<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
Form 8-K
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
__________________
Date of Report (Date of earliest event reported): December 17, 1999
(December 12, 1999)
RCN Corporation
---------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 0-22825 22-3498533
- --------------------------------------------------------------------------------
(State or other jurisdiction (Commission File No.) (I.R.S. Employer
of incorporation or Identification Number)
organization)
105 Carnegie Center
Princeton, NJ 08540
---------------------------------------
(Address of principal executive office)
(609) 734-3700
----------------------
(Registrant's telephone number, including area code)
Not Applicable
----------------------------------
(Former name, former address and former fiscal year, if applicable)
<PAGE>
Item 5. Other Events
The registrant has announced that it has entered into a definitive
agreement with respect to the acquisition of 21st Century Telecom Group, Inc.
Pro forma financial statements of RCN Corporation and financial statements for
21st Century Telecom Group, Inc. are filed as Exhibit 99.1 hereto.
Item 7. Exhibits
23.1 Consent of Independent Accountants for 21st Century Telecom Group, Inc.
99.1 Index to Financial Statements
<PAGE>
SIGNATURE
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 hereunto duly authorized.
RCN Corporation
By: /s/ John J. Jones
-----------------------------
John J. Jones
Executive Vice President,
General Counsel, Corporate
Secretary
Date: December 17, 1999
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion in this
Form 8-K of our report dated February 5, 1999 covering 21st Century Telecom
Group, Inc.'s consolidated financial statements as of December 31, 1998 and
March 31, 1998 and the results of its operations and its cash flows for the nine
months ended December 31, 1998 and for each of the two years in the period ended
March 31, 1998. It should be noted that we have not audited any financial
statements of the company subsequent to December 31, 1998 or performed any audit
procedures subsequent to the date of our report.
Chicago, Illinois /s/ Arthur Andersen LLP
December 17, 1999
<PAGE>
EXHIBIT 99.1
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
I. Unaudited Pro Forma Consolidated Financial Statements for RCN Corporation
-------------------------------------------------------------------------
Unaudited Pro Forma Consolidated Statements of Operations for
the year ended December 31, 1998................................................. F - 1
Unaudited Pro Forma Consolidated Statements of Operations for the nine
months ended September 30, 1999.................................................. F - 2
Unaudited Pro Forma Balance Sheets as of September 30, 1999...................... F - 3
II. Audited Consolidated Financial Statements for 21st Century Telecom Group,
-------------------------------------------------------------------------
Inc. for the Year Ended December 31, 1998
-----------------------------------------
Report of Independent Public Accountants......................................... F - 7
Consolidated Balance Sheets as of December 31, 1998 and March 31, 1998........... F - 8
Consolidated Statements of Operations for the nine months ended December 31,
1998 and for the years ended March 31, 1998 and 1997............................. F - 9
Consolidated Statements of Changes in Shareholders' Equity for the nine
months ended December 31, 1998 and for the years ended March 31, 1998 and
1997............................................................................. F - 10
Consolidated Statements of Cash Flows for the nine months ended December
31, 1998 and for the years ended March 31, 1998 and 1997......................... F - 11
Notes to Consolidated Financial Statements....................................... F - 12
III. Unaudited Interim Consolidated Financial Statements for 21st Century
--------------------------------------------------------------------
Telecom Group, Inc.
-------------------
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998....... F - 27
Consolidated Statements of Operations for the three and nine months ended
September 30, 1999 and September 30, 1998........................................ F - 28
Consolidated Statements of Cash Flows for the nine months ended September
30, 1999 and September 30, 1998.................................................. F - 29
Consolidated Statements of Changes in Shareholders' Equity for the nine
months ended September 30, 1999.................................................. F - 30
Notes to Unaudited Interim Consolidated Financial Statements..................... F - 31
</TABLE>
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
The following unaudited pro forma consolidated statements of operations set
forth the historical statements of operations of RCN for the year ended December
31, 1998 and the nine months ended September 30, 1999 and as adjusted for the
definitive agreement for acquisition of 21st Century Telecom Group, Inc as if
such transaction had been consummated on the first day of the respective periods
for the purposes of the pro forma statements of operations and on September
30,1999 for the purpose of the pro forma balance sheet.
Management believes that the assumptions used provide a reasonable basis on
which to present such unaudited pro forma statements of operations. The
unaudited pro forma statements of operations should be read in conjunction with
the financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in our 10-K for the year ended December 31,
1998.
The unaudited pro forma statements of operations are provided for information
purposes only and should not be construed to be indicative of RCN's results of
operations had the transaction and events described above been consummated on
the dates assumed, and are not necessarily indicative of RCN's future results of
operations or financial condition.
RCN Corporation
Unaudited Pro Forma Consolidated Statement of Operations
Year Ended December 31, 1998
($ in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
21st Century Historical 21st Century Historical
RCN For The Three Months For The Nine Months
Historical Ended March 31, 1998 Ended December 31, 1998
<S> <C> <C> <C>
Operating revenues $ 210,940 $ 65 $ 874
Operating expenses
Costs & expenses excluding depreciation & amortization 262,352 4,550 19,024
Depreciation and amortization 89,088 768 3,877
Acquired in-process research & development 18,293 -
--------------------------------------------------------------
Total operating expenses 369,733 5,318 22,901
Operating loss (158,793) (5,253) (22,027)
Interest expense (112,239) (4,426) (19,433)
Interest income 58,679 2,493 8,671
Other (expense) (1,889)
--------------------------------------------------------------
Loss before income taxes (214,242) (7,185) (32,789)
Benefit for income taxes (4,998) - -
--------------------------------------------------------------
Loss before minority interest and equity in unconsolidated
entity (209,244) (7,185) (32,789)
Minority interest in loss of consolidated entities 17,162 - -
Equity in (loss) of unconsolidated entities (12,719) - -
--------------------------------------------------------------
Loss before cumulative effect of change in
accounting principal (204,801) (7,185) (32,789)
Weighted average common
shares outstanding 61,187,354
Basic and diluted loss per share before cumulative effect
of change in accounting principle $ (3.35)
<CAPTION>
Adjustments
for the 21st
Century Acquisition (1) Pro Forma
<S> <C> <C>
Operating revenues $ 211,879
Operating expenses
Costs & expenses excluding depreciation & amortization 285,926
Depreciation and amortization 60,800 (2) 154,533
Acquired in-process research & development - 18,293
----------- -------------
Total operating expenses 60,800 458,752
Operating loss (60,800) (246,873)
Interest expense 23,859 (3) (112,239)
Interest income 69,843
Other (expense) (1,889)
----------- -------------
Loss before income taxes (36,941) (291,157)
Benefit for income taxes (4,998)
----------- -------------
Loss before minority interest and equity in unconsolidated
entity (36,941) (286,159)
Minority interest in loss of consolidated entities 17,162
Equity in (loss) of unconsolidated entities (12,719)
----------- -------------
Loss before cumulative effect
of change in accounting principal (36,941) (281,716)
Weighted average common
shares outstanding 4,738,340 (4) 65,925,694
Basic and diluted loss per share before cumulative
effect of change in accounting principle $ (4.40)
</TABLE>
F-1
<PAGE>
RCN Corporation
Unaudited Pro Forma Consolidated Statement of Operations
Nine Months Ended September 30, 1999
($ in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Adjustments
RCN 21st Century for the 21st
Historical Historical Century Acquisition (1) Proforma
<S> <C> <C> <C> <C>
Operating revenues $ 203,939 $ 6,944 $ - $ 210,883
Operating expenses
Selling, general and administrative costs & expenses
excluding depreciation & amortization 283,381 27,546 - 310,927
Depreciation and amortization 98,948 7,387 45,600 (2) 151,935
---------------------------------------------- -----------
Total operating expenses 382,329 34,933 45,600 462,862
Operating loss (178,390) (27,989) (45,600) (251,979)
Interest expense (112,285) (20,226) 20,226 (3) (112,285)
Interest income 56,222 4,966 - 61,188
Other (expense) (467) (53) - (520)
Gain on the sale of subsidiary 8,930 - - 8,930
---------------------------------------------- -----------
Loss before income taxes (225,990) (43,302) (25,374) (294,666)
Benefit for income taxes (3,971) - - (3,971)
---------------------------------------------- -----------
Loss before minority interest and equity in unconsolidated
entity (222,019) (43,302) (25,374) (290,695)
Minority interest in loss of consolidated entities 19,847 - - 19,847
Equity in (loss) of unconsolidated entities (20,714) - - (20,714)
---------------------------------------------- -----------
Loss before extraordinary charge (222,886) (43,302) (25,374) (291,562)
Weighted average common
shares outstanding 70,416,096 4,738,340 (4) 75,154,436
Basic and diluted loss per share before extraordinary
charge $ (3.28) $ (3.99)
</TABLE>
F-2
<PAGE>
RCN Corporation
Unaudited Pro Forma Balance Sheet
As of September 30, 1999
($ in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Adjustments
RCN 21st Century for the 21st
Historical Historical Century Acquisition (1) Pro Forma
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and temporary cash investments $ 181,058 $ 25,095 4,021 (9) $ 210,174
Short-term Investments 1,411,445 48,941 (245,635) (5) 1,214,751
Accounts receivable from related parties 8,185 - - 8,185
Accounts receivable 53,221 832 - 54,053
Reserve for doubtful accounts (11,217) - - (11,217)
Material and supply inventory 11,858 15,763 - 27,621
Prepayments and other 25,383 996 - 26,379
Deferred income taxes 793 - - 793
Investments restricted for debt service 23,589 - - 23,589
------------------------------------------------------- ------------
Total current assets 1,704,315 91,627 (241,614) 1,554,328
Property, Plant and Equipment, net 736,096 131,391 - 867,487
Investments restricted for debt service 10,531 4,021 (4,021) (9) 10,531
Investments 192,886 - - 192,886
Intangible assets, net 151,741 9,866 304,041 (6) 465,648
Deferred charges and other assets 58,710 10,522 (5,417) (5) 63,815
------------------------------------------------------- ------------
Total Assets $ 2,854,279 $ 247,427 $ 52,989 $ 3,154,695
======================================================= ============
</TABLE>
F-3
<PAGE>
RCN Corporation
Unaudited Pro Forma Balance Sheet
As of September 30, 1999
($ in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
Adjustments
RCN 21st Century for the 21st
Historical Historical Century Acquisition Pro Forma
<S> <C> <C> <C> <C>
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ 385 $ 2,000 $ - $ 2,385
Accounts payable to
related parties 11,027 - - 11,027
Accounts payable 66,081 15,693 - 81,774
Advance billings and
customer deposits 16,324 - - 16,324
Accrued interest 17,346 - - 17,346
Accrued telephony cost of sales 21,858 - - 21,858
Accrued expenses 59,511 3,480 - 62,991
------------------------------------------------- ----------
Total current liabilities 192,532 21,173 - 213,705
Long-term debt 1,743,186 247,445 (243,202) (5) 1,747,429
Other deferred credits 23,070 - - 23,070
Minority interest 128,829 - - 128,829
Commitments and
contingencies
Preferred stock 248,807 59,298 (59,298) (7) 248,807
Common shareholders'
equity (deficit) 517,855 (80,489) 355,489 (8) 792,855
------------------------------------------------- ----------
Total liabilities and
shareholders' equity $ 2,854,279 $ 247,427 $ 52,989 $3,154,695
================================================= ==========
</TABLE>
F-4
<PAGE>
The Pro Forma adjustments, as described below, are keyed to the corresponding
amounts shown in the relevant statement.
(1) On December 13, 1999, RCN announced that it had signed a definitive
agreement to acquire 21st Century Telecom Group, Inc. The closing of the
transaction is subject to (1) the receipt of consents to remove certain
covenants from 21st Century's Senior Discount Notes and Exchangeable
Preferred Stock, (2) a cash tender offer for the Notes at a price not
exceeding 101% of their accreted value, and (3) the exchange of the debt
securities underlying the Exchangeable Preferred Stock for RCN Common,
valued at not more than 101% of their liquidation preference. The closing is
also subject to customary conditions, such as antitrust and other regulatory
approvals, and no assurances can be given that any transaction will occur.
The transaction is expected to be accounted for under the purchase method of
accounting.
A summary of the transaction is as follows:
<TABLE>
<S> <C>
Approximate expected fair value of RCN common stock to be issued $215,310
Approximate expected fair value of options to be exchanged 51,990
Approximate expected liabilities to be assumed 23,400
Approximate expected cash tender offer for 21st Century 12 1/4%
Senior Discount Notes 252,900
-------
Approximate fair value of assets to be acquired $543,600
</TABLE>
The definitive agreement contains provisions for certain future contingent
consideration based on the achievement of certain operational measures. Such
consideration has not been reflected in the purchase price due to
uncertainty of realization. Because of the recent occurrence of this
agreement, RCN has not commenced a study for the purpose of allocating the
purchase price paid. For purposes of the
F-5
<PAGE>
pro forma statement, the purchase price has been allocated based on the net
book values of the assets with the excess preliminarily allocated to
goodwill as follows:
Current assets $ 91,600
Property, plant & equipment 131,400
Other assets 16,600
Goodwill 304,000 (Estimated life of 5 years)
-------
$543,600
The final purchase price allocation may ascribe values differently than
outlined above, ascribe values to other assets including, among other
things, subscribers base and acquired workforce, and may result in varying
estimated useful lives. The effect of such variations is not currently
estimable based on the data currently available.
(2) Adjustment to reflect the change in depreciation and amortization for the
effect of the fair value adjustment of the net assets of 21st Century acquired
(see Note 1). Pro Forma adjustments were not assumed for income tax benefits
associated with the pro forma adjustments for additional depreciation and
amortization because the realization of such benefits would be uncertain.
(3) Adjustment to reflect the decrease in interest expense resulting from RCN's
cash tender offer for 21st Century's 12 1/4% Senior Discount Notes, which is a
condition of closing.
(4) Adjustment for additional RCN shares to be issued in consideration for the
transaction.
(5) Adjustment for the cash tender offer of 21st Century's 12 1/4% Senior
Discount Notes, which is a condition of closing, based on 101% of the accreted
value at September 30, 1999, and related adjustment for write off of associated
debt issuance costs.
(6) Adjustment for allocation of excess cost over fair value of net assets
acquired. Such excess was preliminarily allocated to goodwill (see Note 1)
(7) Adjustment for exchange of securities underlying 21st Century's
Exchangeable Preferred Stock for RCN Common Stock.
(8) Adjustment at fair value for issuance of approximately 4.7 million shares
of RCN common stock and the conversion of 21st Century stock options to
approximately 1.3 million RCN stock options, and the adjustment for the
elimination of the shareholders' equity of 21st Century.
(9) Adjustment to reflect the release of restricted cash in connection with the
redemption of 21st Century's 12 1/4% Senior Discount Notes. (see note 5).
F-6
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
21st Century Telecom Group, Inc.:
We have audited the accompanying consolidated balance sheets of 21st
Century Telecom Group, Inc. (the "Company") (an Illinois corporation) and
subsidiaries as of December 31, 1998 and March 31, 1998, and the related
consolidated statements of operations, cash flows and shareholders' equity for
the nine months ended December 31, 1998 and for each of the two years in the
period ended March 31, 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of 21st Century
Telecom Group, Inc. and subsidiaries as of December 31, 1998 and March 31, 1998,
and the results of their operations and their cash flows for the nine months
ended December 31, 1998 and for each of the two years in the period ended March
31, 1998, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Chicago, Illinois
February 5, 1999
F-7
<PAGE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, March 31,
ASSETS 1998 1998
------ ---------------- ----------------
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 72,901,622 $ 217,640,238
Accounts receivable, less allowances of $1,376 and $0, respectively 157,082 10,359
Short term investments 98,464,936 10,000,000
Inventory 10,385,575 1,991,690
Prepaid expenses and other 598,878 168,152
---------------- ----------------
Total current assets 182,508,093 229,810,439
Property, Plant and Equipment
Leasehold improvements 5,647,709 4,010,868
Other property, plant and equipment 57,475,153 16,588,094
Less: accumulated depreciation (4,814,143) (1,193,236)
---------------- ----------------
Property, plant and equipment, net 58,308,719 19,405,726
Other Assets
Restricted cash collateral reserve 1,796,880 1,796,880
Prepaid franchise fees 3,685,961 3,505,706
Debt issuance costs, net of amortization of $1,386,138 and $218,411,
respectively 6,601,105 7,668,414
Deferred franchise costs, net of amortization of $623,681 and $489,093,
respectively 350,144 463,989
Bank commitment fee, net of amortization of $78,604 898,302 -
Deferred mapping and design, net of amortization of $93,071 and $58,501,
respectively 44,880 79,450
Other deferred costs 149,889 2,000
---------------- ----------------
Total other assets 13,527,161 13,516,439
---------------- ----------------
Total assets $ 254,343,973 $ 262,732,604
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 10,688,242 $ 6,691,683
Accrued severance 1,230,000 200,000
Accrued expenses and other 1,261,982 1,860,410
---------------- ----------------
Total current liabilities 13,180,224 8,752,093
Noncurrent Liabilities
Debentures payable - 28,849
Interest payable - 42,203
Senior discount notes, net of discount of $140,681,223 and $159,656,983,
respectively 222,453,777 203,478,017
---------------- ----------------
Total noncurrent liabilities 222,453,777 203,549,069
---------------- ----------------
Total liabilities 235,634,001 212,301,162
Redeemable Preferred Stock
13 3/4% senior cumulative exchangeable preferred stock, $.01 par value,
55,458.12 and 50,000 shares outstanding, respectively 52,617,006 46,492,812
Shareholders' Equity
Class A convertible 8% cumulative preferred stock, no par value,
1,554.8 shares outstanding 24,611,966 21,751,665
Voting and non-voting common stock (no par value; issued and outstanding shares,
3,493,965.7 at December 31, 1998 and 3,489,467.9 at March 31, 1998;
secondary common share warrants outstanding, 1,747,066 at December 31, 1998
and 1,741,738.9 at March 31, 1998) 7,862,836 6,974,836
Common shares to be issued (no par value; 27,429.2 shares) 123,432 -
Retained deficit (66,505,268) (24,787,871)
---------------- ----------------
Total shareholders' equity (33,907,034) 3,938,630
---------------- ----------------
Total liabilities and shareholders' equity $ 254,343,973 $ 262,732,604
================ ================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-8
<PAGE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Year
For the Nine Ended March 31,
Months Ended -----------------------------------------------
December 31, 1998 1998 1997
-------------------- --------------------- --------------------
<S> <C> <C> <C>
Operating revenues $ 873,898 $ 189,023 $ 27,480
Operating expenses
Network operations 2,678,047 2,023,310 200,911
Sales and marketing 3,533,731 2,213,723 -
General and administrative 12,812,019 8,003,196 2,337,534
Depreciation and amortization 3,876,779 1,411,847 170,108
-------------------- --------------------- --------------------
Total operating expenses 22,900,576 13,652,076 2,708,553
-------------------- --------------------- --------------------
Operating loss (22,026,678) (13,463,053) (2,681,073)
Interest expense (18,232,959) (3,722,947) (437,843)
Interest income 8,670,695 2,373,867 301,624
Amortization of issuance costs (1,199,770) (218,411) -
-------------------- --------------------- --------------------
Net loss (32,788,712) (15,030,544) (2,817,292)
Preferred stock requirements (8,928,707) (4,234,463) (478,981)
-------------------- --------------------- --------------------
Net loss attributable to common shares $ (41,717,419) $ (19,265,007) $ (3,296,273)
==================== ===================== ====================
Weighted average common
shares outstanding 3,493,836.5 2,615,061.0 1,988,365.0
Basic and diluted loss per share $ (11.94) $ (7.37) $ (1.66)
==================== ===================== ====================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-9
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED DECEMBER 31, 1998 AND FOR THE YEARS ENDED MARCH 31,
1998 AND 1997
<TABLE>
<CAPTION>
Common Class A
Shares to Preferred Retained Unearned
Total Common Stock be Issued Stock Deficit Compensation
------------- ------------- ----------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balances, March 31, 1996 $ (1,744,556) $ 488,001 $ $ $(2,226,557) $ (6,000)
Net loss (2,817,292) (2,817,292)
Stock issuances 1,421,281 1,421,281
Accrued preferred stock dividends (280,795) (280,795)
Class A preferred stock proceeds
allocated to related common share
warrants 4,324,549 4,324,549
Class A preferred stock issuance
costs allocated to related common
share warrants (286,927) (286,927)
Preferred stock accretion (198,186) (198,186)
Amortization of unearned
compensation 2,889 2,889
Related party purchase, in excess
of cost (3,381,300) (3,381,300)
------------ ------------- ----------- ------------ ------------ -------------
Balances, March 31, 1997 (2,960,337) 2,565,604 (5,522,830) (3,111)
Net loss (15,030,544) (15,030,544)
Reclassification of Class A preferred
stock to permanent equity 16,794,963 16,794,963
Stock issuances 2,597,380 2,597,380
Exchange of initial and debt warrants
for voting and non voting common
shares
Accrued preferred stock dividends (973,958) 1,872,892 (2,846,850)
Preferred stock accretion (87,014) 1,300,633 (1,387,647)
Class A preferred stock proceeds
allocated to related common share
warrants 825,037 (825,037)
Class A preferred stock issuance
costs allocated to related common
share warrants (10,834) 10,834
Exchangeable Preferred Stock
proceeds allocated to related
common shares warrants 2,700,000 2,700,000
Exchangeable Preferred stock
issuance costs allocated to related
common share warrants (106,636) (106,636)
Stock option accrual 972,865 972,865
Stock compensation 28,800 28,800
Amortization of unearned
compensation 3,111 3,111
------------ ------------- ---------- ------------ ------------- -------------
Balances, March 31, 1998 3,938,630 6,974,836 21,751,665 (24,787,871)
Net loss (32,788,712) (32,788,712)
Stock issuances 223,432 44,211 123,432 55,789
Accrued preferred stock dividends (5,437,332) 1,620,938 (7,058,270)
Preferred stock accretion (686,841) 1,183,574 (1,870,415)
Stock options 843,789 843,789
------------ ------------- ---------- ------------ ------------ -------------
Balances, December 31, 1998 $(33,907,034) $ 7,862,836 $ 123,432 $ 24,611,966 $(66,505,268) $ -
============ ============= ========== ============ ============ =============
<CAPTION>
Common Common Class A
Shares to Share Preferred
Common Shares be Issued Warrants Shares
-------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Balances, March 31, 1996 1,683,000.0
Net loss
Stock issuances 691,343.6
Accrued preferred stock dividends
Class A preferred stock proceeds
allocated to related common share
warrants 1,161,307.6
Class A preferred stock issuance
costs allocated to related common
share warrants
Preferred stock accretion
Amortization of unearned
compensation
Related party purchase, in excess
of cost
------------- ------------ ----------- ----------
Balances, March 31, 1997 2,374,343.6 1,161,307.6
Net loss
Reclassification of Class A preferred
stock to permanent equity 1,380.3
Stock issuances 168.2
Exchange of initial and debt warrants
for voting and non voting common
shares 1,100,724.4
Accrued preferred stock dividends
Preferred stock accretion
Class A preferred stock proceeds
allocated to related common share
warrants 141,561.3
Class A preferred stock issuance
costs allocated to related common
share warrants
Exchangeable Preferred Stock
proceeds allocated to related
common shares warrants 438,870
Exchangeable Preferred stock
issuance costs allocated to related
common share warrants
Stock option accrual
Stock compensation 14,399.9
Amortization of unearned
compensation
------------- ----------- ----------- ----------
Balances, March 31, 1998 3,489,467.9 1,741,738.9 1,548.5
Net loss
Stock issuances 4,497.8 27,429.2 5,327.1 6.3
Accrued preferred stock dividends
Preferred stock accretion
Stock options
------------- ----------- ----------- ----------
Balances, December 31, 1998 3,493,965.7 27,429.2 1,747,066.0 1,554.8
============= =========== =========== ==========
</TABLE>
F-10
<PAGE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year
For the Nine Ended March 31,
Months Ended -------------------------------------------
December 31, 1998 1998 1997
------------------- ------------------- --------------------
<S> <C> <C> <C>
Operating Activities
Net loss $ (32,788,712) $ (15,030,544) $ (2,817,292)
Adjustments to reconcile net loss to net
cash used for operating activities:
Depreciation and amortization 3,876,779 1,411,847 170,108
Amortization of debt discount 18,975,760 3,478,017
Amortization of debt issuance costs 1,199,770 218,411
Stock compensation 843,789 1,004,776 44,190
Common stock to be issued 123,432 - -
Changes in operating assets and liabilities:
Affiliate receivable and payable - - (372,819)
Receivables, net (146,723) 103,121 (27,480)
Other current assets (8,982,612) (2,299,723) (3,365,825)
Accounts payable (274,621) 3,154,912 (331,025)
Accrued expenses and other
current liabilities 963,330 - 147,533
Noncurrent assets and liabilities, net (1,308,343) (121,333) (358,156)
------------------ ------------------ -------------------
Net Cash Used for Operating Activities (17,518,151) (8,080,516) (6,910,766)
------------------ ------------------ -------------------
Investing Activities
Purchase of held-to-maturity securities (88,464,936) (10,000,000) -
Purchase of subscribers from affiliate - - (3,381,300)
Capital expenditures (38,305,421) (15,665,047) (246,863)
------------------ ------------------ -------------------
Net Cash Used for Investing Activities (126,770,357) (25,665,047) (3,628,163)
------------------ ------------------ -------------------
Financing Activities
Payable to bank (419,068) 419,068 -
Proceeds from senior discount notes - 200,000,000 -
Issuance costs related to senior discount notes - (7,886,825) -
Proceeds from issuance of exchangeable preferred
stock, net of issuance costs - 48,025,236 -
Cash paid for letters of credit - - (1,796,880)
Proceeds from (payments on) debentures (131,040) - 153,660
Proceeds from issuance of class A preferred stock,
net of issuance costs 100,000 2,597,380 20,267,604
Issuance of common stock - - 144,531
------------------ ------------------ -------------------
Net Cash Provided by (Used For) Financing Activities (450,108) 243,154,859 18,768,915
------------------ ------------------ -------------------
Increase (Decrease) in Cash and Cash Equivalents (144,738,616) 209,409,296 8,229,986
Cash and Cash Equivalents at Beginning of Period 217,640,238 8,230,942 956
------------------ ------------------ -------------------
Cash and Cash Equivalents at End of Period $ 72,901,622 $ 217,640,238 $ 8,230,942
================== ================== ===================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-11
<PAGE>
21st CENTURY TELECOM GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
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. At December 31,
1998, management believes the Company operates in only one reportable segment.
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. The consolidated financial statements include
two wholly-owned subsidiaries. There have been no significant intercompany
transactions or activities within or between these subsidiaries through December
31, 1998. On December 21, 1998 the Company changed its fiscal year end from
March 31 to December 31.
Cash and Cash Equivalents
Cash and cash equivalents at December 31, 1998 and March 31, 1998, consist
of cash on hand at certain banks, as well as investments with maturities of 90
days or less. The investments are stated at cost, which approximates market
value. All investments were purchased in accordance with debt restrictions.
Receivables
Receivables are reflected at their net realizable value.
Short Term Investments
Short term investments are held to maturity and are stated at cost which
approximates market value. At December 31, 1998 and March 31, 1998, short term
investments consisted of time deposit accounts, certificates of deposit and
money market deposits, with fixed rates of interest all with maturities of less
than one year. These investments were purchased in accordance with debt
restrictions.
Inventories
Inventory consists primarily of converters, modems and materials that will
be requisitioned for use in constructing the Company's network and is stated at
the lower of cost (principally the first-in, first-out method) or market.
Property, Plant and Equipment
Property, plant and equipment are stated at cost including labor and
overhead expenses associated with construction. Cost includes capitalized
interest on funds borrowed to finance construction. Capitalized interest for the
nine months ended December 31, 1998 was $780,680. Depreciation on property,
plant and equipment was computed by applying the straight-line method over the
estimated service lives for depreciable plant and equipment. Repairs of all
property, plant and equipment and minor replacements and renewals are charged to
expense as incurred. Major replacements and betterments are capitalized.
Leasehold improvements were depreciated on a straight-line basis over the term
of the lease, fifteen years. The Company began to depreciate leasehold
improvements in September 1997.
The lives of depreciable property, plant and equipment range from 3 to 15
years. Effective July 1, 1998, the estimated service lives for hub sites and
outside plant were changed from 7 to 13 years. In addition, the estimated
service lives for certain software and furniture and fixtures were changed from
5 to 7 years. These changes were made to correspond to industry norms for these
types of assets. These changes in depreciable lives resulted in a reduction of
depreciation expense of approximately $1,200,000.
F-12
<PAGE>
Deferred Franchise Costs
The Company has deferred franchise costs, including legal costs, associated
with obtaining the franchises from the City of Chicago and the Village of
Skokie. Deferred franchise costs are being amortized over five years.
Deferred Mapping and Design Costs
The Company has deferred certain mapping and design costs associated with
strand mapping the Area 1 region within the City of Chicago. Deferred mapping
and design costs are being amortized over three years.
Debt Issuance Costs
Costs associated with the issuance of the Company's debt securities (see
Note 5) have been capitalized and are being amortized using the effective
interest rate method.
Advertising Costs
The Company expenses the cost of advertising as incurred. Advertising
expense for the nine months ended December 31, 1998 was $1,270,592. The Company
did not incur significant advertising costs prior to April 1, 1998.
Revenue Recognition
The Company recognizes voice, video, Internet and data revenues as services
are provided to subscribers.
Accounting for Stock-Based Compensation
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation," for disclosure purposes.
However, it continues to recognize compensation cost based on Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." See
Note 9 for the disclosures required by SFAS No. 123.
Earnings Per Share
Basic per share amounts were based on weighted average common shares
outstanding, excluding common stock equivalents, of 3,493,836.5, 2,615,061.0 and
1,988,365.0 for the nine months ended December 31, 1998 and for the twelve
months ended March 31, 1998 and 1997, respectively. Given the anti-dilutive
effect of including common stock equivalents in the calculation, diluted
earnings per share amounts are not presented.
At December 31, 1998, common stock equivalents 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) 575,766.8 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 earning 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 March 31, 1998, these common stock equivalents included the following:
(1) 1,302,868.9 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) 287,829.9 employee
vested 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 March 31, 1997, these common stock equivalents included the following:
(1) 1,161,307.6 common share warrants related to the Class A Convertible 8%
Cumulative Preferred Stock, (2) 1,000,966.8 shares of voting and non-voting
common stock which replaced the initial and debt warrants associated with the
Class A Convertible 8% Cumulative Preferred Stock as discussed in Note 9, (3)
1,250,000 options issued in connection with certain Directors' guarantee of a
loan, and (4) 18,994.7 stock warrants issued to a financial advisor.
F-13
<PAGE>
Cash Flow Information
For the nine months ended December 31, 1998 and for the years ended March
31, 1998 and 1997, the Company has not paid any income taxes. For the nine
months ended December 31, 1998 and for the years ended March 31, 1998 and 1997,
the Company paid $131,040, $193,922 and $274,993, respectively, in interest.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Long-Lived Assets
The Company periodically reviews the values assigned to long-lived assets
such as property, plant and equipment and identifiable intangibles to determine
whether any impairments are other than temporary. If the impairment is
permanent, a loss is recognized. No impairment losses have been recognized by
the Company.
Disclosure of Fair Value of Financial Instruments
The carrying amount reported in the balance sheets for cash and cash
equivalents, accounts receivable, short term investments, accounts payable and
other current liabilities approximates fair value because of the short-term
maturity of these financial instruments. The carrying amount reported in the
balance sheets for the 12 1/4% Senior Discount Notes approximates fair value.
Reclassifications
Certain prior year balances have been reclassified to conform with the
current year presentation.
2. Property, Plant and Equipment
The components of property, plant and equipment follow:
<TABLE>
<CAPTION>
December 31, March 31, Estimated life
1998 1998 (years)
------------------ ------------------ -----------------
<S> <C> <C> <C>
Transmission and distribution systems $40,831,723 $14,994,770 3 - 13
Leasehold improvements 5,647,709 4,010,868 15
Other equipment 5,272,864 641,825 3 - 7
Furniture and fixtures 727,522 403,702 3 - 7
Construction in progress 10,643,044 547,797 N/A
---------------- ----------------
Property, plant and equipment, at cost 63,122,862 20,598,962
Less: accumulated depreciation (4,814,143) (1,193,236)
---------------- ----------------
Net property, plant and equipment $58,308,719 $19,405,726
================ ================
</TABLE>
Depreciation expense charged to operations for the nine months ended
December 31, 1998 and for the years ended March 31, 1998 and 1997 was
$3,629,017, $1,186,302 and $6,934, respectively.
3. Prepaid Franchise Fees
The Company was required to prepay $3,000,000 of franchise fees within
120 days of being awarded the franchise by the City of Chicago. In accordance
with the franchise agreement, the prepaid franchise fees earn interest for the
period outstanding at a rate equal to the Company's cost of borrowed funds. The
borrowing rate of the Company, at the time of the prepayment, was 10%. The
interest accrued on the prepaid franchise fees for the nine months ended
December 31, 1998 and for the years ended March 31, 1998 and 1997 amounted to
$226,027, $299,994, and $216,575, respectively. These prepaid franchise fees are
reduced as revenues are billed to customers.
F-14
<PAGE>
4. Related Party Transactions
The Company was related through some common ownership and common management
to 21st Century Technology Group, Inc. ("Technology").
In January 1997, the Company paid approximately $459,000 of accrued legal
fees to one of its directors, either individually or to entities controlled by
him, for legal services rendered by him to the Company in connection with the
Company's cable service offering and its obtaining the Chicago franchise.
5. Debt
A summary of debt outstanding at December 31, 1998 and March 31, 1998, is
as follows:
<TABLE>
<CAPTION>
December 31, March 31,
1998 1998
------------------- -------------------
<S> <C> <C>
Convertible Subordinated Debentures, Series 1, 25%, due 1998 $ - $ 52,702
Convertible Subordinated Debentures, Series 2, 25%, due 1999 28,849 28,849
12 1/4% Senior Discount Notes Due 2008 222,453,777 203,478,017
------------------- -------------------
Total $ 222,482,626 $ 203,559,568
=================== ===================
</TABLE>
Convertible Subordinated Debentures
Prior to February 1, 1997, all subordinated debentures were convertible to
common stock based on a conversion ratio of $2 to 1 share of common stock.
Conversion of $147,298 of the Series 1 convertible debentures occurred on
May 17, 1996. Conversion of $111,151 of the Series 2 convertible debentures
occurred on April 28, 1996. Conversion of $150,000 of the Series 3 convertible
debentures occurred on November 14, 1996. Conversion of $200,000 of the Series 4
convertible debentures and $196,854 of the Series 5 convertible debentures
occurred on January 31, 1997.
Total debenture conversions to common stock for Series 1 through 5
convertible debentures resulted in the issuance of 616,280 additional shares of
common stock between April 1996 and January 1997. (See Note 8 for conversion
effects on common shares outstanding.) Subsequent to January 31, 1997, these
debentures were no longer convertible.
During the three months ended September 30, 1998, the convertible
subordinated debentures, Series 1, at 25% interest, due 1998 in the amount of
$52,702 plus accrued interest was paid. In addition, the convertible
subordinated debentures, Series 2, at 25% interest, due 1999 in the amount of
$28,849 was reclassed from long term debt to short term debt and is included in
accrued expenses and other in the Consolidated Balance Sheet at December 31,
1998.
12 1/4% Senior Discount Notes Due 2008
On February 9, 1998, the Company issued $363,135,000 of 12 1/4% Senior
Discount Notes due 2008 (the "Notes"). The proceeds from the issue were
$200,000,000 which represent a yield to maturity on the Notes of 12 1/4%
(computed on a semi-annual bond equivalent basis). The discount and issuance
costs are being amortized through February 15, 2003 using the effective interest
rate method. Thereafter, cash interest accrues until the notes mature in 2008.
For the nine months ended December 31, 1998 and for the year ended March 31,
1998, the amortized discount totaled $18,975,760 and $3,478,017, respectively.
Issuance costs for the transaction totaled $7,886,825. The amount of
amortization recognized for the nine months ended December 31, 1998 and the year
ended March 31, 1998 was $1,199,770 and $218,411, respectively. The notes are
unsecured obligations.
The notes are redeemable at the Company's option in whole or part, on
February 15, 2003, 2004 and 2005, at a redemption price of 106.1250, 104.0833
and 102.0417, respectively and at the principal amount thereafter. In addition,
the Company has the right to redeem up to 1/3 of the Notes with the proceeds of
an initial public offering. The redemption price would also include accrued
interest earned through the date of redemption.
F-15
<PAGE>
Upon a change of control, each holder of Notes may require the Company to
purchase all or any portion of such holder's Notes at a purchase price equal to
101% of the Accreted Value thereof plus accrued and unpaid interest, if any, to
the date of purchase. Accreted value means, as of any date, the amount for each
$1,000 principal amount at maturity of the Senior Discount Notes as specified in
the terms of the Notes.
The Notes include certain restrictive covenants relating to, among other
things, limitations on additional indebtedness, payment of dividends, investment
options, asset sales, liens on assets and mergers and consolidations. The
Company is in compliance with the covenants at December 31, 1998.
Bank Revolving Credit Facility
On August 5, 1998, the Company entered into a revolving credit facility
with a number of banks for an aggregate amount of $40,000,000. As of December
31, 1998, no borrowings have been made under this facility. In connection with
the initiation of its bank revolving credit facility, as of December 31, 1998,
the Company incurred $976,906 in bank commitment fees and other related costs
which are being amortized on a straight-line basis over its five year term.
The credit facility contains general and financial covenants that place
certain restrictions on the Company. On October 30, 1998, the Company entered
into Amendment No. 1 to its bank revolving credit facility which adjusted
certain operating covenants. The Company is limited with respect to: the
incurrence of certain liens; the sale of assets under certain circumstances;
permitting any subsidiary distribution restrictions; certain consolidations;
mergers and transfers; and the use of loan proceeds.
6. Class A Convertible 8% Cumulative Preferred Stock
Preferred
Shares Amount
------------ --------------
March 31, 1996 -- --
January 30, 1997
Proceeds 1,380.3 $17,475,451
Issuance costs -- (1,159,469)
Accrued dividends -- 280,795
Accretion -- 198,186
----------- --------------
March 31, 1997 1,380.3 16,794,963
September 23, 1997
Proceeds 63.3 819,439
Issuance costs -- (49,166)
November 20, 1997
Proceeds 9.5 121,842
January 20, 1998
Proceeds 95.4 891,062
Accrued dividends 1,872,892
Accretion 1,300,633
----------- --------------
March 31, 1998 1,548.5 21,751,665
Stock issuance 6.3 55,789
Accrued dividends -- 1,620,938
Accretion -- 1,183,574
=========== ==============
December 31, 1998 1,554.8 $24,611,966
=========== ==============
On January 30, 1997 several investors contracted with the Company to
purchase 1,380.3 shares of the Company's Class A Convertible 8% Cumulative
Preferred Stock and initial, secondary and debt warrants for a purchase price of
$15,793.84 per share, totaling $21.8 million. A portion of the initial purchase
price was allocated to the common share warrants. The allocation was based on
the market value of the common stock at the date of the sale of the Class A
Convertible 8% Cumulative Preferred Stock and the number of related secondary
warrants, initial warrants and debt warrants associated with such preferred
stock. The fair market value of the common stock at the date of the sale was
estimated to be $2 per share. The number of secondary warrants associated with
the initial purchase amounted to 1,161,307.6. The number of initial and debt
warrants associated with the initial purchase was based on the number of voting
and non-voting common shares that these warrants were replaced with as a result
of a subsequent amendment to the related stock purchase agreement as discussed
below. These initial and debt warrants were replaced with 1,000,966.8 shares of
voting and non-voting common stock. This allocation resulted in $4,324,549 and
$17,475,451 being recorded as common stock and redeemable preferred stock,
respectively, at March 31, 1997. Issuance costs of $1,446,396 were incurred in
conjunction with the sale of the Class A Convertible 8% Cumulative Preferred
Stock. These issuance costs were allocated between the Class A Convertible 8%
Cumulative Preferred Stock and the related warrants based on the relative
portions of the proceeds allocated to each. The carrying value of the Class A
F-16
<PAGE>
Convertible 8% Cumulative Preferred Stock is being accreted to its redemption
value (using the effective interest method) over the four year period from the
date of the original preferred stock purchase agreement to the date the stock
becomes mandatorily redeemable under the original agreement or the date at which
the Class A preferred shareholders can compel sale of the Company under the
amended agreement, both dates being January 30, 2001. The Class A convertible 8%
Cumulative Preferred Stock is recorded on the balance sheet at the allocated
portion of the purchase price paid by investors, less the allocated portion of
the issuance costs, plus accrued and unpaid preferred stock dividends, plus
accretion. At March 31, 1997, certain of the provisions of the agreement were as
follows:
- Each preferred share is convertible into one thousand common shares.
- Dividends accrue daily on the aggregate amount paid at an annual rate
of 8%. Unpaid dividends compound on a semi-annual basis on June 30 and December
31. At the consummation of a qualified public offering, all accrued and unpaid
dividends would be converted into common stock without the issuance of
additional shares. A qualified public offering is one in which (1) the public
purchases at least $25 million of common stock, (2) the price per share paid is
at least twice the liquidation value per share of the Class A Convertible 8%
Cumulative Preferred Stock, (3) the common stock is traded on a national
exchange or The Nasdaq Stock Market, and (4) the shares issued and sold
represent at least 20% of the common stock outstanding after the public
offering.
- Upon consummation of a qualified public offering, all preferred shares
are required to be converted into common shares.
- At any time after the fourth anniversary of the date of the purchase
and before the earlier of the date of the consummation of a qualified public
offering or the seventh anniversary of the date of the purchase, each holder of
the stock has the right from time to time to require the Company to repurchase
all, but not less than all, of their shares held (the put arrangement). The
shares would be repurchased by the Company for the greater of: (1) the purchase
price paid by the holder of the stock, plus all accrued and unpaid dividends, or
(2) the market value of the shares.
- "Initial Warrants" were granted to the investors who may increase their
ownership percentage up to another 12%. These warrants expire on May 31, 2008.
The warrants are exercisable at $.000001 per share of common stock only if the
Company does not meet certain pre-established performance indicators. The
Company had until May 31, 1998 to meet these performance indicators.
- "Secondary Warrants" to purchase up to 1,331,774.8 shares of common
stock at $.000001 per share of common stock were also granted to the investors.
These secondary warrants expire on January 30, 2007.
- "Debt Warrants", in addition to the initial and secondary warrants
discussed above, will vest to the new investors if the Company does not receive
Board of Director approval by July 31, 1997, for a $50 million senior debt
financing arrangement. Under this provision the Company is to issue warrants to
purchase shares representing 2% of the outstanding common stock on the first day
of each month until the definitive document with respect to such debt is in
place. Any such warrants issued would expire ten years from the date of issue.
Any debt warrants would also be exercisable at $.000001 per share of common
stock.
During December 1997, the Company and its Class A Convertible 8% Cumulative
Preferred Stock shareholders negotiated a number of changes to the original
Stock Purchase Agreement. These changes were formally ratified on January 8 and
14, 1998. The original put arrangement as discussed above was removed and was
replaced by the right of the Class A preferred shareholders to require the sale
of the Company. The new provision provides that at any time and from time to
time after the fourth anniversary of the date of issuance of the senior discount
notes and senior cumulative exchangeable preferred stock and ending on the
earlier to occur of the consummation of a qualified public offering and the
seventh anniversary of the date of issuance of the senior discount notes, the
Class A preferred shareholders have the right to require the sale of the
Company. The liquidation value of the preferred stock is the sum of the original
cost plus any accrued and unpaid dividends. The right to obtain additional
common shares under the initial warrant and debt warrant provisions as discussed
above was removed and was replaced by an agreement to increase the Class A
preferred shareholders ownership on a fully diluted basis by an additional 8% by
issuing additional common stock. One-half of this additional stock is voting and
the other half is non-voting. A portion of the proceeds and issuance costs
associated with the sale of the Class A Convertible 8% Cumulative Preferred
stock were allocated to the initial and debt warrants and reflected in common
stock at March 31, 1997.
F-17
<PAGE>
In addition, the holders of the Class A preferred stock are collectively in
a position to control the taking of many significant corporate actions by the
Company, including the making of any significant capital commitments, the
incurrence of any significant indebtedness, merger and the payment of dividends
on the common stock, pursuant to agreements which provide that prior to taking
such actions, the Company will need to obtain the approval of the nominees to
the Board of Directors of the holders of the Class A preferred stock. These
rights have been modified by the covenants related to the 12 1/4% Senior
Discount Notes (see Note 5).
Of the $21.8 million for the related January 30, 1997 sale, $21.7 million
was received by March 31, 1997, with the remainder received by April 22, 1997.
The purchase resulted in the preferred shareholders having an approximate 37%
ownership interest in the Company on a fully diluted basis excluding the
contingently issuable common shares from the exercise of the initial warrants
and the debt warrants. The proceeds from this preferred stock offering were used
to (1) repay a $5 million revolving credit note to LaSalle Northwest National
Bank, (2) purchase the subscriber base of a related party located in the Chicago
franchise area for $3,381,300, (3) retire existing Company debt and accounts
payable in the amount of $541,166, and (4) pay transaction costs of $1,446,396.
The balance of the proceeds were used for working capital and capital
expenditures to build the network, operating center and network infrastructure.
On September 23, November 20, 1997 and January 20, 1998, several investors
contracted with the Company to purchase 63.3, 9.5 and 95.4 shares, respectively,
of the Company's Class A Convertible 8% Cumulative Preferred Stock and initial,
secondary and debt warrants for a purchase price of $15,793.84 per share,
totaling approximately $2.6 million. A portion of the initial purchase price was
allocated to the common share warrants. The allocation was based on the market
value of the common stock at the date of the sale of the Class A Convertible 8%
Cumulative Preferred Stock and the number of related secondary, initial and debt
warrants associated with such preferred stock. The fair market value of the
common stock at the date of the sale was estimated to be $2 per share for the
September 23 and November 20, 1997 sales and $4.50 per share for the January 20,
1998 sale. The number of secondary warrants associated with the three purchases
amounted to 53,271, 7,990, and 80,300, respectively. The number of initial and
debt warrants associated with the three purchases was based on the number of
voting and non-voting common shares that these warrants were replaced with as a
result of the amendment to the related stock purchase agreement as discussed
above. These initial and debt warrants were replaced with 37,009, 6,089 and
56,660 shares of voting and non-voting common stock, respectively. This
allocation resulted in $180,561, $28,158 and $616,318 being recorded as common
stock on the three sales dates, respectively and $819,439, $121,842 and $891,062
being recorded as Class A preferred stock on the three sales dates,
respectively. Issuance costs of $60,000 were incurred in conjunction with the
sale of the Class A Convertible 8% Cumulative Preferred Stock on September 23,
1997. These issuance costs were allocated between the Class A Convertible 8%
Cumulative Preferred Stock and the related warrants based on the relative
portions of the proceeds allocated to each. The purchases were based on the same
terms as those previously mentioned for the $21.8 million preferred stock
issuance.
In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company agreed to issue 6.3316 shares of Class A Convertible 8% Cumulative
Preferred Stock at a price of $15,793.84 per share and warrants to purchase
5,327.1 shares of Common Stock at a price of $.000001 per share to an investor.
7. 13 3/4% Senior Cumulative Exchangeable Preferred Stock
<TABLE>
<CAPTION>
Preferred
Shares Amount
----------- -------------
<S> <C> <C>
February 9, 1998
Proceeds 50,000 $47,300,000
Issuance costs -- (1,868,126)
Accrued dividends -- 973,924
Accretion -- 87,014
----------- -------------
March 31, 1998 50,000 46,492,812
Accrued dividends -- 5,437,353
Accretion -- 686,841
Stock dividends 5,458.12 --
----------- -------------
December 31, 1998 55,458.12 $52,617,006
=========== =============
</TABLE>
F-18
<PAGE>
On February 9, 1998, 50,000 shares of 13 3/4% Senior Cumulative
Exchangeable Preferred Stock Due 2010 and related common share warrants were
issued. The net proceeds received were $48,025,236. The Exchangeable Preferred
Stock will rank senior to all other classes of equity securities of the Company.
The value of the 438,870 common stock warrants issued, $2,605,000, has been
allocated to common shareholders' equity, (see Note 8).
The carrying value of the 13 3/4% Senior Cumulative Exchangeable Preferred
Stock is being accreted to its redemption value (using the effective interest
method) over the five year period from the date of issue to the date the stock
first becomes redeemable, February 15, 2003. The 13 3/4% Senior Cumulative
Exchangeable Preferred Stock is recorded on the balance sheet at the allocated
portion of the purchase price paid by investors, less the allocated portion of
the issuance costs, plus accrued and unpaid dividends, plus accretion.
On or prior to February 15, 2001, the Company may redeem in whole but not
in part, the outstanding Exchangeable Preferred Stock at a redemption price of
113 3/4% of the liquidation preference ($1,000 per share) plus accumulated
unpaid dividends to date of redemption with the net proceeds of an Equity
Offering. An equity offering means either (a) an underwritten primary public
offering of common stock of the Company pursuant to an effective registration
statement under the Securities Act or (b) a primary offering of capital stock
(other than disqualified stock) of the Company to one or more persons primarily
engaged in a related business. On February 15, 2003, 2004, 2005 and 2006 (and
thereafter), at a redemption price of 106.8750%, 104.5833%,102.2917% and 100%,
respectively, of the liquidation preference ($1,000 per share) plus accumulated
unpaid dividends, the Exchangeable Preferred Stock may be redeemed in whole, or
in part, at the Company's option. On February 15, 2010, the Exchangeable
Preferred Stock is mandatorily redeemable.
In the event of a change of control, the Company shall offer to purchase
all outstanding shares of Exchangeable Preferred Stock, in whole or in part, at
a purchase price equal to 101% of the aggregate liquidation preference ($1,000
per share) thereof, plus accumulated and unpaid dividends, if any to the date of
purchase.
Dividends are payable quarterly on February 15, May 15, August 15 and
November 15. Dividends are payable in cash except that on or prior to February
15, 2003, dividends may be paid by the issuance of additional shares of
Exchangeable Preferred Stock at the Company's option.
On May 15, August 17 and November 16, 1998, the Company issued 1,833.3,
1,781.8 and 1,843.02, respectively, of additional shares of Exchangeable
Preferred Stock as the quarterly dividends on the 13 3/4 % Senior Cumulative
Exchangeable Preferred Stock Due 2010.
The restrictive covenants related to the Exchangeable Preferred Stock are
similar to those indicated for the 12 1/4% Senior Debenture Notes as discussed
in Note 5. The Company is in compliance with these covenants at December 31,
1998.
8. Common Shares
On January 9, 1998, the common shareholders approved an amendment to the
Articles of Incorporation to increase the number of authorized common shares to
50,000,000 from 1,000,000. On the same date, the directors of the Company
declared a 1,000 for 1 share split of the Company's issued and outstanding
common shares. All common share amounts and per share amounts have been restated
to reflect this amendment and related split.
On January 9, 1998, the Company obtained the approval of the common
shareholders for an amendment to the Articles of Incorporation to authorize
1,000,000 shares of non-voting common stock.
At December 31, 1998 and March 31, 1998, the Company had 50,000,000 shares
of no par common stock authorized, of which 3,493,965.7 and 3,489,467.9 are
issued and outstanding, respectively.
F-19
<PAGE>
Changes in the Company's common shares and related amounts during the nine
months ended December 31, 1998 and the years ended March 31, 1998 and 1997, are
as follows:
<TABLE>
<CAPTION>
Common
Shares Amount
--------------- --------------
<S> <C> <C>
March 31, 1996 1,683,000.0 $ 488,001
April 28, 1996 84,490.0 168,980
May 17, 1996 146,540.0 293,080
November 14, 1996 115,410.0 230,820
January, 1997 -- (3,381,300)
January 28, 1997 75,063.6 188,721
January 30, 1997 -- 4,037,622
January 31, 1997 269,840.0 539,680
--------------- --------------
March 31, 1997 2,374,343.6 2,565,604
September 23, 1997 -- 169,727
November 20, 1997 -- 28,158
January 20, 1998 1,100,724.4 --
January 20, 1998 -- 616,318
February 9, 1998 -- 2,593,364
February 9, 1998 14,399.9 28,800
Compensation expense
related to stock
option plan -- 972,865
--------------- --------------
March 31, 1998 3,489,467.9 6,974,836
April 14, 1998 4,497.8 44,211
Compensation expense
related to stock
option plan -- 843,789
--------------- --------------
December 31, 1998 3,493,965.7 $ 7,862,836
=============== ==============
</TABLE>
In January 1997, the Company purchased Technology's Area 1 subscriber base
and related equipment for $3,381,300. As this is considered to be a related
party transaction, the Company could only capitalize Technology's book value of
the purchased subscribers and the related equipment. As Technology's book value
was zero at the time of purchase, the entire purchase price is shown as a
reduction to shareholders' equity and is included in voting and non-voting
common stock on the Consolidated Balance Sheets.
As discussed in Note 6, portions of the proceeds and issuance costs
associated with the September 23 and November 20, 1997 and January 20, 1998
sales of Class A Convertible 8% Cumulative Preferred Stock were allocated to the
related common share warrants. These allocations resulted in net amounts of
$169,727, $28,158 and $616,318 being recorded as common equity on September 23
and November 20, 1997 and January 20, 1998, respectively, (see Note 6 for
additional discussion related to the allocation of the proceeds and issuance
costs). Certain of the common stock warrants were replaced with voting and non-
voting common stock. These shares were reflected as outstanding on January 20,
1998.
On January 20, 1998, as a result of the amended Class A Convertible 8%
Cumulative Preferred Stock purchase agreement (formally ratified in January 1998
and discussed in Note 6) 550,362.2 voting and 550,362.2 non-voting shares were
effectively issued. These shares replaced the initial and debt warrants
associated with the Class A Preferred Stock. The value associated with these
warrants was recorded on the related purchase dates of the Preferred Stock:
January 30, September 23, and November 20, 1997, and January 20, 1998.
F-20
<PAGE>
On February 9, 1998, certain Company officers received common shares as
part of their compensation. Total shares issued were 14,399.9 at $2 per share.
Also on February 9, 1998, as discussed in Note 7, portions of the proceeds and
issuance costs from the sale of 13 3/4% Exchangeable Preferred Stock were
allocated to the related common share warrants.
In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company issued 2,248.9 shares of voting common stock and 2,248.9 shares of non-
voting common stock and warrants to purchase 5,327.1 shares of Common Stock at a
price of $.000001 per share to an investor.
On December 31, 1998, the Company entered into an agreement with Glen
Milligan, a Director of the Company and Chairman of the Company's Board of
Directors, whereby the Company will issue 27,429.2 common shares to Mr. Milligan
over a period of three years, beginning August 21, 1999, or such other number of
shares as is necessary to provide Mr. Milligan with .261% of the Company's
common stock outstanding at August 21 of each year for the next three years.
These shares have been reflected on the Consolidated Balance Sheet at December
31, 1998 as common shares to be issued.
9. Stock Based Compensation Plans
Effective January 30, 1997, the Company established a common stock option
plan. No options were granted under the plan until October 14, 1997. Options to
purchase 728,667.8 shares of the Company's stock were originally granted under
the plan of which 591,324 were outstanding as of December 31, 1998. Options vest
over 48 months from the date of employment and expire after ten years. Options
vested under this plan as of December 31, 1998 totaled 367,521.1. During the
nine months ended December 31, 1998, an executive participant in this plan
separated from the Company. This executive was originally granted 91,083.5
shares of which 54,083.5 shares were forfeited as of December 31, 1998.
Effective April 14, 1998, the Company established three new additional
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 December 31, 1998, 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 options 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 at the time of grant. All
remaining options vest over 48 months from the date of employment and expire
after ten years. At December 31, 1998, 185,745.7 options were vested under the
Executive Plan.
F-21
<PAGE>
Under the Key Management Plan and the Employee Plan, 150,000 and 50,000
options, respectively, were available for grant. As of December 31, 1998, a
total of 137,500 options were granted under the Key Management Plan, 22,500 of
which vested immediately. A total of 25,925 options were granted under the
Employee Plan. 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 at the time of grant, is $4.50 per share. All remaining
options under these plans vest over four years beginning July 1, 1999 and expire
10 years from date of grant.
The Company accounts for the plans under APB Opinion No. 25, under which
$843,789 and $972,865 of compensation expense was recognized for the nine months
ended December 31, 1998 and for the year ended March 31, 1998, respectively,
relating to stock option awards to employees. Had compensation cost for such
stock option awards under the plan been determined consistent with SFAS No. 123,
the Company's net loss, net loss attributable to common shares and basic and
diluted loss per share would have been increased to the following pro forma
amounts:
<TABLE>
<CAPTION>
Nine Months Ended Twelve Months Ended
December 31, 1998 March 31, 1998
----------------- -------------------
<S> <C> <C>
Net loss As reported ($32,788,712) ($15,030,544)
Pro forma ($33,001,845) ($15,102,676)
Net loss attributable As reported ($41,717,419) ($19,265,007)
to common shares Pro forma ($42,930,552) ($19,337,139)
Basic and diluted As Reported ($11.94) ($7.37)
loss per share Pro forma ($12.00) ($7.39)
</TABLE>
F-22
<PAGE>
A summary of the status of the Company's stock option plans for the nine
months ended December 31, 1998 and the twelve months ended March 31, 1998 and
changes during the respective periods is presented in the table and narrative
below:
<TABLE>
<CAPTION>
Nine Months Ended Twelve Months Ended
December 31, 1998 March 31, 1998
------------------------ ------------------------
Shares Wtd Avg Shares Wtd Avg
(000) Ex Price (000) Ex Price
<S> <C> <C> <C> <C>
Outstanding at beginning of year 692.3 1.12
Granted 493.8 2.60 728.7 1.12
Exercised
Forfeited 100.9 1.12 36.4 1.12
Expired
Canceled ------- ______
Outstanding at end of year 1,085.2 1.79 692.3 1.12
Exercisable end of year 575.8 287.8
Weighted average fair value of
options granted 2.99 3.91
</TABLE>
The 493,825 options granted in the nine months ended December 31, 1998 have
an exercise price between $1.12 and $4.50 with a weighted average exercise price
of $1.79 and a weighted average remaining contractual life of 8.75 years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for the option grants in the nine months ended December 31,
1998: risk-free interest rate of 5.51 percent; expected dividend yields of 0
percent; expected life of 10 years; and expected volatility of 0 percent.
10. Income Taxes
The Company uses an asset and liability approach to account for income
taxes. Deferred income taxes (credit) reflect the impact of temporary
differences between amounts of assets and liabilities for financial reporting
purposes and such amounts as measured by tax laws. These temporary differences
are determined in accordance with Statement of Financial Accounting Standards
(FAS) No. 109, "Accounting for Income Taxes." The temporary differences and net
operating loss carryforward, which give rise to deferred tax assets at December
31, 1998 and March 31, 1998, are as follows:
<TABLE>
<CAPTION>
December 31, 1998 March 31, 1998
Deferred Tax Deferred Tax
Asset/(Liability) Asset/(Liability)
----------------- -----------------
<S> <C> <C>
Employee related $ 1,235,194 $ 463,584
Property, plant and equipment
depreciation expense (2,072,079) (588,411)
Accretion of discount on senior
discount notes 8,876,819 1,374,974
Amortization of debt issuance costs
related to senior discount notes 275,091 43,297
Other 67,016 --
Net operating loss carryforward 12,330,877 6,619,846
Valuation allowance (20,712,918) (7,913,290)
---------------- ---------------
$ -- $ --
================ ===============
</TABLE>
F-23
<PAGE>
The provision (credit) for income taxes is summarized as follows:
<TABLE>
<CAPTION>
For the nine
months ended Year Ended Year Ended
December 31, 1998 March 31, 1998 March 31, 1997
<S> <C> <C> <C>
Current income tax expense
Federal $ -- $ -- $ --
State -- -- --
Deferred income tax expense
Federal (11,435,581) (4,850,473) (896,666)
State (2,345,790) (1,092,854) (202,026)
------------- ------------- ------------
(13,781,371) (5,943,327) (1,098,692)
Valuation allowance 13,781,371 5,943,327 1,098,692
------------- ------------ ------------
$ -- $ -- $ --
============= ============ ============
</TABLE>
The income tax provision (credit) differs from amounts at the statutory
federal income tax rate as follows:
<TABLE>
<CAPTION>
For the nine
months ended Year Ended Year Ended
December 31, 1998 March 31, 1998 March 31, 1997
----------------- --------------- --------------
<S> <C> <C> <C>
Income tax provision (credit) at
statutory rate $ (11,476,049) $ (5,260,690) $ (986,052)
Meals and entertainment 15,338 14,993 19,210
Disallowed portion of original
issue discount on senior 5,799 --
discount notes 33,570
State income taxes (2,354,230) (703,429) (131,850)
Valuation allowance 13,781,371 5,943,327 1,098,692
------------- ------------ ----------
Income tax provision (credit) as
reported $ -- $ -- $ --
============= ============ ==========
</TABLE>
At December 31, 1998, the Company had cumulative tax net operating loss
carryforwards aggregating approximately $31,060,000 expiring between 2008 and
2019. At December 31, 1998, the Company had recorded a valuation allowance
related to its net deferred tax assets aggregating approximately $20,713,000.
F-24
<PAGE>
11. Commitments And Contingencies
Litigation
The Company is not aware of any pending or threatened litigation that could
have a material adverse effect on the results of operations, financial position
or cash flow of the Company.
Operating Leases and Other
The Company obtained two letters of credit totaling $1,796,880. The first
letter, for $500,000, was obtained as part of the Chicago franchise agreement
mentioned earlier. The second letter is for the benefit of the Merchandise Mart
totaling $1,296,880 and was obtained in place of a security deposit related to
the Merchandise Mart lease. These letters of credit are fully collateralized by
cash, which is reflected as a restricted cash collateral reserve on the balance
sheet. The Company invests the cash in commercial paper which matures daily. For
the nine months ended December 31, 1998 and for the years ended March 31, 1998
and 1997, the commercial paper investments had earned $71,920, $95,505 and
$11,411, respectively, in interest income.
The Company entered into a 15-year lease, dated January 31, 1997 (the
"Apparel Lease") for its headquarters and NOC. The Apparel Lease initially
covered 32,422 square feet, and was increased on July 1, 1998 to cover 40,397
square feet.
As of December 31, 1998, the aggregate minimum rental commitments under
this and other lease agreements were as follows:
1999 $ 1,509,497
2000 1,569,007
2001 1,568,549
2002 1,426,606
2003 1,369,391
Thereafter 10,757,262
-----------
Total $18,200,312
Rent expense under operating leases was $1,499,097, $662,753 and $55,152
for the nine months ended December 31, 1998 and for the years ended March 31,
1998 and 1997 respectively.
In March 1998, The Company signed a purchase agreement with Nortel for
telecommunications equipment. This agreement covers three years and the purchase
of a minimum of $25,000,000 of equipment during the three year period.
12. Subsequent Events
On February 15, 1999, the Company issued 1,906.37 additional shares of
Exchangeable Preferred Stock as the quarterly dividends on the 13 3/4% Senior
Cumulative Exchangeable Preferred Stock Due 2010.
On February 26, 1999, the Company acquired EnterAct Corp. ("EnterAct"), a
Chicago-based provider of Internet access and commercial data services. EnterAct
has 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 will become 21st Century's commercial division, developing,
marketing and selling data and telephony services to the business community.
F-25
<PAGE>
<TABLE>
<CAPTION>
Quarterly Financial Data
(Unaudited)
For the Three Months Ended
---------------------------------------------------------------------------------
December 31, 1998 September 30, 1998 June 30, 1998 March 31, 1998
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenues $ 453,861 $ 280,159 $ 139,878 $ 65,491
Operating loss $ (8,847,454) $ (7,293,150) $ (5,886,074) $ (5,252,740)
Net loss attributable to common shares $ (15,514,946) $ (13,978,871) $ (12,223,602) $ (9,132,218)
Basic and diluted loss per share $ (4.44) $ (4.00) $ (3.50) $ (2.74)
<CAPTION>
For the Three Months Ended
---------------------------------------------------------------------------------
December 31, 1997 September 30, 1997 June 30, 1997 March 31, 1997
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating revenue $ 43,877 $ 37,158 $ 42,497 $ 27,480
Operating loss $ (4,816,430) $ (2,190,282) $ (1,203,601) $ (802,586)
Net loss attributable to common shares $ (5,573,193) $ (2,638,655) $ (1,920,941) $ (1,183,561)
Basic and diluted loss per share $ (2.34) $ (1.11) $ (0.81) $ (0.52)
</TABLE>
Quarterly loss per share amounts may not total loss per share amounts for the
year due to changes in the number of shares outstanding.
F-26
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1999 1998
------ --------------- -------------
(Unaudited)
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 25,094,932 $ 72,901,622
Accounts receivable, less allowances
of $409,266 and $1,376, respectively 832,049 157,082
Short term investments 48,941,472 98,464,936
Inventory 15,763,062 10,385,575
Prepaid expenses and other 996,164 598,878
--------------- -------------
Total current assets 91,627,679 182,508,093
Property, Plant and Equipment
Leasehold improvements 9,935,089 5,647,709
Capital equipment leases 2,899,077
Property, plant and equipment 130,018,895 57,475,153
Less: accumulated depreciation (11,462,143) (4,814,143)
--------------- -------------
Property, plant and equipment, net 131,390,918 58,308,719
Other Assets
Restricted cash collateral reserve 4,021,496 1,796,880
Prepaid franchise fees 3,779,331 3,685,961
Debt issuance costs, net of amortization of $2,581,417 and $1,386,138, respectively 5,417,320 6,601,105
Deferred franchise costs, net of amortization of $758,269 and $623,681, respectively 279,956 350,144
Bank commitment fee, net of amortization of $234,079 and $78,604, respectively 742,827
Deferred mapping and design, net of amortization of $127,641 and $93,071,
respectively 104,707 44,880
Goodwill, net of amortization of $602,136 9,865,520 -
Other deferred costs 197,503 149,889
--------------- -------------
Total other assets 24,408,660 13,527,161
--------------- -------------
Total assets $ 247,427,257 $ 254,343,973
=============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current Liabilities
Accounts payable $ 15,692,919 $ 10,688,242
Accrued severance 1,387,430 1,230,000
Notes payable 2,000,000 -
Accrued expenses and other 2,093,479 1,261,982
--------------- -------------
Total current liabilities 21,173,828 13,180,224
Senior discount notes, net of discount of $119,932,594 and $140,681,223, 243,202,406 222,453,777
respectively
Notes payable 2,000,000 -
Other long term obligations 2,242,411 -
--------------- -------------
Total noncurrent liabilities 247,444,817 222,453,777
--------------- -------------
Total liabilities 268,618,645 235,634,001
Redeemable Preferred Stock
13 3/4% senior cumulative exchangeable preferred stock, $.01 par value
61,376.08 and 55,458.12 shares outstanding, respectively 59,297,753 52,617,006
Shareholders' Equity
Class A convertible 8% cumulative preferred stock, no par value 27,592,791 24,611,966
Voting and non-voting common stock 11,346,651 7,862,836
Common shares to be issued 40,787 123,432
Retained deficit (119,469,370) (66,505,268)
--------------- -------------
Total shareholders' equity (80,489,141) (33,907,034)
--------------- -------------
Total liabilities and shareholders' equity $ 247,427,257 $ 254,343,973
=============== =============
</TABLE>
F-27
<PAGE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------------------------- ---------------------------------------
1999 1998 1999 1998
--------------- ---------------- ----------------- -------------------
<S> <C> <C> <C> <C>
Operating revenues $ 3,150,238 280,159 $ 6,943,878 485,528
--------------- ---------------- ----------------- -------------------
Operating expenses
Network operations 3,312,900 991,259 7,728,852 2,450,951
Sales and marketing 2,741,891 882,437 6,244,813 2,878,264
General and administrative 5,154,591 4,479,229 13,572,644 10,724,536
Depreciation and amortization 3,147,628 1,220,384 7,387,043 2,865,312
--------------- ---------------- ----------------- -----------------
Total operating expenses 14,357,010 7,573,309 34,933,352 18,919,063
--------------- ---------------- ----------------- -----------------
Operating loss (11,206,772) (7,293,150) (27,989,474) (18,433,535)
Other (income) expense
Interest expense 6,076,614 6,262,339 19,030,185 16,099,695
Interest income (1,268,508) (2,971,087) (4,965,650) (8,044,264)
Amortization of debt issuance costs 395,432 407,346 1,195,279 1,017,645
Other (income) expense 53,242 - 53,242 -
--------------- ---------------- ----------------- -----------------
Total other (income) expense 5,256,780 3,698,598 15,313,056 9,073,076
--------------- ---------------- ----------------- -----------------
Net loss (16,463,552) (10,991,748) (43,302,530) (27,506,611)
Preferred stock requirements (3,319,135) (2,987,123) (9,661,572) (7,828,057)
--------------- ---------------- ----------------- -----------------
Net loss attributable to common shares $ (19,782,687) $ (13,978,871) $ (52,964,102) $ (35,334,668)
=============== ================ ================= =================
Weighted average common
shares outstanding
12,683,772.2 10,481,897.1 12,237,169.5 10,228,509.7
Basic and diluted loss per share $ (1.56) $ (1.33) $ (4.33) $ (3.45)
=============== ================ ================= =================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-28
<PAGE>
21st CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
--------------------------------------------
1999 1998
----------------- ----------------
<S> <C> <C>
Operating Activities
Net loss $ (43,302,530) $ (27,506,611)
Adjustments to reconcile net loss to net
cash used for operating activities:
Depreciation and amortization 7,387,044 2,865,312
Amortization of debt discount 20,748,629 15,940,951
Amortization of debt issuance costs 1,195,279 1,017,645
Stock compensation 373,144 792,182
Changes in operating assets and liabilities:
Receivables, net (331,225) (71,084)
Inventory (5,377,487) (2,458,360)
Other current assets (387,296) (696,438)
Accounts payable 5,124,583 3,387,502
Accrued expenses and other
current liabilities 80,018 1,582,238
Noncurrent assets and liabilities, net (3,243,750) (1,353,872)
---------------- ----------------
Net Cash Used for Operating Activities (17,733,591) (6,500,535)
---------------- ----------------
Investing Activities
Capital expenditures (79,280,306) (35,966,958)
Purchases and sales/maturities of short term investments, net 49,523,464 (99,561,203)
Acquisition, net of cash acquired (2,653,914) -
---------------- ----------------
Net Cash Used for Investing Activities (32,410,756) (135,528,161)
---------------- ----------------
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
Proceeds from issuance of Common Stock 72,216 -
Repurchase of Options (183,194) -
Proceeds from leases, net 2,448,635 -
Payment under interim credit facility - (8,000,000)
---------------- ----------------
Net Cash Provided by Financing Activities 2,337,657 233,659,792
---------------- ----------------
(Decrease)/Increase in Cash and Cash Equivalents (47,806,690) 91,631,096
Cash and Cash Equivalents at Beginning of Period 72,901,622 1,404,975
---------------- ----------------
Cash and Cash Equivalents at End of Period $ 25,094,932 $ 93,036,071
================ ================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-29
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(Unaudited)
<TABLE>
<CAPTION>
Common Class A
Shares to be Preferred Retained
Total Common Stock Issued Stock Deficit
------------- -------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1998 $ (33,907,034) $ 7,862,836 $ 123,432 $ 24,611,966 $ (66,505,268)
Net loss (43,302,530) - - - (43,302,530)
Stock issuances 3,211,220 3,211,220 - - -
Accrued preferred stock dividends (6,019,683) - - 1,717,926 (7,737,609)
Preferred stock accretion (661,064) - - 1,262,899 (1,923,963)
Issuance of shares to be issued - 82,645 (82,645) - -
Stock options 373,144 373,144 - - -
Repurchase of options (183,194) (183,194) - - -
Shares issued for stock split - - - - -
-------------------------------------------------------------------------------
Balances, September 30, 1999 $ (80,489,141) $ 11,346,651 $ 40,787 $ 27,592,791 $ (119,469,370)
===============================================================================
<CAPTION>
Common Common Class A
Common Shares to be Share Preferred
Shares Issued Warrants Shares
------------- -------------- ------------ ------------
<S> <C> <C> <C> <C>
Balances, December 31, 1998 3,493,965.7 27,429.2 1,747,066.0 1,554.8
Net loss - - - -
Stock issuances 721,066.1 - - -
Accrued preferred stock dividends - - - -
Preferred stock accretion - - - -
Issuance of shares to be issued 18,365.7 (18,365.7) - -
Stock options - - - -
Repurchase of options - - - -
Shares issued for stock split 8,484,922.0 - 3,494,132.0 -
------------- ------------ ------------ -----------
Balances, September 30, 1999 12,718,319.5 9,063.5 5,241,198.0 1,554.8
============= ============ ============ ===========
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
F-30
<PAGE>
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.
The Company declared a three for one common stock split effective September
30, 1999. All common stock amounts and per share amounts reported reflect this
stock split.
2. Acquisition of Business
On February 26, 1999, the Company acquired EnterAct, L.L.C. ("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 2,090,982 shares of its no par
value common stock valued by the Company at $1.50 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, stock option plans were
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
nine months ended September 30, 1999. Comparatively, had the Company reflected
the acquisition as of January 1, 1998, its revenues would have
F-31
<PAGE>
increased approximately $864,319 and $2,132,959 for the three and nine months
ended September 30, 1998, respectively. All other reportable supplemental pro
forma information would not be materially different than the reported amounts.
3. Earnings Per Share
As mentioned in Note 1, the Company declared a three for one common stock
split effective September 30, 1999. All common stock amounts and per share
amounts reported reflect this stock split.
Basic per share amounts were based on weighted average common shares
outstanding, excluding common stock equivalents, of 12,683,772.2 and
10,481,897.1 shares for the three months ended September 30 1999 and 1998,
respectively and 12,237,169.5 and 10,228,509.7 shares for the nine months ended
September 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 September 30, 1999, common shares issuable pursuant to options and
warrants included: (1) 3,924,588 common share warrants related to the Class A
Convertible 8% Cumulative Preferred Stock, (2) 1,316,610 common share warrants
related to 13 3/4% Senior Cumulative Exchangeable Preferred Stock, (3) 3,750,000
options issued in connection with certain Directors' guarantee of a loan, (4)
2,359,980.9 vested employee stock options, and (5) 56,984.1 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 September 30, 1998, common shares issuable pursuant to options and
warrants included: (1) 3,924,588 common share warrants related to the Class A
Convertible 8% Cumulative Preferred Stock, (2) 1,316,610 common share warrants
related to the 13 3/4% Senior Cumulative Exchangeable Preferred Stock, (3)
3,750,000 options issued in connection with certain Directors' guarantee of a
loan, (4) 1,618,280.7 vested employee stock options, and (5) 56,984.1 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
<TABLE>
<CAPTION>
Preferred
Shares Amount
----------- ------------
<S> <C> <C>
December 31, 1998 1,554.8 $24,611,966
Accrued Dividends - 1,717,926
Accretion - 1,262,899
----------- -------------
September 30, 1999 1,554.8 $27,592,791
=========== =============
</TABLE>
5. 13 3/4% Senior Cumulative Exchangeable Preferred Stock
<TABLE>
<CAPTION>
Preferred
Shares Amount
<S> <C> <C>
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 -
August 16, 1999 Stock Dividend 2,039.69 -
Accrued Dividends - 6,019,683
Accretion - 661,064
----------- -------------
September 30, 1999 61,376.08 $59,297,753
=========== =============
</TABLE>
F-32
<PAGE>
On August 16, 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
November 15, 1999. An additional 2,039.69 shares of 13 3/4% Senior Cumulative
Exchangeable Preferred stock was issued on August 16, 1999 in settlement of
these dividends.
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 1,841,129.7 shares of the Company's stock were originally granted under
the plan of which 1,841,129.7 were outstanding as of September 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 September 30, 1999,
totaled 1,191,285.
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, 993,600 options are available for grant to two
executive officers of the Company. As of September 30, 1999, all 993,600 shares
available under the Executive Plan were awarded. Effective March 6, 1998,
834,600 options were awarded to an executive officer. The exercise price of the
834,600 shares was established at $0.37 per share which is less than the $1.50
per share fair market value determined by the Board of Directors. One half of
the 834,600 shares awarded on March 6, 1998 or 417,300 shares vested immediately
and a total of $470,158 was recorded as compensation expense as a result of the
vesting of the 417,300 options. On April 14, 1998, an executive officer was
awarded 159,000 options under the Executive Plan at an exercise price of $1.50
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 September 30, 1999, 665,292.9
options were vested.
Under the Key Management Plan and the Employee Plan, 474,000 and 470,873
options, respectively, were available for grant. As of September 30, 1999, a
total of 474,000 options were granted under the Key Management Plan, 167,625 of
which are vested. A total of 341,349 options were granted under the Employee
Plan, of which 24,456 are vested. 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 $1.50 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 180,000 options are available for grant
primarily to specifically named former employees of EnterAct. On February 26,
1999, 150,300 of the shares available under the 1999 Stock Incentive Plan were
awarded to such employees with an additional 12,615 options awarded to newly
hired employees of the Company in March 1999 and 8,805 options awarded to newly
hired employees of the Company in April 1999. Options related to both awards
have an exercise price of $1.50 which is equal to the $1.50 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 September 30, 1999, there were no options
vested.
Under the 1999 ISP Stock Plan 1,799,748 options are available for grant to
specifically named former employees of EnterAct. On February 26, 1999, all
1,799,748 shares available under the 1999 ISP Stock Plan were
F-33
<PAGE>
awarded at various exercise prices with the vesting status determined by the
respective measurement dates. Under the 1999 ISP Stock Plan, three series of
options have been issued. The series "A" option price is $11.75 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 $15.11
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 $21.83 that is subject to a measurement date of the third
anniversary date of the grant and expires 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
September 30, 1999, there were no options vested.
Under the ISP Employee Stock Option Plan 296,109 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, 293,733 shares available under the
1999 ISP Employee Stock Option Plan were awarded at an exercise price of $1.50
which is equal to the $1.50 fair market value determined by the Board of
Directors. For purposes of vesting, certain of the grant dates are deemed to be
the original grant date under the original EnterAct option plan. 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 September 30, 1999, 223,239 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
September 30, 1999, no equipment had been leased.
8. Subsequent Events
On November 3, 1999, the Company entered into Amendment No. 2 to its bank
revolving credit facility which adjusted certain operating covenants.
On October 12, 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 November 1, 1999, payable on
November 15, 1999. An additional 2,109.80 shares of 13 3/4% Senior Cumulative
Exchangeable Preferred stock will be issued on November 15, 1999 in settlement
of these dividends.
F-34
