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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 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 __________
COMMISSION FILE NUMBER: 333-47235
[LOGO]
21ST CENTURY TELECOM GROUP, INC.
(Exact Name of Registrant as specified in its charter)
ILLINOIS 36-4076758
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
WORLD TRADE CENTER
350 NORTH ORLEANS
SUITE 600
CHICAGO, ILLINOIS 60654
(312) 955-2100
(Address and telephone number of principal executive office)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
On August 13, 1999, 4,225,606.6 shares of the Registrant's Common Stock were
outstanding.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
PAGE
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998 1
Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 1999 and June 30, 1998 2
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1999
and June 30, 1998 3
Consolidated Statement of Changes in Shareholders' Equity for the Six Months
Ended June 30, 1999 4
Notes to Unaudited Interim Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 13
When used in this Report, the words "intends," "expects," "plans," "estimates,"
"projects," "believes," "anticipates," and similar expressions are intended to
identify forward-looking statements. Except for historical information contained
herein, the matters discussed and the statements made herein concerning the
Company's future prospects are "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act. Although the Company believes that its plans, intentions and expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such plans, intentions or expectations will be achieved. There
can be no assurance that future results will be achieved, and actual results
could differ materially from the forecast and estimates. Important factors that
could cause actual results to differ materially include, but are not limited to,
the Company's limited operating history, including a history of losses,
significant capital requirements, high leverage, debt service requirements and
restrictive covenants related to its outstanding securities, ability to complete
DRS Network construction, its dependence on key personnel and ability to manage
growth. The Company's future results may also be impacted by other risk factors
listed in its Registration Statement filed on Form S-4 (333-47235). In addition,
such forward-looking statements are necessarily based upon assumptions and
estimates that may be incorrect or imprecise and involve known and unknown risks
and other facts. Given these uncertainties, prospective investors are cautioned
not to place undue reliance upon such forward-looking statements. The Company
undertakes no obligation to publicly release any revisions to the
forward-looking statements or reflect events or circumstances after the date of
this document.
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1999 1998
ASSETS ----------------- -----------------
------ (UNAUDITED)
CURRENT ASSETS
Cash and cash equivalents $ 57,892,594 $ 72,901,622
Accounts receivable, less allowances
of $432,569 and $1,376, respectively 546,412 157,082
Short term investments 58,794,425 98,464,936
Inventory 13,167,920 10,385,575
Prepaid expenses and other 723,734 598,878
----------------- -----------------
Total current assets 131,125,085 182,508,093
PROPERTY, PLANT AND EQUIPMENT
Leasehold improvements 6,718,390 5,647,709
Capital equipment leases 2,492,137 -
Property, plant and equipment 103,364,799 57,475,153
Less: accumulated depreciation (8,684,643) (4,814,143)
----------------- -----------------
Property, plant and equipment, net 103,890,683 58,308,719
OTHER ASSETS
Restricted cash collateral reserve 1,921,496 1,796,880
Prepaid franchise fees 3,751,698 3,685,961
Debt issuance costs, net of amortization of $2,174,490 and $1,386,138, respectively 5,812,753 6,601,105
Deferred franchise costs, net of amortization of $713,406 and $623,681, respectively 314,424 350,144
Bank commitment fee, net of amortization of $182,254 and $78,604, respectively 794,652 898,302
Deferred mapping and design, net of amortization of $116,117 and $93,071, respectively 21,833 44,880
Goodwill, net of amortization of $340,220 10,127,436 -
Other deferred costs 167,465 149,889
----------------- -----------------
Total other assets 22,911,757 13,527,161
----------------- -----------------
Total assets $ 257,927,525 $ 254,343,973
----------------- -----------------
----------------- -----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 16,764,403 $ 10,688,242
Accrued severance 1,420,123 1,230,000
Notes payable 2,000,000 -
Accrued expenses and other 2,627,979 1,261,982
----------------- -----------------
Total current liabilities 22,812,505 13,180,224
Senior discount notes, net of discount of $127,056,396 and $140,681,223, respectively 236,078,604 222,453,777
Notes payable 2,000,000 -
Other long term obligations 1,986,754 -
----------------- -----------------
Total noncurrent liabilities 240,065,358 222,453,777
----------------- -----------------
Total liabilities 262,877,863 235,634,001
REDEEMABLE PREFERRED STOCK
13 3/4% senior cumulative exchangeable preferred stock, $.01 par value
59,336.39 and 55,458.12 shares outstanding, respectively 57,001,608 52,617,006
SHAREHOLDERS' EQUITY
Class A convertible 8% cumulative preferred stock, no par value 26,569,801 24,611,966
Voting and non-voting common stock 11,082,538 7,862,836
Common shares to be issued 82,398 123,432
Retained deficit (99,686,683) (66,505,268)
----------------- -----------------
Total shareholders' equity (61,951,946) (33,907,034)
----------------- -----------------
Total liabilities and shareholders' equity $ 257,927,525 $ 254,343,973
----------------- -----------------
----------------- -----------------
See accompanying Notes to the Consolidated Financial Statements.
1
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------------------------- ------------------------------------
1999 1998 1999 1998
---------------- ---------------- ---------------- ----------------
OPERATING REVENUES $ 2,668,239 $ 139,878 $ 3,793,640 $ 205,369
---------------- ---------------- ---------------- ----------------
OPERATING EXPENSES
Network operations 2,769,533 976,091 4,415,952 1,492,559
Sales and marketing 2,309,668 1,046,835 3,502,922 1,995,827
General and administrative 4,750,534 3,126,518 8,418,052 6,212,440
Depreciation and amortization 2,539,650 876,508 4,239,416 1,644,928
---------------- ---------------- ---------------- ----------------
Total operating expenses 12,369,385 6,025,952 20,576,342 11,345,754
---------------- ---------------- ---------------- ----------------
OPERATING LOSS (9,701,146) (5,886,074) (16,782,702) (11,140,385)
OTHER (INCOME) EXPENSE
Interest expense 6,610,270 6,233,635 12,953,573 9,837,357
Interest income (1,807,641) (3,183,987) (3,697,143) (5,073,175)
Amortization of debt issuance costs 394,479 393,481 799,846 610,297
---------------- ---------------- ---------------- ----------------
Total other (income) expense 5,197,108 3,443,129 10,056,276 5,374,479
---------------- ---------------- ---------------- ----------------
NET LOSS (14,898,254) (9,329,203) (26,838,978) (16,514,864)
Preferred stock requirements (3,213,137) (2,894,399) (6,342,437) (4,840,934)
---------------- ---------------- ---------------- ----------------
NET LOSS ATTRIBUTABLE TO COMMON SHARES $ (18,111,391) $ (12,223,602) $ (33,181,415) $ (21,355,798)
---------------- ---------------- ---------------- ----------------
---------------- ---------------- ---------------- ----------------
Weighted average common
shares outstanding 4,219,671.2 3,493,273.7 3,999,538.2 3,366,572.0
BASIC AND DILUTED LOSS PER SHARE $ (4.29) $ (3.50) $ (8.30) $ (6.34)
---------------- ---------------- ---------------- ----------------
---------------- ---------------- ---------------- ----------------
See accompanying Notes to the Consolidated Financial Statements.
2
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS
ENDED JUNE 30,
-----------------------------------------
1999 1998
----------------- -----------------
OPERATING ACTIVITIES
Net loss $ (26,838,978) $ (16,514,864)
Adjustments to reconcile net loss to net
cash used for operating activities:
Depreciation and amortization 4,239,416 1,644,928
Amortization of debt discount 13,624,827 9,683,893
Amortization of debt issuance costs 799,846 610,297
Stock compensation 211,160 228,889
Changes in operating assets and liabilities:
Receivables, net (45,588) (12,907)
Other current assets (2,897,211) (1,714,623)
Accounts payable 4,635,327 867,464
Accrued expenses and other
current liabilities 647,211 835,378
Noncurrent assets and liabilities, net (814,322) (227,014)
----------------- -----------------
NET CASH USED FOR OPERATING ACTIVITIES (6,438,312) (4,598,559)
----------------- -----------------
INVESTING ACTIVITIES
Capital expenditures (45,587,313) (21,948,861)
Purchases and sales/maturities of short term investments, net 39,670,511 (10,000,000)
Acquisition, net of cash acquired (2,653,914) -
----------------- -----------------
NET CASH USED FOR INVESTING ACTIVITIES (8,570,716) (31,948,861)
----------------- -----------------
FINANCING ACTIVITIES
Proceeds from issuance of senior discount notes - 200,000,000
Proceeds from issuance of class A preferred stock,
net of issuance costs - 1,521,381
Issuance costs related to senior discount notes - (7,886,825)
Proceeds from issuance of exchangeable preferred stock,
net of issuance costs - 48,025,236
Payment under interim credit facility - (8,000,000)
----------------- -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES - 233,659,792
----------------- -----------------
(DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (15,009,028) 197,112,372
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 72,901,622 1,404,975
----------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 57,892,594 $ 198,517,347
----------------- -----------------
----------------- -----------------
See accompanying Notes to the Consolidated Financial Statements.
3
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1999
(UNAUDITED)
COMMON CLASS A
SHARES TO BE PREFERRED
TOTAL COMMON STOCK ISSUED STOCK
--------------------- -------------------- ----------------- ------------------
BALANCES, DECEMBER 31, 1998 $ (33,907,034) $ 7,862,836 $ 123,432 $ 24,611,966
Net loss (26,838,978) - - -
Stock issuances 3,150,702 3,150,702 - -
Accrued preferred stock dividends (3,944,937) - - 1,123,965
Preferred stock accretion (439,665) - - 833,870
Issuance of shares to be issued - 41,034 (41,034) -
Stock options 211,160 211,160 - -
Repurchase of options (183,194) (183,194) - -
--------------------- -------------------- ----------------- ------------------
BALANCES, JUNE 30, 1999 $ (61,951,946) $ 11,082,538 $ 82,398 $ 26,569,801
--------------------- -------------------- ----------------- ------------------
--------------------- -------------------- ----------------- ------------------
COMMON COMMON CLASS A
SHARES TO BE SHARE PREFERRED
RETAINED DEFICIT COMMON SHARES ISSUED WARRANTS SHARES
--------------------- ---------------- -------------- -------------- -------------
BALANCES, DECEMBER 31, 1998 $ (66,505,268) 3,493,965.7 27,429.2 1,747,066.0 1,554.8
Net loss (26,838,978) - - - -
Stock issuances - 700,156.1 - - -
Accrued preferred stock dividends (5,068,902) - - - -
Preferred stock accretion (1,273,535) - - - -
Issuance of shares to be issued - 9,118.7 (9,118.7) - -
Stock options - - - - -
Repurchase of options - - - - -
--------------------- ---------------- -------------- -------------- -------------
BALANCES, JUNE 30, 1999 $ (99,686,683) 4,203,240.5 18,310.5 1,747,066.0 1,554.8
--------------------- ---------------- -------------- -------------- -------------
--------------------- ---------------- -------------- -------------- -------------
See accompanying Notes to Consolidated Financial Statements.
4
21ST CENTURY TELECOM GROUP, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF CONSOLIDATION AND PRESENTATION
21st Century Telecom Group, Inc. ("21st Century" or the "Company") is a
Chicago-based company incorporated in October 1992. 21st Century is an
integrated, facilities-based communications company, which seeks to be the first
provider of bundled voice, video and high-speed Internet and data services in
selected midwestern markets beginning with Chicago's Area 1. The City of Chicago
has awarded the Company a 15-year renewable franchise for Area 1. Area 1
stretches more than 16 miles along Chicago's densely populated lakefront skyline
including the nation's second largest business and financial district.
The Company's accounting and reporting principles conform to generally
accepted accounting principles. All significant intercompany accounts and
transactions have been eliminated in consolidation. Management believes the
Company operates in only one reportable segment.
The condensed consolidated financial statements have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These financial statements include estimates and assumptions that
affect the reported amounts of assets and liabilities and the amounts of
revenues and expenses. Actual amounts could differ from those estimates.
However, in the opinion of management of the Company, the financial statements
include all adjustments, consisting only of normally recurring adjustments,
necessary for a fair statement of results for each period shown. These
unaudited consolidated financial statements should be read in conjunction with
the financial statements and notes thereto included in the Company's latest
Annual Report on Form 10-K. Certain amounts reported in prior periods have been
reclassified to conform to the current period presentation.
2. ACQUISITION OF BUSINESS
On February 26, 1999, the Company acquired EnterAct Corp. ("EnterAct"), a
Chicago-based provider of Internet access and commercial data services. EnterAct
had approximately 50 employees. The majority of EnterAct's approximately 10,000
customers were residential dial up Internet access customers; however, a
significant portion of EnterAct's 1998 calendar year revenues were derived from
Internet, data and consulting services provided to its business customer base.
The Company issued 696,994 shares of its no par value common stock valued by the
Company at $4.50 per share to certain officers of EnterAct and agreed to pay an
additional $6,500,000. The Company paid $2,500,000 at the closing and issued two
non-interest bearing notes totaling $4 million. The notes are payable to
executives of EnterAct over two years, one half due on the first anniversary
date and one half due on the second anniversary date. This acquisition was
accounted for as a purchase and accordingly the purchased assets and assumed
liabilities have been recorded at their fair market values at the date of
acquisition. The purchase price exceeded the estimated fair market value of the
net assets acquired resulting in goodwill in the amount of $10,467,656, which is
being amortized using the straight line method over 10 years. In addition, a
stock option plan was approved and options were awarded to certain employees of
EnterAct. EnterAct became the Company's Business Services Group, developing,
marketing and selling data and telephony services to the business community.
Since the acquisition of EnterAct was accounted for as a purchase its
results of operations have been included with the Company's since the date of
acquisition. Had the Company reflected the acquisition as of the beginning of
the period, its revenues would have increased approximately $710,000 for the six
months ended June 30, 1999. Comparatively, had the Company reflected the
acquisition as of January 1, 1998, its revenues would have increased
approximately $740,000 and $1,269,000 for the three and six months ended June
30, 1998, respectively. All other reportable supplemental pro forma information
would not be materially different than the reported amounts.
5
3. EARNINGS PER SHARE
Basic per share amounts were based on weighted average common shares
outstanding, excluding common stock equivalents, of 4,219,671.2 and 3,493,273.7
shares for the three months ended June 30 1999 and 1998, respectively and
3,999,538.2 and 3,366,572.0 shares for the six months ended June 30, 1999 and
1998, respectively. Given the anti-dilutive effect of including common stock
equivalents in the calculation, diluted earnings per share amounts are not
presented.
At June 30, 1999, common shares issuable pursuant to options and
warrants included: (1) 1,308,196 common share warrants related to the Class A
Convertible 8% Cumulative Preferred Stock, (2) 438,870 common share warrants
related to 13 3/4% Senior Cumulative Exchangeable Preferred Stock, (3)
1,250,000 options issued in connection with certain Directors' guarantee of a
loan, (4) 707,987.17 vested employee stock options, and (5) 18,994.7 common
share warrants issued to a financial advisor. The net loss attributable to
common shares on which the basic earnings per share calculation is based,
reflects the net loss increased by the amount of preferred dividends and
accretion related to the Class A Convertible 8% Cumulative Preferred Stock
and 13 3/4% Senior Cumulative Exchangeable Preferred Stock.
At June 30, 1998, common shares issuable pursuant to options and warrants
included: (1) 1,308,196 common share warrants related to the Class A Convertible
8% Cumulative Preferred Stock, (2) 438,870 common share warrants related to the
13 3/4% Senior Cumulative Exchangeable Preferred Stock, (3) 1,250,000 options
issued in connection with certain Directors' guarantee of a loan, (4) 330,072.2
vested employee stock options, and (5) 18,994.7 stock warrants issued to a
financial advisor. The net loss attributable to common shares, on which the
basic earnings per share calculation is based, reflects the net loss increased
by the amount of preferred dividends and accretion related to the Class A
Convertible 8% Cumulative Preferred Stock and 13 3/4% Senior Cumulative
Exchangeable Preferred Stock.
4. CLASS A CONVERTIBLE 8% CUMULATIVE PREFERRED STOCK
PREFERRED
SHARES AMOUNT
-------------- -----------------
December 31, 1998 1,554.8 $ 24,611,966
Accrued Dividends - 1,123,965
Accretion - 833,870
-------------- -----------------
June 30, 1999 1,554.8 $26,569,801
-------------- -----------------
-------------- -----------------
5. 13 3/4% SENIOR CUMULATIVE EXCHANGEABLE PREFERRED STOCK
PREFERRED
SHARES AMOUNT
December 31, 1998 55,458.12 $ 52,617,006
February 15, 1999 Stock Dividend 1,906.37 -
May 17, 1999 Stock Dividend 1,971.90 -
Accrued Dividends 3,944,937
Accretion - 439,665
-------------- -----------------
June 30, 1999 59,336.39 $57,001,608
-------------- -----------------
-------------- -----------------
On June 8, 1999, the Company declared a quarterly dividend of .034375 share
of 13 3/4% Senior Cumulative Exchangeable Preferred Stock per each share of
Exchangeable Preferred Stock outstanding as of August 1, 1999, payable on August
16, 1999. An additional 2,039.69 shares of 13 3/4% Senior Cumulative
Exchangeable Preferred stock will be issued on August 16, 1999 in settlement of
these dividends.
6
6. STOCK BASED COMPENSATION PLANS
Effective January 30, 1997, the Company established a common stock option
plan. No options were granted under this plan until October 1997. Options to
purchase 728,667.8 shares of the Company's stock were originally granted under
the plan of which 628,476.9 were outstanding as of June 30, 1999. Generally,
options vest over 48 months from the date of employment and expire after ten
years. Options vested under this plan as of June 30, 1999, totaled 410,916.1.
Effective June 18, 1999, the Board of Directors voted to suspend the common
stock option plan. No further awards will be granted. The Plan shall remain in
effect with respect to all outstanding awards until such time as those
outstanding awards are exercised, canceled, or otherwise terminated. The balance
of shares reserved for the plan shall be allocated to one or more existing
plans.
Effective April 14, 1998, the Company established three stock option plans:
the Executive Plan, the Key Management Plan, and the Employee Plan.
Under the Executive Plan, 331,200 options are available for grant to two
executive officers of the Company. As of June 30, 1999, all 331,200 shares
available under the Executive Plan were awarded. Effective March 6, 1998,
278,200 options were awarded to an executive officer. The exercise price of the
278,200 shares was established at $1.12 per share which is less than the $4.50
per share fair market value determined by the Board of Directors. One half of
the 278,200 shares awarded on March 6, 1998 or 139,100 shares vested immediately
and a total of $470,158 was recorded as compensation expense as a result of the
vesting of the 139,100 options. On April 14, 1998, an executive officer was
awarded 53,000 options under the Executive Plan at an exercise price of $4.50
per share, which was determined by the Board of Directors to be the fair market
value of the underlying common stock. All options vest over 48 months from the
date of employment and expire after ten years. At June 30, 1999, 209,758.1
options were vested.
Under the Key Management Plan and the Employee Plan, 150,000 and 50,000
options, respectively, were available for grant. As of June 30, 1999, a total of
154,000 options were granted under the Key Management Plan, 23,500 of which
vested immediately. A total of 41,100 options were granted under the Employee
Plan, 2,550 of which vested immediately. The exercise price of options under
both plans, which was determined by the Board of Directors to be the fair market
value of the underlying common stock, is $4.50 per share. All options under
these plans vest over four years beginning July 1, 1999 and expire 10 years from
date of grant.
Effective February 26, 1999, the Company established three new additional
stock option plans related to the former employees of EnterAct. EnterAct was
acquired by the Company on February 26, 1999. The plans are: the 21st Century
Telecom Group, Inc. 1999 Stock Incentive Plan (the "1999 Stock Incentive Plan"),
the 21st Century Telecom Group, Inc. 1999 ISP Stock Plan (the "1999 ISP Stock
Plan"), and the 21st Century Telecom Group, Inc. ISP Employee Stock Option Plan
(the "ISP Employee Stock Option Plan").
Under the 1999 Stock Incentive Plan 60,000 options are available for grant
primarily to specifically named former employees of EnterAct. On February 26,
1999, 51,000 of the shares available under the 1999 Stock Incentive Plan were
awarded to such employees with an additional 4,205 options awarded to newly
hired employees of the Company in March 1999 and 4,905 options awarded to newly
hired employees of the Company in April 1999. Options related to both awards
have an exercise price of $4.50 which is equal to the $4.50 fair market value
determined by the Board of Directors. All options vest at 25% of the total
shares subject to the option, so that the option is fully vested on the fourth
anniversary of the grant date. At June 30, 1999, there were no options vested.
Under the 1999 ISP Stock Plan 599,958 options are available for grant to
specifically named former employees of EnterAct. On February 26, 1999, all
599,958 shares available under the 1999 ISP Stock Plan were awarded at various
exercise prices with the vesting status determined by the respective measurement
dates. The series "A" option price is $35.26 that is subject to a measurement
date of the second anniversary date of the grant and expires on the seventh
anniversary date of the grant. The series "B" option price is $45.33 that is
subject to a measurement date of the second anniversary date of the grant and
expires on the seventh anniversary date of the grant. The series "C" option
price is $65.48 that is subject to a measurement date of the third anniversary
date of the grant and expires
7
on the eighth anniversary date of the grant. Unless terminated, all options
vest at 100% on the measurement date provided the fair market value per share
of the stock is equal to or greater than the exercise price per share on the
measurement date. If on the measurement date the fair market value per share
of the stock is less than the exercise price per share the option shall
terminate in its entirety. Depending upon the reason and timing for
termination of employment, there are specific provisions that allow the
employee to exercise vested shares for a period up to one year after
termination of employment. Specific vesting guidelines related to change of
Company control or death or disability of the employee could result in 100%
vesting of options prior to the measurement dates previously stated. At June
30, 1999, there were no options vested.
Under the ISP Employee Stock Option Plan 98,703 options are available for
grant to specifically named former employees of EnterAct. The ISP Employee Stock
Option Plan was created by the Company as a substitute for EnterAct's previous
option plan. On February 26, 1999, 98,678 shares available under the 1999 ISP
Employee Stock Option Plan were awarded at an exercise price of $4.50 which is
equal to the $4.50 fair market value determined by the Board of Directors. All
options vest at 50% on the first anniversary of the original grant date, 75% on
the second anniversary of the original grant date and 100% on the third
anniversary of the original grant date. Depending upon the reason for
termination of employment, there are specific provisions that allow the employee
to exercise vested shares within 60 days of termination of employment. Options
expire after ten years from the date of grant. At June 30, 1999, 61,263 options
were vested.
7. COMMITMENTS AND CONTINGENCIES
On June 30, 1999, the Company entered into a three-year master equipment
lease with Cisco Systems Capital Corporation under which the Company may lease
computer equipment as needed. This lease is effectively a financing arrangement
that allows the Company to finance up to $3 million in equipment. Total lease
payments are dependent upon the types and quantities of equipment needed. As of
June 30, 1999, no equipment had been leased.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a discussion and analysis of the historical results of
operations and financial condition of 21st Century Telecom Group, Inc. (the
"Company") and factors affecting the Company's financial resources. This
discussion should be read in conjunction with the consolidated financial
statements, including the notes thereto, set forth herein under "Financial
Statements" and the Company's Quarterly Report on Form 10-Q for the three
months ended March 31, 1999 and the Company's Annual Report on Form 10-K for
the transition period from April 1, 1998 to December 31, 1998. This
discussion contains forward-looking statements which are qualified by
reference to, and should be read in conjunction with, the Company's
discussion regarding forward-looking statements as set forth in this report.
GENERAL
21st Century was awarded a franchise in 1996 by the City of Chicago that
allows for the construction of the Distributed Ring-Star (DRS) Network in
Chicago's Area 1. Under this 15-year renewable license, the Company is granted
unrestricted access to the public right-of-way to construct, operate and
maintain its DRS Network to all residential and commercial subscribers. In March
1998, the Company was awarded a franchise to provide cable service to the
Village of Skokie. Construction of the Skokie system began during the second
quarter 1999. In March 1999, the Company was awarded a franchise in the Village
of Northbrook. In June 1999, the Company applied for franchises in Areas 2, 3
and 4 in the City of Chicago. The Company's principal focus remains the
development of its communications business in Chicago's Area 1.
The Company has incurred net losses in each year since its inception, and
as of June 30, 1999, the Company had an accumulated deficit of $99,686,683. As
the Company continues to expand its operations, it anticipates that it will
continue to incur net losses during the next several years as a result of (i)
substantially increased depreciation and amortization from the construction of
networks, (ii) significantly increased operating expenses as it builds its
subscriber base and (iii) interest charges associated with the Senior Discount
Notes. There can be no assurance that growth in the Company's revenues or
subscriber base will occur or that the Company will be able to achieve or
sustain profitability or positive cash flow.
The Company acquired EnterAct Corp. ("EnterAct") on February 26, 1999. The
acquistion was accounted for as a purchase. As such, its results of operations
have been included since the acquisition date.
RESULTS OF OPERATIONS
REVENUES
The Company generated subscriber revenues of $2,668,239 and $3,793,640 for
the three and six months ended June 30, 1999 and $139,878 and $205,369 for the
three and six months ended June 30, 1998. The increased subscriber revenues
resulted from the installation of service into contracted buildings on the new
DRS network and sales efforts to increase penetration of services into these
buildings. The acquisition of EnterAct, the Company's Business Services Group
("BSG"), contributed to approximately 60% of the total increase in revenues
during the six months ended June 30, 1999 when compared to the corresponding
prior period. The Company's BSG offers dial-up access to the Internet, as well
as an expanding line of commercial business services, including, web hosting,
Internet consulting, co-location and networking. At June 30, 1999, the Company
was providing service to approximately 19,000 voice, video and data connections
in 74 bulk MDU's and 322 right of entry ("ROE") buildings as well as over 8,600
dialup Internet connections and approximately 2,200 business data and telephony
connections. As of June 30, 1999, there were 4,240 backlogged connection orders
for bulk MDU and ROE customers.
EXPENSES
The Company incurred operating expenses of $12,369,385 and $20,576,342 for
the three and six months ended June 30, 1999, and $6,025,952 and $11,345,754 for
the three and six months ended June 30, 1998. The increase in operating expenses
resulted from activities required to accelerate the network build-out, operate
the franchise and deliver services. Approximately, $1,815,000 and $2,253,000 of
the increased operating expenses for the three and six months ended June 30,
1999 was due to the acquisition of EnterAct.
9
NETWORK OPERATIONS
The component of operating expenses that represents network operating costs
related to the delivery of cable and internet services increased $1,793,442 and
$2,923,393 during the three and six months ended June 30, 1999, when compared to
the corresponding prior periods. Of this increase, $1,237,000 and $1,744,000 for
the respective periods relate to increases in the direct costs of providing
services to customers such as the cost of video programming, license and fees,
access and connection costs for telephony and internet. The remaining increase
is directly related to the continued ramp-up in the design and construction of
the network and addition of personnel.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses were $7,060,202 and
$11,920,974 for the three and six months ended June 30, 1999 and $4,173,353 and
$8,208,267 for the three and six months ended June 30, 1998. The increase in
selling, general and administrative expenses reflects the Company's acquisition
and servicing of subscribers, promotion costs, and the addition of employees to
support Information Technology functions established within the Company, as well
as certain key sales and marketing positions. During the fourth quarter of 1998,
the Company established a state-of-the-art call center staffed with customer
service professionals and technical support specialists available 24 hours a
day, seven days a week. This has contributed to the increase in general and
administrative expenses for the three and six months ended June 30, 1999 when
compared to the corresponding prior periods.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization costs were $2,539,650 and $4,239,416 for the
three and six months ended June 30, 1999 and $876,508 and $1,644,928 for the
three and six months ended June 30, 1998. The increase in depreciation and
amortization costs is primarily attributable to the increase in plant placed
into service as the Company continues to buildout its network, goodwill
amortization relating to the purchase of EnterAct, and depreciation on vehicles
being capitalized under a master fleet lease arrangement.
INTEREST AND OTHER CHARGES
Interest expense increased $376,635 and $3,116,216 during the three and six
months ended June 30, 1999, when compared to the corresponding prior periods.
The increase was due primarily to the amortization of the debt discount
associated with the Senior Discount Notes having been issued in February 1998,
thus the six months ended June 30,1998 received less than a full period of
amortization. Amortization of issuance costs on Senior Discount Notes was
$394,479 and $799,846 during the three and six months ended June 30, 1999 and
$393,481 and $610,297 for the three and six months ended June 30, 1998. These
charges resulted from the issuance costs associated with the Senior Discount
Notes issued in February 1998 and their subsequent amortization. The increase in
interest and other charges was partially offset by capitalized interest on
construction work in process.
NET LOSS
For the three months ended June 30, 1999 and 1998, the Company incurred
net losses amounting to $14,898,254 and $9,329,203. For the six months ended
June 30, 1999 and 1998, the Company incurred net losses amounting to
$26,838,978 and $16,514,864 respectively. The Company expects its net losses
to continue to increase as it introduces new services and as the Company
continues to build-out the DRS Network and seeks to expand its business.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities was $6,438,312 for the six months
ended June 30, 1999, and $4,598,559 for the six months ended June 30, 1998. Net
cash used for operating activities for the six months ended June 30, 1999 and
1998 resulted principally from the Company's net loss from operations and
increases in the amount of inventory on hand. These items were partially
offset by amortization of the discount on the 12 1/4% Senior Discount Notes,
10
amortization of debt issuance costs, depreciation expense, stock compensation
expenses and the increase in accounts payable.
Cash flows used for investing activities totaled $8,570,716 in the six
months ended June 30, 1999. Cash flows used for investing activities totaled
$31,948,861 in the six months ended June 30, 1998. Cash requirements in the six
months ended June 30, 1999 consisted of costs for continued deployment of the
network in the Area 1 franchise and installing and facilitating the telephone
switching equipment in the Telephone Operations Center (TOC), which is also
located at the corporate headquarters. The sale and maturity of short term
investments, which was net of purchases, offset the cash used to continue to
build-out the network. On February 26, 1999, the Company acquired EnterAct, a
Chicago-based provider of Internet access and commercial data services. EnterAct
had approximately 50 employees. The majority of EnterAct's approximately 10,000
customers are residential dial up Internet access customers; however, a
significant portion of EnterAct's 1998 calendar year revenues were derived from
Internet, data and consulting services provided to its business customer base.
In connection with this transaction, the Company issued 696,994 shares of its no
par value common stock to certain officers of EnterAct and agreed to pay an
additional $6,500,000. The Company paid $2,500,000 at the closing and issued two
non-interest bearing notes totaling $4 million. The notes are payable to
executives of EnterAct over two years, one half due on the first anniversary
date and one half due on the second anniversary date. In addition, a stock
option plan was approved and options were awarded to certain employees of
EnterAct. EnterAct became the Company's Business Services Group developing,
marketing and selling data and telephone services to the business community.
Cash requirements for the six months ended June 30, 1998 consisted primarily of
the cost of building and equipping the NOC and facilitating the corporate
headquarters and network construction.
Cash flow from financing activities was $233,659,792 in the six months
ended June 30, 1998. In the six months ended June 30, 1998, the private sale of
$ 200 million in Senior Discount Notes; the sale of $ 50 million in Exchangeable
Preferred Stock; and the sale of Class A Preferred Stock; generated a net of
$192,113,175, $48,025,236, and $1,521,381, respectively. This was offset by the
$8,000,000 repayment of the interim credit facility.
The cost of network development, construction and start-up activities of
the Company has required and will continue to require substantial capital. The
Company estimates that its aggregate capital expenditure requirements related to
DRS Network construction in Area 1 until completion in mid-2000, will total
approximately $220 million, of which approximately $100 million has been spent
since the construction of Area 1 was initiated. The Company will fund these
expenditures from the net proceeds of the sale of the 12 1/4% Senior Discount
Notes and the 13 3/4% Senior Cumulative Exchangeable Preferred Stock. In order
to retain funds available to support its operations, the Company has no
expectation of paying cash interest on the Senior Discount Notes or cash
dividends on the Exchangeable Preferred Stock prior to February 15, 2003. The
Company may require additional financing in the future if it begins to develop
additional franchise areas or if the development of Area 1 in Chicago is delayed
or requires costs in excess of current expectations. There can be no assurance
that the Company will be able to obtain any additional debt or equity financing,
or that the terms thereof will be favorable to the Company or its existing
creditors or investors. On August 5, 1998 the Company entered into a $40 million
bank revolving credit facility with a number of banks to provide supplemental
financing. On October 30, 1998 the Company entered into Amendment No. 1 to its
bank revolving credit facility which adjusted certain operating covenants. On
February 26, 1999, the Company entered into a letter of credit which was secured
by $2 million under its bank revolving credit facility. The letter of credit
serves as security for a promissory note due to executives of EnterAct. On June
30, 1999, the Company entered into a three-year master equipment lease with
Cisco Systems Capital Corporation under which the Company may lease computer
equipment as needed. This lease is effectively a financing arrangement that
allows the Company to finance up to $3 million in equipment. Total lease
payments are dependent upon the types and quantities of equipment needed. As of
June 30, 1999, no equipment had been leased.
IMPACT OF YEAR 2000
The Company has been actively and aggressively working to ensure Year 2000
compliance which included an awareness program started in the third quarter of
1998. The Company has initiated a formal program to address the Year 2000 issue
that includes a project office. The Company has substantially completed a
comprehensive inventory and assessment of Information Technology (IT) and non-IT
related systems and equipment that may be affected by Year 2000 issues. The
Company has contracted with a third party to assist with its Year 2000
assessment. The Company has completed the replacement of all financial systems
to meet Year 2000 compliance. Substantially all of
11
the remaining critical business systems have been certified by the vendors to
be Year 2000 compliant. The Company's testing plan may include unit testing
as well as regression analysis. The replacement and remediation of IT and
non-IT systems is approximately 80% to 85% complete and is on target for
completion in the third quarter of 1999. The Company is assessing the Year
2000 readiness of its critical vendors and suppliers and has sent letters
inquiring as to their status regarding their Year 2000 readiness. The Company
will perform additional procedures as necessary to evaluate risks associated
with third parties and will consider these risks when establishing
contingency plans. The Company is developing contingency plans to mitigate
the potential disruptions that may result from Year 2000 issues. These plans
may include securing alternative sources for critical vendors and suppliers,
as well as other measures considered appropriate by management and is on
target for completion in the third quarter of 1999.
While the Company believes its efforts to avoid any material adverse effect
on the Company's operations or financial condition will be successful, given the
complexity and risks, there can be no assurance these efforts will be
successful. Risks include, but are not limited to, the readiness of vendors,
suppliers, and remediation projects. However, the Company does not anticipate
any disruptions in the ability to provide its products and services subsequent
to December 31, 1999. The Company has not incurred incremental costs to date and
believes the total cost of the Year 2000 project will not have a material effect
on its results of operations.
12
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibits are listed in the Exhibit Index.
(b) Reports on Form 8-K
None.
13
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT
HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND
IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Robert J. Currey President, Chief Executive Officer
- ------------------------- and Director August 13, 1999
Robert J. Currey
/s/ Ronald D. Webster Chief Financial Officer August 13, 1999
- --------------------------
Ronald D. Webster
14
EXHIBIT INDEX
- --------------------------------------------------------------------------------
Exhibit Number Description of Exhibits
- --------------------------------------------------------------------------------
3.1* Amended Articles of Incorporation
- --------------------------------------------------------------------------------
3.2* By-laws
- --------------------------------------------------------------------------------
4.1* Indenture dated February 15, 1998 between the Company, as
Issuer, and State Street Bank and Trust, as Trustee, with
respect to the 12 1/4 Senior Discount Notes Due 2008
- --------------------------------------------------------------------------------
4.2* Form of the 12 1/4 Senior Discount Notes Due 2008
- --------------------------------------------------------------------------------
4.3* Indenture dated as of February 15, 1998 between the Company
and IBJ Stirred Bank & Trust Company, as Trustee, with
respect to the Exchange Debenture
- --------------------------------------------------------------------------------
4.4* Form of the 13 3/4 Senior Cumulative Exchangeable Preferred
Stock Due 2010
- --------------------------------------------------------------------------------
4.5* Registration Rights Agreement dated as of February 2, 1998
by and among the Company and Credit Suisse First Boston
Corporation, BancAmerica Robertson Stephens and BancBoston
Securities, Inc., as Initial Purchasers
- --------------------------------------------------------------------------------
10.1* Franchise Agreement dated as of June 24, 1996 by and among
the City of Chicago and the Company
- --------------------------------------------------------------------------------
10.2* License Agreement dated as of October 27, 1994 by and among
the Chicago Transit Authority and the Company
- --------------------------------------------------------------------------------
10.3* CSG Master Subscriber Management System Agreement dated as
of May 28, 1997 by and among CSG Systems, Inc. and the
Company
- --------------------------------------------------------------------------------
10.4* Telemarketing Consultation Agreement dated as of August 5,
1997 by and among the Company and ITI Marketing Services,
Inc.
- --------------------------------------------------------------------------------
10.5* Pole Attachment Agreement dated as of April 3, 1996 by and
among the Company and Commonwealth Edison Company
- --------------------------------------------------------------------------------
10.6* Pole Attachment Agreement dated as of November 14, 1998 by
and among the Company and Ameritech--Illinois
- --------------------------------------------------------------------------------
10.7* Office Lease dated January 31, 1997 by and among the
Company and LaSalle National Bank
- --------------------------------------------------------------------------------
10.8* Franchise Agreement dated as of March 16, 1998 by and
between the Village of Skokie, Illinois and 21st Century
Cable TV of Illinois, Inc.
- --------------------------------------------------------------------------------
10.9* Interconnection Agreement dated as of May 5, 1997 by and
between Ameritech Information Industry Services and 21st
Century Telecom of Illinois, Inc.
- --------------------------------------------------------------------------------
10.10* Network Products Purchase Agreement by and between Northern
Telecom Inc. and the Company
- --------------------------------------------------------------------------------
21.1* Subsidiaries of the Company
- --------------------------------------------------------------------------------
27.1 Financial Data Schedule
- --------------------------------------------------------------------------------
*Incorporated herein by reference to the Company's S-4 Registration Statement
filed on March 3, 1998
(Commission File No. 333-47235).
15