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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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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
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Common Stock, par value $0.01 852,676 shares,
per share. as of November 12, 1999
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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, 1998 and September 30, 1999...................... 2
Unaudited Condensed Consolidated Statements of Operations,
Three Months Ended September 30, 1998 and 1999
and Nine Months Ended September 30, 1998 and 1999 ............ 3
Unaudited Condensed Consolidated Statements of Cash Flows,
Nine Months Ended September 30, 1998 and 1999................. 4
Notes to Unaudited Condensed Consolidated Financial Statements... 5
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 14
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk....... 21
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 1. Legal Proceedings................................................ 22
ITEM 2. Changes in Securities and Use of Proceeds........................ 22
ITEM 3. Defaults Upon Senior Securities.................................. 22
ITEM 4. Submission of Matters to a Vote of Security Holders.............. 22
ITEM 5. Other Information................................................ 22
ITEM 6. Exhibits and Reports on Form 8-K................................. 22
SIGNATURES.................................................................. 24
PART I - FINANCIAL INFORMATION
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
1998 1999
--------------- ------------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 21,181 $ 21,207
Restricted investments....................................................... - 37,125
Accounts receivable, net of allowance for doubtful accounts of $350 and
$2,095 in 1998 and 1999, respectively 7,539 23,810
Prepaid expenses and other current assets.................................... 1,315 1,076
--------------- ------------------
Total current assets............................................................ 30,035 83,218
Investments held for future capital expenditures................................ 27,920 75,000
Long term restricted investments................................................ - 68,348
Networks and equipment, net..................................................... 224,890 426,782
Intangible assets, net.......................................................... 2,829 2,985
Deferred financing costs, net................................................... 20,903 40,045
Other assets.................................................................... 4,733 1,118
--------------- ------------------
$ 311,310 $ 697,496
=============== ==================
LIABILITIES, REDEEMABLE AND NONREDEEMABLE EQUITY (DEFICIENCY) Current
liabilities:
Accounts payable............................................................. $ 21,052 $ 33,232
Accrued expenses............................................................. 10,374 49,109
Notes payable................................................................ - 125,000
--------------- ------------------
Total current liabilities....................................................... 31,426 207,341
Notes payable................................................................... 41,414 -
Senior discount notes payable................................................... 267,811 292,161
Senior notes payable............................................................ - 275,000
--------------- ------------------
Total liabilities............................................................... 340,651 774,502
Commitments and contingencies
Redeemable equity:
Senior redeemable, exchangeable, PIK preferred stock, par value $.01 per
share; authorized: -0- shares in 1998, 630 shares in 1999; shares issued
and outstanding:
Series E, - 0 - shares in 1998 and 63 shares in 1999 ($62,681
liquidation preference)................................................. - 48,130
Series F, - 0 - shares in 1998 and 43 shares in 1999 ($42,599
liquidation preference)................................................. - 39,143
Redeemable cumulative convertible preferred stock, par value $.01 per share
499 shares authorized; shares issued and outstanding:
Series A, 124 shares in 1998 and 1999 ($12,380 liquidation preference).. 30,390 50,813
Series C, 175 shares in 1998 and 1999 ($17,500 liquidation preference).. 21,643 30,727
Redeemable common stock, 224 shares issued and outstanding................... 27,459
22,305
Redeemable common stock warrants............................................. 674 11,664
--------------- ------------------
Total redeemable equity......................................................... 75,012 207,936
--------------- ------------------
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 3,000 shares authorized, 614 shares
and 629 shares issued and outstanding in 1998 and 1999, respectively...... 6
6
Additional paid-in capital................................................... 13,750 -
Unearned compensation........................................................ (5,824) (6,227)
Accumulated deficit.......................................................... (112,285) (278,721)
--------------- ------------------
Total nonredeemable equity (deficiency)......................................... (104,353) (284,942)
--------------- ------------------
$ 311,310 $ 697,496
=============== ==================
See accompanying notes.
2
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ---------------------------------
1998 1999 1998 1999
---------------- ---------------- ---------------- ---------------
Revenue................................................ $ 6,250 $ 15,572 $ 13,588 $ 42,284
Operating expenses:
Network operating costs............................. 10,658 31,154 24,577 75,209
Selling, general and administrative................. 6,081 14,956 15,301 41,680
Stock option compensation expense................... 398 (6,961) 6,594 13,240
Depreciation and amortization....................... 3,142 7,593 5,198 19,230
---------------- ---------------- ---------------- ---------------
Total operating expenses......................... 20,279 46,742 51,670 149,359
---------------- ---------------- ---------------- ---------------
Loss from operations................................... (14,029) (38,082) (107,075)
(31,170)
Other expense.......................................... - - - (4,297)
Interest income........................................
5,330 3,980 10,349 7,035
Interest expense....................................... (11,407) (21,834) (25,970) (47,848)
---------------- ---------------- ---------------- ---------------
Net loss............................................... (20,106) (49,024) (53,703) (152,185)
Dividends and accretion on redeemable preferred stock.. (4,117) 1,330 (14,157) (42,085)
---------------- ---------------- ---------------- ---------------
Net loss applicable to common shareholders............. $ (24,223) $ ( 47,694) $ (67,860) $ (194,270)
================ ================ ================ ===============
Net loss per common share.............................. $ (28.91) $ (55.93) $ (81.94) $ (228.20)
================ ================ ================ ===============
Weighted average number of common shares outstanding. 837,876 852,676 828,181 851,321
================ ================ ================ ===============
See accompanying notes.
3
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1998 1999
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OPERATING ACTIVITIES
Net loss........................................................................ $ (53,703) $ (152,185)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................ 5,198 19,230
Non-cash interest expense.................................................... 22,774 40,174
Non-cash stock option compensation expense................................... 6,593 13,240
Changes in assets and liabilities:
Accounts receivable....................................................... (3,941) (16,271)
Prepaid expenses and other current assets................................. (354) 239
Other assets.............................................................. (584) 1,065
Accounts payable.......................................................... (2,653) 14,707
Accrued expenses.......................................................... 3,571 12,585
Due from affiliate........................................................ (47) -
--------------- ----------------
Net cash used in operating activities........................................... (23,146) (67,216)
--------------- ----------------
INVESTING ACTIVITIES
Construction of networks and purchases of equipment............................. (90,938) (216,508)
Acquisitions of franchises, authorizations and related assets................... (1,100) (1,221)
Deposit on purchases of equipment............................................... (3,055) -
Purchases of investments, net................................................... (90,000) (47,080)
--------------- ----------------
Net cash used in investing activities........................................... (185,093) (264,809)
--------------- ----------------
FINANCING ACTIVITIES
Repayment of notes payable...................................................... (20,801) -
Proceeds from issuance of preferred stock and related warrants, net of issuance
costs........................................................................ - 91,235
Proceeds from issuance of common stock and warrants, net of issuance costs ..... 10,000 -
Proceeds from exercise of stock options......................................... - 333
Proceeds from issuance of senior discount notes, net of issuance costs.......... 236,369 -
Proceeds from issuance of senior notes, net of issuance costs and purchase of
portfolio of restricted investments.......................................... - 159,942
Proceeds from senior secured credit facility, net of issuance costs............. - 82,770
Issuance costs of Lucent facility............................................... - (2,229)
Dividends on preferred stock of subsidiary...................................... (592) -
--------------- ----------------
Net cash provided by financing activities....................................... 224,976 332,051
--------------- ----------------
Net increase in cash and cash equivalents....................................... 16,737 26
Cash and cash equivalents, beginning of period.................................. 15,553 21,181
--------------- ----------------
Cash and cash equivalents, end of period........................................ $ 32,290 $ 21,207
=============== ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net of amounts capitalized............ $ 3,274 $ 5,751
=============== ================
See accompanying notes.
4
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
1. BASIS OF PRESENTATION AND ORGANIZATION
KMC Telecom Holdings, Inc. and its subsidiaries, KMC Telecom Inc., KMC
Telecom II, Inc., KMC Telecom III, Inc., KMC Telecom of Virginia, Inc., and KMC
Investments, Inc. are collectively referred to herein as the Company. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
On July 1, 1999, the Company acquired all of the membership interests
of KMC Services LLC from Harold N. Kamine, the Chairman of our Board of
Directors, for nominal consideration. KMC Services LLC was formed to provide
services to the Company and its customers, initially offering a leasing program
for equipment physically installed at a customer's premises. The acquisition was
accounted for as a combination of entities under common control, and no changes
were made to the historical cost basis of KMC Services LLC's assets.
Accordingly, during the second quarter of 1999, the Company reduced the carrying
value of its $709,000 loan receivable from KMC Services LLC to an amount equal
to the value of KMC Services LLC's net assets at the acquisition date. KMC
Services LLC has been consolidated with the Company since July 1, 1999.
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, 1998.
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, 1998
was derived from the audited consolidated balance sheet at that date.
2. INVESTMENTS HELD FOR FUTURE CAPITAL EXPENDITURES
The Company has designated certain amounts as investments held for
future capital expenditures. As of September 30, 1999, 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 $69.8
million and debt securities (US government obligations and commercial bonds due
within 1 year) of $5.2 million. All debt securities have been designated by the
Company as held-to-maturity. Accordingly, such securities are recorded in the
accompanying financial statements at amortized cost. At September 30, 1999, the
carrying value of such held-to-maturity debt securities approximated their fair
value.
5
3. NETWORKS AND EQUIPMENT
Networks and equipment are comprised of the following (in thousands):
DECEMBER 31, SEPTEMBER 30,
1998 1999
----------------- -----------------
Fiber optic systems...................... $ 99,502 $ 138,577
Telecommunications equipment............. 115,769 162,011
Furniture and other...................... 7,340 19,209
Leasehold improvements................... 1,177 1,555
Construction-in-progress................. 11,770 132,703
----------------- -----------------
235,558 454,055
Less accumulated depreciation............ (10,668) (27,273)
----------------- -----------------
$ 224,890 $ 426,782
================= =================
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, 1998 and 1999 amounted to
$2.9 million and $3.5 million, respectively.
4. INTANGIBLE ASSETS
Intangible assets are comprised of the following (in thousands):
DECEMBER 31, SEPTEMBER 30,
1998 1999
---------------- ----------------
Franchise costs.......................... $ 1,690 $ 1,672
Authorizations and rights-of-way......... 1,455 1,965
Building access agreements and other..... 1,062 697
---------------- ----------------
4,207 4,334
Less accumulated amortization............ (1,378) (1,349)
---------------- ----------------
$ 2,829 $ 2,985
================ ================
5. ACCRUED EXPENSES
Accrued expenses are comprised of the following (in thousands):
DECEMBER 31, SEPTEMBER 30,
1998 1999
-------------- --------------
Accrued compensation........................... $ 4,138 $ 10,721
Deferred revenue............................... 1,187 2,934
Accrued costs related to financing activities.. 380 8,423
Accrued interest payable....................... 162 17,502
Accrued cost of sales.......................... 565 2,549
Other accrued expenses......................... 3,942 6,980
============== ===============
$ 10,374 $ 49,109
============== ===============
6
6. LUCENT LOAN AND SECURITY AGREEMENT
LUCENT LOAN AND SECURITY AGREEMENT
KMC Telecom III entered into a Loan and Security Agreement (the "Lucent
Facility") dated February 4, 1999 with Lucent Technologies Inc. ("Lucent") which
provides for borrowings to be used to fund the acquisition of certain
telecommunications equipment and related expenses. The Lucent Facility provides
for an aggregate commitment of up to $600 million, of which $250 million is
currently available to purchase Lucent products. Further, up to an additional
$350 million will be available upon (a) additional lenders participating in the
Lucent Facility and making commitments to make loans so that Lucent's aggregate
commitment does not exceed $250 million and (b) the Company satisfying certain
other requirements, the most significant of which is KMC Holdings raising and
contributing at least $300 million in high yield debt or equity (other than
disqualified stock) to KMC Telecom III. The Lucent Facility places certain
restrictions upon KMC Telecom III's ability to purchase non-Lucent equipment
with proceeds from such facility. At September 30, 1999, no amounts had been
borrowed under the Lucent Facility.
Interest on borrowings under the Lucent Facility is charged, at the
option of KMC Telecom III, at a floating rate of LIBOR plus the "Applicable
LIBOR Margin", or at an alternative base rate plus the "Applicable Base Rate
Margin" (as defined). Such margins will be increased by 0.25% until KMC Telecom
III and its subsidiaries have completed systems in fourteen markets. If KMC
Telecom III defaults on any payment due under the Lucent Facility, the interest
rate will increase by four percentage points. If any other event of default
shall occur, the interest rate will be increased by two percentage points.
Interest on each LIBOR loan is payable on each LIBOR interest payment date in
arrears and interest on each base rate loan is payable quarterly in arrears. KMC
Telecom III must pay an annual commitment fee on the unused portion of the
Lucent Facility of 1.25%.
Loans borrowed under the Lucent Facility amortize in amounts based upon
the following percentages of the aggregate amount of the loans drawn under the
Lucent Facility:
PAYMENT DATES AMORTIZATION
-------------------------------------- -------------------
May 1, 2002 - February 1, 2003 2.5% per quarter
May 1, 2003 - February 1, 2006 5.0% per quarter
May 1, 2006 - February 1, 2007 7.5% per quarter
KMC Holdings has unconditionally guaranteed the repayment of up to $250
million under the Lucent Facility when such repayment is due, whether at
maturity, upon acceleration, or otherwise. KMC Telecom III Holdings, Inc., which
owns the shares of KMC Telecom III and is wholly-owned by KMC Holdings, has
pledged the shares of KMC Telecom III to Lucent to collateralize its obligations
under the guaranty. In addition, KMC Telecom III has pledged all of its assets
to Lucent.
The Lucent Facility contains a number of affirmative and negative
covenants including, among others, covenants restricting the ability of KMC
Telecom III to consolidate or merge with any person, sell or lease assets not in
the ordinary course of business, sell or enter into any long term leases of dark
fiber, redeem stock, pay dividends or make any other payments (including
payments of principal or interest on loans) to KMC Holdings, create
subsidiaries, transfer any permits or licenses, or incur additional indebtedness
or act as guarantor for the debt of any other person, subject to certain
conditions.
KMC Telecom III is required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a ratio of total
debt to contributed capital, certain minimum revenues, maximum EBITDA losses and
7
minimum EBITDA, maximum capital expenditures and minimum access lines, a maximum
total leverage ratio, a minimum debt service coverage ratio, a minimum fixed
charge coverage ratio and a maximum consolidated leverage ratio. The covenants
become more restrictive upon the earlier of (i) July 1, 2002 and (ii) after KMC
Telecom III achieves positive EBITDA for two consecutive fiscal quarters.
Failure to satisfy any of the financial covenants will constitute an
event of default under the Lucent Facility, permitting the lenders to terminate
the commitment and/or accelerate payment of outstanding indebtedness. The Lucent
Facility also includes other customary events of default, including, without
limitation, a cross-default to other material indebtedness, material
undischarged judgments, bankruptcy, loss of a material franchise or material
license, breach of representations and warranties, a material adverse change,
and the occurrence of a change of control.
WAIVER AND AMENDMENTS TO FINANCIAL COVENANTS
The Company obtained a waiver of compliance, for the quarter ended
September 30, 1999, with certain financial covenants (related to revenue and
EBITDA) contained in the Senior Secured Credit Facility (for a description of
the Senior Secured Credit Facility, see Note 6 of the Notes to the Consolidated
Financial Statements in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998). In addition, the EBITDA covenant was amended for the
fourth quarter of 1999 to a level which the Company expects to achieve.
The Company has received a signed commitment from Lucent to refinance
the existing Lucent Facility upon terms which would involve the provision of
additional funding to the Company and the resetting of the financial covenants
for periods after the fourth quarter of 1999. The Company is currently engaged
in discussions with the agents for the lenders under the Senior Secured Credit
Facility which presently contemplate comparable amendments to the financial
covenants in the Senior Secured Credit Facility. The Company believes that these
negotiations will lead to definitive agreements during the first quarter of
2000. If, however, the Company is not successful in completing the negotiations
as presently contemplated and amending the financial covenants in the Senior
Secured Credit Facility and the Lucent Facility, the Company is likely to fail
to comply with one or more of the covenants presently contained in those
facilities for the quarter ended March 31, 2000, which failure, unless waived,
would constitute a default under those credit facilities. Given that, as of this
date, the Company has not yet signed definitive agreements with Lucent and the
agents for the lenders under the Senior Secured Credit Facility implementing the
foregoing refinancings, under applicable financial accounting standards, the
Company was required to reclassify the $125 million outstanding at September 30,
1999 under the Senior Secured Credit Facility as current liabilities in the
accompanying balance sheet. If, as expected, the Company successfully completes
the contemplated refinancings of the Senior Secured Credit Facility and Lucent
Facility prior to the issuance of its financial statements for the year ended
December 31, 1999, the applicable accounting standards will permit it to
classify the amounts outstanding under the Senior Secured Credit Facility as
long-term debt in its balance sheet as of December 31, 1999. A covenant default
under the Senior Secured Credit Facility or the Lucent Facility is not an
automatic default under the Company's other outstanding indebtedness but, under
certain circumstances, may become one, depending upon the actions of the lenders
under the Senior Secured Credit Facility and Lucent Facility.
7. INTEREST RATE SWAP AGREEMENT
The Company has entered into an interest rate swap agreement with a
commercial bank to reduce the impact of changes in interest rates on its
outstanding variable rate debt. The agreement effectively fixes the Company's
interest rate on the $125 million of outstanding variable rate borrowings under
8
the Senior Secured Credit Facility due 2007. The interest rate swap agreement
terminates in April 2004. The Company is exposed to credit loss in the event of
nonperformance by the other party to the interest rate swap agreement. However,
the Company does not anticipate nonperformance by the counterparty.
8. PREFERRED STOCK AND WARRANT ISSUANCES
SERIES E PREFERRED STOCK
On February 4, 1999, the Company issued 25,000 shares of Series E
Senior Redeemable, Exchangeable, PIK Preferred Stock (the "Series E Preferred
Stock") to Newcourt Commercial Finance Corporation ("Newcourt Finance"),
generating aggregate gross proceeds of $22.9 million. On April 30, 1999, the
Company issued an additional 35,000 shares of Series E Preferred Stock for gross
proceeds of $25.9 million. The Series E Preferred Stock has a liquidation
preference of $1,000 per share and an annual dividend equal to 14.5% of the
liquidation preference, payable quarterly. On or before January 15, 2004, the
Company may pay dividends in cash or in additional fully paid and nonassessable
shares of Series E Preferred Stock. After January 15, 2004, dividends must be
paid in cash, subject to certain conditions. Unpaid dividends accrue at the
dividend rate of the Series E Preferred Stock, compounded quarterly. On April
15, 1999 and July 15, 1999, the Company issued 695 shares and 1,986 shares,
respectively, of Series E Preferred Stock to pay the dividends due for such
periods.
The Series E Preferred Stock must be redeemed on February 1, 2011,
subject to the legal availability of funds therefor, at a redemption price,
payable in cash, equal to the liquidation preference thereof on the redemption
date, plus all accumulated and unpaid dividends to the date of redemption. After
April 15, 2004, the Series E Preferred Stock may be redeemed, in whole or in
part, at the option of the Company, at a redemption price equal to 110% of the
liquidation preference of the Series E Preferred Stock plus all accrued and
unpaid dividends to the date of redemption. The redemption price declines to an
amount equal to 100% of the liquidation preference as of April 15, 2007.
In addition, on or prior to April 15, 2002, the Company may, at its
option, redeem up to 35% of the aggregate liquidation preference of Series E
Preferred Stock with the proceeds of sales of its capital stock at a redemption
price equal to 110% of the liquidation preference on the redemption date plus
accrued and unpaid dividends.
The holders of Series E Preferred Stock have voting rights in certain
circumstances. Upon the occurrence of a change of control, the Company will be
required to make an offer to repurchase the Series E Preferred Stock for cash at
a purchase price of 101% of the liquidation preference thereof, together with
all accumulated and unpaid dividends to the date of purchase.
The Series E Preferred Stock is not convertible. The Company may, at
the sole option of the Board of Directors (out of funds legally available),
exchange all, but not less than all, of the Series E Preferred Stock then
outstanding, including any shares of Series E Preferred Stock issued as payment
for dividends, for a new series of subordinated debentures (the "Exchange
Debentures") issued pursuant to an exchange debenture indenture. The holders of
Series E Preferred Stock are entitled to receive on the date of any such
exchange, Exchange Debentures having an aggregate principal amount equal to (i)
the total of the liquidation preference for each share of Series E Preferred
Stock exchanged, plus (ii) an amount equal to all accrued but unpaid dividends
payable on such share.
SERIES F PREFERRED STOCK
On February 4, 1999, the Company issued 40,000 shares of Series F
Senior Redeemable, Exchangeable, PIK Preferred Stock (the "Series F Preferred
Stock") to Lucent and Newcourt Finance, generating aggregate gross proceeds of
9
$38.9 million. The Series F Preferred Stock has a liquidation preference of
$1,000 per share and an annual dividend equal to 14.5% of the liquidation
preference, payable quarterly. The Company may pay dividends in cash or in
additional fully paid and nonassessable shares of Series F Preferred Stock. On
April 15, 1999 and July 15, 1999, the Company issued 1,112 shares and 1,486
shares, respectively, of Series F Preferred Stock to pay the dividends due for
such period.
The Series F Preferred Stock may be redeemed at any time, in whole or
in part, at the option of the Company, at a redemption price equal to 110% of
the liquidation preference on the redemption date plus an amount in cash equal
to all accrued and unpaid dividends thereon to the redemption date. Upon the
occurrence of a change of control, the Company will be required to make an offer
to purchase the Series F Preferred Stock for cash at a purchase price of 101% of
the liquidation preference thereof, together with all accumulated and unpaid
dividends to the date of purchase.
The holders of Series F Preferred Stock have voting rights under
certain circumstances.
Upon the earlier of (i) the date that is sixty days after the date on
which the Company closes an underwritten primary offering of at least $200
million of its Common Stock, pursuant to an effective registration statement
under the Securities Act or (ii) February 4, 2001, any outstanding Series F
Preferred Stock will automatically convert into Series E Preferred Stock, on a
one for one basis.
The Company may, at the sole option of the Board of Directors (out of
funds legally available), exchange all, but not less than all, of the Series F
Preferred Stock then outstanding, including any shares of Series F Preferred
Stock issued as payment for dividends, for Exchange Debentures. The holders of
Series F Preferred Stock are entitled to receive on the date of any such
exchange, Exchange Debentures having an aggregate principal amount equal to (i)
the total of the liquidation preference for each share of Series F Preferred
Stock exchanged, plus (ii) an amount equal to all accrued but unpaid dividends
payable on such share.
WARRANTS
In connection with the February 4, 1999 issuances of the Series E
Preferred Stock and the Series F Preferred Stock, warrants to purchase an
aggregate of 24,660 shares of Common Stock were sold to Newcourt Finance and
Lucent. The aggregate gross proceeds from the sale of these warrants was
approximately $3.2 million. These warrants, at an exercise price of $.01 per
share, are exercisable from February 4, 2000 through February 1, 2009.
In addition, the Company also delivered to the Warrant Agent
certificates representing warrants to purchase an aggregate of an additional
107,228 shares of Common Stock at an exercise price of $.01 per share (the
"Springing Warrants"). The Springing Warrants may become issuable under the
circumstances described in the following paragraph.
If the Company fails to redeem all shares of Series F Preferred Stock
prior to the date (the "Springing Warrant Date") which is the earlier of (i) the
date that is sixty days after the date on which the Company closes an
underwritten primary offering of at least $200 million of its Common Stock
pursuant to an effective registration statement under the Securities Act or (ii)
February 4, 2001, the Warrant Agent is authorized to issue the Springing
Warrants to the Eligible Holders (as defined in the warrant agreement) of the
Series E and Series F Preferred Stock. In the event the Company has redeemed all
outstanding shares of Series F Preferred Stock prior to the Springing Warrant
Date, the Springing Warrants will not be issued and the Warrant Agent will
return the certificates to the Company. To the extent the Company exercises its
option to exchange all of the Series F Preferred Stock for Exchange Debentures
prior to the Springing Warrant Date, the Springing Warrants will not become
issuable. Therefore, as the future issuance of the Springing Warrants is
10
entirely within the control of the Company and the likelihood of their issuance
is deemed to be remote, no value has been ascribed to the Springing Warrants.
In connection with the April 30, 1999 issuance of additional shares of
the Series E Preferred Stock, warrants to purchase an aggregate of 60,353 shares
of Common Stock were issued to Newcourt Finance and First Union. The aggregate
gross proceeds from the sale of these warrants was approximately $9.1 million.
These warrants, at an exercise price of $.01 per share, are exercisable from
February 4, 2000 through February 1, 2009.
9. SERVICE REVENUES
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 revenues consist of the following (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ----------------------------
1998 1999 1998 1999
---------- ----------- ----------- -------------
On-net.............. $ 2,125 $ 9,693 $ 4,240 $ 23,992
Resale.............. 4,125 5,879 9,348 18,292
---------- ----------- ----------- -------------
Total............... $ 6,250 $15,572 $ 13,588 $ 42,284
========== =========== =========== =============
10. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
As of September 30, 1999, the Company has outstanding commitments
aggregating approximately $92.8 million related to purchases of
telecommunications equipment and fiber optic cable and its obligations under its
agreements with certain suppliers.
ARBITRATION AWARD
During the second quarter of 1999, the company recorded a $4.3 million
charge to other expense in connection with an unfavorable arbitration award. The
net amount due under the terms of the award was paid in full in June 1999.
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
11
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, 1999, the aggregate redemption value of the redeemable equity was
approximately $235 million, reflecting per share redemption amounts of $897 for
the Series A Preferred Stock, $352 for the Series C Preferred Stock and $185 for
the redeemable common stock and redeemable common stock warrants.
11. NET LOSS PER COMMON SHARE
The following table sets forth the computation of net loss per common
share-basic (in thousands, except share and per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ---------------------------------
1998 1999 1998 1999
---------------- ---------------- ---------------- ---------------
Numerator:
Net loss.......................................... $ (20,106) $ (49,024) $ (53,703) $ (152,185)
Dividends and accretion on redeemable preferred stock (4,117) 1,330 (14,157) (42,085)
---------------- ---------------- ---------------- ---------------
Numerator for net loss per common share - basic... $ (24,223) $ ( 47,694) $ (67,860) $ (194,270)
================ ================ ================ ===============
Denominator:
Denominator for net loss per common share -
weighted average number of common shares
outstanding.......................................... 837,876 852,676 828,181 851,321
================ ================ ================ ===============
Net loss per common share - basic.................... $ (28.91) $ (55.93) $ (81.94) $ (228.20)
================ ================ ================ ===============
Options and warrants to purchase an aggregate of 373,135 and 483,273
shares of common stock were outstanding as of September 30, 1998 and 1999,
respectively, but a computation of diluted net loss per common share has not
been presented, as the effect would be anti-dilutive.
12. LOUISIANA RECIPROCAL REVENUE
During 1998 and the first nine months of 1999 the Company recognized
revenue which it believed was due from incumbent local exchange carriers for
terminating local traffic of Internet service providers (ISPs). The Company
determined to recognize this revenue because, based upon all of the facts and
circumstances known at the time, including numerous state public service
commission and state and federal court decisions upholding competitive local
exchange carriers' entitlement to reciprocal compensation for such calls, that
realization of those amounts was reasonably assured. On October 13, 1999,
however, the Louisiana Public Service Commission ruled that local traffic to
ISPs in Louisiana is not eligible for reciprocal compensation. As a result of
that ruling, the Company determined that it could no longer conclude that
realization of amounts attributable to termination of local calls to ISPs in
Louisiana was reasonably assured. Accordingly, an adjustment was recorded to
reduce revenue in the 1999 Third Quarter, which reversed all reciprocal revenue
recognized related to ISP traffic in Louisiana for the entire year of 1998 and
the first nine months of 1999. The adjustment amounted to $4.4 million, of which
12
$1.1 million relates to the year ended December 31, 1998 and $3.3 million
relates to the nine months ended September 30, 1999.
The Company has been advised by its regulatory counsel that this
decision appears to be well out of the mainstream on the issue. To date,
Louisiana is the only state which has rendered a decision, pursuant to an
existing agreement, that has permitted an incumbent local exchange carrier to
use a competitive local exchange carriers' facilities to complete calls without
compensation to the competitive local exchange carrier. Thirty-three other
states have ruled that the originating carrier must compensate the terminating
carrier for such use. Many of these decisions have been affirmed by state and
federal courts on appeal and none have been reversed. The Company intends to
appeal the decision to the appropriate authority.
13
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, 1999 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 1998
REVENUE. Revenue increased from $6.3 million for the three months ended
September 30, 1998 (the "1998 Third Quarter") to $15.6 million for the three
months ended September 30, 1999 (the "1999 Third Quarter"). This increase is
primarily attributable to the fact that we derived revenues from 23 markets
during the 1999 Third Quarter compared to 11 markets during the 1998 Third
Quarter. During 1998 and the first nine months of 1999 we recognized revenue
which we believed was due to us from incumbent local exchange carriers for
terminating local traffic of Internet service providers (ISPs). We determined to
recognize this revenue because we concluded, based upon all of the facts and
circumstances known to us at the time, including numerous state public service
commission and state and federal court decisions upholding competitive local
exchange carriers' entitlement to reciprocal compensation for such calls, that
realization of those amounts was reasonably assured. On October 13, 1999,
however, the Louisiana Public Service Commission ruled that local traffic to
ISPs in Louisiana is not eligible for reciprocal compensation. As a result of
that ruling, we determined that we could no longer conclude that realization of
amounts attributable to termination of local calls to ISPs in Louisiana was
reasonably assured. Accordingly, we recorded an adjustment to reduce revenue in
the 1999 Third Quarter, which reversed all reciprocal revenue recognized related
to ISP traffic in Louisiana for the entire year of 1998 and the first nine
months of 1999. The adjustment amounted to $4.4 million, of which $1.1 million
relates to the year ended December 31, 1998 and $3.3 million relates to the nine
months ended September 30, 1999.
Excluding the effect of the adjustment, revenue for the 1999 Third
Quarter would have been $20.0 million, including $4.7 million of revenue related
to reciprocal compensation. With the exception of our two Louisiana systems,
which are affected by the Louisiana Public Service Commission's reciprocal
compensation decision, each of our systems that generated revenue during the
1998 Third Quarter generated higher revenue during the 1999 Third Quarter.
Excluding the effect of the adjustment, our two systems located in Louisiana
also generated higher revenue during the 1999 Third Quarter than during the 1998
Third Quarter.
Revenue for the 1998 Third Quarter and 1999 Third Quarter included $4.2
million and $5.9 million, respectively, of revenue derived from resale of
switched services and an aggregate of $2.1 million and $9.7 million (including,
after giving effect to the $4.4 million adjustment for Louisiana, $0.3 million
of revenue related to reciprocal compensation during the 1999 Third Quarter),
respectively, of revenue derived from on-net special access, private line and
switched services.
14
Although incumbent local exchange carriers, such as BellSouth, have
generally withheld payments of amounts due for reciprocal compensation to
competitive local exchange carriers such as the Company for calls to ISPs and
disputed the entitlement of competitive local exchange carriers to reciprocal
compensation for such calls in jurisdictions other than Louisiana as well, we
have determined to continue to recognize amounts due to us for reciprocal
compensation for such calls in jurisdictions other than Louisiana because we
have concluded, based upon all of the facts and circumstances, including
numerous state public service commission and state and federal court decisions
upholding competitive local exchange carriers' entitlement to reciprocal
compensation for such calls, that realization of such amounts is reasonably
assured.
NETWORK OPERATING COSTS. Network operating costs increased from $10.7
million in the 1998 Third Quarter to $31.2 million in the 1999 Third Quarter.
This increase of $20.5 million was due primarily to the increase in the number
of markets in which we operated in the 1999 Third Quarter and the related
increases of $5.0 million in personnel costs, $4.8 million in costs associated
with providing resale services and leasing unbundled network element services,
$2.5 million in consultant and professional services related costs, $1.8 million
in contracted network support costs, $1.4 million in reciprocal expense,
$700,000 in telecommunications costs, $700,000 in facility costs, and $3.6
million in other direct operating costs.
Costs associated with providing on-net switched services were greater
than revenue generated from on-net switched services because we hired personnel
and staffed local offices prior to generating revenue and obtaining sufficient
revenue volume to cover such fixed operating costs.
Costs associated with providing resale services were greater than the
revenues generated from these services because of narrow discounts provided by
the incumbent local exchange carriers and because initial installation charges
by the incumbent local exchange carrier to us are greater than our installation
charges to our customers. Initially, resale has been used as an interim strategy
for us to create a backlog of customers to be transitioned to our on-net
switched facilities as our own switches become commercially operational. We now
have switches in commercial operation in 23 markets. We are in the process of
transitioning the majority of our resale customers to on-net switched services,
but this can be a time-consuming task.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $6.1 million for the 1998 Third Quarter
to $15.0 million for the 1999 Third Quarter. This increase of $8.9 million
resulted primarily from increases of $6.4 million in personnel costs, $1.2
million in professional costs (consisting primarily of legal costs), $800,000 in
travel related expenses and $100,000 in advertising costs, along with increases
in other marketing and general and administrative costs aggregating
approximately $400,000.
STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge, decreased from $398,000 for the 1998 Third Quarter to a credit
of $7.0 million for the 1999 Third Quarter. This decrease primarily resulted
from a decrease in the estimated fair value of the Company's Common Stock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased from $3.1 million for the 1998 Third Quarter to $7.6 million for the
1999 Third Quarter primarily as a result of depreciation expense associated with
the greater number of networks in commercial operation during the 1999 Third
Quarter.
INTEREST EXPENSE. Interest expense increased from $11.4 million in the
1998 Third Quarter to $21.8 million in the 1999 Third Quarter. The increase
resulted primarily from the issuance of the Senior Notes in May 1999, additional
accretion on the Senior Discount Notes and increased interest charges related to
higher borrowings under the Senior Secured Credit Facility. The Company
15
capitalized interest related to network construction projects of $1.5 million
during the 1998 Third Quarter and $2.2 million during the 1999 Third Quarter.
NET LOSS. For the reasons stated above, net loss increased from $20.1
million for the 1998 Third Quarter to $49.0 million for the 1999 Third Quarter.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 1998
REVENUE. Revenue increased from $13.6 million for the nine months ended
September 30, 1998 (the "1998 Nine Months") to $42.3 million for the nine months
ended September 30, 1999 (the "1999 Nine Months"). This increase is primarily
attributable to the fact that we derived revenue from 23 markets during the 1999
Nine Months compared to 11 markets during the 1998 Nine Months. During 1998 and
the first nine months of 1999 we recognized revenue which we believed was due to
us from incumbent local exchange carriers for terminating local traffic of ISPs.
We determined to recognize this revenue because we concluded, based upon all of
the facts and circumstances known to us at the time, including numerous state
public service commission and state and federal court decisions upholding
competitive local exchange carriers' entitlement to reciprocal compensation for
such calls, that realization of those amounts was reasonably assured. On October
13, 1999, however, the Louisiana Public Service Commission ruled that local
traffic to ISPs in Louisiana is not eligible for reciprocal compensation. As a
result of that ruling, we determined that we could no longer conclude that
realization of amounts attributable to termination of local calls to ISPs in
Louisiana was reasonably assured. Accordingly, we recorded an adjustment to
reduce revenue in the 1999 Third Quarter, which reversed all reciprocal revenue
recognized related to ISP traffic in Louisiana for the entire year of 1998 and
the first nine months of 1999. The adjustment amounted to $4.4 million, of which
$1.1 million relates to the year ended December 31, 1998 and $3.3 million
relates to the nine months ended September 30, 1999.
Excluding the effect of the adjustment, revenue for the 1999 Nine
Months would have been $46.7 million, including $9.2 million of revenue related
to reciprocal compensation. Each of our systems that generated revenue during
the 1998 Nine Months generated higher revenue during the 1999 Nine Months.
Revenue for the 1998 Nine Months and 1999 Nine Months included $9.4
million and $18.3 million, respectively, of revenue derived from resale of
switched services and an aggregate of $4.2 million and $24.0 million (including,
after giving effect to the $4.4 million adjustment for Louisiana, $4.8 million
of revenue related to reciprocal compensation during the 1999 Nine Months),
respectively, of revenue derived from on-net special access, private line and
switched services.
Although incumbent local exchange carriers, such as BellSouth, have
generally withheld payments of amounts due for reciprocal compensation to
competitive local exchange carriers such as the Company for calls to ISPs and
disputed the entitlement of competitive local exchange carriers to reciprocal
compensation for such calls in jurisdictions other than Louisiana as well, we
have determined to continue to recognize amounts due to us for reciprocal
compensation for such calls in jurisdictions other than Louisiana, because we
have concluded, based upon all of the facts and circumstances, including
numerous state public service commission and state and federal court decisions
upholding competitive local exchange carriers' entitlement to reciprocal
compensation for such calls, that realization of such amounts is reasonably
assured.
NETWORK OPERATING COSTS. Network operating costs increased from $24.6
million in the 1998 Nine Months to $75.2 million in the 1999 Nine Months. This
increase of $50.6 million was due primarily to the increase in the number of
markets in which we operated in the 1999 Nine Months and the related increases
of $13.4 million in personnel costs, $12.4 million in costs associated with
providing resale services and leasing unbundled network element services, $5.4
million in contracted network support costs, $5.1 million in consultant and
16
professional services related costs, $2.7 million in reciprocal expense, $1.8
million in facility costs, $1.5 million in telecommunications costs, and $8.3
million in other direct operating costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $15.3 million for the 1998 Nine Months to
$41.7 million for the 1999 Nine Months. This increase of $26.4 million resulted
primarily from increases of $15.6 million in personnel costs, $4.0 million in
professional costs (consisting primarily of legal costs), $2.4 million in travel
related expenses, and $400,000 in advertising costs, along with increases in
other marketing and general and administrative costs aggregating approximately
$4.0 million.
STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge, increased from $6.6 million for the 1998 Nine Months to $13.2
million for the 1999 Nine Months. This increase primarily resulted from an
increase in the estimated fair value of the Company's Common Stock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased from $5.2 million for the 1998 Nine Months to $19.2 million for the
1999 Nine Months primarily as a result of depreciation expense associated with
the greater number of networks in commercial operation during the 1999 Nine
Months.
OTHER EXPENSE. During the second quarter of 1999, the Company recorded
a $4.3 million charge to other expense in connection with an unfavorable
arbitration award. The net amount due under the terms of the award was paid in
full in June 1999.
INTEREST EXPENSE. Interest expense increased from $26.0 million in the
1998 Nine Months to $47.8 million in the 1999 Nine Months. The increase resulted
primarily from the issuance of the Senior Notes in May 1999, additional
accretion on the Senior Discount Notes, and increased interest charges related
to higher borrowings under the Senior Secured Credit Facility. The Company
capitalized interest related to network construction projects of $2.9 million
during the 1998 Nine Months and $3.5 million during the 1999 Nine Months.
NET LOSS. For the reasons stated above, net loss increased from $53.7
million for the 1998 Nine Months to $152.2 million for the 1999 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 emphasize the development, construction and expansion of our
networks and build our customer base. As a result, there will not be any cash
provided by operations in the near future and we will need to fund the expansion
of our networks. We have financed our operating losses and capital expenditures
with equity invested by our founders, preferred stock placements, credit
facility borrowings, the 12 1/2% Senior Discount Notes and 13 1/2% Senior Notes.
On May 24, 1999, we issued $275.0 million in aggregate principal amount
of 13 1/2% Senior Notes due 2009. Approximately $104.1 million of the net
proceeds of this offering were used to purchase a portfolio of U.S. treasury
securities that have been pledged to secure the first six scheduled interest
payments on these notes.
In February 1999, we issued PIK Preferred Stock and warrants to
purchase common stock for aggregate gross proceeds of $65.0 million to two
purchasers. In April 1999, we issued additional shares of PIK Preferred Stock
and warrants to purchase common stock to one additional purchaser for aggregate
gross proceeds of $35.0 million.
17
In February 1999, our subsidiary which owns the 14 additional networks
currently under development, entered into a secured vendor financing facility
with Lucent Technologies Inc. Under this Lucent Facility, our subsidiary will be
permitted to borrow, subject to certain conditions, up to an aggregate of $600.0
million, primarily for the purchase from Lucent of switches and other
telecommunications equipment. Currently, $250.0 million is available under this
facility. The balance of $350.0 million will become available only upon (a)
additional lenders agreeing to participate in the facility so that Lucent's own
aggregate commitment does not exceed $250.0 million and (b) the Company
satisfying certain other requirements, the most significant of which is the
Company raising, and contributing to the subsidiary, at least $300.0 million
from the sale of high yield debt or equity. As of September 30, 1999 the Company
had no borrowings outstanding under this facility.
Net cash provided by financing activities from borrowings and equity
issuances was $332.1 million for the nine months ended September 30, 1999. Our
net cash used in operating and investing activities was $332.0 million for the
nine months ended September 30, 1999.
We made capital expenditures of $218.5 million in the nine months ended
September 30, 1999. We currently plan to make additional capital expenditures of
approximately $132.0 million during the remainder of 1999. Continued significant
capital expenditures are expected to be made thereafter. The majority of these
expenditures is expected to be made for network construction and the purchase of
switches and related equipment to facilitate the offering of our services. In
addition, 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.
At September 30, 1999, the Company had outstanding commitments
aggregating approximately $92.8 million related to the purchase of fiber optic
cable and telecommunications equipment as well as engineering services,
principally under the Company's agreements with Lucent Technologies Inc.
At September 30, 1999, the Company had $125.0 million of indebtedness
outstanding under the Senior Secured Credit Facility, and had $125.0 million in
borrowing capacity available under the Senior Secured Credit Facility, subject
to certain conditions. On the same date, the Company had no indebtedness
outstanding under the Lucent Facility and had $250.0 million in borrowing
capacity available thereunder.
We obtained a waiver of compliance, for the quarter ended September 30,
1999, with certain financial covenants (related to revenue and EBITDA) contained
in the Senior Secured Credit Facility. In addition, the EBITDA covenant was
amended for the fourth quarter of 1999 to a level which we expect to achieve.
We have received a signed commitment from Lucent to refinance the
existing Lucent Facility upon terms which would involve the provision of
additional funding to the Company and the resetting of the financial covenants
for periods after the fourth quarter of 1999. We are currently engaged in
discussions with the agents for the lenders under the Senior Secured Credit
Facility which presently contemplate comparable amendments to the financial
covenants in the Senior Secured Credit Facility. We believe that these
negotiations will lead to definitive agreements during the first quarter of
2000. If, however, we are not successful in completing the negotiations as
presently contemplated and amending the financial covenants in the Senior
Secured Credit Facility and the Lucent Facility, it is likely that we will fail
to comply with one or more of the covenants presently contained in those
facilities for the quarter ended March 31, 2000, which failure, unless waived,
would constitute a default under those credit facilities. A covenant default
under the Senior Secured Credit Facility or the Lucent Facility is not an
automatic default under our other outstanding indebtedness but, under certain
18
circumstances, may become one, depending upon the actions of the lenders under
the Senior Secured Credit Facility and Lucent Facility.
We believe that our cash, investments held for future capital
expenditures and borrowings available under our Senior Secured Credit Facility
and the Lucent Facility, will be sufficient to meet our liquidity needs through
the completion of the 14 additional networks currently under development and
anticipated to be completed in the first half of 2000, although we can give no
assurance in this regard. Thereafter we will require additional financing.
However, in the event that our plans change, the assumptions upon which our
plans are based prove inaccurate, we expand or accelerate our business plan or
we determine to consummate acquisitions, the foregoing sources of funds may
prove insufficient to complete all of the networks, 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 by the
Company, capitalized 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. Failure to obtain such financing could result in the delay or abandonment
of some or all of our development and expansion plans and expenditures. Such a
failure could also limit our ability to make principal and interest payments on
our indebtedness and meet our dividend and redemption obligations with respect
to our preferred stock. The Company has no working capital or other credit
facility under which it may borrow for working capital and other general
purposes. We can give no assurance that such financing will be available to the
Company in the future or that, if such financing were available, it would be
available on terms and conditions acceptable to the Company.
YEAR 2000 COMPLIANCE
Similar to all businesses, we may be affected by the inability of
certain computer software to distinguish between the years 1900 and 2000 due to
a commonly-used programming convention. Unless such programs are modified or
replaced prior to January 1, 2000, calculations based on date arithmetic or
logical operations performed by such programs may be incorrect. In addition, the
Senior Secured Credit Facility and the Lucent Facility impose certain Year 2000
compliance obligations on the Company.
Management's plan to address the effect of the Year 2000 issue focuses
on the following areas: applications systems (including our billing system and
financial software), infrastructure (including personal computers and servers
used throughout the Company), and other third party business partners, vendors
and suppliers. Management's analysis and review of these areas is comprised
primarily of the following phases: developing an inventory of hardware, software
and embedded chips; assessing the degree to which each area is currently
compliant with Year 2000 requirements; performing renovations, repairs and
replacements as needed to attain compliance; testing to ensure compliance; and,
developing a contingency plan for each area if our initial efforts to attain
compliance are either unsuccessful or untimely.
Management completed the inventory and assessment phases of the project
during the fourth quarter of 1998. The renovation, repair and replacement phase
and the testing phase have commenced; however, we expect to continue these
phases throughout 1999.
Further, we have completed the initial installation and are continuing
the process of implementing new billing software systems, operational software
systems and financial and personnel software systems. Although these
implementations were made necessary by the expansion of our business and were
not directly related to Year 2000 issues, they have enabled us to utilize new
software for these purposes which the respective suppliers have certified as
Year 2000 compliant.
19
Costs incurred to date have primarily consisted of labor from the
redeployment of existing information services and operational resources. We
expect to spend approximately $150,000 for these Year 2000 compliance efforts
which will be expensed as incurred. This amount does not include the costs of
the new billing software, operational software and financial and personnel
software systems which we are implementing as a result of the expansion of our
business.
If the software applications of the local exchange carriers, long
distance carriers or others on whose services we depend or with which our
systems interact are not Year 2000 compliant, it could affect our systems which
could have a material adverse effect on our business, financial condition and
results of operations.
Although we do not presently anticipate a material business
interruption as a result of the Year 2000 issue, the worst case scenario if all
of our Year 2000 efforts fail would result in a daily loss of revenues of
approximately $250,000 calculated based upon our current revenues.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to the Company's operations result primarily
from changes in interest rates. The substantial majority of the Company's
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. The Company is
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. The Company has entered into an interest rate swap
agreement with a commercial bank to reduce the impact of changes in interest
rates on its outstanding variable rate debt. The agreement effectively fixes the
Company's interest rate on the $125 million of outstanding variable rate
borrowings under the Senior Secured Credit Facility due 2007. The interest rate
swap agreement terminates in April 2004.
The following table provides information about the Company's
significant financial instruments that are sensitive to changes in interest
rates (in millions):
Fair Future Principal Payments
Value on
September 1999 2000 2001 2002 2003 Thereafter Total
30, 1999
-------------------------------------------------------------------
Long-Term Debt
Fixed Rate:
Senior Discount Notes,
Interest payable at 12 1/2%,
Maturing 2008 $ 282.2 - - - - - $ 292.3 $ 292.3
Senior Notes,
Interest payable at 13 1/2 %,
Maturing 2009 275.0 - - - - - 275.0 275.0
Interest Rate Swap Derivative:
Variable to fixed
Senior Secured Credit Facility
Pay rate at September 30, 1999 - 9.113%(a)
Receive rate at September 30, 1999 - 6.075% 125.0 - - - 0.6 0.8 123.6 125.0
-------------------------------------------------------------------
Total $ 682.2 - - - $.6 $.8 $ 690.9 $ 692.3
===================================================================
(a) Pay interest rate is based on a variable rate, which at the Company's
option, is determined by either a base rate or LIBOR, plus, in each case, a
specified margin.
21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a discussion of an arbitration proceeding between the Company's
subsidiary, KMC Telecom, Inc. and Wang Laboratories, Inc. (as successor to
I-Net, Inc.) see Item 3 of the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 and Item 1 of the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999.
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.
Not Applicable.
ITEM 5. OTHER INFORMATION.
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
4.1 First Supplemental Indenture dated as of May 24, 1999 among
KMC Telecom Holdings, Inc., KMC Telecom Financing, Inc. and
The Chase Manhattan Bank, as Trustee, to the Indenture dated
as of January 29, 1998 between KMC Telecom Holdings, Inc. and
The Chase Manhattan Bank, as Trustee.
4.2 Indenture dated as of May 24, 1999 among KMC Telecom Holdings,
Inc., KMC Telecom Financing, Inc. and The Chase Manhattan
Bank, as Trustee, including specimen of KMC Telecom Holdings,
Inc.'s 13 1/2% Senior Notes due 2009.
4.3 Purchase Agreement dated May 19, 1999 among KMC Telecom
Holdings, Inc. and Morgan Stanley & Co. Incorporated, Credit
Suisse First Boston Corporation, First Union Capital Markets
Corp., CIBC World Markets Corp., BancBoston Robertson Stephens
Inc. and Wasserstein Perella Securities, Inc.
4.4 Collateral Pledge and Security Agreement made and entered into
as of May 24, 1999 by KMC Telecom Financing, Inc. in favor of
The Chase Manhattan Bank, as Trustee.
4.5 Registration Rights Agreement dated May 19, 1999 among KMC
Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated,
Credit Suisse First Boston Corporation, First Union Capital
Markets Corp., CIBC World Markets Corp., BancBoston Robertson
Stephens Inc. and Wasserstein Perella Securities, Inc.
27.1 Financial Data Schedule.
22
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended September 30, 1999.
23
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 12, 1999
KMC TELECOM HOLDINGS, INC.
(Registrant)
By: /S/ MICHAEL A. STERNBERG
-------------------------------
Michael A. Sternberg
President and Chief Executive Officer
(Principal Executive Officer)
By: /S/ JAMES D. GRENFELL
-------------------------------
James D. Grenfell
Executive Vice President, Chief
Financial Officer and Secretary
(Principal Financial Officer)
24
EXHIBIT INDEX
NO. DESCRIPTION
4.1 First Supplemental Indenture dated as of May 24, 1999 among
KMC Telecom Holdings, Inc., KMC Telecom Financing, Inc. and
The Chase Manhattan Bank, as Trustee, to the Indenture dated
as of January 29, 1998 between KMC Telecom Holdings, Inc. and
The Chase Manhattan Bank, as Trustee.
4.2 Indenture dated as of May 24, 1999 among KMC Telecom Holdings,
Inc., KMC Telecom Financing, Inc. and The Chase Manhattan
Bank, as Trustee, including specimen of KMC Telecom Holdings,
Inc.'s 13 1/2% Senior Notes due 2009.
4.3 Purchase Agreement dated May 19, 1999 among KMC Telecom
Holdings, Inc. and Morgan Stanley & Co. Incorporated, Credit
Suisse First Boston Corporation, First Union Capital Markets
Corp., CIBC World Markets Corp., BancBoston Robertson Stephens
Inc. and Wasserstein Perella Securities, Inc.
4.4 Collateral Pledge and Security Agreement made and entered into
as of May 24, 1999 by KMC Telecom Financing, Inc. in favor of
The Chase Manhattan Bank, as Trustee.
4.5 Registration Rights Agreement dated May 19, 1999 among KMC
Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated,
Credit Suisse First Boston Corporation, First Union Capital
Markets Corp., CIBC World Markets Corp., BancBoston Robertson
Stephens Inc. and Wasserstein Perella Securities, Inc.
27.1 Financial Data Schedule.