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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 September 30, 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 of (I.R.S. Employer Identification No.)
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 November 8, 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 September 30,
2001..........................................................................................2
Unaudited Condensed Consolidated Statements of Operations, Three Months Ended
September 30, 2000 and 2001 and Nine Months Ended September 30, 2000 and
2001..........................................................................................3
Unaudited Condensed Consolidated Statements of Cash Flows, Nine Months Ended
September 30, 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.......................................................................16
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk......................................27
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...............................................................................28
ITEM 2. Changes in Securities and Use of Proceeds.......................................................28
ITEM 3. Defaults Upon Senior Securities.................................................................28
ITEM 4. Submission of Matters to a Vote of Security Holders.............................................28
ITEM 5. Other Information...............................................................................28
ITEM 6. Exhibits and Reports on Form 8-K................................................................28
SIGNATURES.................................................................................................29
PART I - FINANCIAL INFORMATION
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER
DECEMBER 31, 30,
2000 2001
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents......................................................... $ 109,977 $ 123,182
Restricted investments............................................................ 37,125 49,645
Accounts receivable, net of allowance for doubtful accounts of $10,921 and
$9,425 in 2000 and 2001, respectively.......................................... 47,141 61,658
Prepaid expenses and other current assets......................................... 14,888 14,876
-------------- -------------
Total current assets................................................................. 209,131 249,361
Long-term restricted investments..................................................... 62,931 23,138
Networks, property and equipment, net................................................ 1,021,684 1,242,056
Intangible assets, net............................................................... 3,835 3,967
Deferred financing costs, net........................................................ 32,766 35,208
Other assets......................................................................... 928 1,851
------------- -------------
$ 1,331,275 $ 1,555,581
============= =============
LIABILITIES, REDEEMABLE AND NONREDEEMABLE EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable.................................................................. $ 180,803 $ 116,591
Accrued expenses.................................................................. 73,605 95,571
Deferred revenue.................................................................. 17,839 26,265
Current portion of notes payable.................................................. - 244,253
------------- -------------
Total current liabilities............................................................ 272,247 482,680
Other liabilities.................................................................... - 35,373
Notes payable........................................................................ 728,173 979,615
Senior notes payable................................................................. 275,000 275,000
Senior discount notes payable........................................................ 340,181 232,227
------------- -------------
Total liabilities.................................................................... 1,615,601 2,004,895
Commitments and contingencies
Redeemable equity:
Senior redeemable, exchangeable, PIK preferred stock, par value $.01 per
share; 630 shares authorized; shares issued and outstanding:
Series E, 75 shares in 2000 and 132 shares in 2001 ($131,861 liquidation
preference)................................................................. 61,992 127,586
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 12,380
Series C, 175 shares in 2000 and 2001 ($17,500 liquidation preference)...... 72,701 17,500
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 19,554
Series G-2, 481 shares in 2000 and 2001 ($162,600 liquidation preference)... 158,797 159,775
Redeemable common stock, shares issued and outstanding, 224 in 2000 and 2001...... 45,563 21,652
Redeemable common stock warrants.................................................. 16,817 22,390
------------- -------------
Total redeemable equity.............................................................. 535,145 380,837
------------- -------------
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 4,250 shares authorized; shares issued
and outstanding: 630 shares and 637 shares in 2000 and 2001, respectively..... 6 6
Additional paid-in capital........................................................ - 44,073
Unearned compensation............................................................. (16,608) (277)
Accumulated deficit............................................................... (802,869) (838,580)
Accumulated other comprehensive income............................................ - (35,373)
------------- -------------
Total nonredeemable equity (deficiency).............................................. (819,471) (830,151)
------------- -------------
$ 1,331,275 $ 1,555,581
============= =============
See accompanying notes.
2
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -------------------------------
2000 2001 2000 2001
------------ ------------- ------------- ------------
Revenue......................................................$ 60,949 $ 119,846 $ 129,025 $ 324,789
Operating expenses:
Network operating costs:
Non-cash stock compensation expense/(credit)..... 482 (340) 2,335 (6,383)
Other network operating costs.................... 46,944 56,049 112,234 179,360
Selling, general and administrative:
Non-cash stock compensation expense/(credit)..... 6,402 (3,959) 27,221 (74,412)
Other selling, general and administrative costs.. 41,058 39,570 120,108 131,298
Depreciation and amortization......................... 20,431 39,309 51,549 120,600
------------ ------------- ------------ ------------
Total operating expenses......................... 115,317 130,629 313,447 350,463
------------ ------------- ------------ ------------
Loss from operations....................................... (54,368) (10,783) (184,422) (25,674)
Interest income............................................ 3,782 1,947 8,290 7,947
Interest expense........................................... (36,073) (50,840) (94,473) (140,490)
------------ ------------- ------------- ------------
Net loss before extraordinary item and cumulative effect
of change in accounting principle.................... (86,659) (59,676) (270,605) (158,217)
Extraordinary item......................................... - - - 109,400
Cumulative effect of change in accounting principle........ - - (1,705) -
------------ ------------- ------------- ------------
Net loss.................................................. (86,659) (59,676) (272,310) (48,817)
(Dividends and accretion)/reversal of accretion on
redeemable preferred stock.......................... (13,229) 3,112 (72,210) 110,142
------------ ------------- ------------- ------------
Net income/(loss) applicable to common shareholders....... $ (99,888) $ (56,564) $ (344,520) $ 61,325
============ ============= ============= ============
Net loss per common share before extraordinary item and
cumulative effect of change in accounting
principle - basic................................... $ (116.06) $ (65.68) $ (400.52) $ (55.83)
Extraordinary item -basic................................. - - - 127.04
Cumulative effect of change in accounting principle
basic.............................................. - - (1.99) -
------------ ------------- ------------- ------------
Net income/(loss) per common share - basic................ $ (116.06) $ (65.68) $ (402.51) $ 71.21
============ ============= ============= ============
Weighted average number of common shares outstanding - 860,639 861,145 855,932 861,145
basic............................................... ============ ============= ============= ============
Pro forma amounts assuming the change in accounting principle
was applied retroactively:
Net income/(loss) applicable to common shareholders........ $ (99,888) $ (56,564) $ (342,815) $ 61,325
============ ============= ============= ============
Net income/(loss) per common share-basic.................... $ (116.06) $ (65.68) $ (400.52) $ 71.21
============ ============= ============= ============
See accompanying notes.
3
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
2000 2001
--------------- ----------------
OPERATING ACTIVITIES
Net loss ..................................................................... $ (272,310) $ (48,817)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization........................................... 51,549 120,600
Non-cash interest expense............................................... 41,368 42,317
Non-cash stock option compensation expense/(credit)..................... 29,556 (80,795)
Gain on repurchase of senior discount notes............................. - (109,400)
Changes in assets and liabilities:
Accounts receivable.................................................. (21,360) (14,517)
Prepaid expenses and other current assets............................ (7,154) 12
Other assets......................................................... (30,680) 23,195
Accounts payable..................................................... (18,113) (96,415)
Accrued expenses..................................................... 34,228 6,374
Deferred revenue..................................................... 14,792 8,426
--------------- ----------------
Net cash used in operating activities......................................... (178,124) (149,020)
--------------- ----------------
INVESTING ACTIVITIES
Construction of networks and purchases of equipment........................... (328,678) (306,997)
Acquisitions of franchises, authorizations and related assets................. (1,239) (603)
--------------- ----------------
Net cash used in investing activities......................................... (329,917) (307,600)
--------------- ----------------
FINANCING ACTIVITIES
Proceeds from monetizations, net of issuance costs............................ - 617,036
Proceeds from issuance of preferred stock, net of issuance costs.............. 177,500 -
Proceeds from exercise of stock options....................................... 562 -
Repurchase of senior discount notes........................................... - (19,178)
Repayment of monetization debt................................................ - (54,871)
Repayment of credit facility.................................................. - (189,710)
Repurchase and retirement of Series F preferred stock......................... (3,329) -
Proceeds from credit facilities, net of issuance costs........................ 375,862 116,548
--------------- ----------------
Net cash provided by financing activities..................................... 550,595 469,825
--------------- ----------------
Net increase in cash and cash equivalents..................................... 42,554 13,205
Cash and cash equivalents, beginning of period................................ 85,966 109,977
--------------- ----------------
Cash and cash equivalents, end of period...................................... $ 128,520 $ 123,182
=============== ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net of amounts capitalized.......... $ 43,010 $ 96,868
=============== ================
See accompanying notes.
4
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 nine months ended September
30, 2000 includes $1.6 million of revenue that, prior to the accounting change,
had been recognized through December 31, 1999.
5
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
3. NETWORKS, PROPERTY AND EQUIPMENT
Networks and equipment are comprised of the following:
DECEMBER 31, SEPTEMBER 30,
2000 2001
--------------------------------------------
(IN THOUSANDS)
Fiber optic systems.......................................... $ 249,690 $ 269,892
Telecommunications equipment................................. 696,683 1,158,143
Furniture and fixtures....................................... 27,790 28,819
Leasehold improvements....................................... 2,704 2,917
Construction-in-progress..................................... 157,075 12,876
------------------ ------------------
1,133,942 1,472,647
Less accumulated depreciation................................ (112,258) (230,591)
------------------ ------------------
$ 1,021,684 $ 1,242,056
================== ==================
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 nine months ended September 30, 2000 and 2001 amounted to
$10.1 million and $1.3 million, respectively.
4. ACCRUED EXPENSES
Accrued expenses are comprised of the following:
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------------------------------------
(IN THOUSANDS)
Accrued compensation and benefits............................ $ 20,068 $ 17,741
Accrued telecommunications costs............................. 8,125 13,097
Accrued interest payable..................................... 20,419 23,032
Accrued property taxes....................................... 3,143 9,582
Other accrued expenses....................................... 21,850 32,119
------------------ -------------------
$ 73,605 $ 95,571
================== ===================
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
non-cash stock compensation expense/(credit) ("Adjusted EBITDA"). There are no
significant intersegment transactions.
6
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
Prior to the development of the Nationwide Data Platform segment in
late fiscal 2000, the Company was managed as one reporting segment for the nine
months ended September 30, 2000. Therefore, segment data for such period is not
presented.
THREE MONTHS ENDED SEPTEMBER 30, 2001
(IN THOUSANDS)
NATIONWIDE DATA
TIER III MARKETS PLATFORM CORPORATE TOTAL
---------------- ------------------- ------------------- -------------------
Revenue................................... $ 54,836 $ 65,010 $ - $ 119,846
Adjusted EBITDA........................... (5,628) 29,941 (86) 24,227
Depreciation and amortization............. (21,642) (13,157) (4,510) (39,309)
Stock compensation credit................. 86 43 4,170 4,299
Interest income........................... 943 325 679 1,947
Interest expense.......................... (34,067) (10,905) (5,868) (50,840)
Net income/(loss) common shareholders..... (60,308) 6,247 (5,615) (59,676)
Extraordinary item........................ - - - -
Dividends and reversal of accretion on
redeemable preferred stock............. - - 3,112 3,112
-------------- --------------- --------------- ---------------
Net income/(loss) applicable to common
shareholders........................... $ (60,308) $ 6,247 $ (2,503) $ (56,564)
============== =============== =============== ===============
Total assets.............................. $ 948,871 $ 532,198 $ 74,512 $ 1,555,581
============== =============== =============== ===============
Capital expenditures...................... $ 10,447 $ 1,931 $ - $ 12,378
============== =============== =============== ===============
Total debt................................ $ 1,162,138 $ 568,957 $ - $ 1,731,095
============== =============== =============== ===============
Total principal repayments of
indebtedness.......................... $ - $ 29,988 $ - $ 29,988
============== =============== =============== ===============
NINE MONTHS ENDED SEPTEMBER 30, 2001
(IN THOUSANDS)
NATIONWIDE DATA
TIER III MARKETS PLATFORM CORPORATE TOTAL
---------------- ------------------- ------------------- -------------------
Revenue................................... $ 156,869 $ 167,920 $ - $ 324,789
Adjusted EBITDA........................... (57,341) 76,085 (4,613) 14,131
Depreciation and amortization............. (64,768) (40,627) (15,205) (120,600)
Stock compensation credit................. 2,697 913 77,185 80,795
Interest income........................... 3,153 1,555 3,239 7,947
Interest expense.......................... (108,544) (25,226) (6,720) (140,490)
Net income/(loss) common shareholders..... (224,803) 12,700 53,886 (158,217)
Extraordinary item........................ - - 109,400 109,400
Dividends and reversal of accretion on
redeemable preferred stock............. - - 110,142 110,142
------------- ------------- ------------- --------------
Net income/(loss) applicable to common $ (224,803) $ 12,700 $ 273,428 $ 61,325
shareholders........................... ============= ============= ============= ==============
Total assets.............................. $ 948,871 $ 532,198 $ 74,512 $ 1,555,581
============= ============= ============= ==============
Capital expenditures...................... $ 33,857 $ 304,847 $ - $ 338,704
============= ============= ============= ==============
Total debt................................ $ 1,162,138 $ 568,957 $ - $ 1,731,095
============= $============= ============= ==============
Total principal repayments of
indebtedness............................ $ - $ 54,871 $ - $ 54,871
============= ============= ============= ==============
7
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ----------------------------
2000 2001 2000 2001
------------- ------------- ------------- -----------
(IN THOUSANDS) (IN THOUSANDS)
On-net.................................... $ 58,408 $ 118,006 $ 120,298 $ 318,888
Resale.................................... 2,541 1,840 8,727 5,901
--------- ---------- --------- ----------
Total...................................... $ 60,949 $ 119,846 $ 129,025 $ 324,789
========= ========== ========= ==========
Contracts with Qwest Communications Corporation and Qwest
Communications International, Inc. accounted for approximately 30% and 58% of
the Company's total revenue during the nine months ended September 30, 2000 and
2001, respectively.
6. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
As of September 30, 2001, the Company has outstanding commitments
aggregating approximately $8.6 million related to purchases of
telecommunications equipment and fiber optic cable and its obligations under its
agreements with certain suppliers and service providers.
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
September 30, 2001, the aggregate redemption value of the redeemable equity was
approximately $217.1 million, reflecting per share redemption amounts of $100
for the Series A Preferred Stock, $100
8
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
for the Series C Preferred Stock, $338 for the Series G Preferred Stock and $11
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 (in thousands, except share and per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------------------
2000 2001 2000 2001
---------------------------------------------------------------------------
Numerator:
Net loss before extraordinary item and
cumulative effect of change in
accounting principle................. $ (86,659) $ (59,676) $ (270,605) $ (158,217)
Extraordinary item...................... - - - 109,400
Cumulative effect of change in
accounting principle................. - - (1,705) -
-------------------------------------------------------------------
Net loss................................ (86,659) (59,676) (272,310) (48,817)
(Dividends and accretion)/reversal of
accretion on redeemable preferred
stock................................ (13,229) 3,112 (72,210) 110,142
-------------------------------------------------------------------
Numerator for net income/(loss)
applicable to common shareholders..... $ (99,888) $ (56,564) $ (344,520) $ 61,325
===================================================================
Denominator:
Denominator for net loss per common
share-weighted average number of
common shares outstanding - basic..... 860,639 861,145 855,932 861,145
====================================================================
Net loss per common share before
extraordinary item and cumulative
effect of change in accounting
principle - basic........................ $ (116.06) $ (65.68) $ (400.52) $ (55.83)
Extraordinary item - basic.................. - - - 127.04
Cumulative effect of change in accounting
principle - basic........................ - - (1.99) -
--------------------------------------------------------------------------
Net income/(loss) per common share before
extraordinary item - basic............... $ (116.06) $ (65.68) $ (402.51) $ 71.21
==========================================================================
Options and warrants to purchase an aggregate of 666,730 and 860,622
shares of common stock were outstanding as of September 30, 2000 and 2001, but
computations of diluted net loss per common share for such periods have not been
presented, as the effect would be anti-dilutive.
8. SIGNIFICANT CONTRACTS
VOIP MGS CONTRACT
In March 2001, the Company entered into an agreement with a major
carrier customer pursuant to which the Company agreed to purchase, install and
maintain, throughout the United States, approximately $65.0 million of Voice
over Internet Protocol equipment (the "KMC Funding VIII Equipment"), principally
9
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
to handle Voice over Internet Protocol traffic on behalf of the carrier. The
services agreement commenced in the second half of 2001 and expires 48 months
later, and provides annualized revenues of approximately $28.7 million. The
Company has recognized the full monthly revenue commencing July 2001, in
accordance with the installation and acceptance provisions specified in the
service agreement. The Company financed the cost of the KMC Funding VIII
Equipment in August 2001 (see Note 9 - KMC Funding VIII
Financing).
PORT ACCESS CONTRACT
In June 2001, the Company entered into an agreement with a major
carrier customer pursuant to which the Company agreed to purchase, install and
maintain, throughout the United States, approximately $83.0 million of Internet
protocol routers, switches and other equipment; principally to handle high speed
Internet traffic on behalf of the carrier. The services agreement commenced in
the second half of 2001 and expires 63 months later, and provides annualized
revenues of approximately $42.4 million. The Company expects to finance the cost
of this equipment in 2001.
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 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 a portion of
the gross 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
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
KMC FUNDING VIII FINANCING
In August 2001, the Company entered into a financing transaction (the
"KMC Funding VIII Financing") that resulted in the Company receiving
unrestricted gross proceeds of $73.4 million from a secured loan. The KMC
Funding VIII Financing is secured by the future cash flows from the Company's
VOIP MGS contract that was entered into in March 2001. The KMC Funding VIII
Financing 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 $1.0 million after using the gross proceeds to finance its
acquisition of the KMC VIII Funding Equipment, as well as to pay any financing
fees and expenses related to the financing. The interest rate on the KMC Funding
VIII Financing is 6.19%.
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.
SERIES F PREFERRED STOCK
Effective February 4, 2001, all then outstanding 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 decreases in the estimated fair value of the Company's
common stock in the first three quarters of 2001 as compared to December 31,
2000, the Company reversed $63.4 million, $13.0 million and $4.4 million of
previously recognized stock compensation expense during the first, second and
third quarters of 2001, respectively. In addition, the decreases in the
estimated fair value of the Company's common stock also resulted in the reversal
of $67.6 million, $39.4 million and $3.1 million of previously recognized
accretion on redeemable equity instruments during the first, second and third
quarters of 2001, respectively. Neither of these non-cash items were directly
generated by the Company's operating activities. In view of the significant
decrease in the estimated fair value of the common stock, during the first
quarter of 2001, the Compensation Committee of the Company's Board of Directors
determined to reprice 77,931 options to purchase shares of its common stock
which had been previously granted under its 1998 Stock Purchase and Option Plan.
The exercise price of these options, which were originally granted with exercise
prices ranging from $250 to $300 per share, was reduced to $100 per share. This
repricing had no impact on the Company's 2001 results of operations.
11
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
11. RELATED PARTIES
Pursuant to an arrangement between the Company and KNT Network
Technologies, LLC ("KNT"), a company independently owned by Harold N. Kamine and
Nassau Capital, the principal stockholders of the Company, 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 nine months ended September 30, 2001
related to this arrangement amounted to $29.1 million, of which $14.7 million
was for network related construction and was capitalized into networks and
equipment, $8.1 million was expensed as general and administrative costs and
$6.3 million was expensed as direct maintenance costs.
The Company has reached an agreement with Mr. Kamine and Nassau Capital
as to terms upon which the Company would acquire all of the membership interests
in KNT from Mr. Kamine and Nassau Capital. In accordance with the provisions of
its Amended Senior Secured Credit Facility, the Company submitted the terms to
the Lenders under the Amended Senior Secured Credit Facility for their approval.
The submission was not accepted by the Lenders and the parties are discussing
this matter.
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
period from January 1, 2001 through September 30, 2001, the value of the swaps
decreased to a liability of $35.3 million, reflecting payments of $4.3 million
and decreases in fair value of $26.4 million (included as a component of 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 loss. 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 loss. The Company's comprehensive loss
for the three months and nine months ended September 30, 2001 is set forth in
the following table:
12
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
THREE MONTHS NINE MONTHS ENDED
ENDED SEPTEMBER 30, SEPTEMBER 30,
2001 2001
------------------- --------------------
Net loss................................................................ $ (59,676) $ (48,817)
Other comprehensive loss:
Change in fair value of the swaps.................................. (18,114) (26,407)
------------------- --------------------
Comprehensive loss...................................................... $ (77,790) $ (75,224)
=================== ====================
14. AMENDMENTS TO AMENDED SENIOR SECURED CREDIT FACILITY
APRIL 2001 AMENDMENT
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 60 days 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 $100.0 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
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.
13
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
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 also agreed to form a subsidiary holding company to own
all of the common stock of its operating subsidiaries which are engaged in its
Nationwide Data Platform business. KMC Holdings has pledged 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.
JULY 2001 AMENDMENT
In July 2001, the Company and the Lenders entered into an additional
amendment to the Amended Senior Secured Credit Facility, to clarify that any
Lender may issue a Letter of Credit with automatic extensions.
AUGUST WAIVER
The Company and the Lenders executed a waiver, effective as of August
30, 2001 (the "August Waiver"), which extended to September 28, 2001 the time by
which the Company was to submit a proposal, acceptable to the Lenders, to
resolve all outstanding issues relating to the arrangements between the Company
and KNT (see Note 11 Related Parties). In connection with this waiver, the
Company also agreed that it would not repurchase any additional debt securities
of the Company (see Note 15 Extraordinary Item - Note Repurchases) without the
prior written consent of the Lenders and that it would execute an additional
formal amendment to the Amended Senior Secured Credit Facility reflecting this
agreement, and addressing certain other matters, by September 21, 2001. The
Company and the Lenders have not yet executed the formal amendment called for by
the terms of the August Waiver. The parties are discussing this matter.
LENDER WARRANTS
In connection with the execution of the April 2001 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 (i) on or before October 31, 2001, the Company shall have failed to
prepay an aggregate of $50.0 million under the Amended Senior Secured Credit
Facility (which prepayment was not made by October 31, 2001) and (ii) on or
before January 31, 2002 the Company shall have failed to (A) prepay an
additional $50.0 million under the Amended Senior Secured Credit Facility and
(B) make additional cash capital contributions to the Borrowers in the aggregate
amount of $50.0 million, 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 aggregate cash capital contributions to the Borrowers in the
amount of $100.0 million by March 31, 2002 (including any amounts taken into
consideration pursuant to clause (ii)(B),
14
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
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.
15. EXTRAORDINARY ITEM - NOTE REPURCHASES
During the second quarter of 2001, the Company recognized a net gain of
$109.4 million on the repurchase of a portion of its senior discount notes. The
Company used $19.2 million of the cash proceeds from the two monetizations
completed in the first quarter of 2001 (see Note 9 Significant Financing
Transactions) to purchase approximately 39% of its senior discount notes (with
an aggregate carrying value of $135.1 million). The repurchased notes are held
by a subsidiary of the Company and have been pledged as additional collateral to
the Lenders under the Amended Senior Secured Credit Facility (the "Pledged
Notes"). The pledge does not constitute a reissuance of the Pledged Notes and
does not obligate the Company to make any of the scheduled payments of principal
or interest on the Pledged Notes. However, if there is a default under the
Amended Senior Secured Credit Facility and the Lenders have either (i)
accelerated the amounts due under the Amended Senior Secured Credit Facility or
(ii) exercised their rights under the pledge agreement, then any principal or
interest payments thereafter due under the Pledged Notes would be payable to the
Lenders in accordance with the terms of the Pledged Notes, to be applied against
the Company's obligations under the Amended Senior Secured Credit Facility. The
Company has agreed not to make further repurchases of its senior discount notes
or senior notes without receiving the prior written consent of the Lenders under
the Amended Senior Secured Credit Facility.
The Company is aware that its outstanding senior discount notes and
senior notes are continuing to trade at substantial discounts to their accreted
value and face amounts, respectively. In order to reduce future cash interest
payments, as well as future amounts due at maturity, the Company or its
affiliates intend, from time to time, consistent with its agreement with the
Lenders, to purchase such securities for cash, exchange them for common stock
under the exemption provided by Section 3(a)(9) of the Securities Act of 1933,
or acquire such securities for a combination of cash and common stock, in each
case in open market purchases or negotiated private transactions with
institutional holders. The Company will evaluate any such transactions in light
of then existing market conditions, taking into account its present liquidity
and prospects for future access to capital. The amounts involved in any such
transactions, individually or in the aggregate, may be material. There can be no
assurance that the Lenders will grant permission for any additional repurchases,
in whole or in part.
16. RECIPROCAL COMPENSATION SETTLEMENT
During the third quarter of 2001, the Company reached an agreement with
SBC Telecommunications, Inc.("SBC") with respect to the Company's complaint
regarding payment of past due reciprocal compensation. The companies agreed to a
cash settlement of the disputed reciprocal compensation balance owed by SBC for
usage on or before May 31, 2001. A related agreement resolved the Company's
entitlement, and the rates to be applied, to future reciprocal compensation from
SBC through May of 2004.
15
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
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 currently provide local Internet
access infrastructure, high speed Internet teering services supporting Gigabit
Ethernet Internet services and other enhanced data services. Currently, we
16
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
have contracts representing approximately $300 million in annualized revenues.
The Internet infrastructure we are deploying includes 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 69% of our revenues for the nine months ended September 30, 1999
to approximately 98% of our revenues for the nine months ended September 30,
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 63 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 second half
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.
In March 2001, we entered into an agreement pursuant to which we agreed
to purchase, install and maintain, throughout the United States, approximately
$65.0 million of Voice over Internet Protocol equipment, principally to handle
Voice over Internet Protocol traffic on behalf of a major carrier customer. The
related services agreement commenced in the second half of 2001 and expires 48
months later. We have recognized the full monthly revenue commencing July 2001,
in accordance with the installation and acceptance provisions specified in the
service agreement. We financed the cost of this
17
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
KMC Funding VIII Equipment in August of 2001. See "--Liquidity and Capital
Resources" below for a detailed description of these transactions.
In June 2001, we entered into an agreement pursuant to which we agreed
to purchase, install and maintain, throughout the United States, approximately
$83.0 million of Internet protocol routers, switches and other equipment,
principally to handle high speed Internet traffic on behalf of a major carrier
customer. The services agreement commences in the second half of 2001 and
expires 63 months later. We expect to finance the cost of this equipment in
2001.
The table below provides selected key operational and financial data on
a consolidated basis as of the following dates:
Quarter Ended
----------------------------------------------------------------------------------
September 30, December 31, March 31, June 30, September 30,
2000 2000 2001 2001 2001
------------- ------------ ---------- ---------- -------
Tier III operational markets..... 35 37 37 37 37
Route miles...................... 2,178 2,285 2,325 2,336 2,429
Fiber miles...................... 134,952 140,988 143,508 143,935 150,830
Collocations..................... 125 134 140 140 140
Customers........................ 9,990 11,602 13,064 14,414 15,301
Total buildings connected........ 9,085 9,745 11,343 12,934 14,284
Total lines in service........... 1,865,390 2,284,375 2,857,304 3,127,659 3,628,097
On-network revenues(a)(b)........ 96% 97% 98% 98% 98%
Resale revenues(a)(c)............ 4% 3% 2% 2% 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 $14.3 million, or 11% of our total revenue for the nine months
ended September 30, 2000 and approximately $13.1 million or 4% of our total
revenue for the nine months ended September 30, 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 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.
18
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
During the third quarter of 2001, we reached an agreement with SBC
Telecommunications, Inc., with respect to our complaint regarding payment of
past due reciprocal compensation. We agreed to a cash settlement of the disputed
reciprocal compensation balance owed to us by SBC for usage on or before May 31,
2001. A related agreement resolved our entitlement, and the rates to be applied,
to future reciprocal compensation from SBC through May of 2004.
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. However,
we cannot assure you that we will reach new agreements with these carriers on
favorable terms.
As of September 30, 2001, we have 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 for incumbent local exchange carriers that opt into the
Federal Communications Commission's plan. 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. Numerous competitive local exchange carriers, including us,
petitioned for review of the Federal Communications Commission's decision. We
are unable to predict the outcome of this review proceeding. If the Federal
Communications Commission's order is upheld 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, and
general and administrative expenses. 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.
19
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
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.
EXTRAORDINARY ITEM - NOTE REPURCHASES. During the second quarter of
2001, we recognized a net gain of $109.4 million on the repurchase of a portion
of our senior discount notes. We used $19.2 million of the cash proceeds from
the two monetizations completed in the first quarter of 2001(see Note 9,
"Significant Financing Transactions," of the Notes to Unaudited Condensed
Consolidated Financial Statements included in Item 1 of this Report on Form
10-Q) to purchase approximately 39% of our senior discount notes (with an
aggregate carrying value of $135.1 million). The repurchased notes are held by
one of our subsidiaries and have been pledged as additional collateral to the
lenders under our amended senior secured credit facility. The pledge does not
constitute a reissuance of the pledged notes and does not obligate us to make
any of the scheduled payments of principal or interest on the pledged notes.
However, if there is a default under the amended senior secured credit facility
and the lenders have either (i) accelerated the amounts due under the amended
senior secured credit facility or (ii) exercised their rights under the pledge
agreement, then any principal or interest payments thereafter due under the
pledged notes would be payable to the lenders in accordance with the terms of
the pledged notes, to be applied against our obligations under the
amended senior secured credit facility. We agreed not to make further
repurchases of our senior discount notes or senior notes without receiving the
prior written consent of the lenders under our amended senior secured credit
facility.
We are aware that our outstanding senior discount notes and our senior
notes are continuing to trade at substantial discounts to their accreted value
and face amounts, respectively. In order to reduce future cash interest
payments, as well as future amounts due at maturity, we or our affiliates
intend, from time to time, consistent with our agreement with the lenders under
our amended senior secured credit facility, to purchase such securities for
cash, exchange them for common stock under the exemption provided by Section
3(a)(9) of the Securities Act of 1933, or acquire such securities for a
combination of cash and common stock, in each case in open market purchases or
negotiated private transactions with institutional holders. We will evaluate any
such transactions in light of then existing market conditions, taking into
account our present liquidity and prospects for future access to capital. The
amounts involved in any such transactions, individually or in the aggregate, may
be material. There can be no assurance that the lenders will grant permission
for any additional repurchases, in whole or in part.
RESULTS OF OPERATIONS
As a result of the development and rapid growth of our business during
the periods presented, the period-to-period comparisons of our results of
operations are not necessarily meaningful and should not be relied upon as an
indication of future performance.
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 2000
REVENUE. Revenue increased 97% from $60.9 million for the three months
ended September 30, 2000 (the "2000 Third Quarter") to $119.8 million for the
three months ended September 30, 2001 (the "2001 Third Quarter"). This increase
is principally attributable to the fact that our data services business
generated substantially greater revenues in the 2001 Third Quarter than in the
2000 Third Quarter, as well as, to a lesser extent, increased sales in our Tier
III Markets business in the 2001 Third Quarter compared to the 2000 Third
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")
20
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
represented 98% of total revenue in the 2001 Third Quarter, compared to 96% of
total revenue in the 2000 Third Quarter; while revenue derived from the resale
of switched services ("Resale revenue") represented 2% and 4% 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 $4.8 million, or 4% of our total revenues,
during the 2001 Third Quarter as compared to $4.0 million, or 7% of our total
revenues, during the 2000 Third Quarter.
NETWORK OPERATING COSTS. Network operating costs, excluding non-cash
stock compensation expense, increased 19% from $46.9 million for the 2000 Third
Quarter to $56.0 million for the 2001 Third Quarter. This increase of
approximately $9.1 million is primarily attributable to the fact that our data
services business generated substantial direct costs in the 2001 Third Quarter,
but had only generated limited direct costs in the 2000 Third Quarter as that
business was in its early stages, as well as, to a lesser extent, increased
direct costs in the Tier III Markets business as a result of increased sales in
this segment for the 2001 Third Quarter compared to the 2000 Third Quarter. The
detailed components of the network operating costs increase are $8.8 million in
direct costs associated with providing on-network services, resale services and
leasing unbundled network element services, $1.6 million in telecommunications
costs, $1.0 million in network support services and $800,000 in personnel costs;
all of which were partially offset by a $3.1 million decrease in consulting and
professional services costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, excluding non-cash stock compensation expense,
decreased 4% from $41.1 million for the 2000 Third Quarter to $39.6 million in
the 2001 Third Quarter. This decrease of approximately $1.5 million consists of
decreases of: $3.8 million in personnel related costs, $1.7 million in
consulting and professional services, $800,000 in travel and entertainment
expenses and $400,000 in telecommunications expenses; all of which were
partially offset by increases of $5.2 million in other general and
administrative costs.
STOCK COMPENSATION. Stock compensation, a non-cash item, decreased from
an aggregate charge of $6.9 million in the 2000 Third Quarter to an aggregate
credit of $4.3 million for the 2001 Third Quarter. This decrease is due to a
significant decrease in the estimated fair value of the Company's common stock
in the 2001 Third Quarter compared to an increase in the fair value of such
stock in the 2000 Third Quarter.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased 93% from $20.4 million for the 2000 Third Quarter to $39.3 million for
the 2001 Third Quarter. This increase is due primarily to depreciation expense
associated with the startup of our Nationwide Data Platform business during the
third quarter of 2000 and the expansion of the networks for our Tier III Markets
business.
INTEREST INCOME. Interest income decreased from $3.8 million in the
2000 Third Quarter to $1.9 million in the 2001 Third Quarter. This decrease is
due primarily to smaller average cash, cash equivalents and restricted cash
balances during the 2001 Third Quarter as compared to the 2000 Third Quarter, as
well as the lower interest rates that prevailed in the 2001 Third Quarter.
INTEREST EXPENSE. Interest expense increased from $36.1 million in the
2000 Third Quarter to $50.8 million in the 2001 Third Quarter. Of this increase,
$9.8 million is due to the financing of our Internet infrastructure equipment
and $4.4 million is attributable to unfavorable positions in our interest rate
swap agreements. These increases were partially offset by a reduction in
interest expense of $2.1 million on our senior discount notes as a result of the
repurchase of a portion of those notes, as well as a $900,000 reduction in
interest expense resulting from the termination of a term loan to our subsidiary
KMC Telecom IV, Inc. in late 2000 and a $700,000 reduction in interest expense
in our amended senior
21
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
secured credit facility. In addition, we capitalized interest of $4.2 million
related to network construction projects during the 2000 Third Quarter versus no
capitalized interest during the 2001 Third Quarter.
NET LOSS BEFORE EXTRAORDINARY ITEM AND CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE. For the reasons stated above, net loss before
extraordinary item and cumulative effect of change in accounting principle
decreased from $86.7 million for the 2000 Third Quarter to $59.7 million for the
2001 Third Quarter.
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 2000
REVENUE. Revenue increased 152% from $129.0 million for the nine months
ended September 30, 2000 (the "2000 Nine Months") to $324.8 million for the nine
months ended September 30, 2001 (the "2001 Nine Months"). This increase is
principally attributable to the fact that our data services business generated
substantial revenues in the 2001 Nine Months, but generated limited revenues in
the 2000 Nine Months, as well as, to a lesser extent, increased sales in our
Tier III Markets business in the 2001 Nine Months compared to the 2000 Nine
Months.
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 Nine Months, compared to 93% of total revenue in
the 2000 Nine Months; while revenue derived from the resale of switched services
("Resale revenue") represented 2% and 7% 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 $13.1 million, or 4% of our total revenues during the 2001 Nine
Months as compared to $14.3 million, or 11% of our total revenues during the
2000 Nine Months.
NETWORK OPERATING COSTS. Network operating costs, excluding non-cash
stock compensation expense, increased 60% from $112.2 million for the 2000 Nine
Months to $179.4 million for the 2001 Nine Months. This increase of
approximately $67.2 million is attributable to the fact that our data services
business generated significant direct costs in the 2001 Nine Months, but
generated limited direct costs in the 2000 Nine Months, as well as increased
direct costs in the Tier III Markets business as a result of increased sales in
this segment for the 2001 Nine Months compared to the 2000 Nine Months. The
detailed components of the network operating costs increase are $51.2 million in
direct costs associated with providing on-network services, resale services,
leasing unbundled network element services and operating lease payments, $8.0
million in network support services, $4.7 million in personnel costs, $1.7
million in telecommunications costs and $3.1 million in other direct operating
costs; all of which were partially offset by a $1.0 million decrease in
consulting fees and a $500,000 decrease in travel and entertainment expenses.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses, excluding non-cash stock compensation expense,
increased 9% from $120.1 million for the 2000 Nine Months to $131.3 million in
the 2001 Nine Months. This increase of approximately $11.2 million consists of
increases of: $3.7 million in consulting and professional services costs, $1.0
million in facility costs and $12.4 million in other costs (which included
funding for KNT); all of which were
partially offset by reductions of $4.0 million in personnel costs, $1.2 million
in travel and entertainment expenses and $700,000 in telecommunications costs.
STOCK COMPENSATION. Stock compensation, a non-cash item, decreased from
an aggregate charge of $29.6 million in the 2000 Nine Months to an aggregate
credit of $80.8 million for the 2001 Nine
22
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
Months. This decrease is due to a significant decrease in the estimated fair
value of the Company's common stock in the 2001 Nine Months compared to an
increase in the fair value of such stock in the 2000 Nine Months.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased 134% from $51.5 million for the 2000 Nine Months to $120.6 million for
the 2001 Nine Months. This increase is due primarily to depreciation expense
associated with the startup of our Nationwide Data Platform business during the
third quarter of 2000 and the expansion of the networks for our Tier III Markets
business.
INTEREST INCOME. Interest income decreased from $8.3 million in the
2000 Nine Months to $7.9 million in the 2001 Nine Months. This decrease is due
primarily to smaller average cash, cash equivalents and restricted cash balances
during the 2001 Nine Months as compared to the 2000 Nine Months, as well as the
lower interest rates that prevailed in the 2001 Nine Months.
INTEREST EXPENSE. Interest expense increased from $94.5 million in the
2000 Nine Months to $140.5 million in the 2001 Nine Months. Of this increase,
$23.9 million is due to the financing of our Internet infrastructure equipment,
$10.4 million is attributable to higher borrowings under our amended senior
secured credit facility, $5.8 million is due to unfavorable positions in our
interest rate swap agreements; all of which were partially offset by a $2.0
million decrease in interest expense on our senior discount notes as a result of
the repurchase of a portion of these notes as well as a $900,000 reduction in
interest expense due to the termination of a term loan to our subsidiary KMC
Telecom IV, Inc. in late 2000. In addition, we capitalized interest of $10.1
million related to network construction projects during the 2000 Nine Months
versus $1.3 million during the 2001 Nine Months.
NET LOSS BEFORE EXTRAORDINARY ITEM AND CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE. For the reasons stated above, net loss before
extraordinary item and cumulative effect of change in accounting principle
decreased from $270.6 million for the 2000 Nine Months to $158.2 million for the
2001 Nine Months.
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 service our debt, expand 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 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.
23
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
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 a
portion of the gross 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
a major carrier customer (see Note 8, "Significant Contracts - VOIP MGS
CONTRACT," of the Notes to Unaudited Condensed Consolidated Financial Statements
included in Item 1 of this Report on Form 10-Q). In August 2001, we entered into
a financing transaction (see Note 9, "Significant Financing Transactions-KMC
FUNDING VIII FINANCING," 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 $73.4 million from a
secured loan. The KMC Funding VIII Financing is secured by the future cash flows
from our VOIP MGS contract that was entered into in March 2001. The KMC Funding
VIII Financing 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
$1.0 million after using the gross proceeds to finance our acquisition of the
KMC Funding VIII Equipment, as well as to pay any financing fees and expenses
related to the 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 $100.0 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, "Amendments to Amended Senior Secured
Credit Facility," of the Notes to
24
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
Unaudited Condensed Consolidated Financial Statements included in Item 1 of this
Report on Form 10-Q.
In June 2001, we purchased approximately $83.0 million of high speed
Internet protocol routers, switches and other equipment in association with
entering into an agreement with a major carrier customer (see Note 8,
"Significant Contracts - PORT ACCESS CONTRACT," of the Notes to Unaudited
Condensed Consolidated Financial Statements included in Item 1 of this Report on
Form 10-Q). We expect to finance the cost of this equipment in 2001, however, we
can give no assurances that we will be able to obtain such financing.
As of November 7, 2001, we had $654.9 million and $557.3 million of
indebtedness outstanding under the amended senior secured credit facility and
the combined KMC Funding V Monetization , KMC Funding Monetization and the KMC
Funding VIII Financing, respectively. The undrawn portion of our $700.0 million
amended senior secured credit facility at the end of the third quarter was $45.0
million. However, $10.0 million is reserved for letter of credit obligations and
$30.0 million is limited to funding purchases from a specific equipment
supplier, leaving $5.0 million to be borrowed without restrictions. The KMC
Funding V Monetization , KMC Funding Monetization and KMC Funding VIII Financing
were all fully drawn at that date.
Net cash provided by financing activities from borrowings was $469.8
million and our net cash used in operating and investing activities was $456.6
million for the 2001 Nine Months.
We made capital expenditures of $254.5 million in the 2000 Nine Months
versus $338.7 million in the 2001 Nine Months. Of the total capital expenditures
for the 2001 Nine Months, $33.9 million was related to the Tier III Markets
business segment and $304.8 million was for the Nationwide Data Platform
business segment. As of October 31, 2001, we had outstanding purchase
commitments aggregating approximately $9.1 million related to the purchase of
fiber optic cable and telecommunications equipment under our agreements with
certain suppliers and service providers. We currently anticipate capital
expenditures for 2001 to be approximately $60.0 million for the Tier III Markets
business. 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 first quarter of 2003. This date is predicated on the
continued ramp-up in our Tier III Markets and Nationwide Data Platform
businesses, our ability to finance our capital expenditure requirements for the
Nationwide Data Platform business, reduced capital expenditures for our Tier III
Markets business, prudent cost controls and continued gross margin improvements.
In addition, under the terms of our amended senior secured credit facility, by
May 1, 2002, we are required to effect loan prepayments and reductions in the
revolving loan commitment thereunder in the aggregate amount of $100.0 million,
which is not reflected in the first quarter 2003 liquidity position described
above. We may need to arrange additional financing to fund these prepayments. We
can give no assurance that this additional financing will be available to us, or
if available, that it can be obtained on a timely basis and on acceptable terms.
25
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
In addition, 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.
During the second quarter of 2001, we recognized a net gain of $109.4
million on the repurchase of a portion of our senior discount notes. We used
$19.2 million of the cash proceeds from the two monetizations completed in the
first quarter of 2001 (see Note 9, "Significant Financing Transactions," of the
Notes to Unaudited Condensed Consolidated Financial Statements included in Item
1 of this Report on Form 10-Q) to purchase approximately 39% of our senior
discount notes (with an aggregate carrying value of $135.1 million). The
repurchased notes are held by one of our subsidiaries and have been pledged as
additional collateral to the lenders under our amended senior secured credit
facility. The pledge does not constitute a reissuance of the pledged notes and
does not obligate the Company to make any of the scheduled payments of principal
or interest on the pledged notes. However, if there is a default under the
amended senior secured credit facility and the lenders have either (i)
accelerated the amounts due under the amended senior secured credit facility or
(ii) exercised their rights under the pledge agreement, then any principal or
interest payments thereafter due under the pledged notes would be payable to
the lenders in accordance with the terms of the pledged notes, to be applied
against our obligations under the amended senior secured credit facility. We
have agreed not to make further repurchases of our senior discount notes or
senior notes without the prior written consent of the lenders under our amended
senior secured credit facility.
We are aware that our outstanding senior discount notes and our senior
notes are continuing to trade at substantial discounts to their accreted value
and face amounts, respectively. In order to reduce future cash interest
payments, as well as future amounts due at maturity, we or our affiliates
intend, from time to time, consistent with our agreement with the lenders, to
purchase such securities for cash, exchange them for common stock under the
exemption provided by Section 3(a)(9) of the Securities Act of 1933, or acquire
such securities for a combination of cash and common stock, in each case in open
market purchases or negotiated private transactions with institutional holders.
We will evaluate any such transactions in light of then existing market
conditions, taking into account our present liquidity and prospects for future
access to capital. The amounts involved in any such transactions, individually
or in the aggregate, may be material. There can be no assurance that the lenders
will grant permission for any additional repurchases, in whole or in part.
26
PART I - (CONT'D)
KMC TELECOM HOLDINGS, INC.
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
September
30, 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...... $ 8.5 $ - $ - $ - $ - $ - $ 232.2 $ 232.2
Senior Notes, interest
payable at 13 1/2%, maturing
2009....................... 43.1 - - - - - 275.0 275.0
KMC Funding Monetization,
interest payable at 7.34%,
maturing 2005.............. 298.0 16.5 69.4 74.7 80.4 57.0 - 298.0
KMC Funding V Monetization,
interest payable at 6.77%,
maturing 2004.............. 197.5 14.2 59.7 65.0 58.6 - - 197.5
KMC Funding VIII Financing,
interest payable at 6.19%,
maturing 2005.............. 73.4 4.3 17.8 18.9 20.1 12.3 - 73.4
Variable Rate:
Amended Senior Secured Credit
Facility, interest variable
(9.42% at September 30,
2001)(a) .................. 654.9 - 100.0 80.6 129.0 161.2 184.1 654.9
-------- -------- -------- -------- -------- ------- ----------- -----
Interest Rate swaps:
Variable rate for fixed rate 35.4 - - - - - - -
Total.................... $ 1,310.8 $ 35.0 $ 246.9 $ 239.2 $288.1 $230.5 $691.3 $1,731.0
=======================================================================================
(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.
27
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) In the third quarter, the Company granted options to purchase
33,574 shares of common stock, respectively, to certain of its 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 $100
per share. In each instance, 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.
(d) Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
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. 5 and Limited Waiver, dated as of July 16, 2001,
to Amended and Restated Loan and Security Agreement, dated as of
February 15, 2000, among KMC Telecom Inc., KMC Telecom II, Inc.,
KMC Telecom III, Inc., KMC Telecom of Virginia, Inc., KMC
Telecom Leasing I LLC, KMC Telecom Leasing II LLC, KMC Telecom
Leasing III LLC, KMC Telecom.com, Inc., KMC III Services LLC,
the "Lenders" party thereto, and First Union National Bank, as
administrative agent for the Lenders.
(b) Reports on Form 8-K
Not Applicable.
28
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: November 9, 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
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
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EXHIBIT INDEX
NO. DESCRIPTION
10.1 Amendment No. 5 and Limited Waiver, dated as of July 16, 2001,
to Amended and Restated Loan and Security Agreement, dated as
of February 15, 2000, among KMC Telecom Inc., KMC Telecom II,
Inc., KMC Telecom III, Inc., KMC Telecom of Virginia, Inc.,
KMC Telecom Leasing I LLC, KMC Telecom Leasing II LLC, KMC
Telecom Leasing III LLC, KMC Telecom.com, Inc., KMC III
Services LLC, the "Lenders" party thereto, and First Union
National Bank, as administrative agent for the Lenders.
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