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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________________ to ___________________
COMMISSION FILE NUMBER: 333-50475
KMC TELECOM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-3545325
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1545 ROUTE 206
BEDMINSTER, NEW JERSEY 07921
(Address, including zip code, of principal executive offices)
(908) 470-2100
(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.
[X ] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING
----- -----------
Common Stock, par value $0.01 861,145 shares,
per share. as of May 9, 2001
================================================================================
KMC TELECOM HOLDINGS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
--------
ITEM 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets,
December 31, 2000 and March 31, 2001..............................2
Unaudited Condensed Consolidated Statements of Operations,
Three Months Ended March 31, 2000 and 2001........................3
Unaudited Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2000 and 2001........................4
Notes to Unaudited Condensed Consolidated Financial
Statements........................................................5
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................14
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.........22
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings..................................................23
ITEM 2. Changes in Securities and Use of Proceeds..........................23
ITEM 3. Defaults Upon Senior Securities....................................23
ITEM 4. Submission of Matters to a Vote of Security Holders................24
ITEM 5. Other Information..................................................24
ITEM 6. Exhibits and Reports on Form 8-K...................................24
SIGNATURES....................................................................26
PART I - FINANCIAL INFORMATION
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, MARCH 31,
2000 2001
------------ ----------
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 109,977 $ 131,189
Restricted investments........................................................... 37,125 37,125
Accounts receivable, net of allowance for doubtful accounts of $10,921 and
$11,392 in 2000 and 2001, respectively........................................ 47,141 44,424
Monetization proceeds receivable................................................. - 325,000
Prepaid expenses and other current assets........................................ 14,888 26,114
---------- ----------
Total current assets................................................................ 209,131 563,852
Long-term restricted investments.................................................... 62,931 69,368
Networks, property and equipment, net............................................... 1,021,684 1,207,781
Intangible assets, net.............................................................. 3,835 3,823
Deferred financing costs, net....................................................... 32,766 32,752
Other assets........................................................................ 928 1,080
---------- ----------
$1,331,275 $1,878,656
========== ==========
LIABILITIES, REDEEMABLE AND NONREDEEMABLE EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable................................................................. $ 180,803 $ 149,301
Accrued expenses................................................................. 73,605 76,054
Deferred revenue................................................................. 17,839 14,229
---------- ----------
Total current liabilities........................................................... 272,247 239,584
Other liabilities................................................................... - 23,036
Notes payable....................................................................... 728,173 1,384,444
Senior notes payable................................................................ 275,000 275,000
Senior discount notes payable....................................................... 340,181 350,664
---------- ----------
Total liabilities................................................................... 1,615,601 2,272,728
Commitments and contingencies
Redeemable equity:
Senior redeemable, exchangeable, PIK preferred stock, par value $.01 per
share; authorized: 630 shares in 2000 and 2001; shares issued and outstanding:
Series E, 75 shares in 2000 and 127 shares in 2001 ($127,309 liquidation
preference)................................................................... 61,992 117,631
Series F, 48 shares in 2000 and -0- shares in 2001............................. 50,568 -
Redeemable cumulative convertible preferred stock, par value $.01 per share;
499 shares authorized; shares issued and outstanding:
Series A, 124 shares in 2000 and 2001 ($12,380 liquidation preference)......... 109,272 62,052
Series C, 175 shares in 2000 and 2001 ($17,500 liquidation preference)......... 72,701 42,908
Redeemable cumulative convertible preferred stock, par value $.01 per share;
2,500 shares authorized; shares issued and outstanding:
Series G-1, 59 shares in 2000 and 2001 ($19,900 liquidation preference)........ 19,435 19,474
Series G-2, 481 shares in 2000 and 2001 ($162,600 liquidation preference)...... 158,797 159,123
Redeemable common stock, shares issued and outstanding, 224 in 2000 and 2001..... 45,563 22,404
Redeemable common stock warrants................................................. 16,817 19,117
---------- ----------
Total redeemable equity............................................................. 535,145 442,709
---------- ----------
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 4,250 shares authorized, issued and
outstanding, 630 shares and 637 shares in 2000 and 2001, respectively.......... 6 6
Unearned compensation............................................................. (16,608) (703)
Accumulated deficit............................................................... (802,869) (813,048)
Accumulated other comprehensive income............................................ - (23,036)
---------- ----------
Total nonredeemable equity (deficiency)............................................. (819,471) (836,781)
---------- ----------
$1,331,275 $1,878,656
========== ==========
See accompanying notes.
2
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2000 2001
------------------------------
Revenue........................................................................ $ 29,151 $ 96,826
Operating expenses:
Network operating costs:
Non-cash stock compensation expense/(credit)......................... 1,051 (5,010)
Other network operating costs........................................ 28,807 61,330
Selling, general and administrative:
Non-cash stock compensation expense/(credit)......................... 12,257 (58,414)
Other selling, general and administrative costs...................... 39,326 48,957
Depreciation and amortization............................................. 13,737 32,615
------------------------------
Total operating expenses............................................. 95,178 79,478
------------------------------
Income/(loss) from operations.................................................. (66,027) 17,348
Interest income................................................................ 1,969 2,524
Interest expense............................................................... (27,164) (43,149)
------------------------------
Net loss before cumulative effect of change in accounting principle............ (91,222) (23,277)
Cumulative effect of change in accounting principle............................ (1,705) -
------------------------------
Net loss....................................................................... (92,927) (23,277)
(Dividends and accretion)/reversal of accretion on redeemable preferred stock.. (33,527) 67,634
------------------------------
Net income/(loss) applicable to common shareholders............................ $ (126,454) $ 44,357
==============================
Net income/(loss) per common share before cumulative effect of change in
accounting principle..................................................... $ (146.19) $ 51.51
Cumulative effect of change in accounting principle............................ (2.00) -
------------------------------
Net income/(loss) per common share - basic..................................... $ (148.19) $ 51.51
==============================
Net income per common share - diluted.......................................... - $ 29.54
==============================
Weighted average number of common shares outstanding - basic................... 853,341 861,145
==============================
Weighted average number of common and common equivalent shares outstanding -
diluted.................................................................. - 1,501,598
==============================
Pro forma amounts assuming the change in accounting principle was
applied retroactively:
Net income/(loss) applicable to common shareholders............................ $ (124,749) $ 44,357
==============================
Net income/(loss) per common share-basic....................................... $ (146.19) $ 51.51
==============================
See accompanying notes.
3
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2000 2001
-------------------------------
OPERATING ACTIVITIES
Net loss ..................................................................... $ (92,927) $ (23,277)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................... 13,737 32,615
Non-cash interest expense............................................... 9,061 21,695
Non-cash stock compensation expense/(credit)............................ 13,308 (63,424)
Changes in assets and liabilities:
Accounts receivable.................................................. (7,239) 2,717
Prepaid expenses and other current assets............................ (348) (4,672)
Other assets......................................................... (7,229) (6,673)
Accounts payable..................................................... (45,416) (81,725)
Accrued expenses..................................................... 13,554 (7,452)
Deferred revenue..................................................... 2,322 (3,610)
-------------------------------
Net cash used in operating activities......................................... (101,177) (133,806)
-------------------------------
INVESTING ACTIVITIES
Construction of networks and purchases of equipment........................... (145,850) (174,038)
Acquisitions of franchises, authorizations and related assets................. (395) (112)
-------------------------------
Net cash used in investing activities......................................... (146,245) (174,150)
-------------------------------
FINANCING ACTIVITIES
Proceeds from issuance of notes, net of issuance costs........................ - 223,345
Proceeds from credit facilities, net of issuance costs........................ 259,134 105,823
-------------------------------
Net cash provided by financing activities..................................... 259,134 329,168
-------------------------------
Net increase/(decrease) in cash and cash equivalents.......................... 11,712 21,212
Cash and cash equivalents, beginning of period................................ 85,966 109,977
-------------------------------
Cash and cash equivalents, end of period...................................... $ 97,678 $ 131,189
===============================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net of amounts capitalized.......... $ 3,332 $ 21,454
==============================
See accompanying notes.
4
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
1. BASIS OF PRESENTATION AND ORGANIZATION
KMC Telecom Holdings, Inc. and its subsidiaries are collectively referred
to herein as the Company. All significant intercompany accounts and transactions
have been eliminated in consolidation.
The Company is a fiber-based integrated communications provider offering
data, voice and Internet infrastructure services. The Company offers these
services to businesses, governments and institutional end-users, Internet
service providers, long distance carriers and wireless service providers,
primarily in the South, Southeast, Midwest and Mid-Atlantic United States. The
business has two distinct components: serving communications-intensive customers
in Tier III markets, and providing data services on a nationwide basis.
The unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial reporting. Accordingly, they do not include certain information and
note disclosures required by generally accepted accounting principles for annual
financial reporting and should be read in conjunction with the financial
statements and notes thereto of KMC Telecom Holdings, Inc. as of and for the
year ended December 31, 2000.
The unaudited interim financial statements reflect all adjustments
(consisting only of normal recurring adjustments) which management considers
necessary for a fair presentation of the results of operations for these
periods. The results of operations for the interim periods are not necessarily
indicative of the results for the full year.
The balance sheet of KMC Telecom Holdings, Inc. at December 31, 2000 was
derived from the audited consolidated balance sheet at that date.
Certain reclassifications have been made to the 2000 unaudited condensed
consolidated financial statements to conform with the 2001 presentation.
2. ACCOUNTING CHANGE
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), REVENUE RECOGNITION IN FINANCIAL
STATEMENTS. SAB 101 provides additional guidance in applying generally accepted
accounting principles to revenue recognition in financial statements. Through
December 31, 1999, the Company recognized installation revenue upon completion
of the installation. Effective January 1, 2000, in accordance with the
provisions of SAB 101, the Company is recognizing installation revenue over the
average contract period. The cumulative effect of this change in accounting
principle resulted in a charge of approximately $1.7 million which was recorded
in the quarter ended March 31, 2000. Revenue for the three months ended March
31, 2000 includes $654,000 of revenue that, prior to the accounting change, had
been recognized through December 31, 1999.
5
3. NETWORKS, PROPERTY AND EQUIPMENT
Networks and equipment are comprised of the following:
DECEMBER 31, MARCH 31,
2000 2001
-------------------------------
(IN THOUSANDS)
Fiber optic systems......................... $ 249,690 $ 260,180
Telecommunications equipment................ 696,683 989,530
Furniture and fixtures...................... 27,790 28,453
Leasehold improvements...................... 2,704 2,908
Construction-in-progress.................... 157,075 70,121
------------------------------
1,133,942 1,351,192
Less accumulated depreciation............... (112,258) (143,411)
------------------------------
$ 1,021,684 $ 1,207,781
==============================
Costs capitalized during the development of the Company's networks include
amounts incurred related to network engineering, design and construction and
capitalized interest. Capitalized interest related to the construction of the
networks for the three months ended March 31, 2000 and 2001 amounted to $2.2
million and $881,000, respectively.
4. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
DECEMBER 31, MARCH 31,
2000 2001
------------------------------
(IN THOUSANDS)
Accrued interest payable.................... $ 20,419 $ 26,881
Accrued telecommunications costs............ 8,125 11,043
Accrued compensation........................ 20,068 9,654
Accrued property taxes...................... 3,143 5,477
Other accrued expenses...................... 21,850 22,999
------------------------------
$ 73,605 $ 76,054
==============================
5. INFORMATION BY BUSINESS SEGMENT
The Company has two reportable segments as defined by FASB Statement No.
131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION": a
Tier III Markets segment and a Nationwide Data Platform segment. The Company
owns and operates robust fiber-based networks and switching equipment in all of
its 37 Tier III markets, which are predominantly located in the South,
Southeast, Midwest and Mid-Atlantic United States. The Nationwide Data Platform
segment provides local Internet access infrastructure and other enhanced data
services in over 140 markets nationwide.
The Company evaluates the performance of its operating segments based on
earnings before interest, taxes, depreciation and amortization, excluding
general corporate expenses and stock compensation expense ("Adjusted EBITDA").
There are no significant intersegment transactions.
6
Prior to the development of the Nationwide Data Platform segment in late
fiscal 2000, the Company was managed as one reporting segment for the three
months ended March 31, 2000. Therefore, segment data for such period is not
presented.
THREE MONTHS ENDED MARCH 31, 2001
(IN THOUSANDS)
TIER III NATIONWIDE
MARKETS DATA PLATFORM CORPORATE TOTAL
------------ ------------- --------- -------
Revenue.......................... $ 50,599 $ 46,227 $ - $ 96,826
Adjusted EBITDA.................. (27,673) $ 14,212 - (13,461)
Depreciation and amortization.... (21,383) $ (5,123) (6,109) (32,615)
Stock compensation credit........ 1,903 634 60,887 63,424
Interest income.................. 515 551 1,458 2,524
Interest expense................. (37,382) (4,215) (1,552) (43,149)
Net income/(loss) common
shareholders..................... (84,020) 6,059 54,684 (23,277)
Dividends and reversal of
accretion on redeemable
preferred stock............... - - 67,634 67,634
------------ ------------ ------------ ------------
Net income/(loss) applicable to
common shareholders........... $ (84,020) $ 6,059 $ 122,318 $ 44,357
============ ============ ============ ============
Total assets..................... $ 934,009 $ 781,317 $ 163,330 $ 1,878,656
============ ============ ============ ============
Capital expenditures............. $ 12,175 $ 205,075 $ - $ 217,250
============ ============ ============ ============
SERVICE REVENUE
The Company provides on-net switched and dedicated services and resells
switched services previously purchased from the incumbent local exchange
carrier. On-net services include both services provided through direct
connections to our own networks and services provided by means of unbundled
network elements leased from the incumbent local exchange carrier.
The Company's service revenue consists of the following:
THREE MONTHS ENDED
MARCH 31,
2000 2001
-------------------------
(IN THOUSANDS)
On-net.........................................................................$ 25,741 $ 94,734
Resale......................................................................... 3,410 2,092
-------------------------
Total..........................................................................$ 29,151 $ 96,826
=========================
7
6. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
As of March 31, 2001, the Company has outstanding commitments aggregating
approximately $32.2 million related to purchases of telecommunications equipment
and fiber optic cable and its obligations under its agreements with certain
suppliers.
REDEMPTION RIGHTS
Pursuant to a stockholders agreement, certain of the Company's stockholders
and warrant holders have "put rights" entitling them to have the Company
repurchase their preferred and common shares and redeemable common stock
warrants for the fair value of such securities if no Liquidity Event (defined as
(i) an initial public offering with gross proceeds of at least $40 million, (ii)
the sale of substantially all of the stock or assets of the Company or (iii) the
merger or consolidation of the Company with one or more other corporations) has
taken place by the later of (x) October 22, 2003 or (y) 90 days after the final
maturity date of the Senior Discount Notes. The restrictive covenants of the
Senior Discount Notes limit the Company's ability to repurchase such securities.
All of the securities subject to such "put rights" are presented as redeemable
equity in the accompanying balance sheets.
The redeemable preferred stock, redeemable common stock and redeemable
common stock warrants, which are subject to the stockholders agreement, are
being accreted up to their fair market values from their respective issuance
dates to their earliest potential redemption date (October 22, 2003). At March
31, 2001, the aggregate redemption value of the redeemable equity was
approximately $202 million, reflecting per share redemption amounts of $501 for
the Series A Preferred Stock, $245 for the Series C Preferred Stock, $103 for
the Series G Preferred Stock and $100 for the redeemable common stock and
redeemable common stock warrants.
7. NET INCOME/(LOSS) PER COMMON SHARE
The following table sets forth the computation of net income/(loss) per
common share-basic and diluted (in thousands, except share and per share
amounts):
8
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2000 2001
-----------------------------
Numerator:
Net loss before cumulative effect of change in accounting
principle.............................................. $ (91,222) $ (23,277)
Cumulative effect of change in accounting principle....... (1,705) -
-----------------------------
Net loss.................................................. (92,927) (23,277)
(Dividends and accretion)/reversal of accretion on
redeemable preferred stock............................. (33,527) 67,634
-----------------------------
Numerator for net income/(loss) applicable to common
shareholders........................................... $ (126,454) $ 44,357
=============================
Denominator:
Denominator for basic net income/(loss) per common
share-weighted average number of common shares
outstanding............................................ 853,341 861,145
===============
Dilutive effect of options and warrants................... 640,453
-------------
Denominator for diluted net income/(loss) per common
share-weighted average number of common and common
equivalent shares outstanding.......................... 1,501,598
=============
Net income/(loss) per common share before cumulative effect
of change in accounting principle - basic................. $ (146.19) $ 51.51
Cumulative effect of change in accounting principle.......... (2.00) -
-----------------------------
Net income/(loss) per common share - basic................... $ (148.19) $ 51.51
=============================
Net income per common share - diluted........................ $ 29.54
=============
Options and warrants to purchase an aggregate of 520,531 shares of common
stock were outstanding as of March 31, 2000, but a computation of diluted net
loss per common share for such period has not been presented, as the effect
would be anti-dilutive.
8. SIGNIFICANT CONTRACTS AND CUSTOMERS
VOIP EQUIPMENT CONTRACT
In March 2001, the Company entered into an agreement with Qwest
Communications Corporation and Qwest Communications International, Inc.
("Qwest") pursuant to which (i) the Company purchased approximately $65.0
million of Voice over Internet Protocol equipment from Qwest and (ii) the
Company agreed to install and maintain this equipment throughout the United
States, principally to handle Voice over Internet Protocol traffic on behalf of
Qwest. The services agreement commences in the second half of 2001 and expires
48 months later, and provides guaranteed annualized revenues of approximately
$28.7 million. The Company expects to enter into a financing transaction to fund
the cost of this equipment.
Contracts with Qwest accounted for approximately 57% of the Company's total
revenue during the three months ended March 31, 2001. The majority of the Qwest
business was generated from long term guaranteed revenue contracts. For the
three months ended March 31, 2000, no one customer accounted for more than 10%
of revenue.
9
9. SIGNIFICANT FINANCING TRANSACTIONS
KMC FUNDING MONETIZATION
In March 2001, the Company entered into a financing transaction (the "KMC
Funding Monetization") that resulted in the Company receiving unrestricted gross
proceeds of $325.0 million from a secured loan (the $325.0 million is reflected
as a receivable at March 31, 2001 as this monetization closed on March 30, 2001
but the cash settlement occurred on April 2, 2001). The KMC Funding Monetization
is secured by the future cash flows from the Company's Nationwide Data Platform
business contract that was entered into in June 2000. The KMC Funding
Monetization requires that the principal and interest be paid on a monthly basis
upon receipt of the monthly proceeds from the related contract. The Company
retains the right to receive the remaining cash flows from this contract which
are expected to be approximately 25% of the monthly cash flows (from which
on-going operational expenses must be paid). The Company realized net proceeds
of approximately $145.5 million after using a portion of the gross proceeds to
repay the 48 month loan which the Company obtained from Dresdner Kleinwort
Benson North American Leasing, Inc. in November 2000 to finance its acquisition
of the KMC Funding Equipment, as well as to pay any financing fees and expenses
related to the monetization. The interest rate on the KMC Funding Monetization
is 7.34%.
KMC FUNDING V MONETIZATION
In March 2001, the Company entered into a financing transaction (the "KMC
Funding V Monetization") that resulted in the Company receiving unrestricted
gross proceeds of $225.4 million from a secured loan. The KMC Funding V
Monetization is secured by the future cash flows from the Company's Nationwide
Data Platform business contract that was entered into in March 2000. The KMC
Funding V Monetization requires that the principal and interest be paid on a
monthly basis upon receipt of the monthly proceeds from the related contract.
The Company retains the right to receive the remaining cash flows from this
contract which are expected to be approximately 25% of the monthly cash flows
(from which on-going operational expenses must be paid). The Company realized
net proceeds of approximately $125.5 million after using the proceeds to
exercise its purchase option with respect to the KMC Funding V Equipment which
the Company was leasing from GECC and CIT Lending Services Corporation under an
operating lease, as well as to pay any financing fees and expenses related to
the monetization. The interest rate on the KMC Funding V Monetization is 6.77%.
10. EQUITY TRANSACTIONS
SPRINGING WARRANTS
Effective February 4, 2001, the Company became obligated to issue warrants
to purchase an aggregate of 107,228 shares of its common stock at an exercise
price of $.01 per share to certain holders of the Series E Preferred Stock and
Series F Preferred Stock as a result of the Company's failure to redeem, prior
to that date, all of the outstanding shares of Series F Preferred Stock. The
issuance of these warrants will trigger anti-dilution provisions in our Series A
Preferred Stock, Series C Preferred Stock and Series G Preferred Stock resulting
in adjustments to the conversion prices which will result in an increase in the
number of shares of common stock into which they are convertible of 20,522
shares, 14,194 shares and 18,478 shares, respectively. The issuance of the
Springing Warrants will also trigger anti-dilution provisions in certain of our
other outstanding warrants which will increase the number of shares of common
stock for which such warrants are exercisable by 3,740 shares.
10
SERIES F PREFERRED STOCK
Effective February 4, 2001, all the shares of Series F Preferred Stock were
converted into shares of Series E Preferred Stock on a one to one basis in
accordance with the provisions of the Certificate of Designations of the Series
F Preferred Stock.
CHANGE IN FAIR VALUE OF COMMON STOCK
As a result of a decrease in the estimated fair value of the Company's
common stock in the first quarter of 2001 as compared to December 31, 2000, the
Company reversed $63.4 million of previously recognized stock compensation
expense during the quarter ended March 31, 2001. In addition, the decrease in
the estimated fair value of the Company's common stock also resulted in the
reversal of $67.6 million of previously recognized accretion on redeemable
equity instruments during the first quarter of 2001. Neither of these non-cash
items were directly generated by the Company's operating activities.
11. RELATED PARTIES
The Company is currently in negotiations to complete the transfer of its
construction division to KNT Network Technologies, LLC ("KNT"), a company
independently owned by Harold N. Kamine and Nassau Capital, the principal
stockholders of the Company. Pursuant to an arrangement between the parties,
effective June 1, 2000, the Company transferred substantially all of the
employees of its construction division to KNT. KNT is providing construction and
maintenance services to the Company and is being reimbursed for all of the
direct costs of these activities. In addition, the Company is currently funding
substantially all of KNT's general overhead and administrative costs at an
amount not to exceed $15 million per annum.
Amounts paid to KNT during the three months ended March 31, 2001 related to
this arrangement amounted to $13.1 million, of which $7.0 million was for
network related construction and was capitalized into networks and equipment,
$4.3 million was expensed as general overhead and administrative costs and $1.8
million was expensed as direct maintenance costs. Further, the Company may be
entitled to participate in future profits of KNT, to the extent KNT develops a
successful third-party construction business.
The Company is currently negotiating with KNT to finalize the terms of this
arrangement and execute a formal contract which is required to be completed by
June 15, 2001.
12. HEDGING ACTIVITIES
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, as amended, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES ("Statement 133"), which requires the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings.
The Company has two interest rate swap agreements to hedge its interest
rate exposure, and the effect of applying Statement 133 as of January 1, 2001
resulted in the fair value of the swaps of $13.2 million being included as a
liability with a corresponding charge to other comprehensive income. For the
11
period from January 1, 2001 through March 31, 2001, the value of the swaps
decreased to a liability of $23.0 million, with the $9.8 million decrease being
recorded in other comprehensive income.
13. COMPREHENSIVE INCOME
The Company has adopted Statement of Financial Accounting Standards No.
130, REPORTING COMPREHENSIVE INCOME, which establishes standards for the
reporting and disclosure of comprehensive income and its components in the
financial statements. The adoption of this Statement had no impact on the
Company's net income. Prior to the adoption of Statement 133 in the quarter
ended March 31, 2001 (see Note 12), the Company did not have any items that were
required to be disclosed in comprehensive income. The Company's comprehensive
income for the three months ended March 31, 2001 is set forth in the following
table:
THREE MONTHS ENDED
MARCH 31,
2001
----------------------
Net income applicable to common shareholders........... $ 44,357
Other comprehensive income:
Unrealized loss on hedging transactions........... (9,765)
-----------------------
Comprehensive income................................... $ 34,592
======================
14. SUBSEQUENT EVENTS
AMENDMENT TO AMENDED SENIOR SECURED CREDIT FACILITY
In April 2001, the Company and its Lenders under the Amended Senior Secured
Credit Facility agreed to make certain further amendments to the facility,
including the following:
Certain of the financial covenants were amended to reflect changes in the
Company's business since the Amended Senior Secured Credit Facility was entered
into and to permit continued compliance with those covenants by the Borrowers in
accordance with the Company's revised business plan. In addition, certain
additional financial covenants were added, the most significant of which will
require the Borrowers to meet specific liquidity tests prior to each due date of
cash interest and dividend payments on the Company's senior discount notes,
senior notes and preferred stock.
In addition to the existing reductions in the aggregate Revolver
commitment, the Revolver commitment will be further reduced, pro rata with the
Term Loan and Lucent Term Loan, (i) by applying the net asset sale proceeds of
certain asset sales (both as defined in the Amended Senior Secured Credit
Facility) in an amount equal to 85% of gross property, plant and equipment
allocated to the assets sold, plus 50% of any proceeds in excess of the full
gross property, plant and equipment allocated to the assets sold (plus a make up
of any shortfall on prior asset sales), (ii) by 50% of the net securities
proceeds (as defined) from the future issuance of equity interests by KMC
Holdings in excess of a cumulative $200.0 million and (iii) by prepayment of an
aggregate of $100 million on or before May 1, 2002.
The Company will be required to use 50% of the excess cash flows (as
defined) from its National Data Platform business to make additional capital
contributions to the Borrowers.
The repayment schedule for the Term Loan was amended to provide for 17
consecutive quarterly installments commencing April 1, 2003 in the same
percentages of outstanding principal amount as the specified percentage
12
reduction in the Revolver commitment on the same date. The final installment
will now be due on April 1, 2007. Repayments of the Term Loan will also be made
from its pro rata share of net asset sale proceeds, net securities proceeds and
the $100.0 million repayment required to be made by May 1, 2002, all as
described above.
The repayment schedule for the Lucent Term Loan was also amended to provide
for 17 consecutive quarterly installments commencing April 1, 2003 in the same
percentages of outstanding principal amount as the specified percentage
reduction in the Revolver commitment on the same date. The final installment
will now be due on April 1, 2007. Repayments on the Lucent Term Loan will also
be made from its pro rata share of net asset sale proceeds, net securities
proceeds and the $100.0 million repayment required to be made by May 1, 2002,
all as described above.
The interest rates on loans under the Amended Senior Secured Credit
Facility were increased. The "Applicable Base Rate Margin" now ranges from 3.25%
to 4.25% and the "Applicable LIBOR Margin" now ranges from 4.25% to 5.25%.
Interest is now payable monthly.
KMC Holdings has agreed that it will form a subsidiary holding company
which will own all of the common stock of its operating subsidiaries which are
engaged in its Nationwide Data Platform business. KMC Holdings has agreed to
pledge the shares of the data subsidiary holding company as further collateral
for KMC Holdings' guaranty of the Amended Senior Secured Credit Facility.
In connection with the amendment, the Lenders also waived failures by the
Borrowers to comply with certain of the prior financial covenants as of March
31, 2001 and the Company made aggregate capital contributions to the Borrowers
of $200.0 million. In addition, the collateral for KMC Holdings' guaranty of the
Amended Senior Secured Credit Facility was expanded to include substantially all
of the assets of KMC Holdings.
LENDER WARRANTS
In connection with the execution of the amendment to the Amended Senior
Secured Credit Facility discussed above, the Company agreed to deliver to a
warrant agent certificates representing warrants to purchase an aggregate of
166,542 shares of common stock at an exercise price of $.01 per share (the
"Lender Warrants"). The terms of the Lender Warrants provide that they will
become issuable under the circumstances described in the following paragraph.
If the Company fails to (i) prepay an aggregate of $50 million under the
Amended Senior Secured Credit Facility by October 31, 2001, (ii) prepay an
additional $50 million under the Amended Senior Secured Credit Facility by
January 31, 2002 and (iii) make additional cash capital contributions to the
Borrowers in the aggregate amount of $50 million by January 31, 2002, 50% of the
Lender Warrants will be issued pro rata to the Lenders under the Amended Senior
Secured Credit Facility. If the Company fails to make additional cash capital
contributions to the Borrowers in the aggregate amount of $100 million by March
31, 2002 (including any amounts taken into consideration pursuant to clause
(iii) above), 50% of the Lender Warrants will be issued pro rata to the Lenders
under the Amended Senior Secured Credit Facility. Any Lender Warrants which do
not become issuable as described herein will be returned to the Company by the
warrant agent.
NOTE REPURCHASES
The Company's subsidiaries have recently made, and may in the future make,
purchases of senior discount notes and/or senior notes in the open market from
time to time.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS. THESE STATEMENTS
REFLECT OUR CURRENT ESTIMATES, EXPECTATIONS AND PROJECTIONS ABOUT OUR FUTURE
RESULTS, PERFORMANCE, PROSPECTS AND OPPORTUNITIES. IN SOME CASES, YOU CAN
IDENTIFY THESE STATEMENTS BY FORWARD-LOOKING WORDS SUCH AS "ANTICIPATE",
"BELIEVE", "COULD", "ESTIMATE", "EXPECT", "INTEND", "MAY", "SHOULD", "WILL",
"WOULD" AND SIMILAR EXPRESSIONS. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON
ALL INFORMATION CURRENTLY AVAILABLE TO US AND ARE SUBJECT TO A NUMBER OF RISKS,
UNCERTAINTIES AND OTHER FACTORS THAT COULD CAUSE OUR ACTUAL RESULTS,
PERFORMANCE, PROSPECTS OR OPPORTUNITIES TO DIFFER MATERIALLY FROM THOSE
EXPRESSED IN, OR IMPLIED BY, THESE FORWARD-LOOKING STATEMENTS. THESE RISKS,
UNCERTAINTIES AND OTHER FACTORS INCLUDE MATTERS RELATED TO:
o OUR OPERATIONS AND PROSPECTS,
o OUR EXPECTED FINANCIAL POSITION,
o OUR FUNDING NEEDS AND POTENTIAL FINANCING SOURCES,
o OUR NETWORK DEVELOPMENT AND EXPANSION PLANS,
o THE MARKETS IN WHICH OUR SERVICES ARE CURRENTLY OFFERED OR WILL BE
OFFERED IN THE FUTURE,
o THE SERVICES WHICH WE EXPECT TO OFFER IN THE FUTURE,
o THE CONTINUING IMPLEMENTATION OF OUR OPERATIONS SUPPORT SYSTEM,
o REGULATORY MATTERS,
o EXPECTED COMPETITORS IN OUR MARKETS, AND
o THE FACTORS SET FORTH IN ITEM 7 OF OUR ANNUAL REPORT ON FORM 10-K FOR
THE YEAR ENDED DECEMBER 31, 2000 UNDER THE HEADING "-CERTAIN FACTORS
WHICH MAY AFFECT OUR FUTURE RESULTS."
EXCEPT AS OTHERWISE REQUIRED TO BE DISCLOSED IN PERIODIC REPORTS REQUIRED
TO BE FILED BY PUBLIC COMPANIES WITH THE SECURITIES AND EXCHANGE COMMISSION
PURSUANT TO THE COMMISSION'S RULES, WE HAVE NO DUTY TO UPDATE THESE STATEMENTS.
OVERVIEW
We are a rapidly growing fiber-based integrated communications provider
offering data, voice and Internet infrastructure services. We offer these
services to businesses, governments and institutional end-users, Internet
service providers, long distance carriers and wireless service providers. Our
business has two distinct components: serving communications-intensive customers
in Tier III markets, and providing data services on a nationwide basis.
We provide a full suite of broadband communications services in 37 Tier III
markets, which we define as markets with a population between 100,000 and
750,000. We own and operate robust fiber-based networks and switching equipment
in all of our Tier III markets, which are predominantly located in the South,
Southeast, Midwest and Mid-Atlantic United States. We will continue to expand in
our existing Tier III markets because we believe that these markets have
attractive growth attributes and are typically less competitive than larger
markets. Our customers in these markets include: AT&T, Boeing, City of Augusta,
Columbia Hospital, NASA, Pillsbury, State of Wisconsin, Texas A&M University and
Wal-Mart.
We also provide nationwide data services under long-term guaranteed revenue
contracts. Under these contracts, we provide local Internet access
infrastructure and other enhanced data services and will be providing Voice over
Internet Protocol services beginning in the second half of 2001. Currently, we
have contracts representing approximately $280 million in annualized revenues in
approximately 140 markets. The Internet infrastructure we are deploying includes
14
the latest technology platforms from Cisco and Nortel, which we believe will
result in a cost-effective and technologically superior solution for our
customers.
TIER III MARKETS. We have installed fiber-based SONET networks, or
self-healing synchronous optical networks, using a Class 5 switch in all of our
37 markets. Our fiber optic networks are initially designed and built to reach
approximately 80% of the business access lines in each of our markets, typically
requiring a local fiber loop of about 30 to 40 miles.
As our switches have become operational, our operating margins have
improved meaningfully. Our operating margins have also improved due to increased
on-network revenues relative to resale revenues. On-network revenues are
revenues earned from services provided on our network, including by direct
connection to our switch, unbundled network element or dedicated line. Resale
revenues are generated when traffic is carried completely on the incumbent local
exchange carriers' facilities. On-network revenues have increased from
approximately 44% of our revenues for the three months ended March 31, 1999 to
approximately 98% of our revenues for the three months ended March 31, 2001.
NATIONWIDE DATA PLATFORM. We currently provide Internet access
infrastructure using remote access servers manufactured by Cisco and Nortel
which we are deploying in our 41 supernodes, including ten in our existing Tier
III markets. Supernodes are concentration points for high-speed connectivity to
the Internet.
Under the terms of our existing guaranteed revenue contracts, we provide
the routing and ancillary equipment for each supernode, as well as data
transport service from the incumbent local exchange carrier to our supernode
location. Our customers pay us a fixed price per port and compensate us for
certain expenses, including space, power and transport, that we may incur above
an agreed level. This structure provides highly predictable revenues and costs
over the life of each contract, currently ranging from 42 to 51 months. These
contracts began generating revenues during the third quarter of 2000. Revenues
will continue to increase as the contracts are phased in through the third
quarter of 2001. These contracts started providing positive margins beginning
with the commencement of revenues in the third quarter of 2000.
We purchased approximately $134.4 million of equipment (the "KMC Funding V
Equipment") relating to these contracts during the first quarter of 2000. We
sold this equipment to General Electric Credit Corporation and CIT Lending
Services Corporation, and leased it back from them, during the second quarter of
2000. We purchased an additional $168.6 million of equipment (the "KMC Funding
Equipment") relating to these contracts during the second quarter of 2000 and
signed an agreement in November 2000 with Dresdner Kleinwort Benson North
American Leasing, Inc. to finance this equipment by means of a 48 month term
loan. In March 2001, we entered into two financing transactions (the "KMC
Funding V Monetization" and the "KMC Funding Monetization," respectively) and
repaid the remaining balance on this term loan and exercised our purchase option
on the KMC Funding V Equipment under the operating lease. See "--Liquidity and
Capital Resources" below for a detailed description of these transactions.
15
The table below provides selected key operational and financial data on a
consolidated basis as of the following dates:
Quarter Ended
--------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31,
2000 2000 2000 2000 2001
---------- -------- ------------- ------------ -------
Tier III operational markets.... 35 35 35 37 37
Route miles..................... 1,724 1,989 2,178 2,285 2,325
Fiber miles..................... 110,335 122,376 134,952 140,988 143,508
Collocations.................... 111 124 125 134 140
Customers....................... 7,305 8,513 9,990 11,602 13,064
Total buildings connected....... 5,615 7,088 9,085 9,745 11,343
Total lines in service.......... 480,079 767,992 1,865,390 2,284,375 2,857,304
On-network revenues(a)(b)....... 88% 93% 96% 97% 98%
Resale revenues(a)(c)........... 12% 7% 4% 3% 2%
- --------
(a) As a percentage of total revenues.
(b) On-network revenues are revenues earned from services provided on our
network, including by direct connection to our switch, unbundled network
element or dedicated line.
(c) Resale revenues are generated when traffic is carried completely on the
incumbent local exchange carriers' facilities.
REVENUE. Our revenue is derived from the sale of local switched services,
long distance services, Centrex-type services, private line services, special
access services and Internet access infrastructure. In prior years, a
significant portion of our revenue was derived from the resale of switched
services. We have transitioned the majority of our customers on-network and, as
a result, the portion of our revenue related to the resale of switched services
has decreased significantly.
RECIPROCAL COMPENSATION. We recognized reciprocal compensation revenue of
approximately $6.4 million, or 22% of our total revenue for the quarter ended
March 31, 2000 and approximately $4.0 million or 4% of our total revenue for the
quarter ended March 31, 2001. In May 2000, we reached a resolution of our claims
for payment of certain reciprocal compensation charges, previously disputed by
BellSouth Corporation. Under the agreement, BellSouth made a one-time payment
that resolved all amounts billed through March 31, 2000. In addition, we agreed
with BellSouth on future rates for reciprocal compensation, setting new
contractual terms for payment. Our prior agreement with BellSouth provided for a
rate of $.009 per minute of use for reciprocal compensation. Under the terms of
the new agreement, the rates for reciprocal compensation which will apply to all
local traffic, including ISP-bound traffic, will decrease over time. The
reduction will be phased in over a three-year period beginning with a rate of
$.002 per minute of use until March 31, 2001, $.00175 per minute of use from
April 1, 2001 through March 31, 2002 and $.0015 per minute of use from April 1,
2002 through March 31, 2003.
In March 2001, we filed a formal complaint against Southwestern Bell
Telephone Company with the Kansas Corporation Commission seeking payment of past
due reciprocal compensation for calls to Internet service providers. We cannot
predict the outcome of this proceeding.
We are currently pursuing resolution of this issue with other incumbent
local exchange carriers. Our goal is to reach mutually acceptable terms for both
outstanding and future reciprocal compensation amounts for all traffic. We
cannot assure you that we will reach new agreements with these carriers on
favorable terms.
16
As of March 31, 2001, we have provided reserves which we believe are
sufficient to cover any amounts which may not be collected, but we cannot assure
you that this will be the case. Our management will continue to consider the
circumstances surrounding this dispute periodically in determining whether
additional reserves against unpaid balances are warranted.
On April 27, 2001, the Federal Communications Commission released an order
addressing reciprocal compensation for ISP-bound traffic. The Federal
Communications Commission established a three year phase-down of compensation
for ISP-bound traffic. A rebuttable 3:1 ratio of terminating to originating
minutes was adopted as a proxy for identifying ISP-bound traffic. State
reciprocal compensation rates will apply to traffic exchanged within the ratio.
The rate cap on compensation for traffic above the ratio was set at $0.0015 per
minute of use for the first six months following the effective date of the
Federal Communications Commission's order, $0.0010 per minute of use for the
next eighteen months, and $0.0007 per minute of use through the thirty-sixth
month or until the Federal Communications Commission adopts a new mechanism,
whichever is later. In addition, a ten percent growth cap (applied on a per
interconnection agreement basis) applies to ISP-bound traffic eligible for
compensation. The order preserves the compensation mechanisms contained in
existing interconnection agreements, but permits the incumbent local exchange
carriers to invoke change-in-law provisions that may be contained in those
agreements. It is expected that numerous competitive local exchange carriers
will file for review of the Federal Communications Commission's decision. We are
unable to predict the outcome of any review proceedings that may be initiated.
While we have not yet had an opportunity to fully evaluate the impact of the
order on our business, if it remains in its present form, it is likely to
adversely affect our future revenues.
OPERATING EXPENSES. Our principal operating expenses consist of network
operating costs, selling, general and administrative expenses, stock option
compensation expense and depreciation and amortization. Network operating costs
include charges from termination and unbundled network element charges; charges
from incumbent local exchange carriers for resale services; charges from long
distance carriers for resale of long distance services; salaries and benefits
associated with network operations, billing and information services and
customer care personnel; franchise fees and other costs. Network operating costs
also include a percentage of both our intrastate and interstate revenues which
we pay as universal service fund charges. Nationwide Data Platform operating
expenses include space, power, transport, maintenance, staffing, sales, general
and administrative and rental expenses under our operating lease agreements.
Certain of these costs are passed through to the carrier customer which allows
us to limit our maintenance and servicing costs to predetermined levels, and to
receive additional revenues for any costs incurred in excess of such
predetermined levels. Selling, general and administrative expenses consist of
sales personnel and support costs, corporate and finance personnel and support
costs and legal and accounting expenses. Depreciation and amortization includes
charges related to plant, property and equipment and amortization of intangible
assets, including franchise acquisition costs. Depreciation and amortization
expense will increase as we place additional equipment into service, expanding
our existing networks.
INTEREST EXPENSE. Interest expense includes interest charges on our senior
notes, senior discount notes, our senior secured credit facilities and our
Internet infrastructure equipment financings. Interest expense also includes
amortization of deferred financing costs.
RESULTS OF OPERATIONS
As a result of the development and rapid growth of the Company's business
during the periods presented, the period-to-period comparisons of the Company's
results of operations are not necessarily meaningful and should not be relied
upon as an indication of future performance.
17
THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO
THREE MONTHS ENDED MARCH 31, 2000
REVENUE. Revenue increased 232% from $29.2 million for the three months
ended March 31, 2000 (the "2000 First Quarter") to $96.8 million for the three
months ended March 31, 2001 (the "2001 First Quarter"). This increase is
principally attributable to the fact that our data services business generated
revenues in the 2001 First Quarter, but had not generated any revenues in the
2000 First Quarter, as well as increased sales in our Tier III Markets business
in the 2001 First Quarter compared to the 2000 First Quarter.
On-network local switched services, long distance services, Centrex-type
services, private line services, special access services and Internet access
infrastructure revenues ("On-network revenues") represented 98% of total revenue
in the 2001 First Quarter, compared to 88% of total revenue in the 2000 First
Quarter; while revenue derived from the resale of switched services ("Resale
revenue") represented 2% and 12% of total revenue, respectively, during those
periods. On-network revenues are revenues earned from services provided on our
network, including by direct connection to our switch, unbundled network element
or dedicated circuit. In addition, we recognized reciprocal compensation revenue
of $4.0 million, or 4% of our total revenues during the 2001 First Quarter as
compared to $6.4 million, or 22% of our total revenues during the 2000 First
Quarter.
NETWORK OPERATING COSTS. Network operating costs, excluding non-cash stock
compensation expense, increased 113% from $28.8 million for the 2000 First
Quarter to $61.3 million for the 2001 First Quarter. This increase of
approximately $32.5 million was due primarily to the increased sales in our Tier
III Markets business in the 2001 First Quarter, combined with the fact that we
were making operating lease payments in the 2001 First Quarter related to the
equipment utilized in the Nationwide Data Platform business. As a result of the
KMC Funding V Monetization, this equipment was purchased from the lessors in
March 2001 and such lease payments will no longer be made. The detailed
components of the network operating costs increase are $24.5 million in direct
costs associated with providing on-network services, resale services, leasing
unbundled network element services and operating lease payments, $3.0 million in
personnel costs, $2.3 million in network support services, $1.3 million in
consulting and professional services costs, $800,000 in telecommunications costs
and $600,000 in other direct operating costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, excluding non-cash stock compensation expense,
increased 25% from $39.3 million for the 2000 First Quarter to $49.0 million in
the 2001 First Quarter. This increase of approximately $9.7 million consists of
the following detailed components: $5.3 million in consulting and professional
services costs, most of which were associated with our agreement with KNT, $2.3
million in personnel costs, $1.2 million in telecommunications costs and
$900,000 million in facility costs.
STOCK COMPENSATION. Stock compensation, a non-cash item, decreased from an
aggregate charge of $13.3 million in the 2000 First Quarter to an aggregate
credit of $63.4 million for the 2001 First Quarter. This decrease is due to a
significant decrease in the estimated fair value of the Company's common stock
in the 2001 First Quarter compared to the fair value of such stock in the 2000
First Quarter.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased 138% from $13.7 million for the 2000 First Quarter to $32.6 million
for the 2001 First Quarter. This increase is due primarily to depreciation
expense associated with the expansion of our Tier III Markets business networks
and the startup of our Nationwide Data Platform business networks during the
third quarter of 2000.
18
INTEREST INCOME. Interest income increased from $2.0 million in the 2000
First Quarter to $2.5 million in the 2001 First Quarter. This increase is due
primarily to larger average cash, cash equivalents and restricted cash balances
during the 2001 First Quarter as compared to the 2000 First Quarter.
INTEREST EXPENSE. Interest expense increased from $27.2 million in the 2000
First Quarter to $43.1 million in the 2001 First Quarter. Of this increase, $9.7
million is attributable to higher borrowings under our amended senior secured
credit facility, $3.7 million is attributable to the financing of our Internet
infrastructure equipment purchased in June 2000 and $1.2 million is attributable
to additional accretion on our senior discount notes. In addition, we
capitalized interest of $2.2 million related to network construction projects
during the 2000 First Quarter versus $881,000 during the 2001 First Quarter.
NET LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. For
the reasons stated above, net loss before cumulative effect of change in
accounting principle decreased from $91.2 million for the 2000 First Quarter to
$23.3 million for the 2001 First Quarter.
LIQUIDITY AND CAPITAL RESOURCES
We have incurred significant operating and net losses as a result of the
development and operation of our networks. We expect that such losses will
continue as we emphasize the development, construction and expansion of our
networks and build our customer base. As a result, we do not expect there to be
any cash provided by operations in the near future. We will also need to fund
the expansion of our networks and our capital expenditures related to our
Nationwide Data Platform business. We have financed our operating losses and
capital expenditures with equity invested by our founders, preferred stock
placements, credit facility borrowings, equipment loans, operating leases,
monetizations and our 12 1/2% senior discount notes and 13 1/2% senior notes.
In March 2001, we entered into a financing transaction (see Note 9,
"Significant Financing Transactions-KMC FUNDING MONETIZATION," of the Notes to
Unaudited Condensed Consolidated Financial Statements included in Item 1 of this
Report on Form 10-Q) that resulted in us receiving unrestricted gross proceeds
of $325.0 million from a secured loan. The KMC Funding Monetization is secured
by the future cash flows from our Nationwide Data Platform business contract
that was entered into in June 2000. The KMC Funding Monetization requires that
the principal and interest be paid on a monthly basis upon receipt of the
monthly proceeds from the related contract. We retain the right to receive the
remaining cash flows from this contract which are expected to be approximately
25% of the monthly cash flows (from which on-going operational expenses must be
paid). We realized net proceeds of approximately $145.5 million after using a
portion of the gross proceeds to repay the 48 month term loan which we obtained
pursuant to our November 2000 agreement with Dresdner Kleinwort Benson North
American Leasing, Inc. to finance our acquisition of the KMC Funding Equipment,
as well as to pay any financing fees and expenses related to the monetization.
In March 2001, we entered into a financing transaction (see Note 9,
"Significant Financing Transactions-KMC FUNDING V MONETIZATION," of the Notes to
Unaudited Condensed Consolidated Financial Statements included in Item 1 of this
Report on Form 10-Q) that resulted in us receiving unrestricted gross proceeds
of $225.4 million from a secured loan. The KMC Funding V Monetization is secured
by the future cash flows from our Nationwide Data Platform business contract
that was entered into in March 2000. The KMC Funding V Monetization requires
that the principal and interest be paid on a monthly basis upon receipt of the
monthly proceeds from the related contract. We retain the right to receive the
remaining cash flows from this contract which are expected to be approximately
25% of the monthly cash flows (from which on-going operational expenses must be
paid). We realized net proceeds of approximately $125.5 million after using the
19
proceeds to exercise our purchase option with respect to the KMC Funding V
Equipment which we were leasing from GECC and CIT Lending Services Corporation
under an operating lease, as well as to pay any financing fees and expenses
related to the monetization.
In March 2001, we purchased approximately $65.0 million of Voice over
Internet Protocol equipment in association with entering into an agreement with
Qwest (see Note 8, "Significant Contracts and Customers - VOIP EQUIPMENT
CONTRACT," of the Notes to Unaudited Condensed Consolidated Financial Statements
included in Item 1 of this Report on Form 10-Q). We expect to enter into a
financing transaction to fund the cost of this equipment; however, we can give
no assurances that we will be able to obtain such financing.
In April 2001, we further amended our amended senior secured credit
facility. The aggregate amount of the facility remains at $700.0 million and
funds are available under it for the same purposes. The primary changes effected
by the amendment were (i) changes to certain of the financial covenants to
reflect changes in the Company's business since the amended senior secured
credit facility was entered into and to permit continued compliance with those
covenants by the borrowers in accordance with its revised business plan, (ii) to
conform the repayment schedules of both term loans and the revolving loan, (iii)
to require the borrowers to make an aggregate of $100 million in prepayments on
the loans in accordance with an agreed schedule, (iv) to require the Company to
use a portion of the proceeds of future equity issuances in excess of a
cumulative $200.0 million to make additional prepayments on the loans, (v) to
require the Company to use agreed upon portions of the proceeds from certain
sales of assets to make additional prepayments on the loans, (vi) to require the
Company to use agreed upon portions of the excess cash flows from its Nationwide
Data Platform business to make additional capital contributions to the
borrowers, (vii) to require the Company to restructure those of its subsidiaries
involved in its Nationwide Data Platform business under a single subsidiary
holding company, the shares of which will be pledged as additional collateral
for KMC Holdings' obligations under its guaranty of the amended senior secured
credit facility, and (viii) to increase the interest rate. In connection with
the amendment, the lenders also waived failures by the borrowers to comply with
certain of the prior financial covenants as of March 31, 2001, and the Company
made aggregate capital contributions to the borrowers of $200.0 million. In
addition, the collateral for KMC Holdings' guaranty of the facility was expanded
to include substantially all of the assets of KMC Holdings. For a more detailed
discussion of this amendment see Note 14, "Subsequent Events - AMENDMENT TO
AMENDED SENIOR SECURED CREDIT FACILITY," of the Notes to Unaudited Condensed
Consolidated Financial Statements included in Item 1 of this Report on Form
10-Q.
As of April 30, 2001, we had $654.9 million and $550.4 million of
indebtedness outstanding under the amended senior secured credit facility and
the combined KMC Funding V Monetization and KMC Funding Monetization,
respectively. Subject to certain conditions, as of that date we had an
additional $38.4 million in borrowing capacity available under the amended
senior secured facility, excluding $6.7 million of drawn letters of credit. The
KMC Funding V Monetization and KMC Funding Monetization were both fully drawn at
that date.
Net cash provided by financing activities from borrowings and equity
issuances was $329.2 million and our net cash used in operating and investing
activities was $308.0 million for the 2001 First Quarter.
We made capital expenditures of $100.3 million in the 2000 First Quarter
versus $217.3 million in the 2001 First Quarter. Of the total capital
expenditures for the 2001 First Quarter, $12.2 million was related to the Tier
III Markets business segment and $205.1 million was for the Nationwide Data
Platform business segment. As of April 30, 2001, we had outstanding purchase
commitments aggregating approximately $26.6 million related to the purchase of
fiber optic cable and telecommunications equipment under our agreements with
20
certain suppliers and service providers. We currently anticipate capital
expenditures to be approximately $120.0 million for the Tier III Markets
business for 2001. It is our intention that capital expenditures for the
Nationwide Data Platform business will be financed separately and therefore will
not affect our current liquidity position. The majority of the Tier III Market
expenditures are expected to be made for network expansion to facilitate the
offering of our services. We expect to continue to incur operating losses while
we expand our business and build our customer base. Actual capital expenditures
and operating losses will depend on numerous factors, including the nature of
future expansion and acquisition opportunities and factors beyond our control,
including economic conditions, competition, regulatory developments and the
availability of capital.
We believe that our cash and borrowings available under the amended senior
secured credit facility will be sufficient to meet our liquidity needs to fund
operating losses and capital expenditure requirements for our current business
plan into the second quarter of 2002.
However, in the event that our plans change, the assumptions upon which our
plans are based prove inaccurate, we expand or accelerate our business plan or
we determine to consummate acquisitions, the foregoing sources of funds may
prove insufficient and we may be required to seek additional financing sooner
than we currently expect. Additional sources of financing may include public or
private equity or debt financings, leases and other financing arrangements. We
can give no assurance that additional financing will be available to us or, if
available, that it can be obtained on a timely basis and on acceptable terms.
Our subsidiaries have recently made, and may in the future make, purchases
of senior discount notes and/or senior notes in the open market from time to
time.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in
interest rates. A substantial portion of our long-term debt bears interest at a
fixed rate. However, the fair market value of the fixed rate debt is sensitive
to changes in interest rates. We are subject to the risk that market interest
rates will decline and the interest expense due under the fixed rate debt will
exceed the amounts due based on current market rates. We have entered into two
interest rate swap agreements with commercial banks to reduce the impact of
changes in interest rates on a portion of our outstanding variable rate debt.
The agreements effectively fix the interest rate on $415.0 million of our
outstanding variable rate borrowings under the amended senior secured credit
facility due 2007. A $325.0 million interest rate swap agreement entered into in
April 2000 terminates in April 2004 and a $90.0 million interest rate swap
agreement entered into in June 2000 terminates in June 2005.
The following table provides information about our significant
financial instruments that are sensitive to changes in interest rates (in
millions):
Fair Value
on March
31, Future Principal Payments
2001 2001 2002 2003 2004 2005 Thereafter Total
---------- -------- -------- -------- -------- -------- ---------- -------
Long-Term Debt:
Fixed Rate:
Senior Discount Notes,
interest payable at
12 1/2%, maturing 2008........ $ 50.0 $ - $ - $ - $ - $ - $ 350.7 $ 350.7
Senior Notes, interest
payable at 13 1/2%, maturing
2009.......................... 93.7 - - - - - 275.0 275.0
KMC Funding Monetization,
interest payable at 7.34%,
maturing 2005................. 225.4 42.1 59.7 65.0 58.6 - - 225.4
KMC Funding V Monetization,
interest payable at 6.77%,
maturing 2005................. 325.0 43.5 69.4 74.7 80.4 57.0 - 325.0
Variable rate:
Amended Senior Secured Credit
Facility, interest variable
(11.73% at March 31,2001)(a).. 645.0 - - 80.6 129.0 161.2 274.2 645.0
Internet Infrastructure
Equipment Financing (8.75%
at March 31, 2001) (a) ....... 189.0 31.5 54.0 54.0 49.5 - - 189.0
---------- -------- -------- --------- ------ ------ ------ --------
Interest rate swaps:
Variable rate for fixed rate... 23.0 - - - - - - -
---------- -------- -------- --------- ------ ------ ------ --------
Total....................... $ 1,551.1 $ 117.1 $ 183.1 $ 274.3 $317.5 $218.2 $899.9 $2,010.1
========== ======== ======== ========= ====== ====== ====== ========
- ---------------------
(a) Interest is based on a variable rate, which at our option, is determined by
either a base rate or LIBOR, plus, in each case, a specified margin.
22
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Not Applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not Applicable.
(b) Not Applicable.
(c) On January 1, 2001, the Company granted options
to purchase an aggregate of 10,965 shares of common stock to certain employees
and employees of certain of its affiliates under the 1998 Stock Purchase and
Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates. No
consideration was received by the Company for the issuance of the options. The
options to purchase these shares are exercisable at an exercise price of $300
per share. The issuance of the options was made in reliance upon the exemption
from the registration requirements of the Securities Act provided by Section
4(2) of that Act, on the basis that the transaction did not involve a public
offering.
On February 4, 2001, each outstanding share of the
Company's Series F Senior Redeemable, Exchangeable PIK Preferred Stock was
automatically converted into the right to receive one share of the Company's
Series E Senior Redeemable, Exchangeable PIK Preferred Stock as provided in
Article XXI of the Certificate of Voting Powers, Designations, Preferences and
Relative Participating, Optional or Other Special Rights and Qualifications,
Limitations and Restrictions Thereof of the Series F PIK Preferred Stock. No
consideration was received by the Company in connection with the conversion. The
Company's Certificate of Voting Powers, Designations, Preferences and Relative
Participating, Optional or Other Special Rights and Qualifications, Limitations
and Restrictions Thereof of the Series E PIK Preferred Stock places substantial
restrictions upon transfer of the securities and the certificates representing
the securities have been legended to that effect.
On February 4, 2001, the Company became obligated
to issue an aggregate of 227,273 warrants to purchase an aggregate of 107,207
shares of common stock to certain holders of Series E Senior Redeemable,
Exchangeable PIK Preferred Stock and Series F Senior Redeemable, Exchangeable
PIK Preferred Stock pursuant to the terms of the Series E Senior Redeemable,
Exchangeable PIK Preferred Stock and Series F Senior Redeemable, Exchangeable
PIK Preferred Stock. No consideration will be received by the Company for
issuance of the warrants. The warrants are exercisable at an exercise price of
$0.01 per share. The issuance of the warrants will be made in reliance upon the
exemption from the registration requirements of the Securities Act provided by
Section 4(2) of that Act, on the basis that the transaction does not involve a
public offering. The Warrant Agreement pursuant to which the warrants will be
issued imposes substantial restrictions upon the transfer of the warrants and
any shares of common stock which may be issued upon exercise thereof and the
certificates representing the securities will be legended to that effect.
(d) Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
ITEM 5. OTHER INFORMATION.
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
10.1* Amendment No. 1, dated as of December 31, 2000, to
Amended and Restated Media Gateway Services Agreement
II, by and among Qwest Communications Corporation, Qwest
Communications International Inc. and KMC Telecom V Inc.
10.2* Amendment No. 2, dated as of November 1, 2000, to Media
Gateway Services Agreement III, by and among Qwest
Communications Corporation, Qwest Communications
International Inc. and KMC Telecom VI Inc.
10.3* Amendment No. 3, dated as of March 1, 2001, to Media
Gateway Services Agreement III, by and among Qwest
Communications Corporation, Qwest Communications
International Inc. and KMC Telecom VI Inc.
10.4 Amendment No. 1, dated as of October 1, 1998, to
Professional Services Agreement, by and between KMC
Telecom Inc. and Lucent Technologies Inc.
10.5 Amendment No. 2, dated as of September 29, 2000, to
Professional Services Agreement, by and between KMC
Telecom Inc. and Lucent Technologies Inc.
10.6 Second Amendment made as of March 1, 2000 to the 1998
Stock Purchase and Option Plan for Key Employees of KMC
Telecom Holdings, Inc. and Affiliates.
10.7 Indenture, dated as of March 1, 2001, between KMC
Funding Corporation and Wells Fargo Bank Minnesota,
National Association.
10.8 Note Purchase Agreement, dated March 30, 2001, for KMC
Funding Corporation Media Internet Gateway Service
Notes, Series 2001-1.
10.9 Lease Agreement, dated August 2000, between A-K
Bedminster Associates, L.P., KMC Telecom Holdings, Inc.
and KMC Telecom Inc.
10.10 Office Lease Agreement, dated as of February 29, 2000,
among 1755 North Brown Road, LLC, KMC Telecom Holdings,
Inc., KMC Telecom Inc., KMC Telecom II, Inc. and KMC
Telecom III, Inc.
24
10.11 Office Lease Agreement, dated as of February 29, 2000,
among 1745 North Brown Road, LLC, KMC Telecom Holdings,
Inc., KMC Telecom Inc., KMC Telecom II, Inc. and KMC
Telecom III, Inc.
-----------
* Filed herewith with information omitted. Confidential
treatment has been requested as to certain portions, and the
omitted portions have been separately filed.
(b) REPORTS ON FORM 8-K
Not Applicable.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 15, 2001
KMC TELECOM HOLDINGS, INC.
(Registrant)
By: /S/ WILLIAM F. LENAHAN
----------------------
William F. Lenahan
Chief Executive Officer
(Principal Executive Officer)
By: /S/ WILLIAM H. STEWART
----------------------
William H. Stewart
Chief Financial Officer
(Principal Financial Officer)
26
EXHIBIT INDEX
NO. DESCRIPTION
---- -----------
10.1* Amendment No. 1, dated as of December 31, 2000, to Amended and
Restated Media Gateway Services Agreement II, by and among
Qwest Communications Corporation, Qwest Communications
International Inc. and KMC Telecom V Inc.
10.2* Amendment No. 2, dated as of November 1, 2000, to Media
Gateway Services Agreement III, by and among Qwest
Communications Corporation, Qwest Communications International
Inc. and KMC Telecom VI Inc.
10.3* Amendment No. 3, dated as of March 1, 2001, to Media Gateway
Services Agreement III, by and among Qwest Communications
Corporation, Qwest Communications International Inc. and KMC
Telecom VI Inc.
10.4 Amendment No. 1, dated as of October 1, 1998, to Professional
Services Agreement, by and between KMC Telecom Inc. and Lucent
Technologies Inc.
10.5 Amendment No. 2, dated as of September 29, 2000, to
Professional Services Agreement, by and between KMC Telecom
Inc. and Lucent Technologies Inc.
10.6 Second Amendment made as of March 1, 2000 to the 1998 Stock
Purchase and Option Plan for Key Employees of KMC Telecom
Holdings, Inc. and Affiliates.
10.7 Indenture, dated as of March 1, 2001, between KMC Funding
Corporation and Wells Fargo Bank Minnesota, National
Association.
10.8 Note Purchase Agreement, dated March 30, 2001, for KMC Funding
Corporation Media Internet Gateway Service Notes, Series
2001-1.
10.9 Lease Agreement, dated August 2000, between A-K Bedminster
Associates, L.P., KMC Telecom Holdings, Inc. and KMC Telecom
Inc.
10.10 Office Lease Agreement, dated as of February 29, 2000, among
1755 North Brown Road, LLC, KMC Telecom Holdings, Inc., KMC
Telecom Inc., KMC Telecom II, Inc. and KMC Telecom III, Inc.
10.11 Office Lease Agreement, dated as of February 29, 2000, among
1745 North Brown Road, LLC, KMC Telecom Holdings, Inc., KMC
Telecom Inc., KMC Telecom II, Inc. and KMC Telecom III, Inc.
-----------
* Filed herewith with information omitted. Confidential treatment has
been requested as to certain portions, and the omitted portions have
been separately filed.
27