable contracts are recognized in the consolidated income statement as a component of net interest expense. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion includes certain forward-looking statements. Such forward-looking statements are subject to material risks and uncertainties and other factors. For a discussion of material risks and uncertainties and other factors that could cause actual results to differ materially from the forward-looking statements, see "Recent Losses; Potential Fluctuations in Operating Results," "Substantial Indebtedness; Need for Additional Capital," "Dependence on Transmission Facilities-Based Carriers," "Potential Adverse Effects of Regulation," "Increasing Domestic and International Competition," "Expansion of Local Exchange Business," "Risks of Growth and Expansion," "Risks Associated with International Operations," "Dependence on Effective Information Systems," "Risks Associated With Acquisitions, Investments and Strategic Alliances," "Technological Changes May Adversely Affect Competitiveness and Financial Results," "Risks Associated with Rapidly Changing Industry," "Dependence on Key Personnel," "Risks Associated with Financing Arrangements; Dividend Restrictions," "Holding Company Structure; Reliance on Subsidiaries for Dividends," "Potential Volatility of Stock Price," "Risks Associated with Derivative Financial Instruments," "Currency Risks; Possible Effect on Financial Condition, Operating Results and Financing Costs; Exchange Controls," "International Tax Risks" and "Risks of Entry into Cellular Business and Expansion of Internet, Paging and Data Transmission Businesses," included under the caption "Company Risk Factors" in Exhibit 99.1 hereto, which is incorporated by reference herein, and the Company's periodic reports and other documents filed with the SEC. General The Company's revenue is comprised of toll revenue(per minute charges for long distance services) and local service and other revenue. Toll revenue consists of revenue derived from ACC's long distance and operator-assisted services. Local service and other revenue consists of revenue derived from the provision of local exchange services, including local dial tone, direct access lines, Internet fees and monthly subscription fees, and also from data services. Network costs consist of expenses associated with the leasing of transmission lines, access charges and certain variable costs associated with the Company's network. The following table shows the total revenue (net of intercompany revenue) and billable long distance minutes of use attributable to the Company's North American and European operations during the three and nine month periods ended September 30, 1997 and 1996: Three Months ended Nine Months ended September 30, 1997 and 1996 September 30, 1997 and 1996 (dollars and minutes in thousands) (dollars and minutes in thousands) 1997 1996 1997 1996 Amount Percent Amount Percent Amount Percent Amount Percent Total Revenue: North America: US $ 30,873 32.5% $ 23,107 29.9% $ 83,282 31.2% $ 71,840 32.0% Canada 28,192 29.6 29,804 38.6 87,582 32.8 87,371 39.0 Total North America 59,065 62.1 52,911 68.5 170,864 63.9 159,211 71.0 Europe: UK 34,506 36.3 24,374 31.5 94,857 35.5 65,016 29.0 Germany 1,553 1.6 - 0.0 1,556 0.6 - 0.0 Total Europe 36,059 37.9 24,374 31.5 96,413 36.1 65,016 29.0 Total Revenue $ 95,124 100% $ 77,285 100% $267,277 100% $224,227 100% Billable Long Distance Minutes of Use: North America: US 211,102 35.1% 142,157 31.3% 554,644 33.0% 417,607 32.4% Canada 194,525 32.4 170,667 37.6 584,008 34.7 497,870 38.6 Total North America 405,627 67.5 312,824 68.9 1,138,652 67.7 915,477 71.0 Europe: UK 194,309 32.3 141,452 31.1 542,695 32.3 374,315 29.0 Germany 1,362 0.2 - 0.0 1,362 0.1 - 0.0 Total Europe 195,671 32.5 141,452 31.1 544,057 32.3 374,315 29.0 Total Minutes 601,298 100% 454,276 100% 1,682,709 100% 1,289,792 100%
The following table presents certain information concerning long distance toll revenue (net of intercompany revenue) per billable minute and network cost per billable minute attributable to the Company's North American and European operations during the three and nine month periods ended September 30, 1997 and 1996: Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 Toll Revenue Per Billable Long Distance Minute: North America United States $0.116 $0.141 $0.123 $0.155 Canada 0.121 0.152 0.127 0.154 Total North America 0.118 $0.147 0.125 $0.155 Europe United Kingdom $0.177 $0.171 $0.174 $0.173 Germany 1.140 - 1.142 - Total Europe $0.184 $0.171 $0.177 $0.173 Network Cost Per Billable Long Distance Minute: Total North America $0.081 $0.104 $0.085 $0.109 Total Europe 0.113 0.114 0.111 0.117 The Company believes that historically its revenue growth as well as its network costs and results of operations for its U.S., Canadian and U.K. operations generally reflect the state of development of the Company's operations, the Company's customer mix and the competitive and regulatory environment in those markets. The Company entered the U.S, Canadian, and U.K telecommunications markets in 1982, 1985, and 1993, respectively. In 1997, the Company established a subsidiary in Germany, and commenced offering long distance service as a switchless reseller during the third quarter of 1997. The Company believes that toll revenue per billable minute and network cost per billable minute will be lower in future periods, and heavily influenced by competitive pressures and regulatory actions. Deregulatory influences have affected the telecommunications industry in the U.S. since 1984 and the U.S. market has experienced considerable competition for a number of years. The competitive influences on the pricing of ACC services and network costs have been stabilizing during the past few years. This may change in the future as a result of the 1996 Amendment to the U.S. Communications Act (the "1996 Act") that further opened the market to competition, particularly from the regional Bell operating companies ("RBOCs"). The Company has actively pursued growth opportunities in the U.S. market. During the third quarter of 1997, the Company acquired VISTA International Communications, Inc. ("VISTA"). VISTA, headquartered in Mount Arlington, New Jersey, provides long distance and other services to small to medium sizes commercial customers in the Northeastern U.S. with concentrations primarily in New Jersey and Pennsylvania. The VISTA acquisition represents expansion into a contiguous geographic area, and with a similar targeted customer segment, which is viewed as consistent with the Company's expansion strategy. The deregulatory trend in Canada, which commenced in 1989, has increased competition. ACC Canada experienced significant downward pressure on the pricing of its services during 1994 and 1995. Although revenue per minute increased from 1995 to 1996 due to changes in customer and product mix, revenue per minute fell during the first half of 1997, and the Company expects such downward pressure to continue. The impact of this pricing pressure on revenues of ACC Canada is being offset by an increase in the Canadian commercial and student billable minutes of usage as a percentage of total Canadian billable minutes of usage, and introduction of new products and services including 800 service, local exchange resale, Internet services, and, since February 1997, paging services. The Company believes that, because deregulatory influences have only fairly recently begun to impact the U.K. telecommunications industry, the Company will continue to experience a significant increase in revenue from that market, but the rate of growth is expected to decline. The foregoing belief is based upon expectations of actions that may be taken by U.K. regulatory authorities and the Company's competitors; if such third parties do not act as expected, the Company's opportunities for revenue growth could be impacted. If ACC U.K. were to experience increased revenues, the Company believes it should be able to enhance its economies of scale and scope with more efficient use of the fixed cost elements of its network. Nevertheless, the deregulatory trend in that market is expected to result in competitive pricing pressure on the Company's U.K. operations which could adversely affect revenues and margins. Since the U.K. market for transmission facilities is dominated by British Telecommunications PLC ("British Telecom") and Mercury Communications Ltd. ("Mercury"), the downward pressure on prices for services offered by ACC U.K. may not be accompanied by a corresponding reduction in ACC UK's network costs in the short term and, consequently, could adversely affect the Company's business, results of operations and financial condition, particularly in the event revenue derived from the Company's U.K. operations accounts for an increasing percentage of the Company's total revenue. Moreover, the Company's U.K. operations are highly dependent upon the transmission lines leased from British Telecom. As each of the telecommunications markets in which it operates continues to mature, the rate of growth in its revenue and customer base in each such market is likely to decrease over time. The Company has actively pursued growth opportunities in the U.K. market. During the second quarter of 1997, the Company acquired Transphone Ltd. Transphone provides domestic and international long distance service as a reseller, and is based in London, U.K. In acquiring Transphone Ltd., the Company obtained what it believes is a strong base of commercial customers in a desirable geographic area. During the third quarter of 1997 the Company also acquired United Telecom Ltd. ("UT"). UT provides domestic and international long distance services through a pre-paid calling card platform in retail telephone shops. UT is based in London, U.K.. In acquiring UT, the Company obtains what it believes is a new delivery channel in a growing niche market. The acquisition is also expected to create network cost efficiencies, as UT's customers have peak calling activity at night and on weekends. This calling pattern will enable the Company to facilitate routing of off-peak traffic over the Company's switched based network, thereby adding to economies of scale. The Transphone Ltd. and UT acquisitions are expected to be accretive to earnings commencing in 1998. The foregoing forward looking statements are based upon expectations with respect to customer behavior, market trends and the Company's ability to successfully integrate and develop the businesses acquired. If such expectations are not realized, actual results may differ materially from the foregoing discussion. The German telecommunications market is expected to substantially deregulate in January 1998, as a result of the European Union ("EU") mandate to open telecommunications markets to competition. Most significantly, the German market is scheduled to be open for interconnection in January 1998. The Company has established a subsidiary in Germany, and signed a resale agreement with Deutsche Telekom ("DT") on May 20, 1997. Further, the Company received a Class 4 full voice telephony license from the German Ministry of Post and Telecommunications which is effective January 1, 1998. This license is a requirement for the Company to become a switch-based provider of telecommunications services in Germany. In October 1997, the Company signed a network interconnect agreement with Deutsche Telekom, which will permit utilization of Deutsche Telekom's networks to link ACC with its customers. With this agreement in place, the Company plans to install, and have in service, a switch by the first quarter of 1998. The Company expects to develop a small amount of revenue in the fourth quarter of 1997 as a switchless reseller, with potentially more substantial revenue growth in 1998 as a switch-based reseller when the market is fully deregulated. The foregoing forward-looking statement is based upon expectations with respect to regulatory actions and cooperation from DT with regard to which the Company is unable to control. If such expectations are not realized, the expected revenue growth from the German market may not materialize. In addition to the core growth expected from switch-based resale, the Company has actively pursued other growth opportunities in Germany. During the third quarter of 1997, the Company acquired Telenational Communications Deutschland Limited Partnership ("TNC"), a privately held telecommunications service provider headquartered in Hamburg, Germany. TNC provides prepaid calling cards through affinity programs with large commercial customers including Lufthansa, Citibank and Diners Club. The TNC acquisition provides the Company an existing customer base, and facilitates the start up efforts in Germany. Since the commencement of the Company's operations, the Company has undertaken a program of developing and expanding its service offerings, geographic focus and network. In connection with this development and expansion, the Company has made significant investments in telecommunications circuits, switches, equipment and software. These investments generally are made significantly in advance of anticipated customer growth and resulting revenue. The Company also has increased its sales and marketing, customer support, network operations and field services commitments in anticipation of the expansion of its customer base and geographic markets. The Company expects to continue to expand the breadth and scale of its network and related sales and marketing, customer support and operating activities. These expansion efforts are likely to cause the Company to incur significant increases in expenses from time to time, in anticipation of potential future growth in the Company's customer base and geographic markets. The Company recently announced the creation of two continental operating divisions in North America and Europe. In conjunction with this new structure, the Company plans to further expand its European operations as business activity more fully develops in the deregulating German market and by entering other telecommunications marketplaces when regulatory and market conditions warrant. While the Company has had a successful history of entering into newly deregulated markets, there can be no assurances that the same successes will be experienced in the future. The Company has also expanded operations in the U.S. local exchange business and anticipates that a significant portion of its future growth will come from this business. The local exchange business is highly competitive and includes several larger, better capitalized local service providers, including AT&T, among others, who can sustain losses associated with discount pricing, and the high initial investment and expenses typically incurred to attract local customers. The Company's U.S. local service business commenced operations in 1994 and generated a small operating profit for the first nine months of 1997, and for the full year 1996. However, there can be no assurances that the Company will continue to achieve positive cash flow or profitability in this business in the future. The Company's operating results have fluctuated in the past and they may continue to fluctuate significantly in the future as a result of a variety of factors, some of which are beyond the Company's control. The Company expects to focus in the near term on building and increasing its customer base, service offerings and targeted geographic markets, which will require it to increase significantly its expenses for marketing and development of its network and new services, and may adversely impact operating results from time to time. Revenues from wholesale carriers accounted for approximately 18% and 30% of the revenues of ACC North America and ACC Europe, respectively, in the third quarter of 1997, and 18% and 28% for the nine months ended September 30, 1997. Included in 1996 second quarter and nine month revenues were $9 million of North American non-recurring carrier revenues, or 4% of consolidated revenues. With respect to these customers, the Company competes almost exclusively on price, does not have long term contracts and generates lower gross margins as a percentage of revenue. The Company's primary interest in carrier revenue is to utilize excess capacity on its network. Carrier revenue for the third quarter of 1997 was 23% of the Company's consolidated total revenue compared to 25% in the third quarter of 1996, and 22% for the nine months ended September 30, 1997 compared to 24% for the nine months ended September 30, 1996. Management believes that carrier revenue will continue to average 20% to 25% of consolidated total revenue as the core businesses continue to grow. The foregoing forward- looking statement is based upon expectations with respect to growth in the Company's customer base and total revenues. If such expectations are not realized, the Company's actual results may differ materially from the foregoing discussion. Results of Operations The following table presents, for the three months ended September 30, 1997 and 1996, and the nine months ended September 30, 1997 and 1996, certain Statement of Operations data expressed as a percentage of total revenue: Three Months ended Nine Months ended September30, 1997 and 1996 September 30, 1997 and 1996 1997 1996 1997 1996 Revenue: Toll revenue 88.2% 90.9% 89.3% 92.0% Local service and other 11.8 9.1 10.7 8.0 Total revenue 100.0 100.0 100.0 100.0 Network costs 57.6 63.2 58.7 64.1 Gross profit 42.4 36.8 41.3 35.9 Other operating expenses: Depreciation and amortization 6.2 5.5 6.1 5.4 Selling, general and administrativ 29.2 27.2 28.5 26.3 Total other operating expenses 35.4 32.7 34.6 31.7 Income from operations 6.9 4.2 6.7 4.2 Total other income (expenses) (0.6) (0.2) (0.8) (1.1) Income from operations before provision for income taxes and minority interest 6.3 3.9 5.9 3.0 Provision for income taxes 1.1 0.7 0.9 0.6 Income before minority interest 5.2 3.2 5.0 2.4 Minority interest in (income) loss of consolidated subsidiary - (0.4) - (0.4) Income (loss) from operations 5.2% 2.8% 5.0% 2.0%
Quarter ended September 30, 1997 compared with quarter ended September 30, 1996 REVENUE Total revenue for the quarter ended September 30, 1997 increased $17.8 million, or 23%, to $95.1 million from $77.3 million for the same period in 1996. Long distance toll revenue increased $13.7 million, or 19%, to $83.9 million from $70.2 million, and local service and other revenue increased $4.1 million, or 59%, to $11.2 million from $7.1 million. The growth in long distance toll revenues was fueled by a 32% increase in billable minutes. Revenue from wholesale carriers during the current quarter increased slightly to $21.5 million (23% of total revenues) from $19.1 million (25% of total revenues)for the same period in 1996. Significantly reduced revenues from two Canadian carriers were realized in the current quarter, accounting for a $3.8 million reduction in carrier revenues from the same quarter in 1996. Excluding total wholesale carrier revenues, long distance toll revenue for the current quarter increased 22% from the same period in 1996. Long distance toll revenue per billable minute for the current quarter decreased 10%, from $.155 to $.140, largely a result of competitive pricing pressures. The growth in other revenues is largely attributable to growth in market share in the competitive local exchange business in the U.S. Total revenue (unaffiliated) in North America for the current quarter increased 12% from the same period in 1996. Long distance toll revenue (unaffiliated) increased 4% from 1996. Excluding carrier revenues, long distance toll revenue for the current quarter increased 14% from the same period in 1996, and is attributable to growth in minutes and customer accounts. Long distance toll revenue per minute for the current quarter decreased 19% from $.147 to $.118, largely a result of competitive pricing pressures in both the U.S. and Canada. Retail price pressures in each market are expected to continue, which may impact the Company's margin. Local service and other revenues for the current quarter increased 59% over the same period in 1996, a result of growth in U.S. local exchange revenues and increased Internet related revenues in Canada. The Company continues to invest in the local exchange business, having installed switches during 1997 in Buffalo, Albany, New York City, Boston and Springfield Massachusetts. Continued expansion and growth in non toll revenue, including local exchange service, Internet and other services is expected to become a larger component of total revenues in future periods. As a percent of total revenue, non toll revenue for the current quarter was 12% compared to 9% for the same period in 1996. Total revenue (unaffiliated) in Europe (substantially all long distance toll revenue) for the current quarter increased 48% from the same period in 1996. Excluding carrier revenues, long distance toll revenue for the current period increased 36% from the same period in 1996, and is attributable to growth in minutes and commercial and student customers accounts. Long distance toll revenue per billable minute for the current quarter increased 7% from $.171 to $.184 as increased international traffic (which typically has higher rates per minute) and the impact of higher revenues from carriers offset retail price reductions implemented during the quarter for international and domestic long distance rates. The German operating unit contributed a modest amount of revenue from the acquired TNC customer base as well as from switchless resale activity. NETWORK COST Network cost for the quarter ended September 30, 1997 increased $6.0 million, or 12%, to $54.8 million from $48.8 million for the same period in 1996. As a percent of revenue, network cost for the current quarter was 58% compared to 63% for the same period in 1996. Network cost per billable minute for the current quarter decreased 15%, from $.107 to $.091. The reduction of current quarter network cost as a percent of revenue, and per minute, is largely attributable to a favorable shift in business/customer mix, as higher margin local exchange revenues constitute a higher percent of revenues in 1997 as compared to 1996, declining access rates for origination and termination, and internal network efficiencies. Network cost in North America for the current quarter as a percent of unaffiliated revenue decreased to 57% from 62% for the same period in 1996, and per billable minute also decreased 23% from $.104 to $.081. These improvements resulted from the aforementioned increased in higher margin local exchange revenue in the U.S., and internal network efficiencies. Network cost in Europe for the current quarter as a percent of unaffiliated revenue decreased to 59% from 66% for the same period in 1996, and per billable minute declined by .001%. Recent investments in switches, a microwave network and IRU are expected to more significantly lower network costs in the near term, as ownership of these facilities will enable the company to reduce reliance on leased lines and increase network capacity. This forward looking statement is based on expectations regarding customer demand and the relative cost and availability of leased lines and alternative transmission facilities in the Company's markets, and could be adversely impacted by competitive pricing pressures. If such expectations are not realized, the Company's actual results may differ materially from the foregoing discussion. OTHER OPERATING EXPENSES - DEPRECIATION AND AMORTIZATION Total depreciation expense for the quarter ended September 30, 1997 increased $1.6 million, or 39%, from $4.3 million for the same period in 1996, largely attributable to recent local and long distance switch installations and other capital expenditures, as well as higher amortization of the customer base and goodwill associated with the recent acquisitions of Transphone, United Telecom, VISTA and TNC. OTHER OPERATING EXPENSES - SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Total Selling, General and Administrative expenses ("SG&A") for the quarter ended September 30, 1997 increased $6.8 million, or 32%, to $27.8 million from $21.0 million for the same period in 1996. As a percent of revenue, SG&A increased 2% to 29% from 27%. This increase is largely attributable to higher selling expenses (i.e. agent, salesperson and other commissions) associated with growth in local exchange revenues, added overhead from acquired entities and infrastructure costs to support expansion in Germany. OTHER INCOME/EXPENSES Net interest expense for the quarter ended September 30, 1997 increased $.4 million compared to 1996 as a result of increased utilization of the credit facility to fund expansion. Foreign exchange gains/losses reflect changes in the value of amounts borrowed by the foreign subsidiaries from ACC Corp. and ACC US. The Company continues to hedge substantially all intercompany loans to foreign subsidiaries in an attempt to reduce the impact of transaction gains or losses. The Company does not engage in speculative foreign currency transactions. During the quarter ended September 30, 1997 the Company recognized gains on foreign currency transactions of $20,000 compared to $22,000 for the same period of 1996. PROVISION FOR TAXES Provision for taxes for the quarter ended September 30, 1997 increased $.6 million, from $.5 million to $1.1 million. Stated as a percent of pre-tax income, the effective tax rate for the current quarter was 18% as compared to 18% for the same period in 1996. Income taxes are provided on all revenues in excess of available net operating loss carryforwards ("NOL's") at the statutory rate applicable for each country. The Company continues to utilize NOL's to offset taxable income generated in Canada and the U.K. The increase in operating earnings in both of these subsidiaries, which is not subject to tax due to utilization of NOL's, reduces the effective tax rate for the consolidated Company. MINORITY INTEREST IN (EARNINGS) OF CONSOLIDATED SUBSIDIARY Minority interest for the quarter ended September 30, 1996 reflects the portion of the Company's Canadian subsidiary's income attributable to the approximately 30% of that subsidiary's common stock that was publicly traded in Canada. Prior to December 31, 1996, the Company repurchased approximately 24% of the outstanding shares, and the remaining 6% was repurchased in January 1997. As a result, the Canadian subsidiary is currently 100% owned, with no remaining minority interest. The Company's income from operations for the quarter ended September 30, 1997 was $6.6 million compared to $3.2 million for the same period in 1996, and was comprised of the following: North America operations $4.1 million as compared to $2.5 million in 1996, and European operations, $2.5 million as compared to $.7 million in 1996. Nine months ended September 30, 1997 compared with nine months ended September 30, 1996 REVENUE Total revenue for the nine months ended September 30, 1997 increased $43.0 million, or 19%, to $267.3 million from $224.2 million for the same period in 1996. Long distance toll revenue increased $32.2 million, or 16%, to $238.6 million from $206.4 million, and local service and other revenue increased $10.8 million, or 61%, to $28.7 million from $17.9 million. The growth in long distance toll revenues was fueled by a 30% increase in billable minutes. Revenue from wholesale carriers during the current period increased to $58.3 million (22% of total revenues) from $54.2 million (24% of total revenues)for the same period in 1996. Significantly reduced revenues from two Canadian carriers were realized in the current period, accounting for a $10.0 million reduction in carrier revenues from the same period in 1996. Additionally, the 1996 period reflects $9 million of non recurring carrier revenues. Excluding total wholesale carrier revenues, long distance toll revenue for the current period increased 19% from the same period in 1996. Long distance toll revenue per billable minute for the current period decreased 11%, from $.160 to $.142, largely a result of competitive pricing pressures. The growth in other revenues is largely attributable to growth in market share in the competitive local exchange business in the U.S. and a full nine months of revenues in 1997 from Internet revenues in Canada compared to four months in 1996. Total revenue (unaffiliated) in North America for the current period increased 7% from the same period in 1996. Long distance toll revenue (unaffiliated) increased 1% from 1996, as the 1996 period included $9 million of non recurring carrier revenue. Excluding carrier revenues, long distance toll revenue for the current period increased 12% from the same period in 1996, and is attributable to growth in minutes and customer accounts. Long distance toll revenue per minute for the current period decreased 19% from $.155 to $.125, largely a result of competitive pricing pressures in both the U.S. and Canada. Retail price pressures in each market are expected to continue which may impact the Company's margin. Local service and other revenues for the current period increased 61% over the same period in 1996, a result of growth in U.S. local exchange revenues and increased Internet related revenues in Canada. The Company continues to invest in the local exchange business, having installed switches during 1997 in Buffalo, Albany, New York City, Boston and Springfield Massachusetts. Continued expansion and growth in non toll revenue, including local exchange service, Internet and other services is expected to become a larger component of total revenues in future periods. As a percent of total revenue, non toll revenue for the current period was 11% compared to 8% for the same period in 1996. Total revenue (unaffiliated) in Europe (substantially all long distance toll revenue) for the current period increased 48% from the same period in 1996. Excluding carrier revenues, long distance toll revenue for the current period increased 30% from the same period in 1996, and is attributable to growth in minutes and commercial and student customer accounts. Long distance toll revenue per billable minute for the current period increased 2% from $.173 to $.177 as the impact of higher revenues from carriers partially offset retail price reductions implemented during the period for international and domestic long distance rates. The German operating unit contributed a modest amount of revenue from the acquired TNC customer base as well as from switchless resale activity. NETWORK COST Network cost for the nine months ended September 30, 1997 increased $13.2 million, or 9%, to $157.0 million from $143.8 million for the same period in 1996. As a percent of revenue, network cost for the current period was 59% compared to 64% for the same period in 1996. Network cost per billable minute for the current period decreased 16%, from $.111 to $.093. The reduction of current period network cost as a percent of revenue, and per minute, is largely attributable to reduced contribution charges enacted during the period in Canada, a favorable shift in business/customer mix, as higher margin local exchange revenues constitute a higher percent of revenues in 1997 as compared to 1996, and lower margin wholesale carrier revenues constitute a lower percentage of 1997 revenues as compared to 1996, declining access rates for origination and termination and internal network efficiencies. Network cost in North America for the current period as a percent of unaffiliated revenue decreased to 58% from 63% for the same period in 1996, and per billable minute also decreased from $.109 to $.085. These improvements resulted from the aforementioned reduction in Canadian contribution charges, increased amount of higher margin local exchange revenue in the U.S., and internal network efficiencies. Network cost in Europe for the current period as a percent of unaffiliated revenue decreased to 60% from 67% for the same period in 1996, and per billable minute decreased from $.117 to $.111. Recent investments in switches, a microwave network and IRU are expected to more significantly lower network costs in the near term, as ownership of these facilities will enable the Company to reduce reliance on leased lines and increase network capacity. This forward looking statement is based on expectations regarding customer demand and the relative cost and availability of leased lines and alternative transmission facilities in the Company's markets, and could be adversely impacted by competitive pricing pressures. If such expectations are not realized, the Company's actual results may differ materially from the foregoing discussion. OTHER OPERATING EXPENSES - DEPRECIATION AND AMORTIZATION Total depreciation expense for the nine months ended September 30, 1997 increased $4.3 million, or 36%, from $12.1 million for the same period in 1996, largely attributable to recent local and long distance switch installations and other capital expenditures, as well as higher amortization of the customer base and goodwill associated with the Internet Canada acquisition in 1996, and recent acquisitions of Transphone, United Telecom, VISTA and TNC. OTHER OPERATING EXPENSES - SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Total Selling, General and Administrative expenses ("SG&A") for the nine months ended September 30, 1997 increased $17.1 million, or 29%, to $76.1 million from $59.0 million for the same period in 1996. As a percent of revenue, SG&A increased 2% to 28% from 26%. This increase is largely attributable to higher selling expenses (i.e. agent, salesperson and other commissions) associated with growth in local exchange revenues, added overhead from acquired entities and infrastructure costs to support expansion in Germany. OTHER INCOME/EXPENSES Net interest expense for the nine months ended September 30, 1997 decreased $.7 million. Foreign exchange gains/losses reflect changes in the value of amounts borrowed by the foreign subsidiaries from ACC Corp. and ACC U.S. The Company continues to hedge substantially all intercompany loans to foreign subsidiaries in an attempt to reduce the impact of transaction gains or losses. The Company does not engage in speculative foreign currency transactions. During the nine months ended September 30, 1997 the Company recognized losses on foreign currency transactions of $168,000 compared to a $48,000 gain in the same period of 1996. PROVISION FOR TAXES Provision for taxes for the nine months ended September 30, 1997 increased $1.0 million from $1.4 million to $2.4 million. Stated as a percent of pre-tax income, the effective tax rate for the current period was 15% as compared to 20% for the same period in 1996. Income taxes are provided on all revenues in excess of available net operating loss carryforwards ("NOL's") at the statutory rate applicable for each country. The Company continues to utilize NOL's to offset taxable income generated in Canada and the U.K.. The increase in operating earnings in both of these subsidiaries, which is not subject to tax due to utilization of NOL's, reduces the effective tax rate for the consolidated Company. MINORITY INTEREST IN (EARNINGS) OF CONSOLIDATED SUBSIDIARY Minority interest for the nine months ended September 30, 1996 reflects the portion of the Company's Canadian subsidiary's income attributable to the approximately 30% of that subsidiary's common stock that was publicly traded in Canada. Prior to December 31, 1996, the Company repurchased approximately 24% of the outstanding shares, and the remaining 6% was repurchased in January 1997. As a result, the Canadian subsidiary is currently 100% owned, with no remaining minority interest. The Company's income from operations for the nine months ended September 30, 1997 was $17.8 million compared to $9.4 million for the same period in 1996, and was comprised of the following: North America operations $11.2 million as compared to $8.9 million in 1996, and European operations $6.6 million as compared to ($.4) million in 1996. Liquidity And Capital Resources In May 1996, the Company raised net proceeds of $63.1 million through an offering of Common Stock. The proceeds from this offering were used to repay indebtedness under the Credit Facility, for working capital needs, and capital expenditures. The Company also expended $32.1 million in 1996 to repurchase the minority interest in ACC Canada. Historically, the Company has satisfied its working capital requirements through cash flow from operations, through borrowings and financings from financial institutions, vendors and other third parties, and through the issuance of securities. The Company also received net proceeds of approximately $1.9 million from the exercise of options and warrants by selling shareholders in the October 1996 secondary Common Stock offering and an additional $4.9 million from the exercise of employee stock options at various times during the year. In January 1997, the Company entered into an amended and restated $100 million credit facility, subject to availability under a borrowing base formula and certain other conditions (including borrowing limits based on the Company's operating cash flow). As of September 30, 1997, the unused amount under the Credit Facility was approximately $24.1 million. Net cash flows used in operations for the nine months ended September 30, 1997 were $14.2 million compared to $1.6 million for the same period in 1996. The increase of $12.6 million primarily resulted from $18.2 million of higher payments of previously accrued expenses associated with the Canadian minority interest repurchase and accrued year-end bonuses, and expenditures for other non-current assets (including an IRU for $5.2 million), partially offset by higher net income of $8.8 million and depreciation of $4.3 million, and other changes to working capital. Net cash flows used in investing activities (for capital expenditures, acquisition of customer base and subsidiaries) for the nine months ended September 30, 1997 were $58.0 million compared with $17.1 million for the same period in 1996. Net cash provided by financing activities for the nine months ended September 30, 1997 was $68.1 million compared with $41.7 million for the same period of 1996. The increase reflects utilization of the Credit Facility to fund working capital needs, capital expenditures and acquisitions. The Company's principal need for working capital is to fund network costs and to meet its selling, general and administrative expenses as its business expands. In addition, the Company's capital resources have been used for acquisitions (i.e., Metrowide Communications, Internet Canada, Transphone Ltd., United Telecom, VISTA and TNC), capital expenditures, and the repurchase of the minority interest in ACC Canada. The Company has historically reflected working capital deficits at the end of the last several years but, at September 30, 1997, reflected a working capital surplus of approximately $17.0 million compared to a deficit of approximately $15.5 million at December 31, 1996, due primarily to utilization of the Credit Facility to satisfy current liabilities. The Company anticipates that, throughout the remainder of 1997, its capital expenditures will be approximately $25 million for the expansion of its network, acquisitions, upgrading and development of switches and other telecommunications equipment as conditions warrant, the development, licensing and integration of its management information system and other software, the development and expansion of its service offerings and customer programs and other capital expenditures. Approximately $35 million in capital expenditures were recorded during the nine months ended September 30, 1997. ACC expects that it will continue to make significant capital expenditures during future periods, particularly for switching equipment for the U.K. and Germany, and for local exchange switches in U.S markets, and related costs. The Company's actual capital expenditures and cash requirements will depend on numerous factors, including the nature of future expansion (including the extent of local exchange services, which is particularly capital intensive), and acquisition opportunities, economic conditions, competition, regulatory developments, the availability of capital and the ability to incur debt and make capital expenditures under the terms of the Company's financing arrangements. As of September 30, 1997, the Company had approximately $-0- of cash and cash equivalents and maintained the $100 million Credit Facility, subject to availability under a borrowing base formula and certain other conditions (including borrowing limits based the Company's operating cash flow), under which $72 million was outstanding. The maximum aggregate principal amount of the Credit Facility is required to be reduced by $8 million per quarter commencing on March 31, 1999 until December 31, 2000, and by $9 million per quarter commencing on March 31, 2001 until maturity of the loan in January 2002. In addition, as of September 30, 1997, the Company had $4.8 million of capital lease obligations which mature at various times from 1997 through 2000. During the nine months ended September 30, 1997, the Company prepaid a $4.0 million capitalized lease obligation using funds from the Credit Facility. The Company's financing arrangements, which are secured by substantially all of the Company's assets including stock of certain subsidiaries, require the Company to maintain certain financial ratios. In the normal course of business, the Company uses various financial instruments, including derivative financial instruments, for purposes other than trading. These instruments include letters of credit, guarantees of debt, interest rate swap agreements and foreign currency exchange contracts relating to U.S. dollar payables of foreign subsidiaries. The Company does not use derivative financial instruments for speculative purposes. Foreign currency exchange contracts are used to mitigate foreign currency exposure and are intended to protect the U.S. dollar value of certain currency positions and future foreign currency transactions. The aggregate fair value, based on published market exchange rates, of the Company's foreign currency contracts at September 30, 1997 was $79.9 million. From time to time, the Company uses interest rate swap agreements to reduce its exposure to risks associated with interest rate fluctuations. As is customary for these types of instruments, collateral is generally not required to support these financial instruments. By their nature, all such instruments involve risk, including the risk of nonperformance by counterparties, and the Company's maximum potential loss may exceed the amount recognized on the Company's balance sheet. However, at September 30, 1997, in management's opinion there was no significant risk of loss due to nonperformance of the counterparties to these financial instruments. The Company controls its exposure to counterparty credit risk through monitoring procedures and by entering into multiple contracts. Based upon the Company's knowledge of the financial position of the counterparties to its existing derivative instruments, the Company believes that it does not have any significant exposure to any individual counterparty or any major concentration of credit risk related to any such financial instruments. The Company is currently negotiating an amendment to its Credit Facility to increase the borrowing availability by an additional $50 million. The Company believes that, under its present business plan, the amended Credit Facility which it expects to obtain, and cash from operations will be sufficient to meet anticipated working capital, capital expenditure requirements and expansion plans for the foreseeable future. The forward-looking information contained in the previous sentence may be affected by a number of factors, including the matters described in this paragraph and in Exhibit 99.1 attached hereto. The Company may need to raise additional capital from public or private equity or debt sources in order to finance its operations, capital expenditures and growth for future periods. In addition, the Company may have to refinance a substantial amount of indebtedness and obtain additional funds prior to 2002, when the Credit Facility matures. Moreover, the Company believes that continued growth and expansion through acquisitions, investments and strategic alliances is important to maintain a competitive position in the market and, consequently, a principal element of the Company's business strategy is to develop relationships with strategic partners and to acquire assets or make investments in businesses that are complementary to its current operations. The Company may need to raise additional funds in order to take advantage of opportunities for acquisitions, investments and strategic alliances or more rapid international expansion, to develop new products or to respond to competitive pressures. There can be no assurance that the Company will be able to raise such capital on acceptable terms or at all. The Company's ability to obtain additional sources of capital will depend upon, among other things, its financial condition at the time, the restrictions and the instruments governing its indebtedness and other factors, including market conditions, beyond the control of the Company. Additional sources of capital may include public and private equity and debt financings, sale of assets, capitalized leases and other financing arrangements. In the event that the Company is unable to obtain additional capital or is unable to obtain additional capital on acceptable terms, the Company may be required to reduce the scope of its presently anticipated expansion opportunities and capital expenditures, which could have a material adverse effect on its business, results of operations and financial condition and could adversely impact its ability to compete. The Company may seek to develop relationships with strategic partners both domestically and internationally and to acquire assets or make investments in businesses that are complementary to its current operations. Such acquisitions, strategic alliances, or investments may require that the Company obtain additional financing and, in some cases, the approval of the Company's creditors. The Company's ability to effect acquisitions, strategic alliances, or investments may be dependent upon its ability to obtain such financing and, to the extent applicable, consents from creditors. Recent Developments On October 30, 1997, ACC announced that it had received an unsolicited proposal from Tel-Save Holdings, Inc. ("Tel-Save") regarding a potential business combination with Tel-Save. Tel- Save's original proposal was to offer to ACC shareholders $50 in Tel-Save common stock per share of ACC common stock, subject to adjustment, or $40 per share if the proposed merger involving ACC and US WATS, Inc. ("US WATS") is effected. Tel-Save has subsequently announced that the purchase price proposed by Tel- Save will not be reduced based on the outcome of the proposed merger involving ACC and US WATS. The Board of Directors of ACC has confirmed that it has initiated a review of the Tel-Save proposal as well as other alternatives available to the Company. The Company also announced that the Company's Shareholder Rights Plan has been amended to reduce the threshold by which the rights granted under the plan become exercisable from 15 percent to 7.5 percent. Any shareholder whose ownership exceeds 7.5 percent on November 6, 1997, and who does not acquire additional shares, is exempt from the amendment. The amendment is effective until December 31, 1997. PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. See Exhibit Index. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused the Report to be signed on its behalf by the Undersigned thereunto duly authorized. ACC CORP. (Registrant) Dated: November 13, 1997 /s/ Michael R. Daley Michael R. Daley Executive Vice President and Chief Financial Officer Dated: November 13, 1997 /s/ Frank C. Szabo Frank C. Szabo Vice President and Controller EXHIBIT INDEX Exhibit Number Description Location 11.1 Statement re Computation of See note 3 to the Per Share Earnings notes to Consolidated Financial Statements filed herewith 27.1 Financial Data Schedule Filed herewith 99.1 Company Risk Factors Filed herewith EX-27 2
5 9-MOS DEC-31-1997 SEP-30-1997 0 0 73,072 3,533 1,057 79,462 153,758 49,308 276,597 62,441 74,388 0 0 271 136,100 276,597 238,596 267,277 156,973 92,492 0 1,930 1,941 15,703 2,379 13,324 0 0 0 13,324 0.76 0 add back allowance gross total long-term debt tolls only network costs total operating expenses unusual operating expenses bad debt expense net
EX-99 3 EXHIBIT 99.1 COMPANY RISK FACTORS As used herein, unless the context otherwise requires, the "Company" and "ACC" refer to ACC Corp. and its subsidiaries, including ACC Long Distance Corp. ("ACC U.S."), ACC TelEnterprises Ltd. ("ACC Canada"), and ACC Long Distance UK Ltd. ("ACC U.K."). References herein to "dollar" and "$" are to United States dollars, references to "Cdn. $" are to Canadian dollars, references to "" are to English pounds sterling, the terms "United States" and "U.S." mean the United States of America and, unless the context otherwise requires, its states, territories and possessions and all areas subject to its jurisdiction, and the terms "United Kingdom" and "U.K." mean England, Scotland and Wales. RECENT LOSSES; POTENTIAL FLUCTUATIONS IN OPERATING RESULTS Although the Company has experienced revenue growth on an annual basis since 1990 and net income in 1996 and the first nine months of 1997, it incurred net losses and losses from continuing operations during 1994 and 1995. There can be no assurance that revenue growth will continue or that the Company will be able to maintain its profitability and positive cash flow from operations. If the Company cannot continue its revenue growth and maintain profitability and positive cash flow from operations, it may not be able to meet its debt service or working capital requirements. The Company intends to focus in the near term on the expansion of its service offerings, including its local telephone service and Internet services, and expanding its geographic markets, including deregulating Western European markets. Such expansion, particularly the establishment of new operations or acquisition of existing operations in deregulating Western European markets, may adversely affect cash flow and operating performance and these effects may be material, as was the case with the Company's U.K. operations in 1994 and 1995. As each of the telecommunications markets in which the Company operates continues to mature, growth in the Company's revenues and customer base is likely to decrease over time. The Company's operating results have fluctuated in the past and may fluctuate significantly in the future as a result of a variety of factors, some of which are outside of the Company's control, including general economic conditions, specific economic conditions in the telecommunications industry, the effects of governmental regulation and regulatory changes, user demand, capital expenditures and other costs relating to the expansion of operations, the introduction of new services by the Company or its competitors, the mix of services sold and the mix of channels through which those services are sold, pricing changes by the Company or its competitors and prices charged by suppliers. As a strategic response to a changing competitive environment, the Company may elect from time to time to make certain pricing, service or marketing decisions or enter into strategic alliances, acquisitions or investments that could have a material adverse effect on the Company's business, results of operations and cash flow. Revenues from other resellers accounted for approximately 12.7% of consolidated revenues in 1995, 25.2% of consolidated revenues in 1996 and 22% of consolidated revenues during the first nine months of 1997. Carrier revenues during 1997 will be adversely affected by the loss of wholesale traffic from a large Canadian long distance carrier which accounted for approximately $13.4 million of revenue during 1996, most of which is expected to be non-recurring. Because sales to other carriers are at margins that are lower than those derived from most of the Company's other revenues, increases in carrier revenue as a percentage of revenues have in the past reduced and may in the future reduce, the Company's gross margins as a percentage of revenue. In addition, certain of its long distance carrier customers may pose credit or collection risks. See the Risk Factor discussion below of " Risks Associated With Acquisitions, Investments and Strategic Alliances" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUBSTANTIAL INDEBTEDNESS; NEED FOR ADDITIONAL CAPITAL The Company will need to continue to enhance and expand its operations in order to maintain its competitive position, expand its service offerings and geographic markets and continue to meet the increasing demands for service quality, availability and competitive pricing. As of the end of its last five fiscal years, the Company has experienced a working capital deficit. The Company believes that, under its present business plan, cash from operations and borrowings available under its credit facility will be sufficient to meet its anticipated capital and capital expenditure requirements for the foreseeable future. The Company may need to raise additional capital from public or private equity or debt sources in order to finance its anticipated growth, including local service expansion and expansion into international markets (both of which will be capital intensive), working capital needs, debt service obligations, and, contemplated capital expenditures. In addition, the Company may need to raise additional funds in order to take advantage of unanticipated opportunities, including more rapid international expansion or acquisitions of, investments in or strategic alliances with companies that are complementary to the Company's current operations, or to develop new products or otherwise respond to unanticipated competitive pressures. If additional funds are raised through the issuance of equity securities, the percentage ownership of the Company's then current shareholders would be reduced and, if such equity securities take the form of Preferred Stock or Class B Common Stock, the holders of such Preferred Stock or Class B Common Stock may have rights, preferences or privileges senior to those of holders of Class A Common Stock. There can be no assurance that the Company will be able to raise such capital on satisfactory terms or at all. If the Company decides to raise additional funds through the incurrence of debt, the Company would need to obtain the consent of its lenders under the Company's credit facility and would likely become subject to additional or more restrictive financial covenants. In the event that the Company is unable to obtain such additional capital or is unable to obtain such additional capital on acceptable terms, the Company may be required to reduce the scope of its presently anticipated expansion, which could materially adversely affect the Company's business, results of operations and financial condition and its ability to compete. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." DEPENDENCE ON TRANSMISSION FACILITIES-BASED CARRIERS The Company generally does not own telecommunications transmission lines other than the recently acquired Indefeasible Rights of Use. Telephone calls made by the Company's customers are connected through transmission lines that the Company leases under a variety of arrangements with transmission facilities-based long distance carriers, some of which are or may become competitors of the Company, including AT&T Corp. ("AT&T"), Bell Canada and British Telecommunications plc ("British Telecom"). Most inter-city transmission lines used by the Company are leased at rates that currently are less than the rates the Company charges its customers for connecting calls through these lines. Accordingly, to the extent that the Company continues to lease transmission lines, it will remain vulnerable to changes in its lease arrangements, such as price increases and service cancellations. ACC's ability to maintain and expand its business is dependent upon maintaining favorable relationships with the transmission facilities-based carriers from which the Company leases transmission lines, particularly in the U.K., where British Telecom and Mercury Communications Ltd. ("Mercury") are the two principal, dominant carriers. The Company's U.K. operations are highly dependent upon the transmission lines leased from British Telecom. Although the Company believes that its relationships with carriers generally are satisfactory, the deterioration or termination of the Company's relationships with one or more of those carriers could have a material adverse effect upon the Company's business, results of operations and financial condition. Certain of the vendors from whom the Company leases transmission lines, including the 22 former Bell System Operating Companies ("RBOCs") and other local exchange carriers, currently are subject to tariff controls and other price constraints which in the future may be changed. Under the 1996 amendments to the U.S. Communications Act of 1934 (the "1996 Act"), constraints on the operations of the RBOCs have been dramatically reduced, which will bring into the long distance market additional competitors from whom the Company leases transmission lines. In addition, certain regulatory issues are pending that may affect the prices charged by the RBOCs and other local exchange carriers to the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "-Potential Adverse Effects of Regulation." POTENTIAL ADVERSE EFFECTS OF REGULATION The 1996 Act provides specific guidelines under which the RBOCs can provide long distance services, which will permit the RBOCs to compete with the Company in the provision of domestic and international long distance services. The legislation also opens all local service markets to competition from any entity (including, for example, long distance carriers, such as AT&T, cable television companies and utilities). Because the legislation opens the Company's markets to additional competition, particularly from the RBOCs, the Company may be subject to additional competition. Moreover, as a result of and to implement the legislation, certain federal and state governmental regulations will be adopted, amended or modified, and any such adoption, amendment or modification could have a material adverse effect on the Company's business, results of operations and financial condition. In the U.S., the Federal Communications Commission ("FCC") and relevant state public service commissions ("PSCs") have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities, and the terms and conditions under which the Company's services are provided. Federal and state regulations and regulatory trends have had, and in the future are likely to have, both positive and negative effects on the Company and its ability to compete. The recent trend in both Federal and state regulation of telecommunications service providers has been in the direction of lessened regulation. In general, neither the FCC nor the relevant state PSCs currently regulate the Company's long distance rates or profit levels, but either or both may do so in the future. However, the general recent trend toward reduced regulation has given AT&T, the largest long distance carrier in the U.S., as well as the RBOCs, increased pricing flexibility that has permitted them to compete more effectively with smaller interexchange carriers, such as the Company. In addition, the commitments made by the U.S. government in the recently-completed World Trade Organization ("WTO") negotiations will allow foreign-affiliated carriers previously prohibited from providing service in the U.S. market to compete with the Company in the U.S. market. There can be no assurance that changes in current or future Federal or state regulations or future judicial changes would not have a material adverse effect on the Company's business, results of operations and financial condition. In order to provide their services, interexchange carriers, including the Company, must generally purchase "access" from local exchange carriers to originate calls from and terminate calls in the local exchange telephone networks. Access charges presently represent a significant portion of the Company's network costs in all areas in which it operates. In the U.S., the FCC regulates interstate access and the states regulate intrastate access. Pursuant to the 1996 Act, on May 16, 1997, the FCC issued an order to implement certain reforms to its access charge rules (the "Access Charge Reform Order"). The Access Charge Reform Order will require incumbent LECs to substantially decrease over time the prices they charge for switched and special access, and change how access charges are calculated. These changes are intended to reduce access charges paid by interexchange carriers to LECs and shift certain usage-based charges to flat-rated, monthly per-line charges. To the extent that these rules begin to reduce charges to reflect the forward-looking cost of providing access, the Company's competitive advantage in providing customers with access services might decrease. In addition, the FCC has determined that it will give incumbent LECs pricing flexibility with respect to access charges. To the extent such pricing flexibility is granted before substantial facilities-based competition develops, such flexibility could be misused to the detriment of new entrants, including the Company. Until the FCC adopts and releases rules detailing the extent and timing of such pricing flexibility, the impact of these rules on the Company cannot be determined. In its order, the FCC abolished the unitary rate structure option for local transport. This effectively abolishes the "equal price per unit of traffic" rule which has been in effect since the divestiture of AT&T, and may have an adverse effect on smaller interexchange carriers such as the Company because it may permit volume discounts in the pricing of access charges. On May 8, 1997, the FCC issued an order to implement the provisions of the 1996 Act relating to the preservation and advancement of universal telephone service (the "Universal Service Order"). The Universal Service Order affirmed the policy principles for universal telephone services set forth in the Telecommunications Act, including quality service, affordable rates, access to advanced services, access in rural and high-cost areas, equitable and non-discriminatory contributions, specific and predictable support mechanisms, and access to advanced telecommunications services for schools, health care providers and libraries. The Universal Service Order added "competitive neutrality" to the FCC's universal service principles by providing that universal service support mechanisms and rules should not unfairly advantage or disadvantage one provider over another, nor unfairly favor or disfavor one technology over another. The Universal Service Order also requires all telecommunications carriers providing interstate telecommunications services, including the Company, to contribute to universal service support. Such contributions will be assessed based on interstate and international end-user telecommunications revenues. Both the Universal Service and Access Charge Reform Orders are subject to petitions seeking reconsideration by the FCC and direct appeals to U.S. Courts of Appeals. Until the time when any such petitions or appeals are decided, there can be no assurance of how the Universal Service and/or Access Charge Reform Orders will be implemented or enforced, or what effect the Orders will have on competition within the telecommunications industry, generally, or on the competitive position of the Company, specifically. The Company currently competes with the RBOCs and other local exchange carriers such as the GTE Operating Companies ("GTOCs") in the provision of "short haul" toll calls completed within a Local Access and Transport Area ("LATA"). Subject to a number of conditions, the 1996 Act established conditions that would allow for the eventual elimination of many of the restrictions which prohibited the RBOCs from providing long-haul, or inter-LATA, toll service, and thus the Company will face additional competition in this market. To complete long-haul and short-haul toll calls, the Company must purchase "access" from the local exchange carriers. The Company must generally price its toll services at levels equal to or below the retail rates established by the local exchange carriers for their own short- haul or long-haul toll rates. To the extent that the local exchange carriers are able to reduce the margin between the access costs to the Company and the retail toll prices charged by local exchange carriers, either by increasing access costs or lowering retail toll rates, or both, the Company will encounter adverse pricing and cost pressures in competing against local exchange carriers in both the short-haul and long-haul toll markets. Under the 1996 Act, local exchange carriers must permit resale of their bundled local services and unbundled network elements. Pricing principles for those services were set forth in the 1996 Act, with states directed to approve specific tariffs based on these principles. At the end of 1996, the New York State PSC ("NYSPSC") replaced temporary wholesale discounts with permanent wholesale discounts of 19.1% for New York Telephone (business and residential) and 17% for Frontier Corp. (business and residential). Discounts were made applicable to centrex, private line and PBX lines. On April 1, 1997, the NYPSC adopted permanent rates for unbundled links and certain other unbundled network elements for New York Telephone. The monthly rate for unbundled links in designated areas of dense traffic (accounting for approximately 70% of all loops in the state) is $12.49, plus a recurring $1.90 connection charge. The monthly rate in other areas of the state is $19.24, plus a $1.90 recurring connection charge. Permanent unbundled link and unbundled network element rates have not yet been established for Frontier Corp. The permanent New York Telephone link rate is lower than the temporary rates for New York Telephone's unbundled links; it is greater than the $10.10 rate for the comparable service New York Telephone offers to its own residential customers, but below the rate of approximately $22 for the comparable service New York Telephone offers to its business customers. However, in order to utilize unbundled links, the Company must arrange for collocation in New York Telephone's central offices, which adds significant costs. As a result, the Company's marketing efforts are primarily directed toward business customers (and certain concentrated residential customers) which can be served through the Company's own facilities, rather than through use of unbundled links obtained from New York Telephone or Frontier Corp. In Canada, the Canadian Radio-television and Telecommunications Commission ("CRTC") annually reviews the "contribution charges" (the equivalent of access charges in the U.S.) assessed by the dominant carriers for the access lines leased by Canadian long distance resellers, including the Company, from the local telephone companies in Canada. Changes in these contribution charges could have a material adverse effect on the Company's business, results of operations and financial condition. On May 1, 1997 the CRTC issued several rules intended to encourage increased competition in the telecommunications and broadcast distribution (cable) industries. Generally, the rules describe how new service providers can enter the local exchange market, how and when telephone companies can apply for broadcasting licenses, and the details of a new methodology that will be used to regulate local telephone rates. The rules governing entry in the local exchange market cover issues of inter- connection, resale, subscriber listings, number portability, rate rebalancing, local service subsidies, rate regulation, service obligations and cable competition. The rules will likely increase competition in Canadian local exchange service through new entrants. The Company is unable to predict the extent to which the full implementation of the rules will have a material adverse effect on the Company's business, results of operations or financial condition. The Canadian long distance telecommunications industry is the subject of ongoing regulatory change. These regulations and regulatory decisions have a direct and material effect on the ability of the Company to conduct its business. The recent trend of such regulatory changes has been to open the market to commercial competition, generally to the Company's benefit. There can be no assurance, however, that any future changes in or additions to laws, regulations, government policy or administrative rulings will not have a material adverse effect on the Company's business, results of operations and financial condition. The telecommunications services provided by ACC U.K. are subject to and affected by regulations introduced by the U.K. telecommunications regulatory authority, The Office of Telecommunications ("Oftel"). Since the break up of the U.K. telecommunications duopoly consisting of British Telecom and Mercury in 1991, it has been the stated goal of Oftel to create a competitive marketplace from which detailed regulation could eventually be withdrawn. The regulatory regime currently being introduced by Oftel has a direct and material effect on the ability of the Company to conduct its business. Oftel has imposed mandatory rate reductions on British Telecom in the past, which are expected to continue for the foreseeable future, and this has had and may have, the effect of reducing the prices the Company can charge its customers. Additionally, a new network charge control regime has been implemented on October 1, 1997, which may increase the Company's network costs in the U.K. market. Under the new regime, price ceilings have been established for various types of network services. However, British Telecom may unilaterally control prices under the established price ceilings. The impact of the new regime on the company will depend on the prices assessed by British Telecom in relation to the price ceilings set by Oftel, and the volume and mix of services. Although the Company is optimistic about its ability to continue to compete effectively in the U.K. market, there can be no assurance that future changes in regulation and government will not have a material adverse effect on the Company's business, results of operations and financial condition. EXPANSION OF LOCAL EXCHANGE BUSINESS The Company anticipates that a significant portion of its growth in its U.S. operations in the future will come from local exchange operations and anticipates incurring approximately $13.7 million in capital expenditures during 1997 relating to the installation of additional local exchange switches in the northeastern United States. The Company has only limited experience in providing local telephone services, having commenced providing such services in 1994. The Company's revenues from local telephone and other services in North America in 1995 and 1996 were $13.6 million and $26.3 million, respectively, and $17.9 million and $28.7 million, respectively, for the first nine months of 1996 and 1997. In order to attract local customers, the Company must offer substantial discounts from the prices charged by local exchange carriers and must compete with other alternative local service companies that offer such discounts. The local service business requires significant initial investments in capital equipment as well as significant initial promotional and selling expenses. Larger, better capitalized local service providers, including AT&T, among others, will be better able to sustain losses associated with discount pricing and initial investments and expenses. Although the Company's local service business generated a small operating profit in 1996, it incurred operating losses in 1994 and 1995 and many companies that compete with the Company's local service business are not profitable. There can be no assurance that the Company will continue to achieve positive cash flow or profitability in its local telephone service business. In addition, the FCC and PSCs are considering regulatory changes in rate structures and access charges which could materially adversely affect the ability of small interexchange carriers, such as the Company, to compete in the provision of local service. See "- Potential Adverse Effects of Regulation." INCREASING DOMESTIC AND INTERNATIONAL COMPETITION The long distance telecommunications industry is highly competitive and is significantly influenced by the marketing and pricing decisions of the larger industry participants. The industry has relatively insignificant barriers to entry, numerous entities competing for the same customers and high churn rates (customer turnover), as customers frequently change long distance providers in response to the offering of lower rates or promotional incentives by competitors. In each of its markets, the Company competes primarily on the basis of price and also on the basis of customer service and its ability to provide a variety of telecommunications services, including the ability to provide both intra- and inter-LATA toll service. The Company expects competition on the basis of price and service offerings to increase. Although many of the Company's university customers are under multi-year contracts, several of the Company's largest customers (primarily other long distance carriers) are on month-to-month contracts and are particularly With respect to its reseller customers, the Company competes almost exclusively on the basis of price. Many of the Company's competitors are significantly larger, have substantially greater financial, technical and marketing resources and larger networks than the Company, control more transmission lines and have long- standing relationships with the Company's target customers. These competitors include, among others, AT&T, MCI Telecommunications Corporation ("MCI"), and Sprint Corp. ("Sprint") in the U.S.; Bell Canada, BC Telecom, Inc., AT&T Canada Long Distance Services Company ("AT&T Canada") and Sprint Canada (a subsidiary of Call-Net Telecommunications Inc.) in Canada; and British Telecom, Mercury, AT&T, and WorldCom, Inc. ("Worldcom") in the U.K. Other U.S. carriers also have and are expected to enter the U.K. market. The Company also competes with numerous other long distance providers, some of which focus their efforts on the same business customers targeted by the Company and selected residential customers and colleges and universities, the Company's other target customers. In addition, through its local telephone service business in upstate New York and Massachusetts, the Company competes with New York Telephone Company ("New York Telephone"), Frontier Corp., Citizens Telephone Co., WorldCom and Time Warner and others, including cellular and other wireless providers. Furthermore, corporate transactions such as the proposed merger of Bell Atlantic Corp. and NYNEX Corp., the proposed merger of MCI and WorldCom, the joint venture between MCI and Microsoft Corporation ("Microsoft") under which Microsoft will promote MCI's services, the joint venture among Sprint, Deutsche Telekom AG and France Telecom called Global One, the joint venture among British Telecom, MCI and Telefonica de Espana SA, and additional mergers, acquisitions and strategic alliances which are likely to occur, could also increase competitive pressures upon the Company and have a material adverse effect on the Company's business, results of operations and financial condition. In addition to these competitive factors, recent and pending deregulation in each of the Company's markets may encourage new entrants. For example, as a result of the 1996 Act, RBOCs are allowed to enter the long distance market, AT&T, MCI and other long distance carriers are allowed to enter the local telephone services market, and any entity (including cable television companies and utilities) is allowed to enter both the local service and long distance telecommunications markets. In addition, the FCC has, on several occasions since 1984, approved or required price reductions by AT&T and, in 1995 and 1996, the FCC reclassified AT&T as a "non-dominant" carrier, which substantially reduces the regulatory constraints on AT&T. As the Company expands its geographic coverage, it will encounter increased competition. Moreover, the Company believes that competition in non-U.S. markets is likely to increase and become more similar to competition in U.S. markets over time as such non-U.S. markets continue to experience deregulatory influences. The WTO accord reached in February 1997 is likely to accelerate this trend in some markets. Prices in the long distance industry have declined from time to time in recent years and are likely to continue to decrease. For example, Bell Canada substantially reduced its rates during the first quarter of 1994 and British Telecom substantially reduced its rates in 1996. The Company's competitors may reduce rates or offer incentives to existing and potential customers of the Company. AT&T, in particular, has experienced sharp declines in its market share over recent years and may make aggressive pricing decisions in an effort to halt or reverse this decline. To maintain its competitive position, the Company believes that it must be able to reduce its prices in order to meet reductions in rates, if any, by others. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RISKS OF GROWTH AND EXPANSION The Company plans to expand its service offerings and principal geographic markets in the United States, Canada and the United Kingdom. In addition, the Company intends to establish a presence in deregulating Western European markets that have high density telecommunications traffic, when the Company believes that business and regulatory conditions warrant. The Company has entered the German market as a switchless reseller in anticipation of deregulation in 1998, and has established a German subsidiary. There can be no assurance, however, that the Company will be able to add service or expand its markets at the rate presently planned by the Company or that the existing regulatory barriers to such expansion will be reduced or eliminated. The Company's rapid growth has placed, and in the future may continue to place, a significant strain on the Company's administrative, operational and financial resources and increased demands on its systems and controls. As the Company increases its service offerings and expands its targeted markets, there will be additional demands on the Company's customer support, sales and marketing and administrative resources and network infrastructure. There can be no assurance that the Company's operating and financial control systems and infrastructure will be adequate to maintain and effectively monitor future growth. The failure to continue to upgrade the administrative, operating and financial control systems or the emergence of unexpected expansion difficulties could materially adversely affect the Company's business, results of operations and financial condition. RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS A key component of the Company's strategy is its planned expansion in Western European markets. In the WTO accord reached in February 1997, a number of countries agreed to accelerate or initiate liberalization of their telecommunications markets by allowing increased competition and foreign ownership of telecommunications providers and by adopting measures to ensure reasonable nondiscriminatory interconnection, effective competitive safeguards, and an effective independent regulation. This agreement may, therefore, expand the international opportunities available to the Company. To date, the Company has no significant experience in providing telecommunications service outside the United States, Canada and the U.K. The Company is making preparations to enter the emerging German market in anticipation of deregulation in 1998. There can be no assurance, however, that the Company will be able to obtain the capital it requires to finance its expansion in international markets on satisfactory terms or at all. In many international markets, protective regulations and long-standing relationships between potential customers of the Company and their local providers create barriers to entry. Where protective regulations are being eliminated, the pro-competitive effect of this action could substantially increase the number of entities competing with the Company. Pursuit of international growth opportunities may require significant investments for an extended period before returns, if any, on such investments are realized. The Company intends to focus in the near term on the expansion of its service offerings, including its local telephone business and Internet services, and expanding its geographic markets to more locations in its existing markets, and when conditions warrant, to deregulating Western European markets. Such expansion, particularly the establishment of new operations or acquisition of existing operations in deregulating international markets, may adversely affect cash flow and operating performance and these effects may be material, as was the case with the Company's U.K. operations in 1994 and 1995. In addition, there can be no assurance that the Company will be able to obtain the permits and operating licenses required for it to operate, hire and train employees or to market, sell and deliver high quality services in these international markets. In addition to the uncertainty as to the Company's ability to expand its international presence, there are certain risks inherent to doing business on an international level, such as unexpected changes in regulatory requirements, tariffs, customs, duties and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, political risks, fluctuations in currency exchange rates, foreign exchange controls which restrict or prohibit repatriation of funds, technology export and import restrictions or prohibitions, delays from customs brokers or government agencies, seasonal reductions in business activity during the summer months in Europe and certain other parts of the world and potentially adverse tax consequences resulting from operating in multiple jurisdictions with different tax laws, which could materially adversely impact the success of the Company's international operations. In many countries, the Company may need to enter into a joint venture or other strategic relationship with one or more third parties in order to successfully conduct its operations. There are risks in participating in joint ventures, including the risk that the other participant in the joint venture may at any time have economic, business or legal interests that are inconsistent with those of the joint venture or the Company. As its revenues from its Canadian and U.K. operations increase and as it establishes operations in other countries, an increasing portion of the Company's revenues will be denominated in currencies other than U.S. dollars, although a significant portion of the Company's interest expense may be denominated in U.S. dollars. Therefore, changes in exchange rates (particularly a strengthening of the U.S. dollar) will have a greater effect on the Company's results of operations. There can be no assurance that such factors will not have a material adverse effect on the Company's future operations and, consequently, on the Company's business, results of operations and financial condition. In addition, there can be no assurance that laws or administrative practices relating to taxation, foreign exchange or other matters of countries within which the Company operates will not change. Any such change could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON EFFECTIVE INFORMATION SYSTEMS To complete its billing, the Company must record and process massive amounts of data quickly and accurately. The Company believes that the successful implementation and integration of new information systems is important to its continued growth and its ability to monitor costs, to bill customers and to achieve operating efficiencies, but there can be no assurance that the Company will not encounter delays or cost-overruns or suffer adverse consequences in implementing the systems. In addition, as the Company's suppliers revise and upgrade their hardware, software and equipment technology, there can be no assurance that the Company will not encounter difficulties in integrating the new technology into the Company's systems or that the new systems will be appropriate for the Company's business. RISKS ASSOCIATED WITH ACQUISITIONS, INVESTMENTS AND STRATEGIC ALLIANCES As part of its business strategy, the Company expects to seek to develop strategic alliances both domestically and internationally and to acquire assets and businesses or make investments in companies that are complementary to its current operations. Except for the merger agreement entered into with US Wats, Inc., the Company has no present commitments or agreements with respect to any material strategic alliance, investment or acquisition. Any such future strategic alliances, investments or acquisitions would be accompanied by the risks commonly encountered in strategic alliances with or acquisitions of or investments in companies. Such risks include, among other things, the difficulty of assimilating the operations and personnel of the companies, the potential disruption of the Company's ongoing business, the difficulty of successfully incorporating licensed or acquired technology and rights into the Company's service offerings, the maintenance of uniform standards, controls, procedures and policies and the impairment of relationships with employees and customers as a result of changes in management. In addition, the Company has in the past experienced higher attrition rates with respect to customers obtained through acquisitions, and may again experience higher attrition rates with respect to any customers resulting from future acquisitions. Moreover, to the extent that any such acquisition, investment or alliance involved a business located outside the United States, the transaction would involve the risks associated with international expansion discussed above under "Risks Associated with International Operations." There can be no assurance that the Company would be successful in overcoming these risks or any other problems encountered with such strategic alliances, investments or acquisitions. In addition, if the Company were to proceed with one or more significant strategic alliances, acquisitions or investments in which the consideration consists of cash, a substantial portion of the Company's available cash could be used to consummate the strategic alliances, acquisitions or investments. Many of the businesses that might become attractive acquisition candidates for the Company may have significant goodwill and intangible assets, and acquisitions of these businesses, if accounted for as a purchase, would typically result in substantial amortization charges to the Company. The financial impact of acquisitions, investments and strategic alliances could have a material adverse effect on the Company's business, financial condition and results of operations and could cause substantial fluctuations in the Company's quarterly and yearly operating results. TECHNOLOGICAL CHANGES MAY ADVERSELY AFFECT COMPETITIVENESS AND FINANCIAL RESULTS The telecommunications industry is characterized by rapid and significant technological advancements and introductions of new products and services utilizing new technologies. There can be no assurance that the Company will maintain competitive services or that the Company will obtain appropriate new technologies on a timely basis or on satisfactory terms. RISKS ASSOCIATED WITH RAPIDLY CHANGING INDUSTRY The international telecommunications industry is changing rapidly due to, among other things, deregulation, privatization of dominant telecommunications providers, technological improvements, expansion of telecommunications infrastructure and the globalization of the world's economies and free trade. There can be no assurance that one or more of these factors will not vary unpredictably, which could have a material adverse effect on the Company. There can also be no assurance, even if these factors turn out as anticipated, that the Company will be able to implement its strategy or that its strategy will be successful in this rapidly evolving market. There can be no assurance that the Company will be able to compete effectively or adjust its contemplated plan of development to meet changing market conditions. Much of the Company's planned growth is predicated upon the deregulation of telecommunications markets. There can be no assurance that such deregulation will occur when or as anticipated, if at all, or that the Company will be able to grow in the manner or at the rates currently contemplated. As a result of existing excess international transmission capacity, the marginal cost of carrying an additional international call is often very low for carriers that own transmission lines. Industry observers have predicted that these low marginal costs may result in significant pricing pressures and that, within a few years after the end of this century, there may be no charges based on the distance a call is carried. Certain of the Company's competitors have introduced calling plans that provide for flat rates on calls within the U.S. and Canada, regardless of time of day or distance of the call. If this type of pricing were to become prevalent, it would have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant degree upon the continued contributions of its management team and technical, marketing and sales personnel. The Company's employees may voluntarily terminate their employment with the Company at any time. Competition for qualified employees and personnel in the telecommunications industry is intense and, from time to time, there are a limited number of persons with knowledge of and experience in particular sectors of the telecommunications industry. The Company's success also will depend on its ability to attract and retain qualified management, marketing, technical and sales executives and personnel. The process of locating such personnel with the combination of skills and attributes required to carry out the Company's strategies is often lengthy. The loss of the services of key personnel, or the inability to attract additional qualified personnel, could have a material adverse effect on the Company's results of operations, development efforts and ability to expand. There can be no assurance that the Company will be successful in attracting and retaining such executives and personnel. Any such event could have a material adverse effect on the Company's business, financial condition and results of operations. RISKS ASSOCIATED WITH FINANCING ARRANGEMENTS; DIVIDEND RESTRICTIONS The Company's financing arrangements are secured by substantially all of the Company's assets and require the Company to maintain certain financial ratios and restrict the payment of dividends, and the Company anticipates that it will not pay any dividends on Class A Common Stock in the foreseeable future. The Company's secured lenders would be entitled to foreclose upon those assets in the event of a default under the financing arrangements and to be repaid from the proceeds of the liquidation of those assets before the assets would be available for distribution to the Company's other creditors and shareholders in the event that the Company is liquidated. In addition, the collateral security arrangements under the Company's existing financing arrangements may adversely affect the Company's ability to obtain additional borrowings or other capital. The Company may need to raise additional capital from equity or debt sources to finance its projected growth and capital expenditures contemplated for periods after 1997. See the Risk Factor discussion above under "Substantial Indebtedness; Need for Additional Capital" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." HOLDING COMPANY STRUCTURE; RELIANCE ON SUBSIDIARIES FOR DIVIDENDS ACC Corp. is a holding company, the principal assets of which are its operating subsidiaries in the U.S., Canada and the U.K. ACC U.S., ACC Canada, ACC U.K. and other operating subsidiaries of the Company are subject to corporate law restrictions on their ability to pay dividends to ACC Corp. There can be no assurance that ACC Corp. will be able to cause its operating subsidiaries to declare and pay dividends or make other payments to ACC Corp. when requested by ACC Corp. The failure to pay any such dividends or make any such other payments could have a material adverse effect upon the Company's business, financial condition and results of operations. POTENTIAL VOLATILITY OF STOCK PRICE The market price of the Class A Common Stock has been and may continue to be, highly volatile. Factors such as variations in the Company's revenue, earnings and cash flow, the difference between the Company's actual results and the results expected by investors and analysts, "buy," "hold" and "sell" ratings by securities analysts and announcements of new service offerings, marketing plans or price reductions by the Company or its competitors could cause the market price of the Class A Common Stock to fluctuate substantially. In addition, the stock markets recently have experienced significant price and volume fluctuations that particularly have affected telecommunications companies and resulted in changes in the market prices of the stocks of many companies that have not been directly related to the operating performance of those companies. Such market fluctuations may materially adversely affect the market price of the Class A Common Stock. RISKS ASSOCIATED WITH DERIVATIVE FINANCIAL INSTRUMENTS In the normal course of business, the Company uses various financial instruments, including derivative financial instruments, to hedge its foreign exchange and interest rate risks. The Company does not use derivative financial instruments for speculative purposes. By their nature, all such instruments involve risk, including the risk of nonperformance by counterparties, and the Company's maximum potential loss may exceed the amount recognized on the Company's balance sheet. Accordingly, losses relating to derivative financial instruments could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." CURRENCY RISKS; POSSIBLE EFFECT ON FINANCIAL CONDITION, OPERATING RESULTS AND FINANCING COSTS; EXCHANGE CONTROLS A significant portion of the Company's assets, sales and earnings are attributable to operations conducted in Canada and the United Kingdom and, in the future, the Company may increase the amount of business it conducts in jurisdictions outside the United States. Consequently, a significant portion of the Company's revenues and expenses are, and, in the future, are expected to continue to be, denominated in non-U.S. currencies. Fluctuations in exchange rates relative to the U.S. dollar may have a material adverse effect upon the Company's business, financial condition or results of operations and could adversely affect the effective interest rate on the Company's U.S. denominated indebtedness. To the extent the operating subsidiaries distribute dividends in non-U.S. currencies in the future, the amount of cash to be received by ACC Corp. will be affected by fluctuations in exchange rates. In addition, certain countries in which the Company may commence operations restrict the expatriation or conversion of currency. See "-Risks Associated with Derivative Financial Instruments" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." INTERNATIONAL TAX RISKS Distributions of earnings and other payments (including interest) received from the Company's operating subsidiaries and affiliates may be subject to withholding taxes imposed by the jurisdictions in which such entities are formed or operating, which will reduce the amount of after-tax cash the Company can receive from its operating companies. In general, a U.S. corporation may claim a foreign tax credit against its federal income tax expense for such foreign withholding taxes and for foreign income taxes paid directly by foreign corporate entities in which the Company owns 10% or more of the voting stock. The ability to claim such foreign tax credits and to utilize net foreign losses is, however, subject to numerous limitations, and the Company may incur incremental tax costs as a result of these limitations or because the Company is not in a tax-paying position in the United States. The Company may also be required to include in its income for U.S. federal income tax purposes its proportionate share of certain earnings of those foreign corporate subsidiaries that are classified as "controlled foreign corporations" without regard to whether distributions have been actually received from such subsidiaries. RISKS OF ENTRY INTO CELLULAR BUSINESS AND EXPANSION OF INTERNET, PAGING AND DATA TRANSMISSION BUSINESSES The Company believes that offering a full-service portfolio of local, long distance, data transmission and other services is an effective strategy for building upon its market position and obtaining economies of scale in its network and other areas. However, the Company has only limited experience in providing local exchange, Internet, paging and data transmission services in selected markets, and is considering entering the cellular business in Canada when market conditions warrant. The Company may be required to make significant operating and capital investments in order to provide these services. There are numerous operating complexities associated with providing these services. The Company will be required to develop new products, services and systems and new marketing initiatives for selling these services and will also need to implement the necessary billing and collecting systems. The Company may face significant competitive product and pricing pressures in providing these services and entering new markets, and there can be no assurance that the Company's strategy will be successful. -----END PRIVACY-ENHANCED MESSAGE-----