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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, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from --------------- to ---------------
COMMISSION FILE NUMBER: 333-50475
KMC TELECOM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-3545325
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1545 ROUTE 206, SUITE 300
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 $0.01 837,876 shares,
per share. as of November 10, 1998
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KMC TELECOM HOLDINGS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
- ----------------------------------- --------
ITEM 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets,
December 31, 1997 and September 30, 1998 ........................ 2
Unaudited Condensed Consolidated Statements of
Operations, Three Months Ended September 30, 1997 and
1998 and Nine Months Ended September 30, 1997 and 1998 .......... 3
Unaudited Condensed Consolidated Statements of Cash
Flows, Nine Months Ended September 30, 1997 and 1998 ............ 4
Notes to Unaudited Condensed Consolidated Financial
Statements ...................................................... 5
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................. 9
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk....... 12
PART II. OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings................................................ 13
ITEM 2. Changes in Securities and Use of Proceeds........................ 13
ITEM 3. Defaults Upon Senior Securities.................................. 13
ITEM 4. Submission of Matters to a Vote of Security Holders.............. 13
ITEM 5. Other Information................................................ 14
ITEM 6. Exhibits and Reports on Form 8-K................................. 14
SIGNATURES.................................................................. 15
PART I - FINANCIAL INFORMATION
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
1997 1998
--------------- ------------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 15,553 $ 32,290
Accounts receivable, net of allowance for doubtful accounts.................. 1,318 5,259
Prepaid expenses and other current assets.................................... 489 843
--------------- ------------------
Total current assets............................................................ 17,360 38,392
Investments held for future capital expenditures................................ - 90,000
Networks and equipment, net..................................................... 71,371 157,456
Intangible assets, net.......................................................... 2,655 3,410
Deferred financing costs, net................................................... 4,196 14,833
Other assets.................................................................... 361 4,000
--------------- ------------------
$ 95,943 $ 308,091
=============== ==================
LIABILITIES AND REDEEMABLE AND NONREDEEMABLE EQUITY
Current liabilities:
Accounts payable............................................................. $ 5,513 $ 2,860
Accrued expenses............................................................. 8,128 10,868
Due to affiliates............................................................ 47 -
--------------- ------------------
Total current liabilities....................................................... 13,688 13,728
Notes payable................................................................... 51,277 40,476
Subordinated notes payable...................................................... 10,000 -
Senior discount notes payable................................................... - 260,667
--------------- ------------------
Total liabilities............................................................... 74,965 314,871
Redeemable equity:
Redeemable cumulative convertible preferred stock, par value $.01 per share
498,800 shares authorized; shares issued and outstanding:
Series A, 123,800 shares in 1997 and 1998................................. 18,879 27,928
Series C, 150,000 shares in 1997 and 175,000 shares in 1998............... 14,667 20,540
Series D, 25,000 shares in 1997 and 0 shares in 1998...................... 2,379 -
Redeemable common stock, shares issued and outstanding: 132,773 in 1997 and
224,041 in 1998........................................................... 11,187 21,954
Redeemable common stock warrants............................................. 539 642
--------------- ------------------
Total redeemable equity......................................................... 47,651 71,064
--------------- ------------------
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 3,000,000 shares authorized,
613,835 shares issued and outstanding..................................... 6 6
Additional paid-in capital................................................... 15,374 17,696
Unearned compensation........................................................ (6,521) (6,311)
Accumulated deficit.......................................................... (35,532) (89,235)
--------------- ------------------
Total nonredeemable equity (deficiency)......................................... (26,673) (77,844)
--------------- ------------------
$ 95,943 $ 308,091
=============== ==================
See accompanying notes.
2
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ---------------------------------
1997 1998 1997 1998
---------------- ---------------- ---------------- ---------------
Revenue.............................................. $ 1,045 $ 6,250 $ 1,558 $ 13,588
Operating expenses:
Network operating costs........................... 2,501 10,658 3,564 24,577
Selling, general and administrative............... 2,041 6,081 5,606 15,301
Stock option compensation expense................. 508 398 640 6,594
Depreciation and amortization..................... 1,361 3,142 1,647 5,198
---------------- ---------------- ---------------- ---------------
Total operating expenses....................... 6,411 20,279 11,457 51,670
---------------- ---------------- ---------------- ---------------
Loss from operations................................. (5,366) (14,029) (9,899) (38,082)
Interest expense, net................................ 449 6,077 926 15,621
---------------- ---------------- ---------------- ---------------
Net loss............................................. $ (5,815) $ 20,106) $ (10,825) $ (53,703)
Dividends and accretion on redeemable preferred stock (947) (4,117) (2,581) (14,157)
---------------- ---------------- ---------------- ---------------
Net loss applicable to common shareholders........... $ (6,762) $ (24,223) $ (13,406) $ (67,860)
================ ================ ================ ===============
Net loss per common share............................ $ (11.01) $ (28.91) $ (22.16) $ (81.94)
================ ================ ================ ===============
Weighted average number of common shares outstanding. 614,342 837,876 604,833 828,181
================ ================ ================ ===============
See accompanying notes.
3
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1997 1998
--------------- ----------------
OPERATING ACTIVITIES
Net loss........................................................................ $ (10,825) $ (53,703)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................ 1,647 5,198
Non-cash interest expense.................................................... 50 22,774
Non-cash stock option compensation expense................................... 640 6,593
Changes in assets and liabilities:
Accounts receivable....................................................... (472) (3,941)
Prepaid expenses and other current assets................................. (249) (354)
Other assets.............................................................. (15) (584)
Accounts payable.......................................................... (2,564) (2,653)
Accrued expenses.......................................................... 2,959 3,571
Due to affiliates......................................................... (59) (47)
--------------- ----------------
Net cash used in operating activities........................................... (8,888) (23,146)
--------------- ----------------
INVESTING ACTIVITIES
Construction of networks and purchases of equipment............................. (22,363) (90,938)
Acquisitions of franchises, authorizations and related assets................... (2,312) (1,100)
Deposit on purchase of equipment................................................ (5,000) (3,055)
Purchases of investments, net................................................... - (90,000)
--------------- ----------------
Net cash used in investing activities........................................... (29,675) (185,093)
--------------- ----------------
FINANCING ACTIVITIES
Proceeds from notes payable..................................................... 40,848 -
Repayment of notes payable...................................................... - (20,801)
Proceeds from issuance of common stock.......................................... 9,301 10,000
Proceeds from issuance of senior discount notes and warrants, net of issuance
costs of $13.6 million....................................................... - 236,369
Dividends on preferred stock of subsidiary...................................... - (592)
--------------- ----------------
Net cash provided by financing activities....................................... 50,149 224,976
--------------- ----------------
Net increase in cash and cash equivalents....................................... 11,586 16,737
Cash and cash equivalents, beginning of period.................................. 1,487 15,553
--------------- ----------------
Cash and cash equivalents, end of period........................................ $ 13,073 $ 32,290
=============== ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net of amounts capitalized........... $ 435 $ 3,274
=============== ================
See accompanying notes.
4
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION AND ORGANIZATION
KMC Telecom Holdings, Inc. ("KMC Holdings") and its subsidiaries, KMC
Telecom Inc. ("KMC Telecom"), KMC Telecom II, Inc. ("KMC Telecom II") and KMC
Telecom of Virginia, Inc. are collectively referred to herein as the Company.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
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. and Predecessors as
of and for the year ended December 31, 1997.
The unaudited interim financial statements reflect all 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, 1997
was derived from the audited consolidated balance sheet at that date.
2. INVESTMENTS HELD FOR FUTURE CAPITAL EXPENDITURES
The Company has designated a portion of the proceeds from the Senior
Discount Notes offering (See Note 6) as investments held for future capital
expenditures. As of September 30, 1998, the Company's investments held for
future capital expenditures consisted of cash equivalents (bank term deposits
and commercial paper with maturities of less than 90 days) of $44.7 million and
debt securities (US government obligations and commercial bonds due within 1
year) of $45.3 million. All debt securities have been designated by the Company
as held-to-maturity. Accordingly, such securities are recorded in the
accompanying September 30, 1998 financial statements at amortized cost. At
September 30, 1998, the carrying value of such held-to-maturity debt securities
approximated their fair value.
3. NETWORKS AND EQUIPMENT
Networks and equipment are comprised of the following (in thousands):
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
Fiber optic systems........................... $ 20,484 $ 40,009
Telecommunications equipment.................. 27,406 53,001
Furniture and fixtures and other.............. 1,518 6,492
Leasehold improvements........................ 792 1,011
Construction-in-progress...................... 23,555 64,180
------------ -------------
73,755 164,693
Less accumulated depreciation................. (2,384) (7,237)
------------ -------------
$ 71,371 $ 157,456
============ =============
Costs capitalized during the development of the Company's networks
include amounts incurred related to network engineering, design and construction
and capitalized interest. Capitalized interest related to the construction of
the networks for the three months ended September 30, 1997 and 1998 amounted to
approximately $103,000 and $1.5 million respectively, and for the nine months
ended September 30, 1997 and 1998 amounted to $251,000 and $2.9 million
respectively. For the three months and nine months ended September 30, 1998,
interest expense is net of interest income of $2.4 million and $7.4 million,
respectively.
5
4. INTANGIBLE ASSETS
Intangible assets are comprised of the following (in thousands):
DECEMBER 31, SEPTEMBER 30,
1997 1998
---------------- -----------------
Franchise costs........................... $ 1,342 $ 1,673
Authorizations and rights-of-ways......... 1,151 1,468
Building access agreements and other...... 567 1,019
---------------- -----------------
3,060 4,160
Less accumulated amortization............. (405) (750)
---------------- -----------------
$ 2,655 $ 3,410
================ =================
5. OTHER ASSETS
At September 30, 1998, other assets include non-refundable deposits for
the purchase of switching equipment aggregating $3,055,000.
6. SENIOR DISCOUNT NOTES
On January 29, 1998, KMC Holdings sold 460,800 units, each unit
consisting of a 12 1/2% senior discount note with a principal amount at maturity
of $1,000 due 2008 (the "Senior Discount Notes") and one warrant to purchase
.21785 shares of Common Stock of KMC Holdings at an exercise price of $.01 per
share. Interest on the Senior Discount Notes will be payable in cash on each
February 15 and August 15, commencing August 15, 2003. The Senior Discount Notes
are unsubordinated, unsecured indebtedness of KMC Holdings. However, KMC
Holdings is a holding company and the Senior Discount Notes will be effectively
subordinated to all existing and future liabilities (including trade payables)
of the Company's subsidiaries. The gross and net proceeds of the offering were
approximately $250.0 million and $236.4 million, respectively. Upon the closing
of the offering, the Company used the proceeds as follows: $10.8 million to
repay all amounts borrowed by the Company's subsidiary, KMC Telecom II, under an
Amended and Restated Loan and Security Agreement with AT&T Commercial Finance
Corporation ("AT&T Finance"); $10.1 million to repay all amounts borrowed by the
Company's subsidiaries, KMC Telecom and KMC Telecom II, under a subordinated
term loan from AT&T Finance (including $100,000 of accrued interest thereon);
$5.0 million as a non-refundable down payment for future purchases of switching
equipment; and $592,000 to pay dividend arrearages on the Series A Cumulative
Convertible Preferred Stock of KMC Telecom. The balance will be used to finance
the planned expansion and further development of the Company's networks and to
fund operating losses and for other general corporate purposes. As of September
30, 1998, $90 million of the proceeds have been classified as non-current
assets, as such amounts have been designated for future capital expenditures.
The Senior Discount Notes contain covenants that, among other things,
restrict the ability of KMC Holdings and its subsidiaries to incur additional
indebtedness, create liens, engage in sale-leaseback transactions, pay dividends
or make distributions in respect of their capital stock, make investments or
certain other restricted payments, sell assets, redeem capital stock, issue or
sell stock of subsidiaries, enter into transactions with stockholders or
affiliates or, with respect to KMC Holdings, effect a consolidation or merger.
However, these limitations are subject to a number of qualifications and
exceptions.
The Senior Discount Notes are "applicable high yield discount
obligations" ("AHYDOs"), as defined in the Internal Revenue Code of 1986, as
amended, because the yield to maturity of such Senior Discount Notes exceeded
the "applicable federal rate" in effect at the time of their issuance (the
"AFR") plus five percentage points. Under the rules applicable to AHYDOs, a
portion of the original issue discount ("OID") that accrues on the Senior
Discount Notes will not be deductible by the Company at any time. The
non-deductible portion of the OID will be an amount that bears the same ratio to
such OID as (i) the excess of the yield to maturity of the Senior Discount Notes
over the AFR plus six percentage points bears to (ii) the yield to maturity of
the Senior Discount Notes. To the extent that the non-deductible portion of OID
would have been treated as a dividend if it had been distributed with respect to
the Company's stock, it generally will be treated as a dividend to holders of
the Senior Discount Notes for purposes of the rules relating to the dividends
received deduction applicable to corporate holders. Any remaining OID on the
Senior Discount Notes will not be deductible by the Company until such OID is
paid.
6
The warrants may be exercised at any time during the period beginning
on the date that is one year after the closing date of the Senior Discount Note
offering and ending on January 31, 2008. Warrants that are not exercised by such
date will expire. The warrants were recorded at their aggregate fair value of
$11 million.
KMC Telecom's $70.0 million senior line of credit with AT&T Finance
(the "AT&T Facility") restricts the ability of KMC Telecom to pay dividends to,
or to pay principal or interest on loans from, KMC Holdings. Such restrictions
could adversely affect the Company's liquidity and ability to meet its cash
requirements, including its ability to repay the Senior Discount Notes.
7. COMMITMENTS AND CONTINGENCIES
LITIGATION
By letter dated August 29, 1997, KMC Telecom notified I-Net, Inc.
("I-NET") that KMC Telecom considered I-NET to be in default under a Master
Telecommunications System Rollout Agreement dated as of October 1, 1996 (the
"I-NET Agreement"), pursuant to which I-NET had agreed to manage construction of
telephone systems for KMC Telecom in several cities, including the preparation
of design plans and specifications for each system. KMC Telecom considered I-NET
to be in default as a result of I-NET's failure to provide design plans and
specifications for several systems for which it had agreed to provide such plans
and specifications, to properly supervise construction of the systems or to
provide personnel with the necessary expertise to manage the projects. By letter
dated October 27, 1997, I-NET demanded payment of all amounts it alleged were
due under the I-NET Agreement and a related agreement (aggregating $4.1 million)
and stated that it would invoke the arbitration provisions under the I-NET
Agreement if the parties could not agree as to the amount due and payment terms
on or before November 27, 1997. By letter dated December 1, 1997, I-NET extended
its deadline for reaching agreement to December 15, 1997. Although the Company
and I-NET conducted discussions they were unable to reach an agreement and on
February 12, 1998, the Company received a demand for arbitration from Wang
Laboratories, Inc. ("Wang"), the successor to I-NET. The demand seeks at least
$4.1 million. The Company believes that it has meritorious defenses to Wang's
claims and has asserted counterclaims seeking in excess of $2.5 million as a
result of I-NET's defaults under the I-NET Agreement. The arbitration
proceedings are currently under way. The Company believes that resolution of
this matter will not have a material adverse impact on its financial condition.
No assurance can be given, however, as to the ultimate resolution of this
matter.
PURCHASE COMMITMENTS
As of September 30, 1998, the Company has outstanding commitments
aggregating approximately $41.2 million related to purchases of
telecommunications equipment and fiber optic cable and its obligations under its
agreements with certain suppliers.
REDEMPTION RIGHTS
Pursuant to a stockholders agreement, certain of the Company's
stockholders and warrantholders 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 $40.0 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 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 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, 1998, the aggregate redemption value of the
redeemable equity was approximately $152 million, reflecting per share
redemption amounts of $630 for the Series A Preferred Stock, $248 for the Series
C Preferred Stock and $130 for the redeemable common stock and redeemable common
stock warrants.
7
8. NET LOSS PER COMMON SHARE
The following table sets forth the computation of net loss per common
share-basic (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1997 1998 1997 1998
------------ ------------- ------------- ------------
Numerator:
Net loss............................... $ (5,815) $ (20,106) $(10,825) $(53,703)
Dividends and accretion on redeemable
preferred stock..................... (947) (4,117) (2,581) (14,157)
------------ ------------- ------------- ------------
Numerator for net loss per common
share - basic....................... $ (6,762) $ (24,223) $(13,406) $(67,860)
============ ============= ============= ============
Denominator:
Denominator for net loss per common share
- weighted average number of common
shares outstanding..................... 614,342 837,876 604,833 828,181
============ ============= ============= ============
Net loss per common share - basic......... $ (11.01) $ (28.91) $ (22.16) $ (81.94)
============ ============= ============= ============
Options and warrants to purchase an aggregate of 209,768 and 373,135 shares
of common stock were outstanding as of September 30, 1997 and 1998,
respectively, but a computation of diluted net loss per common share has not
been presented, as the effect would be anti-dilutive.
9. STOCK OPTION GRANTS
The Company was formed as a holding company in September 1997. Prior to the
establishment of the present holding company structure, during 1996 and 1997,
KMC Telecom (now the Company's principal operating subsidiary) granted options
to purchase shares of its common stock, par value $.01 per share ("KMC Telecom
Common Stock"), to employees pursuant to the KMC Telecom Stock Option Plan.
In order to reflect the establishment of the Company's holding company
structure, on June 26, 1998, the Board of Directors of the Company adopted,
effective upon stockholder approval, a new stock option plan, the KMC Holdings
Stock Option Plan, which authorizes the grant of options to purchase Common
Stock of the Company. The KMC Holdings Stock Option Plan was approved by the
stockholders of the Company, by unanimous written consent, effective July 15,
1998. In September 1998, the Company replaced the options to purchase KMC
Telecom Common Stock previously granted under the KMC Telecom Stock Option Plan
with options to purchase Common Stock of the Company granted under the KMC
Holdings Stock Option Plan and granted options to additional employees of the
Company under the KMC Holdings Stock Option Plan. The options for Common Stock
of the Company granted under the KMC Holdings Stock Option Plan entitle the
recipients to purchase an aggregate of 262,750 shares of Common Stock of the
Company at an average exercise price of $26.00 per share.
For the three months ended September 30 1998, KMC Telecom recorded charges
to stock option compensation of $1.0 million related to options outstanding
under the KMC Telecom Stock Option Plan through the date of termination of such
options. In connection with the issuance of options under the KMC Holdings Stock
Option Plan and the termination of options previously issued under the KMC
Telecom Stock Option Plan, as described above, in September 1998 the Company
recorded a charge of $20.7 million to stock option compensation expense, while
KMC Telecom recorded a credit to stock option compensation expense of $21.3
million. This net credit of approximately $600,000, when applied to the $1.0
million in charges to stock option compensation recorded by KMC Telecom for the
three months ended September 30, 1998, reduced the Company's stock option
compensation expense for the third quarter to the $398,000 reflected in the
unaudited condensed consolidated statement of operations for the period. Based
upon the provisions of the options granted under the KMC Holdings Stock Option
Plan, the Company will continue to recognize non-cash compensation expense over
the vesting period of such options, with future charges/credits to stock
compensation expense reflecting future increases/decreases in the fair market
value of the Company's Common Stock.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
-------------------------------------------------
THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WHICH INVOLVE RISKS AND
UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THE FOLLOWING DISCUSSION
SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE IN THIS
FORM 10-Q.
RESULTS OF OPERATIONS
As a result of the development and rapid growth of the Company's business
during the periods presented, the period-to-period comparisons of the Company's
results of operations are not necessarily meaningful and should not be relied
upon as an indication of future performance.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 1997
REVENUE. Revenue increased from $1.0 million for the three months ended
September 30, 1997 (the "1997 Third Quarter") to $6.3 million for the three
months ended September 30, 1998 (the "1998 Third Quarter"). This increase is
primarily attributable to the fact that the Company had eight systems in
commercial operation during the entire 1998 Third Quarter, as well as three
additional systems which became commercially operational during this period,
compared to only five systems in commercial operation during the entire 1997
Third Quarter, with two additional systems becoming commercially operational
during such period. Revenue for the 1997 and 1998 Third Quarters included
$700,000 and $4.2 million, respectively, of revenue derived from resale of
switched services and an aggregate of $300,000 and $2.1 million, respectively,
of revenue derived from on-net special access, private line and switched
services.
NETWORK OPERATING COSTS. Network operating costs increased from $2.5
million in the 1997 Third Quarter to $10.7 million in the 1998 Third Quarter.
This increase of approximately $8.2 million was due primarily to the increase in
the number of systems in commercial operation in the 1998 Third Quarter and the
related increases of $3.4 million in costs associated with providing resale
services, $2.7 million in personnel costs, $900,000 in contracted network
support costs, and $1.2 million in facilities, travel and other direct operating
costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $2.0 million for the 1997 Third Quarter
to $6.1 million for the 1998 Third Quarter. This increase of approximately $4.1
million resulted primarily from increases of $2.3 million in personnel costs and
$500,000 in professional costs (consisting primarily of legal costs), as well as
increases in other marketing and general and administrative costs aggregating
approximately $1.3 million.
STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge, decreased from $508,000 in the 1997 Third Quarter to $398,000
in the 1998 Third Quarter. This decrease resulted form a combination of an
increase in charges to stock option compensation expense related to an increase
in the fair market value of the Company's common stock and, to a lesser extent,
as a result of the greater number of options outstanding during the 1998 Nine
Months, which were partially offset by the effects of the restructuring of the
Company's stock option plans, as discussed below.
In September 1998, the Company replaced the options to purchase KMC
Telecom Common Stock previously granted under the KMC Telecom Stock Option Plan
with options to purchase KMC Holdings Common Stock granted under the KMC
Holdings Stock Option Plan and granted options to additional employees of the
Company under the KMC Holdings Stock Option Plan. The options for Common Stock
of the Company granted under the KMC Holdings Stock Option Plan entitle the
recipients to purchase an aggregate of 262,750 shares of the Company's Common
Stock at an average exercise price of $26.00 per share.
9
For the three months ended September 30 1998, KMC Telecom recorded
charges to stock option compensation of $1.0 million related to options
outstanding under the KMC Telecom Stock Option Plan through the date of
termination of such options. In connection with the issuance of options under
the KMC Holdings Stock Option Plan and the termination of options previously
issued under the KMC Telecom Stock Option Plan, in September 1998 KMC Telecom
Holdings recorded a charge of $20.7 million to stock option compensation expense
while KMC Telecom recorded a credit to stock option compensation expense of
$21.3 million. This net credit of approximately $600,000, when applied to the
$1.0 million in charges to stock option compensation recorded by KMC Telecom for
the 1998 Third Quarter, reduced the Company's stock option compensation expense
for the 1998 Third Quarter to $398,000. Based upon the provisions of the options
granted under the KMC Holdings Stock Option Plan, the Company will continue to
recognize non-cash compensation expense over the vesting period of such options,
with future charges/credits to stock compensation expense reflecting future
increases/decreases in the fair market value of the Company's Common Stock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased from $1.4 million for the 1997 Third Quarter to $3.1 million for the
1998 Third Quarter, primarily as a result of depreciation expense associated
with the greater number of networks commercially operational during the 1998
Third Quarter.
INTEREST EXPENSE, NET. Interest expense, net, increased from $449,000
in the 1997 Third Quarter to $6.1 million in the 1998 Third Quarter. The
increase resulted primarily from the issuance of the Senior Discount Notes
during the first quarter of 1998, which generated interest expense of $8.6
million in the 1998 Third Quarter. The increase was partially offset by $2.4
million of interest income earned on the investment of the unused portion of the
proceeds of the Senior Discount Note offering. The Company capitalized interest
of $1.5 million related to network construction projects during the 1998 Third
Quarter, and $103,000 during the 1997 Third Quarter.
NET LOSS. For the reasons stated above, net loss increased from $5.8
million for the 1997 Third Quarter to $20.1 million for the 1998 Third Quarter.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 1997
REVENUE. Revenue increased from $1.6 million for the nine months ended
September 30, 1997 (the "1997 Nine Months") to $13.6 million for the nine months
ended September 30, 1998 (the "1998 Nine Months"). This increase is primarily
attributable to the fact that for the 1998 Nine Months the Company had eight
systems in commercial operation during the entire period, as well as three
additional systems which became commercially operational at various points
during the period, as compared to the 1997 Nine Months when the Company had one
system in commercial operation during the entire period, with six systems
becoming commercially operational at various points during the period. Revenue
for the 1997 Nine Months and 1998 Nine Months included $900,000 and $9.4
million, respectively, of revenue derived from resale of switched services and
an aggregate of $700,000 and $4.2 million, respectively, of revenue derived from
on-net special access, private line and switched services.
NETWORK OPERATING COSTS. Network operating costs increased from $3.6
million in the 1997 Nine Months to $24.6 million in the 1998 Nine Months. This
increase of approximately $21.0 million was due primarily to the increase in the
number of systems in commercial operation in the 1998 Nine Months and the
related increases of $8.8 million in costs associated with providing resale
services, $6.0 million in personnel costs, $1.3 million in consulting and
professional services costs, $1.9 million in contracted network support costs,
and $3.0 million in facilities, travel and other direct operating costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $5.6 million in the 1997 Nine Months to
$15.3 million in the 1998 Nine Months. This increase of approximately $9.7
million resulted primarily from increases of $6.3 million in personnel costs and
$900,000 in professional costs (consisting primarily of legal costs), $800,000
in travel, as well as increases in other marketing and general and
administrative costs aggregating approximately $1.7 million.
STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge, increased from $640,000 in the 1997 Nine Months to $6.6 million
in the 1998 Nine Months, primarily as a result of an increase in the fair market
value of the Company's common stock and, to a lesser extent, as a result of the
greater number of options outstanding during the 1998 Nine Months, which were
partially offset by the effect of the restructuring of the Company's stock
option plans, as discussed below.
10
For the nine months ended September 30 1998, KMC Telecom recorded
charges to stock option compensation of $7.2 million related to options
outstanding under the KMC Telecom Stock Option Plan through the date of
termination of such options. In connection with the issuance of options under
the KMC Holdings Stock Option Plan and the termination of options previously
issued under the KMC Telecom Stock Option Plan, in September 1998 KMC Telecom
Holdings recorded a charge of $20.7 million to stock option compensation expense
while KMC Telecom recorded a credit to stock option compensation expense of
$21.3 million. This net credit of approximately $600,000, when applied to the
$7.2 million in charges to stock option compensation recorded by KMC Telecom for
the 1998 Nine Months, reduced the Company's stock option compensation expense
for the 1998 Nine Months to $6.6 million.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased from $1.6 million for the 1997 Nine Months to $5.2 million for the
1998 Nine Months, primarily as a result of depreciation expense associated with
the greater number of networks commercially operational during the 1998 Nine
Months.
INTEREST EXPENSE, NET. Interest expense, net, increased from $926,000
in the 1997 Nine Months to $15.6 million in the 1998 Nine Months. This increase
resulted primarily from the issuance of the Senior Discount Notes during the
first quarter of 1998, which generated interest expense of $22.2 million in the
1998 Nine Months, as well as the increased expense attributable to the higher
level of borrowings under the AT&T Facility in the 1998 Nine Months. This
increase was partially offset by $7.4 million of interest income earned on the
investment of the unused portion of the proceeds of the Senior Discount Note
offering during the 1998 Nine Months. The Company capitalized interest of $2.9
million related to network construction projects during the 1998 Nine Months,
and $251,000 during the 1997 Nine Months.
NET LOSS. For the reasons stated above, net loss increased from $10.8
million for the 1997 Nine Months to $53.7 million for the 1998 Nine Months.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating and net losses as a
result of the development and operation of its networks. The Company expects
that such losses will continue as the Company emphasizes the development,
construction and expansion of its networks and builds its customer base and that
cash provided by operations will not be sufficient to fund the expansion of its
networks and service capabilities.
Net cash provided by financing activities from borrowings and equity
issuances was $225.0 million for the 1998 Nine Months. The Company's net cash
used in operating and investment activities was $208.2 million for the 1998 Nine
Months.
The Company made capital expenditures of $90.9 million in the 1998 Nine
Months. These capital expenditures were financed from the proceeds of the Senior
Discount Note offering. The Company currently plans to make additional capital
expenditures of approximately $40.0 million during the remainder of 1998.
Continued significant capital expenditures are expected to be made thereafter.
The majority of these expenditures are expected to be made for network
construction and the purchase of switches and related equipment to facilitate
the offering of the Company's services. In addition, the Company expects to
continue to incur operating losses while it expands its business and builds its
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 the Company's control, including economic
conditions, competition, regulatory developments and the availability of
capital.
At September 30, 1998 the Company had outstanding commitments
aggregating approximately $41.2 million related to the purchase of fiber optic
cable and telecommunications equipment as well as engineering services.
11
Under the AT&T Facility, the Company may borrow up to an aggregate of
$70.0 million for the construction of fiber optic telecommunications networks in
certain markets, subject to certain conditions. At September 30, 1998, the
Company had $40.5 million of indebtedness outstanding under the AT&T Facility
and had $29.5 million in borrowing capacity available under the AT&T Facility,
subject to certain conditions. On January 29, 1998, the Company completed an
offering of 460,800 units, each unit consisting of one 12 1/2% Senior Discount
Note due 2008 with a principal amount at maturity of $1,000 (the "Senior
Discount Notes") and one warrant to purchase .21785 shares of Common Stock of
the Company at an exercise price of $.01 per share. The net proceeds to the
Company from the offering were approximately $236.4 million. The AT&T Facility
restricts the ability of KMC Telecom to pay dividends to, or to pay principal or
interest on loans from, KMC Holdings. Such restrictions could adversely affect
the Company's liquidity and ability to meet its cash requirements, including its
ability to repay the Senior Discount Notes.
At September 30, 1998 the Company had cash and cash equivalents and
marketable securities of approximately $122.3 million. The Company believes that
these funds, together with available cash and borrowings expected to be
available under the AT&T Facility, will provide sufficient funds for the Company
to expand its business as currently planned and to fund certain currently
anticipated expenses through the completion of its twelve existing networks, the
six new networks currently under construction and expected to be completed by
the end of 1998, and the five additional networks expected to be completed in
1999, and to fund its working capital requirements for 1999. Thereafter, the
Company will require additional financing. However, in the event that the
Company's plans change, the assumptions upon which the Company's plans are based
prove inaccurate, the Company expands or accelerates its business plan or the
Company determines to consummate additional acquisitions, the foregoing sources
of funds may prove to be insufficient to complete all such networks, and the
Company may be required to seek additional financing.
The Company has entered into a commitment letter, dated September 25,
1998 (the "Commitment Letter"), with AT&T Finance and three additional lenders
(collectively, the "Agents") in which the Agents advised the Company of their
commitment, subject to the terms and conditions set forth in the Commitment
Letter, to provide the Company with an aggregate of $250 million of senior
secured financing (the "Proposed Facility"). The obligations of the Agents under
the Commitment Letter are subject to a number of terms and conditions, as well
as the execution of definitive documentation satisfactory to the Agents. No
assurance can be given that the Proposed Facility will be successfully
completed. If completed, it is anticipated that a portion of the Proposed
Facility will be used to repay all amounts then outstanding under the existing
AT&T Facility (which would then terminate), with the remaining net proceeds
available to the Company for capital expenditures and other operating purposes,
subject to certain restrictions. The Company anticipates that a portion of the
net proceeds will be used to further develop its business, which may include
further expansion of both its existing networks and those networks currently
under construction.
YEAR 2000 COMPLIANCE
The Company believes that its existing software applications are Year
2000 compliant. However, there can be no assurance until the year 2000 occurs
that all systems will then function adequately. The Company currently requests
that all vendors proposing to provide it with software applications certify that
such software is year 2000 compliant. If a proposed vendor were to be unable to
certify compliance, the Company will request that the proposed vendor provide it
with the vendor's plan for bringing its software application into compliance.
The Company will consider that plan in making a decision whether to purchase the
software application. If the software applications of the local exchange
carriers, long distance carriers or others on whose services the Company depends
or with whom the Company's systems interface are not year 2000 compliant, it
could affect the Company's systems which would have a material adverse effect on
the Company's business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
12
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Not Applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) Written consents of the stockholders of the Company, dated as of
July 15,1998, were executed by such stockholders in lieu of an Annual
Meeting of Stockholders.
(b) The existing board of seven directors was re-elected in its
entirety to hold office until the next Annual Meeting of Stockholders,
or until their respective successors shall be elected and qualified, by
unanimous written consent of all stockholders. The persons elected as
directors were:
Harold N. Kamine
Michael A. Sternberg
William H. Stewart
John G. Quigley
Randall A. Hack
Richard H. Patterson
Gary E. Lasher
(c) The Stockholders of the Company, also by unanimous written consent,
approved and adopted the 1998 Stock Purchase and Option Plan for Key
Employees of KMC Telecom Holdings, Inc. and Affiliates (the "KMC
Holdings Stock Option Plan"). The KMC Holdings Stock Option Plan
authorizes the Compensation Committee of the Board of Directors of the
Company (the "Plan Committee") to grant (i) options intended to qualify
as Incentive Stock Options ("Incentive Options") within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended, (ii)
options not intended to so qualify ("Nonqualified Options"), (iii)
stock appreciation rights, (iv) restricted stock, (v) performance
units, (vi) performance shares and (vii) certain other types of awards,
to employees, directors and other persons having a unique relationship
with the Company or any of its affiliates (subject to certain
limitations). The number of shares of Common Stock of the Company
available for grant under the KMC Holdings Stock Option Plan is
262,750. No participant may receive more than 75,000 shares of Common
Stock of the Company under the KMC Holdings Stock Option Plan. The
exercise price of all Incentive Options granted under the KMC Holdings
Stock Option Plan must be at least equal to the fair market value (as
defined in the plan) of Company Common Stock on the date the options
are granted and the exercise price of all Nonqualified Options must be
at least equal to 50% of the fair market value of Company Common Stock
on the date the options are granted. The maximum term of each option
granted under the KMC Holdings Stock Option Plan will be ten years. The
Plan Committee has the power and authority to determine other terms and
conditions of grants under the plan and to interpret the plan.
13
ITEM 5. OTHER INFORMATION.
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
4. 1998 Stock Purchase and Option Plan for Key Employees
of KMC Telecom Holdings, Inc. and Affiliates.
27. Financial Data Schedule.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended September 30, 1998.
14
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 13, 1998
KMC TELECOM HOLDINGS, INC.
(Registrant)
By: /s/ Michael A. Sternberg
----------------------------------------
Michael A. Sternberg
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Cynthia Worthman
----------------------------------------
Cynthia Worthman
Chief Financial Officer, Vice President,
Secretary and Treasurer (Principal
Financial and Accounting Officer)
15
EXHIBIT INDEX
NO. DESCRIPTION
4 1998 Stock Purchase and Option Plan for Key Employees of KMC
Telecom Holdings, Inc. and Affiliates
27 Financial Data Schedule
16