<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(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 of (IRS Employer
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 February 4, 2000, 4,258,635.0 shares of the Registrant's Common Stock were
outstanding.
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
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
</TABLE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
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
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PART 1. 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
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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 4,227,924.1 3,493,965.7 4,079,056.5 3,409,503.2
BASIC AND DILUTED LOSS PER SHARE $ (4.68) $ (4.00) $ (12.98) $ (10.36)
================ ================ ================ ================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
2
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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
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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 PREFERRED RETAINED
TOTAL COMMON STOCK BE 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) - - -
------------------------------------------------------------------------
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 SHARE PREFERRED
SHARES BE 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 - - - -
----------------------------------------------------------------
BALANCES, SEPTEMBER 30, 1999 4,233,397.5 9,063.5 1,747,066.0 1,554.8
================================================================
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
4
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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 which was later rescinded on February 4, 2000. All common stock
amounts and per share amounts reported reflect the recision of the 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 696,944 shares of its no par value common stock valued by the
Company at $4.50 per share to certain officers of EnterAct and agreed to pay an
additional $6,500,000. The Company paid $2,500,000 at the closing and issued two
non-interest bearing notes totaling $4 million. The notes are payable to
executives of EnterAct over two years, one half due on the first anniversary
date and one half due on the second anniversary date. This acquisition was
accounted for as a purchase and accordingly the purchased assets and assumed
liabilities have been recorded at their fair market values at the date of
acquisition. The purchase price exceeded the estimated fair market value of the
net assets acquired resulting in goodwill in the amount of $10,467,656, which is
being amortized using the straight line method over 10 years. In addition, 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,
5
<PAGE>
1999. Comparatively, had the Company reflected the acquisition as of January
1, 1998, its revenues would have 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 which was later rescinded on February 4,
2000. All common stock amounts and per share amounts reported reflect the
recision of the stock
Basic per share amounts were based on weighted average common shares
outstanding, excluding common stock equivalents, of 4,227,924.1 and 3,493,965.7
shares for the three months ended September 30 1999 and 1998, respectively and
4,079,056.5 and 3,409,503.2 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) 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)
786,660.3 vested employee stock options, and (5) 18,994.7 common share warrants
issued to a financial advisor. The net loss attributable to common shares on
which the basic earnings per share calculation is based, reflects the net loss
increased by the amount of preferred dividends and accretion related to the
Class A Convertible 8% Cumulative Preferred Stock and 13 3/4% Senior Cumulative
Exchangeable Preferred Stock.
At September 30, 1998, common shares issuable pursuant to options and
warrants included: (1) 1,308,196 common share warrants related to the Class A
Convertible 8% Cumulative Preferred Stock, (2) 438,870 common share warrants
related to the 13 3/4% Senior Cumulative Exchangeable Preferred Stock, (3)
1,250,000 options issued in connection with certain Directors' guarantee of a
loan, (4) 539,426.9 vested employee stock options, and (5) 18,944.7 stock
warrants issued to a financial advisor. The net loss attributable to common
shares, on which the basic earnings per share calculation is based, reflects the
net loss increased by the amount of preferred dividends and accretion related to
the Class A Convertible 8% Cumulative Preferred Stock and 13 3/4% Senior
Cumulative Exchangeable Preferred Stock.
4. CLASS A CONVERTIBLE 8% CUMULATIVE PREFERRED STOCK
<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>
6
<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 613,709.9 shares of the Company's stock were originally granted under
the plan of which 613,709.9 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 397,095.
Effective June 18, 1999, the Board of Directors voted to suspend the common
stock option plan. No further awards will be granted. The Plan shall remain in
effect with respect to all outstanding awards until such time as those
outstanding awards are exercised, canceled, or otherwise terminated. The balance
of shares reserved for the plan shall be allocated to one or more existing
plans.
Effective April 14, 1998, the Company established three stock option
plans: the Executive Plan, the Key Management Plan, and the Employee Plan.
Under the Executive Plan, 331,200 options are available for grant to two
executive officers of the Company. As of September 30, 1999, all 331,200 shares
available under the Executive Plan were awarded. Effective March 6, 1998,
278,200options were awarded to an executive officer. The exercise price of the
278,200 shares was established at $1.12 per share which is less than the $4.50
per share fair market value determined by the Board of Directors. One half of
the 278,200 shares awarded on March 6, 1998 or 139,100 shares vested immediately
and a total of $470,158 was recorded as compensation expense as a result of the
vesting of the 139,100 options. On April 14, 1998, an executive officer was
awarded 53,000 options under the Executive Plan at an exercise price of $4.50
per share, which was determined by the Board of Directors to be the fair market
value of the underlying common stock. All options vest over 48 months from the
date of employment and expire after ten years. At September 30, 1999, 221,764.3
options were vested.
Under the Key Management Plan and the Employee Plan, 158,000 and
159,657.7 options, respectively, were available for grant. As of September
30, 1999, a total of 158,000 options were granted under the Key Management
Plan, 55,875 of which are vested. A total of 113,783 options were granted
under the Employee Plan, of which 8,152 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 $4.50 per share.
All options under these plans vest over four years beginning July 1, 1999 and
expire 10 years from date of grant.
Effective February 26, 1999, the Company established three new additional
stock option plans related to the former employees of EnterAct. EnterAct was
acquired by the Company on February 26, 1999. The plans are: the 21st Century
Telecom Group, Inc. 1999 Stock Incentive Plan (the "1999 Stock Incentive Plan"),
the 21st Century Telecom Group, Inc. 1999 ISP Stock Plan (the "1999 ISP Stock
Plan"), and the 21st Century Telecom Group, Inc. ISP Employee Stock Option Plan
(the "ISP Employee Stock Option Plan").
Under the 1999 Stock Incentive Plan 60,000 options are available for grant
primarily to specifically named former employees of EnterAct. On February 26,
1999, 50,100 of the shares available under the 1999 Stock Incentive Plan were
awarded to such employees with an additional 4,205 options awarded to newly
hired employees of the Company in March 1999 and 2,935 options awarded to newly
hired employees of the Company in April 1999. Options related to both awards
have an exercise price of $4.50 which is equal to the $4.50 fair market value
determined by the Board of Directors. All options vest at 25% of the total
shares subject to the option, so that the option is fully vested on the fourth
anniversary of the grant date. At September 30, 1999, there were no options
vested.
Under the 1999 ISP Stock Plan 599,916 options are available for grant to
specifically named former employees of EnterAct. On February 26, 1999, all
599,916 shares available under the 1999 ISP Stock Plan were awarded at
7
<PAGE>
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 $35.25 that is subject to a
measurement date of the second anniversary date of the grant and expires on
the seventh anniversary date of the grant. The series "B" option price is
$45.33 that is subject to a measurement date of the second anniversary date
of the grant and expires on the seventh anniversary date of the grant. The
series "C" option price is $65.49 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 98,703 options are available for
grant to specifically named former employees of EnterAct. The ISP Employee Stock
Option Plan was created by the Company as a substitute for EnterAct's previous
option plan. On February 26, 1999, 97,911 shares available under the 1999 ISP
Employee Stock Option Plan were awarded at an exercise price of $4.50 which is
equal to the $4.50 fair market value determined by the Board of Directors. 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, 74,413 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, 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.
9
<PAGE>
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 million under its bank revolving credit facility. The
letter of credit serves as security for a promissory note due to
11
<PAGE>
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
Current Report dated December 12, 1999.
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 February 4, 2000
Robert J. Currey
/s/ Ronald D. Webster Chief Financial Officer February 4, 2000
- -------------------------
Ronald D. Webster
</TABLE>
14
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibits
- -------------- -----------------------
<C> <S>
3.1* Amended Articles of Incorporation
3.2* By-laws
4.1* Indenture dated February 15, 1998 between the Company, as
Issuer, and State Street Bank and Trust, as Trustee, with
respect to the 12 1/4 Senior Discount Notes Due 2008
4.2* Form of the 12 1/4 Senior Discount Notes Due 2008
4.3* Indenture dated as of February 15, 1998 between the Company and IBJ Stirred Bank & Trust
Company, as Trustee, with respect to the Exchange Debenture
4.4* Form of the 13 3/4 Senior Cumulative Exchangeable Preferred Stock Due 2010
4.5* Registration Rights Agreement dated as of February 2, 1998 by and among the Company and
Credit Suisse First Boston Corporation, BancAmerica Robertson Stephens and BancBoston
Securities, Inc., as Initial Purchasers
10.1* Franchise Agreement dated as of June 24, 1996 by and among the City of Chicago and the
Company
10.2* License Agreement dated as of October 27, 1994 by and among the Chicago Transit Authority
and the Company
10.3* CSG Master Subscriber Management System Agreement dated as of May 28, 1997 by and among CSG
Systems, Inc. and the Company
10.4* Telemarketing Consultation Agreement dated as of August 5, 1997 by and among the Company and
ITI Marketing Services, Inc.
10.5* Pole Attachment Agreement dated as of April 3, 1996 by and among the Company and
Commonwealth Edison Company
10.6* Pole Attachment Agreement dated as of November 14, 1998 by and among the Company and
Ameritech--Illinois
10.7* Office Lease dated January 31, 1997 by and among the Company and LaSalle National Bank
10.8* Franchise Agreement dated as of March 16, 1998 by and between the Village of Skokie,
Illinois and 21st Century Cable TV of Illinois, Inc.
10.9* Interconnection Agreement dated as of May 5, 1997 by and
between Ameritech Information Industry Services and 21st
Century Telecom of Illinois, Inc.
10.10* Network Products Purchase Agreement by and between Northern Telecom Inc. and the Company
21.1* Subsidiaries of the Company
27.1 Financial Data Schedule
</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 DATA FROM THE CONSOLIDATED FINANCIAL
STATEMENTS INCLLUDED AS PART OF THE COMPANY'S SEPTEMBER 30, 1999 10Q AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<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> (12.98)
<EPS-DILUTED> (12.98)
</TABLE>
