<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
COMMISSION FILE NUMBER: 333-47235
[LOGO]
21ST CENTURY TELECOM GROUP, INC.
(Exact Name of Registrant as specified in its charter)
ILLINOIS 36-4076758
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
WORLD TRADE CENTER
350 NORTH ORLEANS
SUITE 600
CHICAGO, ILLINOIS 60654
(312) 955-2100
(Address and telephone number of principal executive office)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
On November 10, 1999, 12,751,431.1 shares of the Registrant's Common Stock
were outstanding.
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<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
PAGE
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998 1
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 1999 and September 30, 1998 2
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1999
and September 30, 1998 3
Consolidated Statement of Changes in Shareholders' Equity for the Nine Months
Ended September 30, 1999 4
Notes to Unaudited Interim Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 13
</TABLE>
When used in this Report, the words "intends," "expects," "plans,"
"estimates," "projects," "believes," "anticipates," and similar expressions
are intended to identify forward-looking statements. Except for historical
information contained herein, the matters discussed and the statements made
herein concerning the Company's future prospects are "forward-looking
statements" within the meaning of Section 27A of the Securities Act and
Section 21E of the Securities Exchange Act. Although the Company believes
that its plans, intentions and expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such plans,
intentions or expectations will be achieved. There can be no assurance that
future results will be achieved, and actual results could differ materially
from the forecast and estimates. Important factors that could cause actual
results to differ materially include, but are not limited to, the Company's
limited operating history, including a history of losses, significant capital
requirements, high leverage, debt service requirements and restrictive
covenants related to its outstanding securities, ability to complete DRS
Network construction, its dependence on key personnel and ability to manage
growth. The Company's future results may also be impacted by other risk
factors listed in its Registration Statement filed on Form S-4 (333-47235).
In addition, such forward-looking statements are necessarily based upon
assumptions and estimates that may be incorrect or imprecise and involve
known and unknown risks and other facts. Given these uncertainties,
prospective investors are cautioned not to place undue reliance upon such
forward-looking statements. The Company undertakes no obligation to publicly
release any revisions to the forward-looking statements or reflect events or
circumstances after the date of this document.
i
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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 742,827 898,302
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, respectively 243,202,406 222,453,777
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>
See accompanying Notes to the Consolidated Financial Statements.
1
<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.
2
<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.
3
<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.
4
<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
5
<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
-------------- -----------------
</TABLE>
6
<PAGE>
September 30, 1999 61,376.08 $59,297,753
============== =================
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.
7
<PAGE>
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 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.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a discussion and analysis of the historical results of
operations and financial condition of 21st Century Telecom Group, Inc. (the
"Company") and factors affecting the Company's financial resources. This
discussion should be read in conjunction with the consolidated financial
statements, including the notes thereto, set forth herein under "Financial
Statements" and the Company's Quarterly Report on Form 10-Q for the quarterly
periods ended June 30, 1999 and March 31, 1999, and the Company's Annual Report
on Form 10-K for the transition period from April 1, 1998 to December 31, 1998.
This discussion contains forward-looking statements which are qualified by
reference to, and should be read in conjunction with, the Company's discussion
regarding forward-looking statements as set forth in this report.
GENERAL
21st Century was awarded a franchise in 1996 by the City of Chicago that
allows for the construction of the Distributed Ring-Star (DRS) Network in
Chicago's Area 1. Under this 15-year renewable license, the Company is
granted unrestricted access to the public right-of-way to construct, operate
and maintain its DRS Network to all residential and commercial subscribers.
In March 1998, the Company was awarded a franchise to provide cable service
to the Village of Skokie. Construction of the Skokie system began during the
second quarter 1999. In March 1999, the Company was awarded a franchise in
the Village of Northbrook. In June 1999, the Company applied for franchises
in Areas 2, 3 and 4 in the City of Chicago. The Company's principal focus
remains the development of its communications business in Chicago's Area 1.
The Company has incurred net losses in each year since its inception,
and as of September 30, 1999, the Company had an accumulated deficit of
$119,469,370. As the Company continues to expand its operations, it
anticipates that it will continue to incur net losses during the next several
years as a result of (i) substantially increased depreciation and
amortization from the construction of networks, (ii) significantly increased
operating expenses as it builds its subscriber base and (iii) interest
charges associated with the Senior Discount Notes. There can be no assurance
that growth in the Company's revenues or subscriber base will occur or that
the Company will be able to achieve or sustain profitability or positive cash
flow.
The Company acquired EnterAct, L.L.C. ("EnterAct") on February 26, 1999.
The acquistion was accounted for as a purchase. As such, its results of
operations have been included since the acquisition date.
RESULTS OF OPERATIONS
REVENUES
The Company generated subscriber revenues of $3,150,238 and $6,943,878
for the three and nine months ended September 30, 1999 and $280,159 and
$485,528 for the three and nine months ended September 30, 1998. The
increased subscriber revenues resulted from the installation of service into
contracted buildings on the new DRS network and sales efforts to increase
penetration of services into these buildings. The acquisition of EnterAct,
the Company's Business Services Group ("BSG"), contributed to approximately
53% of the total increase in revenues during the nine months ended September
30, 1999 when compared to the corresponding prior period. The Company's BSG
offers dial-up access to the Internet, as well as an expanding line of
commercial business services including web hosting, Internet consulting,
co-location and networking. At September 30, 1999, the Company was providing
service to approximately 25,400 voice, video and data connections in 95 bulk
multiple dwelling units ("MDU") and 489 right of entry ("ROE") buildings as
well as over 9,700 dialup Internet connections and approximately 2,680
business data and telephony connections. As of September 30, 1999, there were
6,104 backlogged connection orders for bulk MDU and ROE customers.
EXPENSES
The Company incurred operating expenses of $14,357,010 and $34,933,352 for
the three and nine months ended September 30, 1999, and $7,573,309 and
$18,919,063 for the three and nine months ended September 30, 1998. The increase
in operating expenses resulted from activities required to accelerate the
network build-out,
9
<PAGE>
operate the franchise and deliver services. Approximately, $3,052,529 and
$5,403,252 of the increased operating expenses for the three and nine months
ended September 30, 1999 was due to the acquisition of EnterAct.
NETWORK OPERATIONS
The component of operating expenses that represents network operating
costs related to the delivery of cable and internet services increased
$2,321,641 and $5,277,901 during the three and nine months ended September
30, 1999, when compared to the corresponding prior periods. Of this
increase, $1,441,779 and $3,185,909 for the respective periods relate to
increases in the direct costs of providing services to customers such as the
cost of video programming, license and fees, access and connection costs for
telephony and internet. The remaining increase is directly related to new
product launch, additional personnel and training related to customer
installations, and the continued acceleration of the design and construction
of the network.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses were $7,896,482 and
$19,817,457 for the three and nine months ended September 30, 1999 and
$5,361,666 and $13,602,800 for the three and nine months ended September 30,
1998. The increase in selling, general and administrative expenses reflects
the increases in personnel and training costs associated with the acquisition
and servicing of subscribers, increased marketing and promotion costs, and
the addition of employees to support functions established within the
Company, as well as certain key sales and marketing positions. During the
fourth quarter of 1998, the Company established a state-of-the-art call
center staffed with customer service professionals and technical support
specialists available 24 hours a day, seven days a week. Personnel at the
Call Center continue to grow as both the subscriber base expands and the
number of new subscribers added each month continues to increase.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization costs were $3,147,628 and $7,387,043 for
the three and nine months ended September 30, 1999 and $1,220,384 and
$2,865,312 for the three and nine months ended September 30, 1998. The
increase in depreciation and amortization costs is primarily attributable to
the increase in plant placed into service as the Company continues to
buildout its network, capitalized equipment and installation provided to
subscribers, goodwill amortization relating to the purchase of EnterAct, and
depreciation on vehicles being capitalized under a master fleet lease
arrangement.
INTEREST AND OTHER CHARGES
Interest expense decreased $185,725 and increased $2,930,490 during the
three and nine months ended September 30, 1999, when compared to the
corresponding prior periods. Interest and other charges was partially offset
by capitalized interest on construction work in process. The decrease for the
comparable three month period reflects higher capitalization of interest
costs related to the construction of the fiber network as a greater amount of
capital was allocated to construction work in process during 1999 when
compared to 1998. The Senior Discount Notes were issued in February 1998. The
increase for the nine months ended September 30, 1999 reflects both a full
nine month period for 1999 and a higher accredited balance compared to 1998.
NET LOSS
For the three months ended September 30, 1999 and 1998, the Company
incurred net losses amounting to $16,463,552 and $10,991,748. For the nine
months ended September 30, 1999 and 1998, the Company incurred net losses
amounting to $43,302,530 and $27,506,611 respectively. The Company expects
its net losses to continue to increase as it introduces new services and as
the Company continues to build-out the DRS Network and seeks to expand its
business.
10
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Net cash used by operating activities was $17,733,591 for the nine
months ended September 30, 1999, and $6,500,535 for the nine months ended
September 30, 1998. Net cash used for operating activities for the nine
months ended September 30, 1999 and 1998 resulted principally from the
Company's net loss from operations, increases in the amount of inventory on
hand, and increases in other non-current assets and liabilities. These items
were partially offset by amortization of the discount on the 12 1/4% Senior
Discount Notes, depreciation and amortization expense, amortization of debt
issuance costs, stock compensation expense, and increases in accounts payable
and accrued expenses.
Cash flows used for investing activities totaled $32,410,756 in the nine
months ended September 30, 1999. Cash flows used for investing activities
totaled $135,528,161 in the nine months ended September 30, 1998. Cash
requirements in the nine months ended September 30, 1999 consisted of costs
for continued deployment of the network in the Area 1 franchise, installing
and facilitating the telephone switching equipment in the Telephone
Operations Center (TOC) located at the corporate headquarters, and
installation and equipment costs provided to subscribers. The sale and
maturity of short-term investments, which was net of purchases, offset the
cash used to continue to build-out the network. On February 26, 1999, the
Company acquired EnterAct, a Chicago-based provider of Internet access and
commercial data services. EnterAct had approximately 50 employees. The
majority of EnterAct's approximately 10,000 customers are residential dial up
Internet access customers; however, a significant portion of EnterAct's 1998
calendar year revenues were derived from Internet, data and consulting
services provided to its business customer base. In connection with this
transaction, the Company issued 696,994 shares of its no par value common
stock to certain officers of EnterAct and agreed to pay an additional
$6,500,000. The Company paid $2,500,000 at the closing and issued two
non-interest bearing notes totaling $4 million. The notes are payable to
executives of EnterAct over two years, one half due on the first anniversary
date and one half due on the second anniversary date. In addition, 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 telephone services to the business community.
Cash requirements for the nine months ended September 30, 1998 consisted
primarily of the cost of building and equipping the NOC and facilitating the
corporate headquarters and network construction and for the purchase, net of
sales, of short-term investments.
Cash flow from financing activities was $2,337,657 in the nine months
ended September 30, 1999. Cash flow from financing activities was
$233,659,792 in the nine months ended September 30, 1998. In the nine months
ended September 30, 1999, the proceeds from capital lease financing and sale
of common stock provided $2,448,635 and $72,216 respectively. This was offset
by $183,194 repurchase of stock options. In the nine months ended September
30, 1998, the private sale of $200 million in Senior Discount Notes and the
sale of $50 million in Exchangeable Preferred Stock, along with the sale of
Class A Preferred Stock generated a net of $192,113,175, $48,025,236, and
$1,521,381, respectively. This was offset by the $8,000,000 repayment of the
interim credit facility.
The cost of network development, construction and start-up activities of
the Company has required and will continue to require substantial capital.
The Company estimates that its aggregate capital expenditure requirements
related to DRS Network construction in Area 1 until completion in mid-2000,
will total approximately $220 million, of which approximately $143 million
has been spent since the construction of Area 1 was initiated. The Company
will fund these expenditures from the net proceeds of the sale of the 12 1/4%
Senior Discount Notes and the 13 3/4% Senior Cumulative Exchangeable
Preferred Stock. In order to retain funds available to support its
operations, the Company has no expectation of paying cash interest on the
Senior Discount Notes or cash dividends on the Exchangeable Preferred Stock
prior to February 15, 2003. The Company may require additional financing in
the future if it begins to develop additional franchise areas including
Skokie or if the development of Area 1 in Chicago is delayed or requires
costs in excess of current expectations. There can be no assurance that the
Company will be able to obtain any additional debt or equity financing, or
that the terms thereof will be favorable to the Company or its existing
creditors or investors. On August 5, 1998 the Company entered into a $40
million bank revolving credit facility with a number of banks to provide
supplemental financing. On October 30, 1998 the Company entered into
Amendment No. 1 to its bank revolving credit facility which adjusted certain
operating covenants. On November 3, 1999 the Company entered into Amendment
No. 2 to its bank revolving credit facility which adjusted certain operating
covenants. On February 26, 1999, the Company entered into a letter of credit
which was secured by $2
11
<PAGE>
million under its bank revolving credit facility. The letter of credit serves
as security for a promissory note due to executives of EnterAct. On June 30,
1999, the Company entered into a three-year master equipment lease with Cisco
Systems Capital Corporation under which the Company may lease computer
equipment as needed. This lease is effectively a financing arrangement that
allows the Company to finance up to $3 million in equipment. Total lease
payments are dependent upon the types and quantities of equipment needed. As
of September 30, 1999, no equipment had been leased.
IMPACT OF YEAR 2000
The Company has been actively and aggressively working to ensure Year
2000 compliance which included an awareness program started in the third
quarter of 1998. The Company has initiated a formal program to address the
Year 2000 issue that includes a project office. The Company has substantially
completed a comprehensive inventory and assessment of Information Technology
(IT) and non-IT related systems and equipment that may be affected by Year
2000 issues. The Company has contracted with a third party to assist with its
Year 2000 assessment. The Company has completed the replacement of all
financial systems to meet Year 2000 compliance. Substantially all of the
remaining critical business systems have been certified by the vendors to be
Year 2000 compliant. The Company's testing plan may include unit testing as
well as regression analysis. The replacement and remediation of IT and non-IT
systems is approximately 99% complete and is on target for completion in the
fourth quarter of 1999. The Company is assessing the Year 2000 readiness of
its critical vendors and suppliers and continues to make various inquiries as
to their status regarding their Year 2000 readiness. The Company will perform
additional procedures as necessary to evaluate risks associated with third
parties and has considered these risks in establishing its contingency plans.
The Company has developed contingency plans to mitigate the potential
disruptions that may result from Year 2000 issues. These plans include
securing alternative sources for critical vendors and suppliers, as well as
other measures considered appropriate by management and is 98% complete and
is on target for completion in the fourth quarter.
While the Company believes its efforts to avoid any material adverse
effect on the Company's operations or financial condition will be successful,
given the complexity and risks, there can be no assurance these efforts will
be successful. Risks include, but are not limited to, the readiness of
vendors, suppliers, and remediation projects. However, the Company does not
anticipate any disruptions in the ability to provide its products and
services subsequent to December 31, 1999. The total cost of the Year 2000
project has not had a material effect on its results of operations.
12
<PAGE>
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibits are listed in the Exhibit Index.
(b) Reports on Form 8-K
None.
13
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT
HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND
IN THE CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ Robert J. Currey President, Chief Executive
- --------------------- Officer and Director November 10, 1999
Robert J. Currey
/s/ Ronald D. Webster
- --------------------- Chief Financial Officer November 10, 1999
Ronald D. Webster
</TABLE>
14
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
- -------------------- ----------------------------------------------------------------------------------------------
Exhibit Number Description of Exhibits
- -------------------- ----------------------------------------------------------------------------------------------
<S> <C>
3.1* Amended Articles of Incorporation
- -------------------- ----------------------------------------------------------------------------------------------
3.2* By-laws
- -------------------- ----------------------------------------------------------------------------------------------
4.1* Indenture dated February 15, 1998 between the Company, as
Issuer, and State Street Bank and Trust, as Trustee, with
respect to the 12 1/4 Senior Discount Notes Due 2008
- -------------------- ----------------------------------------------------------------------------------------------
4.2* Form of the 12 1/4 Senior Discount Notes Due 2008
- -------------------- ----------------------------------------------------------------------------------------------
4.3* Indenture dated as of February 15, 1998 between the Company and IBJ Stirred Bank & Trust
Company, as Trustee, with respect to the Exchange Debenture
- -------------------- ----------------------------------------------------------------------------------------------
4.4* Form of the 13 3/4 Senior Cumulative Exchangeable Preferred Stock Due 2010
- -------------------- ----------------------------------------------------------------------------------------------
4.5* Registration Rights Agreement dated as of February 2, 1998 by and among the Company and
Credit Suisse First Boston Corporation, BancAmerica Robertson Stephens and BancBoston
Securities, Inc., as Initial Purchasers
- -------------------- ----------------------------------------------------------------------------------------------
10.1* Franchise Agreement dated as of June 24, 1996 by and among the City of Chicago and the
Company
- -------------------- ----------------------------------------------------------------------------------------------
10.2* License Agreement dated as of October 27, 1994 by and among the Chicago Transit Authority
and the Company
- -------------------- ----------------------------------------------------------------------------------------------
10.3* CSG Master Subscriber Management System Agreement dated as of May 28, 1997 by and among CSG
Systems, Inc. and the Company
- -------------------- ----------------------------------------------------------------------------------------------
10.4* Telemarketing Consultation Agreement dated as of August 5, 1997 by and among the Company and
ITI Marketing Services, Inc.
- -------------------- ----------------------------------------------------------------------------------------------
10.5* Pole Attachment Agreement dated as of April 3, 1996 by and among the Company and
Commonwealth Edison Company
- -------------------- ----------------------------------------------------------------------------------------------
10.6* Pole Attachment Agreement dated as of November 14, 1998 by and among the Company and
Ameritech--Illinois
- -------------------- ----------------------------------------------------------------------------------------------
10.7* Office Lease dated January 31, 1997 by and among the Company and LaSalle National Bank
- -------------------- ----------------------------------------------------------------------------------------------
10.8* Franchise Agreement dated as of March 16, 1998 by and between the Village of Skokie,
Illinois and 21st Century Cable TV of Illinois, Inc.
- -------------------- ----------------------------------------------------------------------------------------------
10.9* Interconnection Agreement dated as of May 5, 1997 by and
between Ameritech Information Industry Services and 21st
Century Telecom of Illinois, Inc.
- -------------------- ----------------------------------------------------------------------------------------------
10.10* Network Products Purchase Agreement by and between Northern Telecom Inc. and the Company
- -------------------- ----------------------------------------------------------------------------------------------
21.1* Subsidiaries of the Company
- -------------------- ----------------------------------------------------------------------------------------------
27 Financial Data Schedule
- -------------------- ----------------------------------------------------------------------------------------------
</TABLE>
*Incorporated herein by reference to the Company's S-4 Registration Statement
filed on March 3, 1998
(Commission File No. 333-47235).
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS INCLUDED AS PART OF THE COMPANY'S SEPTEMBER
30, 1999 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 25,094,932
<SECURITIES> 48,941,472
<RECEIVABLES> 1,241,315
<ALLOWANCES> 409,266
<INVENTORY> 15,763,062
<CURRENT-ASSETS> 91,627,679
<PP&E> 142,853,061
<DEPRECIATION> 11,462,143
<TOTAL-ASSETS> 247,427,257
<CURRENT-LIABILITIES> 21,173,828
<BONDS> 243,202,406
59,297,753
27,592,791
<COMMON> 11,346,651
<OTHER-SE> (119,428,583)
<TOTAL-LIABILITY-AND-EQUITY> 247,427,527
<SALES> 6,943,878
<TOTAL-REVENUES> 6,943,878
<CGS> 7,728,852
<TOTAL-COSTS> 13,973,665
<OTHER-EXPENSES> 20,959,687
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,030,185
<INCOME-PRETAX> (43,302,530)
<INCOME-TAX> 0
<INCOME-CONTINUING> (43,302,530)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (43,302,530)
<EPS-BASIC> (4.33)
<EPS-DILUTED> (4.33)
</TABLE>
