<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
[ ] 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:
333-62797
BIRCH TELECOM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 43-1766929
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2020 BALTIMORE AVENUE 64108
KANSAS CITY, MISSOURI (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code:
(816) 300-3000
--------------
Securities registered pursuant to Section 12(b) of the Act:
14% Senior Notes due 2008
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (i) 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 (ii) has been subject to such
filing requirements for the past 90 days. Yes X No
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TABLE OF CONTENTS
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PART I - FINANCIAL INFORMATION PAGE
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ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets as of December 31, 1998 and March 31, 1999 3
Condensed Consolidated Statements of Operations for the three months ended
March 31, 1998 and 1999 4
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 1998 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 10
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 11
SIGNATURE PAGE 12
EXHIBIT INDEX 13
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
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ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................................ $ 39,745 $ 21,213
Pledged securities ................................................... 15,888 16,399
Accounts receivable, net ............................................. 4,039 4,920
Inventory ............................................................ 916 3,209
Prepaid expenses and other ........................................... 526 2,428
--------- ---------
Total current assets .................................................... 61,114 48,169
Property and equipment, net ............................................. 26,153 32,632
Pledged securities - noncurrent ......................................... 21,897 21,897
Goodwill, net ........................................................... 16,863 19,546
Other intangibles, net .................................................. 7,689 7,537
Other assets ............................................................ 433 932
--------- ---------
Total assets ............................................................ $ 134,149 $ 130,713
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term debt and capital lease obligations ... $ 335 $ 380
Accounts payable ..................................................... 8,503 9,299
Accrued expenses ..................................................... 2,556 8,277
--------- ---------
Total current liabilities ............................................... 11,394 17,956
14% Senior Notes ........................................................ 114,681 114,690
Capital lease obligations, net of current maturities .................... 778 717
Other long-term debt, net of current maturities ......................... 332 330
Preferred stock, $.001 par value; 25,000,000 shares authorized:
Series B Redeemable Preferred Stock, 8,572,039 shares issued and
outstanding (stated at redemption and aggregate liquidation value) . 14,063 14,556
Stockholders' deficit:
Series C Preferred Stock, 8,492,749 shares issued and outstanding .... 8 8
Common stock, $.001 par value, 27,000,000 shares authorized, 5,000,296
shares issued and outstanding....................................... 5 5
Warrants ............................................................. 337 337
Additional paid-in capital ........................................... 12,273 12,273
Accumulated deficit .................................................. (19,722) (30,159)
--------- ---------
Total stockholders' deficit ............................................. (7,099) (17,536)
--------- ---------
Total liabilities and stockholders' deficit ............................. $ 134,149 $ 130,713
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands except share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1999
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<S> <C> <C>
Revenue:
Communications services, net ..................... $ 3,257 $ 9,308
Equipment sales, net ............................. 448 1,328
------- --------
Total revenue ...................................... 3,705 10,636
Cost of services:
Cost of communications services .................. 2,328 7,138
Cost of equipment sales .......................... 314 787
------- --------
Total cost of services ............................. 2,642 7,925
------- --------
Gross margin ....................................... 1,063 2,711
Selling, general and administrative expense ........ 1,372 8,296
Depreciation and amortization expense .............. 258 1,543
------- --------
Loss from operations ............................... (567) (7,128)
Interest expense ................................... (56) (3,715)
Interest income .................................... - 907
------- --------
Net loss ........................................... (623) (9,936)
Preferred stock dividends .......................... (216) (493)
Amortization of preferred stock issuance costs ..... - (8)
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Loss applicable to common stock .................... $ (839) $(10,437)
======= ========
Loss per common share-- basic and diluted .......... $ (0.79) $ (2.09)
======= ========
Weighted average number of common shares outstanding 1,065 5,000
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1999
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<S> <C> <C>
NET CASH FROM OPERATING ACTIVITIES (1,217) (5,730)
INVESTING ACTIVITIES
Purchase of property and equipment ................................... (329) (6,957)
Business acquisitions, net of cash acquired .......................... (4,375) (4,368)
Amortization of discount on pledged securities ....................... -- (511)
-------- --------
Net cash from investing activities ................................... (4,704) (11,836)
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock ............................ 9,500 --
Payment of financing costs ........................................... (364) --
Payment of Series A Preferred Stock Dividends ........................ (64) --
Proceeds from convertible notes ...................................... 3,500 --
Amortization of discount on senior notes ............................. -- 8
Repayment of short term notes ........................................ (380) (200)
Repayment of long-term debt .......................................... (2) (674)
Repayment of capital lease obligation ................................ (16) (100)
-------- --------
Net cash from financing activities ................................... 12,174 (966)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .................. 6,253 (18,532)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD....................... 210 39,745
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............................ $ 6,463 $ 21,213
======== ========
Supplementary schedule of non-cash investing and financing activities:
Amounts recorded in connection with acquisitions:
Fair value of net assets acquired, net of cash acquired ......... $ 4,840 $ 2,678
Fair value of intangible assets ................................. 17,592 3,488
Assumption of liabilities ....................................... 2,524 926
Assumption of long-term debt and capital lease obligations ...... 783 872
Issuance of Series A Preferred Stock ............................ 4,750 --
Issuance of Series C Preferred Stock ............................ 10,000 --
Property and equipment additions included in accounts payable ...... 3,242 --
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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BIRCH TELECOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1999
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
of Birch Telecom, Inc. ("Birch" or the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three months ended March 31, 1999 are not necessarily
indicative of the results that may be expected for the year ended December 31,
1999. For further information, refer to the consolidated financial statements
and footnotes thereto included in the Birch Telecom, Inc. annual report on Form
10-K for the fiscal year ended December 31, 1998.
2. RECLASSIFICATIONS
Certain items in the 1998 condensed consolidated financial statements
have been reclassified to be consistent with the classification in the 1999
condensed consolidated financial statements.
3. ACQUISITIONS
In February 1998, Birch merged with Valu-Line Companies, Inc.
(Valu-Line) in a transaction valued at $19.5 million, consisting of $4.75
million in cash, 2,968,750 shares of Series A Preferred Stock having an
aggregate liquidation preference of $4.75 million and 6,250,000 shares of Series
C Preferred Stock having an aggregate liquidation preference of $10.0 million.
Since 1982, Valu-Line has been primarily providing switched long distance
services, customer premises equipment (CPE) sales and services and, since March
1997, local service. The merger was accounted for under the purchase method of
accounting. Accordingly, the operations of Valu-Line are included in the
condensed consolidated statements of operations and cash flows from the date of
acquisition.
In February 1999, the Company acquired American Local
Telecommunications, LLC (ALT), a competitive local exchange carrier based in the
Dallas, Texas metropolitan area. The acquisition, recorded as a purchase,
included substantially all assets of ALT. The total purchase price was
approximately $783,000 plus the potential for additional consideration estimated
at $575,000 at March 31, 1999 based on lines converted to the Company's service
from ALT's existing customer base.
In March 1999, the Company acquired the stock of Capital Communications
Corporation (Capital), a telecommunications equipment provider based in the St.
Louis, Missouri metropolitan area. The purchase price was $3.0 million, plus the
potential for additional consideration based on lines converted to the Company's
service from Capital's existing customer base.
6
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4. PLEDGED SECURITIES, WARRANTS, AND DEBT
During June 1998, the Company completed a $115 million private offering
of 14% Senior Notes due June 2008 (the Senior Notes) and 115,000 warrants to
purchase 1,409,734 shares of common stock. Interest on the Senior Notes is
payable semi-annually in arrears on June 15 and December 15 of each year.
Warrants are exercisable at $0.01 per share and expire June 2008. The Company
received net proceeds from the Senior Notes of $110.2 million and concurrently
purchased pledged securities of $44.2 million. The pledged securities are
restricted for interest payments on the Senior Notes and, together with the
interest accruing thereon, will be used to satisfy such interest payments
through June 2001. The Company classifies its pledged securities, consisting of
$38.3 million and $37.8 million of U.S. Treasury securities at March 31, 1999
and December 31, 1998, respectively, as held to maturity recorded at amortized
cost and maturing between six and thirty months. A portion of the proceeds of
this offering, $337,000, was allocated to the warrants, and the resulting debt
discount is being amortized over the life of the debt on the straight-line
method, which does not differ materially from the effective interest method.
Unamortized discount was $310,000 and $319,000 at March 31, 1999 and December
31, 1998, respectively. The amount allocated to the warrants represents the
estimated fair value of the warrants at the date of issuance. The Senior Notes
rank pari pasu in right of payment to all existing and future senior
indebtedness of the Company and rank senior in the right of payment to all
existing and future subordinated indebtedness of the Company.
The Company filed a registration statement with the Securities and
Exchange Commission (SEC) for the registration of $115 million aggregate
principal amount of 14% Senior Notes due December 2008 (the Exchange Notes) to
be offered in exchange for the Senior Notes (the Exchange Offer). The
registration statement was declared effective by the SEC in February 1999, and
the Exchange Offer was commenced at that time. The Exchange Offer was completed
in March 1999, at which time all of the Senior Notes were exchanged for the
Exchange Notes. The form and terms of the Exchange Notes are identical in all
material respects to the form and terms of the Senior Notes except the Exchange
Notes were registered under the Securities Act and holders of the Exchange Notes
are not entitled to certain rights under a registration agreement relating to
the Senior Notes.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended March 31, 1999 Compared to Three Months Ended March
31, 1998
Revenue. Revenue was $10.6 million for the three months ended March 31,
1999 compared to $3.7 million for the three months ended March 31, 1998,
principally as a result of a full quarter of Valu-Line's operations, the Dunn &
Associates, Inc., d/b/a Boulevard Phone Company (Boulevard), Telesource
Communications, Inc. (Telesource) and TFSnet, Inc. (TFSnet) acquisitions in 1998
and opening five new markets in 1998. The Capital and ALT acquisitions in 1999
provided approximately $600,000 of revenue in the 1999 quarter. Revenue
increases in excess of revenue gained from acquisitons in 1998 were largely from
new customer sales, particularly those focused on local service. For the three
months ended March 31, 1999 and 1998, as a percentage of total revenue,
communications and other services were 87.5% and 87.9%, respectively, and CPE
sales were 12.5% and 12.1%, respectively.
Cost of services. Cost of services was $7.9 million for the three
months ended March 31, 1999, compared to $2.6 million for the three months ended
March 31, 1998, principally as a result of a full quarter of Valu-Line's
operations, the Boulevard, Telesource and TFSnet acquisitions and opening five
new markets in 1998. The Capital and ALT acquisitions added approximately
$380,000 of cost of services in the 1999 quarter. Gross margin for the three
months ended March 31, 1999 and 1998 was $2.7 million and $1.1 million,
respectively, or 25.5% and 28.7% of revenue, respectively. The decline in gross
margin is principally from a greater percentage of revenue being derived from
resold local service during the first quarter of 1999 versus 1998.
Selling, general and administrative expense. Selling, general and
administrative expense was $8.3 million for the three months ended March 31,
1999, compared to $1.4 million for the three months ended March 31, 1998. These
expenses increased principally as a result of a full quarter of Valu-Line's
operations, the Boulevard, Telesource and TFSnet acquisitions and opening five
new markets in 1998, each of which effected wages, rent and advertising
expenses. The Company had approximately 500 employees at March 31, 1999,
compared to 137 employees at March 31, 1998. The Capital and ALT acquisitions
added approximately $180,000 of selling, general and administrative expenses in
the 1999 quarter. EBITDA was $(5.6) million for the three months ended March 31,
1999, compared to $(0.3) million for the three months ended March 31, 1998.
Depreciation and amortization. Depreciation and amortization was $1.5
million for the three months ended March 31, 1999, compared to $0.3 million for
the three months ended March 31, 1998, principally attributable to the fixed and
intangible assets acquired in the Valu-Line, Boulevard, Telesource and TFSnet
acquisitions, as well as the deployment of network assets in the Company's
markets.
Interest. Interest expense was $3.7 million for the three months ended
March 31, 1999, compared to $0.1 million for the three months ended March 31,
1998, primarily attributable to the Senior Note interest charges. Interest
income was $1.0 million for the three months ended March 31, 1999, primarily as
a result of invested funds received from the Senior Notes.
Net loss. Net loss was $10.4 million for the three months ended March
31, 1999, compared to $0.8 million for the three months ended March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The expansion of the Company's business will require significant
capital to fund capital expenditures, working capital needs, debt service and
the cash flow deficits generated by operating losses. The Company's principal
capital expenditure requirements include the purchase, installation, and
expansion of switches and transmission equipment for the Company's local and
data networks and the further development of operations support systems and
automated back office systems. Management does not expect that the growth of the
Company's long distance and CPE business will require significant capital
expenditures.
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To date, the Company has primarily funded its expenditures through the
Senior Notes and private sales of equity securities. During the first quarter of
1997, the Company sold equity securities worth $1.8 million. In February and
March 1998, the Company raised approximately $12.4 million in a private
placement of its Series B Preferred Stock and Convertible Notes. On June 18,
1998, the Company sold the Senior Notes for net proceeds of $110.2 million.
The Company expects to make significant capital outlays for the
foreseeable future in order to continue the development activities called for in
its current business plan and to fund expected operating losses. The Company
currently estimates that the cash required to fund capital expenditures for its
expansion plans will be approximately $40.0 million in 1999. In order for the
Company to implement its current business plan and finance its projected capital
expenditures for 1999 and thereafter, the Company will be required to seek and
obtain significant amounts of additional financing (debt and/or equity) within
the next six months. The Company's expansion into Texas is dependent upon
raising substantial additional financing in the near term. The accuracy of the
Company's current projection of cash flow (and losses) from operations will
depend upon numerous future factors and conditions, many of which are outside of
the Company's control. There can be no assurance that such projections will be
accurate. The Company's cost of developing new networks and services, funding
other strategic initiatives and operating its business will depend on a variety
of factors including, among other things, the number of subscribers and the
service for which they subscribe, the nature and penetration of services that
may be offered by the Company, regulatory changes, and actions taken by
competitors in response to the Company's strategic initiatives. It is almost
certain that actual costs and revenue will vary from expected amounts, very
likely to a material degree, and that such variations are likely to affect the
Company's future capital requirements. Current cash balances will not be
sufficient to fund the Company's current business plan beyond the next six
months. As a consequence, the Company is seeking additional debt and/or equity
financing to fund the Company's liquidity. There can be no assurance that the
Company will be able to raise additional capital on satisfactory terms or at
all. In the event that the Company is unable to obtain such additional capital
or to obtain it on acceptable terms or in sufficient amounts, the Company will
be required to delay the development of its network or take other actions that
could have a material adverse effect on the Company's business, operating
results and financial condition.
The Company expects that it will generate operating losses and will not
generate positive cash flow for the foreseeable future. In addition, the Company
will require significant amounts of additional financing, which may not be
available, before it will be able to generate positive cash flow. If the Company
is unable to generate sufficient cash flow from operations to service its
indebtedness, it may have to modify its growth plans, limit its capital
expenditures, restructure or refinance its indebtedness or seek additional
capital or liquidate its assets. There can be no assurance (i) that any of these
strategies could be effected on satisfactory terms, if at all, in light of the
Company's high leverage or (ii) that any such strategy would yield sufficient
proceeds to provide funds for the company in the future.
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YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize the
date using "00" as the year 1900 rather than the year 2000. In addressing this
problem, the Company anticipates spending $20 million on new systems from
inception through the end of 1999. Specific expenditures for year 2000 costs are
not being made related to the new systems. The Company has completed its
assessment on the consequences of the year 2000 on information technology
systems. As the Company has a relatively short history, virtually all systems
are newly created or are being created. During information technology
development, year 2000 issues have been consistently addressed. The new
information technology systems will, in certain cases, replace systems of
acquired companies in order to provide consistent and integrated systems. The
acquired companies' systems are not all year 2000 compliant; however, these
systems will be replaced by the third quarter of 1999. If all such systems are
not replaced and year 2000 issues occur, significant disruption to the Company's
operations could occur. The most significant system of the acquired companies
relates to the provisioning and billing of resale local and long distance
services which, if not replaced, could prevent the Company from billing or
provisioning service to existing and future customers. Installation of an
integrated billing and provisioning system is on schedule to date.
Other non-information technology systems which may be affected by the
year 2000 issue include systems provided to the Company by third parties. The
most significant third party systems are those which operate the incumbent local
exchange carrier's interfaces and billing records, switching equipment and
customer premises equipment. The Company has been assured by significant third
parties that year 2000 compliance will be accomplished by the end of 1999. If
such compliance is not achieved by these third parties, it would have a material
adverse effect on the Company's business, operating results and financial
condition and its ability to achieve sufficient cash flow.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this quarterly report on Form 10-Q are
forward-looking statements. These statements discuss, among other things,
expected growth and expansion strategy. The forward-looking statements are
subject to risks, uncertainties and assumptions, including, but not limited to,
the impact of competitive products and pricing, product developments, changes in
law and regulations, customer demand, litigation, availability of future
financing, uncertainty of market acceptance of new products and other risks.
Actual results may materially differ from anticipated results described in these
forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk through derivative financial
instruments and other financial instruments, such as investments in marketable
securities and long-term debt, is not material.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27.1 Financial Data Schedule (for SEC use only)
11
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SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF
BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
BIRCH TELECOM, INC.
DATE: MAY 12, 1999 BY:/S/ DAVID E. SCOTT
----------------------
DAVID E. SCOTT
PRESIDENT AND CHIEF EXECUTIVE OFFICER
DATE: MAY 12, 1999 BY:/S/ BRADLEY A. MOLINE
-------------------------
BRADLEY A. MOLINE
CHIEF FINANCIAL OFFICER
12
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 21,213
<SECURITIES> 38,296
<RECEIVABLES> 5,145
<ALLOWANCES> 225
<INVENTORY> 3,209
<CURRENT-ASSETS> 48,169
<PP&E> 34,102
<DEPRECIATION> 1,470
<TOTAL-ASSETS> 130,713
<CURRENT-LIABILITIES> 17,956
<BONDS> 0
14,556
8
<COMMON> 5
<OTHER-SE> 17,549
<TOTAL-LIABILITY-AND-EQUITY> 130,713
<SALES> 10,636
<TOTAL-REVENUES> 10,636
<CGS> 7,925
<TOTAL-COSTS> 7,925
<OTHER-EXPENSES> 9,726
<LOSS-PROVISION> 113
<INTEREST-EXPENSE> 3,715
<INCOME-PRETAX> (9,936)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,936)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,936)
<EPS-PRIMARY> (2.09)
<EPS-DILUTED> (2.09)
</TABLE>
