<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 10, 1998
REGISTRATION NO. 333-50475
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
KMC TELECOM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4813 22-3545325
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
------------------------
1545 ROUTE 206, SUITE 300
BEDMINSTER, NEW JERSEY 07921
(908) 470-2100
(Address, including ZIP Code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------------
MICHAEL A. STERNBERG
PRESIDENT AND CHIEF EXECUTIVE OFFICER
KMC TELECOM HOLDINGS, INC.
1545 ROUTE 206, SUITE 300
BEDMINSTER, NJ 07921
(908) 470-2100
(Name and address, including ZIP Code and telephone number,
including area code, of agent for service)
------------------------------
WITH A COPY TO:
BRIAN J. CALVEY, ESQ.
KELLEY DRYE & WARREN LLP
101 PARK AVENUE
NEW YORK, NEW YORK 10178
(212) 808-7800
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF SECURITIES TO THE
PUBLIC: As soon as practicable after this Registration Statement becomes
effective.
If the securities being registered on this Form are to be offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box / /
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PROSPECTUS
KMC TELECOM HOLDINGS, INC.
OFFER TO EXCHANGE 12 1/2%
SENIOR DISCOUNT NOTES DUE 2008 FOR
ANY AND ALL OUTSTANDING 12 1/2%
SENIOR DISCOUNT NOTES DUE 2008
---------------------
The Exchange Offer will expire at 5:00 p.m., New York City time, on August
11, 1998 unless extended.
------------------------
KMC Telecom Holdings, Inc., a Delaware corporation (the "Company"), hereby
offers to exchange (the "Exchange Offer"), upon the terms and subject to the
conditions set forth in this Prospectus (the "Prospectus") and the accompanying
Letter of Transmittal (the "Letter of Transmittal"), its 12 1/2% Senior Discount
Notes due 2008 (the "Exchange Notes"), which have been registered under the
Securities Act of 1933, as amended (the "Securities Act"), pursuant to a
Registration Statement of which this Prospectus forms a part (together with all
amendments and exhibits thereto, the "Registration Statement"), for a like
principal amount at maturity of its 12 1/2% Senior Discount Notes due 2008 (the
"Original Notes" and, together with the Exchange Notes, the "Notes").
------------------------
The Original Notes were issued by the Company in an offering (the "Initial
Offering") of 460,800 Units (the "Units") exempt from the registration
requirements of the Securities Act, which was consummated on January 29, 1998
(the "Closing Date"). Each Unit issued in the Initial Offering consisted of one
Original Note and one warrant (each a "Warrant" and, collectively, the
"Warrants") to purchase 0.21785 shares of common stock, par value $.01 per
share, of the Company (the "Common Stock"). The Original Notes and the Warrants
will become separately tradeable upon the effectiveness of the Registration
Statement.
------------------------
The terms of the Exchange Notes are identical in all material respects
(including principal amount at maturity, interest rate and maturity) to the
terms of the Original Notes for which they may be exchanged pursuant to the
Exchange Offer, except that the Exchange Notes will generally be freely
transferable by holders thereof (each, a "Holder" and, collectively, the
"Holders") (except as provided herein), and are not subject to any covenant of
the Company regarding registration. The Exchange Notes will evidence the same
indebtedness as the Original Notes (which they replace) and will be entitled to
the benefits of the Indenture, dated as of January 29, 1998, governing the
Original Notes and the Exchange Notes (the "Indenture"). For a description of
the principal terms of the Exchange Notes, see "Description of the Exchange
Notes."
------------------------
Interest on the Exchange Notes will be payable semi-annually on February 15
and August 15 of each year, commencing August 15, 2003. The Notes are redeemable
at the option of the Company, in whole or in part, at any time on or after
February 15, 2003, at the redemption prices set forth herein. In addition, at
any time prior to April 15, 2000, the Company may redeem up to 35% of the
aggregate principal amount at maturity of the Notes from the proceeds of one or
more public or private Equity Offerings (as defined herein) at the redemption
price set forth herein; provided that after any such redemption at least 65% of
the aggregate principal amount at maturity of the Notes remains outstanding.
------------------------
SEE "RISK FACTORS," COMMENCING ON PAGE 17, FOR A DESCRIPTION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PARTICIPANTS IN CONNECTION WITH THE
EXCHANGE OFFER AND AN INVESTMENT IN THE EXCHANGE NOTES.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
COVER CONTINUED ON NEXT PAGE
The date of this Prospectus is July 13, 1998.
<PAGE>
COVER CONTINUED FROM PRECEDING PAGE
The Exchange Notes will be unsubordinated, unsecured indebtedness of the
Company, will rank PARI PASSU in right of payment with all existing and future
unsubordinated, unsecured indebtedness of the Company and senior in right of
payment to all subordinated indebtedness of the Company. As of March 31, 1998,
the Company (on an unconsolidated basis) had $248.6 million of liabilities,
including $244.5 million of indebtedness on the Original Notes (the principal
amount of which at maturity is $460.8 million). However, the Company is a
holding company and the Exchange Notes will be effectively subordinated to all
existing and future liabilities (including trade payables) of the Company's
subsidiaries. As of March 31, 1998, the Company's subsidiaries had approximately
$49.6 million of liabilities (excluding intercompany payables), including
approximately $40.5 million of secured indebtedness.
The Exchange Notes are being offered hereunder in order to satisfy certain
of the obligations of the Company under a registration rights agreement, dated
January 26, 1998 (the "Registration Rights Agreement") between the Company and
the Placement Agent (as defined herein) relating to the Original Notes. See "The
Exchange Offer--Purpose of the Exchange Offer." The Company is making the
Exchange Offer in reliance upon an interpretation by the staff of the Securities
and Exchange Commission (the "Commission") set forth in a series of no-action
letters issued to third parties, although the Company has not sought, and does
not intend to seek, its own no-action letter and there can be no assurance that
the staff of the Commission would make a similar determination with respect to
the Exchange Offer. Based upon the Commission's interpretations, the Company
believes that the Exchange Notes issued pursuant to the Exchange Offer in
exchange for Original Notes may be offered for resale, resold and otherwise
transferred by Holders thereof (other than any Holder that is (i) an "affiliate"
of the Company within the meaning of Rule 405 under the Securities Act (an
"Affiliate"), (ii) a broker-dealer who acquired Original Notes directly from the
Company or (iii) a broker-dealer who acquired Original Notes as a result of
market-making or other trading activities) without compliance with the
registration and prospectus delivery provisions of the Securities Act; provided,
that such Exchange Notes are acquired in the ordinary course of such Holders'
business and such Holders are not participating in, do not intend to participate
in, and have no arrangement or understanding with any person to participate in,
a distribution of such Exchange Notes. Any Holder that cannot rely upon such
interpretations must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a secondary resale
transaction. See "The Exchange Offer--Procedures For Tendering."
Each broker-dealer who receives Exchange Notes pursuant to the Exchange
Offer in exchange for Original Notes acquired for its own account as a result of
market-making activities or other trading activities may be a statutory
underwriter and must acknowledge that it will deliver a prospectus meeting the
requirements of the Securities Act in connection with any resale of such
Exchange Notes. The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it is
an "underwriter" within the meaning of the Securities Act. Broker-dealers who
acquired Original Notes as a result of market-making or other trading activities
may use this Prospectus, as supplemented or amended, in connection with resales
of the Exchange Notes.
The Original Notes are designated eligible for trading in the Private
Offerings, Resales and Trading through Automated Linkages ("PORTAL") market. The
Company does not intend to apply for listing of the Exchange Notes on any
securities exchange or to seek approval through any automated quotation system.
There can be no assurance regarding the future development of a market for the
Exchange Notes, or the ability of Holders of the Exchange Notes to sell their
Exchange Notes or the price at which such Holders may be able to sell their
Exchange Notes. See "Risk Factors--Absence of Public Market."
Any Original Notes not tendered and accepted in the Exchange Offer will
remain outstanding and will be entitled to all of the rights and preferences,
and will be subject to the limitations, applicable thereto under the Indenture.
Following consummation of the Exchange Offer, the Holders of Original Notes will
continue to be subject to the existing restrictions on transfer thereof and the
Company will have no further obligation to such Holders to provide for the
registration under the Securities Act of the Original Notes held by them.
The Exchange Offer is not conditioned upon any minimum aggregate principal
amount at maturity of Original Notes being tendered for exchange but is
otherwise subject to customary conditions. The Company will accept for exchange
any and all validly tendered Original Notes not withdrawn prior to 5:00 p.m.,
New York City time, on August 11, 1998, unless the Exchange Offer is extended by
the Company in its sole discretion (the "Expiration Date"). Original Notes
tendered pursuant to the Exchange Offer may be withdrawn at any time prior to
the Expiration Date; otherwise such tenders are irrevocable. Original Notes may
only be tendered in integral multiples of $1,000 at maturity. See "The Exchange
Offer."
The Company will not receive any proceeds from, and has agreed to bear all
registration expenses of, the Exchange Offer.
2
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE EXCHANGE NOTES TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT WOULD BE UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION
TO SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF.
THIS PROSPECTUS INCLUDES "FORWARD-LOOKING STATEMENTS". ALL STATEMENTS
REGARDING THE COMPANY'S AND ITS SUBSIDIARIES' EXPECTED FINANCIAL POSITION,
BUSINESS AND FINANCING PLANS ARE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE
COMPANY AND ITS SUBSIDIARIES BELIEVE THAT THE EXPECTATIONS REFLECTED IN SUCH
FORWARD-LOOKING STATEMENTS ARE REASONABLE, THERE CAN BE NO ASSURANCE THAT SUCH
EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT. IMPORTANT FACTORS THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH EXPECTATIONS ("CAUTIONARY
STATEMENTS") ARE DISCLOSED IN THIS PROSPECTUS, INCLUDING UNDER "RISK FACTORS."
ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE
COMPANY, ITS SUBSIDIARIES OR PERSONS ACTING ON THEIR BEHALF ARE EXPRESSLY
QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY STATEMENTS. NOTHING CONTAINED IN
THIS PROSPECTUS IS OR SHOULD BE RELIED UPON AS A PROMISE OR REPRESENTATION AS TO
FUTURE RESULTS OR EVENTS.
------------------------
NOTICE TO NEW HAMPSHIRE RESIDENTS
NEITHER THE FACT THAT A REGISTRATION STATEMENT OR AN APPLICATION FOR A
LICENSE HAS BEEN FILED UNDER CHAPTER 421-B WITH THE STATE OF NEW HAMPSHIRE NOR
THE FACT THAT A SECURITY IS EFFECTIVELY REGISTERED OR A PERSON IS LICENSED IN
THE STATE OF NEW HAMPSHIRE CONSTITUTES A FINDING BY THE SECRETARY OF STATE THAT
ANY DOCUMENT FILED UNDER RSA 421-B IS TRUE, COMPLETE AND NOT MISLEADING. NEITHER
ANY SUCH FACT NOR THE FACT THAT AN EXEMPTION OR EXCEPTION IS AVAILABLE FOR A
SECURITY OR A TRANSACTION MEANS THAT THE SECRETARY OF STATE HAS PASSED IN ANY
WAY UPON THE MERITS OR QUALIFICATIONS OF, OR RECOMMENDED OR GIVEN APPROVAL TO,
ANY PERSON, SECURITY OR TRANSACTION. IT IS UNLAWFUL TO MAKE, OR CAUSE TO BE
MADE, TO ANY PROSPECTIVE PURCHASER, CUSTOMER OR CLIENT ANY REPRESENTATION
INCONSISTENT WITH THE PROVISIONS OF THIS PARAGRAPH.
3
<PAGE>
AVAILABLE INFORMATION
This Prospectus constitutes part of an exchange offer Registration Statement
on Form S-4 filed by the Company with the Commission under the Securities Act
with respect to the Exchange Notes. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto, certain portions of which have been omitted in accordance
with the rules and regulations of the Commission. Reference is made to such
Registration Statement and to the exhibits relating thereto for further
information with respect to the Company and the Exchange Notes. Statements made
in this Prospectus as to any contract, agreement or other document are summaries
of the material terms of such contracts, agreements or other documents and are
not necessarily complete. With respect to each such contract, agreement or other
document filed as an exhibit to the Registration Statement, reference is made to
the exhibit for a more complete description of the matter involved, and each
such statement is qualified in its entirety by such reference.
The Company is not currently subject to the informational requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As a
result of the filing of the Registration Statement with the Commission, however,
the Company will become subject to the informational requirements of the
Exchange Act and in accordance therewith will be required to file with, or
furnish to, the Commission certain reports and other information. The
Registration Statement, the exhibits and schedules thereto, reports and other
information filed with or furnished to the Commission by the Company may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and will also be available for inspection and copying at the regional
offices of the Commission at 7 World Trade Center, 13th Floor, New York, New
York 10048 and at Northwestern Atrium Center, 500 West Madison Street (Suite
1400), Chicago, Illinois 60661. Copies of such materials may also be obtained
from the Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. In addition, the Commission
maintains a Web site on the Internet that contains reports and other information
regarding registrants that submit electronic filings to the Commission,
including the Company. The address of the Commission's Web site is HTTP://
WWW.SEC.GOV.
Pursuant to the Indenture, the Company has agreed, whether or not required
by the rules and regulations of the Commission, to file with the Commission and
to furnish to the Trustee and to registered Holders of the Notes, such reports
and other information as it would be required to file with the Commission by
Sections 13(a) or 15(d) of the Exchange Act if it were subject thereto.
4
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION, INCLUDING RISK FACTORS AND FINANCIAL STATEMENTS, INCLUDING THE
NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS THE CONTEXT
OTHERWISE REQUIRES, THE TERM "COMPANY" MEANS KMC TELECOM HOLDINGS, INC. ("KMC")
AND, WHERE APPROPRIATE, ITS SUBSIDIARIES. INDUSTRY FIGURES WERE OBTAINED FROM
REPORTS PUBLISHED BY THE FEDERAL COMMUNICATIONS COMMISSION (THE "FCC"). SEE
"GLOSSARY OF SELECTED TERMS" BEGINNING AT PAGE G-1 FOR THE DEFINITIONS OF
CERTAIN TERMS USED IN THIS PROSPECTUS.
THE COMPANY
The Company is a competitive local exchange carrier ("CLEC") providing
telecommunications and data services in Tier III Markets. The Company targets
business, government and institutional end users, as well as Internet service
providers ("ISPs"), long distance companies ("IXCs") and wireless service
providers. The Company's objective is to provide its customers with a complete
solution for their communications needs. The Company currently provides on-net
special access and private line and Internet access services and, primarily on a
resale basis, switch-based local and long distance services. During the next
year, the Company plans to provide Centrex-type, frame relay, ISDN and ATM
services for applications including LAN-to-LAN interconnect, Internet access,
WAN, and high speed video conferencing.
The Company currently operates in eight Tier III Markets. The Company enters
its targeted markets initially by reselling the services of the ILEC while it is
constructing its fiber optic network backbone and installing its switches.
Lucent Technologies Series 5ESS-Registered Trademark--2000 switches (or Lucent
derivatives of the 5ESS-Registered Trademark-) are currently in commercial
operation in all eight of the Company's existing markets. The Company intends to
install Lucent switches in each of its future markets. The Company expects to
complete construction of 10 additional networks and install 10 additional
switches by the end of 1998. In addition, the Company expects to complete
construction of 5 additional networks and install 5 additional switches in 1999.
Over time, the Company expects to transition the majority of its customers to
its own networks by means of either direct connections or ILEC unbundled network
elements.
Through March 31, 1998, the Company had invested $82.5 million in connection
with the construction of its networks. For the three months ended March 31,
1998, revenues totaled $2.8 million, comprised of $2.1 million from resale of
switched services and $662,000 from on-net special access, private line and
switched services and the Company incurred a net loss of $13.0 million.
5
<PAGE>
The following table presents information, as of May 31, 1998, concerning the
Company's existing eight networks and the seven new networks on which
construction has begun or for which network engineering has been completed:
<TABLE>
<CAPTION>
EXISTING NETWORKS
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
COMMERCIAL
NETWORK SWITCH ADDRESSABLE BUILDINGS
COMMERCIALLY COMMERCIALLY ROUTE COMMERCIAL CONNECTED TO
LOCATION OPERATIONAL(1) OPERATIONAL(2) MILES(3) BUILDINGS(4) THE NETWORK(5)
- ---------------------------------------- ---------------- ---------------- ----------- ------------- ---------------
Huntsville, AL.......................... March 1996 November 1997 94 1,286 66
Baton Rouge, LA......................... March 1997 November 1997 30 1,774 24
Shreveport, LA.......................... March 1997 December 1997 24 1,126 14
Corpus Christi, TX...................... May 1997 December 1997 28 1,105 5
Savannah, GA............................ June 1997 December 1997 25 1,069 51
Melbourne, FL (7)....................... July 1997 May 1998 46 1,163 12
Madison, WI............................. August 1997 December 1997 37 1,322 30
Augusta, GA............................. October 1997 March 1998 31 1,053 2
<CAPTION>
NEW NETWORKS
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Greensboro, NC.......................... Third Quarter Third Quarter
1998 1998 23 1,900 --
Winston-Salem, NC....................... Third Quarter Third Quarter
1998 1998 20 1,208 --
Tallahassee, FL......................... Third Quarter Third Quarter
1998 1998 26 1,032 --
Roanoke, VA............................. Third Quarter Fourth Quarter
1998 1998 22 981 --
Ann Arbor, MI........................... Fourth Quarter Fourth Quarter
1998 1998 22 1,355 --
Topeka, KS.............................. Fourth Quarter Fourth Quarter
1998 1998 24 847 --
Fort Wayne, IN.......................... Fourth Quarter Fourth Quarter
1998 1998 24 1,532 --
<CAPTION>
<S> <C>
DS-0
EQUIVALENT
ACCESS
LOCATION LINES(6)
- ---------------------------------------- -------------
Huntsville, AL.......................... 27,431
Baton Rouge, LA......................... 7,605
Shreveport, LA.......................... 6,772
Corpus Christi, TX...................... 3,123
Savannah, GA............................ 2,728
Melbourne, FL (7)....................... 4,155
Madison, WI............................. 4,086
Augusta, GA............................. 2,946
<S> <C>
Greensboro, NC..........................
--
Winston-Salem, NC.......................
--
Tallahassee, FL.........................
--
Roanoke, VA.............................
--
Ann Arbor, MI...........................
--
Topeka, KS..............................
--
Fort Wayne, IN..........................
--
</TABLE>
- ------------------------
(1) The Company considers a network to be commercially operational when its
fiber optic cable and related electronics permit the Company to commence
service. The quarters presented for new networks represent the Company's
estimate of the calendar quarters in which the new networks will be
commercially operational. There can be no assurance that the new networks
will be commercially operational when estimated.
(2) Refers to the date on which testing is completed and the switch is first
available to carry customer traffic. Generally, the Company believes that
the actual transition of the majority of customers to on-net switched
services should be complete within six to nine months or less following the
date on which the switch becomes commercially operational. The quarters
presented for new networks represent the Company's estimate of the calendar
quarters in which the switches for these networks will be commercially
operational. However, there can be no assurance regarding when switches for
the new networks will be commercially operational or when customers will be
transitioned to on-net services.
(3) Represents (i) for existing networks, current owned operational route miles
and (ii) for new networks, the number of route miles currently estimated to
be owned and operational at the time the network becomes commercially
operational.
(4) Addressable by either ILEC unbundled network elements or a direct connection
to the Company's network. The Company defines a commercial building as one
with greater than ten employees.
(5) Represents commercial buildings connected to the Company's network either by
a direct connection or by ILEC unbundled network elements.
(6) Represents all active digital channels provided to customers either by
resale via the ILEC's network, direct connection to the Company's network or
by ILEC unbundled network elements.
(7) The Melbourne, Florida network (the "Melbourne System") was already
commercially operational when it was acquired in July 1997.
The Company was founded in 1994 by its Chairman, Harold N. Kamine, who
invested approximately $6.3 million in Common Stock of the Company. Mr. Kamine
is Chairman and Chief Executive Officer of Kamine Development Corp., a major
developer of electric cogeneration plants. Additional equity financing for the
Company has been provided by Nassau Capital Partners L.P. ("Nassau"), an
affiliate of the firm that manages Princeton University's endowment's private
investment program, which has invested $14.9 million in Preferred Stock of the
Company; AT&T Credit Corporation ("AT&T Credit") which has invested $20.0
million in Common Stock of the Company; General Electric Capital Corporation
("GECC") which has invested $10.0 million in Preferred Stock of the Company and
CoreStates Bank, N.A. ("CoreStates") which has invested $5.0 million in
Preferred Stock. AT&T Credit and AT&T Commercial Finance Corporation ("AT&T
Finance"), which is referred to later herein, are subsidiaries of Newcourt
Capital.
6
<PAGE>
BUSINESS STRATEGY
The principal elements of the Company's business strategy include:
TIER III MARKET FOCUS. The Company intends to operate in Tier III Markets.
The Company believes that many Tier III Markets offer attractive demographic,
economic, competitive and demand characteristics. In addition, network
construction is less expensive in Tier III Markets than in Tier I and Tier II
Markets. Generally, labor costs and the costs of obtaining rights of way are
lower in Tier III Markets. In addition, many Tier III Markets permit significant
aerial deployment of fiber optic cable which is less expensive than the buried
deployment required in many Tier I and Tier II Markets.
EARLY TO MARKET ADVANTAGE. The Company strives to be the first CLEC in a
geographic area to actively market and provide services. The Company believes
that by effecting early entry into Tier III Markets it will be able to limit
significant competition from other CLECs which may focus on Tier III Markets
where no CLEC has yet established operations, although there can be no assurance
in this regard. See "Risk Factors--Competition."
COMPREHENSIVE NETWORKS. The Company builds geographically extensive, full
service networks. The Company believes that such networks provide greater
operating leverage, facilitate the capture of market share, and are likely to
deter other CLECs from attempting to penetrate its markets. In each of its
existing eight markets, the Company has completed its backbone construction
connecting the market's central business district with outlying office parks,
large institutions and IXC Points of Presence ("POPs"). In addition, the Company
will continue to expand its existing networks in response to anticipated
customer demand.
LOCAL PRESENCE. The Company intends to capture and retain customers through
effective, personalized sales, marketing and customer service programs. The
Company establishes sales offices in each market in which it operates a network,
relies on a face-to-face selling approach for its customers and will support its
sales staff with locally based customer service and technical support personnel.
The Company believes that its "Creative Solutions with a Hometown Touch"-TM-
sales approach is very important to customers in Tier III Markets, who do not
typically receive local customer support from the ILEC.
LOW COST CONSTRUCTION. The Company uses innovative "switch-in-a-box"
construction and deployment techniques for many of its networks. Using these
techniques, lightwave, switching and power equipment are pre-installed by Lucent
Technologies Inc. ("Lucent") under controlled factory conditions in
weatherproof, storm-proof concrete buildings delivered to the Lucent facility by
a Company contractor. The completed buildings are then shipped to the
appropriate city for final installation, reducing costs, installation risks and
time to market.
EXPERIENCED EXECUTIVE TEAM. The Company's executive team is led by Harold
N. Kamine, Chairman of the Board of Directors, and Michael A. Sternberg, the
Company's President and Chief Executive Officer. Other members of the team
include Gary E. Lasher, Vice Chairman of the Board, Roscoe C. Young II, Chief
Operating Officer, Cynthia Worthman, Vice President and Chief Financial Officer,
Secretary and Treasurer, and James L. Barwick, Senior Vice President-Technology.
These executives, collectively, have over 130 years of experience in the
telecommunications industry.
RECENT DEVELOPMENTS
Since January, 1998, the Company has continued the expansion of the business
as set forth below:
NEW SYSTEMS; NETWORK EXPANSION. The Company has commenced construction of
new networks in Greensboro and Winston-Salem, North Carolina, Tallahassee,
Florida, Roanoke, Virginia, Ann Arbor, Michigan and Topeka, Kansas and completed
network engineering for a new network in Fort Wayne, Indiana, all of which are
planned for completion in 1998. The Company has commenced development
7
<PAGE>
work on another eight networks planned for completion in 1998 and 1999. The
Company increased the number of its commercially operational switches from six
to eight. In addition, the Company increased the number of commercial buildings
connected to its existing networks by means of either direct connection or ILEC
unbundled network elements from 112 to 204, and increased the number of fiber
optic route miles in its existing networks from 249 to 315.
REVENUE AND CUSTOMER GROWTH. The Company's monthly revenues have increased
each month since January. Revenues for January, February, March, April and May,
1998 were $824,000, $871,000, $1.1 million, $1.4 million, and $1.5 million,
respectively. The Company increased the number of its customers from 369 at the
end of January to 769 at the end of May.
EMPLOYEE EXPANSION. The number of the Company's employees increased from
160 to 272 from January to May 1998. Included in the increase were 42 field
sales personnel (including City Directors for 10 of the 15 new networks planned
for completion in 1998 and 1999); 45 network operations, customer support and
information technology personnel; and 25 corporate marketing and administrative
personnel.
The Company continues to evaluate additional Tier III markets for possible
further expansion, as well as potential acquisition candidates. Any such
expansion or major acquisitions would be dependent upon the Company's ability to
obtain additional financing. No assurance can be given that such financing will
be available, although the Company continues to evaluate potential financing
opportunities.
The Company is a Delaware corporation with its principal executive offices
located at 1545 Route 206, Suite 300, Bedminster, New Jersey 07921 and its
telephone number at that location is (908) 470-2100.
8
<PAGE>
SUMMARY OF THE EXCHANGE OFFER
<TABLE>
<S> <C>
THE EXCHANGE OFFER..................... The Company is offering to exchange $1,000
principal amount at maturity of Exchange Notes that
have been registered under the Securities Act for
each $1,000 principal amount at maturity of the
Original Notes. In order to be exchanged, an
Original Note must be properly tendered and
accepted. All Original Notes that are validly
tendered and not validly withdrawn will be
exchanged. As of this date, there is approximately
$460.8 million aggregate principal amount at
maturity of Original Notes outstanding. The Company
will issue registered Exchange Notes on, or
promptly after, the Expiration Date. Each of the
Original Notes was originally issued as part of a
Unit consisting of one Original Note and a Warrant
to purchase 0.21785 shares of Common Stock. These
Warrants will become separately tradeable on the
commencement of the Exchange Offer and the Company
is not offering to exchange them.
RESALES................................ Based on interpretations by the staff of the
Commission set forth in no-action letters issued to
third parties, the Company believes that the
Exchange Notes may be offered for resale, resold
and otherwise transferred by Holders without
compliance with the registration and prospectus
delivery provisions of the Securities Act;
provided, that:
(i) the Holder is acquiring Exchange Notes in the
ordinary course of the Holder's business;
(ii) the Holder is not participating, does not
intend to participate, and has no arrangement or
understanding with any person to participate,
in the distribution of the Exchange Notes; and
(iii) the Holder is not an Affiliate of the
Company.
If the Company's belief is inaccurate and a Holder
transfers any Exchange Note without delivering a
prospectus meeting the requirements of the
Securities Act or without an exemption from such
requirements, such Holder may incur liability under
the Securities Act. The Company does not assume or
indemnify Holders against such liability.
Each broker-dealer that is issued Exchange Notes
for its own account in exchange for Original Notes
which were acquired by such broker-dealer as a
result of market-making or other trading activities
must acknowledge that it will deliver a prospectus
meeting the requirements of the Securities Act in
connection with any resale of the Exchange Notes
issued in the Exchange Offer. This Prospectus, as
it may be amended or supplemented from
</TABLE>
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<S> <C>
time to time, may be used by a broker-dealer in
connection with resales of Exchange Notes received
in exchange for Original Notes acquired by such
broker-dealer as a result of market-making
activities or other trading activities. The Letter
of Transmittal that accompanies this Prospectus
states that by so acknowledging and by delivering a
prospectus, a broker-dealer will not be deemed to
admit that it is an "underwriter" within the
meaning of the Securities Act.
REGISTRATION RIGHTS.................... The Original Notes were sold by the Company on
January 29, 1998 to Morgan Stanley & Co.
Incorporated (the "Placement Agent") pursuant to a
Placement Agreement, dated January 26, 1998 (the
"Placement Agreement"), between the Company and the
Placement Agent. Pursuant to the Placement
Agreement, the Company entered into the
Registration Rights Agreement with the Placement
Agent, which agreement grants the Holders of
Original Notes certain exchange and registration
rights. The Exchange Offer is intended to satisfy,
as to all Notes, such rights, which will terminate
upon consummation of the Exchange Offer. The
Holders of the Exchange Notes will not be entitled
to any exchange or registration rights with respect
to the Exchange Notes. Holders of Original Notes
who do not participate in the Exchange Offer may
thereafter hold a less liquid security. See "The
Exchange Offer--Termination of Certain Rights."
EXPIRATION DATE........................ The Exchange Offer will expire at 5:00 p.m., New
York City time, on August 11, 1998, unless the
Exchange Offer is extended by the Company in its
sole discretion, in which case the term "Expiration
Date" shall mean the latest date and time to which
the Exchange Offer is extended.
PROCEDURES FOR
TENDERING ORIGINAL NOTES............. Each Holder of Original Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein
and therein, and mail or otherwise deliver such
Letter of Transmittal, or such facsimile, together
with such Original Notes and any other required
documentation to The Chase Manhattan Bank, as
Exchange Agent (the "Exchange Agent"), at the
address set forth herein. By executing the Letter
of Transmittal, the Holder will represent to and
agree with the Company that, among other things,
(i) the Exchange Notes to be acquired by such
Holder of Original Notes in connection with the
Exchange Offer are being acquired by such Holder in
the ordinary course of its business, (ii) such
Holder is not participating, does not intend to
participate and has no arrangement or understanding
with any person to
</TABLE>
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<S> <C>
participate, in a distribution of the Exchange
Notes, and (iii) such Holder is not an Affiliate of
the Company. If the Holder is a broker-dealer that
will receive Exchange Notes for its own account in
exchange for Original Notes that were acquired as a
result of market-making or other trading
activities, such Holder will be required to
acknowledge in the Letter of Transmittal that such
Holder will deliver a prospectus in connection with
any resale of such Exchange Notes; however, by so
acknowledging and by delivering a prospectus, such
Holder will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities
Act. See "The Exchange Offer--Procedures for
Tendering."
SPECIAL PROCEDURES
FOR BENEFICIAL OWNERS................ Any beneficial owner whose Original Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee and
who wishes to tender such Original Notes in the
Exchange Offer should contact such registered
holder promptly and instruct such registered holder
to tender on such beneficial owner's behalf. If
such beneficial owner wishes to tender on such
owner's own behalf, such owner must, prior to
completing and executing the Letter of Transmittal
and delivering such owner's Original Notes, either
make appropriate arrangements to register ownership
of the Original Notes in such owner's name or
obtain a properly completed bond power from the
registered holder. The transfer of registered
ownership may take considerable time and may not be
able to be completed prior to the Expiration Date.
See "The Exchange Offer--Procedures for Tendering."
GUARANTEED DELIVERY PROCEDURES......... Holders of Original Notes who wish to tender their
Original Notes and whose Original Notes are not
immediately available or who cannot deliver their
Original Notes, the Letter of Transmittal or any
other documentation required by the Letter of
Transmittal, to the Exchange Agent prior to the
Expiration Date must tender their Original Notes
according to the guaranteed delivery procedures set
forth under "The Exchange Offer--Guaranteed
Delivery Procedures."
WITHDRAWAL RIGHTS...................... Holders may withdraw the tender of their Original
Notes at any time prior to 5:00 p.m. New York City
time on the Expiration Date.
CERTAIN U.S. FEDERAL INCOME TAX
CONSEQUENCES......................... The exchange of Original Notes for Exchange Notes
will not be a taxable exchange for United States
federal income tax purposes. Holders will not
recognize any taxable gain or loss or any interest
income as a result of such exchange. See "Certain
United States Federal Income Tax Considerations."
</TABLE>
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<S> <C>
USE OF PROCEEDS........................ The Company will not receive any proceeds from the
issuance of the Exchange Notes pursuant to the
Exchange Offer. The Company will pay all expenses
incident to the Exchange Offer.
EXCHANGE AGENT......................... The Chase Manhattan Bank is serving as the Exchange
Agent in connection with the Exchange Offer. The
Chase Manhattan Bank also serves as trustee (the
"Trustee") under the Indenture.
</TABLE>
THE NOTES
The Exchange Offer applies to the approximately $460.8 million aggregate
principal amount at maturity of the Original Notes. The form and terms of the
Exchange Notes are the same in all material respects as the form and terms of
the Original Notes, except that the Exchange Notes will be registered under the
Securities Act and, therefore, will not bear legends restricting their transfer
and Holders of the Exchange Notes will not be entitled to any of the
registration rights of Holders of the Original Notes under the Registration
Rights Agreement, which rights will terminate upon consummation of the Exchange
Offer. The Exchange Notes will evidence the same indebtedness as the Original
Notes (which they replace) and both the Original Notes and the Exchange Notes
are governed by the same Indenture.
<TABLE>
<S> <C>
NOTES.................................. $460,800,000 aggregate principal amount at maturity
($249,965,568 original issue price) of 12 1/2%
Senior Discount Notes due 2008.
MATURITY............................... February 15, 2008.
YIELD AND INTEREST..................... The Original Notes were sold at a substantial
discount from their principal amount at maturity,
and there will not be any payment of interest on
the Notes prior to August 15, 2003. For a
discussion of the U.S. federal income tax treatment
of the Notes under the original issue discount
rules, see "Certain United States Federal Income
Tax Considerations." The Notes will fully accrete
to face value on February 15, 2003. From and after
February 15, 2003, the Notes will bear interest,
which will be payable in cash, at a rate of 12 1/2%
per annum on each February 15 and August 15,
commencing August 15, 2003.
OPTIONAL REDEMPTION.................... The Notes will be redeemable at the option of the
Company, in whole or in part, at any time or from
time to time, on or after February 15, 2003, at the
redemption prices set forth herein. In addition, at
any time prior to April 15, 2000, the Company may
redeem up to 35% of the aggregate principal amount
at maturity of the Notes from the proceeds of one
or more public or private Equity Offerings (as
defined) at 112.5% of their Accreted Value (as
defined) on the redemption date; provided, that
after any such redemption at least 65% of the
aggregate principal amount at maturity of the Notes
remains outstanding. See "Description of the
Exchange Notes-- Optional Redemption."
</TABLE>
12
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<S> <C>
RANKING................................ The Notes will be unsubordinated, unsecured
indebtedness of the Company, will rank PARI PASSU
in right of payment with all existing and future
unsubordinated, unsecured indebtedness of the
Company and will be senior in right of payment to
any future subordinated indebtedness of the
Company. As of March 31, 1998, the Company (on an
unconsolidated basis) had $248.6 million of
liabilities, including $244.5 million of
indebtedness on the Original Notes (the principal
amount of which at maturity is $460.8 million).
However, the Company is a holding company and the
Exchange Notes will be effectively subordinated to
all existing and future indebtedness (including the
AT&T Facility, as defined herein) and liabilities
(including trade payables and any subordinated
indebtedness) of the Company's subsidiaries. As of
March 31, 1998, the Company's subsidiaries had
approximately $49.6 million of liabilities
(excluding intercompany payables), including
approximately $40.5 million of secured
indebtedness. See "Risk Factors--Substantial
Indebtedness; Debt Service Requirements;
Refinancing Risks," "--Holding Company's Reliance
on Subsidiaries' Funds; Priority of Other
Creditors" and "Description of Certain
Indebtedness."
CERTAIN COVENANTS...................... The Indenture contains covenants that, among other
things, restrict the ability of the Company and its
Restricted Subsidiaries to incur additional
indebtedness, create liens, engage in
sale-leaseback transactions, pay dividends or make
distributions in respect of their capital stock,
make investments or certain other restricted
payments, sell assets, redeem capital stock, issue
or sell stock of Restricted Subsidiaries, enter
into transactions with stockholders or affiliates
or, with respect to the Company, effect a
consolidation or merger. However, these limitations
will be subject to a number of important
qualifications and exceptions. See "Description of
the Exchange Notes--Covenants."
CHANGE OF CONTROL...................... In the event of a Change of Control (as defined
herein), the Company will be required to make an
offer to purchase all of the Notes outstanding at a
purchase price in cash equal to 101% of their
Accreted Value on the date of purchase, plus
accrued interest. There can be no assurance that
the Company will be able to fund this repurchase
obligation should a Change of Control occur. See
"Description of the Exchange Notes--Repurchase of
Notes Upon a Change of Control."
BOOK ENTRY; DELIVERY AND FORM.......... It is expected that delivery of the Exchange Notes
will be made in book-entry or certificated form.
The Company expects that Exchange Notes exchanged
for Original Notes currently represented by Global
Notes (as defined under
</TABLE>
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<S> <C>
"Description of the Exchange Notes") deposited
with, or on behalf of The Depository Trust Company
(the "Depository" or "DTC") and registered in the
name of Cede & Co., its nominee, will be
represented by Global Notes and deposited upon
issuance with the Depository and registered in its
name or the name of its nominee. Beneficial
interests in Global Notes will be shown on, and
transfers thereof will be effected through, records
maintained by the Depository and its participants.
</TABLE>
For additional information regarding the Notes, see "Description of the
Exchange Notes" and "Certain United States Federal Income Tax Considerations."
RISK FACTORS
See "Risk Factors," immediately following this Prospectus Summary, for a
discussion of certain factors relating to an investment in the Notes, including
risks relating to competition in local markets, the Company's limited operating
history, historical and anticipated operating losses and negative cash flow.
14
<PAGE>
SUMMARY HISTORICAL AND PRO FORMA CONSOLIDATED FINANCIAL DATA
The summary historical financial data for the years ended December 31, 1995,
1996 and 1997 and PRO FORMA consolidated statement of operations data for the
year ended December 31, 1997 presented below were derived from the audited
financial statements and pro forma consolidated financial statement of the
Company. The summary historical consolidated financial data as of March 31, 1998
and for the three months ended March 31, 1997 and 1998 presented below were
derived from the unaudited consolidated financial statements of the Company.
Such data is unaudited but in the opinion of the management of the Company
reflects all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of results for interim periods. Operating
results for interim periods are not necessarily indicative of results to be
expected for the full fiscal year. The summary historical and pro forma
consolidated financial data should be read in conjunction with "Selected
Financial Data," "Unaudited Pro Forma Consolidated Statement of Operations,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical financial statements and notes thereto included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, THREE MONTHS
------------------------------------------------ ENDED MARCH 31,
PRO FORMA -----------------------
1995 1996 1997 1997(A)(B) 1997 1998
---------- ---------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue............................ $ -- $ 205,087 $ 3,417,441 $ 3,655,254 $ 125,438 $ 2,792,950
Operating expenses:
Network operating costs.......... -- 1,360,553 7,735,849 7,830,179 611,359 5,816,133
Selling, general and
administrative................. 1,591,159 2,217,091 9,922,804 10,348,286 1,122,581 3,472,520
Stock option compensation
expense........................ -- 240,000 13,869,346 13,869,346 66,000 1,098,930
Depreciation and amortization.... 5,770 286,509 2,505,875 2,616,913 135,551 993,573
---------- ---------- ----------- ----------- ---------- -----------
Total operating expenses....... 1,596,929 4,104,153 34,033,874 34,664,724 1,935,491 11,381,156
---------- ---------- ----------- ----------- ---------- -----------
Loss from operations............... (1,596,929) (3,899,066) (30,616,433) (31,009,470) (1,810,053) (8,588,206)
Interest expense, net(c)........... 23,463 596,248 2,068,730 2,202,670 163,033 4,376,008
---------- ---------- ----------- ----------- ---------- -----------
Net loss........................... (1,620,392) (4,495,314) (32,685,163) (33,212,140) (1,973,086) (12,964,214)
Dividends and accretion on
redeemable preferred stock....... -- -- (8,904,403) (8,904,403) (163,823) (3,353,208)
---------- ---------- ----------- ----------- ---------- -----------
Net loss applicable to common
shareholders..................... $(1,620,392) $(4,495,314) $(41,589,566) $(42,116,543) $(2,136,909) $(16,317,422)
---------- ---------- ----------- ----------- ---------- -----------
---------- ---------- ----------- ----------- ---------- -----------
Net loss per common share.......... $ (2.70) $ (7.49) $ (64.93) $ (65.75) $ (3.56) $ (20.18)
---------- ---------- ----------- ----------- ---------- -----------
---------- ---------- ----------- ----------- ---------- -----------
Weighted average common shares
outstanding...................... 600,000 600,000 640,568 640,568 600,000 808,467
---------- ---------- ----------- ----------- ---------- -----------
---------- ---------- ----------- ----------- ---------- -----------
OTHER DATA:
Capital expenditures............... $3,498,458 $9,110,989 $59,145,924 $59,145,924 $4,417,618 $ 8,771,727
EBITDA(d).......................... (1,591,159) (3,612,557) (28,110,558) (28,392,557) (1,674,502) (7,594,633)
Cash used in operating
activities....................... (779,033) (2,687,290) (8,675,556) (3,640,743) (6,423,072)
Cash used in investing
activities....................... (1,920,088) (10,174,336) (62,992,347) (5,422,254) (179,703,428)
Cash provided by financing
activities....................... 2,728,400 14,313,770 85,734,292 7,959,466 224,981,513
Ratio of earnings to fixed
charges(e)....................... -- -- -- -- -- --
</TABLE>
(accompanying notes are on the following page)
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<TABLE>
<CAPTION>
MARCH 31, 1998
--------------
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................................................................... $ 54,407,916
Investments held for future capital expenditures.................................................. 165,500,000
Networks and equipment, net....................................................................... 79,222,036
Total assets...................................................................................... 326,645,713
Long-term debt.................................................................................... 284,930,186
Redeemable preferred stock........................................................................ 38,755,513
Redeemable common stock and warrants.............................................................. 21,413,729
Total nonredeemable equity (deficiency)........................................................... (31,704,116)
</TABLE>
- ------------------------------
(a) Pro forma consolidated statement of operations data and other data for the
year ended December 31, 1997 gives effect to the acquisition of the
Melbourne System in July 1997 (the "Melbourne Acquisition") as if the
Melbourne Acquisition had occurred as of January 1, 1997. See "Use of
Proceeds," "Selected Financial Data," "Unaudited Pro Forma Consolidated
Statement of Operations" and the historical financial statements and notes
thereto included elsewhere in this Prospectus.
(b) The pro forma financial data does not give effect to the Initial Offering
and the initial application of the net proceeds therefrom. Assuming that the
Initial Offering had been consummated as of the beginning of the respective
years ended December 31, 1996 and 1997 and the respective three month
periods ended March 31, 1997 and 1998, pro forma interest expense for such
periods would have been $34.7 million, $35.9 million, $8.4 million and $6.9
million, respectively.
(c) Excludes capitalized interest of (i) $36,940 for 1995, (ii) $103,000 for
1996, (iii) $854,000 for 1997, (iv) $27,000 for the three months ended March
31, 1997 and (v) $605,000 for the three months ended March 31, 1998. During
the construction of the Company's networks, the interest costs related to
construction expenditures are capitalized. For the three months ended March
31, 1998, interest expense is net of $2.2 million of interest income.
(d) EBITDA consists of earnings (loss) before net interest, income taxes,
depreciation and amortization, excluding loss on impairment of long-lived
assets. EBITDA is provided because it is a measure commonly used in the
telecommunications industry. It is presented to enhance an understanding of
the Company's operating results and is not intended to represent cash flow
or results of operations in accordance with generally accepted accounting
principles ("GAAP"). EBITDA is not calculated under GAAP and is not
necessarily comparable to similarly titled measures of other companies. For
a presentation of cash flows calculated under GAAP, see the Company's
historical financial statements contained elsewhere in this Prospectus.
(e) The ratio of earnings to fixed charges is computed by dividing pretax income
from continuing operations before fixed charges (other than capitalized
interest) by fixed charges. Fixed charges consist of interest charges and
amortization of debt expense and discount or premium related to
indebtedness, whether expensed or capitalized, and that portion of rental
expense the Company believes to be representative of interest. For 1995,
1996, 1997, the three months ended March 31, 1997 and the three months ended
March 31, 1998, earnings were insufficient to cover fixed charges by $1.7
million, $4.6 million, $33.5 million, $2.0 million and $13.6 million,
respectively. After giving PRO FORMA effect to the increase in interest
expense resulting from the Melbourne Acquisition and the Initial Offering as
of the beginning of each year, earnings would have been insufficient to
cover fixed charges by $41.0 million and, $67.8 million for 1996 and 1997,
respectively. After giving PRO FORMA effect to the increase in interest
expense resulting from the Initial Offering as of January 1, 1998, earnings
would have been insufficient to cover fixed charges by $16.1 million for the
three months ended March 31, 1998.
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RISK FACTORS
AN INVESTMENT IN THE NOTES OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
THE FOLLOWING RISK FACTORS, TOGETHER WITH THE OTHER INFORMATION SET FORTH IN
THIS PROSPECTUS, SHOULD BE CONSIDERED WHEN EVALUATING AN INVESTMENT IN THE
NOTES.
LIMITED OPERATING HISTORY; NEGATIVE GROSS PROFITS, OPERATING LOSSES AND NEGATIVE
CASH FLOW
The Company was formed in September 1997 as a holding company. The Company's
subsidiaries commenced operations in 1994 and, as a result, the Company has a
limited operating history and limited revenues. The Company has incurred and
expects to continue to incur significant and increasing negative gross margins,
operating losses and negative EBITDA while it expands its business and builds
its customer base. There can be no assurance that an adequate customer base with
respect to any or all of its services will be obtained or sustained. For 1996,
1997, the three months ended March 31, 1997 and the three months ended March 31,
1998, the Company had revenues of $205,000, $3.4 million, $125,000 and $2.8
million, respectively, negative gross profits of $1.2 million, $4.3 million,
$486,000 and $3.0 million, respectively, operating losses of $3.9 million, $30.6
million, $1.8 million and $8.6 million, respectively, and negative EBITDA of
$3.6 million, $28.1 million, $1.7 million and $7.6 million, respectively. For
1996, 1997, the three months ended March 31, 1997 and the three months ended
March 31, 1998, cash used by operations was $2.7 million, $8.7 million, $3.6
million and $6.4 million, respectively; cash expended for investing purposes was
$10.2 million, $63.0 million, $5.4 million and $179.7 million, respectively, and
cash provided by financing activities was $14.3 million, $85.7 million, $8.0
million and $225.0 million, respectively. On a PRO FORMA basis giving effect to
the increase in interest expense resulting from the Melbourne Acquisition and
the Initial Offering as of the beginning of each period, the Company's free cash
flow (EBITDA minus capital expenditures and interest expense) for 1996, 1997 and
the three months ended March 31, 1997 would have been negative $48.2 million,
negative $123.4 million and negative $14.6 million, respectively. On a PRO FORMA
basis giving effect to the increase in interest expense resulting from the
Initial Offering as of January 1, 1998, the Company's free cash flow for the
three months ended March 31, 1998 would have been negative $23.3 million. The
Company's negative gross profits, operating losses, negative EBITDA, cash used
by operations and capital expenditures are expected to increase as a result of
the continuation of the Company's expansion strategy. There can be no assurance
that the Company will achieve or sustain profitability or generate positive
EBITDA or at any time have sufficient resources to meet its capital expenditure
and working capital requirements or make payments on its indebtedness, including
the Notes. The Company must significantly increase its revenues and cash flows
to meet its debt service obligations, including its obligations on the Notes.
See "Selected Financial Data" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
SIGNIFICANT CAPITAL REQUIREMENTS
The Company's current plans for expansion of existing networks, the
development of new networks, the further development of the Company's products
and services and the continued funding of operating losses will require
substantial additional cash from outside sources. The Company anticipates that
its capital expenditures for 1998 will be approximately $150.0 million, that it
will have substantial net losses to fund in 1998 and that its substantial cash
requirements will continue into the foreseeable future. The Company believes
that the net proceeds of the Initial Offering, the issuance of the Company's
Series C Preferred Stock to GECC and CoreStates on November 5, 1997 (the "Series
C Placement") and the issuance of the Company's Series D Preferred Stock to
Nassau on November 5, 1997 (the "Series D Placement"), together with available
cash and borrowings expected to be available under the the Company's $70.0
million senior line of credit with AT&T Finance (the "AT&T Facility") will
provide sufficient funds for the Company to expand its business as currently
planned and to fund its currently anticipated expenses through the completion of
its eight existing networks, the ten new networks currently planned for
completion by the end of 1998 and the five additional networks planned for
completion in 1999, and to
17
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fund its working capital requirements for 1999. Thereafter, the Company will
require additional financing. However, in the event that the Company's plans
change, the assumptions upon which the Company's plans are based prove
inaccurate, the Company expands or accelerates its business plan or the Company
determines to consummate additional acquisitions, the foregoing sources of funds
may prove to be insufficient to complete all such networks, and the Company may
be required to seek additional financing. In this regard, the Company has begun
preliminary consideration of entering San Juan and other markets in Puerto Rico.
The Company is currently considering a plan pursuant to which the Company would
contribute its franchise rights in Puerto Rico, other rights and preparatory
work previously performed by it, and approximately $4.0 million in exchange for
approximately forty percent (40%) of the equity in an entity to be formed to
construct and operate a network in Puerto Rico. The plan contemplates that other
equity investors may include Mr. Kamine, Nassau, GECC and a Puerto Rican venture
capital group. These discussions are still preliminary and no assurance can be
given that the plan will not be significantly amended or abandoned. Additional
sources of financing may include public or private equity or debt financings by
the Company, capitalized leases and other financing arrangements. Pursuant to
the Certificates of the Powers, Designations, Preferences and Rights of the
Series A and Series C Preferred Stock, the Company may not increase the
authorized number of shares of preferred stock or Common Stock without the
consent of the holders of two-thirds of the shares of both the Series A
Preferred Stock and the Series C Preferred Stock. The Company has only three
million shares of Common Stock authorized. There can be no assurance that
additional financing will be available to the Company or, if available, that it
can be obtained on a timely basis and on acceptable terms or within the
limitations contained in the AT&T Facility, the Indenture or in any future
financing arrangements. Failure to obtain such financing could result in the
delay or abandonment of some or all of the Company's development and expansion
plans and expenditures, which would have a material adverse effect on its
business prospects and the Company's ability to make principal and interest
payments on the Notes. See "--Substantial Indebtedness; Debt Service
Requirements; Refinancing Risks," "Use of Proceeds," "Unaudited Pro Forma
Consolidated Statement of Operations" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
SUBSTANTIAL INDEBTEDNESS; DEBT SERVICE REQUIREMENTS; REFINANCING RISKS
At March 31, 1998, the Company had outstanding approximately $298.2 million
of indebtedness and its total redeemable and nonredeemable equity was $28.5
million. AT&T Finance, together with participating lenders GECC and CoreStates,
had previously agreed to provide the Company's subsidiaries, KMC Telecom Inc.,
the owner of the Company's existing eight networks ("KMC Telecom") and KMC
Telecom II, Inc., the company that will own and operate nine of the ten new
networks currently planned for completion in 1998 ("KMC Telecom II") with up to
an aggregate of $70.0 million of financing under the AT&T Facility, subject to
certain conditions. All amounts previously borrowed by KMC Telecom II under the
AT&T Facility (approximately $10.8 million), however, were repaid on the Closing
Date of the Initial Offering and KMC Telecom II will no longer be a borrower or
an obligor under the AT&T Facility. KMC Telecom is now permitted to borrow up to
the full $70.0 million amount of the AT&T Facility. See "Description of Certain
Indebtedness." The Indenture limits, but does not prohibit, the incurrence of
additional indebtedness by the Company. In particular, the Indenture permits the
Company and its subsidiaries to incur an unlimited amount of purchase money
indebtedness. See "Description of the Exchange Notes--Covenants." There can be
no assurance that any additional financing will be available to the Company on
acceptable terms. In the absence of such financing, the Company could be forced
to dispose of assets in order to make up for any shortfall in payments due on
its indebtedness under circumstances that might not be favorable to realizing
the highest price for such assets. There can be no assurance that the Company's
assets could be sold quickly enough or for sufficient amounts to enable the
Company to meet its obligations, including its obligations with respect to the
Notes. Although the net proceeds from the Initial Offering have enhanced the
Company's liquidity and improved its financial flexibility in the near term, the
Company's total indebtedness and interest expense have been significantly
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increased as a result of the Initial Offering. After giving PRO FORMA effect to
the increase in interest expense resulting from the Melbourne Acquisition and
the Initial Offering as of the beginning of each period, revenue, EBITDA and
interest expense for 1996 would have been $558,000, negative $3.9 million and
$34.7 million, respectively; for 1997 would have been $3.7 million, negative
$28.4 million and $35.9 million, respectively; and for the three months ended
March 31, 1997 would have been $244,000, negative $1.8 million and negative $8.4
million, respectively. After giving PRO FORMA effect to the increase in interest
expense resulting from the Initial Offering as of January 1, 1998, revenue,
EBITDA and interest expense for the three months ended March 31, 1998 would have
been $2.8 million, negative $7.6 million and $6.9 million, respectively. The
level of the Company's indebtedness could have important consequences to its
future prospects, including the following: (i) limiting the ability of the
Company to obtain any necessary financing in the future for working capital,
capital expenditures, debt service requirements or other purposes; (ii)
requiring that a substantial portion of the Company's cash flow from operations,
if any, be dedicated to the payment of principal of and interest on its
indebtedness and other obligations; (iii) limiting its flexibility in planning
for, or reacting to changes in, its business; (iv) making the Company more
highly leveraged than some of its competitors, which may place it at a
competitive disadvantage; (v) making it more difficult for the Company to make
payments on the Notes; and (vi) increasing its vulnerability in the event of a
downturn in its business. Failure by the Company to meet its obligations could
result in a default on its indebtedness which would permit the holders of
substantially all of the Company's indebtedness to accelerate the maturity
thereof. In such event, the Company may not be able to meet its obligations on
the Notes. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
In connection with the buildup of its networks and expansion of its CLEC
services, the Company has been experiencing increasing negative EBITDA and the
Company's earnings were insufficient to cover fixed charges for 1996, 1997 and
the three months ended March 31, 1998. For 1996 and 1997, after giving PRO FORMA
effect to the increase in interest expense resulting from the Melbourne
Acquisition and the Initial Offering as of the beginning of each year, the
Company's earnings would have been insufficient to cover fixed charges by $41.0
million and $67.8 million, respectively. For the three months ended March 31,
1998, after giving PRO FORMA effect to the increase in interest expense
resulting from the Initial Offering as of January 1, 1998, the Company's
earnings would have been insufficient to cover fixed charges by $16.1 million.
There can be no assurance that the Company will be able to improve its earnings
before fixed charges or EBITDA or that it will be able to meet its debt service
obligations.
Cash flow from operations may be insufficient to repay the Company's
indebtedness, including the Notes and the AT&T Facility, in full and a
substantial portion of its indebtedness will need to be refinanced. The AT&T
Facility matures prior to the Notes and any additional indebtedness incurred in
the future may mature prior to the Notes and may need to be refinanced. There
can be no assurance that the Company will be able to effect such refinancings.
The ability of the Company to meet its debt service requirements and to effect
refinancings will be dependent upon, among other things, the future performance
of the Company, which will be subject to prevailing economic conditions and to
financial, business, regulatory and other factors, including factors beyond the
control of the Company.
Under the AT&T Facility, the Company's subsidiaries are required to meet
certain financial tests at the end of each quarter. See "Description of Certain
Indebtedness." Failure to comply with these covenants could limit the ability of
the Company to make further borrowings, or could result in a default, under the
AT&T Facility, allowing AT&T Finance to accelerate the maturity of the loans
made thereunder. There can be no assurance that the Company will be able to
comply with such covenants in the future.
HOLDING COMPANY'S RELIANCE ON SUBSIDIARIES' FUNDS; PRIORITY OF OTHER CREDITORS
KMC is a holding company whose sole material asset is the common stock of
its subsidiaries. The common stock of KMC Telecom and the ownership interests in
its wholly-owned limited liability company, which own the Company's eight
existing networks, have been pledged to AT&T Finance under the AT&T
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Facility. The Company loaned or contributed a substantial portion of the net
proceeds from the Initial Offering to certain of its subsidiaries. See "Use of
Proceeds." The Company must rely upon dividends and other payments from its
subsidiaries to generate the funds necessary to meet its obligations, including
the payment of principal and interest on the Notes. The subsidiaries are legally
distinct from the Company and have no obligation, contingent or otherwise, to
pay amounts due with respect to the Notes or to make funds available for such
payments, except to the extent that they may be obliged to repay loans made to
them by the Company. The Company's subsidiaries will not guarantee the Notes.
The ability of the Company's subsidiaries to make such payments to the Company
will be subject to, among other things, the availability of funds, the terms of
each subsidiary's indebtedness and applicable state laws. In particular, the
AT&T Facility prohibits the Company's subsidiaries which are Borrowers
thereunder from paying dividends and principal and interest on intercompany
borrowings unless, among other things, for the preceding four quarters, EBITDA
(as defined in the AT&T Facility) met certain existing target levels and the
Fixed Charge Coverage Ratio (as defined in the AT&T Facility) was at least
1.25:1. See "Description of Certain Indebtedness." Accordingly, there can be no
assurance that the Company will be able to obtain any funds from its
subsidiaries. Claims of creditors of the Company's subsidiaries, including trade
creditors, will generally have priority as to the assets of such subsidiaries
over the claims of the Company and the holders of the Company's indebtedness,
including the Notes. Accordingly, the Notes will be effectively subordinated to
the liabilities (including the AT&T Facility and trade payables) of the
Company's subsidiaries. At March 31, 1998, the Company's subsidiaries had
approximately $49.6 million of liabilities (excluding intercompany payables),
including $40.5 million of secured indebtedness and $29.5 million available for
borrowing under the AT&T Facility, subject to certain conditions. The Company
has unconditionally guaranteed the repayment of the AT&T Facility when such
repayment is due, whether at maturity, upon acceleration, or otherwise. The
Company has agreed to pay all amounts outstanding under the AT&T Facility, on
demand, upon the occurrence and during the continuation of any Event of Default
(as defined therein).
The Notes will be unsubordinated, unsecured indebtedness of the Company. At
March 31, 1998, the Company had, on a consolidated basis, an aggregate of
approximately $40.5 million of secured indebtedness. Such indebtedness is
secured by a pledge of all of the Company's stock in its subsidiary KMC Telecom
and all of the ownership interests in KMC Telecom's wholly-owned limited
liability company and substantially all of the assets of KMC Telecom and KMC
Telecom's wholly-owned limited liability company. In the event such secured
indebtedness goes into default and the holders thereof foreclose on the
collateral, the holders of secured indebtedness will be entitled to payment out
of the proceeds of their collateral prior to any holders of general unsecured
indebtedness, including the Notes, notwithstanding the existence of any event of
default with respect to the Notes. In the event of bankruptcy, liquidation or
reorganization of the Company, holders of secured indebtedness will have a
claim, prior to the claim of the holders of the Notes, on the assets of the
Company securing such indebtedness. In addition, to the extent that the value of
such collateral is insufficient to satisfy such secured indebtedness, holders of
amounts remaining outstanding on such secured indebtedness would be entitled to
share PARI PASSU with the Notes with respect to any other assets of the Company.
Assets remaining after satisfaction of the claims of holders of secured
indebtedness may not be sufficient to pay amounts due on any or all of the Notes
then outstanding.
COMPETITION
In all of its markets, the Company faces competition from the ILEC, which is
generally one of the Regional Bell Operating Companies (the "RBOCs"), GTE
Corporation or one of its affiliated companies (the "GTE Companies") or Sprint
Corporation or one of its affiliated companies ("Sprint"). The ILECs have
long-standing relationships with their customers, have financial, technical and
marketing resources substantially greater than those of the Company, have the
potential to fund competitive services with revenues from a variety of
businesses and currently benefit from certain existing regulations that favor
the ILECs over the Company in certain respects.
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The Company does not believe that Tier III Markets can profitably support
more than two competitors to the ILEC. Accordingly, the Company believes that
once it has completed backbone construction and switch installation in a given
market, potential new entrants in that market are likely to seek to deploy their
capital elsewhere. The Company generally will continue to build in its markets
after initial backbone construction and switch installation. This demonstration
of its commitment to its markets is expected to further deter new entrants.
However, it is likely that in one or more of its markets the Company will
face competition from two or more facilities-based CLECs. After the investment
and expense of establishing a network and support services in a given market,
the marginal cost of carrying an additional call is negligible. Accordingly, in
Tier III Markets where there are three or more facilities-based CLECs, the
Company expects substantial price competition. The Company believes that
operations in such markets are likely to be unprofitable for one or more
operators.
The CLEC competitors which have started either construction or solicitation
activities in the Company's eight existing markets include, among others:
American Communications Services Inc. ("ACSI") has constructed, or is
constructing, networks in Baton Rouge, Corpus Christi, Madison, Savannah and
Shreveport. Brooks Fiber Properties, Inc. ("Brooks") has also commenced
construction activities in Corpus Christi. CSW/ChoiceCom L.P. ("CSW/ChoiceCom"),
a subsidiary of Central and South West Corporation (an electric utility) with a
strategic relationship with ICG Communications, Inc., has announced that it will
provide services in Corpus Christi. Hyperion Telecommunications, Inc. has
announced its intention to offer services using the fiber optic facilities of
Entergy Corporation, a utility, in Baton Rouge. ITC Deltacom offers services in
Huntsville. LDS Corp. (a privately owned company that has agreed to be acquired
by Intermedia Communications, Inc.) has fiber optic networks in Huntsville and
Shreveport, has resale operations in Baton Rouge, Melbourne and Savannah and has
announced plans to build fiber optic facilities in Savannah and Baton Rouge.
McLeodUSA, Inc. is engaged in reselling in Madison. Mid-Plains, Inc., an ILEC in
Wisconsin, has announced plans to offer services in Madison. TDS Metrocom ("TDS
Metro"), a subsidiary of TDS Telecom, has announced plans to build a 54 mile
fiber optic network in Madison and to commence services in early 1998. Time
Warner Telecom, Inc. ("Time Warner") has announced its intention to offer
services in Melbourne. Including the Company, there are four CLECs, that intend
to operate in Corpus Christi.
Competitors which have started either construction or solicitation
activities in the seven new markets in which the Company has commenced
construction or for which network engineering has been completed include, among
others: Williams Vyvx, QWEST, AT&T Corp. ("AT&T"), MCI Communications
Corporation ("MCI"), Time Warner, US LEC, and PV Telecom in Greensboro, as well
as BTI, Eagle, ICG and NewSouth which are believed to be interested in the
Greensboro market; FiberCap Digital, Inc. and Time Warner in Winston-Salem; USN,
which has a resale operation, and Brooks, which has established a private
network at the University of Michigan, in Ann Arbor; US LEC and CFW, which have
expressed interest in entering the market, and Cox Communications in Roanoke;
Birch Telecom in Topeka; and US Xchange which has filed an application in Fort
Wayne.
The Company believes that there may be additional competitors that have
formulated plans to enter its markets, including the ten markets it plans to
enter in 1998 and the five markets it plans to enter in 1999.
Potential competitors in the Company's markets include microwave and
satellite carriers, wireless telecommunications providers, cable television
companies, utilities and RBOCs seeking to operate outside their current local
service areas. In particular, utilities and cable companies are likely
competitors given their existing rights of way. In addition, there may be future
competition from large long distance carriers, such as AT&T, MCI and WorldCom
Inc. ("WorldCom"), which have begun to offer integrated local and long distance
telecommunications services. AT&T also recently announced its intention to offer
local
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services using a new wireless technology. Consolidation of telecommunications
companies and the formation of strategic alliances within the telecommunications
industry, as well as the development of new technologies, could give rise to
significant new competitors to the Company. One of the primary purposes of the
Telecommunications Act of 1996 (the "Telecommunications Act") is to promote
competition, particularly in local markets. The Company believes that Tier III
Markets will also see more agent and distributor resale initiatives.
While recent regulatory initiatives, which allow CLECs such as the Company
to interconnect with ILEC facilities, provide increased business opportunities
for the Company, such regulatory initiatives have been accompanied by increased
pricing flexibility for, and relaxation of regulatory oversight of, the ILECs.
If the ILECs engage in increased volume and discount pricing practices or charge
CLECs increased fees for interconnection to their networks, or if the ILECs
delay implementation of interconnection to their networks, the Company's
business, financial condition and results of operations and its ability to make
payments on the Notes could be adversely affected. To the extent the Company
interconnects with and uses ILEC networks to service its customers, the Company
will be dependent upon the technology and capabilities of the ILECs to provide
services and to maintain its service standards. The Company will become
increasingly dependent on interconnection with ILECs as switched services become
a greater percentage of the Company's business. The Telecommunications Act
imposes interconnection obligations on ILECs, but there can be no assurance that
the Company will be able to obtain the interconnections it requires at rates,
and on terms and conditions, that permit the Company to offer switched services
at rates that are both competitive and profitable. See "--Implementation Risks."
In the event that the Company experiences difficulties in obtaining high
quality, reliable and reasonably priced service from the ILECs, the
attractiveness of the Company's services to its customers could be impaired.
Both the long distance business and the data transmission business are
extremely competitive. Prices in both businesses have declined significantly in
recent years and are expected to continue to decline. In the long distance
business the Company will face competition from large carriers such as AT&T,
MCI, Sprint and WorldCom. The Company will rely on other carriers to provide
transmission and termination for its long distance traffic and therefore will be
dependent on such carriers. See "--Risks of Entry into Long Distance Business"
and "--Risks of Entry into Data Transmission Business."
The Company expects to experience declining prices and increasing price
competition. There can be no assurance that the Company will be able to achieve
or maintain adequate market share or revenue, or compete effectively, in any of
its markets. Any of the foregoing factors could have a material adverse effect
on the Company's business, financial condition and results of operations and its
ability to make payments on the Notes. See "Business--Competition."
RISKS RELATED TO RECIPROCAL COMPENSATION
Beginning in June, 1997, every RBOC advised CLECs that they did not consider
calls in the same local calling area from the RBOCs' customers to CLEC customers
who are ISPs to be local calls under the interconnection agreements between the
RBOCs and the CLECs. The RBOCs claim that the calls should be classified as
exchange access calls and that the FCC exempted these calls from payment of
access charges so that no compensation is owed to the CLECs for transporting and
terminating such calls. As a result the RBOCs threatened to withhold, and in
many cases did withhold, reciprocal compensation for the transport and
termination of such calls. To date nineteen state commissions have ruled on this
issue in the context of state commission arbitration proceedings or enforcement
proceedings. In every state, to date, the state commission has determined that
reciprocal compensation is owed for such calls. Several of these cases are
presently on appeal. The Company cannot predict the outcome of these appeals, or
of additional pending cases. If these calls were to be determined not to be
local calls and not subject to access charges, it could have an adverse effect
on the Company's business, financial condition and results of operations and its
ability to make payments on the Notes.
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DEVELOPMENT AND EXPANSION RISK; NEED TO MANAGE GROWTH
The Company must achieve substantial growth in order to meet its payment
obligations under its indebtedness, including the Notes. The Company's networks
have only recently become commercially operational and it has only recently
deployed switches in its networks. The success of the Company will depend, among
other things, upon its ability to assess potential markets, design fiber optic
backbone routes that provide ready access to a substantial customer base,
achieve a sufficient customer base, secure financing, install facilities, obtain
required rights-of-way, building access and governmental permits, implement
interconnection and collocation with facilities owned by ILECs and obtain
unbundled network elements from ILECs, and upon subsequent developments in state
and federal regulations. In addition, the Company may make additional
acquisitions of existing operating systems, such as the potential acquisition of
the Winston-Salem Network (as defined herein), an existing network of
approximately 13 fiber route miles located in Winston-Salem, North Carolina. See
"Business--Systems Construction and Development." Any such acquisitions could
divert the resources and management time of the Company and will require
integration with the Company's management information, payroll and other
systems, existing networks and service offerings. There can be no assurance that
any networks to be developed or further developed will be completed on schedule,
at a commercially reasonable cost or within the Company's specifications. The
Company's growth may place a significant strain on the Company's financial,
management and operational resources. The Company's future performance will
depend, in part, upon its ability to manage its growth effectively, monitor
operations, control costs and maintain effective quality control which will
require it to continue to implement and improve its operating, financial and
accounting systems, to expand, train and manage its employee base and to
effectively manage the integration of acquired businesses. These factors could
adversely affect the expansion of the Company's customer base and service
offerings. The Company's inability either to expand in accordance with its plans
or to manage its growth could have a material adverse effect on its business,
financial condition and results of operations. In addition, the establishment of
new operations or acquisitions will involve significant expenses in advance of
anticipated revenues and may cause fluctuations in the Company's operating
results. Any of the foregoing risks could have a material adverse effect on the
Company's ability to make payments on the Notes. See "Business."
IMPLEMENTATION RISKS
The Company is deploying high capacity digital switches in its markets. This
will enable the Company to offer a variety of switched access services, enhanced
services and local dial tone. The Company expects to incur negative gross
profits and negative EBITDA from its switched services in any given market
during the 24 to 36 month period after the switch is deployed. The Company
expects operating margins to improve as each network is expanded and larger
volumes of traffic are carried on the Company's network. In each of its markets,
the Company relies on ILECs to originate and terminate all of its switched
services traffic until its own switch becomes operational. Although under the
Telecommunications Act the ILECs will be required to unbundle local network
elements and to permit the Company to purchase only the origination and
termination services it needs, thereby decreasing operating expenses, there can
be no assurance that such unbundling will be effected in a timely manner and
result in prices favorable to the Company.
In August 1996, the FCC released a decision implementing the interconnection
portions of the Telecommunications Act (the "Interconnection Decision"). The
Interconnection Decision sought to establish national rules for negotiating
interconnection agreements and guidelines for review of such agreements by state
public utilities commissions, which rules, in general, are favorable to new
competitive entrants. In July 1997, the U.S. Court of Appeals for the Eighth
Circuit found much of the Interconnection Decision to be beyond the scope of the
FCC's legal authority. The court ruled that the state public service
commissions, not the FCC, have jurisdiction over the pricing of interconnection,
unbundled network elements and resale services. The Eighth Circuit Court also
ruled that the FCC's interpretation of Section
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252(i) of the Telecommunications Act, the so-called "pick and choose" provision,
was incorrect. The Eighth Circuit Court held that the Telecommunications Act
allows CLECs to adopt whole interconnection agreements negotiated by other
competitors, but not to "pick and choose" pieces of existing agreements. On
October 14, 1997, the Eighth Circuit Court issued a decision vacating additional
FCC rules that will likely have the effect of increasing the costs of obtaining
the use of ILEC unbundled network elements. In November 1997, the FCC filed a
petition for a writ of certiorari with the United States Supreme Court
challenging the decisions of the Eighth Circuit Court of Appeals. On January 26,
1998, the United States Supreme Court granted all petitions and cross petitions
for certiorari of the Eighth Circuit decisions. See "--Government Regulation"
On December 31, 1997, the U.S. District Court for the Northern District of
Texas issued a decision (the "SBC Decision") finding that Sections 271 to 275 of
the Telecommunications Act are unconstitutional. These sections of the
Telecommunications Act impose restrictions on the lines of business in which the
RBOCs may engage, including establishing the conditions the RBOCs must satisfy
before they may provide in-region inter-LATA long distance telecommunications
services. Under the SBC Decision, the RBOCs would be able to provide in-region
inter-LATA long distance services immediately without satisfying the statutory
conditions. The District Court stayed its own decision, pending an appeal to the
U.S. Fifth Circuit Court of Appeals. The Company believes that the factual
assumptions and legal reasoning in the SBC Decision are erroneous and therefore
the decision will likely be reversed on appeal, although there can be no
assurance of this outcome. If the SBC Decision is upheld on appeal it would
likely have an unfavorable effect on the Company's business for at least two
reasons. First, RBOCs currently have an incentive to foster competition within
their service areas so that they can qualify to offer inter-LATA long distance
services. The SBC Decision removes this incentive by allowing RBOCs to offer
inter-LATA long distance service without regard to their progress in opening
their local markets to competition. Second, the Company is legally able to offer
its customers both long distance and local exchange services, which the RBOCs
currently are prohibited from offering directly, although some marketing
affiliations have been proposed. The ability to offer "one-stop shopping" gives
the Company a marketing advantage that it would no longer enjoy if the SBC
Decision were upheld on appeal.
The Company is a recent entrant into the newly created competitive local
telecommunications services industry. The local dial tone services market was
opened to competition by the Telecommunications Act in 1996, and related
regulatory rulings. There are numerous operating complexities associated with
providing these services. The Company will be required to develop new products,
services and systems and will need to develop new marketing initiatives to sell
these services.
The Company's services may not be profitable due to, among other factors,
lack of customer demand, inability to secure access to ILEC facilities at
acceptable rates, competition and pricing pressure from other CLECs and the
ILECs and cost overruns in connection with network build-outs. The Company
expects to face significant competitive product and pricing pressure from the
ILECs in its markets. The Company has very limited experience providing switched
access and local dial tone services and there can be no assurance that the
Company will be able to successfully implement its switched and enhanced
services strategy. Implementation of the Company's switched and enhanced
services is also subject to equipment manufacturers' ability to meet the
Company's switch deployment schedule. There can be no assurance that all of such
switches will be deployed on the schedule contemplated by the Company or that,
if deployed, such switches will be utilized to the degree contemplated by the
Company. Any of the foregoing risks could have a material adverse effect on the
Company's ability to make payments on the Notes.
Franchises obtained by the Company may require the Company to complete the
build-out of its network within a period specified in the franchise grant. If
the Company is unable to complete the build-out of a network within the
specified period, or obtain an extension of time in which to complete the build-
out, its franchise agreement may be terminable by the local authority. Any such
termination of a franchise
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agreement could have a material adverse effect on the Company's business,
financial condition and results of operations and the Company's ability to make
payments on the Notes.
RISKS OF ENTRY INTO LONG DISTANCE BUSINESS
In order to offer its end user customers a complete package of
telecommunications services, the Company recently began to offer long distance
services. Although the Company has an executive team with telecommunications,
sales, marketing and management expertise, the Company itself has no direct
previous experience providing long distance services. As a new entrant in the
long distance business, the Company expects to generate low gross margins and
substantial start-up expenses as it rolls out its long distance service
offerings.
Long distance telecommunications services will involve the origination of
traffic from end user customers, either directly connected to the Company's
network or through facilities leased from the ILEC, to the Company's
telecommunications switches. The Company will rely on other carriers to provide
transmission and termination services for its long distance traffic and will
therefore be dependent on such carriers. The Company expects to enter into
resale agreements with long distance carriers to provide it with long distance
transmission services. Such agreements typically provide for the resale of long
distance services on a per minute basis (some with minimum volume commitments or
volume discounts). The negotiation of these agreements involves estimates of
future supply and demand for long distance telecommunications transmission
capacity as well as estimates of the calling pattern and traffic levels of the
Company's future long distance customers. Should the Company fail to meet its
minimum volume commitments, if any, pursuant to these resale agreements, it may
be obligated to pay underutilization charges. Likewise, the Company may
underestimate its need for long distance facilities and therefore be required to
obtain the necessary transmission capacity through more expensive means. There
can be no assurance that the Company will acquire long distance capacity on
favorable terms or that the Company can accurately predict long distance prices
and volumes so that it can generate favorable gross margins from its long
distance business. The success of the Company's entry into the long distance
business will be dependent upon, among other things, the Company's ability to
select new equipment and software and integrate these into its networks, hire
and train qualified personnel, enhance its billing, back-office and information
systems to accommodate long distance services and the acceptance by potential
customers of the Company's long distance service offerings. If the Company's
long distance transmission business fails to generate favorable gross margins or
if the Company fails in any of the foregoing respects, such failure may have a
material adverse effect on the Company's business, financial condition and
results of operations and its ability to make payments on the Notes.
RISKS OF ENTRY INTO DATA TRANSMISSION BUSINESS
To complement its telecommunications services offerings, the Company began
offering data transmission services in certain of its markets in 1997. These
services, which include frame relay and ATM, are targeted at large and medium
sized businesses with substantial data communications requirements. As a new
entrant in the data transmission business, the Company expects to generate low
or negative gross margins and substantial start-up expenses as it begins to
offer data transmission services. The Company does not expect data transmission
services to generate a material portion of its revenues over the near term. In
providing these services, the Company will be dependent upon vendors for
assistance in the planning and deployment of its initial data product offerings,
as well as ongoing training and support. The success of the Company's entry into
the data transmission business will be dependent upon, among other things, the
Company's ability to select new equipment and software and integrate these into
its networks, hire and train qualified personnel, enhance its billing,
back-office and information systems to accommodate data transmission services
and the acceptance by potential customers of the Company's service offerings. No
assurance can be given that the Company will be successful with respect to these
matters. If the Company is not successful with respect to these matters, there
may be a material adverse effect on the
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Company's business, financial condition and results of operations and its
ability to make payments on the Notes.
GOVERNMENT REGULATION
The Company's networks and the provision of switched and private line
services are subject to significant regulation at the federal, state and local
levels. The telecommunications industry in general, and the CLEC industry in
particular, is undergoing substantial regulatory change and uncertainty. Delays
in receiving required regulatory approvals, new court decisions or the enactment
of new adverse regulations or regulatory requirements may have a material
adverse effect on the Company's business, financial condition and results of
operations and its ability to make payments on the Notes.
The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry, including the local exchange, long
distance and cable television industries. The Telecommunications Act remains
subject to judicial review and additional FCC and state public service
commission rulemaking, and thus it is difficult to predict what effect the
legislation will have on the Company and its operations. There are currently
many regulatory actions underway and being contemplated by federal and state
authorities regarding interconnection pricing and other issues that could result
in significant changes to the business conditions in the telecommunications
industry. The Company may be required to cancel its federal interstate tariff
filings at the FCC and implement replacement contractual arrangements, which
could result in substantial legal and administrative expenses. There can be no
assurance that these changes will not have a material adverse effect on the
Company's business, financial condition and results of operations and its
ability to make payments on the Notes.
In addition to requirements placed on ILECs, the Telecommunications Act
subjects the Company to certain federal regulatory requirements regarding the
provision of local exchange services. All ILECs and CLECs must offer reciprocal
compensation for termination of traffic and provide dialing parity. However,
negotiations with ILECs have sometimes involved considerable delays and the
agreements may not be on terms and conditions that are favorable to the Company.
In May 1997, the FCC adopted a rule that will require the Company and other
CLECs to contribute to a universal service fund provided for in the
Telecommunications Act. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business--Regulation--Universal
Service Reform." At the same time, the FCC adopted rules that will change how
access charges are calculated. These changes will reduce access charge levels
closer to their cost and will shift certain charges currently based on minutes
to flat-rate, monthly per-line charges. As a result, the aggregate access
revenue paid to access providers in the United States is expected to decrease.
In addition, the FCC has also adopted rules that will give ILECs pricing
flexibility with respect to access charges. No assurance can be given that the
changes to current regulations or the adoption of new regulations (pursuant to
the Telecommunications Act or otherwise) by the FCC or state public service
commissions will not have a material adverse effect on the Company's business,
financial condition and results of operations and its ability to make payments
on the Notes.
On December 31, 1997, the U.S. District Court for the Northern District of
Texas issued the SBC Decision finding that Sections 271 to 275 of the
Telecommunications Act are unconstitutional. These sections of the
Telecommunications Act impose restrictions on the lines of business in which the
RBOCs may engage, including establishing the conditions the RBOCs must satisfy
before they may provide inter-LATA long distance telecommunications services.
Under the SBC Decision, the RBOCs would be able to provide inter-LATA long
distance services immediately without satisfying the statutory conditions. The
SBC Decision has been stayed pending review by the U.S. Fifth Circuit Court of
Appeals. Further, the Company believes that the factual assumptions and legal
reasoning in the SBC Decision are erroneous and therefore the decision will
likely be reversed on appeal, although there can be no assurance of this
outcome. If the SBC Decision were upheld on appeal it would likely have an
unfavorable effect on the Company's business for at least two reasons. First,
RBOCs currently have an incentive to foster competition within their service
areas so that they can qualify to offer in-region inter-LATA long distance
services.
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The SBC Decision removes this incentive by allowing RBOCs to offer in-region
inter-LATA long distance service without regard to their progress in opening
their local markets to competition. Second, the Company is legally able to offer
its customers both long distance and local exchange services, which the RBOCs
currently are prohibited from offering directly, although some marketing
affiliations have been proposed. The ability to offer "one-stop shopping" gives
the Company a marketing advantage that it would no longer enjoy if the SBC
Decision were upheld on appeal.
State regulatory commissions exercise jurisdiction over the Company to the
extent it provides intrastate services. As such a provider, the Company is
required to obtain regulatory authorization and/or file tariffs or rate
schedules at state agencies in all of the states in which it operates. Local
authorities regulate the Company's access to municipal rights-of-way. The
networks are also subject to numerous local regulations such as building codes
and licensing. Such regulations vary on a city by city and county by county
basis. See "Business--Regulation." If authority is not obtained or if tariffs
are not filed, or are not updated, or otherwise do not fully comply with the
tariff filing rules of the FCC or state regulatory agencies, third parties or
regulators could challenge these actions. Such challenges could cause an
interruption or termination of the Company's services and could cause the
Company to incur substantial legal and administrative expenses.
Many states also regulate transfers of control or assets, and issuances of
stock or debt instruments, by authorized carriers. Accordingly, the Company may
be subject to prior approval or other filing requirements for such transactions.
See "--Implementation Risks" and "Business--Regulation."
DEPENDENCE ON RIGHTS-OF-WAY AND OTHER THIRD PARTY AGREEMENTS
The Company must obtain easements, rights-of-way, entry to premises,
franchises and licenses from various private parties, actual and potential
competitors and state and local governments in order to construct and operate
its networks, some of which may be terminated upon 30 or 60 days' notice to the
Company. There can be no assurance that the Company will obtain rights-of-way
and franchise agreements on acceptable terms or that current or potential
competitors will not obtain similar rights-of-way and franchise agreements that
will allow them to compete against the Company. If any of the existing franchise
or license agreements were terminated or not renewed and the Company were forced
to remove its fiber optic cables or abandon its networks in place, such
termination could have a material adverse effect on the Company's business,
financial condition and results of operations and its ability to make payments
on the Notes. See "Business--Systems Construction and Development,"
"--Regulation" and "--Legal and Administrative Proceedings."
DEPENDENCE ON KEY CUSTOMERS
The Company's five largest customers accounted for approximately 92% of the
Company's revenue in 1996 and 32% in 1997. This customer concentration will
decrease as the Company expands into new markets and begins full scale marketing
of an integrated service package. However, the loss of, or decrease of business
from, one or more of the Company's principal customers could have a material
adverse effect on the business, financial condition and results of operations of
the Company and its ability to make payments on the Notes. Although the Company
actively markets its products and services, there can be no assurance that the
Company will be able to attract new customers or retain its existing customers.
See "Business--Sales and Marketing" and "--Competition."
DEPENDENCE ON BILLING, CUSTOMER SERVICES AND INFORMATION SYSTEMS
Sophisticated information and processing systems are vital to the Company's
growth and its ability to monitor costs, bill customers, provision customer
orders and achieve operating efficiencies. The Company's existing billing and
information systems have been produced largely in-house with partial reliance on
third-party vendors. These systems have generally met the Company's needs due in
part to the
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Company's low volume of bills and orders. As the Company commences providing
dial tone services, the need for sophisticated billing and information systems
is increased significantly. Recently, the Company entered into an agreement with
ACE*COMM Corporation ("ACE*COMM") to provide the Company with comprehensive
billing, order processing and customer care software for all existing and
contemplated services the Company will market. Additionally, the Company is
developing customer service centers to provision orders. Information systems are
vital to the success of these centers, and the information systems for these
centers are largely being developed by third party vendors. The failure of (i)
these vendors to deliver proposed products and services in a timely and
effective manner, (ii) the Company to adequately identify all of its information
and processing needs, or (iii) the Company to upgrade systems as necessary,
could have a material adverse effect on the Company's business, financial
condition and results of operations and its ability to make payments on the
Notes.
While the Company believes that its software applications are year 2000
compliant, there can be no assurance until the year 2000 occurs that all systems
will then function adequately. Further, if the software applications of local
exchange carriers, long distance carriers or others on whose services the
Company depends or with whom the Company's systems interface are not year 2000
compliant, it could affect the Company's systems, which would have a material
adverse effect on the Company's business, financial condition and results of
operations and its ability to make payments on the Notes.
RAPID TECHNOLOGICAL CHANGE
The telecommunications industry is subject to rapid and significant changes
in technology, with the Company relying on third parties for the development of
and access to new technology. The effect of technological changes on the
business of the Company cannot be predicted. The Company believes its future
success will depend, in part, on its ability to anticipate or adapt to such
changes and to offer, on a timely basis, services that meet customer demands.
There can be no assurance that the Company will be able to anticipate or adapt
to such changes and to offer, on a timely basis, services that meet customers'
demands. A failure to do so would have a material adverse effect on the
Company's business, financial condition and results of operations and its
ability to make payments on the Notes.
DEPENDENCE ON KEY PERSONNEL
The efforts of a small number of key management and operating personnel will
largely determine the Company's success and the loss of any of such persons
could adversely affect the Company. The Company does not maintain so-called "key
man" insurance on any of its personnel. The Company has an employment agreement
with Mr. Sternberg, its President and Chief Executive Officer, which currently
runs through July 29, 1999, with a Company option to extend for two additional
years. The success of the Company also depends in part upon its ability to hire
and retain highly skilled and qualified operating, marketing, financial and
technical personnel. The competition for qualified personnel in the
telecommunications industry is intense and, accordingly, there can be no
assurance that the Company will be able to hire or retain necessary personnel. A
failure by the Company to hire or retain necessary personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations and its ability to make payments on the Notes. See
"Management."
CONTROL BY PRINCIPAL STOCKHOLDERS
Harold N. Kamine, Chairman of the Board of the Company, presently owns
approximately 68.5% of the outstanding shares of Common Stock of the Company. If
all outstanding shares of the Company's preferred stock were to be converted,
all outstanding warrants (other than the Warrants) were to be exercised, and the
options (the "Company Options") expected to be granted to employees of the
Company and certain affiliated companies during the third quarter of 1998 (See
"Management--Stock Option Grants") were to be exercised, Nassau and Mr. Kamine
would own approximately 32.4% and 28.1% of the outstanding shares of Common
Stock, respectively. The Company, Mr. Kamine, Nassau, AT&T Credit,
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GECC and CoreStates are parties to an Amended and Restated Stockholders
Agreement, dated as of October 31, 1997, as amended (the "Stockholders
Agreement"). Pursuant to provisions contained in both the Company's certificate
of incorporation and the Stockholders Agreement, Mr. Kamine and Nassau are
currently entitled to elect all of the Company's seven Directors with each
entitled to nominate three Directors, and the seventh to be nominated by
agreement of Mr. Kamine, Nassau and either AT&T Credit or the holders of a
majority of the outstanding shares of the Company's Series C Preferred Stock.
The number of Directors which Mr. Kamine is entitled to elect would be reduced
to two if the number of shares owned by him were to fall below two-thirds of the
number of shares of the Company initially issued to him, and to one if the
number of shares owned by him were to fall below one-third of the number of
shares initially issued to him. If his ownership were to fall below 5% of the
number of shares initially issued to him, Mr. Kamine would no longer be entitled
to elect any Directors pursuant to such provisions. Comparable reductions would
be made to the number of Directors which Nassau is entitled to elect if its
ownership were to fall below the specified fractions. Certain decisions
concerning the operations or financial structure of the Company may present
conflicts of interest between Mr. Kamine and Nassau and the holders of the
Notes. Pursuant to the Certificates of the Powers, Designations, Preferences and
Rights of the Series A and Series C Preferred Stock, the Company may not
increase the authorized number of shares of preferred stock or Common Stock,
without the consent of the holders of two-thirds of the shares of both the
Series A Preferred Stock and the Series C Preferred Stock. The Company has only
three million shares of Common Stock authorized.
ORIGINAL ISSUE DISCOUNT CONSEQUENCES
The Original Notes were issued with original issue discount for U.S. federal
income tax purposes. The Exchange Notes should be treated as a continuation of
the Original Notes. Consequently, Holders of the Exchange Notes generally will
be required to include amounts in gross income for U.S. federal income tax
purposes in advance of receipt of the cash payments to which the income is
attributable. The Exchange Notes will be subject to the applicable high-yield
discount obligation rules, which will defer and will, in part, eliminate the
Company's ability to deduct for U.S. federal income tax purposes the original
issue discount attributable to the Exchange Notes. Accordingly, the Company's
after-tax cash flow might be less than if the original issue discount on the
Exchange Notes was deductible when it accrued. See "Certain United States
Federal Income Tax Considerations" for a more detailed discussion of the U.S.
federal income tax consequences resulting from the Exchange Offer.
If a bankruptcy case is commenced by or against the Company under the U.S.
Bankruptcy Code, the claim of an owner of the Notes with respect to the
principal amount thereof may be limited to an amount equal to the sum of (i) the
initial offering price and (ii) that portion of the original issue discount that
is not deemed to constitute "unmatured interest" for purposes of the U.S.
Bankruptcy Code. Any original issue discount that was not amortized as of any
such bankruptcy filing would constitute "unmatured interest."
ABSENCE OF PUBLIC MARKET
The NASD has designated the Original Notes as securities eligible for
trading in the PORTAL market of the NASD. However, the Exchange Notes will be
new securities for which there is currently no public market. The Company does
not intend to list the Exchange Notes on any national securities exchange or for
quotation through the Nasdaq National Market. There can be no assurance that an
active trading market for the Exchange Notes will develop, or if one does
develop, that it will be sustained. Accordingly, no assurance can be made as to
the liquidity of the trading market for the Exchange Notes. If a market for the
Exchange Notes does not develop, purchasers may be unable to resell such
Exchange Notes for an extended period of time, if at all. Historically, the
market for non-investment grade debt has been subject to disruptions that have
caused substantial volatility in the prices of securities similar to the
Exchange Notes. There can be no assurance that, if a market for the Exchange
Notes were to develop, such market would not be subject to similar disruptions.
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CONSEQUENCES OF FAILURE TO EXCHANGE
The issuance of the Exchange Notes in exchange for the Original Notes
pursuant to the Exchange Offer will be made only after timely receipt by the
Exchange Agent of such Original Notes, a properly completed and duly executed
Letter of Transmittal and all other required documents. Therefore, holders of
Original Notes desiring to tender such Original Notes in exchange for Exchange
Notes should allow sufficient time to ensure timely delivery. Neither the
Exchange Agent nor the Company is under any duty to give notification of defects
or irregularities with respect to tenders of Original Notes for exchange.
Original Notes that are not validly tendered will, following the
consummation of the Exchange Offer, continue to be subject to the existing
restrictions upon transfer thereof and the Company will have no further
obligation to provide for the registration under the Securities Act of such
Original Notes. In addition, any holder of Original Notes who tenders in the
Exchange Offer for the purpose of participating in a distribution of the
Exchange Notes may be deemed to have received restricted securities and, if so,
will be required to comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale transaction. To
the extent that Original Notes are tendered and accepted in the Exchange Offer,
the trading market for untendered and tendered but unaccepted Original Notes
could be adversely affected. Each broker or dealer that receives Exchange Notes
for its own account in exchange for Original Notes where such Original Notes
were acquired by such broker or dealer as a result of market-making activities
or other trading activities must acknowledge that it will deliver a prospectus
in connection with any resale of such Exchange Notes. See "Plan of
Distribution."
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
Certain statements in this Prospectus, including under "Prospectus Summary,"
"Business" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," including statements regarding the anticipated
development and expansion of the Company's business, the markets in which the
Company's services are currently offered, or will be offered in the future,
anticipated capital expenditures and regulatory reform, the intent, belief or
current expectations of the Company, its directors or its officers with respect
to the Company's future financial performance and other matters, and other
statements regarding matters that are not historical facts, are
"forward-looking" statements. Such "forward-looking" statements are subject to
various risks and uncertainties. Accordingly, actual results may differ
materially from those expressed or implied by such forward-looking statements.
Important factors that could cause actual results to differ materially from
those expressed or implied by such forward-looking statements include the risk
factors set forth herein.
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THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
The Original Notes were initially issued and sold by the Company on the
Closing Date to the Placement Agent pursuant to the Placement Agreement. The
Placement Agent subsequently resold the Original Notes to (i) "qualified
institutional buyers" ("QIBs") as defined in Rule 144A under the Securities Act
("Rule 144A"), in reliance on Rule 144A, (ii) non-U.S. persons in off-shore
transactions in reliance on Regulation S under the Securities Act, and (iii) a
limited number of institutional "accredited investors," as defined in Rule
501(a)(1), (2), (3) or (7) under the Securities Act. Pursuant to the Placement
Agreement, the Company and the Placement Agent entered into a Registration
Rights Agreement. Pursuant to the Registration Rights Agreement, the Company
agreed to use its best efforts to consummate the Exchange Offer on or prior to
July 29, 1998. A copy of the Registration Rights Agreement has been filed as an
exhibit to the Registration Statement of which this Prospectus is a part and the
description of the terms of the Registration Rights Agreement is qualified in
its entirety by reference thereto. The Registration Statement of which this
Prospectus is a part is intended to satisfy the Company's obligations with
respect to the registration of Original Notes in accordance with the terms of
the Registration Rights Agreement.
Following the consummation of the Exchange Offer, Holders of Original Notes
not validly tendered in the Exchange Offer and Holders of Exchange Notes will
not have any further registration rights. In addition, Holders of Original Notes
will continue to be subject to certain restrictions on transfer. Accordingly,
the liquidity of the market for Original Notes could be adversely affected. See
"Risk Factors --Consequences of Failure to Exchange."
The Original Notes were issued in Units together with the Warrants. Upon the
effectiveness of the Registration Statement, the Warrants will become separately
tradeable from the Original Notes and the Warrants are not part of the Exchange
Offer.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the accompanying Letter of Transmittal, the Company will accept any and
all Original Notes validly tendered and not withdrawn prior to 5:00 p.m., New
York City time on August 11, 1998 or such later time and date to which the
Exchange Offer is extended by the Company in its sole discretion, which time and
date, as indicated herein or as extended, is referred to herein as the
"Expiration Date". The Company will issue $1,000 principal amount at maturity of
Exchange Notes in exchange for each $1,000 principal amount at maturity of
Original Notes validly tendered pursuant to the Exchange Offer and not withdrawn
prior to the Expiration Date. Original Notes may only be tendered in integral
multiples of $1,000 at maturity.
The form and terms of the Exchange Notes are the same as the form and terms
of the Original Notes except that (i) the Exchange Notes will have been
registered under the Securities Act and, therefore, will not bear legends
restricting their transfer and (ii) the Holders of the Exchange Notes will not
be entitled to any of the registration rights of Holders of Original Notes under
the Registration Rights Agreement, which rights, in any event, will terminate
with respect to the Original Notes upon consummation of the Exchange Offer. The
Exchange Notes will evidence the same indebtedness as the Original Notes (which
they replace) and will be issued under, and be entitled to the benefits of, the
Indenture, which also authorized the issuance of the Original Notes, such that
both the Exchange Notes and the Original Notes will be treated as a single class
of debt securities under the Indenture.
As of the date of this Prospectus, approximately $460.8 million in aggregate
principal amount at maturity of Original Notes was outstanding. Only a
registered Holder of Original Notes (or such Holder's legal representative or
attorney-in-fact), as reflected on the records of the Trustee under the
Indenture, may participate in the Exchange Offer. There will be no fixed record
date for determining Holders of the
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Original Notes entitled to participate in the Exchange Offer. Holders of the
Original Notes do not have any appraisal or dissenters' rights under the General
Corporation Law of Delaware or the Indenture in connection with the Exchange
Offer. The Company intends to conduct the Exchange Offer in accordance with the
applicable provisions of the Registration Rights Agreement and the applicable
requirements of the Securities Act and the rules and regulations of the
Commission thereunder.
The Company shall be deemed to have accepted validly tendered Original Notes
when, and if, the Company has given oral or written notice thereof to The Chase
Manhattan Bank, as Exchange Agent. The Exchange Agent will act as agent for the
tendering Holders of Original Notes for the purposes of receiving the Exchange
Notes from the Company.
Holders who tender Original Notes in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Original
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than certain applicable taxes described below, in connection
with the Exchange Offer. See "--Fees and Expenses."
EXTENSION; AMENDMENTS
In order to extend the Exchange Offer, the Company will notify the Exchange
Agent of any extension by oral or written notice (oral notice being promptly
confirmed in writing) and will make public announcement thereof, each prior to
9:00 a.m., New York City time, on the next business day after the previously
scheduled Expiration Date.
The Company reserves the right, in its sole discretion, (i) to delay
accepting any Original Notes, (ii) to extend the Exchange Offer, or (iii) to
amend the terms of the Exchange Offer in any manner, by giving oral or written
notice of such delay, extension or amendment to the Exchange Agent. Any such
delay in acceptance, extension or amendment will be followed as promptly as
practicable by a public announcement thereof. If the Exchange Offer is amended
in a manner determined by the Company to constitute a material change, the
Company will promptly disclose such amendment or amendments by means of a
prospectus supplement that will be distributed to registered Holders and the
Company will extend the Exchange Offer for a period of five to ten business
days, depending upon the significance of the amendment and the manner of
disclosure to the registered Holders, if the Exchange Offer would otherwise
expire during such five to ten business day period.
Without limiting the manner in which the Company may choose to make a public
announcement of any delay, extension or amendment of the Exchange Offer, the
Company shall have no obligation to publish, advertise or otherwise communicate
any such public announcement, other than by making a timely release to an
appropriate news agency.
PROCEDURES FOR TENDERING
Only a registered Holder of Original Notes may tender such Original Notes in
the Exchange Offer. To tender in the Exchange Offer, a Holder of Original Notes
must complete, sign and date the Letter of Transmittal, or a facsimile thereof,
have the signatures thereon guaranteed if required by the Letter of Transmittal,
and mail or otherwise deliver such Letter of Transmittal or such facsimile to
the Exchange Agent at the address set forth below under "--Exchange Agent" for
receipt prior to the Expiration Date. In addition, either (i) certificates for
such Original Notes must be received by the Exchange Agent along with the Letter
of Transmittal, (ii) a timely confirmation of a book-entry transfer (a
"Book-Entry Confirmation") of such Original Notes, if such procedure is
available, into the Exchange Agent's account at the Depository pursuant to the
procedure for book-entry transfer described below, must be received by the
Exchange Agent prior to the Expiration Date (see, "--Book-Entry Transfer") or
(iii) the Holder must comply with the guaranteed delivery procedures described
below (see, "--Guaranteed Delivery Procedures").
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A tender by a Holder that is not withdrawn prior to the Expiration Date will
constitute an agreement between such Holder and the Company in accordance with
the terms and subject to the conditions set forth herein and in the Letter of
Transmittal.
THE METHOD OF DELIVERY OF ORIGINAL NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT
BEFORE THE EXPIRATION DATE. DO NOT SEND THE LETTER OF TRANSMITTAL OR ANY
ORIGINAL NOTES TO THE COMPANY. HOLDERS MAY REQUEST THEIR RESPECTIVE BROKERS,
DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES TO EFFECT THE ABOVE
TRANSACTIONS FOR SUCH HOLDERS.
Any beneficial owner of Original Notes whose Original Notes are registered
in the name of a broker, dealer, commercial bank, trust company or other nominee
and who wishes to tender should contact the registered Holder promptly and
instruct such registered Holder to tender on such beneficial owner's behalf. If
such beneficial owner wishes to tender on such owner's own behalf, such owner
must, prior to completing and executing the Letter of Transmittal and delivering
such owner's Original Notes, either make appropriate arrangements to register
ownership of the Original Notes in such owner's name or obtain a properly
completed bond power from the registered Holder. The transfer of registered
ownership may take considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal described
below (see "--Withdrawal of Tenders"), as the case may be, must be guaranteed by
an Eligible Institution (as defined below) unless the Original Notes tendered
pursuant thereto are tendered (i) by a registered Holder who has not completed
the box titled "Special Delivery Instructions" on the Letter of Transmittal or
(ii) for the account of an Eligible Institution. In the event that signatures on
a Letter of Transmittal or a notice of withdrawal, as the case may be, are
required to be guaranteed, such guarantee must be made by a member firm of a
registered national securities exchange or of the National Association of
Securities Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States or an "eligible guarantor institution"
(within the meaning of Rule 17Ad-15 under the Exchange Act) that is a member of
one of the recognized signature guarantee programs identified in the Letter of
Transmittal (an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the registered
Holder of any Original Notes listed therein, such Original Notes must be
endorsed or accompanied by a properly completed bond power, signed by such
registered Holder exactly as such registered Holder's name appears on such
Original Notes.
If the Letter of Transmittal or any Original Notes are signed by trustees,
executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and, unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
The Exchange Agent and the Depository have confirmed that any financial
institution that is a participant in the Depository's system may utilize the
Depository's Automated Tender Offer Program to tender Original Notes.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Original Notes will be
determined by the Company in its sole discretion, which determination will be
final and binding. The Company reserves the absolute right to reject any and all
Original Notes not properly tendered or any Original Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the right to waive any defects,
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irregularities or conditions of tender as to particular Original Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Original Notes must be cured within such time as the
Company shall determine. Although the Company intends to notify Holders of
defects or irregularities with respect to tenders of Original Notes, neither the
Company, the Exchange Agent nor any other person shall incur any liability for
failure to give such notification. Tenders of Original Notes will not be deemed
to have been made until such defects or irregularities have been cured or
waived.
While the Company has no present plan to acquire any Original Notes that are
not tendered in the Exchange Offer or to file a registration statement to permit
resales of any Original Notes that are not tendered pursuant to the Exchange
Offer, the Company reserves the right in its sole discretion to purchase or make
offers for any Original Notes that remain outstanding subsequent to the
Expiration Date and, to the extent permitted by applicable law, purchase
Original Notes in the open market, in privately negotiated transactions or
otherwise. The terms of any such purchases or offers could differ from the terms
of the Exchange Offer.
By tendering, each Holder of Original Notes will represent to the Company
that, among other things, (i) the Exchange Notes to be acquired by such Holder
of Original Notes in connection with the Exchange Offer are being acquired by
such Holder in the ordinary course of business of such Holder, (ii) such Holder
has no arrangement or understanding with any person to participate in the
distribution of the Exchange Notes, (iii) such Holder acknowledges and agrees
that any person who is participating in the Exchange Offer for the purposes of
distributing the Exchange Notes must comply with the registration and prospectus
delivery requirements of the Securities Act in connection with a secondary
resale transaction of the Exchange Notes acquired by such person and cannot rely
on the position of the staff of the Commission set forth in certain no-action
letters, (iv) such Holder understands that a secondary resale transaction
described in clause (iii) above and any resales of Exchange Notes obtained by
such Holder in exchange for Original Notes acquired by such Holder directly from
the Company should be covered by an effective registration statement containing
the selling security holder information required by Item 507 or Item 508, as
applicable, of Regulation S-K of the Commission and (v) such Holder is not an
Affiliate of the Company. If the Holder is a broker-dealer that will receive
Exchange Notes for such Holder's own account in exchange for Original Notes that
were acquired as a result of market-making activities or other trading
activities, such Holder will be required to acknowledge in the Letter of
Transmittal that such Holder will deliver a prospectus in connection with any
resale of such Exchange Notes; however, by so acknowledging and by delivering a
prospectus, such Holder will not be deemed to admit that it is an "underwriter"
within the meaning of the Securities Act.
ACCEPTANCE OF ORIGINAL NOTES FOR EXCHANGE; DELIVERY OF EXCHANGE NOTES
Upon satisfaction or waiver of all of the conditions to the Exchange Offer,
the Company will accept, promptly after the Expiration Date, all Original Notes
properly tendered and will issue the Exchange Notes promptly after acceptance of
the Original Notes. For purposes of the Exchange Offer, the Company shall be
deemed to have accepted properly tendered Original Notes for exchange when, and
if, the Company has given oral or written notice thereof to the Exchange Agent.
RETURN OF ORIGINAL NOTES
If any tendered Original Notes are not accepted for any reason set forth in
the terms and conditions of the Exchange Offer or if Original Notes are
withdrawn, then such unaccepted, withdrawn or non-exchanged Original Notes will
be returned without expense to the tendering Holder thereof (or, in the case of
Original Notes tendered by book-entry transfer into the Exchange Agent's account
at the Depository pursuant to the book-entry transfer procedures described
below, such Original Notes will be credited to an account maintained with the
Depository) as promptly as practicable.
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BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect
to the Original Notes with the Depository for purposes of the Exchange Offer
promptly after the date of this Prospectus. Any financial institution that is a
participant in the Depository's Book-Entry Transfer Facility system may make
book-entry delivery of the Original Notes by causing the Depository to transfer
such Original Notes into the Exchange Agent's account and to deliver an "Agent's
Message" (as defined below) on or prior to the Expiration Date in accordance
with the Depository's procedures for such transfer and delivery. If delivery of
Original Notes is effected through book-entry transfer into the Exchange Agent's
account at the Depository and an Agent's Message is not delivered, the Letter of
Transmittal (or facsimile thereof), with any required signature guarantees and
any other required documents must be transmitted to and received or confirmed by
the Exchange Agent at its address set forth herein under "--Exchange Agent"
prior to 5:00 p.m., New York City time on the Expiration Date or pursuant to the
guaranteed delivery procedures described below. DELIVERY OF DOCUMENTS TO THE
DEPOSITORY IN ACCORDANCE WITH ITS PROCEDURES DOES NOT CONSTITUTE DELIVERY TO THE
EXCHANGE AGENT.
The term "Agent's Message" means a message transmitted by the Depository to
and received by the Exchange Agent and forming a part of a Book-Entry
Confirmation which states that the Depository has received an express
acknowledgment from the tendering participant, which acknowledgment states that
such participant has received and agrees to be bound by, and makes the
representations and warranties contained in the Letter of Transmittal and that
the Company may enforce the Letter of Transmittal against such participant.
GUARANTEED DELIVERY PROCEDURES
If a Holder of Original Notes desires to tender such Original Notes and time
will not permit such Holder's required documents to reach the Exchange Agent on
or prior to the Expiration Date, a tender may be effected if (i) the tender is
made through an Eligible Institution, (ii) on or prior to the Expiration Date,
the Exchange Agent receives from such Eligible Institution a properly completed
and duly executed Notice of Guaranteed Delivery, substantially in the form
provided by the Company (by facsimile transmission, mail or hand delivery),
setting forth the name and address of such Holder of Original Notes and the
amount of Original Notes tendered, stating that the tender is being made thereby
and guaranteeing that within three business days after the Expiration Date, a
Book-Entry Confirmation or the certificates relating to the Original Notes, the
Letter of Transmittal (or a facsimile thereof) and all other documents required
by the Letter of Transmittal will be deposited by the Eligible Institution with
the Exchange Agent, and (iii) a Book-Entry Confirmation or the certificates
relating to the Original Notes, a properly executed Letter of Transmittal (or
facsimile thereof) and all other documents required by the Letter of Transmittal
are received by the Exchange Agent within three business days after the
Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to Holders who wish to tender their Original Notes according to the
guaranteed delivery procedures set forth above.
WITHDRAWAL OF TENDERS
A tender of Original Notes may be withdrawn any time prior to the Expiration
Date.
For a withdrawal to be effective, (i) a written notice of withdrawal must be
received by the Exchange Agent at the address set forth below under "--Exchange
Agent" prior to the Expiration Date. Any such notice of withdrawal must (i)
specify the name of the person having deposited the Original Notes to be
withdrawn and (ii) identify the Original Notes to be withdrawn (including the
certificate number and principal amount at maturity of Original Notes). Any such
written withdrawal must be signed by the Holder in the same manner as the
original signature on the Letter of Transmittal by which such Original Notes
were tendered (including required signature guarantees). All questions as to the
validity, form and eligibility (including time of receipt) of such notices will
be determined by the Company, in its sole
35
<PAGE>
discretion and whose determination shall be final and binding on all parties.
Any Original Notes so withdrawn will be deemed not to have been validly tendered
for exchange for purposes of the Exchange Offer, and no Exchange Notes will be
issued with respect thereto unless the Original Notes so withdrawn are validly
retendered. Properly withdrawn Original Notes may be retendered by following one
of the procedures described above at any time on or prior to the Expiration
Date.
TERMINATION OF CERTAIN RIGHTS
All registration rights under the Registration Rights Agreement accorded to
holders of the Original Notes (and all rights to receive additional interest on
the Notes to the extent and in the circumstances specified therein) will
terminate upon consummation of the Exchange Offer except with respect to the
Company's duty to keep the Registration Statement effective until the closing of
the Exchange Offer and, for a period of 180 days after the closing of the
Exchange Offer, to provide copies of the latest version of the Prospectus to any
broker-dealer that requests copies of such Prospectus in the Letter of
Transmittal for use in connection with any resale by such broker-dealer of
Exchange Notes received for its own account pursuant to the Exchange Offer in
exchange for Original Notes acquired for its own account as a result of
market-making or other trading activities.
EXCHANGE AGENT
The Chase Manhattan Bank has been appointed as Exchange Agent for the
Exchange Offer. Questions and requests for assistance, requests for additional
copies of this Prospectus or of the Letter of Transmittal and requests for
Notices of Guaranteed Delivery should be directed to the Exchange Agent
addressed as follows:
BY REGISTERED OR CERTIFIED MAIL, BY OVERNIGHT COURIER OR BY HAND:
The Chase Manhattan Bank
55 Water Street
Room 234, North Building
New York, New York 10041
Attention: Carlos Esteves
or:
BY FACSIMILE TRANSMISSION:
The Chase Manhattan Bank
Facsimile Number: (212) 638-7380 or (212) 638-7381
Confirm by Telephone: (212) 638-0828
In addition, Letters of Transmittal and any other required documentation
should be sent to the Exchange Agent at the address set forth above, except
where facsimile transmission is specifically authorized (e.g., withdrawals and
Notices of Guaranteed Delivery). DELIVERY OF THE LETTER OF TRANSMITTAL TO AN
ADDRESS OTHER THAN AS SET FORTH ABOVE OR TRANSMISSION VIA FACSIMILE OTHER THAN
AS SET FORTH ABOVE WILL NOT CONSTITUTE A VALID DELIVERY.
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, facsimile transmission, telephone or in person by
officers and regular employees of the Company and its Affiliates.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptance of the Exchange Offer. The
36
<PAGE>
Company, however, will pay the Exchange Agent reasonable and customary fees for
its services and will reimburse its reasonable out-of-pocket expenses in
connection therewith.
The Company will pay all transfer taxes, if any, applicable to the exchange
of the Original Notes pursuant to the Exchange Offer. If, however, a transfer
tax is imposed for any reason other than the exchange of the Original Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be payable
by the tendering holder. If satisfactory evidence of payment of such taxes or
exemption therefrom is not submitted with the Letter of Transmittal, the amount
of such transfer taxes will be billed directly to the tendering holder.
CONSEQUENCES OF FAILURE TO EXCHANGE
Participation in the Exchange Offer is voluntary. Holders of the Original
Notes are urged to consult their financial and tax advisors in making their own
decisions on what action to take.
Original Notes that are not exchanged for Exchange Notes pursuant to the
Exchange Offer will remain "restricted securities" within the meaning of Rule
144 of the Securities Act. Accordingly, such Original Notes may be resold only
(i) to the Company or any subsidiary thereof, (ii) so long as the Original Notes
are eligible for resale pursuant to Rule 144A, to a person whom the seller
reasonably believes is a "qualified institutional buyer" within the meaning of
Rule 144A under the Securities Act, purchasing for its own account or for the
account of a qualified institutional buyer, to whom notice is given that the
resale, pledge or other transfer is being made in reliance on Rule 144A, (iii)
outside the United States to non-U.S. Persons in an offshore transaction in
compliance with Rule 904 under the Securities Act, (iv) pursuant to an exemption
from registration under the Securities Act in accordance with Rule 144 (if
available), (v) to an institutional "accredited investor" that, prior to such
transfer, furnishes to the Trustee a signed letter containing certain
representations and agreements relating to the restrictions on transfer of the
Original Notes and, if such transfer is in respect of a principal amount at
maturity of Original Notes at the time of transfer of less than $500,000, an
opinion of counsel acceptable to the Company that such transfer is in compliance
with the Securities Act, or (vi) pursuant to an effective registration statement
under the Securities Act, in each case in accordance with any applicable
securities laws of any state of the United States and subject to certain
requirements of the Trustee being met. The liquidity of the Original Notes could
be adversely affected by the Exchange Offer. See "Risk Factors--Consequences of
Failure to Exchange."
RESALES OF THE EXCHANGE NOTES
Based on interpretations by the staff of the Commission set forth in certain
no-action letters issued to third parties, the Company believes that the
Exchange Notes or interests therein issued pursuant to the Exchange Offer in
exchange for Original Notes or interests therein may be offered for resale,
resold and otherwise transferred by a Holder thereof (other than (i) a
broker-dealer who purchases such Exchange Notes directly from the Company to
resell pursuant to Rule 144A or any other available exemption under the
Securities Act or (ii) a person that is an Affiliate of the Company), without
compliance with the registration and prospectus delivery requirements of the
Securities Act; provided, that the Holder is acquiring the Exchange Notes in the
ordinary course of its business and is not participating, does not intend to
participate, and has no arrangement or understanding with any person to
participate, in the distribution of Exchange Notes. However, if any Holder
acquires Exchange Notes in the Exchange Offer for the purpose of distributing or
participating in the distribution of the Exchange Notes, such Holder cannot rely
on the position of the staff of the Commission in the no-action letters issued
to third parties and must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale transaction,
unless an exemption from registration is otherwise available. Each broker-dealer
that receives Exchange Notes for its own account in exchange for Original Notes
must represent that the Original Notes tendered in the Exchange Offer were
acquired by such broker-dealer as a result of market-making activities or other
trading activities and must acknowledge that it will deliver a
37
<PAGE>
prospectus meeting the requirements of the Securities Act in connection with any
resale of such Exchange Notes. By so acknowledging and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act. This Prospectus, as it
may be amended or supplemented from time or time, may be used by a broker-dealer
in connection with resales of Exchange Notes received in exchange for Original
Notes where such Original Notes were acquired by such broker-dealer as a result
of market-making activities or other trading activities. Pursuant to the
Registration Rights Agreement, the Company has indicated its intention to make
this Prospectus (as it may be amended or supplemented) available to any
broker-dealer for use in connection with any such resale for a period not to
exceed 180 days after the closing of the Exchange Offer. See "Plan of
Distribution."
38
<PAGE>
USE OF PROCEEDS
The Exchange Offer is being effected to satisfy certain obligations of the
Company under the Registration Rights Agreement. The Company will not receive
any cash proceeds from the issuance of the Exchange Notes offered hereby. In
consideration for issuing the Exchange Notes in the Exchange Offer, the Company
will receive, in exchange, an equal aggregate principal amount at maturity of
Original Notes. Original Notes that are properly tendered in the Exchange Offer
and not validly withdrawn will be accepted, canceled and retired and cannot be
reissued. Accordingly, the issuance of the Exchange Notes will not result in any
increase in the outstanding indebtedness of the Company.
The net proceeds to the Company from the Initial Offering were approximately
$236.4 million, after deducting underwriting discounts, commissions and other
expenses paid by the Company. The Company used $10.8 million of the proceeds of
the Initial Offering to repay all amounts borrowed by KMC Telecom II under the
AT&T Facility (approximately $40.5 million borrowed by KMC Telecom remained
outstanding). The Company used $10.1 million of the proceeds of the Initial
Offering to repay on the Closing Date all amounts due (including accrued
interest) in connection with a $10.0 million Subordinated Loan and Security
Agreement, dated September 22, 1997 (the "Supplemental AT&T Facility"), between
AT&T Finance, KMC Telecom and KMC Telecom II. AT&T Credit exercised a warrant to
purchase shares of the Company's Common Stock for an aggregate purchase price of
$10.0 million upon repayment of the Supplemental AT&T Facility (the "AT&T Stock
Investment"). The Company used $5.0 million of the proceeds of the Initial
Offering as a nonrefundable downpayment under its agreement with Lucent for
future purchases of switching equipment. The Company used approximately $600,000
of the proceeds of the Initial Offering to pay dividend arrearages to the former
holders of Series A Cumulative Convertible Preferred Stock of KMC Telecom.
The Company has used and intends to continue to use the remaining net
proceeds of the Offering (approximately $209.9 million), together with the $10.0
million from the AT&T Stock Investment and funds available under the AT&T
Facility, to finance the planned expansion and further development of the
Company's networks, including through acquisitions, and for other general
corporate purposes, including to fund operating losses. Expected capital
expenditures for expansion and further development of the Company's networks
primarily include the purchase and installation of switches, electronic
components, fiber optic cable and additional equipment, and to a lesser extent,
acquisitions. Expected expenditures for general corporate and working capital
purposes include (i) expenditures with respect to the Company's management
information system and customer service support infrastructure, (ii) operating
and administrative expenses, primarily those associated with sales and
marketing, with respect to the development and operation of existing and new
networks, and (iii) the funding of operating losses. Pending the foregoing uses,
the net proceeds of the Initial Offering are invested in short-term, interest
bearing investment-grade securities. The Company's investment objectives are
safety, liquidity and yield, in that order.
39
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of March
31, 1998. This table should be read in conjunction with "Use of Proceeds,"
"Selected Financial Data," "Unaudited Pro Forma Consolidated Statement of
Operations," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the financial statements and related notes thereto
included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31,
1998(A)
---------------
<S> <C>
Cash and cash equivalents........................................................................ $ 54,407,916
---------------
---------------
Investments held for future capital expenditures................................................. $ 165,500,000
---------------
---------------
Long-term debt:
AT&T Facility.................................................................................. $ 40,476,149
Notes, net of original issue discount.......................................................... 244,454,037
---------------
Total long-term debt......................................................................... 284,930,186
---------------
Redeemable equity:
Redeemable cumulative convertible preferred stock, par value $.01 per share; authorized:
498,800 shares; issued and outstanding: 298,800 shares....................................... 38,755,513
Redeemable common stock; issued and outstanding: 224,041 shares................................ 20,850,416
Redeemable common stock warrants............................................................... 563,313
---------------
Total redeemable equity...................................................................... 60,169,242
---------------
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; authorized: 3,000,000 shares; issued and outstanding:
613,835 shares............................................................................... 6,138
Additional paid-in capital..................................................................... 22,208,005
Unearned compensation.......................................................................... (5,422,419)
Accumulated deficit............................................................................ (48,495,840)
---------------
Total nonredeemable equity (deficiency)...................................................... (31,704,116)
---------------
Total capitalization....................................................................... $ 313,395,312
---------------
---------------
</TABLE>
- ------------------------
(a) Approximately $226.0 million of the proceeds of the Initial Offering has
been allocated to the Notes and approximately $10.4 million of the proceeds
has been allocated to the Warrants, after deducting underwriting discounts
and commissions and other expenses related to the Notes and Warrants of
$13.0 million and $554,000, respectively.
40
<PAGE>
SELECTED FINANCIAL DATA
The selected financial data set forth below for the period from May 10, 1994
(date of inception) to December 31, 1994 and for the years ended December 31,
1995, 1996 and 1997 were derived from the audited financial statements of the
Company and its predecessors. The selected financial data as of March 31, 1998
and for the three months ended March 31, 1997 and 1998 is unaudited, but in the
opinion of the management of the Company, reflects all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation of
results for interim periods. Operating results for interim periods are not
necessarily indicative of results to be expected for the full fiscal year. The
selected financial data should be read in conjunction with "Unaudited Pro Forma
Consolidated Statement of Operations," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements and
the notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MAY 10, 1994 THREE MONTHS
(DATE OF YEAR ENDED DECEMBER 31, ENDED MARCH
INCEPTION) ---------------------------------------------------------- 31,
TO PRO FORMA ------------
DECEMBER 31, 1994 1995 1996 1997 1997(A)(B) 1997
----------------- ------------- ------------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue............................ $ -- $ -- $ 205,087 $ 3,417,441 $ 3,655,254 $ 125,438
Operating expenses:
Network operating costs.......... -- -- 1,360,553 7,735,849 7,830,179 611,359
Selling, general and
administrative................. 4,475 1,591,159 2,217,091 9,922,804 10,348,286 1,122,581
Stock option compensation
expense........................ -- -- 240,000 13,869,346 13,869,346 66,000
Depreciation and amortization.... -- 5,770 286,509 2,505,875 2,616,913 135,551
----------------- ------------- ------------- ------------- ------------- ------------
Total operating expenses....... 4,475 1,596,929 4,104,153 34,033,874 34,664,724 1,935,491
----------------- ------------- ------------- ------------- ------------- ------------
Loss from operations............... (4,475) (1,596,929) (3,899,066) (30,616,433) (31,009,470) (1,810,053)
Interest expense, net(c)........... -- 23,463 596,248 2,068,730 2,202,670 163,033
----------------- ------------- ------------- ------------- ------------- ------------
Net loss........................... (4,475) (1,620,392) (4,495,314) (32,685,163) (33,212,140) (1,973,086)
Dividends and accretion on
redeemable preferred stock....... -- -- -- (8,904,403) (8,904,403) (163,823)
----------------- ------------- ------------- ------------- ------------- ------------
Net loss applicable to common
shareholders..................... $ (4,475) $ (1,620,392) $ (4,495,314) $ (41,589,566) $ (42,116,543) $ (2,136,909)
----------------- ------------- ------------- ------------- ------------- ------------
----------------- ------------- ------------- ------------- ------------- ------------
Net loss per common share.......... $ (.01) $ (2.70) $ (7.49) $ (64.93) $ (65.75) $ (3.56)
----------------- ------------- ------------- ------------- ------------- ------------
----------------- ------------- ------------- ------------- ------------- ------------
Weighted average common shares
outstanding...................... 600,000 600,000 600,000 640,568 640,568 600,000
----------------- ------------- ------------- ------------- ------------- ------------
----------------- ------------- ------------- ------------- ------------- ------------
OTHER DATA:
Capital expenditures............... $ -- $ 3,498,458 $ 9,110,989 $ 59,145,924 $ 59,145,924 $ 4,417,618
EBITDA(d).......................... (4,475) (1,591,159) (3,612,557) (28,110,558) (28,392,557) (1,674,502)
Cash used in operating activities.. 4,091 (779,033) (2,687,290) (8,675,556) (3,640,743)
Cash used in investing
activities....................... -- (1,920,088) (10,174,336) (62,992,347) (5,422,254)
Cash provided by financing
activities....................... 1,000 2,728,400 14,313,770 85,734,292 7,959,466
Ratio of earnings to fixed
charges(e)....................... -- -- -- -- -- --
<CAPTION>
1998
--------------
<S> <C>
STATEMENT OF OPERATIONS DATA:
Revenue............................ $ 2,792,950
Operating expenses:
Network operating costs.......... 5,816,133
Selling, general and
administrative................. 3,472,520
Stock option compensation
expense........................ 1,098,930
Depreciation and amortization.... 993,573
--------------
Total operating expenses....... 11,381,156
--------------
Loss from operations............... (8,588,206)
Interest expense, net(c)........... 4,376,008
--------------
Net loss........................... (12,964,214)
Dividends and accretion on
redeemable preferred stock....... (3,353,208)
--------------
Net loss applicable to common
shareholders..................... $ (16,317,422)
--------------
--------------
Net loss per common share.......... $ (20.18)
--------------
--------------
Weighted average common shares
outstanding...................... 808,467
--------------
--------------
OTHER DATA:
Capital expenditures............... $ 8,771,727
EBITDA(d).......................... (7,594,633)
Cash used in operating activities.. (6,423,072)
Cash used in investing
activities....................... (179,703,428)
Cash provided by financing
activities....................... 224,981,513
Ratio of earnings to fixed
charges(e)....................... --
</TABLE>
(accompanying notes are on the following page)
41
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
---------------------------------------------------- --------------
1994 1995 1996 1997 1998
--------- ------------ ------------ ------------- --------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 5,091 $ 34,370 $ 1,486,514 $ 15,552,903 $ 54,407,916
Investments held for future capital expenditures.......... -- -- -- -- 165,500,000
Networks and equipment, net............................... -- 3,496,277 12,347,216 71,371,063 79,222,036
Total assets.............................................. 7,700 3,703,721 16,715,209 95,943,307 326,645,713
Long-term debt............................................ -- 2,727,400 12,330,006 61,276,933 284,930,186
Redeemable preferred stock................................ -- -- -- 35,925,384 38,755,513
Redeemable common stock and warrants...................... -- -- -- 11,726,305 21,413,729
Total nonredeemable equity (deficiency)................... (3,475) (1,622,867) 388,882 (26,673,279) (31,704,116)
</TABLE>
- ------------------------
(a) Pro forma consolidated statement of operations data and other data for the
year ended December 31, 1997 gives effect to the Melbourne Acquisition in
July 1997 as if the Melbourne Acquisition had occurred as of January 1,
1997. See "Use of Proceeds," "Unaudited Pro Forma Consolidated Statement of
Operations" and the historical financial statements and notes thereto
included elsewhere in this Prospectus.
(b) The pro forma financial data does not give effect to the Initial Offering
and the initial application of the net proceeds therefrom. Assuming that the
Initial Offering had been consummated as of the beginning of the respective
years ended December 31, 1996 and 1997 and the respective three month
periods ended March 31, 1997 and 1998, pro forma interest expense for such
periods would have been $34.7 million, $35.9 million, $8.4 million and $6.9
million, respectively.
(c) Excludes capitalized interest of (i) $36,940 for 1995, (ii) $103,000 for
1996, (iii) $854,000 for 1997, (iv) $27,000 for the three months ended March
31, 1997 and (v) $605,000 for the three months ended March 31, 1998. During
the construction of the Company's networks, the interest costs related to
construction expenditures are capitalized. For the three months ended March
31, 1998, interest expense is net of $2.2 million of interest income.
(d) EBITDA consists of earnings (loss) before net interest, income taxes,
depreciation and amortization, excluding loss on impairment of long-lived
assets. EBITDA is provided because it is a measure commonly used in the
telecommunications industry. It is presented to enhance an understanding of
the Company's operating results and is not intended to represent cash flow
or results of operations in accordance with GAAP. EBITDA is not calculated
under GAAP and is not necessarily comparable to similarly titled measures of
other companies. For a presentation of cash flows calculated under GAAP, see
the Company's historical financial statements contained elsewhere in this
Prospectus.
(e) The ratio of earnings to fixed charges is computed by dividing pretax income
from continuing operations before fixed charges (other than capitalized
interest) by fixed charges. Fixed charges consist of interest charges and
amortization of debt expense and discount or premium related to
indebtedness, whether expensed or capitalized, and that portion of rental
expense the Company believes to be representative of interest. For 1994,
1995, 1996, 1997, the three months ended March 31, 1997 and the three months
ended March 31, 1998, earnings were insufficient to cover fixed charges by
$4,475, $1.7 million, $4.6 million, $33.5 million, $2.0 million and $13.6
million, respectively. After giving PRO FORMA effect to the increase in
interest expense resulting from the Melbourne Acquisition and the Initial
Offering as of the beginning of each year, earnings would have been
insufficient to cover fixed charges by $41.0 million and $67.8 million for
1996 and 1997, respectively. After giving PRO FORMA effect to the increase
in interest expense resulting from the Initial Offering as of January 1,
1998, earnings would have been insufficient to cover fixed charges by $16.1
million for the three months ended March 31, 1998.
42
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
The accompanying unaudited pro forma consolidated statement of operations
for the year ended December 31, 1997 is based upon the historical statements of
operations of the Company and the Melbourne System, which the Company acquired
from ICG Communications, Inc. in July 1997. The unaudited pro forma consolidated
statement of operations has been prepared assuming the Melbourne Acquisition was
consummated as of January 1, 1997, and after giving effect to the pro forma
adjustments. See "Notes to Unaudited Pro Forma Consolidated Statement of
Operations."
This unaudited pro forma consolidated statement of operations and notes
thereto should be read in conjunction with "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical financial statements and notes thereto of the Company and the
Melbourne System included elsewhere in this Prospectus. The unaudited pro forma
consolidated statement of operations is based upon certain assumptions and
estimates of management which are subject to change. This unaudited pro forma
consolidated statement of operations and the notes thereto is provided for
informational purposes only and does not purport to be indicative of the results
of operations that would actually have been attained had the Melbourne
Acquisition been completed as of January 1, 1997, or that may be expected to
occur in the future.
The unaudited pro forma consolidated statement of operations does not give
effect to the Initial Offering.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------------------------------------
PRO FORMA
KMC TELECOM MELBOURNE PRO FORMA CONSOLIDATED
HOLDINGS, INC. SYSTEM ADJUSTMENTS AMOUNTS(4)
-------------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
Revenue........................................... $ 3,417,441 $ 237,813 $ -- $ 3,655,254
Operating expenses:
Network operating costs......................... 7,735,849 63,080 31,250(1) 7,830,179
Selling, general and administrative............. 9,922,804 384,857 40,625(1) 10,348,286
Stock option compensation expense............... 13,869,346 -- -- 13,869,346
Depreciation and amortization................... 2,505,875 138,884 (27,846 (2) 2,616,913
-------------- ----------- ------------- --------------
Total operating expenses.................... 34,033,874 586,821 44,029 34,664,724
-------------- ----------- ------------- --------------
Loss from operations.............................. (30,616,433) (349,008) (44,029) (31,009,470)
Interest expense.................................. 2,068,730 26,940 107,000(3) 2,202,670
-------------- ----------- ------------- --------------
Net loss.......................................... (32,685,163) $ (375,948) $ (151,029) (33,212,140)
----------- -------------
----------- -------------
Dividends and accretion on redeemable preferred
stock........................................... (8,904,403) (8,904,403)
-------------- --------------
Net loss applicable to common shareholders........ $ (41,589,566) $ (42,116,543)
-------------- --------------
-------------- --------------
Net loss per common share......................... $ (64.93) $ (65.75)
-------------- --------------
-------------- --------------
Weighted average common shares outstanding........ 640,568 640,568
-------------- --------------
-------------- --------------
</TABLE>
(accompanying notes are on the following page)
43
<PAGE>
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED STATEMENT OF OPERATIONS
The unaudited pro forma consolidated statement of operations for the year
ended December 31, 1997 gives effect to the following pro forma adjustments:
(1) To give retroactive effect to the increase in operating expenses estimated
by the Company attributable to additional management and customer care staff
deployed to operate the Melbourne System.
(2) To reflect depreciation of the acquired network and electronics based upon
revised asset values and estimated useful lives of 20 years and 10 years,
respectively.
(3) To reflect additional interest expense incurred on $2.0 million of
borrowings under the AT&T Facility to fund the Melbourne Acquisition.
(4) The unaudited pro forma consolidated statement of operations does not give
effect to the Initial Offering and the initial application of the net
proceeds therefrom. Assuming that the Initial Offering had been consummated
as of the beginning of the year, pro forma interest expense for the year
ended December 31, 1997 would have been $35.9 million.
44
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS REFLECTS THE HISTORICAL RESULTS OF THE COMPANY. DUE TO THE LIMITED
OPERATING HISTORY, STARTUP NATURE AND RAPID GROWTH OF THE COMPANY,
PERIOD-TO-PERIOD COMPARISONS OF FINANCIAL DATA ARE NOT NECESSARILY INDICATIVE,
AND SHOULD NOT BE RELIED UPON AS AN INDICATOR, OF THE FUTURE PERFORMANCE OF THE
COMPANY. THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS. FOR A
DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER FROM
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS, SEE "RISK FACTORS."
OVERVIEW
GENERAL. The Company is a CLEC providing telecommunications and data
services in Tier III Markets. The Company targets business, government and
institutional end users, as well as ISPs, IXCs and wireless service providers.
The Company's objective is to provide its customers with a complete solution for
their communications needs. The Company currently provides on-net special access
and private line and Internet access services and, primarily on a resale basis,
switch-based local and long distance services. During the next year, the Company
plans to provide Centrex-type, frame relay, ISDN and ATM services for
applications including LAN-to-LAN interconnect, Internet access, WAN, and high
speed video conferencing. Over time, the Company expects to transition the
majority of its customers to its own networks by means of either direct
connections or ILEC unbundled network elements.
The Company has invested significant capital and effort in developing its
telecommunications business. This capital has been invested in the development
of the Company's networks, the hiring of an experienced management team, the
development and installation of operating systems, the introduction of services,
marketing and sales efforts, and acquisitions. The Company expects to make
increasing capital expenditures to build additional networks, to expand current
networks to additional customer buildings, IXC POPs and ILEC central offices,
and to broaden its service offerings, and may consummate additional
acquisitions. Proper management of the Company's growth will require the Company
to maintain cost controls, continue to assess market potential, ensure quality
control in implementing its services as well as to expand the Company's internal
management, customer care and billing and information systems, all of which will
require substantial investment. See "--Liquidity and Capital Resources" and
"Risk Factors-- Significant Capital Requirements," "--Development and Expansion
Risk; Need to Manage Growth" and "--Dependence on Billing, Customer Services and
Information Systems."
The development, construction and expansion of the Company's networks
requires significant capital, a large portion of which is invested before any
revenue is generated. See "Risk Factors--Significant Capital Requirements." The
Company has incurred, and expects to continue to incur, significant and
increasing negative gross margins, operating losses, negative EBITDA and net
cash outflows for operating and investing activities while it expands its
network operations and builds its customer base. See "Risk Factors--Limited
Operating History; Negative Gross Profits, Operating Losses and Negative Cash
Flow." None of the Company's existing networks is generating positive EBITDA.
Based on its experience to date and that of its competitors, the Company
estimates that a new network will begin to generate positive EBITDA within 24 to
36 months after commencement of commercial operations. Construction periods and
operating results will vary from network to network. There can be no assurance
that the Company will be able to establish a sufficient revenue-generating
customer base or gross margins in any particular market or on a consolidated
basis.
The CLEC business is capital intensive. The Company estimates that the total
initial costs associated with the purchase and installation of fiber optic cable
and transmission and switching equipment, including capitalized engineering
costs, will range from $8.0 million to $10.0 million per network, depending upon
the size of the market served, the scope and complexity of the network, and the
proportion of aerial to underground fiber deployment. Actual costs could vary
significantly from this range. The amounts and timing of these expenditures are
subject to a variety of factors that may vary significantly with the
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geographic and demographic characteristics of each market. In addition to
equipment and construction expenditure requirements, upon commencement of the
construction phase of a network, the Company begins to incur direct operating
costs for such items as salaries and rent. As network construction progresses,
the Company incurs costs associated with construction, including preparation of
rights-of-way, and increased sales, marketing, operating and administrative
expenses. Certain direct costs related to network planning and construction
costs for new networks are capitalized.
The initial construction of a network takes approximately six months,
depending upon the size and complexity of the network. The time required during
the construction phase is also significantly influenced by the number of route
miles involved, the mix of aerial versus underground fiber deployment, possible
delays in preparing rights-of-way, provisioning fiber optic cable and electronic
equipment, and required construction permits and other factors, including
weather.
LOCAL SERVICES. To facilitate its entry into local services, the Company
plans to install switching equipment in all of its networks. Switches are in
commercial operation in each of of the Company's eight existing markets.
Generally, the Company believes that the transition of the majority of customers
to on-net switched services should be complete within six to nine months or less
following the date on which a switch becomes commercially operational. The
Company expects to have switches in commercial operation in 18 networks by the
end of 1998 and in 5 additional networks in 1999. Once a switch is commercially
operational, where regulatory conditions permit, the Company offers local dial
tone, in addition to enhanced services such as ISDN, Centrex-type, voice mail
and other custom calling features and switched data services. Until such time,
the Company will rely on the ILEC to originate and terminate its switched
traffic.
The Company expects operating margins to improve as switching becomes
operational and switched services are provided on-net, the network is expanded
(primarily by adding buildings to the network), and larger volumes of traffic
are carried on the Company's network. Although under the Telecommunications Act
the ILECs will be required to unbundle local network elements, decreasing
operating expenses by permitting the Company to purchase only the origination
and termination services it needs, there can be no assurance that such
unbundling will be effected in a timely manner and result in prices favorable to
the Company. See "Risk Factors--Implementation Risks."
REVENUE AND OPERATING EXPENSES. The Company currently derives its revenue
primarily from resale of switched services, and special access and private line
and Internet access services provided on the Company's facilities. In addition,
future revenue will include on-net switch-based local services, including
Centrex-type and frame relay, ISDN and ATM services for applications including
LAN-to-LAN interconnect, Internet access, WAN, and high speed video
conferencing. The Company expects to experience declining unit prices and costs
for a substantial portion of its services; however, the Company expects that
these declines will not be as pronounced as those which might be expected in
Tier I and Tier II Markets, due to its expectation that there will be a more
limited number of competitors in the average Tier III Market. The Company's
principal operating expenses consist of network operating costs, selling,
general and administrative expenses, stock option compensation expense,
depreciation and amortization, and interest expense. Network operating costs
include charges from ILECs for resale services, charges from IXCs for resale of
long distance services, salaries and benefits associated with network
operations, billing, information services and customer care personnel, franchise
fees (some of which are calculated as a percentage of revenues in the applicable
market, ranging from 3% to 5%, depending upon the market involved) and other
costs, including direct city administration costs. In the future, the Company
anticipates that network operating costs will include origination charges and
unbundled network element charges from the ILECs. Further, in 1998 the Company
expects to pay a percentage of both its intrastate and interstate revenues as
universal service fund charges. The contribution factors for first quarter 1998
contributions were 3.19% of the Company's estimated quarterly interstate and
international gross end user telecommunications revenue for the high cost and
low income fund and .72% of the Company's estimated quarterly intrastate,
interstate and international gross end user telecommunications revenue for the
schools and
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libraries and healthcare fund. Contribution factors for second quarter 1998 were
3.14% and .76%, respectively. Contribution factors for third quarter 1998 are
3.14% and .75% respectively. The Company cannot predict the amount of its
universal service fund contributions for the fourth quarter of 1998, or
thereafter, until the FCC issues contribution factors for such periods. These
universal service charges will be accounted for as network operating costs. See
"Business --Regulation--Universal Service Reform." Selling, general and
administrative expenses consists of sales personnel and supporting costs,
corporate and finance personnel and supporting costs, legal and accounting
expenses. Depreciation and amortization includes charges related to plant,
property and equipment and amortization of intangible assets, including
franchise acquisition costs. The Company expects depreciation and amortization
expense to increase as the Company places additional networks into service.
Interest expense includes interest charges on the Notes and the AT&T Facility as
well as on the initial debt financing provided to the Company by Nassau and
Harold N. Kamine. Interest expense also includes amortization of deferred
financing costs. Interest expense will increase substantially in future periods
as a result of the issuance of the Notes and additional borrowings under the
AT&T Facility to finance network build-out.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO
THREE MONTHS ENDED MARCH 31, 1997
REVENUE. Revenue increased from $125,000 for the three months ended March
31, 1997 (the "1997 First Quarter") to $2.8 million for the three months ended
March 31, 1998 (the "1998 First Quarter"). The revenue increase is primarily
attributable to the fact that the Company had eight systems in commercial
operation during the 1998 First Quarter compared to one system in commercial
operation during the entire 1997 First Quarter. Two additional systems became
commercially operational in March of 1997, but had not yet generated significant
revenues. For the 1998 First Quarter, out of total revenues of $2.8 million,
$2.1 million was derived from resale of switched services and an aggregate of
$662,000 was derived from on-net special access, private line and switched
services.
NETWORK OPERATING COSTS. Network operating costs increased from $611,000 in
the 1997 First Quarter to $5.8 million in the 1998 First Quarter. The increase
was due primarily to the increase in the number of systems in commercial
operation in the 1998 First Quarter and the related increases of $2.2 million in
costs associated with providing resale services, $1.4 million in personnel
costs, and $1.6 million in billing, customer care, insurance, facilities and
other direct operating costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $1.1 million for the 1997 First Quarter
to $3.5 million for the 1998 First Quarter. The $2.4 million increase resulted
primarily from an increase of $1.6 million in personnel costs, as well as
increases in advertising and other costs associated with marketing activities.
STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge, increased from $66,000 in the 1997 First Quarter to $1.1
million in the 1998 First Quarter, primarily as a result of an increase in the
fair market value of KMC Telecom's common stock, as well as the greater number
of options outstanding during the 1998 First Quarter, reflecting option grants
during 1997.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased from $136,000 for the 1997 First Quarter to $994,000 for the 1998
First Quarter as a result of depreciation expense associated with the additional
networks that became commercially operational during 1997.
INTEREST EXPENSE. Interest expense increased from $163,000 in the 1997
First Quarter to $4.4 million in the 1998 First Quarter. The increase resulted
primarily from the issuance of the Original Notes during the 1998 First Quarter,
which generated interest expense of $5.6 million, as well as the increased
expense attributable to the higher level of borrowings under the AT&T Facility
in the 1998 First Quarter. The increase was partially offset by $2.2 million of
interest income earned on the investment of the unused
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portion of the proceeds of the Initial Offering. The Company capitalized
interest of $605,000 related to network construction projects during the 1998
First Quarter.
NET LOSS. For the reasons stated above, net loss increased from $2.0
million for the 1997 First Quarter to $13.0 million for the 1998 First Quarter.
1997 COMPARED TO 1996
REVENUE. Revenue increased from $205,000 for 1996 to $3.4 million for 1997.
Revenue increased primarily because the Company began aggressively marketing its
services in its first market, Huntsville, Alabama ("Huntsville"), which
generated $1.6 million of revenue for 1997. In addition, the Melbourne System,
which was purchased during 1997, and the six other systems which became
commercially operational during 1997, generated an aggregate of $1.8 million in
revenue during 1997. Furthermore, the Company initiated marketing efforts in May
1997 in all of the markets in which its networks had become commercially
operational or in which it was constructing networks. For 1997, out of total
revenues of $3.4 million, $2.3 million was derived from resale of switched
services and $1.1 million was derived from special access and private line
services, of which $943,000 was generated by on-net services.
NETWORK OPERATING COSTS. Network operating costs increased from $1.4
million for 1996 to $7.7 million for 1997. The increase was due primarily to
costs of $2.4 million associated with hiring personnel and staffing local
offices, $1.8 million in selling, customer care, insurance, facilities and other
direct operating costs and $2.1 million in costs associated with providing
resale services which were initiated in May 1997.
Costs associated with providing on-net services were greater than revenue
generated from on-net services because the Company was required to hire
personnel and staff local offices prior to generating revenue and obtaining
sufficient revenue volume to cover such fixed operating costs.
Costs associated with providing resale services are greater than the
revenues currently generated because of narrow discounts on ongoing resale
services provided by the ILEC and because initial installation charges by the
ILEC to the Company are greater than the Company's installation charges to its
customers. Resale is primarily an interim strategy for the Company to create a
backlog of customers to be transitioned to the Company's on-net switched
facilities once the Company's own switches become commercially operational.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $2.2 million for 1996 to $9.9 million for
1997. The increase was due primarily to increases of $4.3 million attributable
to hiring additional personnel in all categories, particularly in senior
management and sales and marketing, $1.1 million in consulting costs (primarily
related to marketing services), and $1.2 million in legal expenditures
(primarily incurred in connection with vendor contracts and regulatory
activities). The Company expects that selling, general and administrative
expenses will continue to increase in absolute terms as the Company continues to
expand its network services and marketing activities, but that they will decline
as an overall percentage of revenue.
STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a
non-cash charge, increased from $240,000 in 1996 to $13.9 million in 1997. The
increase was due primarily to an increase in the fair value of KMC Telecom's
common stock.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses
increased from $287,000 for 1996 to $2.5 million for 1997. The increase
reflected the six networks that became commercially operational and the one
network that was purchased during 1997 as well as higher amortization of
intangible assets.
INTEREST EXPENSE. Interest expense increased from $596,000 for 1996 to $2.1
million for 1997, primarily reflecting borrowings under the AT&T Facility in
1997, as well as amortization of deferred financing costs of $561,000. The
Company capitalized interest of $854,000 related to network construction
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projects during 1997. Interest expense will continue to increase as a result of
the issuance of the Notes and to the extent that the Company increases its
borrowings under the AT&T Facility.
NET LOSS. For the reasons stated above, net loss increased from $4.5
million for 1996 to $32.7 million for 1997.
1996 COMPARED TO 1995
REVENUE. Revenue increased from $0 for 1995 to $205,000 for 1996. The
increase in revenue was due to the commencement of the Huntsville network
operations in 1996.
NETWORK OPERATING COSTS. Network operating costs increased from $0 for 1995
to $1.4 million for 1996. This increase was primarily related to the
commencement of operations of the Huntsville network and the related increases
of $550,000 of personnel costs and $850,000 in facilities and other direct
operating costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $1.6 million for 1995 to $2.2 million for
1996. The increase was due primarily to the hiring of additional senior
management personnel and development of network construction and implementation
plans. Of these amounts, approximately $568,000 for 1996 was incurred by the
Company from affiliated companies owned by Harold N. Kamine for services
(including rent) which the Company shared with such affiliated companies. See
"Certain Relationships and Related Transactions."
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased from
$6,000 for 1995 to $287,000 for 1996. This increase was due primarily to the
completion of construction of the Huntsville network.
INTEREST EXPENSE. Interest expense increased from $23,000 for 1995 to
$596,000 for 1996. This increase was due primarily to the increase in loans from
stockholders in 1996 and the convertible debt provided by Nassau in 1996, as
well as the amortization of financing costs on the convertible debt.
NET LOSS. For the reasons stated above, net loss increased from $1.6
million for 1995 to $4.5 million for 1996.
1995 COMPARED TO 1994
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased from $4,000 for 1994 to $1.6 million for 1995.
The increase was due primarily to expenses incurred in connection with business
planning and initiating Company activities, including hiring personnel. Of these
amounts, approximately $859,000 for 1995 was incurred by the Company from
affiliated companies owned by Harold N. Kamine for services which the Company
shared with such affiliated companies.
INTEREST EXPENSE. Interest expense increased from $0 for 1994 to $23,000
for 1995, due primarily to the incurrence by the Company in 1995 of a loan made
by a stockholder of the Company.
NET LOSS. For the reasons stated above, net loss increased from $4,000 in
1994 to $1.6 million in 1995.
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STOCK COMPENSATION PLAN
During 1996 and 1997, KMC Telecom, now the Company's principal operating
subsidiary, granted options to purchase shares of KMC Telecom Common Stock
pursuant to its 1996 Stock Purchase and Option Plan for Key Employees of KMC
Telecom Inc. and Affiliates (the "KMC Telecom Stock Option Plan"). On June 26,
1998, the Board of Directors of the Company adopted, effective upon stockholder
approval, the 1998 Stock Purchase and Option Plan for Key Employees of KMC
Telecom Holdings, Inc. and Affiliates which authorizes the grant of options to
purchase Common Stock of the Company (the "KMC Holdings Stock Option Plan"). It
is currently anticipated that, during the third quarter of 1998, the Company
will replace the options to purchase KMC Telecom Common Stock previously granted
under the KMC Telecom Stock Option Plan with options to purchase Common Stock of
the Company granted under the KMC Holdings Stock Option Plan and will grant
options to additional employees of the Company. The Company, upon cancellation
of the outstanding options under the KMC Telecom Stock Option Plan, will reverse
all compensation expense previously recorded with respect to such options.
Additionally, to the extent the fair value of the Common Stock of the Company
exceeds the exercise price of the options granted under the KMC Holdings Stock
Option Plan, the Company will then recognize compensation expense related to
such options over their vesting period. The Company expects the net effect of
the cancellation of the options outstanding under the KMC Telecom Stock Option
Plan and the grant of options under the KMC Holdings Stock Option Plan will
result in a net charge to compensation expense.
Certain provisions in the stock option awards expected to be granted under
the KMC Holdings Stock Option Plan would necessitate that such awards be treated
as variable stock compensation awards pursuant to Accounting Principles Board
Opinion No. 25. Accordingly, compensation expense will be charged or credited
periodically through the date of exercise or cancellation of such stock options,
based on changes in the value of the Company's stock as well as the vesting
schedule of such options. These compensation charges or credits are non-cash in
nature, but could have a material effect on the Company's future reported
results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred significant operating and net losses as a result of
the development and operation of its networks. The Company expects that such
losses will continue as the Company emphasizes the development, construction and
expansion of its networks and builds its customer base and that cash provided by
operations will not be sufficient to fund the expansion of its networks and
service capabilities.
On January 29, 1998, the Company issued the Units at an original issue price
of approximately $250.0 million (including $460.8 million aggregate principal
amount at maturity of Notes). On the same date, the Company repaid all amounts
outstanding under the Supplemental AT&T Facility in full ($10.1 million,
including accrued interest) and AT&T Credit exercised a warrant to purchase
91,268 shares of Common Stock of the Company for an aggregate purchase price of
$10.0 million. On January 29, 1998, the Company also repaid $10.8 million
previously borrowed by KMC Telecom II under the AT&T Facility. As a result, KMC
Telecom II is no longer eligible to borrow under the AT&T Facility (nor is it an
obligor thereunder) and KMC Telecom is now permitted to borrow up to the full
$70.0 million amount of the AT&T Facility. On January 29, 1998, the Company
deposited $5.0 million as a non-refundable downpayment under an agreement with
Lucent for future purchases of switching equipment and paid approximately
$600,000 in dividend arrearages to the former holders of Series A Cumulative
Convertible Preferred Stock of KMC Telecom. See "Use of Proceeds."
Net cash provided by financing activities from borrowings and equity
issuances was $2.7 million for 1995, $14.3 million for 1996, $85.7 million for
1997 and $225.0 million for the 1998 First Quarter. The Company's net cash used
in operating and investment activities was $2.7 million for 1995, $12.9 million
for 1996, $71.7 million for 1997 and $186.1 million for the 1998 First Quarter.
The Company made capital expenditures of $9.1 million in 1996, $59.1 million
in 1997 and $8.8 million in the 1998 First Quarter. The Company currently plans
to make additional capital expenditures of approximately $140.0 million during
the remainder of 1998. Continued significant capital expenditures are
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expected to be made thereafter. The majority of these expenditures is expected
to be made for network construction and the purchase of switches and related
equipment to facilitate the offering of the Company's services. In addition, the
Company expects to continue to incur operating losses while it expands its
business and builds its customer base. Actual capital expenditures and operating
losses will depend on numerous factors, including the nature of future expansion
and acquisition opportunities and factors beyond the Company's control,
including economic conditions, competition, regulatory developments and the
availability of capital. See "Risk Factors--Limited Operating History; Negative
Gross Profits, Operating Losses and Negative Cash Flow" and "--Significant
Capital Requirements."
In addition to the Company's capital expenditures in 1997, the Company
acquired the Melbourne System for a purchase price of $2.0 million.
The Company has entered into an agreement with ACE*COMM pursuant to which
ACE*COMM will provide the Company with comprehensive billing, order processing
and customer care software for all existing and contemplated services the
Company will market. At March 31, 1998, the Company had outstanding an aggregate
of approximately $1.2 million of obligations under this agreement.
At March 31, 1998 the Company had outstanding commitments aggregating
approximately $55.0 million related to the purchase of fiber optic cable and
telecommunications equipment as well as engineering services, principally under
the Company's agreements with Lucent.
On November 5, 1997, the Company issued 100,000 shares of Series C Preferred
Stock to GECC for an aggregate purchase price of $10.0 million and 50,000 shares
of Series C Preferred Stock to CoreStates for an aggregate purchase price of
$5.0 million. The Company also issued 25,000 shares of Series D Preferred Stock
to Nassau for an aggregate purchase price of $2.5 million on the same date. On
January 6, 1998, Nassau converted its 25,000 shares of Series D Preferred Stock
into an equal number of shares of Series C Preferred Stock.
At March 31, 1998, the Company had $40.5 million of indebtedness outstanding
under the AT&T Facility, and had $29.5 million in borrowing capacity available
under the AT&T Facility, subject to certain conditions.
The AT&T Facility restricts the ability of KMC Telecom to pay dividends to,
or to pay principal or interest on loans from, KMC Holdings. Such restrictions
could adversely affect the Company's liquidity and ability to meet its cash
requirements, including its ability to repay the Notes in full at maturity. See
"Risk Factors--Holding Company's Reliance on Subsidiaries' Funds; Priority of
Other Creditors," and "Description of Certain Indebtedness."
The AT&T Facility requires that the Company purchase interest rate cap
agreements under which, if the Commercial Paper Rate (as defined therein) or
LIBOR rises above 12%, the Company will receive payments to offset the higher
interest rates due on the debt. As a result, the Company has entered into an
interest rate cap agreement with The Chase Manhattan Bank which expires on
December 1, 1998, to hedge the Company's interest expense on $35.0 million of
its indebtedness under the AT&T Facility. During 1997, the Company expanded the
AT&T Facility to increase its borrowing capacity thereunder from $35.0 million
to $70.0 million. In addition, during 1997, the Company obtained equity
financing of $10.0 million from AT&T Credit and debt financing of $10.0 million
from the Supplemental AT&T Facility.
During 1996, KMC Telecom issued to Nassau an aggregate of $12.0 million in
convertible notes in two tranches. On January 21, 1997, the aggregate principal
amount of convertible notes, together with accrued interest, was converted into
Series A Cumulative Convertible Preferred Stock of KMC Telecom which, in turn,
was exchanged for Series A Preferred Stock of the Company in September 1997.
During 1995, Mr. Kamine loaned the Company $2.7 million. In 1996, he loaned
the Company an additional $3.4 million. In November 1996, $4.0 million principal
amount of the loan was repaid and the remaining loan balance of $2.1 million,
together with accrued but unpaid interest, was contributed to equity and
reflected as a credit to additional paid-in capital. At the same time, KMC
Telecommunications L.P., which was owned by Mr. Kamine and affiliates, purchased
$4.0 million of Common Stock from the Company.
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At March 31, 1998, the Company had cash, cash equivalents and marketable
securities of approximately $219.9 million. The Company believes that these
funds, together with available cash and borrowings expected to be available
under the AT&T Facility, will provide sufficient funds for the Company to expand
its business as currently planned and to fund its currently anticipated expenses
through the completion of its eight existing networks, the ten new networks
currently planned for completion by the end of 1998 and the five additional
networks planned for completion in 1999, and to fund its working capital
requirements for 1999. Thereafter, the Company will require additional
financing. However, in the event that the Company's plans change, the
assumptions upon which the Company's plans are based prove inaccurate, the
Company expands or accelerates its business plan or the Company determines to
consummate additional acquisitions, the foregoing sources of funds may prove to
be insufficient to complete all such networks, and the Company may be required
to seek additional financing. In this regard, the Company has begun preliminary
consideration of entering San Juan and other markets in Puerto Rico. The Company
is currently considering a plan pursuant to which the Company would contribute
its franchise rights in Puerto Rico, other rights and preparatory work
previously performed by it, and approximately $4.0 million in exchange for
approximately forty percent (40%) of the equity in an entity to be formed to
construct and operate a network in Puerto Rico. The plan contemplates that other
equity investors may include Mr. Kamine, Nassau, GECC and a Puerto Rican venture
capital group. These discussions are still preliminary and no assurance can be
given that the plan will not be significantly amended or abandoned. Additional
sources of financing may include public or private equity or debt financings by
the Company, capitalized leases and other financing arrangements. Pursuant to
the Certificates of the Powers, Designations, Preferences and Rights of the
Series A and Series C Preferred Stock, the Company may not increase the
authorized number of shares of preferred stock or Common Stock without the
consent of the holders of two-thirds of the shares of both the Series A
Preferred Stock and the Series C Preferred Stock. The Company has only three
million shares of Common Stock authorized. There can be no assurance that
additional financing will be available to the Company or, if available, that it
can be obtained on a timely basis and on acceptable terms or within the
limitations contained in the AT&T Facility, the Indenture or in any future
financing arrangements. Failure to obtain such financing could result in the
delay or abandonment of some or all of the Company's development and expansion
plans and expenditures, which would have a material adverse effect on the
Company's business, financial condition and results of operations. Such a
failure could also limit the ability of the Company to make principal and
interest payments on its outstanding indebtedness, including the Notes. The
Company has no working capital or other credit facility under which it may
borrow for working capital and other general corporate purposes. There can be no
assurance that such financing will be available to the Company in the future or
that, if such financing were available, it would be available on terms and
conditions acceptable to the Company. See "Risk Factors-- Significant Capital
Requirements," "Use of Proceeds" and "Unaudited Pro Forma Consolidated Statement
of Operations."
For 1997, after giving PRO FORMA effect to the increase in interest expense
resulting from the Melbourne Acquisition and the Initial Offering as of the
beginning of the year, the Company's earnings would have been insufficient to
cover fixed charges by $67.8 million. For the 1998 First Quarter, after giving
PRO FORMA effect to the increase in interest expense resulting from the Initial
Offering as of January 1, 1998, the Company's earnings would have been
insufficient to cover fixed charges by $16.1 million. The Company's liquidity
has improved as a result of the Initial Offering because the Notes do not
require payment of principal until maturity in 2008. However, the indebtedness
under the AT&T Facility will mature prior to 2008. The Company anticipates that
cash from operations will not be sufficient to repay the amounts owing under the
AT&T Facility. Accordingly, the Company may need to refinance a substantial
amount of indebtedness. The ability of the Company to effect such refinancings
will be dependent upon the future performance of the Company, which will be
subject to prevailing economic conditions and to financial, business, regulatory
and other factors, including factors beyond the control of the Company. There
can be no assurance that the Company will be able to improve its earnings before
fixed charges or that the Company will be able to meet its debt service
obligations, including its obligations
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under the AT&T Facility or the Notes. See "Risk Factors--Significant Capital
Requirements" and "-- Substantial Indebtedness; Debt Service Requirements;
Refinancing Risks."
The Company believes that its existing software applications are year 2000
compliant. However, there can be no assurance until the year 2000 occurs that
all systems will then function adequately. The Company currently requests that
all vendors proposing to provide it with software applications certify that such
software is year 2000 compliant. If a proposed vendor were to be unable to
certify compliance, the Company will request that the proposed vendor provide it
with the vendor's plan for bringing its software application into compliance.
The Company will consider that plan in making a decision whether to purchase the
software application. If the software applications of the local exchange
carriers, long distance carriers or others on whose services the Company depends
or with whom the Company's systems interface are not year 2000 compliant, it
could affect the Company's systems, which would have a material adverse effect
on the Company's business, financial condition and results of operations and its
ability to make payments on the Notes.
By letter dated August 29, 1997, the Company notified I-Net, Inc. ("I-NET")
that the Company considered I-NET to be in default under a Master
Telecommunications System Rollout Agreement dated as of October 1, 1996 (the
"I-NET Agreement") as a result of I-NET's failure to provide design plans and
specifications for several systems for which it had agreed to provide such plans
and specifications, to properly supervise construction of the systems or to
provide personnel with the necessary expertise to manage the projects. By letter
dated October 27, 1997, I-NET demanded payment of all amounts it alleged were
due under the I-NET Agreement and a related agreement (aggregating $4.1 million)
and stated that it would invoke the arbitration provisions under the I-NET
Agreement if the parties could not agree as to the amount due and payment terms
on or before November 27, 1997. By letter dated December 1, 1997, I-NET extended
its deadline for reaching agreement to December 15, 1997. Although the Company
and I-NET conducted discussions they were unable to reach an agreement and on
February 12, 1998, the Company received a demand for arbitration from Wang
Laboratories, Inc. ("Wang"), the successor to I-NET. The demand seeks at least
$4.1 million. The Company believes that it has meritorious defenses to Wang's
claims and has asserted counterclaims seeking in excess of $2.5 million as a
result of I-NET's defaults under the I-NET Agreement. The Company believes that
resolution of this matter will not have a material adverse impact on its
financial condition. No assurance can be given, however, as to the ultimate
resolution of this matter. See "Business--Legal and Administrative Proceedings."
As of December 31, 1997, the Company and its subsidiaries had consolidated
net operating loss carryforwards for United States income tax purposes ("NOLs")
of approximately $22.8 million which expire through 2012. Under Section 382 of
the Internal Revenue Code of 1986, as amended, if the Company undergoes an
"ownership change," its ability to use its pre-ownership change NOLs (NOLs
accrued through the date of the ownership change) would generally be limited
annually to an amount equal to the product of (i) the long-term tax-exempt rate
for ownership changes prescribed monthly by the Treasury Department and (ii) the
value of the Company's outstanding equity immediately before the ownership
change excluding certain capital contributions (the "Section 382 Limitation").
Any allowable portion of the pre-ownership change NOLs that is not used in a
particular taxable year following the ownership change could be carried forward
to subsequent taxable years until the NOLs expire, usually 15 years after they
are generated.
As a result of the cumulative effect of issuances of preferred and common
stock through September 22, 1997, KMC Telecom has undergone an ownership change.
For financial reporting purposes, the Company has an aggregate of
approximately $38.2 million of loss carryforwards and net temporary differences
at December 31, 1997. At existing tax rates the future benefit of these items
approximates $13.0 million. A valuation allowance has been established equal to
the entire net tax benefit associated with all carryforwards and temporary
differences at December 31, 1997 as their realization is uncertain.
53
<PAGE>
BUSINESS
THE COMPANY
The Company is a CLEC providing telecommunications and data services in Tier
III Markets (population from 100,000 to 750,000). The Company targets business,
government and institutional end users, as well as ISPs, IXCs and wireless
service providers. The Company's objective is to provide its customers with a
complete solution for their communications needs. The Company currently provides
on-net special access and private line and Internet access services and,
primarily on a resale basis, switch-based local and long distance services.
During the next year, the Company plans to provide Centrex-type, frame relay,
ISDN and ATM services for applications including LAN-to-LAN interconnect,
Internet access, WAN, and high speed video conferencing.
The Company currently operates in eight Tier III Markets. The Company enters
its targeted markets initially by reselling the services of the ILEC while it is
constructing its fiber optic network backbone and installing its switches.
Lucent Technologies Series 5ESS-Registered Trademark--2000 switches (or Lucent
derivatives of the 5ESS-Registered Trademark-) are currently in commercial
operation in all eight of the Company's existing markets. The Company intends to
install Lucent switches in each of its future markets. The Company expects to
construct 10 additional networks and install 10 additional switches by the end
of 1998. In addition, the Company expects to construct 5 additional networks and
install 5 additional switches in 1999. Over time, the Company expects to
transition the majority of its customers to its own networks by means of either
direct connections or ILEC unbundled network elements.
INDUSTRY OVERVIEW
According to the FCC's Statistics of Communications Common Carriers, ILECs
in the United States generated approximately $100.7 billion in revenue in 1996
from the provision of local exchange services. Local exchange services consist
of a number of service components and are defined by specific regulatory
classifications. For 1996, total revenue by service was (i) interstate dedicated
access service (i.e., connecting a customer to a long distance carrier's
facilities) revenues of $3.6 billion; (ii) interstate switched access service
(i.e., originating and terminating calls from a long distance carrier) revenues
of $12.4 billion; (iii) end-user fees (i.e., access charges paid by the consumer
for the use of the ILEC's networks) of $7.3 billion; (iv) basic local service
(including dial tone, local area charges, dedicated point-to-point intra-LATA
service and enhanced calling features) revenues of $49.5 billion; (v) intra-LATA
toll call revenues of $10.4 billion; (vi) intrastate switched access (i.e.,
local origination and termination for long distance carriers for calls within a
state) revenues of $7.6 billion; and (vii) miscellaneous (including provision of
directories, billing and collection services and corporate operations) revenues
of $9.8 billion. In addition, the FCC reported that total toll service revenues
in the United States in 1996 were $99.7 billion.
Until recently, the CAP/CLEC industry has generally been limited to
providing special access services and private line services to corporations and
government agencies physically located on the network of the CAP/CLEC. The
Telecommunications Act opens local service markets to competition by preempting
state and local laws, to the extent that they prevent competitive entry with
respect to the provision of any telecommunications service, and imposes a
variety of new duties on ILECs in order to promote competition in local exchange
and access services.
In May 1997, the FCC adopted rules that will change how access charges are
calculated. These changes will reduce access charges and will shift certain
charges currently based on minutes to flat-rate, monthly per-line charges. In
addition, the FCC has also adopted rules that will give ILECs pricing
flexibility with respect to access charges.
BUSINESS STRATEGY
The principal elements of the Company's business strategy include:
TIER III MARKET FOCUS. The Company intends to operate in Tier III Markets.
The Company believes that many Tier III Markets offer attractive demographic,
economic, competitive and demand characteristics. In addition, network
construction is less expensive in Tier III Markets than in Tier I and Tier II
54
<PAGE>
Markets. Generally, labor costs and the costs of obtaining rights of way are
lower in Tier III Markets. In addition, many Tier III Markets permit significant
aerial deployment of fiber optic cable which is less expensive than the buried
deployment required in many Tier I and Tier II Markets. The Company selects the
markets in which it proposes to develop networks from among the approximately
300 Tier III Markets by first identifying those markets that do not yet have
significant, established competitors to the existing ILEC, and by then reviewing
the demographic, economic, competitive and telecommunications demand
characteristics of such markets to determine their suitability for the types of
services offered by the Company. Market demand is estimated on the basis of the
concentration of potential business, government and institutional end user
customers and the general economic prospects for the area.
EARLY TO MARKET ADVANTAGE. The Company strives to be the first CLEC in a
geographic area to actively market and provide services. The Company believes
that by effecting early entry into Tier III Markets it will be able to limit
significant competition from other CLECs which may focus on Tier III Markets
where no CLEC has yet established operations, although there can be no assurance
in this regard. See "Risk Factors--Competition."
COMPREHENSIVE NETWORKS. The Company builds geographically extensive, full
service networks. The Company believes that such networks provide greater
operating leverage, facilitate the capture of market share, and are likely to
deter other CLECs from attempting to penetrate its markets. Prior to both
initial backbone construction and subsequent to any network expansion or
overbuild, the Company performs detailed rate of return analyses to justify such
capital expenditures. In each of its existing eight markets, the Company has
completed its backbone construction connecting the market's central business
district with outlying office parks, large institutions and IXC POPs. In
addition, the Company will continue to expand its existing networks in response
to anticipated customer demand.
LOCAL PRESENCE. The Company intends to capture and retain customers through
effective, personalized sales, marketing and customer service programs. The
Company establishes sales offices in each market in which it operates a network,
relies on a face-to-face selling approach for its customers and will support its
sales staff with locally based customer service and technical support personnel.
The Company believes that its "Creative Solutions with a Hometown Touch"-TM-
sales approach is very important to customers in Tier III Markets, who do not
typically receive local customer support from the ILEC. The Company seeks to
build long-term relationships with its customers by responding rapidly and
creatively to their telecommunications needs. The Company recently entered into
an agreement with ACE*COMM to provide the Company with comprehensive billing,
order processing and customer care software for all existing and contemplated
services the Company will market.
LOW COST CONSTRUCTION. The Company uses innovative "switch-in-a-box"
construction and deployment techniques for many of its networks. Using these
techniques, lightwave, switching and power equipment are pre-installed by Lucent
under controlled factory conditions in weatherproof, storm-proof concrete
buildings delivered to the Lucent facility by a Company contractor. The
completed buildings are then shipped to the appropriate city for final
installation, reducing costs, installation risks and time to market. These
techniques also afford the Company the option of upgrading the switch in place
or moving the switch to a new city in its existing building if growth in the
network where the switch was originally installed requires that a switch with
greater capacity be installed.
EXPERIENCED EXECUTIVE TEAM. The Company's executive team is led by Harold
N. Kamine, Chairman of the Board of Directors, and Michael A. Sternberg, the
Company's President and Chief Executive Officer. Other members of the team
include Gary E. Lasher, Vice Chairman of the Board, Roscoe C. Young II, Chief
Operating Officer, Cynthia Worthman, Vice President and Chief Financial Officer,
Secretary and Treasurer, and James L. Barwick, Senior Vice President-Technology.
These executives, collectively, have over 130 years of experience in the
telecommunications industry.
55
<PAGE>
SERVICES
GENERAL. The Company has generally provided dedicated access service and
resold switched services which it purchased from ILECs. In December 1997, the
Company began providing its own on-net switched services to several of its
customers. See "--Switch-Based Services." For 1997 dedicated access services
accounted for 34% of the Company's revenue and switched services, primarily
resale, accounted for 66% of the Company's revenue. For the three months ended
March 31, 1998, dedicated access services accounted for 24% of the Company's
revenue and switched services, primarily resale, accounted for 76% of the
Company's revenues.
SPECIAL ACCESS AND PRIVATE LINE SERVICES. The Company currently provides
the following types of on-net dedicated service:
- POP-to-POP Special Access --Communications circuits linking two or more
POPs of one IXC or the POPs of different IXCs in a market, allowing these
POPs to exchange traffic for transport to its final destination.
- End-User / IXC Special Access --Communications circuits between an end
user, such as a large business, and the local POP of its pre-subscribed
IXC.
- Private Line --Communications circuits connecting various customer
locations for transmitting internal voice and data traffic.
- Collocated Special Access --A dedicated high capacity line carrying
switched transmissions at a non-usage sensitive rate from an end user to
the IXC POP, through the Company's facilities.
- Collocated POP-to-ILEC Switched Access Transport --A dedicated high
capacity line carrying switched transmissions of multiple end users from
the Company's facilities to and from the Company's collocation points with
the ILEC to the public switched network at a usage sensitive rate.
SWITCH-BASED SERVICES. The Company has added and is continuing to add
capabilities to provide local dial tone and switched access termination and
origination services to its networks. Switches are currently in commercial
operation in each of the Company's eight existing markets. Generally, the
Company believes that the transition of the majority of customers to on-net
switched services should be complete within six to nine months or less following
the date on which a switch becomes commercially operational. The Company expects
to have switches in commercial operation in 18 networks by the end of 1998 and
in 5 additional networks in 1999. The Company has entered into interconnection
agreements with ILECs for all networks anticipated to be built in 1998 and 1999.
LONG DISTANCE. The Company has begun offering its customers long distance
service by purchasing long distance service in bulk from IXCs and reselling the
service to its customers. The Company believes that many of its customers will
prefer the option of purchasing long distance services from the Company as part
of a one-stop telecommunications solution.
CENTREX-TYPE SERVICES. The Company intends to provide Centrex-type services
to certain of its customers. By using Centrex-type services instead of a private
branch exchange ("PBX") to direct their telecommunications traffic, customers
can avoid the large investment in equipment required and the fixed costs
associated with maintaining a PBX network infrastructure. The Company's digital
Centrex-type service will allow medium to small business customers who lack the
size or resources to support their own PBX to benefit from a sophisticated
telecommunications system. In addition, the Company can provide supplementary
services to businesses which operate their own PBX.
ENHANCED DATA SERVICES. The Company is expanding its capabilities to
provide enhanced services. The Company believes that these services will enhance
its ability to provide an integrated turnkey solution to its customer's voice,
data and video transmission requirements. These enhanced services include frame
relay, ISDN and ATM services for applications including LAN-to-LAN interconnect,
Internet access, WAN and high speed video conferencing.
56
<PAGE>
SYSTEMS CONSTRUCTION AND DEVELOPMENT
As part of determining the economic viability of a network in a particular
market, the Company's corporate development staff reviews the demographic,
economic, competitive and telecommunications demand characteristics of the
market. Market demand is estimated, using data gathered from IXCs, the FCC,
local sources, site visits and specific market studies commissioned by the
Company, on the basis of the concentration of potential business, government and
institutional end user customers and the economic prospects for the area.
Once a market is targeted for development, a network is designed to provide
access to a significant number of the key customers in that market. Typically,
the Company constructs a 20-30 mile "self-healing" synchronous optical network
("SONET") architecture backbone ring to provide coverage of the major business
districts, government offices, hospitals, office parks and universities, the
principal IXC POPs and the ILEC's central office(s). Following construction of
the backbone network, the Company expects to build additional loops to increase
the size of the Company's addressable market.
The following table presents information, as of May 31, 1998, concerning the
Company's existing eight networks and the seven new networks on which
construction has begun or for which network engineering has been completed:
<TABLE>
<CAPTION>
EXISTING NETWORKS
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
COMMERCIAL
BUILDINGS DS-0
NETWORK SWITCH ADDRESSABLE CONNECTED TO EQUIVALENT
COMMERCIALLY COMMERCIALLY ROUTE COMMERCIAL THE ACCESS
LOCATION OPERATIONAL (1) OPERATIONAL (2) MILES (3) BUILDINGS(4) NETWORK (5) LINES(6)
- --------------------------- ---------------- ---------------- ------------- ------------- --------------- -------------
Huntsville, AL............. March 1996 November 1997 94 1,286 66 27,431
Baton Rouge, LA............ March 1997 November 1997 30 1,774 24 7,605
Shreveport, LA............. March 1997 December 1997 24 1,126 14 6,772
Corpus Christi, TX......... May 1997 December 1997 28 1,105 5 3,123
Savannah, GA............... June 1997 December 1997 25 1,069 51 2,728
Melbourne, FL (8).......... July 1997 May 1998 46 1,163 12 4,155
Madison, WI................ August 1997 December 1997 37 1,322 30 4,086
Augusta, GA................ October 1997 March 1998 31 1,053 2 2,946
<CAPTION>
NEW NETWORKS
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Greensboro, NC............. Third Quarter Third Quarter
1998 1998 23 1,900 -- --
Winston-Salem, NC.......... Third Quarter Third Quarter
1998 1998 20 1,208 -- --
Tallahassee, FL............ Third Quarter Third Quarter
1998 1998 26 1,032 -- --
Roanoke, VA................ Third Quarter Fourth Quarter
1998 1998 22 981 -- --
Ann Arbor, MI.............. Fourth Quarter Fourth Quarter
1998 1998 22 1,355 -- --
Topeka, KS................. Fourth Quarter Fourth Quarter
1998 1998 24 847 -- --
Fort Wayne, IN............. Fourth Quarter Fourth Quarter
1998 1998 24 1,532 -- --
<CAPTION>
<S> <C>
FRANCHISE
TERMINATION
LOCATION DATE (7)
- --------------------------- -------------
Huntsville, AL............. October 2010
Baton Rouge, LA............ March 2011
Shreveport, LA............. August 2011
Corpus Christi, TX......... April 2003
Savannah, GA............... November 2003
Melbourne, FL (8).......... November 2000
Madison, WI................ August 2011
Augusta, GA................ November 2005
<S> <C>
Greensboro, NC.............
July 2012
Winston-Salem, NC..........
None
Tallahassee, FL............
February 2002
Roanoke, VA................
March 1999
Ann Arbor, MI..............
December 2007
Topeka, KS.................
January 2007
Fort Wayne, IN.............
August 1998
</TABLE>
- ------------------------
(1) The Company considers a network to be commercially operational when its
fiber optic cable and related electronics permit the Company to commence
service. The quarters presented for new networks represent the Company's
estimate of the calendar quarters in which the new networks will be
commercially operational. There can be no assurance that the new networks
will be commercially operational when estimated.
(2) Refers to the date on which testing is completed and the switch is first
available to carry customer traffic. Generally, the Company believes that
the actual transition of the majority of customers to on-net switched
services should be complete within six to nine months or less following the
date on which the switch becomes commercially operational. The quarters
presented for new networks represent the Company's estimate of the calendar
quarters in which the switches for those networks will be commercially
operational. However, there can be no assurance regarding when switches for
the new networks will be commercially operational or when customers will be
transitioned to on-net services.
(3) Represents (i) for existing networks, current owned operational route miles
and (ii) for new networks, the number of route miles currently estimated to
be owned and operational at the time the network becomes commercially
operational.
(4) Addressable by either ILEC unbundled network elements or a direct connection
to the Company's network. The Company defines a commercial building as one
with greater than ten employees.
(5) Represents commercial buildings connected to the Company's network either by
a direct connection or by ILEC unbundled network elements.
(6) Represents all active digital channels provided to customers either by
resale via the ILEC's network, direct connection to the Company's network or
by ILEC unbundled network elements.
(7) The Company is seeking extensions of the franchises for Roanoke and Fort
Wayne and expects that such extensions will be granted.
(8) The Melbourne System was already commercially operational when it was
acquired in July 1997.
Based upon a comparison of 1996 population data published by state agencies
to population data in the 1990 United States Census for the Metropolitan
Statistical Areas in which the Company's eight existing networks, and the seven
new networks on which network construction has begun or for which network
57
<PAGE>
engineering has been completed, are located, the Company believes that the
populations of such Metropolitan Statistical Areas increased, between 1990 and
1996, by approximately the following percentages: Huntsville, AL -- 9.2%; Baton
Rouge, LA -- 6.0%; Shreveport, LA -- 1.0%; Corpus Christi, TX -- 9.7%; Savannah,
GA -- 9.3%; Madison, WI -- 7.9%; Augusta, GA -- 11.3%; Melbourne, FL -- 14.0%;
Greensboro, NC -- 8.4%; Winston-Salem, NC -- 8.3%; Tallahassee, FL -- 12.3%;
Roanoke, VA -- 2.5%; Ann Arbor, MI -- 7.5%; Topeka, KS -- 2.9% and Fort Wayne,
IN -- 3.8%.
On October 1, 1997, the Company entered into a letter of intent to acquire
from FiberCap Digital Inc. an existing network of approximately 13 fiber route
miles located in Winston-Salem, North Carolina (the "Winston-Salem Network").
The Winston-Salem Network presently serves primarily Wake Forest University.
Although the letter of intent has expired, discussions between the parties have
continued. The acquisition is subject to the receipt of any and all necessary
board, shareholder, governmental, financing or other approvals and the
negotiation and execution of a definitive purchase agreement. As indicated in
the preceding table, the Company is presently constructing its own network in
Winston-Salem. If the acquisition were to be consummated, the Winston-Salem
Network would be added to the Company's own network.
The construction of a network requires the Company to obtain municipal
franchises and other permits. These rights are typically the subject of
non-exclusive agreements of finite duration providing for the payment of fees or
the provision of services by the Company to the municipality without
compensation. In addition, the Company must secure rights-of-way and other
access rights which are typically provided under non-exclusive multi-year
agreements, which generally contain renewal options. Generally, these rights are
obtained from utilities, ILECs, other CLECs, railroads and IXCs. The
Telecommunications Act requires most utilities to afford access to rights-of-way
to CLECs on non-discriminatory terms and conditions and at reasonable rates.
However, there can be no assurance that delays and disputes will not occur. The
Company's agreements for rights-of-way and similar matters generally require the
Company to indemnify the party providing such rights. Such indemnities could
make the Company liable for actions (including negligence) of the other party.
See "Risk Factors--Dependence on Rights-of-Way and Other Third Party
Agreements."
The Company's requirements for a planned network are communicated to an
engineering firm that finalizes the route and completes the network's design.
Independent construction and installation contractors are selected through a
competitive bidding process. The Company's own personnel supervise the
construction, negotiate required contracts, and test and verify the network
components prior to commencing commercial service. Cable, equipment and supplies
required for the networks are available from a variety of sources at competitive
rates. The construction period for a new network varies depending upon such
factors as the number of backbone route miles to be installed, the relative use
of aerial as opposed to buried cable deployment, the initial number of buildings
targeted for connection to the network backbone and other factors. Based upon
the Company's experience with its operational networks, the Company believes
that a new fiber optic network can be made commercially operational within
approximately six months after construction commences.
In a typical Tier III Market, office buildings are connected by network
backbone extensions to one of a number of physical rings of fiber optic cable,
which originate and terminate at the Company's local central office. Within each
building, customer equipment is connected to Company-provided electronic
equipment which is generally located on the customer's premises where customer
transmissions are digitized, combined and converted to an optical signal. The
traffic is then transmitted through the network backbone to the Company's local
central office where it can be routed to its ultimate destination on the
network.
The Company's networks consist of digital fiber optic communications paths
which allow for high speed, high quality transmission of voice, data and video
communications. The Company typically installs backbone fiber optic cables
containing 48 to 144 fiber strands which have significantly greater bandwidth
carrying capacity than other media. The Company's OC-48 SONET networks support
up to 32,256 simultaneous voice conversations over a single pair of glass
fibers. The Company expects that continuing developments in compression
technology and multiplexing equipment will increase the capacity of each fiber,
thereby providing more bandwidth carrying capacity at relatively low incremental
costs.
58
<PAGE>
The Company currently offers end-to-end fully protected fiber services
utilizing SONET ring architecture which routes customer traffic simultaneously
in both directions around the ring to provide protection against fiber cuts.
Back-up electronics become operational in the event of failure of the primary
components, adding further redundancy to the Company's systems.
The Company monitors its fiber optic networks and electronics seven days per
week, 24 hours per day using its own local network control centers. Lucent
monitors the Company's switches seven days per week, 24 hours per day, pursuant
to a contractual agreement. The Company may in the future develop its own
national control center to monitor all aspects of network operations.
SALES AND MARKETING
The Company plans to leverage its networks through sales and marketing
activities targeted at two separate customer groups: retail and wholesale.
Retail customers are composed of business, government and institutional
telecommunications and data services customers. Wholesale customers will consist
of IXCs, wireless providers and ISPs.
RETAIL CUSTOMERS. The Company targets retail customer segments such as
business, government, healthcare and educational institutions which have high
volume telecommunications and data services requirements. The Company is
currently providing these customers private line services and is reselling
switched services which it purchases from ILECs. As the Company introduces
switching, local dial tone and long distance services, it will have the
capability to provide a full telecommunications service bundle to its customers.
In addition to these services, the Company will provide data services, including
frame relay, ISDN and ATM. These services are currently experiencing
significantly higher growth rates than voice services. The Company intends to
deliver and support a full range of advanced data services in a cost-effective
manner through the selective use, where appropriate, of third-party vendors for
both marketing and support.
The Company establishes local sales offices in each market that it serves.
Initially, each local sales office is staffed by a City Director and two or
three salespersons with the number of sales personnel expected to increase to
between four and six as the Company's operations in the market expand. All sales
personnel will be hired locally since the Company believes that knowledge of,
and contacts in, a local market are key factors for competitive differentiation
and commercial success in a Tier III Market. The Company believes that this
local focus will help to set the Company apart from its competitors.
WHOLESALE CUSTOMERS. The Company currently targets the major IXCs such as
AT&T, MCI, Sprint and WorldCom and ISPs. The Company believes that it can
effectively compete to provide access to these customers based on price,
reliability, technology, route diversity, ease-of-ordering and customer service.
Historically, IXCs have paid significant charges to ILECs to access their
networks. The Company provides these services at a discount. In addition, to the
extent that ILECs begin to compete with IXCs for long distance services, IXCs
have a competitive incentive to move access business away from ILECs to CLECs.
Revenues from access services may decline in future years due to a change in
pricing proposed by the FCC. See "--Industry Overview."
SUPPLIERS
LUCENT. The Company has contracted with Lucent, as its primary supplier, to
purchase switching, transport and digital cross connect products. Lucent has
also agreed to implement and test the Company's switches and related equipment.
In addition, Lucent and the Company have entered into an agreement pursuant to
which Lucent has agreed to monitor the Company's switches on an on-going basis.
See "--Systems Construction and Development."
ACE*COMM. The Company has entered into an agreement with ACE*COMM pursuant
to which ACE*COMM will provide the Company with comprehensive billing, order
processing and customer care
59
<PAGE>
software for all existing and contemplated services the Company will market. The
Company anticipates that this software package will allow it to provide its
customers with a single bill for all of the services provided to them, whether
resold or on-net. The Company has begun implementation of the ACE*COMM software
package in certain markets and the implementation will be completed as switches
become commercially operational and customers are transitioned to on-net
switched services.
COMPETITION
OVERVIEW. The telecommunications industry is highly competitive. The
Company's principal competitors in Tier III Markets will be the ILECs; in most
instances one of the RBOCs, one of the GTE Companies or Sprint. ILECs presently
have almost 100% of the market share in those areas the Company considers its
market areas. Because of their relatively small size, the Company does not
believe that Tier III Markets can profitably support more than two competitors
to the ILEC.
ILECS. The Company's principal competitors for local exchange services are
the RBOCs, the GTE Companies or Sprint. Other competitors may include other
CLECs, microwave and satellite carriers, wireless telecommunications providers
and private networks built by large end-users. Potential competitors (using
similar or different technologies) include cable television companies, utilities
and RBOCs seeking to operate outside their current local service areas. In
addition, there may be future competition from large long distance carriers,
such as AT&T, MCI and WorldCom, which have begun to offer integrated local and
long distance telecommunications services. AT&T also recently announced its
intention to offer local services using a new wireless technology. Consolidation
of telecommunications companies and the formation of strategic alliances within
the telecommunications industry, as well as the development of new technologies,
could give rise to significant new competitors to the Company.
As a recent entrant in the integrated telecommunications services industry,
the Company has not achieved a significant market share for any of its services.
In particular, the ILECs have long-standing relationships with their customers,
have financial, technical and marketing resources substantially greater than
those of the Company, have the potential to fund competitive services with
revenues from a variety of businesses and currently benefit from certain
existing regulations that favor the ILECs over the Company in certain respects.
While recent regulatory initiatives, which allow CLECs such as the Company to
interconnect with ILEC facilities, provide increased business opportunities for
the Company, such regulatory initiatives have been accompanied by increased
pricing flexibility for, and relaxation of regulatory oversight of, the ILECs.
If the ILECs engage in increased volume and discount pricing practices or charge
CLECs increased fees for interconnection to their networks, or if the ILECs seek
to delay implementation of interconnection to their networks, the Company's
business, financial condition and results of operations and its ability to make
payments on the Notes could be adversely affected.
To the extent the Company interconnects with and uses ILEC networks to
service its customers, the Company will be dependent upon the technology and
capabilities of the ILECs to meet certain telecommunications needs of the
Company's customers and to maintain its service standards. The Company will
become increasingly dependent on interconnection with ILECs as switched services
become a greater percentage of the Company's business. The Telecommunications
Act imposes interconnection obligations on ILECs, but there can be no assurance
that the Company will be able to obtain the interconnections it requires at
rates, and on terms and conditions, that permit the Company to offer switched
services at rates that are both competitive and profitable. See "Risk
Factors--Competition" and "--Implementation Risks." In the event that the
Company experiences difficulties in obtaining high quality, reliable and
reasonably priced service from the ILECs, the attractiveness of the Company's
services to its customers could be impaired.
CLECS AND OTHER COMPETITORS. The Company will compete from time to time
with other CLECs. However, the Company believes that these competitors will not
pose a major threat due to the Company's focus on Tier III Markets, where there
are generally fewer CLEC competitors.
60
<PAGE>
However, it is likely that in one or more of its markets the Company will
face competition from two or more facilities-based CLECs. After the investment
and expense of establishing a network and support services in a given market,
the marginal cost of carrying an additional call is negligible. Accordingly, in
Tier III Markets where there are three or more facilities-based CLECs, the
Company expects substantial price competition. The Company believes that
operations in such markets are likely to be unprofitable for one or more
operators.
The CLEC competitors which have started either construction or solicitation
activities in the Company's eight existing markets include, among others: ACSI
has constructed, or is constructing, networks in Baton Rouge, Corpus Christi,
Madison, Savannah and Shreveport. Brooks has also commenced construction
activities in Corpus Christi. CSW/ChoiceCom has announced that it will provide
services in Corpus Christi. Hyperion Telecommunications, Inc. has announced its
intention to offer services using the fiber optic facilities of Entergy
Corporation, a utility, in Baton Rouge. ITC Deltacom offers services in
Huntsville. LDS Corp. (a privately owned company that has agreed to be acquired
by Intermedia Communications, Inc.) has fiber optic networks in Huntsville and
Shreveport, has resale operations in Baton Rouge, Melbourne and Savannah and has
announced plans to build fiber optic facilities in Savannah and Baton Rouge.
McLeodUSA, Inc. is engaged in reselling in Madison. Mid-Plains, Inc., an ILEC in
Wisconsin, has announced plans to offer services in Madison. TDS Metro has
announced plans to build a 54 mile fiber optic network in Madison and to
commence services in early 1998. Time Warner has announced its intention to
offer services in Melbourne. Including the Company, there are four CLECs that
intend to operate in Corpus Christi.
Competitors which have started either construction or solicitation
activities in the seven new markets in which the Company has commenced
construction or for which network engineering has been completed include, among
others: Williams Vyvx, QWEST, AT&T, MCI, Time Warner, US LEC, and PV Telecom in
Greensboro, as well as BTI, Eagle, ICG and NewSouth which are believed to be
interested in the Greensboro market; FiberCap Digital, Inc. and Time Warner in
Winston-Salem; USN, which has a resale operation, and Brooks, which has
established a private network at the University of Michigan, in Ann Arbor; US
LEC and CFW, which have expressed interest in entering the market, and Cox
Communications in Roanoke; Birch Telecom in Topeka; and US Xchange which has
filed an application in Fort Wayne.
The Company believes that there may be additional competitors that have
formulated plans to enter its markets, including the ten markets it plans to
enter in 1998 and the five markets it plans to enter in 1999.
The Company expects to face competition in each of its markets. The Company
believes that its commitment to build a significant network, deploy switches and
establish local sales and support facilities at the outset in each of the Tier
III Markets which it targets should reduce the number of facilities-based
competitors and drive other entrants to focus on the resale of ILEC service or
the Company's services or search for other market opportunities. The Company
believes that each market will also see more agent and distributor resale
initiatives.
Both the long distance business and the data transmission business are
extremely competitive. Prices in both businesses have declined significantly in
recent years and are expected to continue to decline. In the long distance
business, the Company will face competition from large carriers such as AT&T,
MCI, Sprint and WorldCom. The Company will rely on other carriers to provide
transmission and termination for its long distance traffic and therefore will be
dependent on such carriers. See "Risk Factors--Risks of Entry into Long Distance
Business" and "--Risks of Entry into Data Transmission Business."
The Company expects to experience declining prices and increasing price
competition. There can be no assurance that the Company will be able to achieve
or maintain adequate market share or revenue, or compete effectively, in any of
its markets. See "Risk Factors--Competition."
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REGULATION
The Company's services are subject to varying degrees of federal, state and
local regulation. The FCC exercises jurisdiction over all facilities of, and
services offered by, telecommunications common carriers to the extent those
facilities are used to provide, originate or terminate interstate or
international communications. The state regulatory commissions retain
jurisdiction over the same facilities and services to the extent they are used
to originate or terminate intrastate communications. Local governments sometimes
impose franchise or licensing requirements on CLECs.
FEDERAL REGULATION
The Company is regulated at the federal level as a nondominant common
carrier subject to minimal regulation under Title II of the Communications Act
of 1934. The Communications Act of 1934 was substantially amended by the
Telecommunications Act, which was signed into law by the President on February
8, 1996. This legislation provides for comprehensive reform of the nation's
telecommunications laws and is designed to enhance competition in, among other
markets, the local telecommunications marketplace by: (i) removing state and
local entry barriers, (ii) requiring ILECs to provide interconnections to their
facilities, (iii) facilitating the end users' choice to switch service providers
from ILECs to CLECs such as the Company and (iv) requiring access to
rights-of-way. The legislation also is designed to enhance the competitive
position of the CLECs and increase local competition by newer competitors such
as IXCs, CATVs and public utility companies. Under the Telecommunications Act,
RBOCs have the opportunity to provide inter-LATA long distance services if
certain conditions are met and are no longer prohibited from providing certain
cable TV services. In addition, the Telecommunications Act eliminates certain
restrictions on utility holding companies, thus clearing the way for them to
diversify into telecommunications services. See "Risk Factors--Competition."
The Telecommunications Act specifically requires all telecommunications
carriers (including ILECs and CLECs (such as the Company)): (i) not to prohibit
or unduly restrict resale of their services; (ii) to provide dialing parity and
nondiscriminatory access to telephone numbers, operator services, directory
assistance and directory listings; (iii) to afford access to poles, ducts,
conduits and rights-of-way; and (iv) to establish reciprocal compensation
arrangements for the transport and termination of telecommunications. It also
requires CLECs and ILECs to provide interconnection for the transmission and
routing of telephone exchange service and exchange access. It requires ILECs to
provide such interconnection (a) at any technically feasible point within the
ILEC's network, (b) that is at least equal in quality to that provided by the
ILEC to itself, its affiliates or any other party to which the ILEC provides
interconnection, and (c) at rates, terms and conditions that are just,
reasonable and nondiscriminatory. ILECs also are required under the new law to
provide nondiscriminatory access to network elements on an unbundled basis at
any technically feasible point, to offer their local telephone services for
resale at wholesale rates, and to facilitate collocation of equipment necessary
for competitors to interconnect with or access the unbundled network elements.
The Telecommunications Act also removed on a prospective basis most
restrictions from AT&T and RBOCs resulting from the Modified Final Judgement,
which was the consent decree entered in 1982 providing for divestiture of the
RBOCs from AT&T in 1984. The Telecommunications Act establishes procedures under
which an RBOC can enter the market for "in-region" inter-LATA (I.E., long
distance between specified areas) services, within the area where it provides
local exchange service. The Telecommunications Act permitted the RBOCs to enter
the out-of-region long distance market immediately upon enactment, and RBOCs can
provide intra-LATA long distance services. Before the RBOC can provide in-region
inter-LATA services, it must obtain FCC approval upon a showing that
facilities-based competition is present in its market, that the RBOC has entered
into interconnection agreements in the states where it seeks authority, that the
interconnection agreements satisfy a 14-point "checklist" of competitive
requirements, and that such entry is in the public interest. To date, such
authority has not been granted, but requests by RBOCs are the subject of pending
petitions and appeals. The provision of inter-LATA services
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by RBOCs is expected to reduce the market share of major IXCs, and consequently,
may have an adverse effect on the ability of CLECs to generate access revenues
from the IXCs.
FCC RULES IMPLEMENTING THE LOCAL COMPETITION PROVISIONS OF THE
TELECOMMUNICATIONS ACT. On August 8, 1996, the FCC released the Interconnection
Decision which established a framework of minimum, national rules enabling state
public service commissions ("PSCs") and the FCC to begin implementing many of
the local competition provisions of the Telecommunications Act. The
Interconnection Decision promulgated rules to implement Congress' statutory
directive concerning the interconnection obligations of all telecommunications
carriers, including obligations of CLEC and ILEC networks. The FCC prescribed
certain minimum points of interconnection necessary to permit competing carriers
to choose the most efficient points at which to interconnect with the ILECs'
networks. The FCC also adopted a minimum list of unbundled network elements that
ILECs must make available to competitors upon request and a methodology for
states to use in establishing rates for interconnection and the purchase of
unbundled network elements. The FCC also adopted a methodology for states to use
when applying the Telecommunications Act's "avoided cost standard" for setting
wholesale prices with respect to retail services.
On July 18, 1997, the U.S. Court of Appeals for the Eighth Circuit vacated
certain portions of the Interconnection Decision, ruling that, among other
things:
- The FCC's pricing rules should be vacated because the FCC had exceeded its
jurisdiction in establishing rules governing the prices that ILECs may
charge competitors for interconnection, unbundled access and resale.
- The FCC's "pick and choose" rule, which allows competitors to select terms
of previously approved interconnection agreements for their own use,
conflicts with the purposes of the Telecommunications Act, and should be
vacated.
- The FCC lacks authority to hear formal complaints which involve the review
and/or enforcement of certain terms of local interconnection agreements
approved by State commissions.
- The FCC may not adopt a blanket requirement that State interconnection
rules must be consistent with the FCC's regulations.
- The FCC correctly concluded that ILEC operations support systems, operator
services and vertical switching features qualify as network elements that
are subject to the unbundling requirements of the Telecommunications Act.
- The FCC erred in deciding that ILECs could be required by competitors to
provide interconnection and unbundled network elements at levels of
quality which exceed those levels at which ILECs provide such services to
themselves.
- The FCC cannot require ILECs to recombine network elements for
competitors, but competitors may recombine such network elements
themselves as necessary to provide telecommunications services.
- FCC rules and policies regarding the ILECs' duty to provide for physical
collocation of equipment were upheld.
A companion appeal was decided on June 27, 1997 in which the court upheld
the FCC's decision that the term "interconnection" as used in the
Telecommunications Act relates to physical access, and does not include
transmission and routing services as well. Several parties have sought rehearing
of portions of the panel decisions by the full Eighth Circuit or review of the
appellate decisions by the U.S. Supreme Court. The Company cannot predict
whether the Eighth Circuit decisions will stand, or what further actions the FCC
may or may not take in response to these appellate decisions. However, in its
August 19, 1997, decision denying Ameritech's application to provide in-region
inter-LATA services, the FCC indicated that
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it would not grant such requests unless its pricing rules vacated by the 8th
Circuit are followed. That FCC ruling is now being appealed to the U.S. Court of
Appeals.
On October 14, 1997, the Eighth Circuit issued a decision vacating
additional FCC rules that will likely have the effect of increasing the costs of
obtaining the use of combinations of an ILEC's unbundled network elements. The
Court ruled that ILECs need not provide combinations of network elements to
CLECs, even when the ILEC has already combined such elements within its network.
The Court's decision does not undermine the ILEC's obligation to provide
unbundled network elements, but clarifies that the ILECs are not obligated to
offer bundled elements. The decisions create uncertainty about the rules
governing pricing, terms and conditions of interconnection agreements and could
make negotiating and enforcing such agreements more difficult and protracted and
may require renegotiation of existing agreements, to the extent that existing
agreements include provisions requiring ILECs to bundle elements. In November
1997, the FCC filed a petition for a writ of certiorari with the United States
Supreme Court challenging the decisions of the Eighth Circuit Court of Appeals.
On January 26, 1998, the United States Supreme Court granted all petitions and
cross petitions for certiorari of the Eighth Circuit decisions. There can be no
assurance that the Company will be able to obtain or enforce interconnection
agreements on terms acceptable to the Company.
On December 31, 1997, the U.S. District Court for the Northern District of
Texas issued the SBC Decision finding that Sections 271 to 275 of the
Telecommunications Act are unconstitutional. These sections of the
Telecommunications Act impose restrictions on the lines of business in which the
RBOCs may engage, including establishing the conditions the RBOCs must satisfy
before they may provide inter-LATA long distance telecommunications services.
Under the SBC Decision, the RBOCs would be able to provide inter-LATA long
distance telecommunications services immediately without satisfying the
statutory conditions. The SBC Decision has been stayed until it can be reviewed
by the U.S. Fifth Circuit Court of Appeals. The Company believes that the
factual assumptions and legal reasoning in the SBC Decision are erroneous and
therefore the decision will likely be reversed on appeal, although there can be
no assurance of this outcome. If the SBC Decision were upheld on appeal it would
likely have an unfavorable effect on the Company's business for at least two
reasons. First, RBOCs currently have an incentive to foster competition within
their service areas so that they can qualify to offer in-region inter-LATA long
distance services. The SBC Decision removes this incentive by allowing RBOCs to
offer in-region inter-LATA long distance service without regard to their
progress in opening their local markets to competition. Second, the Company is
legally able to offer its customers both long distance and local exchange
services, which the RBOCs currently are prohibited from offering directly,
although some marketing affiliations have been proposed. The ability to offer
"one-stop shopping" gives the Company a marketing advantage that it would no
longer enjoy if the SBC Decision were upheld on appeal.
OTHER REGULATION. In general, the FCC has a policy of encouraging the entry
of new competitors, such as the Company, in the telecommunications industry and
preventing anti-competitive practices. Therefore, the FCC has established
different levels of regulation for dominant carriers and nondominant carriers.
For domestic common carrier telecommunications regulation, large ILECs such as
GTE and the RBOCs are currently considered dominant carriers, while CLECs such
as the Company are considered nondominant carriers. As a nondominant carrier,
the Company is subject to relatively minimal FCC regulation.
- TARIFF. As a nondominant carrier, the Company may install and operate
facilities for the transmission of domestic interstate communications
without prior FCC authorization. Services of nondominant carriers have been
subject to relatively limited regulation by the FCC, primarily consisting
of the filing of tariffs and periodic reports concerning the carrier's
interstate circuits and deployment of network facilities. However,
nondominant carriers like the Company must offer interstate services on a
nondiscriminatory basis, at just and reasonable rates, and remain subject
to FCC complaint procedures.
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In October 1996, the FCC adopted an order (the "Detariffing Order") which
eliminated the requirement that nondominant interstate carriers maintain
tariffs on file with the FCC for domestic interstate services, and
providing that after a nine-month transition period, relationships between
interstate carriers and their customers would be set by contract. Several
parties requested reconsideration and/or filed appeals of the Detariffing
Order. On February 13, 1997, the United States Court of Appeals for the
District of Columbia Circuit stayed implementation of the Detariffing
Order. If the Detariffing Order becomes effective, nondominant interstate
services providers will no longer be able to rely on the filing of tariffs
with the FCC as a means of providing notice to customers of prices, terms
and conditions under which they offer their interstate services. If the
Company cancels its FCC tariffs as a result of the Detariffing Order it
will need to implement replacement contracts which could result in
substantial legal and administrative expense.
- ILEC PRICE CAP REGULATION REFORM. In 1991, the FCC replaced traditional
rate of return regulation for large ILECs with price cap regulation. Under
price caps, ILECs can change prices for certain services, including
interconnection services provided to CLECs, only within certain
parameters. On September 14, 1995, the FCC proposed a three-stage plan
that would substantially reduce ILEC price cap regulation as local markets
become increasingly competitive and ultimately would result in granting
ILECs nondominant status. Adoption of the FCC's proposal to reduce
significantly its regulation of ILEC pricing would greatly enhance the
ability of ILECs to compete against the Company and could have a material
adverse effect on the Company. The FCC released an order on December 24,
1996 which adopted certain of these proposals, including the elimination
of the lower service band index limits on price reductions within the
access service category. The FCC's December 1996 order also eased the
requirements necessary for the introduction of new services. On May 7,
1997, the FCC took further action in its CC Docket No. 94-1 updating and
reforming its price cap plan for ILECs. The changes require price cap
ILECs to reduce their price cap indices by 6.5 percent annually, less an
adjustment for inflation. The FCC also eliminated rules that require ILECs
earning more than certain specified rates of return to "share" portions of
the excess with their access customers during the next year in the form of
lower access rates. These actions could have a significant impact on the
interstate access prices charged by the ILECs with which the Company
competes. Review of these FCC decisions is currently pending before the
U.S. Court of Appeals.
- ACCESS CHARGES. The FCC has granted ILECs significant flexibility in
pricing their interstate special and switched access services on a
specific central office by central office basis. Under this pricing
scheme, ILECs may establish pricing zones based on access traffic density
and charge different prices for each zone. The Company anticipates that
this pricing flexibility will result in ILECs lowering their prices in
high traffic density areas, the probable area of competition with the
Company. The Company also anticipates that the FCC will grant ILECs
increasing pricing flexibility as the number of interconnections and
competitors increases. On May 16, 1997, the FCC took action in its CC
Docket No. 96-262 to reform the current interstate access charge system.
The FCC adopted an order which makes various reforms to the existing rate
structure for interstate access that are designed to move access charges,
over time, to more cost based rate levels and structures. These changes
will reduce access charges and will shift charges currently based on
minutes to flat-rate, monthly per line charges. As a result, the aggregate
amount of access charges paid by long distance carriers to access
providers in the United States may decrease.
The FCC also announced that it intends in the future to issue a Report and
Order providing detailed rules for implementing a market-based approach to
further access charge reform. That process will give ILECs progressively greater
flexibility in setting rates as competition develops, gradually replacing
regulation with competition as the primary means of setting prices. The FCC also
adopted a "prescriptive safeguard" to bring access rates to competitive levels
in the absence of competition.
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This series of decisions is likely to have a significant impact on the
operations, expenses, pricing and revenue of the Company. On June 18, 1997, the
FCC denied petitions filed by several ILECs asking the FCC to stay the
effectiveness of its access charge reform decision. The access charge order has
been appealed to the U.S. Court of Appeals and could be set aside or revised.
UNIVERSAL SERVICE REFORM. On May 8, 1997, the FCC issued an order to
implement the provisions of the Telecommunications Act relating to the
preservation and advancement of universal telephone service. The Universal
Service order affirmed Congress' policy principles for universal telephone
service, including quality service, affordable rates, access to advanced
services, access in rural and high-cost areas, equitable and nondiscriminatory
contributions, specific and predictable support mechanisms and access to
advanced telecommunications services for schools, health care providers and
libraries. The order added "competitive neutrality" to the FCC's universal
service principles by providing that universal service support mechanisms and
rules should not unfairly advantage or disadvantage one provider or technology
over another. All telecommunications carriers providing interstate
telecommunications services, including the Company, must contribute to the
universal service support fund. Several parties have appealed the May 8th order.
The appeals have been consolidated in the U.S. Court of Appeals for the Fifth
Circuit. In addition, a number of ILECs filed a petition for stay with the FCC.
That petition is pending. The contribution factors for first quarter 1998
contributions were 3.19% for the high cost and low income fund (to be derived
from the Company's estimated quarterly interstate and international gross end
user telecommunications revenue) and .72% for the schools and libraries and
healthcare fund (to be derived from the Company's estimated quarterly
intrastate, interstate and international gross end user telecommunications
revenue). The contribution factors for the second quarter of 1998 were 3.14% and
.76%, respectively. Contribution factors for third quarter 1998 are 3.14% and
.75%, respectively. The Company cannot predict the amount of its universal
service fund contributions for the fourth quarter of 1998, or thereafter, until
the FCC issues contribution factors for such periods.
STATE REGULATION
The Company believes that most, if not all, states in which it proposes to
operate will require a certification or other authorization to offer intrastate
services. Many of the states in which the Company operates or intends to operate
are in the process of addressing issues relating to the regulation of CLECs. The
Company will also be subject to tariff filing requirements.
These certifications generally require a showing that the carrier has
adequate financial, managerial and technical resources to offer the proposed
services in a manner consistent with the public interest.
As of March 31, 1998, the Company, through its subsidiaries, KMC Telecom and
KMC Telecom II, had obtained intrastate authority for the provision of dedicated
services and a full range of local switched services in Alabama, Florida,
Georgia, Illinois, Indiana, Kansas, Louisiana, Maryland, Michigan, Minnesota,
New Hampshire, North Carolina, Puerto Rico, South Carolina, Texas, Virginia and
Wisconsin. In addition, the Company has obtained PSC certification to provide
inter-LATA services in Alabama, Florida, Illinois, Indiana, Kansas, Maryland,
Minnesota, North Carolina, South Carolina and Wisconsin and will seek such
authority in other states. There can be no assurance that the Company will
receive the authorizations it may seek in the future to the extent it expands
into other states or seeks to provide additional services. In most states, the
Company is required to file tariffs setting forth the terms, conditions and
prices for services that are classified as intrastate. The Company, through its
subsidiaries, KMC Telecom and KMC Telecom II, plans to obtain additional state
authorities to accommodate its business and network expansion.
Some states impose, in addition to tariff filing requirements, reporting,
customer service, and quality requirements, as well as unbundling and universal
service requirements. In addition, the Company will be subject to the outcome of
generic proceedings held by state utility commissions to determine state
regulatory policies with respect to ILEC and CLEC competition, geographic
build-out, mandatory
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detariffing, etc. Certain states have adopted specific universal service funding
obligations. For example, the Kansas commission has ordered telecommunications
companies to pay approximately 9% of their intrastate retail revenues to the
Kansas Universal Service Fund. Proceedings to adopt state universal service
funding obligations rules are pending or contemplated in other states in which
the Company operates.
In addition to obtaining state certifications, the Company must negotiate
terms of interconnection with the ILEC before it can begin providing switched
services. Under the Telecommunications Act, the FCC has adopted interconnection
requirements, certain portions of which have been overturned by the Eighth
Circuit. To date, the Company through its subsidiaries, has negotiated and
executed interconnection agreements with Bell South (8 states), Ameritech (4
states), NYNEX (4 states), US WEST (1 state), SouthWestern Bell (1 state), Bell
Atlantic (1 state), GTE (1 state) and the Puerto Rico Telephone Company
(Commonwealth of Puerto Rico). Under the Telecommunications Act, if the Company
and the negotiating ILEC are unable to reach an agreement 135 days after
submitting a request for interconnection to the ILEC, the negotiations may be
submitted to arbitration under the supervision of the state public utility
commission. At this time, the Company is involved in arbitration proceedings
with GTE in Indiana and Illinois. Those proceedings are currently dormant. The
Company's executed agreements are subject to the approval of the state
commissions. Eleven state commissions have approved the Company's agreements.
The Company anticipates state commission approval of its other interconnection
agreements.
The Company believes that, as the degree of intrastate competition
increases, the states will offer the ILECs increasing pricing flexibility. This
flexibility may present the ILECs with an opportunity to subsidize services that
compete with the Company's services with revenues generated from non-competitive
services, thereby allowing ILECs to offer competitive services at prices below
the cost of providing the service. The Company cannot predict the extent to
which this may occur, but it could have a material adverse effect on the
Company's business.
The Company actively participates in various regulatory proceedings before
the states, the outcome of which may establish policies that affect the
competitive and/or economic position of the Company in the local and other
telecommunications services markets. The Company has, for instance, filed
complaints or intervened in proceedings against ILECs in certain states
challenging the ILECs' refusal to pay reciprocal compensation to a CLEC with
respect to telephone services from the ILEC's customer to an ISP served by a
CLEC, such as the Company.
The Company is also subject to requirements in certain states to obtain
prior approval for, or notify the state commission of, any transfers of control,
sales of assets, corporate reorganizations, issuances of stock or debt
instruments and related transactions.
LOCAL GOVERNMENT AUTHORIZATIONS. The Company is required to obtain street
use and construction permits and licenses and/or franchises to install and
expand its fiber optic networks using municipal rights of way. In some
municipalities where the Company has installed or anticipates constructing
networks, it will be required to pay license or franchise fees based on a
percentage of gross revenues or on a per linear foot basis, as well as post
performance bonds or letters of credit. The Company is actively pursuing in a
number of cities, permits, franchises and other relevant authorities for use of
rights-of-way and utility facilities.
LEGAL AND ADMINISTRATIVE PROCEEDINGS
On June 24, 1997, the Public Service Commission of Wisconsin ("PSCW")
authorized KMC Telecom to provide facilities-based local exchange services in
the territory in which Mid-Plains, Inc. ("Mid-Plains") is the ILEC, which
comprises a small portion (approximately 10%) of the Company's Madison,
Wisconsin market (the "June 24 Order"). On July 28, 1997, Mid-Plains filed a
Petition for Judicial Review in Dane County Circuit Court, seeking judicial
review of the June 24 Order, claiming that the PSCW did not properly provide a
hearing in issuing the June 24 Order. The Petition pertains to the right of KMC
Telecom to provide facilities-based and switched local exchange service in the
territory served by Mid-
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Plains and not the entire Madison, Wisconsin market. An unfavorable outcome
would not preclude KMC Telecom from providing service in the territory served by
Mid-Plains. KMC Telecom would be able to provide all authorized
telecommunications services in the territory served by Mid-Plains, other than
facilities-based local exchange services. KMC Telecom has completed construction
of a fiber optic network in the territory served by Mid-Plains. On January 8,
1998, the Circuit Court issued an order remanding the June 24 Order to the PSCW
for a hearing on, among other things, whether Mid-Plains consented to the entry
of competitors, such as KMC Telecom, in its service territory. On March 25,
1998, the Circuit Court issued a second order reversing and remanding the June
24 Order. In compliance with the Circuit Court orders, the PSCW held a hearing
on March 30 through April 1, 1998, including on all issues related to the
certification of KMC Telecom to provide facilities-based local exchange service
in the territory served by Mid-Plains (the "Certification Hearing"). On April 7,
1998, the PSCW issued an interim certification to KMC Telecom authorizing KMC
Telecom to provide facilities-based local exchange services in the territory
served by Mid-Plains until the decision in the Certification Hearing is final,
or for a period of one year, whichever occurs first. By written order dated May
14, 1998 the PSCW granted KMC Telecom certification to provide facilities-based
local exchange service in the territory served by Mid-Plains. It is expected
that Mid-Plains will continue to challenge the PSCW actions.
By letter dated August 29, 1997, the Company notified I-NET that the Company
considered I-NET to be in default under the I-NET Agreement as a result of
I-NET's failure to provide design plans and specifications for several systems
for which it had agreed to provide such plans and specifications, to properly
supervise construction of the systems or to provide personnel with the necessary
expertise to manage the projects. By letter dated October 27, 1997, I-NET
demanded payment of all amounts it alleged were due under the I-NET Agreement
and a related agreement (aggregating $4.1 million) and stated that it would
invoke the arbitration provisions under the I-NET Agreement if the parties could
not agree as to the amount due and payment terms on or before November 27, 1997.
By letter dated December 1, 1997, I-NET extended its deadline for reaching
agreement to December 15, 1997. Although the Company and I-NET conducted
discussions they were unable to reach an agreement and on February 12, 1998, the
Company received a demand for arbitration from Wang, the successor to I-NET. The
demand seeks at least $4.1 million. The Company believes that it has meritorious
defenses to Wang's claims and has asserted counterclaims seeking in excess of
$2.5 million as a result of I-NET's defaults under the I-NET Agreement. The
Company believes that resolution of this matter will not have a material adverse
impact on its financial condition. No assurance can be given, however, as to the
ultimate resolution of this matter.
The Company is not a party to any other material litigation or proceedings.
EMPLOYEES
As of May 31, 1998, the Company had approximately 270 full time employees.
None of the Company's employees are represented by a labor union or subject to a
collective bargaining agreement, nor has the Company experienced any work
stoppage due to labor disputes. The Company believes that its relations with its
employees are good.
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PROPERTIES
The Company is headquartered in Bedminster, New Jersey and owns or leases
additional properties for its field operations.
The table below lists the Company's current facilities:
<TABLE>
<CAPTION>
LOCATION OWNED/LEASED LEASE EXPIRATION SQUARE FOOTAGE
- -------------------------------------------------------------- ------------- ------------------ ---------------
<S> <C> <C> <C>
Bedminster, New Jersey........................................ Leased January 2007 7,241
Roswell, Georgia.............................................. Leased September 1999 1,820
Duluth, Georgia............................................... Leased February 2003 7,608
Duluth, Georgia............................................... Leased February 2003 12,050
Duluth, Georgia............................................... Leased March 2002 10,751
Greensboro, North Carolina.................................... Leased March 2003 5,768
Greensboro, North Carolina.................................... Owned N/A (1)
Winston-Salem, North Carolina................................. Owned N/A (2)
Huntsville, Alabama........................................... Leased October 2004 1,500
Huntsville, Alabama........................................... Leased August 2005 3,500
Huntsville, Alabama........................................... Leased December 2002 3,749
Baton Rouge, Louisiana........................................ Leased July 2011 6,000
Shreveport, Louisiana......................................... Leased June 2006 3,300
Shreveport, Louisiana......................................... Leased January 2003 3,647
Corpus Christi, Texas......................................... Leased January 2005 4,061
Corpus Christi, Texas......................................... Leased July 2006 3,750
Corpus Christi, Texas......................................... Owned N/A 33,106
Madison, Wisconsin............................................ Leased December 2006 6,404
Melbourne, Florida............................................ Leased December 1998 1,100
Melbourne, Florida............................................ Leased October 2004 4,100
Savannah, Georgia............................................. Owned N/A (3)
Savannah, Georgia............................................. Leased January 2003 3,450
Augusta, Georgia.............................................. Leased December 2006 5,650
Augusta, Georgia.............................................. Leased September 2001 3,000
Roanoke, Virginia............................................. Owned N/A (4)
Tallahassee, Florida.......................................... Leased August, 2003 3,751
Ann Arbor, Michigan........................................... Owned N/A (5)
Fort Wayne, Indiana........................................... Owned N/A 40,020
</TABLE>
- ------------------------
(1) This property is comprised of approximately 0.42 acres.
(2) This property is comprised of approximately 5.26 acres.
(3) This property is comprised of approximately 0.418 acres.
(4) This property is comprised of approximately 0.881 acres.
(5) This property is comprised of approximately 2.196 acres.
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<PAGE>
MANAGEMENT
The following table sets forth certain information concerning the executive
officers and directors of the Company, including their ages as of March 31,
1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Harold N. Kamine..................................... 41 Chairman of the Board of Directors
Gary E. Lasher....................................... 62 Vice Chairman of the Board of Directors
Michael A. Sternberg................................. 53 President, Chief Executive Officer and Director
Roscoe C. Young II................................... 47 Chief Operating Officer
Cynthia Worthman..................................... 44 Vice President and Chief Financial Officer, Secretary
and Treasurer
Charles Rosenblum.................................... 47 Senior Vice President--Human Resources
James L. Barwick..................................... 65 Senior Vice President--Technology
Tricia Breckenridge.................................. 51 Senior Vice President--Business Development
John G. Quigley...................................... 44 Director
Richard H. Patterson................................. 39 Director
Randall A. Hack...................................... 50 Director
William H. Stewart................................... 31 Director
</TABLE>
HAROLD N. KAMINE is the Chairman of the Board of the Company and its founder
and has been a director of the Company since 1994. He is also chief executive
officer and sole owner of Kamine Development Corp. and associated companies in
the independent power industry. Mr. Kamine has successfully financed a number of
unregulated non-utility power generation projects. At the present time,
companies owned by Mr. Kamine own substantial interests in and manage six power
generation plants in the Northeastern United States. Mr. Kamine devotes less
than twenty percent of his time to the affairs of the Company. Mr. Kamine and
Mr. Rosenblum are first cousins.
GARY E. LASHER joined the Company as its Vice Chairman of the Board
effective November 1, 1997. He was the founder, Chief Executive Officer and
President of Eastern TeleLogic Corporation ("ETC") from 1987 to 1997. ETC was a
leading CLEC operating in greater Philadelphia, Delaware and southern New Jersey
before its purchase by TCG (Teleport Communications Group) in October 1996.
Prior to ETC, from 1984-1986, Mr. Lasher was Chief Operating Officer of Private
Satellite Network, a company which built and operated video satellite networks
for major corporations. Mr. Lasher spent 20 years with Continental Telephone
("Contel") holding various positions including Corporate Vice President,
President of the International Engineering and Construction Company, and various
senior positions with Contel's regulated subsidiaries. Mr. Lasher is one of the
founding members of the Association for Local Telecommunications Services
("ALTS") and served for three years as Chairman of the Association.
MICHAEL A. STERNBERG has spent 28 years in telecommunications, including
business development, marketing, sales and general management. Prior to joining
the Company in July 1996 as President and Chief Executive Officer, Mr. Sternberg
was a co-founder and Chief Operating Officer, from April 1991 to July 1996, of
RimSat, a privately owned satellite company which from January 1993 to July 1996
owned and operated two Russian-built satellites which provided television, voice
and data capacity to Asian operators. From March 1990 to April 1991, Mr.
Sternberg served as Chief Executive Officer of Sternberg & Associates, Inc., a
company he founded. From 1988 to 1990 Mr. Sternberg served as Senior Vice
President--Marketing and Sales with MFS Communications. Previously, Mr.
Sternberg had served as President of Stantel Telecommunications, a division of
STC, a digital telecommunications transmissions
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<PAGE>
products company based in Falls Church, Virginia; Senior Vice
President--Marketing and Corporate Development at CIT-Alcatel in Reston,
Virginia; Vice President-Marketing at General Dynamics Communications Company in
St. Louis; Executive Vice President-Marketing and Sales of OKI Electronics of
America in Fort Lauderdale; and Chief Operating Officer of National Telephone
Company in Hartford, Connecticut. He has served as a director of the Company
since August 1996. Mr. Sternberg is a member of the Executive Committee of ALTS.
ROSCOE C. YOUNG II has approximately 20 years experience in the field of
telecommunications with both new venture and Fortune 500 companies. Prior to
joining the Company in November 1996, Mr. Young served as Vice President,
Network Component Services for Ameritech Corporation from June 1994 to October
1996. From March 1988 to June 1994, Mr. Young served as Senior Vice President,
Network Services for MFS Communications. From October 1977 to March 1988, Mr.
Young served in a number of senior operations, sales and marketing, engineering,
financial management, and human resource positions for AT&T Corp.
CYNTHIA WORTHMAN joined the Company in September 1996 as Chief Financial
Officer, Secretary and Treasurer. Prior to joining the Company, Ms. Worthman
served as Chief Financial Officer, Director and a co-founder of Best Digital,
Inc., a personal communications services company (formerly known as QuestCom,
Inc.) from May 1995 to September 1996. From April 1993 to May 1995, she served
as Managing Director, Business Development and Finance of FutureVision of
America. From February 1984 to April 1993, she had served in a number of
progressively responsible roles in Bell Atlantic Corporation ("Bell Atlantic"),
including, Executive Director-Corporate Treasury of Bell Atlantic and Vice
President and Chief Financial Officer of Bell Atlanticom Systems, Inc., an
unregulated subsidiary of Bell Atlantic specializing in customer premise
equipment and supporting software. Ms. Worthman began her professional career
with Deloitte Haskins & Sells, where she held positions in the consulting and
audit practices.
CHARLES ROSENBLUM has over 20 years experience in human resources, primarily
in human resources planning, staffing and development. He joined the Company in
January 1997. From May 1995 to January 1997 he served as Vice President--Human
Resources of Kamine Development Corp. Previously he had held the positions of
Director, Management Development with KPMG Peat Marwick and Manager of
Management Education with Dun & Bradstreet Corporation. Earlier he had served in
various human resource positions with Allstate Insurance Company. Mr. Rosenblum
and Mr. Kamine are first cousins.
JAMES L. BARWICK has 38 years of experience in the telecommunications
industry. Mr. Barwick joined the Company in March 1997. Prior to joining the
Company, Mr. Barwick had been self-employed since 1986 as a telecommunications
consultant with expertise in equipment application engineering, radio path
engineering, analog and digital Mux, switching and transport systems in the IXC
and ILEC areas, technical writing, project management and computer assisted
design systems.
TRICIA BRECKENRIDGE joined the Company in April 1995. From January 1993 to
April 1995 she was Vice President and General Manager of FiberNet USA's
Huntsville, Alabama operations. Previously she had served as Vice President,
External Affairs and later Vice President, Sales and Marketing of Diginet, Inc.
She was co-founder of Chicago Fiber Optic Corporation, the predecessor of
Metropolitan Fiber Systems. Earlier she was Director of Regulatory Affairs for
Telesphere Corporation.
JOHN G. QUIGLEY has served as a director of the Company since August 1996.
Mr. Quigley is a founding member of Nassau Capital L.L.C., which is the general
partner of Nassau Capital Partners. Between 1980 and the formation of Nassau
Capital in 1995, Mr. Quigley was an attorney with the law firm of Kirkland &
Ellis in Chicago; a partner at Adler & Shaykin; and a partner at Clipper Capital
Partners.
RICHARD H. PATTERSON has served as a director of the Company since May 1997.
Since May 1986, Mr. Patterson has served as a Senior Vice President and Partner
of Waller Capital Corporation, a media and communications investment banking
firm. In addition, since August 1997, he has served as a Vice President of
Waller-Sutton Media LLC and Vice President of Waller-Sutton Management Group,
Inc., two entities which manage a media and telecommunications private equity
fund. Mr. Patterson is a member of the
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<PAGE>
Board of Directors of Regent Communications Inc. which owns and operates radio
stations in mid-to-small size markets.
RANDALL A. HACK has served as a director of the Company since August 1996.
Since January 1995, Mr. Hack has been a member of Nassau Capital L.L.C., an
investment management firm. From 1990 to 1994, he was the President and Chief
Executive Officer of Princeton University Investment Company, which manages the
endowment for Princeton University. Mr. Hack also serves on the Boards of
Directors of Sweetwater, Inc., OmniCell Technologies, Inc., Castle Tower Holding
Corp., Mezzanine Capital Property Investors, Inc. and Shape Global Technologies,
Inc.
WILLIAM H. STEWART has served as a director of the Company since August
1997. Mr. Stewart is a Principal of Nassau Capital L.L.C. and joined that firm
in June 1995. From 1989 until joining Nassau, Mr. Stewart was a portfolio
manager and equity analyst at the Bank of New York. Mr. Stewart also serves on
the board of Signius Corporation. He is a Chartered Financial Analyst and a
member of the New York Society of Security Analysts.
Pursuant to provisions contained in both the Company's certificate of
incorporation and the Stockholder's Agreement, Mr. Kamine and Nassau are
currently entitled to elect all of the Directors, three of whom are nominated by
Mr. Kamine (one of whom must be the President and Chief Executive Officer),
three of whom are nominated by Nassau and one of whom is nominated by agreement
of Mr. Kamine, Nassau and either AT&T Credit or the holders of a majority of the
outstanding shares of the Company's Series C Preferred Stock. The number of
Directors which Mr. Kamine is entitled to elect would be reduced to two if the
number of shares owned by him were to fall below two-thirds of the number of
shares of the Company initially issued to him, and to one if the number of
shares owned by him were to fall below one-third of the number of shares
initially issued to him. If his ownership were to fall below 5% of the number of
shares initially issued to him, Mr. Kamine would no longer be entitled to elect
any Directors pursuant to such provisions. Comparable reductions would be made
to the number of Directors which Nassau is entitled to elect if its ownership
were to fall below the specified fractions. If a default relating to payment
occurs under the AT&T Facility, and continues uncured for 90 days, the holders
of Series C Preferred Stock (currently Nassau, NAS, GECC and CoreStates) will be
entitled to elect two additional Directors, who will serve until the default is
cured.
Kamine/Besicorp Allegany L.P., an independent power company 50% owned by
corporations which Mr. Kamine owns, filed a voluntary petition to reorganize its
business under Chapter 11 of the Federal Bankruptcy Code in November 1995. The
proceeding is ongoing. The United States Bankruptcy Court for the Northern
District of Indiana appointed a receiver for RimSat, a company which Mr.
Sternberg co-founded and for which he formerly served as Chief Operating
Officer, and a petition for bankruptcy under Chapter 11 of the Federal
Bankruptcy Code with respect to RimSat was filed in 1996. That proceeding is
ongoing.
Directors hold office until the next Annual Meeting of stockholders or until
their successors are duly elected and qualified. Executive officers are elected
annually by the Board of Directors and serve at the discretion of the Board of
Directors.
COMMITTEES OF THE BOARD
The Board of Directors of the Company has authorized a Compensation
Committee to be composed of three members. The present members of the
Compensation Committee are Messrs. Kamine, Quigley and Patterson. The Board of
Directors has created an Executive Committee consisting of Mr. Kamine and Mr.
Quigley, or, in Mr. Quigley's absence, Mr. Stewart. The Board of Directors has
also created an Audit Committee consisting of Messrs. Lasher, Patterson and
Quigley.
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<PAGE>
SUMMARY COMPENSATION TABLE
The following table discloses compensation paid by the Company during 1997
to the Company's Chief Executive Officer and the four next most highly
compensated executive officers who earned more than $100,000 during 1997 (the
"Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION ---------------
---------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) COMPENSATION ($) OPTIONS (#)(1)
- --------------------------------------------------- --------- ---------- ---------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Michael A. Sternberg............................... 1997 $ 240,385 $ 187,500 $ 45,909(2) 9,228
President and Chief Executive Officer
Roscoe C. Young II................................. 1997 $ 180,000 $ 182,046 $ 198,180(3) 2,309
Chief Operating Officer
Cynthia Worthman................................... 1997 $ 175,000 $ 200,000 -- 3,461
Vice President, Chief Financial Officer
Secretary and Treasurer
Charles Rosenblum.................................. 1997 $ 150,000 $ 77,500 -- 691
Senior Vice President--Human Resources
James L. Barwick(4)................................ 1997 $ 89,038 $ 75,000 -- 5,000
Senior Vice President--Technology
</TABLE>
- ------------------------
(1) The options granted in 1997 were options to purchase shares of common stock
of the Company's principal operating subsidiary KMC Telecom. See "--Stock
Option Grants."
(2) Includes relocation related expenses of $39,662 and personal use of a
Company automobile of $6,247.
(3) Includes relocation related expenses of $196,029 and personal use of a
Company automobile of $2,151.
(4) Mr. Barwick joined the Company on March 3, 1997 and the compensation
disclosed is for the period from that date until December 31, 1997.
STOCK OPTION GRANTS
The Company was formed as a holding company in September 1997. Prior to the
establishment of the present holding company structure, during 1996 and 1997,
KMC Telecom (now the Company's principal operating subsidiary) granted options
to purchase shares of its common stock, par value $.01 per share ("KMC Telecom
Common Stock"), to employees, including Messrs. Sternberg, Young, Rosenblum and
Barwick and Ms. Worthman and selected employees of certain affiliated companies
owned by Mr. Kamine pursuant to the KMC Telecom Stock Option Plan.
In order to reflect the establishment of the Company's holding company
structure, on June 26, 1998, the Board of Directors of the Company adopted,
effective upon stockholder approval, a new stock option plan, the KMC Holdings
Stock Option Plan, which authorizes the grant of options to purchase Common
Stock of the Company. All of the options reflected in the preceding and
following tables are options to purchase shares of KMC Telecom Common Stock
granted under the KMC Telecom Stock Option Plan. It is currently anticipated
that, during the third quarter of 1998, the Company will replace the options to
purchase KMC Telecom Common Stock previously granted under the KMC Telecom Stock
Option Plan with options to purchase Common Stock of the Company granted under
the KMC Holdings Stock Option Plan and will grant options to additional
employees of the Company, including Mr. Lasher, under the KMC Holdings Stock
Option Plan. The options for Common Stock of the Company which replace the
73
<PAGE>
options previously granted under the KMC Telecom Stock Option Plan, or which are
granted to the additional employees, will entitle the recipients to purchase an
aggregate of no more than 262,750 shares of the Company's Common Stock at an
average exercise price of not less than $26.00 per share. The Company may
subsequently grant additional options, although it has no specific plans in this
regard. See "--Employee Plans--KMC Holdings Stock Option Plan."
The following table sets forth information regarding grants of options to
purchase shares of KMC Telecom Common Stock made by KMC Telecom during 1997 to
each of the Named Executive Officers.
OPTION GRANTS IN FISCAL YEAR 1997
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
------------------------------------------------------- ANNUAL RATES OF
NUMBER OF PERCENT OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM (2)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ----------------------------------
NAME GRANTED (#)(1) FISCAL 1997 ($/SHARE) DATE (0%) (5%) (10%)
- ------------------------------- --------------- ------------- ----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Michael A. Sternberg........... 5,536 $ 50.00 1/21/07 $ 155,008 $ 426,570 $ 843,199
1,846 16.7% $ 75.00 1/21/07 $ 5,538 $ 96,091 $ 235,018
1,846 $ 100.00 1/21/07 $ -- $ 49,941 $ 188,868
Roscoe C. Young II............. 1,385 $ 50.00 1/21/07 $ 38,780 $ 106,719 $ 210,952
462 4.2% $ 75.00 1/21/07 $ 1,386 $ 24,049 $ 58,818
462 $ 100.00 1/21/07 $ -- $ 12,499 $ 47,268
Cynthia Worthman............... 2,077 $ 50.00 1/21/07 $ 58,156 $ 160,041 $ 316,352
692 6.2% $ 75.00 1/21/07 $ 2,076 $ 36,021 $ 88,100
692 $ 100.00 1/21/07 $ -- $ 18,721 $ 70,800
Charles Rosenblum.............. 415 $ 50.00 1/21/07 $ 11,620 $ 31,977 $ 63,209
138 1.2% $ 75.00 1/21/07 $ 414 $ 7,183 $ 17,569
138 $ 100.00 1/21/07 $ -- $ 3,733 $ 14,119
James L. Barwick............... 3,000 $ 50.00 3/3/07 $ 84,000 $ 231,161 $ 456,936
1,000 9.0% $ 75.00 3/3/07 $ 3,000 $ 52,054 $ 127,312
1,000 $ 100.00 3/3/07 $ -- $ 27,054 $ 102,312
</TABLE>
- ------------------------
(1) 10% of the aggregate amount of each such option vests on each subsequent
six-month anniversary of the date of grant with options with the lowest
exercise price vesting first followed by others in ascending order of
exercise price.
(2) Amounts reported in these columns represent amounts that may be realized
upon exercise of options immediately prior to the expiration of their term
assuming the specified compounded rates of appreciation (0%, 5% and 10%) on
KMC Telecom Common Stock over the term of the options. These assumptions are
based on rules promulgated by the Commission and do not reflect the
Company's estimate of future stock price appreciation. Actual gains, if any,
on the stock option exercises and KMC Telecom Common Stock holdings are
dependent on the timing of such exercises and the future value of KMC
Telecom Common Stock. There can be no assurance that the rates of
appreciation assumed in this table can be achieved or that the amounts
reflected will be received by the option holder.
OPTION EXERCISES AND OPTION YEAR-END VALUE TABLE
No options to purchase shares of KMC Telecom Common Stock were exercised in
Fiscal 1997 by any of the Named Executive Officers. The following table sets
forth information regarding the number and
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<PAGE>
year-end value of unexercised options to purchase shares of KMC Telecom Common
Stock held at December 31, 1997 by each of the Named Executive Officers.
FISCAL 1997 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF SECURITIES "IN-THE-MONEY"
UNDERLYING UNEXERCISED OPTIONS AT
SHARES VALUE OPTIONS AT DECEMBER 31, 1997
ACQUIRED ON REALIZED DECEMBER 31, 1997 EXERCISABLE/
NAME EXERCISE(#) ($) EXERCISABLE/UNEXERCISABLE UNEXERCISABLE(1)
- ------------------------------------ ------------ --------- ------------------------ -------------------------
<S> <C> <C> <C> <C>
Michael A. Sternberg................ -- -- 8,000/32,000 $ 1,486,817/$5,347,270
Roscoe C. Young II.................. -- -- 2,000/8,000 $371,699/$1,336,795
Cynthia Worthman.................... -- -- 3,000/12,000 $557,559/$2,005,237
Charles Rosenblum................... -- -- 600/2,400 $111,499/$400,994
James L. Barwick.................... -- -- 500/4,500 $81,546/$658,913
</TABLE>
- ------------------------
(1) Options are "In-the-Money" if the fair market value of the underlying
securities exceeds the exercise price of the options. The fair market value
of the option grants at December 31, 1997 was determined by reference to the
Company's January 1998 sale of Common Stock to AT&T Credit.
EXECUTIVE EMPLOYMENT CONTRACTS
The Company has an employment contract with Michael A. Sternberg its
President and Chief Executive Officer. The Company's employment agreement with
Mr. Sternberg provides for an initial term of three years, which began on July
29, 1996 and which may be continued for two additional years at the option of
the Company. Under the agreement, Mr. Sternberg's base salary is $275,000 per
annum and he is entitled to a bonus in an amount up to an aggregate of $250,000.
Mr. Sternberg is entitled to receive benefits generally received by Company
officers, including options to purchase Company stock, reimbursement of expenses
incurred on behalf of the Company, and a leased automobile. Upon termination of
the agreement, Mr. Sternberg is subject to a confidentiality covenant and an 18
month non-competition agreement. If the Company terminates Mr. Sternberg's
employment without cause, he is entitled to a severance payment in an amount
equal to his annual base salary.
In connection with his employment in November 1996, the Company agreed to
pay to Roscoe C. Young II, its Chief Operating Officer, a severance payment
equal to one year's base salary if his employment with the Company were to be
terminated without cause during the second or third years of his employment. Mr.
Young's current base salary is $225,000 per annum.
EMPLOYEE PLANS
KMC TELECOM STOCK OPTION PLAN. Prior to the adoption of the KMC Holdings
Stock Option Plan, certain of the Company's employees were eligible to
participate in the KMC Telecom Stock Option Plan. The KMC Telecom Stock Option
Plan was administered by the Compensation Committee of the Board of Directors of
KMC Telecom (the "Telecom Plan Committee"). The Telecom Plan Committee was
authorized to grant (i) options intended to qualify as Incentive Stock Options
("Incentive Options") within the meaning of Section 422 of the Internal Revenue
Code of 1986, as amended, to employees, directors or other persons having a
unique relationship with KMC Telecom or any of its affiliates, and (ii) options
not intended to so qualify ("Nonqualified Options," and together with the
Incentive Options, "Options"). However, neither Mr. Kamine nor any person
employed by Nassau or any affiliate of Nassau was eligible for grants under the
plan.
75
<PAGE>
The number of shares of KMC Telecom Common Stock available for grants under
the plan was 150,000. No participant could receive more than 40,000 shares of
KMC Telecom Common Stock under the KMC Telecom Stock Option Plan.
The Telecom Plan Committee had the power and authority to designate
recipients of Options, to determine the terms, conditions and limitations of
Options and to interpret the provisions of the KMC Telecom Stock Option Plan.
The exercise price of all Incentive Options granted under the KMC Telecom Stock
Option Plan had to be at least equal to the Fair Market Value (as defined in the
plan) of KMC Telecom Common Stock on the date the options were granted and the
exercise price of all Nonqualified Options granted under the KMC Telecom Stock
Option Plan had to be at least equal to 50% of the Fair Market Value of the KMC
Telecom Common Stock on the date the options were granted. The maximum term of
each Option granted pursuant to the KMC Telecom Stock Option Plan was ten years.
Options became exercisable at such times and in such installments as the Telecom
Plan Committee provided in the terms of each individual Option.
As discussed above under "--Stock Option Grants," the Board of Directors of
the Company recently adopted, effective upon stockholder approval, a new KMC
Holdings Stock Option Plan. As a result, it is currently anticipated that,
during the third quarter of 1998, the Company will replace the options to
purchase KMC Telecom Common Stock previously granted under the the KMC Telecom
Stock Option Plan with options to purchase Company Common Stock granted under
the new KMC Holdings Stock Option Plan and will grant options to additional
employees of the Company. No new options will be granted under the KMC Telecom
Stock Option Plan.
KMC HOLDINGS STOCK OPTION PLAN. Employees, directors or other persons
having a unique relationship with the Company or any of its affiliates are
eligible to participate in the KMC Holdings Stock Option Plan. However, neither
Mr. Kamine nor any person employed by Nassau or any affiliate of Nassau is
eligible for grants under the plan. The KMC Holdings Stock Option Plan is
administered by the Compensation Committee of the Board of Directors of the
Company (the "Holdings Plan Committee"). The Holdings Plan Committee is
authorized to grant (i) options intended to qualify as Incentive Options, (ii)
Non-Qualified Options, (iii) stock appreciation rights, (iv) restricted stock,
(v) performance units, (vi) performance shares and (vii) certain other types of
awards.
The number of shares of Company Common Stock available for grant under the
KMC Holdings Stock Option Plan is 262,750. No participant may receive more than
75,000 shares of Company Common Stock under the KMC Holdings Stock Option Plan.
The Holdings Plan Committee has the power and authority to designate
recipients of grants under the KMC Holdings Stock Option Plan, to determine the
terms, conditions and limitations of grants under the plan and to interpret the
provisions of the plan. The exercise price of all Incentive Options granted
under the KMC Holdings Stock Option Plan must be at least equal to the Fair
Market Value (as defined in the plan) of Company Common Stock on the date the
options are granted and the exercise price of all Nonqualified Options granted
under the KMC Holdings Stock Option Plan must be at least equal to 50% of the
Fair Market Value of Company Common Stock on the date the options are granted.
The maximum term of each Option granted under the KMC Holdings Stock Option Plan
will be 10 years. Options will become exercisable at such time and in such
installments as the Holdings Plan Committee provides in the terms of each
individual Option.
DIRECTOR COMPENSATION
The Company's Directors do not currently receive any compensation for their
services in such capacity, except that Mr. Lasher receives $40,000 per year in
connection with his services as Vice Chairman of the Board. Pursuant to an
agreement among the Company, Mr. Kamine and Nassau, Nassau is paid an annual fee
of $100,000, which includes reimbursement to Nassau for the services of Messrs.
Hack, Quigley and Stewart as Directors. From May 1, 1996 through January 29,
1998, Kamine Development Corp. was paid a fee at an annual rate of $266,000 for
the services of Mr. Kamine as Chairman of the Board. The amount of this fee was
reduced to $100,000 per annum as of January 29, 1998.
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<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company and certain affiliated companies owned by Harold N. Kamine, its
Chairman of the Board, share certain administrative services, such as personnel,
utilities, and supplies. The entity which bears the cost of the service is
reimbursed by the other for the other's proportionate share of such expenses.
Prior to effectiveness of the lease referred to in the next paragraph, these
shared services included rent paid by the Company for its headquarters offices
to an affiliate of Mr. Kamine. The Company reimbursed Kamine-affiliated
companies for these shared services an aggregate of approximately $571,000 and
$488,000, respectively, for 1996 and 1997.
Effective June 1, 1996, the Company entered into a lease agreement with
Cogeneration Services, Inc. (an entity controlled by Mr. Kamine) pursuant to
which the Company leases its headquarters office in Bedminster, New Jersey. The
lease expires in January 2007. The lease provides for a base annual rental of
approximately $207,000 (adjusted periodically for changes in the consumer price
index), plus operating expenses.
In 1996, Mr. Kamine received interest payments totaling $120,000 on loans he
made to the Company. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
From May 1, 1996 through January 29, 1998, Kamine Development Corp., an
affiliate of the Company, was paid a fee at an annual rate of $266,000 as
reimbursement for the services of Mr. Kamine as Chairman of the Board of the
Company. The amount of this fee was reduced to $100,000 per annum as of January
29, 1998. The amount of the fee paid in 1996 and 1997 is included in the
respective shared services payments for those years described in the first
paragraph above.
Pursuant to Mr. G. Scott Brodey Sr.'s termination of employment with the
Company on March 3, 1997, the Company agreed to pay Mr. Brodey severance of
$150,000 payable over the course of a year. Mr. Brodey had been Executive Vice
President--Construction of the Company.
In February, 1998, the Company loaned to Roscoe C. Young II, the Company's
Chief Operating Officer, the principal sum of $350,000. The loan is evidenced by
a promissory note which bears interest at the rate of 6% per annum. Interest and
principal are payable at maturity on February 13, 2003.
In March, 1998, the Company made a bridge loan to Tricia Breckenridge in the
principal amount of $150,000. Mrs. Breckenridge is Senior Vice
President--Business Development of the Company. The loan is evidenced by a
promissory note which bears interest at the rate of 6% per annum, and is secured
by a second mortgage on property located in Gurnee, Illinois. Interest and
principal are due upon the sale of the property.
The Company believes that the above transactions were on terms no less
favorable to the Company than could have been obtained in transactions with
independent third parties. All future transactions between the Company and its
officers, Directors, principal stockholders or their respective affiliates, will
be on terms no less favorable to the Company than can be obtained from
unaffiliated third parties.
Pursuant to agreements entered into in September and October 1997 (the
"Dividend Agreements"), between the Company and each of the holders of Series A
Preferred Stock and Series C Preferred Stock (collectively, the "Preferred
Holders") each Preferred Holder has agreed to forego the payment of accumulated
dividends on its shares of preferred stock of the Company from the date of such
Dividend Agreement through the date on which such Preferred Holder disposes of
its interest in the Company; provided, that, upon such disposition, such
Preferred Holder realizes not less than a ten percent (10%) compound rate of
return on its investment for the period from the date of such Dividend Agreement
to the date of such disposition.
Upon closing of the Initial Offering, the Company paid to Nassau
approximately $600,000 for dividend arrearages on the Series A Cumulative
Convertible Preferred Stock of KMC Telecom which Nassau had exchanged for its
shares of Series A Preferred Stock of the Company.
77
<PAGE>
Pursuant to an Agreement among the Company, Mr. Kamine and Nassau, Nassau is
entitled to an annual payment of $100,000 as a financial advisory fee and as
compensation for the Nassau designees who serve on the Board of Directors of the
Company.
Mr. Kamine, KMC Telecommunications L.P., Nassau, AT&T Credit, CoreStates and
GECC are parties to the Stockholders Agreement. Pursuant to the Stockholder's
Agreement and the Company's certificate of incorporation, Mr. Kamine and Nassau
are currently entitled to elect all of the Company's seven Directors, with each
entitled to nominate three Directors, and the seventh to be nominated by
agreement of Mr. Kamine, Nassau and either AT&T Credit or the holders of a
majority of the outstanding shares of the Company's Series C Preferred Stock.
The number of Directors which Mr. Kamine is entitled to elect would be reduced
to two if the number of shares owned by him were to fall below two-thirds of the
number of shares of the Company initially issued to him, and to one if the
number of shares owned by him were to fall below one-third of the number of
shares initially issued to him. If his ownership were to fall below 5% of the
number of shares initially issued to him, Mr. Kamine would no longer be entitled
to elect any Directors pursuant to such provisions. Comparable reductions would
be made to the number of Directors which Nassau is entitled to elect if its
ownership were to fall below the specified fractions. See "Principal
Stockholders--Stockholders Agreement."
AT&T Finance (an affiliate of AT&T Credit) has provided financing for the
Company in the form of the AT&T Facility. Pursuant to the AT&T Facility, AT&T
Finance has agreed to make available, subject to certain conditions, up to a
total of $70.0 million, on a project by project basis, for construction and
development of the Company's networks. GECC and CoreStates are participating
lenders in the AT&T Facility to the extent of $25.0 million and $15.0 million,
respectively. See "Description of Certain Indebtedness."
AT&T Finance also entered into the Supplemental AT&T Facility with the
Company pursuant to which AT&T Finance loaned the Company $10.0 million. The
Supplemental AT&T Facility was repaid in full upon the consummation of the
Initial Offering. Upon repayment of the Supplemental AT&T Facility, AT&T Credit
exercised a warrant for the purchase of 91,268 shares of Common Stock, for an
aggregate purchase price of $10.0 million.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information as of February 28, 1998
with respect to the beneficial ownership of shares of Common Stock by (i) each
person known to the Company to be a beneficial owner of more than 5% of the
outstanding shares of Common Stock, (ii) each Director of the Company, (iii) the
Named Executive Officers, and (iv) all executive officers and Directors as a
group.
The Company was formed as a holding company in September 1997. Prior to the
establishment of the present holding company structure, during 1996 and 1997,
KMC Telecom (now the Company's principal operating subsidiary) granted options
to purchase shares of KMC Telecom Common Stock to employees, including Messrs.
Sternberg, Young, Rosenblum and Barwick and Ms. Worthman and selected employees
of certain affiliated companies owned by Mr. Kamine. The Board of Directors of
the Company recently adopted, effective upon stockholder approval, the KMC
Holdings Stock Option Plan which authorizes the grant of options to purchase
Common Stock of the Company. It is currently anticipated that, during the third
quarter of 1998, the Company will replace the options to purchase KMC Telecom
Common Stock previously granted under the KMC Telecom Stock Option Plan with
options to purchase Common Stock of the Company and to grant options to
additional employees of the Company, including Mr. Lasher. The options for
Common Stock of the Company which replace the options previously granted under
the KMC Telecom Stock Option Plan, or which are granted to the additional
employees, will entitle the recipients to purchase an aggregate of no more than
262,750 shares of the Company's Common Stock at an average exercise price of not
less than $26.00 per share. The Company may subsequently grant additional
options, although it has no specific plans in this regard. See "Management
- --Stock Option Grants". The existing options to purchase shares of KMC Telecom
Common Stock are described in the footnotes to the following table.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES (1) OWNERSHIP(1)
- -------------------------------------------------------------------------------------- ----------- ---------------
<S> <C> <C>
Harold N. Kamine...................................................................... 573,835 68.5%
c/o Kamine Development Corp.
1545 Route 206
Bedminster, NJ 07921
Nassau Capital Partners L.P........................................................... 661,454 (2) 44.5%
c/o Nassau Capital L.L.C.
22 Chambers Street
Princeton, NJ 08542
AT&T Credit Corporation............................................................... 203,288.5 24.3%
44 Whippany Road
Morristown, NJ 07962-1983
CoreStates Holdings, Inc.............................................................. 102,155.5 (3) 10.9%
1339 Chestnut St.
Philadelphia, PA 19107
General Electric Capital Corporation.................................................. 200,476 (4) 19.3%
120 Long Ridge Road
Stamford, CT 06927
Michael A. Sternberg.................................................................. --(5) --
c/o KMC Telecom Holdings, Inc.
1545 Route 206, Suite 300
Bedminster, New Jersey 07921
Gary E. Lasher........................................................................ -- --
c/o KMC Telecom Holdings, Inc.
1545 Route 206, Suite 300
Bedminster, New Jersey 07921
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER SHARES (1) OWNERSHIP(1)
- -------------------------------------------------------------------------------------- ----------- ---------------
<S> <C> <C>
John G. Quigley....................................................................... 661,454 (6) 44.5%
c/o Nassau Capital L.L.C.
22 Chambers Street
Princeton, NJ 08542
Richard H. Patterson.................................................................. -- --
c/o Waller Capital Corporation
30 Rockefeller Center
Suite 4350
New York, NY 10112
Randall A. Hack....................................................................... 661,454 (6) 44.5%
c/o Nassau Capital L.L.C.
22 Chambers Street
Princeton, NJ 08542
William H. Stewart.................................................................... 661,454 (7) 44.5%
c/o Nassau Capital L.L.C.
22 Chambers Street
Princeton, NJ 08542
Roscoe C. Young II.................................................................... --(8) --
c/o KMC Telecom Holdings, Inc.
1545 Route 206, Suite 300
Bedminster, NJ 07921
Cynthia Worthman...................................................................... --(9) --
c/o KMC Telecom Holdings, Inc.
1545 Route 206, Suite 300
Bedminster, NJ 07921
Charles Rosenblum..................................................................... -- 10) --
c/o KMC Telecom Holdings, Inc.
1545 Route 206, Suite 300
Bedminster, NJ 07925
James A. Barwick...................................................................... -- 11) --
c/o KMC Telecom Holdings, Inc.
1545 Route 206, Suite 300
Bedminster, NJ 07921
Directors and Officers of the Company as a Group (11 persons)......................... 1,235,289 (2) 83.2%
</TABLE>
- ------------------------
(1) Beneficial ownership is determined in accordance with the rules of the
Commission. In computing the number of shares beneficially owned by a person
and the percentage ownership of that person, shares subject to options,
warrants and convertible securities held by that person that are currently
exercisable or exercisable within 60 days of February 28, 1998 are deemed
outstanding. Such shares, however, are not deemed outstanding for the
purposes of computing the percentage ownership of any other person. Except
as indicated in the footnotes to this table, each shareholder named in the
table has sole voting and investment power with respect to the shares set
forth opposite such shareholder's name.
(2) Includes 600,000 shares of Common Stock which Nassau and NAS Partners I
L.L.C. ("NAS"), of which Messrs. Quigley, Hack and Stewart are members, have
the right to acquire upon conversion of 122,708 and 1,092 shares of Series A
Preferred Stock, respectively, and 47,619 shares of Common Stock which
Nassau and NAS have the right to acquire upon conversion of 24,778 and 222
shares of Series C Preferred Stock, respectively. These are the same shares
listed for Messrs. Quigley, Hack and Stewart.
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<PAGE>
(3) Includes 95,238 shares of Common Stock which CoreStates has the right to
acquire upon conversion of 50,000 shares of Series C Preferred Stock of the
Company.
(4) Includes 190,476 shares of Common Stock which GECC has the right to acquire
upon conversion of 100,000 shares of Series C Preferred Stock of the Company
and 10,000 shares of Common Stock which GECC has the right to acquire upon
exercise of a warrant.
(5) Mr. Sternberg does not presently own any shares of Common Stock of the
Company. However, he does hold 8,000 currently exercisable options to
acquire shares of KMC Telecom Common Stock.
(6) Messrs. Quigley and Hack, Directors of the Company, are members of Nassau
Capital L.L.C., the general partner of Nassau; accordingly Messrs. Quigley
and Hack may be deemed to be beneficial owners of such shares and for
purposes of this table they are included. Messrs. Quigley and Hack disclaim
beneficial ownership of all such shares within the meaning of Rule 13d-3
under the Exchange Act. Messrs. Quigley and Hack are also members of NAS;
accordingly Messrs. Quigley and Hack may be deemed to be beneficial owners
of such shares and for purposes of this table they are included. Messrs.
Quigley and Hack disclaim beneficial ownership of all such shares within the
meaning of Rule 13d-3 under the Exchange Act.
(7) All of the shares indicated as owned by Mr. Stewart are owned directly or
indirectly by Nassau and are included because of Mr. Stewart's affiliation
with Nassau. Mr. Stewart is also a member of NAS; accordingly, Mr. Stewart
may be deemed to be the beneficial owner of such shares and for purposes of
this table they are included. Mr. Stewart disclaims beneficial ownership of
all of these shares within the meaning of Rule 13d-3 under the Exchange Act.
(8) Mr. Young does not presently beneficially own any shares of Common Stock of
the Company. However, he does hold 2,000 currently exercisable options to
acquire shares of KMC Telecom Common Stock.
(9) Ms. Worthman does not presently beneficially own any shares of Common Stock
of the Company. However, she does hold 3,000 currently exercisable options
to acquire shares of KMC Telecom Common Stock.
(10) Mr. Rosenblum does not presently beneficially own any shares of Common
Stock of the Company. However, he does hold 600 currently exercisable
options to acquire shares of KMC Telecom Common Stock.
(11) Mr. Barwick does not presently beneficially own any shares of Common Stock
of the Company. However, he does hold 500 currently exercisable options to
acquire shares of KMC Telecom Common Stock.
STOCKHOLDERS AGREEMENT. The Stockholders Agreement restricts the ability of
the current stockholders to transfer shares in the Company to persons not
affiliated with or related to the current stockholders. Pursuant to the
Stockholders Agreement and the Company's certificate of incorporation, Mr.
Kamine and Nassau are currently entitled to elect all of the Directors, three of
whom are nominated by Mr. Kamine (one of whom must be the President and Chief
Executive Officer), three of whom are nominated by Nassau and one of whom is
nominated by agreement of Mr. Kamine, Nassau and either AT&T Credit or the
holders of a majority of the outstanding shares of the Company's Series C
Preferred Stock. The number of Directors which Mr. Kamine is entitled to elect
would be reduced to two if the number of shares owned by him were to fall below
two-thirds of the number of shares of the Company initially issued to him, and
to one if the number of shares owned by him were to fall below one-third of the
number of shares initially issued to him. If his ownership were to fall below 5%
of the number of shares initially issued to him, Mr. Kamine would no longer be
entitled to elect any Directors pursuant to such provisions. Comparable
reductions would be made to the number of Directors which Nassau is entitled to
elect if its ownership were to fall below the specified fractions. If a default
relating to payment occurs under the
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<PAGE>
AT&T Facility, and continues uncured for 90 days, the holders of Series C
Preferred Stock (currently Nassau, NAS, GECC and CoreStates) will be entitled to
elect two additional Directors, who will serve until the default is cured.
Each of Nassau, NAS, CoreStates, GECC and AT&T Credit has a "put right"
entitling it to have the Company repurchase its shares for the fair market value
of such shares if no Liquidity Event (defined as (i) an initial public offering
with gross proceeds of at least $40.0 million, (ii) the sale of substantially
all of the stock or assets of the Company or (iii) the merger or consolidation
of the Company with one or more other corporations) has taken place by the later
of (x) October 22, 2003 or (y) 90 days after the final maturity date of the
Notes. CoreStates, GECC and AT&T Credit may not exercise such put rights unless
Nassau has exercised its put right. The Indenture limits the Company's ability
to repurchase such shares.
The current stockholders have demand registration rights with respect to
their shares of Common Stock of the Company commencing on the earlier of June 5,
2000 (in the case of Mr. Kamine or Nassau) and the date on which the Company
completes an initial public offering of Common Stock (and any related holdback
period expires). Each of the holders of registrable securities also has certain
piggyback registration rights. The parties to the Stockholders Agreement have
agreed not to effect any public sale or distribution of Common Stock of the
Company, or securities convertible into such Common Stock, within 180 days of
the effective date of any demand or piggyback registration.
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<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
AT&T FACILITY
The following summary of the material provisions of the documents comprising
the AT&T Facility does not purport to be complete and is subject to, and
qualified in its entirety by reference to, all the provisions of such documents,
including the definitions of certain terms therein. Terms used and not defined
herein have the meanings given to them in the documents described herein. Copies
of such documents are available from the Company upon request.
GENERAL
Under the AT&T Facility, AT&T Finance agreed to lend the Company's
subsidiaries, KMC Telecom and KMC Telecom II and two limited liability
companies, one of which is wholly-owned by KMC Telecom and one of which is
wholly-owned by KMC Telecom II, up to an aggregate of $70.0 million (the
"Commitment Amount") to be used for the construction of fiber optic
telecommunications networks ("Systems") in certain markets, subject to certain
conditions. Disbursements under the AT&T Facility are available to KMC Telecom
for engineering, design and backbone construction, with additional amounts to
finance expansion of Systems operated by KMC Telecom (which comprise the
Company's eight existing networks), and were available to KMC Telecom II prior
to the Closing Date of the Initial Offering for up to 55% of the invoice price
of switches and electronic equipment purchased under the agreement with Lucent
for the nine Systems proposed to be put into operation in 1998 which are to be
operated by KMC Telecom II (with the tenth system to be operated by a separate
subsidiary, KMC Telecom of Virginia, Inc. ("KMC Virginia")). The total amount
loaned for any System may not exceed the total invoice price property, plant and
equipment plus, without duplication, the capitalized construction costs for such
System.
Loans to KMC Telecom under the AT&T Facility will mature no later than
October 1, 2005. All loans to KMC Telecom II were repaid on the Closing Date of
the Initial Offering and KMC Telecom II is no longer entitled to borrow, and is
no longer an obligor, under the AT&T Facility. KMC Telecom and its subsidiary
limited liability company (collectively, the "Borrowers"), however, are now
permitted to borrow up to the full $70.0 million amount of the AT&T Facility.
Borrowings under the AT&T Facility will bear interest prior to October 1, 1999,
at the Commercial Paper Rate (as defined in the AT&T Facility) plus 5%. After
October 1, 1999, the interest rate will be either a fixed rate equal to the
average rate of U.S. Treasury Notes maturing the same month in which the
remaining average life of the loans ends plus 5.5%, or a variable rate equal to
either the Commercial Paper Rate plus 5%, or the LIBOR rate plus 5%, at the
Borrowers' option. If a Borrower defaults on any payment due under the AT&T
Facility, the interest rate will increase by four percentage points.
The Company has unconditionally guaranteed the repayment of the AT&T
Facility when such repayment is due, whether at maturity, upon acceleration, or
otherwise. The Company has agreed to pay all amounts outstanding under the AT&T
Facility, on demand, upon the occurrence and during the continuation of any
Event of Default (as defined therein). The Company has pledged the shares of KMC
Telecom to AT&T Finance to secure its obligations under the guaranty. KMC
Telecom has pledged its ownership interest in its subsidiary limited liability
company to AT&T Finance. In addition, KMC Telecom and its subsidiary limited
liability company have each pledged all of their assets to AT&T Finance.
PAYMENTS. Interest under the AT&T Facility is payable quarterly in arrears.
The outstanding principal balance of all loans made to the Borrowers under the
AT&T Facility is payable in 24 consecutive quarterly installments beginning on
January 1, 2000. AT&T Finance will receive an annual fee of $100,000 on the
first payment date of each year (interest or principal) beginning January 1,
1998.
MANDATORY PREPAYMENTS. AT&T Finance has the right to require prepayment of
all loans made under the AT&T Facility in the event of a Change in Control (as
defined in the AT&T Facility). Events triggering a Change in Control include the
Company ceasing to own 100% of the outstanding capital stock of each of the
Borrowers, directly or indirectly (except as a result of the exercise of
warrants by AT&T
83
<PAGE>
Finance or its affiliates, successors or assigns). At the Closing of the Initial
Offering, AT&T Finance was paid all amounts previously borrowed by KMC Telecom
II under the AT&T Facility ($10.8 million). Amounts borrowed by KMC Telecom
($40.5 million as of March 31, 1998) remain outstanding.
The AT&T Facility contains a number of negative covenants including, among
others, covenants restricting the ability of the Borrowers to consolidate or
merge with any person, sell or lease assets not in the ordinary course of
business, sell or enter into long term leases of dark fiber, redeem stock, pay
dividends or make any other payments (including payments of principal or
interest on loans) to the Company, create Subsidiaries, transfer any permits or
licenses, or incur additional indebtedness or act as guarantor for the debt of
any person. The AT&T Facility also contains a number of affirmative covenants
including, among others, covenants requiring the Borrowers to preserve and
maintain corporate existence, comply with laws, maintain their properties,
maintain insurance, pay taxes, furnish AT&T Finance with copies of financial
statements, and inform AT&T Finance of litigation. After repayment of all
amounts borrowed by KMC Telecom II on the Closing Date of the Initial Offering,
KMC Telecom II and its subsidiary limited liability company are no longer
Borrowers or obligors or subject to these covenants and restrictions.
The Borrowers are required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a requirement that
at the end of each fiscal quarter of each of the Borrowers commencing with the
fiscal quarter ending September 30, 1997 through and including the fiscal
quarter ending December 31, 1999 the ratio of Available Cash (defined as cash
available plus the amount available under the AT&T Facility for which all
conditions precedent have been fulfilled) plus, only if positive, EBITDA to
Lender Debt Service (as defined below) shall equal at least 1.00 to 1.00. Lender
Debt Service shall be measured on the last day of each fiscal quarter and shall
equal the sum of (i) cash interest expense for the immediately succeeding four
fiscal quarters, to be calculated by giving effect to the total debt outstanding
to AT&T Finance on the last day of such fiscal quarter, with such debt deemed to
be accruing interest over the next four fiscal quarters at an interest rate
equal to the interest rate in effect on such last day of such fiscal quarter,
and (ii) scheduled principal payments for the immediately succeeding four fiscal
quarters. At the end of each fiscal quarter ending March 31, 2000 through June
30, 2001, inclusive, the ratio of the sum of Available Cash, plus, only if
positive, EBITDA to Lender Debt Service must equal at least 1.25 to 1.00.
At the end of each fiscal quarter during each period set forth below, the
ratio of EBITDA for the immediately preceding four fiscal quarters to Lender
Debt Service shall equal at least the ratio set forth below:
<TABLE>
<CAPTION>
FISCAL YEAR RATIO
- ------------------------------------------------------------------------------- -------------
<S> <C>
July 1, 2001 -- December 31, 2001.............................................. 1.25 to 1.00
January 1, 2002 -- December 31, 2002........................................... 1.35 to 1.00
January 1, 2003 -- and each fiscal quarter thereafter.......................... 1.75 to 1.00
</TABLE>
Failure to satisfy any of the financial covenants will constitute an Event
of Default under the AT&T Facility, permitting AT&T Finance, after notice, to
terminate the commitment and/or accelerate payment of outstanding indebtedness.
The AT&T Facility also includes other customary events of default, including,
without limitation, a cross-default to other indebtedness, material undischarged
judgments and bankruptcy.
The Company's subsidiaries KMC Telecom and its subsidiary limited liability
company are currently obligors under the AT&T Facility. Such subsidiaries have
no obligation to holders of the Notes. Accordingly, if there were an Event of
Default under the AT&T Facility, the lenders thereunder would be entitled to
payment in full and could foreclose on the assets of such subsidiaries and the
holders of Notes would have no right to share in such assets.
AT&T Finance has entered into a participation agreement with GECC and
CoreStates providing for the participation of GECC and CoreStates in the AT&T
Facility.
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<PAGE>
DESCRIPTION OF THE EXCHANGE NOTES
The Original Notes were, and the Exchange Notes will be, issued under the
Indenture, dated as of January 29, 1998, between the Company, as issuer, and The
Chase Manhattan Bank (the "Trustee"). A copy of the Indenture has been filed as
an Exhibit to the Registration Statement of which this Prospectus is a part. The
following summary of certain provisions of the Indenture does not purport to be
complete and is subject to, and is qualified in its entirety by reference to,
all of the provisions of the Indenture, including the definitions of certain
terms therein and those terms made a part thereof by the Trust Indenture Act of
1939, as amended. Whenever particular defined terms of the Indenture not
otherwise defined herein are referred to, such defined terms are incorporated
herein by reference. For definitions of certain capitalized terms used in the
following summary, see "--Certain Definitions."
GENERAL
The Exchange Notes will be unsubordinated, unsecured obligations of the
Company, initially limited to $460,800,000 aggregate principal amount at
maturity, and will mature on February 15, 2008. Although for federal income tax
purposes, a significant amount of original issue discount, taxable as ordinary
income, will be recognized by a Holder as such discount accrues from the issue
date of the Exchange Notes, no interest will be payable on the Exchange Notes
prior to August 15, 2003. From and after February 15, 2003, interest on the
Exchange Notes will accrue at the rate indicated on the cover page of this
Prospectus from February 15, 2003, or from the most recent Interest Payment Date
to which interest has been paid or provided for, payable semiannually (to
Holders of record at the close of business on the February 1 or August 1
immediately preceding the Interest Payment Date) on February 15 and August 15 of
each year, commencing August 15, 2003.
Principal of, premium, if any, and interest on the Exchange Notes will be
payable, and the Exchange Notes may be exchanged or transferred, at the office
or agency of the Company in the Borough of Manhattan, the City of New York
(which initially will be the corporate trust office of the Trustee at 450 West
33rd Street, New York, New York 10001), or at the option of the Company, payment
of interest may be made by check mailed to the Holders at their addresses as
they appear in the Security Register; PROVIDED that all payments of principal,
premium, if any, and interest with respect to Notes represented by one or more
permanent global Notes registered in the name of or held by the Depository or
its nominee will be made by wire transfer of immediately available funds to the
accounts specified by the Holder or Holders thereof.
Subject to the covenants described below under "--Covenants" and applicable
law, the Company may issue additional Notes under the Indenture. The Exchange
Notes offered hereby and any additional Notes subsequently issued would be
treated as a single class for purposes of the Indenture.
BOOK-ENTRY; DELIVERY AND FORM
Exchange Notes issued in exchange for the Original Notes currently
represented by one or more fully registered global notes will be represented by
one or more fully registered global notes (collectively, the "Global Note"), and
will be deposited upon issuance with the Depository or an agent of the
Depository and registered in the name of the Depository or a nominee of the
Depository (the "Global Note Registered Owner"). Except as set forth below, the
Global Note may be transferred, in whole and not in part, only to another
nominee of the Depository or to a successor of the Depository or its nominee.
Exchange Notes issued in exchange for other Original Notes will be issued in
registered, certificated form without interest coupons.
The Depository has advised the Company that the Depository is a
limited-purpose trust company created to hold securities for its participating
organizations (collectively, the "Participants") and to facilitate the clearance
and settlement of transactions in those securities between Participants through
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<PAGE>
electronic book-entry changes in the accounts of its Participants. The
Participants include securities brokers and dealers, banks, trust companies,
clearing corporations and certain other organizations. Access to the
Depository's system is also available to other entities such as banks, brokers,
dealers and trust companies that clear through or maintain a custodial
relationship with a Participant, either directly or indirectly (collectively,
the "Indirect Participants"). Persons who are not Participants or Indirect
Participants may beneficially own securities held by or on behalf of the
Depository only through the Participants or the Indirect Participants. The
ownership interests and transfer of ownership interests of such persons held by
or on behalf of the Depository are recorded on the records of the Participants
and Indirect Participants.
The Depository has also advised the Company that pursuant to procedures
established by it, (i) upon deposit of the Global Note, the Depository will
credit the accounts of its Participants with portions of the principal amount of
the Global Note representing the Exchange Notes issued in exchange for the
Original Notes that each such Participant has instructed the Depository to
surrender for exchange and (ii) ownership of such interests in the Global Note
will be shown on, and the transfer of ownership thereof will be effected only
through, records maintained by the Depository (with respect to the Participants)
or by the Participants and the Indirect Participants (with respect to other
owners of beneficial interests in the Global Note).
Under the terms of the Indenture, the Company and the Trustee will treat the
persons in whose names the Exchange Notes, including the Global Note, are
registered as the owners thereof for the purpose of receiving payments in
respect of the principal of and premium, if any, and interest on any Exchange
Notes and for any and all other purposes whatsoever. Payments on any Exchange
Notes registered in the name of the Global Note Registered Owner will be payable
by the Trustee to the Global Note Registered Owner in its capacity as the
registered holder under the Indenture. Consequently, neither the Company, the
Trustee nor any agent of the Company or the Trustee has or will have any
responsibility or liability for (i) any aspect of the Depository's records or
the records of any Participant or Indirect Participant relating to or payments
made on account of beneficial ownership interests in the Global Note, or for
maintaining, supervising or reviewing any of the Depository's records or records
of any Participant or Indirect Participant relating to the beneficial ownership
interests in the Global Note or (ii) any other matter relating to the actions
and practices of the Depository or any of its Participants or Indirect
Participants. The Depository has advised the Company that its current practice,
upon receipt of any payment in respect of securities such as the Exchange Notes
(including principal and interest), is to credit the accounts of the relevant
Participants with the payment on the payment date, in amounts proportionate to
their respective holdings in principal amount of beneficial interests in the
relevant security as shown on the records of the Depository unless the
Depository has reason to believe it will not receive payment on such payment
date. Payments by the Participants and the Indirect Participants to the
beneficial owners of Exchange Notes will be governed by standing instructions
and customary practices and will be the responsibility of the Participants or
the Indirect Participants and will not be the responsibility of the Depository,
the Trustee or the Company. Neither the Company nor the Trustee will be liable
for any delay by the Depository or any of its Participants or Indirect
Participants in identifying the beneficial owners of the Exchange Notes, and the
Company and the Trustee may conclusively rely on and will be protected in
relying on instructions from the Global Note Registered Owner for all purposes.
OPTIONAL REDEMPTION
The Exchange Notes will be redeemable, at the Company's option, in whole or
in part, at any time or from time to time, on or after February 15, 2003 and
prior to maturity, upon not less than 30 nor more than 60 days' prior notice
mailed by first-class mail to each Holder's last address as it appears in the
Security Register, at the following prices (the "Redemption Prices") (expressed
in percentages of principal amount at maturity), plus accrued and unpaid
interest, if any, to the Redemption Date (subject to the right of Holders of
record on the relevant Regular Record Date that is on or prior to the Redemption
Date to
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<PAGE>
receive interest due on an Interest Payment Date), if redeemed during the
12-month period commencing February 15, of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
- -------------------------------------------------------------------------------- ----------------
<S> <C>
2003............................................................................ 106.2500%
2004............................................................................ 104.1666
2005............................................................................ 102.0832
2006 and thereafter............................................................. 100.0000
</TABLE>
In addition, at any time or from time to time, on or prior to April 15,
2000, the Company may, at its option, redeem up to 35% of the aggregate
principal amount at maturity of the Notes with the proceeds of one or more
public or private Equity Offerings, at a Redemption Price equal to 112.5% of
Accreted Value on the Redemption Date; provided that at least 65% of the
aggregate principal amount at maturity of the Notes remains outstanding after
each such redemption.
In the case of any partial redemption, selection of the Exchange Notes for
redemption will be made by the Trustee in compliance with the requirements of
the principal national securities exchange, if any, on which the Exchange Notes
are listed or, if the Exchange Notes are not listed on a national securities
exchange, by lot or by such other method as the Trustee in its sole discretion
shall deem to be fair and appropriate; provided that no Note of $1,000 in
principal amount at maturity or less shall be redeemed in part. If any Note is
to be redeemed in part only, the notice of redemption relating to such Note
shall state the portion of the principal amount thereof to be redeemed. A new
Note in principal amount equal to the unredeemed portion thereof will be issued
in the name of the Holder thereof upon cancellation of the original Note.
REGISTRATION RIGHTS
Pursuant to the Registration Rights Agreement, the Company agreed, for the
benefit of the Holders, that it would use its best efforts, at its cost, to
consummate this Exchange Offer. In satisfaction of this obligation, the Company
is hereby offering the Exchange Notes in return for surrender of the Original
Notes. It is intended by the Company that the Exchange Offer will satisfy these
registration rights, which will terminate upon the consummation of the Exchange
Offer. For each Original Note surrendered to the Company pursuant to the
Exchange Offer, the Holder will receive an Exchange Note of equal principal
amount at maturity. The Accreted Value of each Exchange Note shall be identical
to, and shall be determined in the same manner as, the Accreted Value of the
Original Notes so surrendered and exchanged therefor. Interest on each Exchange
Note shall be calculated and paid in the same manner as interest on the Original
Notes so surrendered and exchanged therefor.
RANKING
The Exchange Notes will be unsubordinated, unsecured indebtedness of the
Company, will rank PARI PASSU in right of payment with all existing and future
unsubordinated, unsecured indebtedness of the Company and will be senior in
right of payment to any future subordinated indebtedness of the Company. As of
March 31, 1998, the Company (on an unconsolidated basis) had $248.6 million of
liabilities including $244.5 million of indebtedness on the Original Notes (the
principal amount of which at maturity is $460.8 million). However, the Company
is a holding company and the Exchange Notes will be effectively subordinated to
all existing and future indebtedness (including the AT&T Facility) and
liabilities (including trade payables and any subordinated indebtedness) of the
Company's subsidiaries. As of March 31, 1998, the subsidiaries of the Company
had approximately $49.6 million of liabilities (excluding intercompany
payables), including approximately $40.5 million of secured indebtedness. See
"Risk Factors--Substantial Indebtedness; Debt Service Requirements; Refinancing
Risks"; "--Holding Company's Reliance on Subsidiaries' Funds; Priority of Other
Creditors" and "Description of Certain Indebtedness."
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CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
covenants and other provisions of the Indenture. Reference is made to the
Indenture for the definition of any other capitalized term used herein for which
no definition is provided.
"Accreted Value" is defined to mean, for any Specified Date, the amount
calculated pursuant to (i), (ii), (iii) or (iv) for each $1,000 principal amount
at maturity of Notes:
(i) if the Specified Date occurs on one of the following dates (each a
"Semi-Annual Accrual Date"), the Accreted Value will equal the amount set
forth below for such Semi-Annual Accrual Date:
<TABLE>
<CAPTION>
SEMI-ANNUAL ACCRETED
ACCRUAL DATE VALUE
- --------------------------------------------------------------------------------- ----------
<S> <C>
August 15, 1998.................................................................. $ 579.48
February 15, 1999................................................................ $ 615.70
August 15, 1999.................................................................. $ 654.18
February 15, 2000................................................................ $ 695.07
August 15, 2000.................................................................. $ 738.51
February 15, 2001................................................................ $ 784.67
August 15, 2001.................................................................. $ 833.71
February 15, 2002................................................................ $ 885.81
August 15, 2002.................................................................. $ 941.18
February 15, 2003................................................................ $ 1,000.00
</TABLE>
(ii) if the Specified Date occurs before the first Semi-Annual Accrual
Date, the Accreted Value will equal the sum of (a) $542.46 and (b) an amount
equal to the product of (1) the Accreted Value for the first Semi-Annual
Accrual Date less $542.46 MULTIPLIED by (2) a fraction, the numerator of
which is the number of days from January 29, 1998 to the Specified Date,
using a 360-day year of twelve 30-day months, and the denominator of which
is the number of days elapsed from January 29, 1998 to the first Semi-Annual
Accrual Date, using a 360-day year of twelve 30-day months;
(iii) if the Specified Date occurs between two Semi-Annual Accrual Dates,
the Accreted Value will equal the sum of (a) the Accreted Value for the
Semi-Annual Accrual Date immediately preceding such Specified Date and (b)
an amount equal to the product of (1) the Accreted Value for the immediately
following Semi-Annual Accrual Date less the Accreted Value for the
immediately preceding Semi-Annual Accrual Date multiplied by (2) a fraction,
the numerator of which is the number of days from the immediately preceding
Semi-Annual Accrual Date to the Specified Date, using a 360-day year of
twelve 30-day months, and the denominator of which is 180; or
(iv) if the Specified Date occurs after the last Semi-Annual Accrual
Date, the Accreted Value will equal $1,000.
"Acquired Indebtedness" means Indebtedness of a Person existing at the time
such Person becomes a Restricted Subsidiary or assumed in connection with an
Asset Acquisition by a Restricted Subsidiary and not Incurred in connection
with, or in anticipation of, such Person becoming a Restricted Subsidiary or
such Asset Acquisition; PROVIDED that Indebtedness of such Person which is
redeemed, defeased, retired or otherwise repaid at the time of or immediately
upon consummation of the transactions by which such Person becomes a Restricted
Subsidiary or upon consummation of such Asset Acquisition shall not be Acquired
Indebtedness.
"Adjusted Consolidated Net Income" means, for any period, the aggregate net
income (or loss) of the Company and its Restricted Subsidiaries for such period
determined in conformity with GAAP; PROVIDED that the following items shall be
excluded in computing Adjusted Consolidated Net Income (without duplication):
(i) the net income (or loss) of any Person that is not a Restricted Subsidiary
(or is an
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Unrestricted Subsidiary), except to the extent of the amount of dividends or
other distributions actually paid to the Company or any of its Restricted
Subsidiaries by such Person or an Unrestricted Subsidiary during such period;
(ii) solely for the purposes of calculating the amount of Restricted Payments
that may be made pursuant to clause (C) of the first paragraph of the
"Limitation on Restricted Payments" covenant described below (and in such case,
except to the extent includable pursuant to clause (i) above), the net income
(or loss) of any Person accrued prior to the date it becomes a Restricted
Subsidiary or is merged into or consolidated with the Company or any of its
Restricted Subsidiaries or all or substantially all of the property and assets
of such Person are acquired by the Company or any of its Restricted
Subsidiaries; (iii) the net income of any Restricted Subsidiary to the extent
that the declaration or payment of dividends or similar distributions by such
Restricted Subsidiary of such net income is not at the time permitted by the
operation of the terms of its charter or any agreement, instrument, judgment,
decree, order, statute, rule or governmental regulation applicable to such
Restricted Subsidiary (except to the extent such restriction has been legally
waived); (iv) any gains or losses (on an after-tax basis) attributable to Asset
Sales or the termination of discontinued operations; (v) except for purposes of
calculating the amount of Restricted Payments that may be made pursuant to
clause (C) of the first paragraph of the "Limitation on Restricted Payments"
covenant described below, any amount paid or accrued as dividends on Preferred
Stock of the Company or any Restricted Subsidiary owned by Persons other than
the Company and any of its Restricted Subsidiaries; (vi) all extraordinary gains
and extraordinary losses; (vii) the cumulative effect of a change in accounting
principles since the Closing Date; and (viii) at the irrevocable election of the
Company for each occurrence, any net after-tax income (loss) from discontinued
operations; PROVIDED that for purposes of any subsequent Investment in the
entity conducting such discontinued operations under the "Restricted Payments"
covenant, such entity shall be treated as an Unrestricted Subsidiary until such
discontinued operations have actually been disposed of.
"Adjusted Consolidated Net Tangible Assets" means the total amount of assets
of the Company and its Restricted Subsidiaries (less applicable depreciation,
amortization and other valuation reserves), except to the extent resulting from
write-ups of capital assets (excluding write-ups in connection with accounting
for acquisitions in conformity with GAAP), after deducting therefrom (i) all
current liabilities of the Company and its Restricted Subsidiaries (excluding
intercompany items) and (ii) all goodwill, trade names, trademarks, patents,
unamortized debt discount and expense and other like intangibles, all as set
forth on the most recent quarterly or annual consolidated balance sheet of the
Company and its Restricted Subsidiaries, prepared in conformity with GAAP and
filed with the Commission or provided to the Trustee pursuant to the "Commission
Reports and Reports to Holders" covenant.
"Affiliate" means, as applied to any Person, any other Person directly or
indirectly controlling, controlled by, or under direct or indirect common
control with, such Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as applied to any Person, means the
possession, directly or indirectly, of the power to direct or cause the
direction of the management and policies of such Person, whether through the
ownership of voting securities, by contract or otherwise.
"Asset Acquisition" means (i) an investment by the Company or any of its
Restricted Subsidiaries in any other Person pursuant to which such Person shall
become a Restricted Subsidiary or shall be merged into or consolidated with the
Company or any of its Restricted Subsidiaries or (ii) an acquisition by the
Company or any of its Restricted Subsidiaries of the property and assets of any
Person other than the Company or any of its Restricted Subsidiaries that
constitute substantially all of a division or line of business of such Person.
"Asset Sale" means any sale, transfer or other disposition (including by way
of merger, consolidation or sale-leaseback transaction) in one transaction or a
series of related transactions by the Company or any of its Restricted
Subsidiaries to any Person other than the Company or any of its Restricted
Subsidiaries of (i) all or any of the Capital Stock of any Restricted
Subsidiary, (ii) all or substantially all of the property and assets of an
operating unit or business of the Company or any of its Restricted Subsidiaries
or (iii) any
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other property and assets (other than the Capital Stock or other Investment in
an Unrestricted Subsidiary) of the Company or any of its Restricted Subsidiaries
outside the ordinary course of business of the Company or such Restricted
Subsidiary and, in each case, that is not governed by the provisions of the
Indenture applicable to mergers, consolidations and sales of all or
substantially all of the assets of the Company; PROVIDED that "Asset Sale" shall
not include (a) sales or other dispositions of inventory, receivables and other
current assets, (b) sales or other dispositions of assets for consideration at
least equal to the fair market value of the assets sold or disposed of, to the
extent that the consideration received would constitute property or assets of
the kind described in clause (B) of the "Limitation on Asset Sales" covenant,
(c) a disposition of cash or Temporary Cash Investments, (d) any Restricted
Payment that is permitted to be made, and is made, under the "Limitation on
Restricted Payments" covenant, (e) sales or other dispositions of assets with a
fair market value (as certified in an Officers' Certificate) not in excess of
$500,000 (provided that any series of related sales or dispositions in excess of
$500,000 shall be considered "Asset Sales"), (f) the lease, assignment of a
lease or sub-lease of any real or personal property in the ordinary course of
business, (g) foreclosures on assets, (h) pledges of assets or stock by the
Company or any of its Restricted Subsidiaries otherwise permitted under the
Indenture, including such pledges securing Indebtedness under the AT&T Facility
and (i) the exercise of common stock warrants by AT&T Finance in respect of KMC
Telecom.
"AT&T Facility" means the Amended and Restated Loan and Security Agreement
dated as of September 22, 1997 among KMC Telecom, KMC Telecom II, and AT&T
Finance and any other lenders or borrowers from time to time party thereto,
collateral documents, instruments and agreements executed in connection
therewith and any amendments, supplements, modifications, extensions, renewals,
restatements, refinancings or refundings thereof.
"Average Life" means, at any date of determination with respect to any debt
security, the quotient obtained by dividing (i) the sum of the products of (a)
the number of years from such date of determination to the dates of each
successive scheduled principal payment of such debt security and (b) the amount
of such principal payment by (ii) the sum of all such principal payments.
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations or other equivalents (however designated, whether
voting or non-voting) in equity of such Person, whether outstanding on the
Closing Date or issued thereafter, including, without limitation, all Common
Stock, Preferred Stock, partnership or membership interests and any other right
to receive a share of the profits and losses of, or distributions of assets of,
the issuing Person.
"Capitalized Lease" means, as applied to any Person, any lease of any
property (whether real, personal or mixed) of which the discounted present value
of the rental obligations of such Person as lessee, in conformity with GAAP, is
required to be capitalized on the balance sheet of such Person.
"Capitalized Lease Obligations" means the amount of the liability in respect
of a Capitalized Lease that would at such time be required to be capitalized and
reflected as a liability on a balance sheet prepared in accordance with GAAP.
"Change of Control" means such time as (i) a "person" or "group" (within the
meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) becomes the ultimate
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) of more
than 35% of the total voting power of the Voting Stock of the Company on a fully
diluted basis and such ownership represents a greater percentage of the total
voting power of the Voting Stock of the Company, on a fully diluted basis, than
is held by the Existing Stockholders on such date; or (ii) individuals who on
the Closing Date constitute the Board of Directors (together with any new
directors whose election by the Board of Directors or whose nomination by the
Board of Directors for election by the Company's stockholders was approved by a
vote of at least a majority of the members of the Board of Directors then in
office who either were members of the Board of Directors on the Closing Date or
whose election or nomination for election was previously so approved) cease for
any reason to constitute a majority of the members of the Board of Directors
then in office.
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"Closing Date" means January 29, 1998, the date on which the Notes were
originally issued under the Indenture.
"Consolidated EBITDA" means, for any period, Adjusted Consolidated Net
Income for such period plus, to the extent such amount was deducted in
calculating such Adjusted Consolidated Net Income, (i) Consolidated Interest
Expense, (ii) income taxes (other than income taxes (either positive or
negative) attributable to extraordinary and non-recurring gains or losses or
sales of assets), (iii) depreciation expense, (iv) amortization expense and (v)
all other non-cash items reducing Adjusted Consolidated Net Income (other than
items that will require cash payments and for which an accrual or reserve is, or
is required by GAAP to be, made), less all non-cash items increasing (or, in the
case of a loss, decreasing) Adjusted Consolidated Net Income, determined, with
respect to clauses (ii), (iii) and (iv), on a consolidated basis for the Company
and its Restricted Subsidiaries in conformity with GAAP; PROVIDED that, if any
Restricted Subsidiary is not a Wholly Owned Restricted Subsidiary, Consolidated
EBITDA shall be reduced (to the extent not otherwise reduced in accordance with
GAAP) by an amount equal to (A) the amount of the Adjusted Consolidated Net
Income attributable to such Restricted Subsidiary multiplied by (B) the
percentage ownership interest in the income of such Restricted Subsidiary not
owned on the last day of such period by the Company or any of its Restricted
Subsidiaries.
"Consolidated Interest Expense" means, for any period, the aggregate amount
(without duplication) of interest in respect of Indebtedness (including, without
limitation, amortization of original issue discount on any Indebtedness and the
interest portion of any deferred payment obligation, calculated in accordance
with the effective interest method of accounting; all commissions, discounts and
other fees and charges owed with respect to letters of credit and bankers'
acceptance financing; the net costs associated with Interest Rate Agreements;
and Indebtedness that is Guaranteed or secured by the Company or any of its
Restricted Subsidiaries) and the interest component of Capitalized Lease
Obligations paid, accrued or scheduled to be paid or to be accrued by the
Company and its Restricted Subsidiaries during such period; EXCLUDING,
HOWEVER,(i) any amount of such interest of any Restricted Subsidiary if the net
income of such Restricted Subsidiary is excluded in the calculation of Adjusted
Consolidated Net Income pursuant to clause (iii) of the definition thereof (but
only in the same proportion as the net income of such Restricted Subsidiary is
excluded from the calculation of Adjusted Consolidated Net Income pursuant to
clause (iii) of the definition thereof) and (ii) any premiums, fees and expenses
(and any amortization thereof) payable in connection with the offering of the
Notes, all as determined on a consolidated basis (without taking into account
Unrestricted Subsidiaries) in conformity with GAAP.
"Consolidated Leverage Ratio" means, on any Transaction Date, the ratio of
(i) the aggregate amount of Indebtedness of the Company and its Restricted
Subsidiaries on a consolidated basis outstanding on such Transaction Date to
(ii) the aggregate amount of Consolidated EBITDA for the then most recent four
fiscal quarters for which financial statements of the Company have been filed
with the Commission or provided to the Trustee pursuant to the "Commission
Reports and Reports to Holders" covenant described below (such four fiscal
quarter period being the "Four Quarter Period"); PROVIDED that, in making the
foregoing calculation, PRO FORMA effect shall be given to the following events
which occur from the beginning of the Four Quarter Period through the
Transaction Date (the "Reference Period"): (i) the Incurrence of the
Indebtedness with respect to which the computation is being made and (if
applicable) the application of the net proceeds therefrom, including to
refinance other Indebtedness, as if such Indebtedness was incurred, and the
application of such proceeds occurred, at the beginning of the Four Quarter
Period; (ii) the Incurrence, repayment or retirement of any other Indebtedness
by the Company and its Restricted Subsidiaries since the first day of the Four
Quarter Period as if such Indebtedness was incurred, repaid or retired at the
beginning of the Four Quarter Period; (iii) in the case of Acquired
Indebtedness, the related acquisition, as if such acquisition occurred at the
beginning of the Four Quarter Period; (iv) any acquisition or disposition by the
Company and its Restricted Subsidiaries of any company or any business or any
assets out of the ordinary course of business, whether by merger, stock purchase
or sale or asset purchase or sale or any related repayment of Indebtedness, in
each case since the first day of
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the Four Quarter Period, assuming such acquisition or disposition had been
consummated on the first day of the Four Quarter Period and after giving PRO
FORMA effect to net cost savings that the Company reasonably believes in good
faith could have been achieved during the Four Quarter Period as a result of
such acquisition or disposition (PROVIDED that both (A) such cost savings were
identified and quantified in an Officers' Certificate delivered to the Trustee
at the time of the consummation of the acquisition or disposition and (B) with
respect to each acquisition or disposition completed prior to the 90th day
preceding such date of determination, actions were commenced or initiated by the
Company within 90 days of such acquisition or disposition to effect such cost
savings identified in such Officers' Certificate and with respect to any other
acquisition or disposition, such Officers' Certificate sets forth the specific
steps to be taken within the 90 days after such acquisition or disposition to
accomplish such cost savings); and PROVIDED FURTHER that (x) in making such
computation, the Consolidated Interest Expense attributable to interest on any
Indebtedness computed on a PRO FORMA basis and (A) bearing a floating interest
rate shall be computed as if the rate in effect on the date of computation had
been the applicable rate for the entire period and (B) which was not outstanding
during the period for which the computation is being made but which bears, at
the option of the Company, a fixed or floating rate of interest shall be
computed by applying, at the option of the Company, either the fixed or floating
rate, and (y) in making such computation, the Consolidated Interest Expense of
the Company attributable to interest on any Indebtedness under a revolving
credit facility computed on a PRO FORMA basis shall be computed based upon the
PRO FORMA average daily balance of such Indebtedness during the applicable
period; and (v) the occurrence of any of the events described in clauses
(i)-(iv) above by any Person that has become a Restricted Subsidiary or has been
merged with or into the Company or any Restricted Subsidiary during such
Reference Period.
"Consolidated Net Worth" means, at any date of determination, stockholders'
equity as set forth on the most recently available quarterly or annual
consolidated balance sheet of the Company and its Restricted Subsidiaries (which
shall be as of a date not more than 90 days prior to the date of such
computation, and which shall not take into account Unrestricted Subsidiaries),
less any amounts attributable to Disqualified Stock or any equity security
convertible into or exchangeable for Indebtedness, the cost of treasury stock
and the principal amount of any promissory notes receivable from the sale of the
Capital Stock of the Company or any of its Restricted Subsidiaries, each item to
be determined in conformity with GAAP (excluding the effects of foreign currency
exchange adjustments under Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 52).
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement.
"Default" means any event that is, or after notice or passage of time or
both would be, an Event of Default.
"Disqualified Stock" means any class or series of Capital Stock of any
Person that by its terms or otherwise is (i) required to be redeemed prior to
the Stated Maturity of the Notes, (ii) redeemable at the option of the holder of
such class or series of Capital Stock at any time prior to the Stated Maturity
of the Notes or (iii) convertible into or exchangeable for Capital Stock
referred to in clause (i) or (ii) above or Indebtedness having a scheduled
maturity prior to the Stated Maturity of the Notes; PROVIDED that any Capital
Stock that would not constitute Disqualified Stock but for provisions thereof
giving holders thereof the right to require such Person to repurchase or redeem
such Capital Stock (or the security for which such Capital Stock is convertible
into or exchangeable for) upon the occurrence of an "asset sale" or "change of
control" occurring prior to the Stated Maturity of the Notes shall not
constitute Disqualified Stock if the "asset sale" or "change of control"
provisions applicable to such Capital Stock (or the security for which such
Capital Stock is convertible into or exchangeable for) are no more favorable to
the holders of such Capital Stock (or the security for which such Capital Stock
is convertible into or exchangeable for) than the provisions contained in the
"Limitation on Asset Sales" and "Repurchase of Notes upon a Change of Control"
covenants described below and such Capital Stock (or the security for which such
Capital Stock is convertible into or exchangeable for) specifically provides
that such Person will not repurchase or redeem
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any such stock pursuant to such provision prior to the Company's repurchase of
such Notes as are required to be repurchased pursuant to the "Limitation on
Asset Sales" and "Repurchase of Notes upon a Change of Control" covenants
described below.
"Equity Offering" means any public or private sale of common stock or
preferred stock of the Company (excluding Disqualified Stock), other than public
offerings with respect to the Company's Common Stock registered on Form S-8.
"Existing Stockholders" means Harold N. Kamine, his Affiliates and Nassau.
"fair market value" means the price that would be paid in an arm's-length
transaction between an informed and willing seller under no compulsion to sell
and an informed and willing buyer under no compulsion to buy, as determined in
good faith by the Board of Directors, whose determination shall be conclusive if
evidenced by a Board Resolution; PROVIDED that for purposes of clause (ix) of
the second paragraph of the "Limitation on Indebtedness" covenant, (x) the fair
market value of any security registered under the Exchange Act shall be the
average of the closing prices, regular way, of such security for the 20
consecutive trading days immediately preceding the sale of Capital Stock and (y)
in the event the aggregate fair market value of any other property (other than
cash or cash equivalents) received by the Company exceeds $10 million, the fair
market value of such property shall be determined by a nationally recognized
investment banking firm or a nationally recognized firm having expertise in the
specific area which is the subject of such determination and set forth in their
written opinion which shall be delivered to the Trustee.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect as of the Closing Date, including, without limitation,
those set forth in the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants and statements
and pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession. All ratios and computations contained or referred to in
the Indenture shall be computed in conformity with GAAP applied on a consistent
basis, except that calculations made for purposes of determining compliance with
the terms of the covenants and with other provisions of the Indenture shall be
made without giving effect to (i) the amortization of any expenses incurred in
connection with the offering of the Notes and the Company's Series C and Series
D Preferred Stock and (ii) except as otherwise provided, the amortization of any
amounts required or permitted by Accounting Principles Board Opinion Nos. 16 and
17.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness of any other Person and,
without limiting the generality of the foregoing, any obligation, direct or
indirect, contingent or otherwise, of such Person (i) to purchase or pay (or
advance or supply funds for the purchase or payment of) such Indebtedness of
such other Person (whether arising by virtue of partnership arrangements, or by
agreements to keep-well, to purchase assets, goods, securities or services
(unless such purchase arrangements are on arm's-length terms and are entered
into in the ordinary course of business), to take-or-pay, or to maintain
financial statement conditions or otherwise) or (ii) entered into for purposes
of assuring in any other manner the obligee of such Indebtedness of the payment
thereof or to protect such obligee against loss in respect thereof (in whole or
in part); PROVIDED that the term "Guarantee" shall not include endorsements for
collection or deposit in the ordinary course of business. The term "Guarantee"
used as a verb has a corresponding meaning.
"Incur" means, with respect to any Indebtedness, to incur, create, issue,
assume, Guarantee or otherwise become liable for or with respect to, or become
responsible for, the payment of, contingently or otherwise, such Indebtedness,
including an "Incurrence" of Acquired Indebtedness; PROVIDED that neither the
accrual of interest nor the accretion of original issue discount shall be
considered an Incurrence of Indebtedness.
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"Indebtedness" means, with respect to any Person at any date of
determination (without duplication), (i) all indebtedness of such Person for
borrowed money, (ii) all obligations of such Person evidenced by bonds,
debentures, notes or other similar instruments, (iii) all obligations of such
Person in respect of letters of credit or other similar instruments (including
reimbursement obligations with respect thereto, but excluding trade letters of
credit), (iv) all obligations of such Person to pay the deferred and unpaid
purchase price of property or services, which purchase price is due more than
six months after the date of placing such property in service or taking delivery
and title thereto or the completion of such services, except Trade Payables and
accrued current liabilities arising in the ordinary course of business, (v) all
Capitalized Lease Obligations of such Person, (vi) all Indebtedness referred to
in clauses (i) through (v) hereof of other Persons secured by a Lien on any
asset of such Person, whether or not such Indebtedness is assumed by such
Person; PROVIDED that the amount of such Indebtedness shall be the lesser of (A)
the fair market value of such asset at such date of determination and (B) the
amount of such Indebtedness, (vii) all Indebtedness of other Persons Guaranteed
by such Person to the extent such Indebtedness is Guaranteed by such Person and
(viii) to the extent not otherwise included in this definition, obligations
under Currency Agreements and Interest Rate Agreements. The amount of
Indebtedness of any Person at any date shall be the outstanding balance at such
date (or, in the case of a revolving credit or other similar facility, the total
amount of funds outstanding on the date of determination) of all unconditional
obligations as described above and, with respect to contingent obligations, the
maximum liability upon the occurrence of the contingency giving rise to the
obligation of the types described above, PROVIDED (A) that the amount
outstanding at any time of any Indebtedness issued with original issue discount
is the original issue price of such Indebtedness, (B) that money borrowed and
set aside at the time of the Incurrence of any Indebtedness in order to prefund
the payment of the interest on such Indebtedness shall not be deemed to be
"Indebtedness" and (C) that Indebtedness shall not include any liability for
federal, state, local or other taxes.
"Interest Rate Agreement" means any interest rate protection agreement,
interest rate future agreement, interest rate option agreement, interest rate
swap agreement, interest rate cap agreement, interest rate collar agreement,
interest rate hedge agreement, option or future contract or other similar
agreement or arrangement.
"Investment" means, with respect to any Person, all investments by such
Person in other Persons in the form of any direct or indirect advance, loan or
other extension of credit (including, without limitation, by way of Guarantee or
similar arrangement; but excluding advances to customers in the ordinary course
of business that are, in conformity with GAAP, recorded as accounts receivable
on the balance sheet of the Company or its Restricted Subsidiaries and
commissions, travel and similar advances to officers and employees made in the
ordinary course of business) or capital contribution to (by means of any
transfer of cash or other property to others or any payment for property or
services for the account or use of others), or any purchase or acquisition of
Capital Stock, bonds, notes, debentures or other similar instruments issued by,
such other Person and shall include (i) the designation of a Restricted
Subsidiary as an Unrestricted Subsidiary and (ii) the fair market value of the
Capital Stock (or any other Investment), held by the Company or any of its
Restricted Subsidiaries, of (or in) any Person that has ceased to be a
Restricted Subsidiary, including without limitation, by reason of any
transaction permitted by clause (iii) of the "Limitation on the Issuance and
Sale of Capital Stock of Restricted Subsidiaries" covenant; PROVIDED that the
fair market value of the Investment remaining in any Person that has ceased to
be a Restricted Subsidiary shall not exceed the aggregate amount of Investments
previously made in such Person valued at the time such Investments were made
less the net reduction of such Investments. For purposes of the definition of
"Unrestricted Subsidiary" and the "Limitation on Restricted Payments" covenant
described below, (i) "Investment" shall include the fair market value of the
assets (net of liabilities (other than liabilities to the Company or any of its
Restricted Subsidiaries)) of any Restricted Subsidiary at the time that such
Restricted Subsidiary is designated an Unrestricted Subsidiary, (ii) the fair
market value of the assets (net of liabilities (other than liabilities to the
Company or any of its Restricted Subsidiaries)) of any Unrestricted Subsidiary
at the time that such Unrestricted Subsidiary is designated a Restricted
Subsidiary
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shall be considered a reduction in outstanding Investments and (iii) any
property transferred to or from an Unrestricted Subsidiary shall be valued at
its fair market value at the time of such transfer.
"Investment Grade Securities" means (i) securities issued or directly and
fully guaranteed or insured by the United States government or any agency or
instrumentality thereof (other than Cash Equivalents), (ii) debt securities or
debt instruments with a rating of BBB+ or higher by S&P or Baa1 or higher by
Moody's or the equivalent of such rating by such rating organization, or, if no
rating of S&P or Moody's then exists, the equivalent of such rating by any other
nationally recognized securities rating agency, but excluding any debt
securities or instruments constituting loans or advances among the Company and
its Subsidiaries, and (iii) investment in any fund that invests exclusively in
investments of the type described in clauses (i) and (ii) which fund may also
hold cash pending investment and/or distribution.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including, without limitation, any conditional sale or other
title retention agreement or lease in the nature thereof or any agreement to
give any security interest).
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Nassau" means Nassau Capital Partners L.P., NAS Partners I L.L.C. or their
respective successors, and their Affiliates.
"Net Cash Proceeds" means (a) with respect to any Asset Sale, the proceeds
of such Asset Sale in the form of cash or cash equivalents, including payments
in respect of deferred payment obligations (to the extent corresponding to the
principal, but not interest, component thereof) when received in the form of
cash or cash equivalents (except to the extent such obligations are financed or
sold with recourse to the Company or any Restricted Subsidiary) and proceeds
from the conversion of other property received when converted to cash or cash
equivalents, net of (i) brokerage commissions and other commissions, fees and
expenses (including fees and expenses of counsel, accountants and investment
bankers) related to such Asset Sale and any relocation expenses incurred as a
result thereof, (ii) provisions for all taxes (whether or not such taxes will
actually be paid or are payable) as a result of such Asset Sale without regard
to the consolidated results of operations of the Company and its Restricted
Subsidiaries, taken as a whole, (iii) payments made to repay Indebtedness or any
other obligation outstanding at the time of such Asset Sale that either (A) is
secured by a Lien on the property or assets sold or (B) is required to be paid
as a result of such sale and (iv) appropriate amounts to be provided by the
Company or any Restricted Subsidiary as a reserve against any liabilities
associated with such Asset Sale, including, without limitation, pension and
other post-employment benefit liabilities, liabilities related to environmental
matters and liabilities under any indemnification obligations associated with
such Asset Sale, all as determined in conformity with GAAP and (b) with respect
to any issuance or sale of Capital Stock, the proceeds of such issuance or sale
in the form of cash or cash equivalents, including payments in respect of
deferred payment obligations (to the extent corresponding to the principal, but
not interest, component thereof) when received in the form of cash or cash
equivalents (except to the extent such obligations are financed or sold with
recourse to the Company or any Restricted Subsidiary) and proceeds from the
conversion of other property received when converted to cash or cash
equivalents, net of attorney's fees, accountants' fees, underwriters' or
placement agents' fees, discounts or commissions and brokerage, consultant and
other fees incurred in connection with such issuance or sale and net of taxes
paid or payable as a result thereof.
"Offer to Purchase" means an offer to purchase Notes by the Company from the
Holders commenced by mailing a notice to the Trustee and each Holder stating:
(i) the covenant pursuant to which the offer is being made and that all Notes
validly tendered will be accepted for payment on a pro rata basis; (ii) the
purchase price and the date of purchase (which shall be a Business Day no
earlier than 30 days nor later than 60 days from the date such notice is mailed)
(the "Payment Date"); (iii) that any Note not tendered will continue to accrue
interest pursuant to its terms; (iv) that, unless the Company defaults in the
payment of the purchase price, any Note accepted for payment pursuant to the
Offer to Purchase shall cease to accrue interest on and after the Payment Date;
(v) that Holders electing to have a Note purchased
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pursuant to the Offer to Purchase will be required to surrender the Note,
together with the form entitled "Option of the Holder to Elect Purchase" on the
reverse side of the Note completed, to the Paying Agent at the address specified
in the notice prior to the close of business on the Business Day immediately
preceding the Payment Date; (vi) that Holders will be entitled to withdraw their
election if the Paying Agent receives, not later than the close of business on
the third Business Day immediately preceding the Payment Date, a telegram,
facsimile transmission or letter setting forth the name of such Holder, the
principal amount of Notes delivered for purchase and a statement that such
Holder is withdrawing his election to have such Notes purchased; and (vii) that
Holders whose Notes are being purchased only in part will be issued new Notes
equal in principal amount at maturity to the unpurchased portion of the Notes
surrendered; PROVIDED that each Note purchased and each new Note issued shall be
in a principal amount of $1,000 or an integral multiple thereof. On the Payment
Date, the Company shall (i) accept for payment on a pro rata basis Notes or
portions thereof tendered pursuant to an Offer to Purchase; (ii) deposit with
the Paying Agent money sufficient to pay the purchase price of all Notes or
portions thereof so accepted; and (iii) deliver, or cause to be delivered, to
the Trustee all Notes or portions thereof so accepted together with an Officers'
Certificate specifying the Notes or portions thereof accepted for payment by the
Company. The Paying Agent shall promptly mail to the Holders of Notes so
accepted payment in an amount equal to the purchase price (or, if the Notes are
represented by one or more permanent global Notes registered in the name of The
Depository Trust Company or its nominee, by such other method as required
thereby), and the Trustee shall promptly authenticate and mail to such Holders a
new Note equal in principal amount at maturity to any unpurchased portion of the
Note surrendered; PROVIDED that each Note purchased and each new Note issued
shall be in a principal amount at maturity of $1,000 or an integral multiple
thereof. The Company will publicly announce the results of an Offer to Purchase
as soon as practicable after the Payment Date. The Trustee shall act as the
Paying Agent for an Offer to Purchase. The Company will comply with Rule 14e-1
under the Exchange Act and any other securities laws and regulations thereunder
to the extent such laws and regulations are applicable, in the event that the
Company is required to repurchase Notes pursuant to an Offer to Purchase.
"Permitted Investment" means (i) an Investment in the Company or a
Restricted Subsidiary or a Person which will, upon the making of such
Investment, become a Restricted Subsidiary or be merged or consolidated with or
into or transfer or convey all or substantially all its assets to, the Company
or a Restricted Subsidiary; PROVIDED that such Person's primary business is
related, ancillary or complementary to the businesses of the Company and its
Restricted Subsidiaries on the date of such Investment; (ii) Temporary Cash
Investments and Investment Grade Securities; (iii) payroll, travel and similar
advances to cover matters that are expected at the time of such advances
ultimately to be treated as expenses in accordance with GAAP and reasonable
advances to sales representatives; (iv) any Investment acquired by the Company
or any of its Restricted Subsidiaries (x) in exchange for any other Investment
or accounts receivable held by the Company or any such Restricted Subsidiary in
connection with or as a result of a bankruptcy, workout, reorganization or
recapitalization of the issuer of such other Investment or accounts receivable
or (y) as a result of a foreclosure by the Company or any of its Restricted
Subsidiaries with respect to any secured Investment or other transfer of title
with respect to any secured Investment in default; (v) any Investment acquired
in consideration for the issuance of Capital Stock (other than Disqualified
Stock) or the proceeds of the issuance of Capital Stock (other than Disqualified
Stock) to the extent such amounts have not been previously applied to a
Restricted Payment pursuant to clause (C)(2) of the first paragraph of the
"Limitation on Restricted Payments" covenant or clause (iii) or (iv) of the
second paragraph of the "Limitation on Restricted Payments" covenant or used to
support the Incurrence of Indebtedness pursuant to clause (x) under the
"Limitation on Indebtedness" covenant and Investments acquired as a capital
contribution; (vi) Guarantees permitted by the "Limitation on Indebtedness"
covenant; (vii) loans or advances to employees of the Company or any Restricted
Subsidiary that do not in the aggregate exceed at any one time outstanding $5.0
million; (viii) Currency Agreements and Interest Rate Agreements permitted under
the "Limitation on Indebtedness" covenant; (ix) Investments in prepaid
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expenses, negotiable instruments held for collection and lease, utility and
workers' compensation, performance and other similar deposits; (x) Investments
in debt securities or other evidences of Indebtedness that are issued by
companies engaged in the Telecommunications Business; provided that when each
Investment pursuant to this clause (x) is made, the aggregate amount of
Investments outstanding under this clause (x) does not exceed $3.0 million; (xi)
Strategic Investments and Investments in Permitted Joint Ventures in an amount
not to exceed $20.0 million at any one time outstanding; (xii) an Investment in
any Person the primary business of which is related, ancillary or complementary
to the business of the Company and its Subsidiaries on the date of such
Investments in an amount not to exceed at any time outstanding the sum of (x)
$23.0 million plus (y) 10% of the Company's Consolidated EBITDA, if positive,
for the immediately preceding four fiscal quarters (valued in each case as
provided in the definition of "Investments"); (xiii) securities received in
connection with Asset Sales to the extent constituting non-cash consideration
permitted under the "Asset Sale" covenant; and (xiv) Investments in an amount
not to exceed $5.0 million at any time outstanding.
"Permitted Joint Venture" means any Unrestricted Subsidiary or any other
Person in which the Company or a Restricted Subsidiary owns, directly or
indirectly, an ownership interest (other than a Restricted Subsidiary) and whose
primary business is related, ancillary or complementary to the businesses of the
Company and its Restricted Subsidiaries at the time of determination.
"Permitted Liens" means (i) Liens for taxes, assessments, governmental
charges or claims that are being contested in good faith by appropriate legal
proceedings promptly instituted and diligently conducted and for which a reserve
or other appropriate provision, if any, as shall be required in conformity with
GAAP shall have been made; (ii) statutory and common law Liens of landlords and
carriers, warehousemen, mechanics, suppliers, materialmen, repairmen, landlord
or other similar Liens arising in the ordinary course of business and with
respect to amounts not yet delinquent or that are bonded or being contested in
good faith by appropriate legal proceedings promptly instituted and diligently
conducted and for which a reserve or other appropriate provision, if any, as
shall be required in conformity with GAAP shall have been made; (iii) Liens
incurred or deposits made in the ordinary course of business in connection with
workers' compensation, unemployment insurance and other types of social
security; (iv) Liens incurred or deposits made to secure the performance of
tenders, bids, leases, licenses, statutory or regulatory obligations, bankers'
acceptances, surety and appeal bonds, trade or government contracts, performance
and return-of-money bonds and other obligations of a similar nature incurred in
the ordinary course of business (exclusive of obligations for the payment of
borrowed money); (v) easements (including reciprocal easement agreements),
rights-of-way, municipal, building and zoning ordinances and similar charges,
utility agreements, covenants, reservations, restrictions, encroachments,
charges, encumbrances, title defects or other irregularities that do not
materially interfere with the ordinary course of business of the Company or any
of its Restricted Subsidiaries; (vi) Liens (including extensions and renewals
thereof) upon real or personal property acquired after the Closing Date;
PROVIDED that (a) such Lien is created solely for the purpose of securing Trade
Payables that the Company reasonably expects to pay within 90 days or
Indebtedness Incurred, in accordance with the "Limitation on Indebtedness"
covenant described below, to finance the cost (including the cost of
improvements or construction) of the item of property or assets subject thereto
and such Lien is created prior to, at the time of or within six months after the
later of the acquisition, the completion of construction or the commencement of
full operation of such property, (b) the principal amount of the Trade Payables
or Indebtedness secured by such Lien does not exceed 100% of such cost and (c)
any such Lien shall not extend to or cover any property or assets other than
such item of property or assets and any improvements on such item; (vii) leases
or subleases granted to others that do not materially interfere with the
ordinary course of business of the Company and its Restricted Subsidiaries,
taken as a whole; (viii) Liens encumbering property or assets under construction
arising from progress or partial payments by a customer of the Company or its
Restricted Subsidiaries relating to such property or assets; (ix) any interest
or title of a lessor in the property subject to any Capitalized Lease or
operating lease; (x) Liens arising from filing Uniform Commercial Code financing
statements regarding leases; (xi) Liens on property of, or on shares of Capital
Stock or Indebtedness of, any Person existing at
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the time such Person becomes, or becomes a part of, any Restricted Subsidiary;
PROVIDED that such Liens do not extend to or cover any property or assets of the
Company or any Restricted Subsidiary other than the property or assets acquired;
(xii) Liens in favor of the Company or any Restricted Subsidiary; (xiii) Liens
arising from the rendering of a final judgment or order against the Company or
any Restricted Subsidiary that does not give rise to an Event of Default; (xiv)
Liens securing reimbursement obligations with respect to letters of credit that
encumber documents and other property relating to such letters of credit and the
products and proceeds thereof; (xv) Liens in favor of customs and revenue
authorities arising as a matter of law to secure payment of customs duties in
connection with the importation of goods; (xvi) Liens encumbering customary
initial deposits and margin deposits, and other Liens that are within the
general parameters customary in the industry and incurred in the ordinary course
of business, in each case, securing Indebtedness under Interest Rate Agreements
and Currency Agreements and forward contracts, options, future contracts,
futures options or similar agreements or arrangements designed solely to protect
the Company or any of its Restricted Subsidiaries from fluctuations in interest
rates, currencies or the price of commodities; (xvii) Liens arising out of
conditional sale, title retention, consignment or similar arrangements for the
sale of goods entered into by the Company or any of its Restricted Subsidiaries
in the ordinary course of business in accordance with the past practices of the
Company and its Restricted Subsidiaries prior to the Closing Date; and (xviii)
Liens on or sales of receivables.
"Public Equity Offering" means an underwritten primary public offering of
Common Stock of the Company pursuant to an effective registration statement
under the Securities Act.
"Restricted Subsidiary" means any Subsidiary of the Company other than an
Unrestricted Subsidiary.
"Significant Subsidiary" means, any Subsidiary that would be a "significant
subsidiary" as defined in 17 CFR Part 210.1-01(w), promulgated pursuant to the
Securities Act, as such regulation is in effect on the date hereof.
"Specified Date" means any Redemption Date, any Payment Date for an Offer to
Purchase or any date on which the Notes first become due and payable after an
Event of Default.
"S&P" means Standard & Poor's Ratings Services and its successors.
"Stated Maturity" means (i) with respect to any debt security, the date
specified in such debt security as the fixed date on which the final installment
of principal of such debt security is due and payable and (ii) with respect to
any scheduled installment of principal of or interest on any debt security, the
date specified in such debt security as the fixed date on which such installment
is due and payable.
"Strategic Investments" means (A) Investments that the Board of Directors
has determined in good faith will enable the Company or any of its Restricted
Subsidiaries to obtain additional business that it might not be able to obtain
without making such Investment and (B) Investments in entities the principal
function of which is to perform research and development with respect to
products and services that may be used or useful in the Telecommunications
Business; PROVIDED that the Company or one of its Restricted Subsidiaries is
entitled or otherwise reasonably expected to obtain rights to such products or
services as a result of such Investment.
"Strategic Subordinated Indebtedness" means Indebtedness of the Company
Incurred to finance the acquisition of a Person engaged in the
Telecommunications Business that by its terms, or by the terms of any agreement
or instrument pursuant to which such Indebtedness is outstanding, (i) is
expressly made subordinate in right of payment to the Notes and (ii) provides
that no payment of principal, premium or interest on, or any other payment with
respect to, such Indebtedness may be made prior to the payment in full of all of
the Company's obligations under the Notes; PROVIDED that such Indebtedness may
provide for and be repaid at any time from the proceeds of the sale of Capital
Stock (other than Disqualified Stock) of the Company after the Incurrence of
such Indebtedness.
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"Subsidiary" means, with respect to any Person, (i) any corporation,
association, or other business entity (other than a partnership) of which more
than 50% of the total voting power of shares of Capital Stock entitled (without
regard to the occurrence of any contingency) to vote in the election of
directors, managers or trustees thereof is at the time of determination owned or
controlled, directly or indirectly, by such Person or one or more of the other
Subsidiaries of such Person or a combination thereof and (ii) any partnership,
joint venture, limited liability company or similar entity of which (x) more
than 50% of the capital accounts, distribution rights, total equity and voting
interests or general or limited partnership interests, as applicable, are owned
or controlled, directly or indirectly, by such Person or one or more of the
other Subsidiaries of such Person or a combination thereof whether in the form
of membership, general, special or limited partnership or otherwise and (y) such
Person or any Wholly Owned Restricted Subsidiary of such Person is a general
partner or otherwise controls such entity.
"Telecommunications Business" means the development, ownership or operation
of one or more telephone, telecommunications or information systems or the
provision of telephony, telecommunications or information services (including,
without limitation, any voice, video transmission, data or Internet services)
and any related, ancillary or complementary business.
"Temporary Cash Investment" means any of the following: (i) direct
obligations of the United States of America or any agency thereof or obligations
fully and unconditionally guaranteed by the United States of America or any
agency or instrumentality thereof, (ii) time deposit accounts, certificates of
deposit, eurodollar time deposits and money market deposits maturing within 180
days or less of the date of acquisition thereof issued by a bank or trust
company which is organized under the laws of the United States of America, any
state thereof or any foreign country recognized by the United States of America,
and which bank or trust company has capital, surplus and undivided profits
aggregating in excess of $50 million (or the foreign currency equivalent
thereof) and has outstanding debt which is rated "A" (or such similar equivalent
rating) or higher by at least one nationally recognized statistical rating
organization (as defined in Rule 436 under the Securities Act) or any
money-market fund sponsored by a registered broker dealer or mutual fund
distributor, (iii) repurchase obligations with a term of not more than 30 days
for underlying securities of the types described in clauses (i) and (ii) above
entered into with a bank meeting the qualifications described in clause (ii)
above, (iv) commercial paper, maturing not more than 90 days after the date of
acquisition, issued by a corporation (other than an Affiliate of the Company)
organized and in existence under the laws of the United States of America, any
state thereof or any foreign country recognized by the United States of America
with a rating at the time as of which any investment therein is made of "P-1"
(or higher) according to Moody's or "A-1" (or higher) according to S&P, (v)
securities with maturities of six months or less from the date of acquisition
issued or fully and unconditionally guaranteed by any state, commonwealth or
territory of the United States of America, or by any political subdivision or
taxing authority thereof, and rated at least "A" by S&P or Moody's, and (vi)
investment funds investing 95% of their assets in securities of the type
described in clauses (i)-(v) above.
"Trade Payables" means, with respect to any Person, any accounts payable or
any other indebtedness or monetary obligation to trade creditors created,
assumed or Guaranteed by such Person or any of its Subsidiaries arising in the
ordinary course of business in connection with the acquisition of goods or
services.
"Transaction Date" means, with respect to the Incurrence of any Indebtedness
by the Company or any of its Restricted Subsidiaries, the date such Indebtedness
is to be Incurred and, with respect to any Restricted Payment, the date such
Restricted Payment is to be made.
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"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below; and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Restricted
Subsidiary (including any newly acquired or newly formed Subsidiary of the
Company) to be an Unrestricted Subsidiary unless such Subsidiary owns any
Capital Stock of, or owns or holds any Lien on any property of, the Company or
any Restricted Subsidiary; PROVIDED that (A) any Guarantee by the Company or any
Restricted Subsidiary of any Indebtedness of the Subsidiary being so designated
shall be deemed an "Incurrence" of such Indebtedness and an "Investment" by the
Company or such Restricted Subsidiary (or both, if applicable) at the time of
such designation; (B) either (I) the Subsidiary to be so designated has total
assets of $1,000 or less or (II) if such Subsidiary has assets greater than
$1,000, such designation would be permitted under the "Limitation on Restricted
Payments" covenant described below and (C) if applicable, the Incurrence of
Indebtedness and the Investment referred to in clause (A) of this proviso would
be permitted under the "Limitation on Indebtedness" and "Limitation on
Restricted Payments" covenants described below. The Board of Directors may
designate any Unrestricted Subsidiary to be a Restricted Subsidiary; PROVIDED
that (i) no Default or Event of Default shall have occurred and be continuing at
the time of or after giving effect to such designation and (ii) all Liens and
Indebtedness of such Unrestricted Subsidiary outstanding immediately after such
designation would, if Incurred at such time, have been permitted to be Incurred
(and shall be deemed to have been Incurred) for all purposes of the Indenture.
Any such designation by the Board of Directors shall be evidenced to the Trustee
by promptly filing with the Trustee a copy of the Board Resolution giving effect
to such designation and an Officers' Certificate certifying that such
designation complied with the foregoing provisions.
"Voting Stock" means with respect to any Person, Capital Stock of any class
or kind ordinarily having the power to vote for the election of directors,
managers or other voting members of the governing body of such Person.
"Warrant Agreement" means the warrant agreement, dated the Closing Date,
between the Company and The Chase Manhattan Bank, as warrant agent.
"Wholly Owned" means, with respect to any Subsidiary of any Person, the
ownership of 95% or more of the outstanding Capital Stock of such Subsidiary
(other than any director's qualifying shares or Investments by foreign nationals
mandated by applicable law) by such Person or one or more Wholly Owned
Subsidiaries of such Person.
COVENANTS
LIMITATION ON INDEBTEDNESS
(a) The Company will not, and will not permit any of its Restricted
Subsidiaries to, Incur any Indebtedness (other than the Notes and Indebtedness
existing on the Closing Date); PROVIDED that the Company may Incur Indebtedness
if, after giving effect to the Incurrence of such Indebtedness and the receipt
and application of the proceeds therefrom, the Consolidated Leverage Ratio would
be greater than zero and less than 6:1.
Notwithstanding the foregoing, the Company and any Restricted Subsidiary
(except as specified below) may Incur each and all of the following: (i)
Indebtedness of the Company or its Restricted Subsidiaries outstanding at any
time in an aggregate principal amount not to exceed $100.0 million of
unsubordinated Indebtedness and $100.0 million of subordinated Indebtedness,
less any amount of such Indebtedness permanently repaid as provided under the
"Limitation on Asset Sales" covenant described below (and any Guarantees thereof
by the Company or its Restricted Subsidiaries); (ii) the Incurrence by the
Company of Indebtedness represented by the Notes; (iii) Indebtedness in
existence on the Closing Date; (iv) Indebtedness of the Company to a Restricted
Subsidiary and Indebtedness of a Restricted Subsidiary to the Company or another
Restricted Subsidiary; PROVIDED that such Indebtedness is made pursuant to an
intercompany note (which, in the case of Indebtedness owed to the Company, shall
be
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unsubordinated) and any event which results in any such Restricted Subsidiary
ceasing to be a Restricted Subsidiary or any subsequent transfer of such
Indebtedness (other than to the Company or another Restricted Subsidiary) shall
be deemed, in each case, to constitute an Incurrence of such Indebtedness not
permitted by this clause (iv); (v) Indebtedness issued in exchange for, or the
net proceeds of which are used to refinance or refund, then outstanding
Indebtedness (other than Indebtedness Incurred under clauses (i), (iv), (vi),
(viii) or (xi) of this paragraph) and any refinancings thereof in an amount not
to exceed the amount so refinanced or refunded (plus premiums, accrued interest,
fees and expenses); PROVIDED that Indebtedness the proceeds of which are used to
refinance or refund Indebtedness that is subordinated in right of payment to the
Notes shall only be permitted under this clause (v) if (A) such new
Indebtedness, by its terms or by the terms of any agreement or instrument
pursuant to which such new Indebtedness is issued or remains outstanding, is
expressly made subordinate in right of payment to the Notes at least to the
extent that the Indebtedness to be refinanced is subordinated to the Notes and
(B) such new Indebtedness, determined as of the date of Incurrence of such new
Indebtedness, does not mature prior to the Stated Maturity of the Indebtedness
to be refinanced or refunded, and the Average Life of such new Indebtedness is
at least equal to the remaining Average Life of the Indebtedness to be
refinanced or refunded; and PROVIDED FURTHER that in no event may Indebtedness
of the Company be refinanced by means of any Indebtedness of any Restricted
Subsidiary pursuant to this clause (v); (vi) Indebtedness (A) in respect of
performance, surety, appeal bonds and completion guarantees provided in the
ordinary course of business, (B) under Currency Agreements and Interest Rate
Agreements; PROVIDED that such agreements (a) are designed solely to protect the
Company or its Restricted Subsidiaries against fluctuations in foreign currency
exchange rates or interest rates and (b) do not increase the Indebtedness of the
obligor outstanding at any time (except to the extent Incurred under another
clause hereof) other than as a result of fluctuations in foreign currency
exchange rates or interest rates or by reason of fees, indemnities and
compensation payable thereunder; and (C) arising from agreements providing for
indemnification, adjustment of purchase price or similar obligations, or from
Guarantees or letters of credit, surety bonds or performance bonds securing any
obligations of the Company or any of its Restricted Subsidiaries pursuant to
such agreements, in each case Incurred in connection with the disposition of any
business, assets or Restricted Subsidiary (other than Guarantees of Indebtedness
Incurred by any Person acquiring all or any portion of such business, assets or
Restricted Subsidiary for the purpose of financing such acquisition), in a
principal amount not to exceed the gross proceeds actually received by the
Company or any Restricted Subsidiary in connection with such disposition; (vii)
Indebtedness of the Company, to the extent the net proceeds thereof are promptly
(A) used to purchase Notes tendered in an Offer to Purchase made as a result of
a Change in Control or (B) deposited to defease the Notes as described below
under "Defeasance"; (viii) Guarantees of the Notes and Guarantees of
Indebtedness of the Company by any Restricted Subsidiary provided the Guarantee
of such Indebtedness is permitted by and made in accordance with the "Limitation
on Issuance of Guarantees by Restricted Subsidiaries" covenant described below
and any Guarantee by the Company of Indebtedness or other obligations of any of
its Restricted Subsidiaries so long as the incurrence of such Indebtedness
Incurred by such Restricted Subsidiary is permitted under the terms of this
covenant; (ix) Indebtedness Incurred to finance the cost (including the cost of
design, development, acquisition, construction, installation, improvement,
transportation or integration) to acquire equipment, inventory or network assets
(including acquisitions by way of acquisitions of real property, leasehold
improvements, Capitalized Leases and acquisitions of the Capital Stock of a
Person that becomes a Restricted Subsidiary to the extent of the fair market
value of the equipment, inventory or network assets so acquired) by the Company
or a Restricted Subsidiary after the Closing Date; (x) Indebtedness of the
Company not to exceed, at any one time outstanding, two times the sum of (A) the
Net Cash Proceeds received by the Company after the Closing Date from the
issuance and sale of its Capital Stock (other than Disqualified Stock) to a
Person that is not a Subsidiary of the Company, to the extent such Net Cash
Proceeds have not been used pursuant to clause (C)(2) of the first paragraph or
clause (iii) or (iv) of the second paragraph of the "Limitation on Restricted
Payments" covenant described below or clause (v) of the definition of "Permitted
Investments" to make a Restricted Payment and (B) 80% of the fair market value
of property (other
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than cash and cash equivalents) received by the Company after the Closing Date
from the sale of its Capital Stock (other than Disqualified Stock) to a Person
that is not a Subsidiary of the Company, to the extent such sale of Capital
Stock has not been used pursuant to clause (iii) or (iv) of the second paragraph
of the "Limitation on Restricted Payments" covenant described below to make a
Restricted Payment; PROVIDED that such Indebtedness does not mature prior to the
Stated Maturity of the Notes and has an Average Life longer than the Notes; (xi)
Indebtedness Incurred by the Company or any of its Restricted Subsidiaries
constituting reimbursement obligations with respect to letters of credit in the
ordinary course of business, including, without limitation, letters of credit in
respect of workers' compensation claims or self insurance, or other Indebtedness
with respect to reimbursement type obligations regarding workers' compensation
claims; PROVIDED, HOWEVER, that upon the drawing of such letters of credit or
the Incurrence of such Indebtedness, such obligations are reimbursed within 30
days following such drawing or Incurrence; (xii) Indebtedness of Persons that
are acquired by the Company or any of its Restricted Subsidiaries or merged into
a Restricted Subsidiary in accordance with the terms of the Indenture; PROVIDED
that such Indebtedness is not incurred in contemplation of such acquisition or
merger; and PROVIDED FURTHER that after giving effect to such acquisition or
merger, either (x) the Company would be permitted to incur at least $1.00 of
additional Indebtedness pursuant to the Consolidated Leverage Ratio test set
forth in the first sentence of this covenant or (y) the Consolidated Leverage
Ratio is lower (if greater than zero) or higher (if less than zero) than
immediately prior to such acquisition; and (xiii) Strategic Subordinated
Indebtedness.
(b) Notwithstanding any other provision of this "Limitation on Indebtedness"
covenant, the maximum amount of Indebtedness that the Company or a Restricted
Subsidiary may Incur pursuant to this "Limitation on Indebtedness" covenant
shall not be deemed to be exceeded, with respect to any outstanding Indebtedness
due solely to the result of fluctuations in the exchange rates of currencies.
Accretion on an instrument issued at a discount will not be deemed to constitute
an Incurrence of Indebtedness.
(c) For purposes of determining any particular amount of Indebtedness under
this "Limitation on Indebtedness" covenant, (1) Guarantees, Liens or obligations
with respect to letters of credit supporting Indebtedness otherwise included in
the determination of such particular amount shall not be included and (2) any
Liens granted pursuant to the equal and ratable provisions referred to in the
"Limitation on Liens" covenant described below shall not be treated as
Indebtedness. For purposes of determining compliance with this "Limitation on
Indebtedness" covenant, in the event that an item of Indebtedness meets the
criteria of more than one of the types of Indebtedness described in the above
clauses, the Company, in its sole discretion, shall classify such item of
Indebtedness and only be required to include the amount and type of such
Indebtedness in one of such clauses.
LIMITATION ON RESTRICTED PAYMENTS
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, (i) declare or pay any dividend or make any distribution
on or with respect to its Capital Stock (other than (x) dividends or
distributions payable solely in shares of its Capital Stock (other than
Disqualified Stock) or in options, warrants or other rights to acquire shares of
such Capital Stock and (y) pro rata dividends or distributions on Common Stock
of Restricted Subsidiaries held by minority stockholders) held by Persons other
than the Company or any of its Restricted Subsidiaries, (ii) purchase, redeem,
retire or otherwise acquire for value any shares of Capital Stock of (A) the
Company or an Unrestricted Subsidiary (including options, warrants or other
rights to acquire such shares of Capital Stock) held by any Person or (B) a
Restricted Subsidiary other than a Wholly Owned Restricted Subsidiary (including
options, warrants or other rights to acquire such shares of Capital Stock) held
by any Affiliate of the Company (other than a Wholly Owned Restricted
Subsidiary), (iii) make any voluntary or optional principal payment, or
voluntary or optional redemption, repurchase, defeasance, or other acquisition
or retirement for value, of Indebtedness of the Company that is subordinated in
right of payment to the Notes (other than the purchase,
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redemption, repurchase or other acquisition of such subordinated Indebtedness
purchased in anticipation of satisfying a sinking fund obligation, principal
installment or final maturity, in each case due within six months of the date of
acquisition) or (iv) make any Investment, other than a Permitted Investment, in
any Person (such payments or any other actions described in clauses (i) through
(iv) above being collectively "Restricted Payments") if, at the time of, and
after giving effect to, the proposed Restricted Payment: (A) a Default or Event
of Default shall have occurred and be continuing, (B) the Company could not
Incur at least $1.00 of Indebtedness under the first paragraph of the
"Limitation on Indebtedness" covenant or (C) the aggregate amount of all
Restricted Payments (the amount, if other than in cash, to be determined in good
faith by the Board of Directors, whose determination shall be conclusive and
evidenced by a Board Resolution) made after the Closing Date shall exceed the
sum of (1) 50% of the aggregate amount of the Adjusted Consolidated Net Income
(or, if the Adjusted Consolidated Net Income is a loss, minus 100% of the amount
of such loss) (determined by excluding income resulting from transfers of assets
by the Company or a Restricted Subsidiary to an Unrestricted Subsidiary) accrued
on a cumulative basis during the period (taken as one accounting period)
beginning on the first day of the fiscal quarter immediately following the
Closing Date and ending on the last day of the last fiscal quarter preceding the
Transaction Date for which reports have been filed with the Commission or
provided to the Trustee pursuant to the "Commission Reports and Reports to
Holders" covenant plus (2) 100% of the aggregate Net Cash Proceeds and the
actual market value of marketable securities (on the date the calculation
hereunder is made) received by the Company after the Closing Date from the
issuance and sale permitted by the Indenture of its Capital Stock (other than
Disqualified Stock) to a Person who is not a Subsidiary of the Company,
including an issuance or sale permitted by the Indenture of Indebtedness of the
Company for cash subsequent to the Closing Date upon the conversion of such
Indebtedness into Capital Stock (other than Disqualified Stock) of the Company,
or from the issuance to a Person who is not a Subsidiary of the Company of any
options, warrants or other rights to acquire Capital Stock of the Company (in
each case, exclusive of any Disqualified Stock or any options, warrants or other
rights that are redeemable at the option of the holder, or are required to be
redeemed, prior to the Stated Maturity of the Notes), and the Net Cash Proceeds
from any capital contributions to the Company after the Closing Date from
Persons other than Subsidiaries of the Company, in each case excluding such Net
Cash Proceeds to the extent used to Incur Indebtedness pursuant to clause (x) of
the second paragraph under the "Limitation on Indebtedness" covenant and
excluding Net Cash Proceeds from the issuance of Capital Stock to the extent
used to make a Permitted Investment in accordance with clause (v) of such
defined term, PLUS (3) amounts received from Investments (other than Permitted
Investments) in any Person resulting from payments of interest on Indebtedness,
dividends, repayments of loans or advances, or other transfers of assets, in
each case to the Company or any Restricted Subsidiary or from the Net Cash
Proceeds from the sale of any such Investment (except, in each case, to the
extent any such payment or proceeds are included in the calculation of Adjusted
Consolidated Net Income), or from redesignations of Unrestricted Subsidiaries as
Restricted Subsidiaries (valued in each case as provided in the definition of
"Investments"), not to exceed, in each case, the amount of Investments
previously made by the Company or any Restricted Subsidiary in such Person or
Unrestricted Subsidiary.
The foregoing provision shall not be violated by reason of: (i) the payment
of any dividend within 60 days after the date of declaration thereof if, at said
date of declaration, such payment would comply with the foregoing paragraph;
(ii) the redemption, repurchase, defeasance or other acquisition or retirement
for value of Indebtedness that is subordinated in right of payment to the Notes
including premium, if any, and accrued and unpaid interest, with the proceeds
of, or in exchange for, Indebtedness Incurred under clause (v) of the second
paragraph of part (a) of the "Limitation on Indebtedness" covenant; (iii) the
repurchase, redemption or other acquisition of Capital Stock of the Company or
an Unrestricted Subsidiary (or options, warrants or other rights to acquire such
Capital Stock) in exchange for, or out of the proceeds of a substantially
concurrent offering of, shares of Capital Stock (other than Disqualified Stock)
of the Company (or options, warrants or other rights to acquire such Capital
Stock); (iv) the making of any principal payment or the repurchase, redemption,
retirement, defeasance or other acquisition for value of
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Indebtedness of the Company which is subordinated in right of payment to the
Notes in exchange for, or out of the proceeds of, a substantially concurrent
offering of, shares of the Capital Stock (other than Disqualified Stock) of the
Company (or options, warrants or other rights to acquire such Capital Stock);
(v) payments or distributions, to dissenting stockholders pursuant to applicable
law, pursuant to or in connection with a consolidation, merger or transfer of
assets that complies with the provisions of the Indenture applicable to mergers,
consolidations and transfers of all or substantially all of the property and
assets of the Company; (vi) the declaration or payment of dividends on the
Common Stock of the Company following a Public Equity Offering of such Common
Stock, of up to 6% per annum of the Net Cash Proceeds received by the Company in
such Public Equity Offering; (vii) the repurchase, retirement or other
acquisition or retirement for value of Capital Stock of the Company that is not
registered under the Exchange Act and is held by any current or former employee,
director or consultant (or their estates or the beneficiaries of such estates)
of the Company or any Subsidiary, not to exceed (A) in any calendar year $2.0
million or (B) $5.0 million in the aggregate; (viii) repurchases of Capital
Stock deemed to occur upon exercise of stock options if such Capital Stock
represents a portion of the exercise price of such options; (ix) repurchases of
fractional shares of Capital Stock in connection with the exercise of Warrants
in accordance with the Warrant Agreement; and (x) other Restricted Payments in
an aggregate amount not to exceed $2.0 million; PROVIDED that, except in the
case of clauses (i), (ii), (iii) and (iv), no Default or Event of Default shall
have occurred and be continuing or occur as a consequence of the actions or
payments set forth therein.
Each Restricted Payment permitted pursuant to the preceding paragraph (other
than the Restricted Payment referred to in clauses (ii) or (viii) thereof, an
exchange of Capital Stock for Capital Stock or Indebtedness referred to in
clause (iii) or (iv) thereof and an Investment referred to in clause (vi)
thereof), and the Net Cash Proceeds from any issuance of Capital Stock referred
to in clauses (iii) and (iv), shall be included in calculating whether the
conditions of clause (C) of the first paragraph of this "Limitation on
Restricted Payments" covenant have been met with respect to any subsequent
Restricted Payments. In the event the proceeds of an issuance of Capital Stock
of the Company are used for the redemption, repurchase or other acquisition of
the Notes, or Indebtedness that is PARI PASSU with the Notes, then the Net Cash
Proceeds of such issuance shall be included in clause (C) of the first paragraph
of this "Limitation on Restricted Payments" covenant only to the extent such
proceeds are not used for such redemption, repurchase or other acquisition of
Indebtedness.
Any Restricted Payments made other than in cash shall be valued at fair
market value. The amount of any Investment "outstanding" at any time shall be
deemed to be equal to the amount of such Investment on the date made, less the
return of capital to the Company and its Restricted Subsidiaries with respect to
such Investment by distribution, sale or otherwise (up to the amount of such
Investment on the date made).
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES
The Company will not, and will not permit any Restricted Subsidiary to,
create or otherwise cause or suffer to exist or become effective any consensual
encumbrance or restriction of any kind on the ability of any Restricted
Subsidiary to (i) pay dividends or make any other distributions permitted by
applicable law on any Capital Stock of such Restricted Subsidiary owned by the
Company or any other Restricted Subsidiary, (ii) pay any Indebtedness owed to
the Company or any other Restricted Subsidiary, (iii) make loans or advances to
the Company or any other Restricted Subsidiary or (iv) transfer any of its
property or assets to the Company or any other Restricted Subsidiary.
The foregoing provisions shall not restrict any encumbrances or
restrictions: (i) existing on the Closing Date in the AT&T Facility, the
Indenture or any other agreements in effect on the Closing Date, and any
extensions, refinancings, renewals or replacements of such agreements; PROVIDED
that the encumbrances and restrictions in any such extensions, refinancings,
renewals or replacements are no less favorable in any material respect to the
Holders than those encumbrances or restrictions that are then in effect and that
are
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being extended, refinanced, renewed or replaced; (ii) existing under or by
reason of applicable law, rule, regulation or order; (iii) existing with respect
to any Person or the property or assets of such Person acquired by the Company
or any Restricted Subsidiary, existing at the time of such acquisition and not
incurred in contemplation thereof, which encumbrances or restrictions are not
applicable to any Person or the property or assets of any Person other than such
Person or the property or assets of such Person so acquired; (iv) in the case of
clause (iv) of the first paragraph of this "Limitation on Dividend and Other
Payment Restrictions Affecting Restricted Subsidiaries" covenant, (A) that
restrict in a customary manner the subletting, assignment or transfer of any
property or asset that is a lease, license, conveyance or contract or similar
property or asset, (B) existing by virtue of any transfer of, agreement to
transfer, option or right with respect to, or Lien on, any property or assets of
the Company or any Restricted Subsidiary not otherwise prohibited by the
Indenture, (C) arising or agreed to in the ordinary course of business, not
relating to any Indebtedness, and that do not, individually or in the aggregate,
detract from the value of property or assets of the Company or any Restricted
Subsidiary in any manner material to the Company or any Restricted Subsidiary or
(D) purchase money obligations for property acquired in the ordinary course of
business that impose restrictions of the nature discussed in clause (iv) above
on the property so acquired; (v) with respect to the Company or a Restricted
Subsidiary and imposed pursuant to an agreement that has been entered into for
the sale of assets, including, without limitation, customary restrictions on the
disposition of all or substantially all of the Capital Stock of, or property and
assets of, such Restricted Subsidiary or the Company; (vi) contained in the
terms of any Indebtedness or any agreement pursuant to which such Indebtedness
was issued (in each case other than Indebtedness incurred under the AT&T
Facility) if (A) the encumbrance or restriction applies only in the event of a
payment default or a default with respect to a financial covenant contained in
such Indebtedness or agreement, (B) the encumbrance or restriction is not
materially more disadvantageous to the Holders of the Notes than is customary in
comparable financings (as determined by the Company) and (C) the Company
determines that any such encumbrance or restriction will not materially affect
the Company's ability to make principal or interest payments on the Notes; (vii)
restrictions on cash or other deposits or net worth imposed by customers under
contracts entered into in the ordinary course of business; (viii) customary
provisions in joint venture agreements and other similar agreements entered into
in the ordinary course of business; and (ix) any encumbrances or restrictions of
the type referred to in clauses (i)-(iv) of the first paragraph of this covenant
imposed by any amendments, modifications, renewals, restatements, increases,
supplements, refundings, replacements or refinancings of the contracts referred
to in clauses (i) through (viii) above; PROVIDED that such amendments,
modifications, restatements, renewals, increases, supplements, refundings,
replacements or refinancings are, in the good faith judgment of the Company, not
materially more disadvantageous to the Holders than those contained in the
restriction prior to such amendment, modification, restatement, renewal,
increase, supplement, refunding, replacement or refinancing. Nothing contained
in this "Limitation on Dividend and Other Payment Restrictions Affecting
Restricted Subsidiaries" covenant shall prevent the Company or any Restricted
Subsidiary from (1) creating, incurring, assuming or suffering to exist any
Liens otherwise permitted in the "Limitation on Liens" covenant or (2)
restricting the sale or other disposition of property or assets of the Company
or any of its Restricted Subsidiaries that secure Indebtedness of the Company or
any of its Restricted Subsidiaries.
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LIMITATION ON THE ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED
SUBSIDIARIES
The Company will not sell, and will not permit any Restricted Subsidiary,
directly or indirectly, to issue or sell, any shares of Capital Stock of a
Restricted Subsidiary (including options, warrants or other rights to purchase
shares of such Capital Stock) except (i) to the Company or a Wholly Owned
Restricted Subsidiary; (ii) issuances of director's qualifying shares or sales
to foreign nationals of shares of Capital Stock of foreign Restricted
Subsidiaries, to the extent required by applicable law; (iii) if, immediately
after giving effect to such issuance or sale, such Restricted Subsidiary would
no longer constitute a Restricted Subsidiary and any Investment in such Person
remaining after giving effect to such issuance or sale would have been permitted
to be made under the "Limitation on Restricted Payments" covenant if made on the
date of such issuance or sale; or (iv) issuances or sales of common stock of a
Restricted Subsidiary, PROVIDED that the Company or any Restricted Subsidiary
applies an amount equal to the Net Cash Proceeds thereof in accordance with the
"Limitation on Asset Sales" covenant.
LIMITATION ON ISSUANCES OF GUARANTEES BY RESTRICTED SUBSIDIARIES
The Company will not permit any Restricted Subsidiary, directly or
indirectly, to Guarantee any Indebtedness of the Company which is PARI PASSU
with or subordinate in right of payment to the Notes ("Guaranteed
Indebtedness"), unless (i) such Restricted Subsidiary simultaneously executes
and delivers a supplemental indenture to the Indenture providing for a Guarantee
(a "Subsidiary Guarantee") of payment of the Notes by such Restricted Subsidiary
and (ii) such Restricted Subsidiary waives and will not in any manner whatsoever
claim or take the benefit or advantage of, any rights of reimbursement,
indemnity or subrogation or any other rights against the Company or any other
Restricted Subsidiary as a result of any payment by such Restricted Subsidiary
under its Subsidiary Guarantee; PROVIDED that this paragraph shall not be
applicable to any Guarantee of any Restricted Subsidiary (x) that existed at the
time such Person became a Restricted Subsidiary and was not Incurred in
connection with, or in contemplation of, such Person becoming a Restricted
Subsidiary or (y) of the Indebtedness Incurred under the AT&T Facility existing
on the Closing Date. If the Guaranteed Indebtedness is (A) PARI PASSU in right
of payment with the Notes, then the Guarantee of such Guaranteed Indebtedness
shall be PARI PASSU in right of payment with, or subordinated to, the Subsidiary
Guarantee or (B) subordinated in right of payment to the Notes, then the
Guarantee of such Guaranteed Indebtedness shall be subordinated in right of
payment to the Subsidiary Guarantee at least to the extent that the Guaranteed
Indebtedness is subordinated to the Notes.
Notwithstanding the foregoing, any Subsidiary Guarantee by a Restricted
Subsidiary may provide by its terms that it shall be automatically and
unconditionally released and discharged upon (i) any sale, exchange or transfer,
to any Person not an Affiliate of the Company, of all of the Company's and each
Restricted Subsidiary's Capital Stock in, or all or substantially all the assets
of, such Restricted Subsidiary (which sale, exchange or transfer is not
prohibited by the Indenture) or (ii) the release or discharge of the Guarantee
which resulted in the creation of such Subsidiary Guarantee, except a discharge
or release by or as a result of payment under such Guarantee.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES
The Company will not, and will not permit any Restricted Subsidiary to,
directly or indirectly, enter into, renew or extend any transaction (including,
without limitation, the purchase, sale, lease or exchange of property or assets,
or the rendering of any service) with any Affiliate of the Company or any
Restricted Subsidiary, except upon fair and reasonable terms no less favorable
to the Company or such Restricted Subsidiary than could be obtained, at the time
of such transaction or, if such transaction is pursuant to a written agreement,
at the time of the execution of the agreement providing therefor, in a
comparable arm's-length transaction with a Person that is not such a holder or
an Affiliate.
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The foregoing limitation does not limit, and shall not apply to (i)
transactions (A) approved by a majority of the disinterested members of the
Board of Directors or (B) for which the Company or a Restricted Subsidiary
delivers to the Trustee a written opinion of a nationally recognized investment
banking firm or a nationally recognized firm having expertise in the specific
area which is the subject of such determination stating that the transaction is
fair to the Company or such Restricted Subsidiary from a financial point of
view; (ii) any transaction solely between the Company and any of its Restricted
Subsidiaries or solely between Restricted Subsidiaries; (iii) the payment of
reasonable and customary regular fees to, and indemnity provided on behalf of,
officers, directors, employees or consultants of the Company or its Restricted
Subsidiaries; (iv) any payments or other transactions pursuant to any
tax-sharing agreement between the Company and any other Person with which the
Company files a consolidated tax return or with which the Company is part of a
consolidated group for tax purposes; (v) any agreement as in effect as of the
Closing Date or any amendment thereto (so long as any such amendment is not
disadvantageous to the Holders in any material respect); (vi) the existence of,
or the performance by the Company or any of its Restricted Subsidiaries of its
obligations under the terms of, any stockholders agreement (including any
registration rights agreement or purchase agreement related thereto) to which it
is a party as of the Closing Date and any similar agreements which it may enter
into thereafter (so long as any such amendment is not disadvantageous to the
Holders in any material respect); or (vii) any Permitted Investments and
Restricted Payments not prohibited by the "Limitation on Restricted Payments"
covenant. Notwithstanding the foregoing, any transaction or series of related
transactions covered by the first paragraph of this "Limitation on Transactions
with Shareholders and Affiliates" covenant and not covered by clauses (ii)
through (vii) of this paragraph the aggregate amount of which exceeds $3.0
million in value, must be approved or determined to be fair in the manner
provided for in clause (i)(A) or (B) above.
LIMITATION ON LIENS
The Company will not, and will not permit any Restricted Subsidiary to,
create, incur, assume or suffer to exist any Lien on any of its assets or
properties of any character (including, without limitation, licenses), or any
shares of Capital Stock or Indebtedness of any Restricted Subsidiary, without
making effective provision for all of the Notes and all other amounts due under
the Indenture to be directly secured equally and ratably with (or, if the
obligation or liability to be secured by such Lien is subordinated in right of
payment to the Notes, prior to) the obligation or liability secured by such
Lien.
The foregoing limitation does not apply to (i) Liens existing on the Closing
Date or required on the Closing Date to be provided in the future; (ii) Liens
securing obligations under the AT&T Facility (including Liens pursuant to
after-acquired clauses); (iii) Liens granted after the Closing Date on any
assets or Capital Stock of the Company or its Restricted Subsidiaries created in
favor of the Holders; (iv) Liens with respect to the assets of a Restricted
Subsidiary granted by such Restricted Subsidiary to the Company or a Restricted
Subsidiary to secure Indebtedness owing to the Company or such other Restricted
Subsidiary; (v) Liens securing Indebtedness which is Incurred to refinance
secured Indebtedness which is permitted to be Incurred under clause (v) of the
second paragraph of the "Limitation on Indebtedness" covenant; PROVIDED that
such Liens do not extend to or cover any property or assets of the Company or
any Restricted Subsidiary other than the property or assets securing the
Indebtedness being refinanced; (vi) Liens on any property or assets of a
Restricted Subsidiary securing Indebtedness of such Restricted Subsidiary
permitted under the "Limitation on Indebtedness" covenant; or (vii) Permitted
Liens.
LIMITATION ON SALE-LEASEBACK TRANSACTIONS
The Company will not, and will not permit any Restricted Subsidiary to,
enter into any sale-leaseback transaction involving any of its assets or
properties whether now owned or hereafter acquired, whereby the Company or a
Restricted Subsidiary sells or transfers such assets or properties and then or
thereafter leases such assets or properties or any part thereof or any other
assets or properties which the Company or
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such Restricted Subsidiary, as the case may be, intends to use for substantially
the same purpose or purposes as the assets or properties sold or transferred.
The foregoing restriction does not apply to any sale-leaseback transaction
if (i) the lease is for a period, including renewal rights, of not in excess of
three years; (ii) the lease secures or relates to industrial revenue or
pollution control bonds; (iii) the transaction is solely between the Company and
any Wholly Owned Restricted Subsidiary or solely between Wholly Owned Restricted
Subsidiaries; or (iv) the Company or such Restricted Subsidiary, within 12
months after the sale or transfer of any assets or properties is completed,
applies an amount not less than the net proceeds received from such sale in
accordance with clause (A) or (B) of the first paragraph of the "Limitation on
Asset Sales" covenant described below.
LIMITATION ON ASSET SALES
The Company will not, and will not permit any Restricted Subsidiary to,
consummate any Asset Sale, unless (i) the consideration received by the Company
or such Restricted Subsidiary is at least equal to the fair market value of the
assets sold or disposed of and (ii) at least 75% of the consideration received
consists of cash or Temporary Cash Investments. For purposes of this covenant,
the following are deemed to be cash: (x) the principal amount or accreted value
(whichever is larger) of Indebtedness of the Company or any Restricted
Subsidiary with respect to which the Company or such Restricted Subsidiary has
either (A) received a written release or (B) been released by operation of law,
in either case, from all liability on such Indebtedness in connection with such
Asset Sale and (y) securities received by the Company or any Restricted
Subsidiary from the transferee that are promptly converted by the Company or
such Restricted Subsidiary into cash. In the event and to the extent that the
Net Cash Proceeds received by the Company or any of its Restricted Subsidiaries
from one or more Asset Sales occurring on or after the Closing Date in any
period of 12 consecutive months exceed 10% of Adjusted Consolidated Net Tangible
Assets (determined as of the date closest to the commencement of such 12-month
period for which a consolidated balance sheet of the Company and its
Subsidiaries has been filed with the Commission or provided to the Trustee
pursuant to the "Commission Reports and Reports to Holders" covenant), then the
Company shall or shall cause the relevant Restricted Subsidiary to (i) within 12
months after the date Net Cash Proceeds so received exceed 10% of Adjusted
Consolidated Net Tangible Assets (A) apply an amount equal to such excess Net
Cash Proceeds to permanently repay unsubordinated Indebtedness of the Company,
or any Restricted Subsidiary providing a Subsidiary Guarantee pursuant to the
"Limitation on Issuances of Guarantees by Restricted Subsidiaries" covenant
described above or Indebtedness of any other Restricted Subsidiary, in each case
owing to a Person other than the Company or any of its Restricted Subsidiaries
or (B) invest an equal amount, or the amount not so applied pursuant to clause
(A) (or enter into a definitive agreement committing to so invest within 12
months after the date of such agreement), in property or assets (other than
current assets) of a nature or type or that are used in a business (or in a
Person (other than a natural person) having property and assets of a nature or
type, or engaged in a business) similar or related to the nature or type of the
property and assets of, or the business of, the Company and its Restricted
Subsidiaries existing on the date of such investment (as determined in good
faith by the Board of Directors, whose determination shall be conclusive and
evidenced by a Board Resolution) and (ii) apply (no later than the end of the
12-month period referred to in clause (i)) such excess Net Cash Proceeds (to the
extent not applied pursuant to clause (i)) as provided in the following
paragraph of this "Limitation on Asset Sales" covenant. The amount of such
excess Net Cash Proceeds required to be applied (or to be committed to be
applied) during such 12-month period as set forth in clause (i) of the preceding
sentence and not applied as so required by the end of such period shall
constitute "Excess Proceeds."
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If, as of the first day of any calendar month, the aggregate amount of
Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to this
"Limitation on Asset Sales" covenant totals at least $5 million, the Company
must commence, not later than the fifteenth Business Day of such month, and
consummate an Offer to Purchase from the Holders on a pro rata basis, and an
offer to purchase any outstanding Indebtedness with similar provisions requiring
the Company to make an offer to purchase such Indebtedness, in an aggregate
principal amount at maturity of Notes (or, if prior to February 15, 2003, the
Accreted Value of the Notes) and such PARI PASSU Indebtedness equal to (A) with
respect to the Notes, the product of such Excess Proceeds multiplied by a
fraction, the numerator of which is the outstanding principal amount at maturity
of the Notes (or, if prior to February 15, 2003, the Accreted Value of the
Notes) and the denominator of which is the sum of the outstanding principal
amount at maturity of the Notes (or, if prior to February 15, 2003, the Accreted
Value of the Notes) and such PARI PASSU Indebtedness (the product hereinafter
referred to as the "Note Amount"), and (B) with respect to the PARI PASSU
Indebtedness, the excess of the Excess Proceeds over the Note Amount, at a
purchase price equal to 100% of the Accreted Value of the Notes or such PARI
PASSU Indebtedness, as the case may be, on the relevant Payment Date or such
other date set forth in the documentation governing the PARI PASSU Indebtedness,
plus, in each case, accrued interest (if any) to the Payment Date or such other
date set forth in the documentation governing the PARI PASSU Indebtedness. If
the aggregate purchase price of the Notes tendered pursuant to the Offer to
Purchase is less than the Excess Proceeds, the remaining will be available for
use by the Company for general corporate purposes. Upon the consummation of any
Offer to Purchase in accordance with the terms of the Indenture, the amount of
Net Cash Proceeds from Asset Sales subject to any future Offer to Purchase shall
be deemed to be zero.
REPURCHASE OF NOTES UPON A CHANGE OF CONTROL
The Company must commence, within 30 days of the occurrence of a Change of
Control, and consummate an Offer to Purchase for all Notes then outstanding, at
a purchase price equal to 101% of the Accreted Value thereof on the relevant
Payment Date, PLUS accrued interest (if any) to the Payment Date; PROVIDED,
HOWEVER, that notwithstanding the occurrence of a Change of Control, the Company
shall not be obligated to purchase the Notes pursuant to this covenant in the
event that it has irrevocably committed to, within 90 days of such Change of
Control, redeem all the Notes in accordance with the terms hereof.
There can be no assurance that the Company will have sufficient funds
available at the time of any Change of Control to make any debt payment
(including repurchases of Notes) required by the foregoing covenant (as well as
may be contained in other securities of the Company which might be outstanding
at the time). The above covenant requiring the Company to repurchase the Notes
will, unless consents are obtained, require the Company to repay all
indebtedness then outstanding which by its terms would prohibit such Note
repurchase, either prior to or concurrently with such Note repurchase.
COMMISSION REPORTS AND REPORTS TO HOLDERS
At all times from and after the date of the commencement of this Exchange
Offer the Company shall deliver for filing to the Commission all such reports
and other information as it would be required to file with the Commission by
Sections 13(a) or 15(d) under the Exchange Act if it were subject thereto. The
Company shall supply the Trustee and each Holder, or shall supply to the Trustee
for forwarding to each such Holder, without cost to such Holder, copies of such
reports and other information.
EVENTS OF DEFAULT
The following events are defined as "Events of Default" in the Indenture:
(a) default in the payment of principal of (or premium, if any, on) any Note
when the same becomes due and payable at maturity, upon acceleration, redemption
or otherwise; (b) default in the payment of interest on any Note when the same
becomes due and payable, and such default continues for a period of 30 days; (c)
the Company defaults in the performance of or breaches any other covenant or
agreement of the Company in the
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Indenture or under the Notes (other than a default specified in clause (a) or
(b) above) and such default or breach continues for a period of 30 consecutive
days after written notice by the Trustee or the Holders of 25% or more in
aggregate principal amount of the Notes; (d) the Company shall have failed to
make or consummate an Offer to Purchase in accordance with the "Limitation on
Asset Sales" covenant above; (e) the Company shall have failed to make or
consummate an Offer to Purchase in accordance with the provisions of "Repurchase
of Notes upon a Change of Control" above; (f) there occurs with respect to any
issue or issues of Indebtedness of the Company or any Significant Subsidiary
having an outstanding principal amount of $5 million or more in the aggregate
for all such issues of all such Persons, whether such Indebtedness now exists or
shall hereafter be created, (I) an event of default that has caused the holder
thereof to declare such Indebtedness to be due and payable prior to its Stated
Maturity and such Indebtedness has not been discharged in full or such
acceleration has not been rescinded or annulled within 30 days of such
acceleration and/or (II) the failure to make a principal payment at the final
(but not any interim) fixed maturity and such defaulted payment shall not have
been made, waived or extended within 30 days of such payment default; (g) any
final judgment or order (not covered by insurance) for the payment of money in
excess of $5 million in the aggregate (treating any deductibles, self-insurance
or retention as not so covered) shall be rendered against the Company or any
Significant Subsidiary and shall not be paid or discharged, and there shall be
any period of 30 consecutive days following entry of the final judgment or order
that causes the aggregate amount for all such final judgments or orders
outstanding and not paid or discharged against the Company or any of its
Significant Subsidiaries to exceed $5 million during which a stay of enforcement
of such final judgment or order, by reason of a pending appeal or otherwise,
shall not be in effect; (h) a court having jurisdiction in the premises enters a
decree or order for (A) relief in respect of the Company or any Significant
Subsidiary in an involuntary case under any applicable bankruptcy, insolvency or
other similar law now or hereafter in effect, (B) appointment of a receiver,
liquidator, assignee, custodian, trustee, sequestrator or similar official of
the Company or any Significant Subsidiary or for all or substantially all of the
property and assets of the Company or any Significant Subsidiary or (C) the
winding up or liquidation of the affairs of the Company or any Significant
Subsidiary and, in each case, such decree or order shall remain unstayed and in
effect for a period of 30 consecutive days; or (i) the Company or any
Significant Subsidiary (A) commences a voluntary case under any applicable
bankruptcy, insolvency or other similar law now or hereafter in effect, or
consents to the entry of an order for relief in an involuntary case under any
such law, (B) consents to the appointment of or taking possession by a receiver,
liquidator, assignee, custodian, trustee, sequestrator or similar official of
the Company or any Significant Subsidiary or for all or substantially all of the
property and assets of the Company or any Significant Subsidiary or (C) effects
any general assignment for the benefit of creditors.
If an Event of Default (other than an Event of Default specified in clause
(h) or (i) above that occurs with respect to the Company) occurs and is
continuing under the Indenture, the Trustee or the Holders of at least 25% in
aggregate principal amount of the Notes then outstanding, by written notice to
the Company (and to the Trustee if such notice is given by the Holders), may,
and the Trustee at the request of such Holders shall, declare the Accreted Value
of, premium, if any, and accrued interest on the Notes to be immediately due and
payable. Upon a declaration of acceleration, such Accreted Value of, premium, if
any, and accrued interest shall be immediately due and payable. In the event of
a declaration of acceleration because an Event of Default set forth in clause
(f) above has occurred and is continuing, such declaration of acceleration shall
be automatically rescinded and annulled if the event of default triggering such
Event of Default pursuant to clause (f) shall be remedied or cured by the
Company or the relevant Significant Subsidiary or waived by the holders of the
relevant Indebtedness within 60 days after the declaration of acceleration with
respect thereto. If an Event of Default specified in clause (h) or (i) above
occurs with respect to the Company, the Accreted Value of, premium, if any, and
accrued interest on the Notes then outstanding shall ipso facto become and be
immediately due and payable without any declaration or other act on the part of
the Trustee or any Holder. The Holders of at least a majority in principal
amount at maturity of the outstanding Notes by written notice to the Company and
to the
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Trustee, may waive all past defaults and rescind and annul a declaration of
acceleration and its consequences if (i) all existing Events of Default, other
than the nonpayment of the Accreted Value of, premium, if any, and interest on
the Notes that have become due solely by such declaration of acceleration, have
been cured or waived and (ii) the rescission would not conflict with any
judgment or decree of a court of competent jurisdiction. For information as to
the waiver of defaults, see "--Modification and Waiver."
The Holders of at least a majority in aggregate principal amount of the
outstanding Notes may direct the time, method and place of conducting any
proceeding for any remedy available to the Trustee or exercising any trust or
power conferred on the Trustee. However, the Trustee may refuse to follow any
direction that conflicts with law or the Indenture, that may involve the Trustee
in personal liability, or that the Trustee determines in good faith may be
unduly prejudicial to the rights of Holders of Notes not joining in the giving
of such direction and may take any other action it deems proper that is not
inconsistent with any such direction received from Holders of Notes. A Holder
may not pursue any remedy with respect to the Indenture or the Notes unless: (i)
the Holder gives the Trustee written notice of a continuing Event of Default;
(ii) the Holders of at least 25% in aggregate principal amount at maturity of
outstanding Notes make a written request to the Trustee to pursue the remedy;
(iii) such Holder or Holders offer the Trustee indemnity satisfactory to the
Trustee against any costs, liability or expense; (iv) the Trustee does not
comply with the request within 60 days after receipt of the request and the
offer of indemnity; and (v) during such 60-day period, the Holders of a majority
in aggregate principal amount of the outstanding Notes do not give the Trustee a
direction that is inconsistent with the request. However, such limitations do
not apply to the right of any Holder of a Note to receive payment of the
principal of, premium, if any, or interest on, such Note or to bring suit for
the enforcement of any such payment, on or after the due date expressed in the
Notes, which right shall not be impaired or affected without the consent of the
Holder.
The Indenture will require certain officers of the Company to certify, on or
before a date not more than 90 days after the end of each fiscal year, that a
review has been conducted of the activities of the Company and its Restricted
Subsidiaries and the Company's and its Restricted Subsidiaries' performance
under the Indenture and that the Company has fulfilled all obligations
thereunder, or, if there has been a default in the fulfillment of any such
obligation, specifying each such default and the nature and status thereof. The
Company will also be obligated to notify the Trustee of any default or defaults
in the performance of any covenants or agreements under the Indenture.
CONSOLIDATION, MERGER AND SALE OF ASSETS
The Company will not consolidate with, merge with or into, or sell, convey,
transfer, lease or otherwise dispose of all or substantially all of its property
and assets (as an entirety or substantially an entirety in one transaction or a
series of related transactions) to, any Person or permit any Person to merge
with or into the Company unless: (i) the Company shall be the continuing Person,
or the Person (if other than the Company) formed by such consolidation or into
which the Company is merged or that acquired or leased such property and assets
of the Company shall be a corporation organized and validly existing under the
laws of the United States of America or any jurisdiction thereof and shall
expressly assume, by a supplemental indenture, executed and delivered to the
Trustee, all of the obligations of the Company on all of the Notes and under the
Indenture; (ii) immediately after giving effect to such transaction, no Default
or Event of Default shall have occurred and be continuing; (iii) immediately
after giving effect to such transaction on a PRO FORMA basis, (A) the Company or
any Person becoming the successor obligor of the Notes, as the case may be,
shall have a Consolidated Net Worth equal to or greater than the Consolidated
Net Worth of the Company immediately prior to such transaction or (B) the
Company or any Person becoming the successor obligor of the Notes, as the case
may be, shall have a Consolidated Leverage Ratio no more than the greater of (I)
6:1 and (II) the Consolidated Leverage Ratio of the Company immediately prior to
such transaction; PROVIDED that this clause (iii) shall not apply to a
consolidation or merger with or into a Wholly Owned Restricted Subsidiary with a
positive net worth; PROVIDED that, in connection with any
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such merger or consolidation, no consideration (other than Capital Stock (other
than Disqualified Stock) in the surviving Person or the Company) shall be issued
or distributed to the stockholders of the Company; and (iv) the Company delivers
to the Trustee an Officers' Certificate (attaching the arithmetic computations
to demonstrate compliance with clause (iii) above) and an Opinion of Counsel, in
each case stating that such consolidation, merger or transfer and such
supplemental indenture complies with this provision and that all conditions
precedent provided for herein relating to such transaction have been complied
with; PROVIDED, HOWEVER, that clause (iii) above does not apply if, in the good
faith determination of the Board of Directors of the Company, whose
determination shall be evidenced by a Board Resolution, the principal purpose of
such transaction is to change the state of incorporation of the Company; and
that any such transaction shall not have as one of its purposes the evasion of
the foregoing limitations.
DEFEASANCE
DEFEASANCE AND DISCHARGE. The Indenture provides that the Company will be
deemed to have paid and will be discharged from any and all obligations in
respect of the Notes on the 123rd day after the deposit referred to below, and
the provisions of the Indenture will no longer be in effect with respect to the
Notes (except for, among other matters, certain obligations to register the
transfer or exchange of the Notes, to replace stolen, lost or mutilated Notes,
to maintain paying agencies and to hold monies for payment in trust) if, among
other things, (A) the Company has deposited with the Trustee, in trust, money
and/or U.S. Government Obligations that through the payment of interest and
principal in respect thereof in accordance with their terms will provide money
in an amount sufficient to pay the principal of, premium, if any, and accrued
interest on the Notes on the Stated Maturity of such payments in accordance with
the terms of the Indenture and the Notes, (B) the Company has delivered to the
Trustee (i) either (x) an Opinion of Counsel to the effect that Holders will not
recognize income, gain or loss for federal income tax purposes as a result of
the Company's exercise of its option under this "Defeasance" provision and will
be subject to federal income tax on the same amount and in the same manner and
at the same times as would have been the case if such deposit, defeasance and
discharge had not occurred, which Opinion of Counsel must be based upon (and
accompanied by a copy of) a ruling of the Internal Revenue Service to the same
effect unless there has been a change in applicable federal income tax law after
the Closing Date such that a ruling is no longer required or (y) a ruling
directed to the Trustee received from the Internal Revenue Service to the same
effect as the aforementioned Opinion of Counsel and (ii) an Opinion of Counsel
to the effect that the creation of the defeasance trust does not violate the
Investment Company Act of 1940 and after the passage of 123 days following the
deposit, the trust fund will not be subject to the effect of Section 547 of the
United States Bankruptcy Code or Section 15 of the New York Debtor and Creditor
Law, (C) immediately after giving effect to such deposit on a pro forma basis,
no Event of Default, or event that after the giving of notice or lapse of time
or both would become an Event of Default, shall have occurred and be continuing
on the date of such deposit or during the period ending on the 123rd day after
the date of such deposit, and such deposit shall not result in a breach or
violation of, or constitute a default under, any other agreement or instrument
to which the Company or any of its Subsidiaries is a party or by which the
Company or any of its Subsidiaries is bound and (D) if at such time the Notes
are listed on a national securities exchange, the Company has delivered to the
Trustee an Opinion of Counsel to the effect that the Notes will not be delisted
as a result of such deposit, defeasance and discharge, PROVIDED that if
simultaneously with the deposit of the money and/or U.S. Government Obligations
referred to in (A) above, the Company has caused an irrevocable, transferable,
standby letter of credit to be issued by a bank with capital and surplus
exceeding the principal amount of the Notes then outstanding, expiring not
earlier than 180 days from its issuance, in favor of the Trustee which permits
the Trustee to draw an amount equal to the principal, premium, if any, and
accrued interest on the Notes through the expiry date of the letter of credit,
then the Company will be deemed to have paid and discharged any and all
obligations in respect of the Notes on the date of the deposit and issuance of
the letter of credit.
DEFEASANCE OF CERTAIN COVENANTS AND CERTAIN EVENTS OF DEFAULT. The
Indenture further provides that the provisions of the Indenture will no longer
be in effect with respect to clause (iii) under "Consolidation,
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Merger and Sale of Assets" and all the covenants described herein under
"Covenants," clause (c) under "Events of Default" with respect to such other
covenants and clauses (c), (d), (e), (f) and (g) under "Events of Default" shall
be deemed not to be Events of Default upon, among other things, the deposit with
the Trustee, in trust, of money and/or U.S. Government Obligations that through
the payment of interest and principal in respect thereof in accordance with
their terms will provide money in an amount sufficient to pay the principal of,
premium, if any, and accrued interest on the Notes on the Stated Maturity of
such payments in accordance with the terms of the Indenture and the Notes, the
satisfaction of the provisions described in clauses (B)(ii), (C) and (D) of the
preceding paragraph and the delivery by the Company to the Trustee of an Opinion
of Counsel to the effect that, among other things, the Holders will not
recognize income, gain or loss for federal income tax purposes as a result of
such deposit and defeasance of certain covenants and Events of Default and will
be subject to federal income tax on the same amount and in the same manner and
at the same times as would have been the case if such deposit and defeasance had
not occurred.
DEFEASANCE AND CERTAIN OTHER EVENTS OF DEFAULT. In the event the Company
exercises its option to omit compliance with certain covenants and provisions of
the Indenture with respect to the Notes as described in the immediately
preceding paragraph and the Notes are declared due and payable because of the
occurrence of an Event of Default that remains applicable, the amount of money
and/or U.S. Government Obligations on deposit with the Trustee will be
sufficient to pay amounts due on the Notes at the time of their Stated Maturity
but may not be sufficient to pay amounts due on the Notes at the time of the
acceleration resulting from such Event of Default. However, the Company will
remain liable for such payments.
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company and
the Trustee with the consent of the Holders of not less than a majority in
aggregate principal amount at maturity of the outstanding Notes; PROVIDED,
HOWEVER, that no such modification or amendment may, without the consent of each
Holder affected thereby, (i) change the Stated Maturity of the principal of, or
any installment of interest on, any Note, (ii) reduce the Accreted Value or
principal amount of, or premium, if any, or interest on, any Note, (iii) change
the place or currency of payment of principal of, or premium, if any, or
interest on, any Note, (iv) impair the right to institute suit for the
enforcement of any payment on or after the Stated Maturity (or, in the case of a
redemption, on or after the Redemption Date) of any Note, (v) reduce the
above-stated percentage of outstanding Notes the consent of whose Holders is
necessary to modify or amend the Indenture, (vi) waive a default in the payment
of principal of, premium, if any, or interest on the Notes or (vii) reduce the
percentage or aggregate principal amount of outstanding Notes the consent of
whose Holders is necessary for waiver of compliance with certain provisions of
the Indenture or for waiver of certain defaults.
NO PERSONAL LIABILITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS, DIRECTORS, OR
EMPLOYEES
The Indenture provides that no recourse for the payment of the principal of,
premium, if any, or interest on any of the Notes or for any claim based thereon
or otherwise in respect thereof, and no recourse under or upon any obligation,
covenant or agreement of the Company in the Indenture, or in any of the Notes or
because of the creation of any Indebtedness represented thereby, shall be had
against any incorporator, stockholder, officer, director, employee or
controlling person of the Company or of any successor Person thereof. Each
Holder, by accepting the Notes, waives and releases all such liability.
CONCERNING THE TRUSTEE
The Indenture provides that, except during the continuance of a Default, the
Trustee will not be liable, except for the performance of such duties as are
specifically set forth in such Indenture. If an Event of Default has occurred
and is continuing, the Trustee will use the same degree of care and skill in its
exercise
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of the rights and powers invested in it under the Indenture as a prudent person
would exercise under the circumstances in the conduct of such person's own
affairs.
The Indenture and provisions of the Trust Indenture Act of 1939, as amended,
incorporated by reference therein contain limitations on the rights of the
Trustee, should it become a creditor of the Company, to obtain payment of claims
in certain cases or to realize on certain property received by it in respect of
any such claims, as security or otherwise. The Trustee is permitted to engage in
other transactions; provided, however, that if it acquires any conflicting
interest, it must eliminate such conflict or resign.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following summary sets forth the opinion of Kelley Drye & Warren,
counsel to the Company, as to the principal U.S. federal income tax consequences
of an exchange of the Original Notes for the Exchange Notes and the ownership
and disposition of the Exchange Notes under U.S. federal income tax law as of
the date hereof. This summary is based on current provisions of the U.S.
Internal Revenue Code of 1986, as amended (the "Code"), applicable final,
temporary and proposed Treasury Regulations ("Treasury Regulations"), judicial
authority, and current administrative rulings and pronouncements of the Internal
Revenue Service (the "Service") and upon the facts concerning the Company as of
the date hereof. There can be no assurance that the Service will not take a
contrary view, and no ruling from the Service has been or will be sought by the
Company. Legislative, judicial, or administrative changes or interpretations may
be forthcoming that could alter or modify the statements and conclusions set
forth herein. Any such changes or interpretations may or may not be retroactive
and could affect the tax consequences to Holders.
This summary does not purport to deal with all aspects of taxation that may
be relevant to particular holders of the Exchange Notes in light of their
personal investment or tax circumstances, or to certain types of investors
(including individual retirement accounts and other tax deferred accounts,
insurance companies, financial institutions, broker-dealers or tax-exempt
organizations) subject to special treatment under the U.S. federal income tax
laws. This discussion does not deal with special tax situations, such as the
holding of the Exchange Notes as part of a straddle with other investments, or
situations in which the functional currency of a holder is not the U.S. dollar.
In addition, this discussion deals only with Exchange Notes held as capital
assets within the meaning of Section 1221 of the Code.
For purposes of this discussion, the term "U.S. Holder" means a citizen or
resident of the U.S., a corporation, limited liability company or partnership
created or organized in the U.S. or under the law of the U.S. or any state
thereof (including the District of Columbia), an estate the income of which is
includible in gross income for U.S. federal income tax purposes regardless of
its source, or a trust if a court within the U.S. is able to exercise primary
supervision over the administration of the trust and one or more U.S. persons
has the authority to control all substantial decisions of the trust (or, under
certain circumstances, a trust the income of which is includible in gross income
for U.S. federal income tax purposes regardless of its source). The term
"Non-U.S. Holder" means any person other than a U.S. Holder.
THE FOLLOWING DISCUSSION IS FOR GENERAL INFORMATION ONLY. THE TAX TREATMENT
MAY VARY DEPENDING UPON A HOLDER'S PARTICULAR SITUATION. HOLDERS SHOULD CONSULT
THEIR OWN TAX ADVISORS AS TO THE PARTICULAR TAX CONSEQUENCES TO THEM OF
PURCHASING, HOLDING AND DISPOSING OF THE EXCHANGE NOTES INCLUDING THE
APPLICABILITY AND EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS.
THE ORIGINAL NOTES--UNITS
For U.S. federal income tax purposes, the Original Notes were originally
issued and sold as part of a Unit, comprised of one Original Note and one
Warrant to purchase 0.21785 shares of Common Stock. The issue price of a Unit
was allocated between the Original Notes and the Warrants based on the Company's
best judgment of the relative fair market values of each such component of the
Unit on the issue date. The Company allocated $518.59 to each Note and $23.87 to
each Warrant. Under regulations issued under provisions of the Code relating to
original issue discount (the "OID Regulations"), each Holder will be bound by
such allocation for U.S. federal income tax purposes unless such Holder
discloses on a statement attached to its tax return for the taxable year that
includes the acquisition date of such Unit that its allocation differs from that
of the Company. No assurance can be given that the Service will accept the
Company's allocation. If the Company's allocation were successfully challenged
by the Service, the issue
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price, original issue discount accrual on the Note and gain or loss on the sale
or disposition of a Note would be different from that resulting under the
allocation determined by the Company.
The exchange of Original Notes for Exchange Notes pursuant to the Exchange
Offer will not be a taxable event for U.S. federal income tax purposes. As a
result, there will not be any material U.S. federal income tax consequences to a
holder exchanging Original Notes for the Exchange Notes pursuant to the Exchange
Offer.
Because each Exchange Note is a continuation of the corresponding Original
Note, the remainder of this discussion of certain federal income tax
consideration generally refers only to "Notes."
THE NOTES
Under applicable authorities, the Notes should be treated as indebtedness
for U.S. federal income tax purposes. In the unlikely event the Notes are
treated as equity, the amount of any actual or constructive distributions on any
such Note would first be taxable to the holder as dividend income to the extent
of the issuer's current and accumulated earnings and profits, and next would be
treated as a return of capital to the extent of the holder's tax basis in the
Note, with any remaining amount treated as gain from the sale of a Note. As a
result, until such time as the issuer has earnings and profits as determined for
U.S. federal income tax purposes, distributions on any Note treated as equity
will be a nontaxable return of capital and will be applied against and reduce
the adjusted tax basis of such Note in the hands of its holder (but not below
zero) and any excess will be treated as gain from the sale of the Note. Further,
payments on the Notes treated as equity to Non-U.S. Holders would not be
eligible for the portfolio interest exception from U.S. withholding tax, and
dividends thereon would be subject to U.S. withholding tax at a flat rate of 30%
(or lower applicable treaty rate) and gain from their sale or other taxable
disposition might also be subject to U.S. tax. In addition, in the event of
equity treatment, the Company would not be entitled to deduct interest on the
Notes for U.S. federal income tax purposes. The remainder of this discussion
assumes that the Notes will constitute indebtedness of the Company for such tax
purposes.
ORIGINAL ISSUE DISCOUNT
GENERAL. The Notes will be issued with original issue discount ("OID"), and
each U.S. Holder will be required to include in income (regardless of whether
such U.S. Holder is a cash or accrual basis taxpayer) in each taxable year, in
advance of the receipt of corresponding cash payments on such Notes, that
portion of the OID, computed on a constant yield basis, attributable to each day
during such year on which the U.S. Holder held the Notes. See "--Taxation of
Original Issue Discount."
The amount of OID with respect to each Note will be equal to the excess of
(i) its "stated redemption price at maturity" over (ii) its issue price. Under
the OID Regulations, the "stated redemption price at maturity" of each Note will
include all payments to be made in respect thereof, including any stated
interest payments, other than "qualified stated interest." Payments of qualified
stated interest are payments of interest which are unconditionally payable in
cash or property (other than debt instruments of the issuer) at least annually
at a qualifying rate, including a single fixed rate. The "issue price" of a Note
is determined in the manner described under "The Original Notes--Units."
TAXATION OF ORIGINAL ISSUE DISCOUNT. A U.S. Holder of a debt instrument
issued with OID is required to include in gross income for U.S. federal income
tax purposes an amount equal to the sum of the "daily portions" of such OID for
all days during the taxable year on which the holder holds the debt instrument.
The daily portions of OID required to be included in a holder's gross income in
a taxable year will be determined upon a constant-yield basis by allocating to
each day during the taxable year on which the holder holds the debt instrument a
pro-rata portion of the OID on such debt instrument which is attributable to the
"accrual period" in which such day is included. Accrual periods with respect to
a Note may be of any length and may vary in length over the term of the Note as
long as (i) no accrual period is longer than one year and (ii) each scheduled
payment of interest or principal on the Note occurs on either
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the final or first day of an accrual period. The amount of the OID attributable
to each "accrual period" will be the product of the "adjusted issue price" at
the beginning of such accrual period and the "yield to maturity" of the debt
instrument (stated in a manner appropriately taking into account the length of
the accrual period). The "yield to maturity" is the discount rate that, when
used in computing the present value of all payments to be made under the Notes,
produces an amount equal to the issue price of the Notes. The "adjusted issue
price" of a debt instrument at the beginning of an accrual period is defined
generally as the issue price of the debt instrument plus the aggregate amount of
OID that accrued in all prior accrual periods, less any cash payments on the
debt instrument. Accordingly, a U.S. Holder of a Note will be required to
include OID in gross income for U.S. federal income tax purposes in advance of
the receipt of cash in respect of such income. The amount of OID allocable to an
initial short accrual period may be computed using any reasonable method if all
other accrual periods, other than a final short accrual period, are of equal
length. The amount of OID allocable to the final accrual period at maturity of
the Note is the difference between (x) the amount payable at the maturity of the
Note, and (y) the Note's adjusted issue price as of the beginning of the final
accrual period.
EFFECT OF MANDATORY AND OPTIONAL REDEMPTIONS ON OID. In the event of a
Change of Control, the Company will be required to offer to redeem all of the
Notes at redemption prices specified elsewhere herein. In the event that the
Company receives net proceeds from one or more Equity Offerings, the Company
may, at any time prior to April 15, 2000, use all or a portion of such net
proceeds to redeem the Notes in amounts and at redemption prices specified
elsewhere herein. Under the OID Regulations, computation of yield and maturity
of the Notes is not affected by such redemption rights and obligations if, based
on all the facts and circumstances as of the issue date, the stated payment
schedule of the Notes (that does not reflect a Change of Control or Equity
Offerings) is significantly more likely than not to occur. The Company has
determined that, based on all of the facts and circumstances as of the issue
date, it is significantly more likely than not that the Notes will be paid
according to their stated schedule.
The Company may redeem the Notes, in whole or in part, at any time on or
after February 15, 2003, at redemption prices specified elsewhere herein, plus
accrued and unpaid interest to the date of redemption. The OID Regulations
contain rules for determining the "maturity date" and the stated redemption
price at maturity of an instrument that may be redeemed prior to its stated
maturity date at the option of the issuer. Under the OID Regulations, solely for
purposes of the accrual of OID, it is assumed that the issuer will exercise any
option to redeem a debt instrument if such exercise will lower the
yield-to-maturity of the debt instrument. The Company believes that it will not
be presumed to redeem the Notes prior to their stated maturity under the
foregoing rules because the exercise of such option would not lower the
yield-to-maturity of the Notes.
APPLICABLE HIGH YIELD DISCOUNT OBLIGATIONS
The Notes are "applicable high yield discount obligations" ("AHYDOs"), as
defined in the Code, because the yield to maturity of such Notes exceeds the
"applicable federal rate" in effect at the time of their issuance (the "AFR")
plus five percentage points. Under the rules applicable to AHYDOs, a portion of
the OID that accrues on the Notes will not be deductible by the Company at any
time. The non-deductible portion of the OID will be an amount that bears the
same ratio to such OID as (i) the excess of the yield to maturity of the Notes
over the AFR plus six percentage points bears to (ii) the yield to maturity of
the Notes. To the extent that the non-deductible portion of OID would have been
treated as a dividend if it had been distributed with respect to the Company's
stock, it generally will be treated as a dividend to holders of the Notes for
purposes of the rules relating to the dividends received deduction applicable to
corporate holders. Any remaining OID on the Notes will not be deductible by the
Company until such OID is paid.
MARKET DISCOUNT, ACQUISITION PREMIUM
If a U.S. Holder acquires a Note for an amount that is less than its revised
issue price (generally, adjusted issue price at the time of acquisition), the
amount of the difference will be treated as "market
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discount," unless such difference is less than a specified DE MINIMIS amount.
Under the market discount rules of the Code, a U.S. Holder will be required to
treat any principal payment on, or any gain on the sale, exchange, retirement or
other disposition (including a gift) of, a Note as ordinary income to the extent
of any accrued market discount that has not previously been included in income.
Market discount generally accrues on a straight-line basis over the remaining
term of the Note, unless the U.S. Holder elects to accrue market discount on a
constant interest method. A U.S. Holder may not be allowed to deduct immediately
all or a portion of the interest expense on any indebtedness incurred or
continued to purchase or to carry such Note.
A U.S. Holder may elect to include market discount in income currently as it
accrues (either on a straight-line basis or, if the U.S. Holder so elects, on a
constant-yield basis), in which case the interest deferral rule set forth in the
preceding paragraph will not apply. Such an election will apply to all bonds
acquired by the U.S. Holder on or after the first day of the first taxable year
to which such election applies and may be revoked only with the consent of the
Service.
A U.S. Holder that acquires a Note for an amount that is greater than the
adjusted issue price of such Note but equal to or less than the sum of all
amounts payable on such Note after the purchase date will be considered to have
purchased such Note at an "acquisition premium." Under the acquisition premium
rules of the Code and the OID Regulations, the daily portion of OID which such
holder must include in its gross income with respect to such Note for any
taxable year will be reduced by an amount equal to the OID multiplied by a
fraction, the numerator of which is the amount of such acquisition premium and
the denominator of which is the OID remaining from the date the Note was
purchased to its maturity date.
SALE OR OTHER DISPOSITION
In general, upon the sale, exchange or redemption of a Note, a U.S. Holder
will recognize taxable gain or loss equal to the difference between (i) the
amount of cash proceeds and the fair market value of any property received on
the sale, exchange or redemption (not including any amount attributable to
accrued but unpaid interest) and (ii) the U.S. Holder's adjusted tax basis in
the Note. A U.S. Holder's adjusted tax basis in a Note generally will be equal
to the cost of the Note to such U.S. Holder (or the portion of the Unit purchase
price allocable to such Notes), increased by the amount of any market discount
or OID previously taken into income by the U.S. Holder and reduced by the amount
of any principal received by the U.S. Holder.
Subject to the discussion of market discount above, gain or loss realized on
the sale, exchange or redemption of a Note will be capital gain or loss. Capital
gain recognized by individual U.S. Holders generally will be subject to a
maximum federal income tax rate of (i) 39.6% if the U.S. Holder held the Note
for not more than one year, (ii) 28% if the U.S. Holder held the Note for more
than one year but not more than eighteen months, and (iii) 20% if the U.S.
Holder held the Note for more than eighteen months. The distinction between
capital gain or loss and ordinary income or loss is also relevant for purposes
of, among other things, limitations with respect to the deductibility of capital
losses.
An exchange of Notes pursuant to the Exchange Offer and the assumption of
the Notes by the Company should not be considered a taxable event.
NON-U.S. HOLDERS
In general, subject to the discussion below concerning backup withholding:
(a) payments of principal or interest (including OID) on the Notes by the
Company or any paying agent to a beneficial owner of a Note that is a Non-U.S.
Holder will not be subject to U.S. withholding tax, provided that, in the case
of interest or accrued OID, (i) such Non-U.S. Holder does not own, actually or
constructively, 10% or more of the total combined voting power of all classes of
stock of the Company entitled to vote, within the meaning of Section 871(h)(3)
of the Code, (ii) such Non-U.S. Holder is not a "controlled foreign corporation"
(within the meaning of the Code) that is related, directly or indirectly, to
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the Company through stock ownership, (iii) such Non-U.S. Holder is not a bank
receiving interest described in Section 881(c)(3)(A) of the Code, and (iv) the
certification requirements under Section 871(h) or Section 881(c) of the Code
and Treasury Regulations thereunder (summarized below) are satisfied;
(b) a Non-U.S. Holder of a Note will not be subject to U.S. income tax on
gains realized on the sale, exchange or other disposition of such Note, unless
(i) such Non-U.S. Holder is an individual who is present in the U.S. for 183
days or more in the taxable year of sale, exchange or other disposition, and
certain conditions are met, (ii) such gain is effectively connected with the
conduct by the Non-U.S. Holder of a trade or business in the U.S. and, if
certain tax treaties apply, is attributable to a U.S. permanent establishment
maintained by the Non-U.S. Holder, or (iii) the Non-U.S. Holder is subject to
Code provisions applicable to certain U.S. expatriates; and
(c) a Note held by an individual who is not a citizen or resident of the
U.S. at the time of his death will not be subject to U.S. estate tax as a result
of such individual's death, provided that, at the time of such individual's
death, the individual does not own, actually or constructively, 10% or more of
the total combined voting power of all classes of stock of the Company entitled
to vote and payments with respect to such Note would not have been effectively
connected with the conduct by such individual of a trade or business in the U.S.
To satisfy the certification requirements referred to in (a)(iv) above,
Sections 871(h) and 881(c) of the Code and currently effective Treasury
Regulations thereunder require that either (i) the beneficial owner of a Note
must certify, under penalties of perjury, to the Company or its paying agent, as
the case may be, that such owner is a Non-U.S. Holder and must provide such
owner's name and address, and U.S. taxpayer identification number ("TIN"), if
any, or (ii) a securities clearing organization, bank or other financial
institution that holds customers securities in the ordinary course of its trade
or business (a "Financial Institution") and holds the Note on behalf of the
beneficial owner thereof must certify, under penalties of perjury, to the
Company or its paying agent, as the case may be, that such certificate has been
received from the beneficial owner and must furnish the payor with a copy
thereof. A certificate described in this paragraph is effective only with
respect to payments of interest made to the certifying Non-U.S. Holder after
delivery of the certificate in the calendar year of its delivery and the two
immediately succeeding calendar years. Under temporary Treasury Regulations,
such requirement will be fulfilled if the beneficial owner of a Note certifies
on IRS Form W-8, under penalties of perjury, that it is a Non-U.S. Holder and
provides its name and address, and any Financial Institution holding the Note on
behalf of the beneficial owner files a statement with the withholding agent to
the effect that it has received such a statement from the beneficial owner (and
furnishes the withholding agent with a copy thereof).
Treasury Regulations published on October 14, 1997 (the "New Regulations"),
and pursuant to an announcement made by the Service on March 30, 1998, effective
for payments made after December 31, 1999, will provide alternative methods for
satisfying the certification requirements described above. The New Regulations
also would require, in the case of Notes held by a foreign partnership, that (i)
the certification be provided by the partners rather than by the foreign
partnership and (ii) the partnership provide certain information, including a
U.S. taxpayer identification number. A look-through rule would apply in the case
of tiered partnerships.
If a Non-U.S. Holder of a Note is engaged in a trade or business in the U.S.
and if interest (including OID) on the Note, or gain realized on the sale,
exchange or other disposition of the Note, is effectively connected with the
conduct of such trade or business and, if certain tax treaties apply, is
attributable to a U.S. permanent establishment maintained by the Non-U.S. Holder
in the U.S., the Non-U.S. Holder, although exempt from U.S. withholding tax
(provided that the certification requirements discussed in the next sentence are
met), will generally be subject to regular U.S. income tax on such interest or
gain in the same manner as if it were a U.S. Holder. In lieu of the certificate
described above, such a Non-U.S. Holder will be required, under currently
effective Treasury Regulations, to provide the Company with a properly
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executed IRS Form 4224 in order to claim an exemption from withholding tax. In
addition, if such Non-U.S. Holder is a foreign corporation, it may be subject to
a branch profits tax equal to 30% (or such lower rate provided by an applicable
treaty) of its effectively connected earnings and profits for the taxable year,
subject to certain adjustments. For purposes of the branch profits tax, interest
(including OID) on a Note and any gain recognized on the sale, exchange or other
disposition of a Note will be included in the earnings and profits of such
Non-U.S. Holder if such interest or gain is effectively connected with the
conduct by a Non-U.S. Holder of a trade or business in the U.S. The New
Regulations will change certain of the withholding reporting and certification
requirements described above, effective for payments made after December 31,
1999, subject to certain grandfathering provisions.
In the unlikely event the Notes were treated as equity, the periodic
distributions received by a Non-U.S. Holder on the Notes would not qualify for
the portfolio interest exemption from U.S. federal income tax described above.
Rather, the periodic distributions would be subject to a 30% U.S. withholding
tax (or reduced rate under an applicable tax treaty) in the case where income on
the Note was not effectively connected with a U.S. trade or business of such
Non-U.S. Holder. Under currently effective Treasury Regulations, a withholding
agent would be required to withhold tax from all distributions paid on the stock
regardless of the company's earnings and profits, but holders could apply for
refunds if such stock's share of the company's earnings and profits were less
than the amount of the distributions. Under the New Regulations, and with
respect to payments made after December 31, 1999, a company may reduce the
amount of withholding required under the foregoing rule if it elects to make a
reasonable estimate of its current and accumulated earnings and profits.
Non-U.S. Holders should consult with their tax advisors regarding U.S. and
foreign tax consequences with respect to the Notes.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Backup withholding of U.S. federal income tax at a rate of 31% may apply to
payments made in respect of a Note to a holder that is not an "exempt recipient"
and that fails to provide certain identifying information (such as the holder's
TIN) in the manner required. Generally, individuals are not exempt recipients,
whereas corporations and certain other entities are exempt recipients. Payments
made in respect of a Note must be reported to the Service, unless the holder is
an exempt recipient or otherwise establishes an exemption.
In the case of payments of interest on a Note to a Non-U.S. Holder, Treasury
Regulations provide that backup withholding and information reporting will not
apply to payments with respect to which either requisite certification has been
received or an exemption has otherwise been established (provided that neither
the Company nor a paying agent has actual knowledge that the holder is a U.S.
Holder or that the conditions of any other exemption are not in fact satisfied).
Payments of the proceeds of the sale of a Note to or through a foreign
office of a broker that is a U.S. person, a "controlled foreign corporation"
(within the meaning of the Code) or a foreign person, 50% or more of whose gross
income from all sources for the three-year period ending with the close of its
taxable year preceding the payment was effectively connected with the conduct of
a trade or business within the U.S., are currently subject to certain
information reporting requirements, unless the payee is an exempt recipient or
such broker has evidence in its records that the payee is a Non-U.S. Holder and
no actual knowledge that such evidence is false and certain other conditions are
met. Temporary Treasury Regulations indicate that such payments are not
currently subject to backup withholding. Under current Treasury Regulations,
payments of the proceeds of a sale of a Note to or through the U.S. office of a
broker will be subject to information reporting and backup withholding unless
the payee certifies under penalties of perjury as to his or her status as a
Non-U.S. Holder and satisfies certain other qualifications (and no agent or
broker who is responsible for receiving or reviewing such statement has actual
knowledge that it is incorrect) and provides his or her name and address or the
payee otherwise establishes an exemption.
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Any amounts withheld under the backup withholding rules from a payment to a
holder of a Note will be allowed as a refund or credit against such holder's
U.S. federal income tax, provided that the required information is furnished to
the Service.
As noted above, the Treasury Department recently issued the New Regulations.
In general, the New Regulations do not significantly alter the substantive
withholding and information reporting requirements but unify current
certification procedures and forms and clarify reliance standards. Under the New
Regulations, special rules apply which permit the shifting of primary
responsibility for withholding to certain financial intermediaries acting on
behalf of beneficial owners. Although the New Regulations do not take effect
until January 1, 1999, the Service announced on March 30, 1998, that it will
regard the 1999 calendar year as a transition period for the administration of
the withholding tax system. Accordingly, in enforcing compliance with current
withholding rules for 1999, the Service will take into account the extent to
which a withholding agent makes a good faith effort to transform its information
systems to comply with the New Regulations. A holder of a Note should consult
with its tax advisor regarding the application of the backup withholding rules
to its particular situation, the availability of an exemption therefrom, the
procedure for obtaining such an exemption, if available, and the impact of the
New Regulations on payments made with respect to Notes or Warrants after
December 31, 1999.
THE FOREGOING SUMMARY DOES NOT DISCUSS ALL ASPECTS OF UNITED STATES FEDERAL
INCOME TAXATION THAT MAY BE RELEVANT TO A PARTICULAR HOLDER OF NOTES IN LIGHT OF
ITS PARTICULAR CIRCUMSTANCES AND INCOME TAX SITUATION. PROSPECTIVE HOLDERS
SHOULD CONSULT THEIR OWN TAX ADVISOR AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM
OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE NOTES, INCLUDING THE
APPLICATION AND EFFECT OF STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND THE
POSSIBLE EFFECTS OF CHANGES IN UNITED STATES OR OTHER TAX LAWS.
PLAN OF DISTRIBUTION
Reference is made to "The Exchange Offer" above for a description of the
Exchange Offer, including the purpose of the Exchange Offer, the basis upon
which the Exchange Notes are offered and expenses incurred in connection with
the Exchange Offer.
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus with
any resale of such Exchange Notes. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of Exchange Notes received in exchange for Original Notes where
such Original Notes were acquired as a result of market making activities or
other trading activities. The Company will, during the period ending 180 days
after the Expiration Date, make this Prospectus, as amended or supplemented,
available to any broker-dealer for use in connection with any such resale.
Neither the Company nor any of its affiliates has entered into any
arrangement or understanding with any broker-dealer to distribute the Exchange
Notes and will not receive any proceeds from any sale of Exchange Notes by any
broker-dealers or any other persons. Exchange Notes received by broker-dealers
for their own account pursuant to the Exchange Offer may be sold from time to
time in one or more transactions in the over-the-counter market, in negotiated
transactions, through the writing of options on the Exchange Notes or a
combination of such methods of resale, at market prices prevailing at the time
of the resale, at prices related to such prevailing market prices or negotiated
prices. Any such resale may be made directly to purchasers or to or through
brokers or dealers who may receive compensation in the form of commissions or
concessions from any such broker or dealer and/or the purchaser of any such
Exchange Notes. Any broker or dealer that resells Exchange Notes that were
received by it for its own account pursuant to the Exchange Offer and any broker
or dealer that participates in a distribution of such Exchange Notes may be
deemed to be an "underwriter" within the meaning of the Securities Act and any
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profit on any such resale of Exchange Notes and any commissions or concessions
received by any such person may be deemed to be underwriting compensation under
the Securities Act. The Letter of Transmittal states that by acknowledging that
it will deliver and by delivering a prospectus, a broker-dealer will not be
deemed to admit that it is an "underwriter" within the meaning of the Securities
Act.
The Company has agreed to pay all expenses incident to the Exchange Offer
other than commissions or concessions of any brokers or dealers and expenses of
counsel for the underwriters or Holders of the Exchange Notes.
LEGAL MATTERS
The validity of the Exchange Notes will be passed upon for the Company by
Kelley Drye & Warren LLP, New York, New York, counsel to the Company. Certain
attorneys in the firm of Kelley Drye & Warren own an aggregate of approximately
$225,000 of the partnership interests in KMC Telecommunications L.P. which owns
40,000 shares of Common Stock of the Company. Certain regulatory matters are
being passed upon for the Company by Swidler & Berlin, Chartered, Washington
D.C.
EXPERTS
The balance sheets of KMC Telecom Holdings, Inc. as of December 31, 1997,
and KMC Telecom Inc. as of December 31, 1996 and the related statements of
operations, redeemable and nonredeemable equity and cash flows for the years
then ended (and the related 1997 financial statement schedule), appearing in
this Prospectus and Registration Statement have been audited by Ernst & Young
LLP, independent auditors, as set forth in their reports appearing elsewhere
herein, and are included in reliance upon such reports given upon the authority
of such firm as experts in accounting and auditing. The Kamine Multimedia Corp.
and KMC Southeast Corp. combined statements of operations, redeemable and
nonredeemable equity and cash flows for the year ended December 31, 1995 have
been audited by KPMG Peat Marwick LLP, independent auditors, as set forth in
their report appearing elsewhere herein and are included in reliance upon such
report given upon the authority of such firm as experts in accounting and
auditing. The balance sheets of the Melbourne System (an operating unit of ICG
Communications, Inc.) as of December 31, 1995 and 1996 and the related
statements of operations and accumulated deficit and cash flows for the years
then ended have been audited by KPMG Peat Marwick LLP, independent auditors, as
set forth in their report appearing elsewhere herein, and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.
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GLOSSARY OF SELECTED TERMS
ACCESS CHARGES. The fees paid by long distance carriers to ILECs for
originating and terminating long distance calls on their local networks.
ATM (Asynchronous Transfer Mode). A switching and transmission technology
that is one of a general class of packet technologies that relay traffic by way
of an address contained within the first five bits of a standard 53 bit-long
packet or cell. ATM-based packet transport was specifically developed to allow
switching and transmission of mixed voice, data and video (sometimes referred to
as "multimedia" information) at varying rates. The ATM format can be used by
many different information systems.
BACKBONE RING. Most CLECs have built their networks in ring configurations
in order to ensure that, if one segment of a network is damaged or cut, the
traffic can be simply re-routed and sent to its destination in the opposite
direction. The Company uses a "self-healing" optical fiber ring architecture
known as SONET.
BACKBONE EXTENSIONS. Fiber optic connections to remote areas not within the
backbone ring network.
BOCS (Bell Operating Companies). The seven local telephone companies
established by the Divestiture. These BOCs were historically prohibited from
providing interLATA services and from manufacturing telecommunications
equipment.
CAP (Competitive Access Provider). A company that provides its customers
with an alternative to the local telephone company for local transport of
private line, special access and interstate transport of switched access
telecommunications services. CAPs are the predecessor companies to the CLECs.
CENTRAL OFFICES. The switching centers or central switching facilities for
the Company and other CLECs and/or ILECs.
CENTREX. Centrex is a service that offers features similar to those of a
Private Branch Exchange (PBX), except the equipment is located at the carrier's
premises and not at the premises of the customer. These features include direct
dialing within a given phone system, voice mail, direct dialing of incoming
calls, and automatic identification of outbound calls, among others. Carriers
with Centrex-type capabilities can provide these value-added services to a wide
range of customers who do not have the size or the funds to support their own
on-site PBX.
CLEC (Competitive Local Exchange Carrier). A CAP that also provides
switched local telecommunications services.
CO-CARRIER STATUS. A relationship between a CLEC and an ILEC that affords
each entity the same access to and right on the other's network, and that
provides access and services on an equal basis.
COLLOCATION. The ability of a CLEC to connect to another LEC's Central
Office. Physical collocation describes the placing of network connection
equipment inside the LEC's central offices. Virtual collocation is an
alternative to physical collocation pursuant to which an LEC permits another LEC
to connect its network to its LEC's central offices on comparable terms, even
though the network connection equipment is not physically located inside the
central offices.
DEDICATED LINES. Telecommunications lines dedicated or reserved for use
exclusively by particular customers along predetermined routes (in contrast to
telecommunications lines within the ILEC's public switched network).
DIALING PARITY. Allows customers to have 1 + and 0+ service no matter which
local or long distance carrier they choose. For example, when MCI first got into
the long distance business, customers had to dial
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a ten digit prefix before the number they were calling. This was considered
unacceptable to many in the industry who favor "dialing parity."
DIVESTITURE. In 1982, the Department of Justice forced the breakup of the
old Bell System. The Divestiture of AT&T established seven separate Regional
Bell Operating Companies (RBOCs) and created two distinct segments of
telecommunications service: local and long distance. This laid the groundwork
for intense competition in the long distance industry, but essentially created
seven separate regionally-based local exchange service monopolies.
DOMINANT CARRIER. Carriers with the market power to raise prices, curtail
overall output or engage in predatory pricing.
DS-O, DS-1, DS-3. Standard telecommunications industry digital signal
formats, which are distinguishable by bit rate (the number of binary digits (0
and 1) transmitted per second). DS-0 service has a bit rate of 64 kilobits per
second. DS- 1 service has a bit rate of 1.544 megabits per second and DS-3
service has a bit rate of 45 megabits per second.
FCC. The Federal Communications Commission, an agency of the United States.
FIBER MILE. The number of route miles installed (excluding pending
installations) along a telecommunications path multiplied by the number of
fibers along that path. See the definition of "route mile" below.
FIBER OPTICS. Fiber optic cable is the medium of choice for the
telecommunications and cable industries. Fiber is immune to electrical
interference and many environmental factors that affect copper wiring and
satellite transmission. Fiber optic technology involves sending laser light
pulses across glass strands in order to transmit digital information.
GECC. General Electric Capital Corporation, a New York corporation.
ILECS (INCUMBENT LOCAL EXCHANGE COMPANY). The local access business, until
recently, has remained the domain of the RBOCs and approximately 1,000 ILECs,
including GTE. In general, the ILECs connect end users inter-LATA and also
provide the local portion for most long distance calls. The ILECs are required
to serve all residential and business users within a restricted geographic area
defined as a LATA. The market for local exchange services consists of a number
of services and related charges that include (i) basic dial tone and private
line services; (ii) the local origination or termination of long distinct
telephone calls; and (iii) the variable portion of charges received by the ILECs
for long distance calls originating and terminating within a LATA or for
intra-LATA toll services.
ISDN (INTEGRATED SERVICES DIGITAL NETWORK). A complex networking concept
designed to provide a variety of voice, data and digital interface standards.
Incorporated into ISDN are many new enhanced services, such as high speed data
file transfer, desk top videoconferencing, telepublishing, telecommuting,
telepresence learning (distance learning), remote collaboration (screened
sharing), data network linking and home information services.
ISP (INTERNET SERVICE PROVIDER). A company that provides subscribers basic
access to the Internet, along with additional services that may include E-Mail,
site hosting, web page development, and other Internet-related services, along
with technical support of these services.
INTERCONNECTION DECISIONS. Rulings by the FCC announced in August 1996,
which established a framework of minimum, national rules enabling state public
service commissions and the FCC to begin implementing many of the local
competition provisions of the Telecommunications Act.
INTER-LATA CALLS. Inter-LATA calls are calls that pass from one LATA to
another. Typically, these calls are referred to as long distance calls.
Historically, the ILECs were prohibited from providing Inter-LATA long distance
service.
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INTRA-LATA CALLS. Intra-LATA calls, also known as short haul calls, are
those local calls that originate and terminate within the same LATA. Although
most states allow some form of Intra-LATA competition, dialing parity still does
not exist, and very little ILEC Intra-LATA revenue has been won by competitors.
IXC. Inter-Exchange Carriers, usually referred to as long distance
providers. There are many facilities-based IXCs including AT&T, MCI, WorldCom,
Sprint and Frontier, as well as many CLECs that are authorized for IXC service.
KILOBIT. One thousand bits of information.
LANS (Local Area Networks). The interconnection of computers for the
purpose of sharing files, programs and various devices such as work stations,
printers and high-speed modems. LANs may include dedicated computers or file
servers that provide a centralized source of shared files and programs.
LATAS. The geographically defined Local Access and Transport Areas in which
ILECs are authorized to provide local exchange services.
LOCAL EXCHANGE CARRIER OR LEC. Provider of local exchange services,
includes the RBOCs, GTE and independent companies such as the Company.
LONG DISTANCE CARRIERS OR IXCS (Interexchange Carriers). Long distance
carriers provide services between local exchanges on an interstate or intrastate
basis. A long distance carrier may offer services over its own or another
carrier's facilities. Major long distance carriers include AT&T, MCI, Sprint,
WorldCom and Frontier, but may also include resellers of long distance capacity.
MEGABIT. One million bits of information.
NUMBER PORTABILITY. The ability of an end user to change local exchange
carriers while retaining the same telephone number. If number portability does
not exist, customers will have to change phone numbers when they change local
exchange carriers. This is considered to be anti-competitive because customers
are reluctant to change numbers, since they may lose business or confuse those
people trying to call them. It is currently being ascertained whether or not
number portability is technologically and economically feasible, and over what
time frame it can be implemented.
PBX. A Private Branch Exchange is a switching system within an office
building which allows calls from outside to be routed directly to the individual
instead of through a central number. This PBX also allows for calling within an
office by way of four digit extensions. Centrex is a service which can simulate
this service from an outside switching source, thereby eliminating the need for
a large capital expenditure on a PBX.
PHYSICAL COLLOCATION. See Collocation.
POPS (Points of Presence). Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
calls to, a network switching center of that long distance carrier.
PRIVATE LINE. A private, dedicated telecommunications connection to
different locations (excluding long distance carrier POPs).
RBOCS (Regional Bell Operating Companies). Same as BOCs.
RECIPROCAL COMPENSATION. The same compensation of a CLEC for termination of
a local call on the CLEC network, as the CLEC pays the ILEC for termination of
local calls on the ILEC network.
ROUTE MILES. The number of miles of the telecommunications path in which
fiber optic cables are installed as it would appear on a network map.
G-3
<PAGE>
SPECIAL ACCESS. The lease of private, dedicated telecommunications lines or
"circuits" along the network of an ILEC or a CLEC (such as the Company), which
lines or circuits run to and from a long distance carrier's POPs. Examples of
special access services are telecommunications lines running between POPs of a
single long distance carrier, from one long distance carrier POP to the POP of
another long distance carrier or from an end user to its long distance carrier
POP. Special access services do not require the use of switches.
SONET (Synchronous Optical Network). SONET is the electronics and network
architecture which enables transmission of voice, video and data (multimedia) at
very high speeds. This state-of-the-art self-healing ring network offers
advantages over older linear networks in that a cut line or equipment failure
can be overcome by rerouting calls within the network. If the line is cut, the
traffic can be simply reversed and sent to its destination around the other side
of the ring.
SWITCH. A sophisticated computer that accepts instructions from a caller in
the form of a telephone number. Like an address on an envelope, the numbers tell
the switch where to route the call. The switch opens or closes circuits or
selects the paths or circuits to be used for transmission of information.
Switching is a process of interconnecting circuits to form a transmission path
between users. Switches allow local telecommunications service providers to
connect calls directly to their destination, while providing advanced features
and recording connection information for future billing.
SWITCHED ACCESS TRANSPORT SERVICES. Transportation of switched traffic
along dedicated lines between the ILEC central offices and long distance carrier
POPs.
SWITCHED SERVICES. These services are the greatest source of revenue for
carriers. While some CLEC networks simply provide special access capacity for
other carriers, those carriers authorized to provide switched service are in a
position to generate significantly greater revenue.
TELECOMMUNICATIONS ACT. The Telecommunications Act of 1996.
TIER I MARKETS. Metropolitan markets in the United States with a population
greater than two million.
TIER II MARKETS. Metropolitan markets in the United States with population
ranging from 750,000 to two million.
TIER III MARKETS. Metropolitan markets in the United States with population
ranging from 100,000 to 750,000.
G-4
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
KMC Telecom Holdings, Inc.
Unaudited Condensed Consolidated Balance Sheets, December 31, 1997 and March 31, 1998.................... F-2
Unaudited Condensed Consolidated Statements of Operations, Three Months Ended March 31, 1997 and 1998.... F-3
Unaudited Condensed Consolidated Statements of Cash Flows, Three Months Ended March 31, 1997 and 1998.... F-4
Notes to Unaudited Condensed Consolidated Financial Statements........................................... F-5
KMC Telecom Holdings, Inc. and Predecessors
Report of Ernst & Young LLP.............................................................................. F-9
Report of KPMG Peat Marwick LLP.......................................................................... F-10
Balance Sheets, December 31, 1996 and 1997............................................................... F-11
Statements of Operations, Years Ended December 31, 1995, 1996 and 1997................................... F-12
Statements of Redeemable and Nonredeemable Equity, Years Ended December 31, 1995, 1996 and 1997.......... F-13
Statements of Cash Flows, Years Ended December 31, 1995, 1996 and 1997................................... F-14
Notes to Financial Statements............................................................................ F-15
Melbourne System (an operating unit of ICG Communications, Inc.)
Report of KPMG Peat Marwick LLP.......................................................................... F-38
Balance Sheets, December 31, 1995 and 1996............................................................... F-39
Statements of Operations and Accumulated Deficit, Years Ended December 31, 1995
and 1996............................................................................................... F-40
Statements of Cash Flows, Years Ended December 31, 1995 and 1996......................................... F-41
Notes to Financial Statements............................................................................ F-42
Unaudited Condensed Statement of Operations and Accumulated Deficit, Period from January 1, 1997 to July
11, 1997............................................................................................... F-45
Unaudited Condensed Statement of Cash Flows, Period from January 1, 1997 to July 11, 1997................ F-46
</TABLE>
F-1
<PAGE>
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1997 1998
------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 15,552,903 $ 54,407,916
Accounts receivable, net of allowance for doubtful accounts of $34,000 in 1997
and 1998...................................................................... 1,318,156 1,945,548
Prepaid expenses and other current assets....................................... 488,719 875,974
------------- --------------
Total current assets.............................................................. 17,359,778 57,229,438
Investments held for future capital expenditures.................................. -- 165,500,000
Networks and equipment, net....................................................... 71,371,063 79,222,036
Intangible assets, net............................................................ 2,655,207 3,014,089
Deferred financing costs, net..................................................... 4,196,613 15,786,922
Other assets...................................................................... 360,646 5,893,228
------------- --------------
$ 95,943,307 $ 326,645,713
------------- --------------
------------- --------------
LIABILITIES AND REDEEMABLE AND NONREDEEMABLE EQUITY
Current liabilities:
Accounts payable................................................................ $ 5,513,487 $ 4,597,856
Accrued expenses................................................................ 8,127,453 8,630,156
Due to affiliates............................................................... 47,024 22,389
------------- --------------
Total current liabilities......................................................... 13,687,964 13,250,401
Notes payable..................................................................... 51,276,933 40,476,149
Subordinated notes payable........................................................ 10,000,000 --
Senior discount notes payable..................................................... -- 244,454,037
------------- --------------
Total liabilities................................................................. 74,964,897 298,180,587
Redeemable equity:
Redeemable cumulative convertible preferred stock, par value $.01 per share
498,800 shares authorized; shares issued and outstanding:
Series A, 123,800 shares in 1997 and 1998..................................... 18,878,626 20,886,230
Series C, 150,000 shares in 1997 and 175,000 shares in 1998................... 14,667,283 17,869,283
Series D, 25,000 shares in 1997 and 0 shares in 1998.......................... 2,379,475 --
Redeemable common stock, shares issued and outstanding: 132,773 in 1997 and
224,041 in 1998............................................................... 11,186,705 20,850,416
Redeemable common stock warrants................................................ 539,600 563,313
------------- --------------
Total redeemable equity........................................................... 47,651,689 60,169,242
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 3,000,000 shares authorized, 613,835
shares issued and outstanding................................................. 6,138 6,138
Additional paid-in capital...................................................... 15,373,558 22,208,005
Unearned compensation........................................................... (6,521,349) (5,422,419)
Accumulated deficit............................................................. (35,531,626) (48,495,840)
------------- --------------
Total nonredeemable equity (deficiency)........................................... (26,673,279) (31,704,116)
------------- --------------
$ 95,943,307 $ 326,645,713
------------- --------------
------------- --------------
</TABLE>
See accompanying notes.
F-2
<PAGE>
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
<S> <C> <C>
1997 1998
-------------- --------------
Revenue........................................................................... $ 125,438 $ 2,792,950
Operating expenses:
Network operating costs......................................................... 611,359 5,816,133
Selling, general and administrative............................................. 1,122,581 3,472,520
Stock option compensation expense............................................... 66,000 1,098,930
Depreciation and amortization................................................... 135,551 993,573
-------------- --------------
Total operating expenses...................................................... 1,935,491 11,381,156
-------------- --------------
Loss from operations.............................................................. (1,810,053) (8,588,206)
Interest expense, net............................................................. 163,033 4,376,008
-------------- --------------
Net loss.......................................................................... (1,973,086) (12,964,214)
Dividends and accretion on redeemable preferred stock............................. (163,823) (3,353,208)
-------------- --------------
Net loss applicable to common shareholders........................................ $ (2,136,909) $ (16,317,422)
-------------- --------------
-------------- --------------
Net loss per common share......................................................... $ (3.56) $ (20.18)
-------------- --------------
-------------- --------------
Weighted average number of common shares outstanding.............................. 600,000 808,467
-------------- --------------
-------------- --------------
</TABLE>
See accompanying notes.
F-3
<PAGE>
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------------
1997 1998
------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................................................... $ (1,973,086) $ (12,964,214)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................................... 135,551 993,573
Non-cash interest expense....................................................... 27,548 5,801,741
Non-cash stock option expense................................................... 66,000 1,098,930
Changes in assets and liabilities:
Accounts receivable........................................................... (10,489) (627,392)
Prepaid expenses and other current assets..................................... (201,841) (387,255)
Accounts payable.............................................................. (1,471,514) (915,631)
Accrued expenses.............................................................. (143,750) 1,134,393
Due to affiliates............................................................. (62,144) (24,635)
Other assets.................................................................. (7,018) (532,582)
------------- ---------------
Net cash used in operating activities............................................. (3,640,743) (6,423,072)
------------- ---------------
INVESTING ACTIVITIES
Construction of networks and purchases of equipment............................... (4,417,618) (8,771,727)
Acquisitions of franchises, authorizations and related assets..................... (1,004,636) (431,701)
Deposit on purchase of equipment.................................................. -- (5,000,000)
Purchases of investments.......................................................... -- (165,500,000)
------------- ---------------
Net cash used in investing activities............................................. (5,422,254) (179,703,428)
------------- ---------------
FINANCING ACTIVITIES
Proceeds from notes payable....................................................... 7,959,466 --
Repayment of notes payable........................................................ -- (20,800,784)
Proceeds from issuance of common stock............................................ -- 10,000,000
Proceeds from issuance of senior discount notes and warrants, net of issuance
costs of $13,591,271............................................................ -- 236,374,297
Dividends on preferred stock of subsidiary........................................ -- (592,000)
------------- ---------------
Net cash provided by financing activities......................................... 7,959,466 224,981,513
------------- ---------------
Net increase in cash and cash equivalents......................................... (1,103,531) 38,855,013
Cash and cash equivalents, beginning of period.................................... 1,486,514 15,552,903
------------- ---------------
Cash and cash equivalents, end of period.......................................... $ 382,983 $ 54,407,916
------------- ---------------
------------- ---------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net of amounts capitalized.............. $ 135,485 $ 875,979
------------- ---------------
------------- ---------------
</TABLE>
See accompanying notes.
F-4
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
1. BASIS OF PRESENTATION AND ORGANIZATION
KMC Telecom Holdings, Inc. ("KMC Holdings") and its subsidiaries, KMC
Telecom Inc. ("KMC Telecom"), KMC Telecom II, Inc. ("KMC Telecom II") and KMC
Telecom of Virginia, Inc. are collectively referred to herein as the Company.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
The unaudited condensed consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial reporting. Accordingly, they do not include certain information and
note disclosures required by generally accepted accounting principles for annual
financial reporting and should be read in conjunction with the financial
statements and notes thereto of KMC Telecom Holdings, Inc. and Predecessors as
of and for the year ended December 31, 1997.
The unaudited interim financial statements reflect all adjustments which
management considers necessary for a fair presentation of the results of
operations for these periods. The results of operations for the interim periods
are not necessarily indicative of the results for the full year.
The balance sheet of KMC Telecom Holdings, Inc. at December 31, 1997 was
derived from the audited consolidated balance sheet at that date.
2. INVESTMENTS HELD FOR FUTURE CAPITAL EXPENDITURES
The Company has designated a portion of the proceeds from the Senior
Discount Notes offering as investments held for future capital expenditures. As
of March 31, 1998, the Company's investments held for future capital
expenditures consisted of cash equivalents (bank term deposits and commercial
paper with maturities of less than 90 days) of $136.9 million and debt
securities (US government obligations and commercial bonds due within 1 year) of
$28.6 million. All debt securities have been designated by the Company as
held-to-maturity. Accordingly, such securities are recorded in the accompanying
March 31, 1998 financial statements at amortized cost. At March 31, 1998, the
carrying value of such held-to-maturity debt securities approximated their fair
value.
3. NETWORKS AND EQUIPMENT
Networks and equipment are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER MARCH
31, 1997 31, 1998
------------- -------------
<S> <C> <C>
Fiber optic systems............................................ $ 29,837,558 $ 33,808,870
Telecommunications equipment................................... 18,052,090 20,117,579
Furniture and fixtures......................................... 1,517,777 2,826,805
Leasehold improvements......................................... 792,039 864,605
Construction-in-progress....................................... 23,555,907 24,909,239
------------- -------------
73,755,371 82,527,098
Less accumulated depreciation.................................. (2,384,308) (3,305,062)
------------- -------------
$ 71,371,063 $ 79,222,036
------------- -------------
------------- -------------
</TABLE>
Costs capitalized during the development of the Company's networks include
amounts incurred related to network engineering, design and construction and
capitalized interest. Capitalized interest
F-5
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
3. NETWORKS AND EQUIPMENT (CONTINUED)
related to the construction of the networks for the three months ended March 31,
1997 and 1998 amounted to approximately $27,000 and $605,000, respectively. For
the three months ended March 31, 1998, interest expense is net of $2.2 million
of interest income.
4. INTANGIBLE ASSETS
Intangible assets are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER MARCH
31, 1997 31, 1998
------------ ------------
<S> <C> <C>
Franchise costs................................................... $ 1,342,016 $ 1,562,530
Authorizations and rights-of-ways................................. 1,150,505 1,309,378
Building access agreements and other.............................. 567,144 619,458
------------ ------------
3,059,665 3,491,366
Less accumulated amortization..................................... (404,458) (477,277)
------------ ------------
$ 2,655,207 $ 3,014,089
------------ ------------
------------ ------------
</TABLE>
5. OTHER ASSETS
At March 31, 1998, other assets includes non-refundable deposits for the
purchase of switching equipment aggregating $5,000,000.
6. SENIOR DISCOUNT NOTES
On January 29, 1998, KMC Holdings sold 460,800 units, each unit consisting
of a 12 1/2% senior discount note with a principal amount at maturity of $1,000
due 2008 (the "Senior Discount Notes") and one warrant to purchase .21785 shares
of Common Stock of KMC Holdings at an exercise price of $.01 per share. Interest
on the Senior Discount Notes will be payable in cash on each February 15 and
August 15, commencing August 15, 2003. The Senior Discount Notes are
unsubordinated, unsecured indebtedness of KMC Holdings. However, KMC Holdings is
a holding company and the Senior Discount Notes will be effectively subordinated
to all existing and future liabilities (including trade payables) of the
Company's subsidiaries. The gross and net proceeds of the offering were
approximately $250.0 million and $236.4 million, respectively. Upon the closing
of the offering, the Company used the proceeds as follows: $10.8 million to
repay all amounts borrowed by KMC Telecom II under an Amended and Restated Loan
and Security Agreement with AT&T Commercial Finance Corporation ("AT&T
Finance"); $10.1 million to repay all amounts borrowed by KMC Telecom and KMC
Telecom II under a subordinated term loan from AT&T Finance (including $100,000
of accrued interest thereon); $5.0 million as a non-refundable down payment for
future purchases of switching equipment; and $592,000 to pay dividend arrearages
on the Series A Cumulative Convertible Preferred Stock of KMC Telecom. The
balance will be used to finance the planned expansion and further development of
the Company's networks and to fund operating losses and for the other general
corporate purposes. As of March 31, 1998, $165.5 million of the proceeds have
been classified as non-current assets, as such amounts have been designated for
future capital expenditures.
F-6
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
6. SENIOR DISCOUNT NOTES (CONTINUED)
The Senior Discount Notes contain covenants that, among other things,
restrict the ability of KMC Holdings and its subsidiaries to incur additional
indebtedness, create liens, engage in sale-leaseback transactions, pay dividends
or make distributions in respect of their capital stock, make investments or
certain other restricted payments, sell assets, redeem capital stock, issue or
sell stock of subsidiaries, enter into transactions with stockholders or
affiliates or, with respect to KMC Holdings, effect a consolidation or merger.
However, these limitations are subject to a number of qualifications and
exceptions.
The Senior Discount Notes are "applicable high yield discount obligations"
("AHYDOs"), as defined in the Internal Revenue Code of 1986, as amended, because
the yield to maturity of such Senior Discount Notes exceeded the "applicable
federal rate" in effect at the time of their issuance (the "AFR") plus five
percentage points. Under the rules applicable to AHYDOs, a portion of the
original issue discount ("OID") that accrues on the Senior Discount Notes will
not be deductible by the Company at any time. The non-deductible portion of the
OID will be an amount that bears the same ratio to such OID as (i) the excess of
the yield to maturity of the Senior Discount Notes over the AFR plus six
percentage points bears to (ii) the yield to maturity of the Senior Discount
Notes. To the extent that the non-deductible portion of OID would have been
treated as a dividend if it had been distributed with respect to the Company's
stock, it generally will be treated as a dividend to holders of the Senior
Discount Notes for purposes of the rules relating to the dividends received
deduction applicable to corporate holders. Any remaining OID on the Senior
Discount Notes will not be deductible by the Company until such OID is paid.
The warrants may be exercised at any time during the period beginning on the
date that is one year after the closing date and ending on January 31, 2008.
Warrants that are not exercised by such date will expire. The warrants were
recorded at their aggregate fair value of $11 million.
The Senior Discount Notes and warrants have not been registered under the
Securities Act of 1933 and are subject to restrictions on transfer.
7. COMMITMENTS AND CONTINGENCIES
LITIGATION
By letter dated August 29, 1997, KMC Telecom notified I-Net, Inc. ("I-NET")
that KMC Telecom considered I-NET to be in default under a Master
Telecommunications System Rollout Agreement dated as of October 1, 1996 (the
"I-NET Agreement"), pursuant to which I-NET had agreed to manage construction of
telephone systems for KMC Telecom in several cities, including the preparation
of design plans and specifications for each system. KMC Telecom considered I-NET
to be in default as a result of I-NET's failure to provide design plans and
specifications for several systems for which it had agreed to provide such plans
and specifications, to properly supervise construction of the systems or to
provide personnel with the necessary expertise to manage the projects. By letter
dated October 27, 1997, I-NET demanded payment of all amounts it alleged were
due under the I-NET Agreement and a related agreement (aggregating $4.1 million)
and stated that it would invoke the arbitration provisions under the I-NET
Agreement if the parties could not agree as to the amount due and payment terms
on or before November 27, 1997. By letter dated December 1, 1997, I-NET extended
its deadline for reaching agreement to December 15, 1997. Although the Company
and I-NET conducted discussions they were unable to reach an agreement and on
February 12, 1998, the Company received a demand for arbitration from Wang
Laboratories, Inc. ("Wang"), the successor to I-NET. The demand seeks at least
$4.1 million.
F-7
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 1998
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company believes that it has meritorious defenses to Wang's claims and has
asserted counterclaims seeking in excess of $2.5 million as a result of I-NET's
defaults under the I-NET Agreement. The Company believes that resolution of this
matter will not have a material adverse impact on its financial condition. No
assurance can be given, however, as to the ultimate resolution of this matter.
PURCHASE COMMITMENTS
As of March 31, 1998, the Company has outstanding commitments aggregating
approximately $56.2 million related to purchases of telecommunications equipment
and fiber optic cable and its obligations under its agreements with certain
suppliers.
8. NET LOSS PER COMMON SHARE
The following table sets forth the computation of net loss per common
share-basic:
<TABLE>
<CAPTION>
MARCH 31
-----------------------------
1997 1998
------------- --------------
<S> <C> <C>
Numerator:
Net loss..................................................... $ (1,973,086) $ (12,964,214)
Dividends and accretion on redeemable preferred stock........ (163,823) (3,353,208)
------------- --------------
Numerator for net loss per common share - basic.............. $ (2,136,909) $ (16,317,422)
------------- --------------
------------- --------------
Denominator:
Denominator for net loss per common share - weighted average
number of common shares outstanding........................ 600,000 808,467
------------- --------------
------------- --------------
Net loss per common share - basic.............................. $ (3.56) $ (20.18)
------------- --------------
------------- --------------
</TABLE>
Options and warrants to purchase an aggregate of 181,840 and 251,885 shares
of common stock were outstanding as of March 31, 1997 and 1998, respectively,
but a computation of diluted net loss per common share has not been presented,
as the effect would be anti-dilutive.
F-8
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
KMC Telecom Holdings, Inc.
We have audited the balance sheets of KMC Telecom Holdings, Inc. as of
December 31, 1997 and KMC Telecom Inc. as of December 31, 1996, and the related
statements of operations, redeemable and nonredeemable equity and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of KMC Telecom Holdings, Inc.
as of December 31, 1997 and KMC Telecom Inc. as of December 31, 1996, and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
March 11, 1998
F-9
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholder
Kamine Multimedia Corp. and
KMC Southeast Corp.:
We have audited the accompanying combined statements of operations,
redeemable and nonredeemable equity and cash flows of Kamine Multimedia Corp.
and KMC Southeast Corp. for the year ended December 31, 1995. These combined
financial statements are the responsibility of the Companies' management. Our
responsibility is to express an opinion on these combined financial statements
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the results of operations of Kamine Multimedia
Corp. and KMC Southeast Corp. and their cash flows for the year ended December
31, 1995 in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
New York, New York
April 26, 1996
F-10
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
(SEE NOTE 1)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
<S> <C> <C>
1996 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 1,486,514 $ 15,552,903
Accounts receivable, net of allowance for doubtful accounts of $0 in 1996 and
$34,000 in 1997................................................................... 22,516 1,318,156
Prepaid expenses and other current assets........................................... 142,416 488,719
------------ ------------
Total current assets.................................................................. 1,651,446 17,359,778
Networks and equipment, net........................................................... 12,347,216 71,371,063
Intangible assets, net................................................................ 1,192,582 2,655,207
Deferred financing costs, net......................................................... 1,458,698 4,196,613
Other assets.......................................................................... 65,267 360,646
------------ ------------
$ 16,715,209 $ 95,943,307
------------ ------------
------------ ------------
LIABILITIES AND REDEEMABLE AND NONREDEEMABLE EQUITY
Current liabilities:
Accounts payable.................................................................... $ 2,580,347 $ 5,513,487
Accrued expenses.................................................................... 1,334,456 8,127,453
Due to affiliates................................................................... 81,518 47,024
------------ ------------
Total current liabilities............................................................. 3,996,321 13,687,964
Convertible notes payable............................................................. 12,330,006 --
Notes payable......................................................................... -- 51,276,933
Subordinated notes payable............................................................ -- 10,000,000
------------ ------------
Total liabilities..................................................................... 16,326,327 74,964,897
Commitments and contingencies
Redeemable equity:
Redeemable cumulative convertible preferred stock, par value $.01 per share; 498,800
shares authorized; shares issued and outstanding:
123,800 shares of Series A ($12,380,000 liquidation preference)................. -- 18,878,626
150,000 shares of Series C ($15,000,000 liquidation preference)................. -- 14,667,283
25,000 shares of Series D ($2,500,000 liquidation preference)................... -- 2,379,475
Redeemable common stock, 132,773 shares issued and outstanding...................... -- 11,186,705
Redeemable common stock warrants.................................................... -- 539,600
------------ ------------
Total redeemable equity............................................................... -- 47,651,689
Nonredeemable equity (deficiency):
KMC Telecom Holdings, Inc.:
Common stock, par value $.01 per share; 3,000,000 shares authorized, 613,835
shares issued and outstanding................................................... -- 6,138
KMC Telecom Inc.:
Preferred stock, par value $.01 per share; 500,000 shares authorized.............. -- --
Common stock, par value $.01 per share; 2,900,000 shares authorized; 600,000
shares issued and outstanding................................................... 6,000 --
Additional paid-in capital.......................................................... 4,468,345 15,373,558
Unearned compensation............................................................... (1,239,000) (6,521,349)
Accumulated deficit................................................................. (2,846,463) (35,531,626)
------------ ------------
Total nonredeemable equity (deficiency)............................................... 388,882 (26,673,279)
------------ ------------
$ 16,715,209 $ 95,943,307
------------ ------------
------------ ------------
</TABLE>
See accompanying notes.
F-11
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
(SEE NOTE 1)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- ------------- --------------
<CAPTION>
(PREDECESSORS)
<S> <C> <C> <C>
Revenue............................................................. $ -- $ 205,087 $ 3,417,441
Operating expenses:
Network operating costs........................................... -- 1,360,553 7,735,849
Selling, general and administrative............................... 1,591,159 2,217,091 9,922,804
Stock option compensation expense................................. -- 240,000 13,869,346
Depreciation and amortization..................................... 5,770 286,509 2,505,875
------------- ------------- --------------
Total operating expenses........................................ 1,596,929 4,104,153 34,033,874
------------- ------------- --------------
Loss from operations................................................ (1,596,929) (3,899,066) (30,616,433)
Interest expense, net............................................... 23,463 596,248 2,068,730
------------- ------------- --------------
Net loss............................................................ (1,620,392) (4,495,314) (32,685,163)
Dividends and accretion on redeemable preferred stock............... -- -- (8,904,403)
------------- ------------- --------------
Net loss applicable to common shareholders.......................... $ (1,620,392) $ (4,495,314) $ (41,589,566)
------------- ------------- --------------
------------- ------------- --------------
Net loss per common share........................................... $ (2.70) $ (7.49) $ (64.93)
------------- ------------- --------------
------------- ------------- --------------
Weighted average number of common shares outstanding................ 600,000 600,000 640,568
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
See accompanying notes.
F-12
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
(SEE NOTE 1)
STATEMENTS OF REDEEMABLE AND NONREDEEMABLE EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
REDEEMABLE EQUITY
-----------------------------------------------------------------------------------------------
PREFERRED STOCK
-----------------------------------------------------------------------
SERIES A SERIES C SERIES D COMMON STOCK
---------------------- ---------------------- ----------------------- ----------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- ----------- --------- ----------- ----------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1994.................... -- $ -- -- $ -- -- $ -- -- $ --
Initial capital
contribution, KMC
Southeast Corp. April
19, 1995................
Net loss..................
--------- ----------- --------- ----------- ----------- ---------- --------- -----------
Balance, December 31,
1995.................... -- -- -- -- -- -- -- --
Change in authorized
capital.................
Contribution of
stockholder's loan and
related imputed interest
to equity...............
Issuance of common stock..
Issuance of stock options
to employees............
Amortization of unearned
compensation............
Fair value of stock
options issued to non-
employees...............
Reclassification of
deficit accumulated
through date of
termination of
Subchapter S election...
Net loss..................
--------- ----------- --------- ----------- ----------- ---------- --------- -----------
Balance, December 31,
1996.................... -- -- -- -- -- -- -- --
Conversion of convertible
notes payable to Series
A Preferred Stock....... 123,800 11,518,527
Issuance of warrants......
Issuance of common stock
and exercise of
warrants................ 132,773 10,863,226
Issuance of Series C
Preferred Stock......... 150,000 14,198,806
Issuance of Series D
Preferred Stock......... 25,000 2,299,648
Accretion on redeemable
equity.................. 7,360,099 468,477 79,827 323,479
Issuance and adjustment to
fair value of stock
options to employees....
Amortization of unearned
compensation............
Increase in fair value of
stock options issued to
non-employees...........
Net loss..................
--------- ----------- --------- ----------- ----------- ---------- --------- -----------
Balance, December 31,
1997.................... 123,800 $18,878,626 150,000 $14,667,283 25,000 $2,379,475 132,773 $11,186,705
--------- ----------- --------- ----------- ----------- ---------- --------- -----------
--------- ----------- --------- ----------- ----------- ---------- --------- -----------
<CAPTION>
NONREDEEMABLE EQUITY
------------------------------------------------------------------
TOTAL COMMON STOCK ADDITIONAL
REDEEMABLE ---------------------- PAID-IN UNEARNED ACCUMULATED
WARRANTS EQUITY SHARES AMOUNT CAPITAL COMPENSATION DEFICIT
----------- ----------- --------- ----------- ----------- -------------- -------------
<S> <C>
Balance, December 31,
1994.................... $ -- $ -- 100 $ 1 $ 999 $ -- $ (4,475)
Initial capital
contribution, KMC
Southeast Corp. April
19, 1995................ 100 1 999
Net loss.................. (1,620,392)
----------- ----------- --------- ----------- ----------- -------------- -------------
Balance, December 31,
1995.................... -- -- 200 2 1,998 -- (1,624,867)
Change in authorized
capital................. 559,800 5,598 (5,598)
Contribution of
stockholder's loan and
related imputed interest
to equity............... 2,267,063
Issuance of common stock.. 40,000 400 3,999,600
Issuance of stock options
to employees............ 1,283,000 (1,283,000)
Amortization of unearned
compensation............ 44,000
Fair value of stock
options issued to non-
employees............... 196,000
Reclassification of
deficit accumulated
through date of
termination of
Subchapter S election... (3,273,718) 3,273,718
Net loss.................. (4,495,314)
----------- ----------- --------- ----------- ----------- -------------- -------------
Balance, December 31,
1996.................... -- -- 600,000 6,000 4,468,345 (1,239,000) (2,846,463)
Conversion of convertible
notes payable to Series
A Preferred Stock....... 11,518,527
Issuance of warrants...... 2,025,277 2,025,277
Issuance of common stock
and exercise of
warrants................ (1,500,277) 9,362,949 13,835 138
Issuance of Series C
Preferred Stock......... 14,198,806
Issuance of Series D
Preferred Stock......... 2,299,648
Accretion on redeemable
equity.................. 14,600 8,246,482 (8,246,482)
Issuance and adjustment to
fair value of stock
options to employees.... 14,295,658 (14,295,658)
Amortization of unearned
compensation............ 9,013,309
Increase in fair value of
stock options issued to
non-employees........... 4,856,037
Net loss.................. (32,685,163)
----------- ----------- --------- ----------- ----------- -------------- -------------
Balance, December 31,
1997.................... $ 539,600 $47,651,689 613,835 $ 6,138 $15,373,558 $ (6,521,349) $(35,531,626)
----------- ----------- --------- ----------- ----------- -------------- -------------
----------- ----------- --------- ----------- ----------- -------------- -------------
<CAPTION>
TOTAL
NONREDEEMABLE
EQUITY
(DEFICIENCY)
---------------
Balance, December 31,
1994.................... $ (3,475)
Initial capital
contribution, KMC
Southeast Corp. April
19, 1995................ 1,000
Net loss.................. (1,620,392)
---------------
Balance, December 31,
1995.................... (1,622,867)
Change in authorized
capital................. --
Contribution of
stockholder's loan and
related imputed interest
to equity............... 2,267,063
Issuance of common stock.. 4,000,000
Issuance of stock options
to employees............ --
Amortization of unearned
compensation............ 44,000
Fair value of stock
options issued to non-
employees............... 196,000
Reclassification of
deficit accumulated
through date of
termination of
Subchapter S election... --
Net loss.................. (4,495,314)
---------------
Balance, December 31,
1996.................... 388,882
Conversion of convertible
notes payable to Series
A Preferred Stock.......
Issuance of warrants......
Issuance of common stock
and exercise of
warrants................ 138
Issuance of Series C
Preferred Stock.........
Issuance of Series D
Preferred Stock.........
Accretion on redeemable
equity.................. (8,246,482)
Issuance and adjustment to
fair value of stock
options to employees.... --
Amortization of unearned
compensation............ 9,013,309
Increase in fair value of
stock options issued to
non-employees........... 4,856,037
Net loss.................. (32,685,163)
---------------
Balance, December 31,
1997.................... $ (26,673,279)
---------------
---------------
</TABLE>
See accompanying notes.
F-13
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
(SEE NOTE 1)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- -------------- --------------
OPERATING ACTIVITIES
Net loss.......................................................... $ (1,620,392) $ (4,495,314) $ (32,685,163)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................... 5,770 286,509 2,505,875
Non-cash interest expense....................................... -- 697,644 611,478
Non-cash stock option compensation expense...................... -- 240,000 13,869,346
Changes in assets and liabilities:
Accounts receivable........................................... -- (22,516) (1,295,640)
Prepaid expenses and other current assets..................... (4,542) (137,874) (346,303)
Accounts payable.............................................. 65,516 789,100 2,933,140
Accrued expenses.............................................. 316,874 417,138 6,061,584
Due to affiliates............................................. 479,967 (409,549) (34,494)
Other assets.................................................. (22,226) (52,428) (295,379)
------------- -------------- --------------
Net cash used in operating activities............................. (779,033) (2,687,290) (8,675,556)
------------- -------------- --------------
INVESTING ACTIVITIES
Construction of networks and purchases of equipment............... (1,772,802) (9,110,989) (59,145,924)
Cash paid for acquisition of Melbourne Network.................... -- -- (2,000,000)
Acquisitions of franchises, authorizations and related assets..... (147,286) (1,063,347) (1,846,423)
------------- -------------- --------------
Net cash used in investing activities............................. (1,920,088) (10,174,336) (62,992,347)
------------- -------------- --------------
FINANCING ACTIVITIES
Proceeds from stockholder loans................................... 2,727,400 3,542,161 --
Repayment of stockholder loans.................................... -- (4,181,561) --
Proceeds from notes payable, net of issuance costs of $1,046,830
in 1996 and $1,404,182 in 1997.................................. -- 10,953,170 59,872,751
Proceeds from issuance of common stock and exercise of warrants,
net of issuance costs of $637,190 in 1997....................... 1,000 4,000,000 9,363,087
Proceeds from issuance of preferred stock, net of issuance costs
of $1,001,546 in 1997........................................... -- -- 16,498,454
------------- -------------- --------------
Net cash provided by financing activities......................... 2,728,400 14,313,770 85,734,292
------------- -------------- --------------
Net increase in cash and cash equivalents......................... 29,279 1,452,144 14,066,389
Cash and cash equivalents, beginning of year...................... 5,091 34,370 1,486,514
------------- -------------- --------------
Cash and cash equivalents, end of year............................ $ 34,370 $ 1,486,514 $ 15,552,903
------------- -------------- --------------
------------- -------------- --------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for interest, net of amounts
capitalized..................................................... $ 56,537 $ 96,974 $ 766,236
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
See accompanying notes.
F-14
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION
KMC Telecom Holdings, Inc. ("KMC Holdings") is a holding company formed
primarily to own all of the shares of its operating subsidiaries, KMC Telecom
Inc. ("KMC Telecom"), KMC Telecom II, Inc. ("KMC Telecom II"), and KMC Telecom
of Virginia Inc. KMC Telecom II was organized as a wholly-owned subsidiary of
KMC Holdings concurrently with the organization of KMC Holdings. Ownership of
KMC Telecom of Virginia, Inc., which was originally organized as a wholly-owned
subsidiary of KMC Telecom, was transferred to KMC Holdings at the same time. On
September 22, 1997, the stockholders of KMC Telecom exchanged all of their KMC
Telecom common and preferred stock for equal numbers of shares of common and
preferred stock of KMC Holdings. The merger was accounted for as an exchange of
shares between entities under common control, and no changes were made to the
historical cost basis of KMC Telecom's net assets.
KMC Holdings and its subsidiaries, KMC Telecom, KMC Telecom II and KMC
Telecom of Virginia, Inc. are collectively referred to herein as the Company.
The predecessors to KMC Telecom, Kamine Multimedia Corp. and KMC Southeast
Corp. (the "Predecessors") were incorporated in the state of Delaware on May 10,
1994 and April 19, 1995, respectively. The Predecessors were established through
the purchase of 100 shares of common stock of each company by Harold N. Kamine
("Kamine") for $1,000 per company. Effective May 23, 1996, Kamine Multimedia
Corp. was merged into KMC Southeast Corp., and the surviving corporation was
renamed KMC Telecom Inc. The merger was accounted for as a combination of
entities under common control, and the net assets of Kamine Multimedia Corp.
were transferred at their historical cost in a manner similar to that in pooling
of interests accounting.
The Company is a facilities-based competitive local exchange carrier
providing telecommunications and data services to its customers; principally
business, industry, institutions, government and other users, primarily in the
Southeastern and Midwestern United States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
As noted above, effective May 23, 1996, KMC Telecom was the successor
resulting from the merger of the Predecessors, and effective September 22, 1997,
KMC Telecom became a wholly-owned subsidiary of KMC Holdings. The accompanying
financial statements include the consolidated financial position and results of
operations of KMC Holdings and its subsidiaries subsequent to September 22,
1997, the financial position and results of operations of KMC Telecom from May
23, 1996, and the combined results of operations of the Predecessors from
January 1, 1995. All significant intercompany accounts and transactions have
been eliminated.
REVENUE RECOGNITION
Revenue is recognized in the period the service is provided.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents.
F-15
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NETWORKS AND EQUIPMENT
Networks and equipment are stated at cost, net of accumulated depreciation.
Depreciation is provided over the estimated useful lives of the respective
assets using the straight-line method for financial statement reporting
purposes.
The estimated useful lives of the Company's principal classes of assets are
as follows:
<TABLE>
<S> <C>
Networks:
Fiber optic systems........................................ 20 years
Telecommunications equipment............................... 10 years
Furniture and fixtures....................................... 5 years
Leasehold improvements....................................... Life of lease
</TABLE>
INTANGIBLE ASSETS
Costs incurred in developing new networks or expanding existing networks,
including negotiation of rights-of-way and obtaining regulatory authorizations
are deferred and amortized over the initial term of the franchise, which
generally range from 5 to 15 years.
Costs incurred to obtain city franchises are deferred by the Company and
amortized over the initial term of the franchise, which generally range from 5
to 15 years.
DEFERRED FINANCING COSTS
The Company capitalizes issuance costs related to its debt. Such costs are
amortized utilizing the interest method over the lives of the related debt.
OTHER ASSETS
Other assets are comprised principally of security deposits and other
deposits.
NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share ("Statement 128"). Statement 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented in accordance with the provisions of Statement 128. The adoption of
Statement 128 had no effect on previously reported earnings per share. Diluted
earnings per share has not been presented for any period, as the impact of
including outstanding options and warrants would be anti-dilutive. The
Predecessors' earnings per share have been computed as if the May 23, 1996
merger and the related change in authorized and issued common stock had occurred
as of May 10, 1994 (date of inception).
F-16
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
Through June 4, 1996, the Predecessors and KMC Telecom elected to be treated
as "S" Corporations for federal income tax purposes. As a result, any income or
loss generated through such date was allocated directly to the Stockholder.
Effective June 5, 1996, KMC Telecom revoked its "S" Corporation election.
The Company uses the liability method to account for income taxes. Deferred
taxes are recorded based upon differences between the financial statement and
tax basis of assets and liabilities.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
FINANCIAL INSTRUMENTS
Premiums paid to purchase interest rate cap agreements are amortized to
interest expense over the terms of the caps. Unamortized premiums are included
in other assets in the balance sheet. Amounts to be received under cap
agreements are accounted for on an accrual basis, and are recognized as a
reduction of interest expense.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company records impairment losses on long-lived assets used in
operations or expected to be disposed of when events and circumstances indicate
that the cash flows expected to be derived from those assets are less than the
carrying amounts of those assets. No such events and circumstances have
occurred.
STOCK-BASED COMPENSATION
As permitted by FASB Statement No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("Statement 123"), the Company has elected to follow Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB
25") and related interpretations in accounting for its employee stock option
plans. Under APB 25, no compensation expense is recognized at the time of option
grant if the exercise price of the employee stock option is fixed and equals or
exceeds the fair market value of the underlying common stock on the date of
grant, and the number of shares to be issued pursuant to the exercise of such
option are known and fixed at the grant date. As more fully described in Note 8,
KMC Telecom's outstanding stock options are not considered fixed options under
APB 25.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 130, REPORTING COMPREHENSIVE INCOME, which establishes
new rules for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements is required to
be adopted by companies for periods beginning after December 15, 1997. The
Company does not believe that this statement will have any current effect on the
Company's financial statement presentation because it presently has no items of
comprehensive income.
F-17
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
3. NETWORKS AND EQUIPMENT
Networks and equipment are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
Fiber optic systems............................................ $ 4,343,027 $ 29,837,558
Telecommunications equipment................................... 838,892 18,052,090
Furniture and fixtures......................................... 264,201 1,517,777
Leasehold improvements......................................... 159,931 792,039
Construction-in-progress....................................... 7,003,396 23,555,907
------------- -------------
12,609,447 73,755,371
Less accumulated depreciation.................................. (262,231) (2,384,308)
------------- -------------
$ 12,347,216 $ 71,371,063
------------- -------------
------------- -------------
</TABLE>
Costs capitalized during the development of the Company's networks include
amounts incurred related to network engineering, design and construction and
capitalized interest. Capitalized interest related to the construction of the
networks during the years ended December 31, 1995, 1996 and 1997 amounted to
approximately $37,000, $103,000, and $854,000, respectively.
For the years ended December 31, 1995, 1996 and 1997, depreciation expense
was $2,181, $260,050 and $2,122,077, respectively.
4. INTANGIBLE ASSETS
Intangible assets are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1996 1997
------------ ------------
<S> <C> <C>
Franchise costs................................................... $ 694,600 $ 1,342,016
Authorizations and rights-of-ways................................. 362,770 1,150,505
Building access agreements and other.............................. 155,872 567,144
------------ ------------
1,213,242 3,059,665
Less accumulated amortization..................................... (20,660) (404,458)
------------ ------------
$ 1,192,582 $ 2,655,207
------------ ------------
------------ ------------
</TABLE>
5. DEFERRED FINANCING COSTS
As of December 31, 1997, the Company has capitalized an aggregate of
approximately $4.0 million (of which $600,000 had been capitalized as of
December 31, 1996) of issuance costs related to its $70 million senior credit
facility and its $10 million subordinated note payable, as well as approximately
$732,000 of costs related to the Company's January 1998 issuance of senior
discount notes and warrants.
Costs related to the senior credit facility and subordinated note payable
are being amortized utilizing the interest method, and approximately $561,000 of
such costs were charged to interest expense during the year ended December 31,
1997.
F-18
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
5. DEFERRED FINANCING COSTS (CONTINUED)
At December 31, 1996, the Company had capitalized an aggregate of
approximately $1,047,000 of issuance costs related to the convertible notes
payable. For the year ended December 31, 1996, $189,000 of such costs were
charged to interest expense. The net unamortized balance of such costs was
charged against redeemable preferred stock in January 1997 upon the conversion
of such notes to preferred stock (see Note 6).
6. CONVERTIBLE NOTES PAYABLE
KMC Telecom entered into an Amended and Restated Note Purchase and
Investment Agreement dated as of October 22, 1996 and amended as of December 30,
1996 (the "Agreement") with Nassau Capital Partners L.P. and NAS Partners I
L.L.C. ("Nassau Capital" and "Nassau Partners", respectively, collectively
referred to as "Nassau") pursuant to which convertible secured notes payable of
$5,941,320 and $58,680 were issued on October 22, 1996 to Nassau Capital and
Nassau Partners, respectively. Additionally, the Agreement amended and restated
certain terms related to convertible secured notes payable of $5,952,616 and
$47,384 issued on June 6, 1996 to Nassau Capital and Nassau Partners,
respectively. (The convertible secured notes payable issued on June 6, 1996 and
October 22, 1996 are collectively referred to herein as the "Convertible
Notes".)
The Convertible Notes bore interest at an annual rate of 7%, payable
quarterly. At the option of KMC Telecom, such interest could be paid either in
cash or through a payment in-kind, increasing the outstanding principal amount
due under the Convertible Notes. KMC Telecom had reflected the $330,006 of
interest due through December 31, 1996 as additional principal.
Concurrent with the January 21, 1997 receipt of the proceeds of KMC
Telecom's initial borrowing under the AT&T Facility, the Convertible Notes,
including accrued interest through that date, aggregating approximately
$12,380,000 were converted into 123,800 shares of Series A Cumulative
Convertible Preferred Stock of KMC Telecom (such stock was exchanged for an
equal number of shares of Series A Preferred Stock of KMC Holdings on September
22, 1997). In connection with the conversion, net unamortized deferred financing
costs of approximately $862,000 were charged against redeemable preferred stock.
7. LONG-TERM DEBT
AT&T FACILITY
KMC Telecom entered into a Loan and Security Agreement dated as of December
31, 1996 with AT&T Commercial Finance Corporation ("AT&T Finance") which
provided for borrowings up to $35 million to fund construction and operating
costs of networks in various cities.
On September 22, 1997, KMC Telecom and KMC Telecom II entered into an
Amended and Restated Loan and Security Agreement (the "AT&T Facility") with AT&T
Finance. Under the AT&T Facility, AT&T Finance agreed to lend KMC Telecom and
KMC Telecom II (the "Borrowers") up to an aggregate of $70 million (the
"Commitment Amount") to be used for the construction of fiber optic
telecommunications networks in certain markets, subject to certain conditions.
Disbursements under the AT&T Facility are available for engineering, design and
backbone construction with additional amounts to finance expansion of networks
operated by KMC Telecom (which comprise the original eight networks), and up to
F-19
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
7. LONG-TERM DEBT (CONTINUED)
55% of the cost of switches and electronic equipment, not to exceed $15 million,
purchased for networks to be operated by KMC Telecom II. The total amount loaned
for any network may not exceed the total property, plant and equipment book
value for such network. At December 31, 1997, an aggregate of $51,276,933 was
outstanding under this facility, of which $10,800,784 had been borrowed by KMC
Telecom II.
The AT&T Facility will mature no later than October 1, 2005. Escalating
quarterly payments are due under the facility beginning January 1, 2000.
Borrowings under the AT&T Facility will bear interest on the outstanding
principal amount. The interest rate, prior to October 1, 1999 will be the
commercial paper rate (as defined in the AT&T Facility) plus 5%. After October
1, 1999, the interest rate will be either a fixed rate equal to 5.5% plus the
average rate of U.S. Treasury Notes maturing the same month in which the
remaining average life of the loans ends, or a variable rate equal to either the
commercial paper rate plus 5%, or the LIBOR rate plus 5%, at Borrowers' option.
If the Borrowers default on any payment due under the AT&T Facility, the
interest rate will increase by four percentage points. An annual administration
fee of $100,000 is payable on the first payment date of each calendar year
beginning January 1, 1998.
KMC Holdings has unconditionally guaranteed the repayment of the AT&T
Facility when such repayment is due, whether at maturity, upon acceleration, or
otherwise. KMC Holdings has agreed to pay all amounts outstanding under the AT&T
Facility, on demand, upon the occurrence and during the continuation of any
event of default (as defined therein). The Company has pledged the shares of KMC
Telecom and KMC Telecom II to AT&T Finance to secure its obligations under the
guaranty. In addition, each of the Borrowers has pledged all of its assets to
AT&T Finance. Accordingly, if there were an event of default under the AT&T
Facility, the lenders thereunder would be entitled to payment in full and could
foreclose on the assets of the Borrowers and the holders of the senior discount
notes (issued in January 1998) would have no right to share in such assets.
AT&T Finance has the right to require prepayment of all loans made under the
AT&T Facility in the event of a change in control (as defined in the AT&T
Facility). Events triggering a change in control include KMC Holdings ceasing to
own 100% of the outstanding capital stock of each of the Borrowers (except as a
result of the exercise of warrants by AT&T Finance or its affiliates, successors
or assigns or the exercise of stock options under KMC Telecom's existing option
plan). AT&T Finance has the right, in its discretion, to require repayment of
the outstanding obligations of KMC Telecom II at the closing of a debt offering
by KMC Holdings with gross cash proceeds of at least $50 million. On January 29,
1998, the $10,800,784 borrowed by KMC Telecom II was repaid in full with a
portion of the proceeds of KMC Holdings' issuance of senior discount notes and
warrants. After repayment of all amounts borrowed by KMC Telecom II on the
Closing Date: (i) KMC Telecom II is no longer a borrower or an obligor under the
AT&T Facility, (ii) KMC Telecom II is no longer subject to the covenants and
restrictions referred to in the immediately succeeding paragraph and (iii) the
stock and assets of KMC Telecom II have been released from the pledge to AT&T
Finance.
The AT&T Facility contains a number of negative covenants including, among
others, covenants restricting the ability of the Borrowers to consolidate or
merge with any person, sell or lease assets not in the ordinary course of
business, sell or enter into long term leases of dark fiber, redeem stock, pay
dividends, create subsidiaries, transfer any permits or licenses, or incur
additional indebtedness or act as guarantor for the debt of any person. The AT&T
Facility also contains a number of affirmative covenants including, among
others, covenants requiring the Borrowers to preserve and maintain corporate
existence,
F-20
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
7. LONG-TERM DEBT (CONTINUED)
comply with laws, maintain their properties, maintain insurance, pay taxes,
furnish AT&T Finance with copies of financial statements and inform the lender
of litigation.
The Borrowers are required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a requirement that
at the end of each fiscal quarter of each of the Borrowers commencing with the
fiscal quarter ending September 30, 1997 through and including the fiscal
quarter ending December 31, 1999 the ratio of available cash (defined as cash
available plus the amount available under the AT&T Facility for which all
conditions precedent have been fulfilled) plus, only if positive, EBITDA to
lender debt service (as defined below) shall equal at least 1.00 to 1.00. Lender
debt service shall be measured on the last day of each fiscal quarter and shall
equal the sum of (i) cash interest expense for the immediately succeeding four
fiscal quarters, to be calculated by giving effect to the total debt outstanding
to AT&T Finance on the last day of such fiscal quarter, with such debt deemed to
be accruing interest over the next four fiscal quarters at an interest rate
equal to the interest rate in effect on such last day of such fiscal quarter,
and (ii) scheduled principal payments for the immediately succeeding four fiscal
quarters. At the end of each fiscal quarter ending March 31, 2000 through June
30, 2001, inclusive, the ratio of the sum of the available cash, plus, only if
positive, EBITDA to lender debt service must equal at least 1.25 to 1.00.
At the end of each fiscal quarter of KMC Telecom during each period set
forth below, the ratio of EBITDA of KMC Telecom for the immediately preceding
four fiscal quarters to lender debt service shall equal at least the ratio set
forth below:
<TABLE>
<CAPTION>
FISCAL PERIODS RATIO
- ------------------------------------------------------------------------------- -------------
<S> <C>
July 1, 2001--December 31, 2001................................................ 1.25 to 1.00
January 1, 2002--December 31, 2002............................................. 1.35 to 1.00
January 1, 2003--and each fiscal quarter thereafter............................ 1.75 to 1.00
</TABLE>
Failure to satisfy any of the financial covenants will constitute an event
of default under the AT&T Facility, permitting AT&T Finance, after notice, to
terminate the commitment and/or accelerate payment of outstanding indebtedness
notwithstanding the ability of the Borrowers to meet their debt service
obligations. The AT&T Facility also includes other customary events of default,
including, without limitation, a cross-default to other indebtedness, material
undischarged judgments and bankruptcy.
The Company is required to make twenty-four consecutive quarterly
installment payments commencing January 1, 2000 as follows, assuming that the
full $70 million has been borrowed (quarterly payments will be reduced pro rata
for any unused portion of the $70 million Commitment Amount):
<TABLE>
<CAPTION>
QUARTERLY QUARTERLY
PAYMENT DATES PRINCIPAL AMOUNT
- --------------------------------------------------------------------- -----------------------
<S> <C>
January 1, 2000--October 1, 2002..................................... $ 1,750,000
January 1, 2003--October 1, 2004..................................... 3,500,000
January 1, 2005--July 1, 2005........................................ 5,250,000
October 1, 2005...................................................... Remaining balance
</TABLE>
Additionally, the AT&T Facility restricts the ability of KMC Telecom to pay
dividends to, or to pay principal or interest on loans from, KMC Holdings. At
December 31, 1997, KMC Telecom had a net
F-21
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
7. LONG-TERM DEBT (CONTINUED)
capital deficiency of approximately $4.7 million. Such restrictions could
adversely affect the Company's liquidity and ability to meet its cash
requirements, including its ability to repay the senior discount notes (issued
in January 1998).
The AT&T Facility requires that the Company purchase interest rate cap
agreements under which, if the commercial paper rate (as defined therein) or
LIBOR rises above 12%, the Company will receive payments to offset the higher
interest rates due on the debt. As a result, the Company has entered into an
interest rate cap agreement with a bank which expires on December 1, 1998, to
hedge the Company's interest expense on $28 million of its indebtedness under
the AT&T Facility.
SUPPLEMENTAL AT&T FACILITY
On September 22, 1997, KMC Telecom and KMC Telecom II obtained a
subordinated term loan (the "Supplemental AT&T Facility") from AT&T Finance with
an original principal amount of $10 million. The proceeds from the loan were
used for working capital and general corporate purposes. The loan bears interest
at the option of the Company at the commercial paper rate plus 6% or the LIBOR
rate plus 6%, payable quarterly. The Supplemental AT&T Facility is due in full
upon the closing of a debt offering with gross cash proceeds of at least $50
million or in escalating quarterly installments commencing January 2000. On
January 29, 1998, the entire $10 million outstanding under this facility was
repaid in full with a portion of the proceeds of the Company's issuance of
senior discount notes and warrants.
The Supplemental AT&T Facility is generally subject to the same terms,
covenants and restrictions as the AT&T Facility.
8. REDEEMABLE AND NONREDEEMABLE EQUITY
KMC TELECOM PREFERRED STOCK
On January 21, 1997, in connection with the initial funding of the AT&T
Facility, the Convertible Notes were converted into 123,800 shares of Series A
Cumulative Convertible Preferred Stock of KMC Telecom with an aggregate
liquidation value of $12,380,000. Effective September 22, 1997, all of the
shares of Series A Cumulative Convertible Preferred Stock were exchanged for a
similar number of shares of Series A Cumulative Convertible Preferred Stock of
KMC Holdings.
Pursuant to an agreement with Nassau, all dividends accumulated on the
Series A Cumulative Convertible Preferred Stock of KMC Telecom through September
22, 1997 ($592,000) were paid upon the closing of KMC Holdings' issuance of
senior discount notes and warrants on January 29, 1998.
SERIES A CUMULATIVE CONVERTIBLE PREFERRED STOCK
There are 123,800 shares of Series A Cumulative Convertible Preferred Stock
of KMC Holdings ("Series A Preferred Stock") authorized and outstanding. Series
A Preferred Stock has a liquidation preference of $100 per share and an annual
dividend equal to 7.0% of the liquidation preference, payable quarterly, when
and if declared by the Board of Directors out of funds legally available
therefor. Unpaid dividends accumulate and the unpaid amount increases at the
annual rate of 7.0%, compounded quarterly. All accumulated but unpaid dividends
will be paid upon the occurrence of a Realization Event (defined as (i) an
initial public offering with gross proceeds of at least $40 million or (ii) sale
of substantially all the
F-22
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
assets or stock of the Company or the merger or consolidation of the Company
into one or more other corporations). As of December 31, 1997, dividends in
arrears on the Series A Preferred Stock aggregated $216,000. Notwithstanding the
foregoing, pursuant to an agreement among Nassau and the Company dated September
22, 1997, Nassau has agreed to forego the payment of dividends from September
22, 1997 through the date on which Nassau disposes of its interest in the
Company; provided that at the time of such disposition Nassau has received not
less than a 10% annual compound rate of return during the period it held the
Series A Preferred Stock.
Series A Preferred Stock is convertible into Common Stock at a conversion
price equal to $20.63 per share of Common Stock, subject to adjustment upon the
occurrence of certain events. Holders of Series A Preferred Stock may convert
all or part of such shares to Common Stock at any time and from time to time.
Upon conversion, subject to the aforementioned agreement dated September 22,
1997 to forego the payment of dividends, the holders are entitled to receive a
cash payment of the accumulated but unpaid dividends; provided, however, that
the Company may substitute common shares having a fair market value equal to the
amount of such cash payment if the conversion occurs before a Realization Event.
Series A Preferred Stock will automatically convert into Common Stock upon the
occurrence of a Qualified Public Offering (defined as the first sale of Common
Stock pursuant to a registration statement filed under the Securities Act in
which the Company receives gross proceeds of at least $40 million, provided that
the per share price at which such shares are sold in such offering is at least
four times the conversion price of the Series A Preferred Stock).
The holders of Series A Preferred Stock, except as otherwise provided in the
Company's Certificate of Incorporation, are entitled to vote on all matters
voted on by holders of Common Stock. Each share of Series A Preferred Stock is
entitled to a number of votes equal to the number of shares of Common Stock into
which such share is convertible. Without the prior consent of two-thirds of the
shares of Series A Preferred Stock, among other things, the Company may not
increase the number of shares of preferred stock (of whatever series) authorized
for issuance, or declare or pay any dividends on shares of Common Stock or other
junior shares. As discussed under "Redemption Rights", below, the holders of
Series A Preferred Stock have certain redemption rights. Accordingly, such stock
has been reflected as redeemable equity in the accompanying financial
statements.
SERIES C CUMULATIVE CONVERTIBLE PREFERRED STOCK
There are 350,000 shares of Series C Cumulative Convertible Preferred Stock
of KMC Holdings ("Series C Preferred Stock") authorized of which 150,000 shares
are outstanding at December 31, 1997. Such shares were issued in November 1997
generating aggregate gross proceeds of $15 million. Series C Preferred Stock has
a liquidation preference of $100 per share and an annual dividend equal to 7.0%
of the liquidation preference, payable quarterly, when and if declared by the
Board of Directors out of funds legally available therefor. Unpaid dividends
accumulate and the unpaid amount increases at the annual rate of 7.0%,
compounded quarterly. All accumulated but unpaid dividends will be paid upon the
occurrence of a Realization Event. As of December 31, 1997, dividends in arrears
on the Series C Preferred Stock aggregated $161,000. Notwithstanding the
foregoing, pursuant to the Purchase Agreement among the Company, Nassau and the
holders of the Series C Preferred Stock dated as of October 31, 1997, each
current holder of Series C Preferred Stock has agreed to forego the payment of
dividends that accumulate during the period from issuance through the date on
which such holder disposes of its interest
F-23
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
in the Company; provided that at the time of such disposition it has received
not less than a 10% annual compound rate of return during such period.
Series C Preferred Stock is convertible into Common Stock at a conversion
price equal to (i) from the date of initial issuance to but excluding the date
which is 30 months after the date of such initial issuance, $52.50 per share of
Common Stock; provided, however, that if a Realization Event occurs during such
30-month period the conversion price will be equal to a fraction the numerator
of which is (A) the consideration per share of Common Stock (on a fully diluted
basis) received in connection with such Realization Event, and the denominator
of which is (B) 1.30 raised to a number equal to the number of years (or
fraction thereof) from the date of initial issuance of the Series C Preferred
Stock until the date of such Realization Event, but in no case greater than
$52.50 nor less than $42.18 per share of Common Stock and (ii) from and after
the date which is 30 months after the date of initial issuance, $42.18, subject
to adjustment upon the happening of certain events. Holders of Series C
Preferred Stock may convert all or part of such shares to Common Stock at any
time and from time to time. Upon conversion, subject to the aforementioned
agreement dated October 31, 1997 to forego the payment of dividends, the holders
are entitled to receive a cash payment of the accumulated but unpaid dividends;
provided, however, that the Company may substitute common shares having a fair
market value equal to the amount of such cash payment if the conversion occurs
before a Realization Event. Series C Preferred Stock will automatically convert
into Common Stock upon the occurrence of a Qualified Public Offering.
The holders of Series C Preferred Stock, except as otherwise provided in the
Company's Certificate of Incorporation, are entitled to vote on all matters
voted on by holders of Common Stock. Each share of Series C Preferred Stock is
entitled to a number of votes equal to the number of shares of Common Stock into
which such share is convertible. Without the prior consent of two-thirds of the
shares of Series C Preferred Stock, among other things, the Company may not
increase the number of shares of preferred stock (of whatever series) authorized
for issuance, or declare or pay any dividends on shares of Common Stock or other
junior shares. As discussed under "Redemption Rights", below, the holders of
Series C Preferred Stock have certain redemption rights. Accordingly, such stock
has been reflected as redeemable equity in the accompanying financial
statements.
The Series C Preferred Stock is subject to redemption at the option of the
Company, in whole but not in part, in connection with an "Acquisition Event." An
Acquisition Event is defined to mean any merger or consolidation of the Company
with any other company, person or entity, whether or not the Company is the
surviving entity, as a result of which the holders of the Company's Common Stock
(determined on a fully diluted basis) will hold less than a majority of the
outstanding shares of Common Stock or other equity interest of the Company,
person or entity resulting from such transaction, or any parent of such entity.
SERIES D CUMULATIVE CONVERTIBLE PREFERRED STOCK
There are 25,000 shares of Series D Cumulative Convertible Preferred Stock
of KMC Holdings ("Series D Preferred Stock") authorized, of which 25,000 shares
are outstanding at December 31, 1997. Such shares were issued to Nassau in
November 1997 generating aggregate gross proceeds of $2.5 million. In January
1998, Nassau exercised its conversion rights and converted its shares of Series
D Preferred Stock into an equal number of shares of Series C Preferred Stock.
Series D Preferred Stock has a liquidation preference of $100 per share and an
annual dividend equal to 7.0% of the liquidation
F-24
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
preference, payable quarterly, when and if declared by the Board of Directors
out of funds legally available therefor. Unpaid dividends accumulate and the
unpaid amount increases at the annual rate of 7.0%, compounded quarterly. All
accumulated but unpaid dividends will be paid upon the occurrence of a
Realization Event. As of December 31, 1997, dividends in arrears on the Series D
Preferred Stock aggregated $27,000.
KMC TELECOM COMMON STOCK
On November 12, 1996, KMC Telecommunications L.P., a limited partnership
owned by Kamine and Kathleen Kamine, purchased 40,000 shares of Class A Common
Stock, $.01 par value, of KMC Telecom for the purchase price of $4 million.
Using the proceeds from this equity issuance, KMC Telecom repaid in full its
indebtedness to Kamine of $4 million.
On September 22, 1997, all of the outstanding shares of Class A Common Stock
of KMC Telecom were exchanged for a similar number of shares of Common Stock of
KMC Holdings.
COMMON STOCK
Holders of Common Stock of the Company are entitled to one vote for each
share held on all matters submitted to a vote of stockholders, except with
respect to the election of Directors. Except as otherwise required by law,
actions at the Company's stockholders meetings (held at least annually), require
the affirmative vote of a majority of the shares represented at the meeting, a
quorum being present. Holders of Common Stock are entitled, subject to the
preferences of preferred stock, to receive such dividends, if any, as may be
declared by the Board of Directors out of funds legally available therefor.
Without the prior consent of two-thirds of the shares of Series A Preferred
Stock and two-thirds of the shares of Series C Preferred Stock, the Company may
not declare or pay any dividends on its Common Stock. Except as discussed under
"Redemption Rights" below, the holders of Common Stock have no preemptive,
redemption or conversion rights. Pursuant to provisions contained in the
Company's Certificate of Incorporation and an Amended and Restated Stockholders
Agreement dated as of October 31, 1997, among the Company, Kamine, Nassau, AT&T
Credit Corporation ("AT&T Credit"), General Electric Capital Corporation
("GECC"), and CoreStates Bank, N.A. ("CoreStates") ( the "Stockholders'
Agreement"), until Kamine and Nassau cease to own Common Stock or preferred
stock convertible into Common Stock representing at least five percent of the
outstanding shares of Common Stock (assuming all convertible securities are
converted), Kamine and Nassau have special rights to elect Directors. Kamine's
shares of Common Stock currently have the right to elect three Directors, one of
whom must be the Company's President and Chief Executive Officer. Nassau's
shares currrently have the right to elect three Directors. A Director elected by
Kamine's shares or Nassau's shares may not be removed except with the
affirmative vote of a majority of the applicable shares of capital stock. If
Kamine or Nassau transfer their shares of capital stock, the number of Directors
their shares are entitled to elect decreases. If Kamine or Nassau hold less than
5% of the shares of capital stock initially issued to them, the shares of such
person have no further right to elect specific Directors. Directors other than
those elected by vote of Kamine's shares or Nassau's shares are elected by
holders of Common Stock and holders of preferred stock that are entitled to vote
in the election of Directors. If a default relating to payment occurs under the
AT&T Facility and continues uncured for 90 days, the holders of Series C
Preferred Stock are entitled to elect two additional Directors, who will serve
until the default is cured.
F-25
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
Immediately preceding the reorganization on September 22, 1997, Nassau and
Kamine each received 13,835 shares of Class A Common Stock of KMC Telecom, which
were subsequently exchanged for a similar number of shares of Common Stock of
KMC Holdings.
On September 22, 1997, KMC Holdings sold to AT&T Credit 91,268 shares of
Common Stock for gross proceeds of $10 million.
REDEMPTION RIGHTS
Pursuant to the Stockholders' Agreement, each of Nassau, CoreStates, AT&T
Credit and GECC has a "put right" entitling it to have the Company repurchase
its preferred and common shares for the fair market value of such shares if no
Liquidity Event (defined as (i) an initial public offering with gross proceeds
of at least $40.0 million, (ii) the sale of substantially all of the stock or
assets of the Company or (iii) the merger or consolidation of the Company with
one or more other corporations) has taken place by the later of (x) October 22,
2003 or (y) 90 days after the final maturity date of the senior discount notes
(issued in January 1998, with a stated maturity date of January 2008).
CoreStates, GECC and AT&T Credit may not exercise such put rights unless Nassau
has exercised its put right. The restrictive covenants of the senior discount
notes limit the Company's ability to repurchase such shares. All of the shares
of preferred and common stock subject to such "put right" are presented as
redeemable equity in the accompanying balance sheet at December 31, 1997.
The redeemable preferred stock, redeemable common stock and redeemable
common stock warrants (described below) are being accreted up to their fair
market values from their respective issuance dates to their earliest potential
redemption date (October 22, 2003). At December 31, 1997, the aggregate
redemption value of the redeemable equity was approximately $118 million,
reflecting per share redemption amounts of $531 for the Series A Preferred
Stock, $209 for the Series C and D Preferred Stock and $110 for the redeemable
common stock and redeemable common stock warrants. Accordingly, $8,246,000 of
accretion has been charged to additional paid-in-capital in 1997.
WARRANTS
In connection with KMC Telecom's 1996 Loan and Security Agreement, warrants
representing a 5% ownership interest in the fully diluted common voting capital
stock of KMC Telecom, including anti-dilution protection, were granted to AT&T
Finance (and subsequently assigned to AT&T Credit and CoreStates). These
warrants, at an exercise price of $.01 per share, were issued on January 21,
1997, concurrent with the initial borrowing under the AT&T Facility, at which
date the fair value of such warrants was determined to be $1.5 million, which
was reflected as a charge to deferred financing costs and credited to equity in
January 1997. On September 22, 1997, 50% of such warrants were exercised, and an
aggregate of 27,670 shares of Class A Common Stock of KMC Telecom were issued to
the warrant holders; these shares were subsequently exchanged for a similar
number of shares of Common Stock of KMC Holdings.
The remaining 50% of the warrants ("Restricted Warrants") are not
exercisable prior to June 30, 1998. The Restricted Warrants will be exercisable
after July 1, 1998 unless the Company obtains additional financing with gross
proceeds in excess of $100 million prior to July 1, 1998. Upon the closing of
KMC
F-26
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
Holdings' senior discount notes and warrants offering in January 1998, the
Restricted Warrants were repurchased by KMC Holdings for a de minimis price.
In connection with the AT&T Facility, warrants to purchase 10,000 shares of
Common Stock were issued to GECC in 1997. These warrants, at an exercise price
of $.01 per share, are exercisable from issuance through January 21, 2005. The
fair value of such warrants was determined to be $525,000, which was reflected
as a charge to deferred financing costs and credited to equity. Pursuant to the
Stockholders' Agreement, GECC may put the shares of Common Stock issuable upon
the exercise of such warrants back to the Company. These warrants have been
presented as redeemable common stock warrants in the accompanying balance sheet
at December 31, 1997.
In connection with the Supplemental AT&T Facility, KMC Holdings issued to
AT&T Finance a warrant to purchase 91,268 shares of its Common Stock for an
aggregate purchase price of $10 million. Upon the closing of KMC Holdings'
senior discount notes and warrants offering in January 1998, such warrant was
exercised and KMC Holdings issued such shares of Common Stock.
OPTIONS
During 1996, the Board of KMC Telecom adopted and Kamine approved the 1996
Stock Purchase and Option Plan for Key Employees of KMC Telecom Inc. and
Affiliates (the "1996 Plan"). The 1996 Plan, which is administered by the
Compensation Committee of the Board of Directors of KMC Telecom, provides for
various grants to key employees, directors, affiliated members or other persons
having a unique relationship with the Company excluding Kamine and any person
employed by Nassau Capital or any Nassau affiliate. Grants may include, without
limitation, incentive stock options, non-qualified stock options, stock
appreciation rights, dividend equivalent rights, restricted stocks, purchase
stocks and performance units. The Compensation Committee has the power and
authority to designate recipients of the options and to determine the terms,
conditions, and limitations of the options.
Under the 1996 Plan, options to purchase 150,000 shares of Class C Common
Stock of KMC Telecom are available for grant, of which 115,385 options were
allocated to the Plan as of December 31, 1996 and 150,000 options were allocated
to the Plan as of December 31, 1997. No individual may receive options for more
than 40,000 shares. The exercise price of all incentive stock options granted
under the 1996 Plan must be at least equal to the fair market value of the
shares on the date of grant. The exercise price of all non-qualified stock
options granted under the 1996 Plan must be at least 50% of the fair market
value of the shares on the date of grant.
Options granted pursuant to the 1996 Plan will have terms not to exceed 10
years and become exercisable over a vesting period as specified in such options.
The 1996 Plan will terminate no later than 2006. Under the 1996 Plan, no options
vest until at least six months after the later of (i) January 1, 1995 or (ii)
the date of employment with the Company or an affiliate. Options granted under
the 1996 Plan are nontransferable, other than by will or by the laws of descent
and distribution, and may be exercised during the optionee's lifetime, only by
the optionee.
The 1996 Plan provides for an adjustment of the number of shares exercisable
in the event of a merger, consolidation, recapitalization, change of control,
stock split, stock dividend, combination of shares or other similar changes,
exchange or reclassification of the common stock at the discretion of the
Compensation Committee. Pursuant to the agreements adopted under the 1996 Plan,
fifty percent of all
F-27
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
unvested options granted become fully vested upon a change-in-control of the
Company or a qualified public offering, as defined.
The holders of options to acquire shares of Class C Common Stock of KMC
Telecom are required to enter into agreements with KMC Telecom which place
certain restrictions upon their ability to sell or otherwise transfer such
shares. In the event of termination of employment of the option holder by KMC
Telecom or the affiliates, KMC Telecom can repurchase all of the shares or
options held by such individuals, generally for an amount equal to the fair
value of such shares or the excess of the fair value of such options over their
exercise price.
During the year ended December 31, 1996, non-qualified options to purchase
an aggregate of 95,385 shares were granted at exercise prices of $50 (57,229
options), $75 (19,078 options) and $100 (19,078 options). The options granted
during 1996 are comprised of 85,000 options granted to employees and 10,385
options granted to individuals employed by certain affiliates of the Company.
All such options have 10 year terms. The $50 options become exercisable over a
three year period in six month intervals commencing six months after the grant
date in increments of 9,538 options each. The $75 options become exercisable in
two increments of 9,539 options each, forty-two and forty-eight months after the
grant date. The $100 options become exercisable in two increments of 9,539
options each, fifty-four and sixty months after the grant date.
During the year ended December 31, 1997, non-qualified options to purchase
an aggregate of 63,115 shares were granted at exercise prices of $50 (37,869
options), $75 (12,623 options) and $100 (12,623 options). The options granted
during 1997 are comprised of 55,385 options granted to employees and 7,730
options granted to individuals employed by certain affiliates of the Company.
All such options have 10 year terms. The $50 options become exercisable over a
three year period in six month intervals commencing six months after the grant
date in increments of 6,311 options each. The $75 options become exercisable in
two increments of 6,311 options each, forty-two and forty-eight months after the
grant date. The $100 options become exercisable in two increments of 6,311
options each, fifty-four and sixty months after the grant date. Additionally,
17,000 options were cancelled during 1997.
Information on stock options is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF SHARES AVERAGE EXERCISE
------------------------ PRICE OF OPTIONS
OUTSTANDING EXERCISABLE OUTSTANDING
----------- ----------- -------------------
<S> <C> <C> <C>
Balances, January 1, 1996
Granted.......................................... 95,385 -- $ 65
Became exercisable............................... -- --
----------- -----------
Balances, December 31, 1996........................ 95,385 -- $ 65
Granted.......................................... 63,115 -- $ 65
Became exercisable............................... -- 22,188
Cancelled........................................ (17,000) (2,616) $ 65
----------- -----------
Balances, December 31, 1997........................ 141,500 19,572 $ 65
<CAPTION>
----------- -----------
----------- -----------
</TABLE>
F-28
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
The weighted-average exercise price of options exercisable at December 31,
1997 is $50 and the weighted average fair value of options granted during 1996
and 1997 were $30 and $49 per share, respectively. Exercise prices for options
outstanding as of December 31, 1997 ranged from $50 to $100. The
weighted-average remaining contractual life of those options is 9.5 years.
As a result of certain anti-dilution provisions governing the conversion of
shares of Class C Common Stock into shares of Class A Common Stock, KMC Telecom
is required to account for the 1996 Plan as a variable stock option plan.
Generally accepted accounting principles, as prescribed by APB 25, for variable
stock option plans require KMC Telecom to recognize a non-cash compensation
charge for these options (amortized over the vesting period of the employee
options and recognized in full as of the grant date for the non-employee
options). Such charge is determined by the difference between the fair value of
the common stock underlying the options and the option price as of the end of
each period, until the Class C Common Stock underlying such options is no longer
protected by such anti-dilution provisions. Based on the estimated fair value of
the Class A Common Stock of KMC Telecom at December 31, 1996 and 1997,
cumulative deferred compensation obligations of $1,283,000 and $15,579,000,
respectively, have been established. The Company has recognized compensation
expense aggregating $240,000 and $13,869,000 for the years ended December 31,
1996 and 1997, respectively, including $44,000 and $9,013,000 of amortization of
unearned compensation. KMC Holdings intends to adopt a new stock option plan in
1998, and to cancel the existing KMC Telecom 1996 Plan at such time.
In accordance with the provisions of Statement No. 123, the Company applies
APB 25 and related interpretations in accounting for its stock option plan. If
the Company had elected to recognize compensation expense based on the fair
value of the options granted at grant date as prescribed by Statement No. 123,
net loss and net loss per common share would have been the following:
<TABLE>
<CAPTION>
1996 1997
-------------- ---------------
<S> <C> <C>
Net loss -- as reported...................................... $(4,495,314) $(32,685,163)
-- pro forma.......................................... $(4,452,528) $(20,542,112)
Net loss per common share -- as reported..................... $(7.49) $(64.93)
-- pro forma......................... $(7.42) $(45.97)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Expected dividend yield.................................................. 0% 0%
Expected stock price volatility.......................................... 50% 50%
Risk-free interest rate.................................................. 6% 6%
Expected life of options................................................. 7 years 7 years
</TABLE>
The expected stock price volatility factors were determined based on an
average of such factors as disclosed in the financial statements of peer
companies. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective
F-29
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
8. REDEEMABLE AND NONREDEEMABLE EQUITY (CONTINUED)
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
9. INCOME TAXES
As of December 31, 1997, the Company and its subsidiaries had consolidated
net operating loss carryforwards for United States income tax purposes ("NOLs")
of approximately $22.8 million which expire through 2012. Under Section 382 of
the Internal Revenue Code of 1986, as amended (the "Code"), if the Company
undergoes an "ownership change," its ability to use its preownership change NOLs
(NOLs accrued through the date of the ownership change) would generally be
limited annually to an amount equal to the product of (i) the long-term
tax-exempt rate for ownership changes prescribed monthly by the Treasury
Department and (ii) the value of the Company's equity immediately before the
ownership change, excluding certain capital contributions. Any allowable portion
of the preownership change NOLs that is not used in a particular taxable year
following the ownership change could be carried forward to subsequent taxable
years until the NOLs expire, usually 15 years after they are generated. As a
result of the cumulative effect of issuances of preferred and common stock
through September 22, 1997, KMC Telecom has undergone an ownership change.
For financial reporting purposes, the Company has an aggregate of
approximately $38.2 million of loss carryforwards and net temporary differences
at December 31, 1997. At existing tax rates, the future benefit of these items
approximates $13.0 million at December 31, 1997. A valuation allowance has been
established equal to the entire net tax benefit associated with all
carryforwards and temporary differences at December 31, 1996 and 1997 as their
realization is uncertain.
The composition of expected future tax benefits at December 31, 1996 and
1997 is as follows:
<TABLE>
<CAPTION>
1996 1997
------------- --------------
<S> <C> <C>
Loss carryforwards............................................. $ 1,036,000 $ 7,754,000
Temporary differences:
Stock option compensation.................................... 82,000 4,797,000
Other, net................................................... 342,000 456,000
------------- --------------
1,460,000 13,007,000
Less valuation allowance....................................... (1,460,000) (13,007,000)
------------- --------------
$ -- $ --
------------- --------------
------------- --------------
</TABLE>
F-30
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases various facilities and equipment under operating leases.
Minimum rental commitments are as follows:
<TABLE>
<CAPTION>
PERIOD ENDING DECEMBER 31:
- --------------------------------------------------------------------------------
<S> <C>
1998............................................................................ $ 790,000
1999............................................................................ 795,000
2000............................................................................ 779,000
2001............................................................................ 770,000
2002............................................................................ 650,000
Thereafter...................................................................... 2,086,000
------------
$ 5,870,000
------------
------------
</TABLE>
Rent expense under operating leases was $98,000 and $478,000 for the years
ended December 31, 1996 and 1997, respectively.
LITIGATION
By letter dated August 29, 1997, KMC Telecom notified I-Net, Inc. ("I-NET")
that KMC Telecom considered I-NET to be in default under a Master
Telecommunications System Rollout Agreement dated as of October 1, 1996 (the
"I-NET Agreement"), pursuant to which I-NET had agreed to manage construction of
telephone systems for KMC Telecom in several cities, including the preparation
of design plans and specifications for each system. KMC Telecom considered I-NET
to be in default as a result of I-NET's failure to provide design plans and
specifications for several systems for which it had agreed to provide such plans
and specifications, to properly supervise construction of the systems or to
provide personnel with the necessary expertise to manage the projects. By letter
dated October 27, 1997, I-NET demanded payment of all amounts it alleged were
due under the I-NET Agreement and a related agreement (aggregating $4.1 million)
and stated that it would invoke the arbitration provisions under the I-NET
Agreement if the parties could not agree as to the amount due and payment terms
on or before November 27, 1997. By letter dated December 1, 1997, I-NET extended
its deadline for reaching agreement to December 15, 1997. Although the Company
and I-NET conducted discussions they were unable to reach an agreement and on
February 12, 1998, the Company received a demand for arbitration from Wang
Laboratories, Inc. ("Wang"), the successor to I-NET. The demand seeks at least
$4.1 million. The Company believes that it has meritorious defenses to Wang's
claims and has asserted counterclaims seeking in excess of $2.5 million as a
result of I-NET's defaults under the I-NET Agreement. The Company believes that
resolution of this matter will not have a material adverse impact on its
financial condition. No assurance can be given, however, as to the ultimate
resolution of this matter.
FRANCHISE AGREEMENTS
At December 31, 1997, the Company was obligated under franchise agreements
to various cities to make payments based upon the Company's financial
performance. The franchise terms range from 5 to 15 years, with several of the
franchise agreements providing for renewal options. The franchise fees payable
under the agreements are generally based on percentages of gross receipts, gross
revenues, or billings.
F-31
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Several of the franchise agreements contain construction commitment clauses,
with specified timeframes for commencement and completion of construction of the
fiber optic telecommunication systems. The Company has not commenced
construction within the time specified by one of its franchise agreements. The
municipality has not indicated to management that it intends to exercise its
option to revoke the franchise. In the event such franchise was revoked, it
would not have a material adverse impact on the Company's financial position or
results of operations.
LUCENT TECHNOLOGIES AGREEMENTS
Pursuant to two contracts between Lucent Technologies Inc. ("Lucent"), KMC
Telecom and KMC Telecom II, Lucent has committed to provide the hardware,
software and related support services for digital local exchange
telecommunications switching systems. Pursuant to the Lucent General Agreement,
the Company committed to spend at least $88 million for hardware and software by
the end of the initial approximately three year contract term ending September
24, 2000, of which $30 million is to be committed for purchases by July 23,
1998. Through December 31, 1997, KMC Telecom and KMC Telecom II have purchased
switching system hardware, software and related services under the Lucent
General Agreement aggregating approximately $36.3 million.
Pursuant to the Lucent Professional Services Agreement, Lucent will (i)
install and test each switch purchased under the General Agreement for a fixed
charge per switch; (ii) monitor and support the telecommunications switching
hardware and software for a minimum, monthly per switch fee; and (iii) provide a
fixed number of hours of other consulting services for specified fee. The
Company can also contract for additional services pursuant to a price schedule
attached to the agreement. The Professional Services Agreement is for an initial
three-year term commencing July 23, 1997 and is subject to renewal on a
year-to-year basis, thereafter.
ACE*COMM AGREEMENTS
Pursuant to two agreements between ACE*COMM Corporation ("ACE*COMM"), KMC
Telecom and KMC Telecom II, each dated September 29, 1997, ACE*COMM is providing
comprehensive billing, order processing and customer care software, which
includes the provision of certain dedicated hardware to be located at ACE*COMM's
Gaithersburg, Maryland facility, together with relevant software, maintenance of
the same, and data processing services. KMC Telecom and KMC Telecom II have
contracted to pay ACE*COMM approximately $1.1 million in connection with the
implementation of the data processing system hardware and software, of which
installments totaling $673,000 were paid as of December 31, 1997. The remaining
balance is due when the system becomes fully operational at completion (the
"Commencement Date"), anticipated to occur by the end of the first quarter of
1998. Pursuant to the second ACE*COMM agreement, ACE*COMM will perform data
processing and system support, and ACE*COMM will be paid fees under a rate
structure based on the number of calls charged to the Company's customers,
provided that, in any event, the Company must pay a minimum combined service
fee, plus an additional minimum monthly payment for support services from and
after such date. The service and support agreement has an initial term ending
four years after the Commencement Date, and is subject to year-to-year renewal
thereafter.
F-32
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
PURCHASE COMMITMENTS
As of December 31, 1997, the Company has outstanding commitments aggregating
approximately $52.3 million related to the purchases of telecommunications
equipment and fiber optic cable and its obligations under its agreements with
Lucent and ACE*COMM.
EMPLOYMENT AGREEMENTS
In July 1996, KMC Telecom entered into a three year employment agreement
with its chief executive officer. In addition to a base salary, the agreement
provides for certain incentive compensation payments, based upon completion of
construction and attainment of specified revenues for additional networks.
The Company has also agreed to make similar incentive compensation payments
to certain other key employees.
11. ACQUISITIONS
On July 11, 1997, KMC Telecom acquired a network in Melbourne, Florida for a
purchase price of $2 million in cash. The acquisition was accounted for under
the purchase method and the purchase price approximated the fair value of the
fixed assets acquired. Assuming the Melbourne Network had been acquired as of
January 1, 1997, the Company's pro forma consolidated revenue and net loss for
the year ended December 31, 1997 would have been $3,655,000 and $33,212,000,
respectively.
On October 1, 1997, the Company entered into a letter of intent to acquire
from FiberCap Digital Inc. an existing network of approximately 13 miles in
length located in Winston-Salem, North Carolina. The acquisition is subject to
various approvals and the negotiation and execution of a definitive purchase
agreement.
12. RELATED PARTY TRANSACTIONS
At December 31, 1995, KMC Telecom had loans payable to Kamine aggregating
$2,727,400, and, through November 1996, KMC Telecom made additional borrowings
from Kamine. In November 1996, KMC Telecom repaid its then-outstanding
indebtedness to Kamine of $4 million in full.
The proceeds of such loans were used to fund the construction of the network
in Huntsville, Alabama, and to fund operating cash flow requirements. These
loans were payable on demand and, through April 30, 1996, bore interest at the
prime rate (8.25% at April 30, 1996). Interest expense charged by Kamine under
these loans amounted to $120,000 for the year ended December 31, 1996. Effective
May 1, 1996, Kamine elected not to charge interest on these loans. However, for
financial reporting purposes, $180,000 of interest expense was imputed on these
loans for the period from May 1, 1996 to November 12, 1996, and a corresponding
credit has been recorded to additional paid-in capital.
The Company has informal agreements with affiliated companies which provide
certain administrative services, including certain personnel, utilities and
supplies. The Company incurred approximately $488,000 and $281,000 of expense
related to these agreements for the years ended December 31, 1996 and 1997,
respectively.
F-33
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
12. RELATED PARTY TRANSACTIONS (CONTINUED)
The Company leases its corporate office space through January 2007 with an
affiliated company. The lease provides for a base annual rental cost of
approximately $207,000, adjusted periodically for changes in the consumer price
index, plus operating expenses. Rent expense recognized under this lease for the
years ended December 31, 1996 and 1997 was $93,000 and $207,000, respectively.
Amounts due to affiliated companies were $81,518 and $47,024 at December 31,
1996 and 1997, respectively.
13. NET LOSS PER COMMON SHARE
The following table sets forth the computation of net loss per common share
- -- basic:
<TABLE>
<CAPTION>
1995 1996 1997
------------- ------------- --------------
<S> <C> <C> <C>
Numerator:
Net loss...................................... $ (1,620,392) $ (4,495,314) $ (32,685,163)
Dividends and accretion on redeemable
preferred stock............................. -- -- (8,904,403)
------------- ------------- --------------
Numerator for net loss per common share --
basic....................................... $ (1,620,392) $ (4,495,314) $ (41,589,566)
------------- ------------- --------------
------------- ------------- --------------
Denominator:
Denominator for net loss per common share --
weighted average number of common shares
outstanding................................. 600,000 600,000 640,568
------------- ------------- --------------
------------- ------------- --------------
Net loss per common share -- basic............ $ (2.70) $ (7.49) $ (64.93)
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
Options and warrants to purchase an aggregate of 242,768 shares of common
stock were outstanding as of December 31, 1997, but a computation of diluted net
loss per common share has not been presented, as the effect would be
anti-dilutive.
14. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Information with respect to noncash investing and financing activities is as
follows:
In 1997, the Convertible Notes, including accrued interest, aggregating
approximately $12,380,000 were converted into 123,800 shares of Series A
Cumulative Convertible Preferred Stock of KMC Telecom. In connection with the
conversion, net unamortized deferred financing costs of approximately $862,000
were charged against redeemable preferred stock.
In 1997, warrants with a fair value of $1.5 million were granted to AT&T.
Credit and warrants with a fair value of $525,000 were granted to GECC.
In connection with KMC Telecom's variable stock option plan, cumulative
deferred compensation obligations of $1,283,000 and $15,579,000 have seen
established in 1996 and 1997, respectively, with offsetting credits to
additional paid-in capital. Compensation expense of $44,000 in 1996 and
$9,013,309 in 1997 was recognized in connection with such options.
F-34
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
14. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
(CONTINUED)
In connection with the grants of options to purchase shares of common stock
of KMC Telecom granted to individuals employed by certain affiliates of the
Company in 1996 and 1997, the Company recognized noncash compensation expense of
$196,000 and $4,856,037, respectively.
In 1996, Kamine contributed a loan and related imputed interest totaling
$2,267,063 to equity.
15. FINANCIAL INSTRUMENTS
The Company has limited involvement with derivative financial instruments,
and does not hold or issue derivatives for trading purposes. The Company uses
interest rate cap agreements to manage its exposure to market risks associated
with interest rate increases on its floating rate debt.
The interest rate cap agreements require premium payments to counterparties
based upon a notional principal amount, and the Company is entitled to receive
from the counterparties the amounts, if any, by which the selected market
interest rates exceed the strike rate stated in the agreements. As of December
31, 1997, the notional amount of debt subject to interest rate cap agreements
was $28 million.
While the Company is exposed to credit loss on its interest rate cap
agreements in the event of nonperformance by the counterparties to such
agreements, management believes that such nonperformance is unlikely to occur
given the financial resources of the counterparties, which are major financial
institutions.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments.
CASH AND CASH EQUIVALENTS
The carrying amounts approximate fair value because of the short-term
maturity of the instruments.
LONG-TERM DEBT
The carrying amount of floating-rate long-term debt approximates its fair
value. The fair value of the Company's fixed-rate long-term debt is estimated
using discounted cash flow analyses based on the Company's incremental borrowing
rates for similar types of borrowing arrangements.
REDEEMABLE EQUITY
The fair value of the Company's redeemable equity instruments are estimated
to be the amounts at which the holders may require the Company to redeem such
securities, adjusted using discounted cash flow analyses.
INTEREST RATE CAP AGREEMENTS
The fair value of these agreements are estimated by obtaining quotes from
dealers.
F-35
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
15. FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair values of the Company's financial instruments are as
follows (in millions):
<TABLE>
<CAPTION>
1996 1997
---------------------- ----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Cash and cash equivalents............................... $ 1.5 $ 1.5 $ 15.6 $ 15.6
Long-term debt.......................................... 12.3 11.5 61.3 61.3
Redeemable equity instruments:
Series A Preferred Stock............................ -- -- 18.9 28.4
Series C Preferred Stock............................ -- -- 14.7 13.5
Series D Preferred Stock............................ -- -- 2.4 2.3
Redeemable Common Stock............................. -- -- 11.2 6.3
Redeemable Common Stock Warrants.................... -- -- .5 .5
Interest rate cap agreements............................ -- -- .1 .1
</TABLE>
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments and
accounts receivable. The Company places its cash investments with major
financial institutions. With respect to accounts receivable, the Company
performs ongoing credit evaluations of its customers' financial conditions and
generally does not require collateral. No individual customer group accounted
for more that 10% of net sales for the year ended December 31, 1997. For the
year ended December 31, 1997, the Company's five largest individual customers,
accounted for 32% of net sales.
16. SUBSEQUENT EVENTS
On January 29, 1998, KMC Holdings sold 460,800 units, each unit consisting
of a 12 1/2% senior discount note with a principal amount at maturity of $1,000
due 2008 (the "Senior Discount Notes") and one warrant to purchase .21785 shares
of Common Stock of KMC Holdings at an exercise price of $.01 per share. Interest
on the Senior Discount Notes will be payable in cash on each February 15 and
August 15, commencing August 15, 2003. The Senior Discount Notes are
unsubordinated, unsecured indebtedness of KMC Holdings. However, KMC Holdings is
a holding company and the Senior Discount Notes will be effectively subordinated
to all existing and future liabilities (including trade payables) of the
Company's subsidiaries. The gross and net proceeds of the offering were
approximately $250.0 million and $236.4 million, respectively. Upon the closing
of the offering, the Company used the proceeds as follows: $10.8 million to
repay all amounts borrowed by KMC Telecom II under the AT&T Facility; $10.1
million to repay the Supplemental AT&T Facility (including $100,000 of accrued
interest thereon); $5.0 million as a non-refundable down payment under its
agreement with Lucent for future purchases of switching equipment; and $592,000
to pay dividend arrearages on the Series A Cumulative Convertible Preferred
Stock of KMC Telecom to Nassau. The balance will be used to finance the planned
expansion and further development of the Company's networks and to fund
operating losses and for other general corporate purposes.
The Senior Discount Notes contain covenants that, among other things,
restrict the ability of KMC Holdings and its subsidiaries to incur additional
indebtedness, create liens, engage in sale-leaseback transactions, pay dividends
or make distributions in respect of their capital stock, make investments or
certain other restricted payments, sell assets, redeem capital stock, issue or
sell stock of subsidiaries, enter
F-36
<PAGE>
KMC TELECOM HOLDINGS, INC. AND PREDECESSORS
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
16. SUBSEQUENT EVENTS (CONTINUED)
into transactions with stockholders or affiliates or, with respect to KMC
Holdings, effect a consolidation or merger. However, these limitations are
subject to a number of qualifications and exceptions.
The Senior Discount Notes are "applicable high yield discount obligations"
("AHYDOs"), as defined in the Code, because the yield to maturity of such Senior
Discount Notes exceeded the "applicable federal rate" in effect at the time of
their issuance (the "AFR") plus five percentage points. Under the rules
applicable to AHYDOs, a portion of the original issue discount ("OID") that
accrues on the Senior Discount Notes will not be deductible by the Company at
any time. The non-deductible portion of the OID will be an amount that bears the
same ratio to such OID as (i) the excess of the yield to maturity of the Senior
Discount Notes over the AFR plus six percentage points bears to (ii) the yield
to maturity of the Senior Discount Notes. To the extent that the non-deductible
portion of OID would have been treated as a dividend if it had been distributed
with respect to the Company's stock, it generally will be treated as a dividend
to holders of the Senior Discount Notes for purposes of the rules relating to
the dividends received deduction applicable to corporate holders. Any remaining
OID on the Senior Discount Notes will not be deductible by the Company until
such OID is paid.
The warrants may be exercised at any time during the period beginning on the
date that is one year after the closing date and ending on January 31, 2008.
Warrants that are not exercised by such date will expire. The warrants were
recorded at their aggregate fair value of $11 million.
The Senior Discount Notes and warrants have not been registered under the
Securities Act of 1933 and are subject to restrictions on transfer.
17. YEAR 2000 (UNAUDITED)
While the Company believes that its software applications are Year 2000
compliant, there can be no assurance until the Year 2000 occurs that all systems
will then function adequately. Further, if the software applications of local
exchange carriers, long distance carriers or others on whose services the
Company depends or with whom the Company's systems interface are not Year 2000
compliant, it could affect the Company's systems, which would have a material
adverse effect on the Company's business, financial condition and results of
operations and its ability to make payments on its then outstanding
indebtedness.
F-37
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
ICG Communications, Inc.:
We have audited the accompanying balance sheets of the Melbourne System (an
operating unit of ICG Communications, Inc.) as of December 31, 1995 and 1996,
and the related statements of operations and accumulated deficit and cash flows
for the years then ended. These financial statements are the responsibility of
the System's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Melbourne System as of
December 31, 1995 and 1996, and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Denver, Colorado
December 16, 1997
F-38
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
<S> <C> <C>
1995 1996
------------ ------------
ASSETS
Current assets:
Cash................................................................................ $ 1,000 $ 1,000
Accounts receivable................................................................. 23,486 57,879
Prepaid expenses and deposits....................................................... 1,633 --
------------ ------------
Total current assets................................................................ 26,119 58,879
Equipment (note 2).................................................................... 5,872,459 2,549,884
Less accumulated depreciation......................................................... (154,131) (459,507)
------------ ------------
Net equipment....................................................................... 5,718,328 2,090,377
------------ ------------
Other assets:
Goodwill, net of accumulated amortization of $26,592................................ 403,514 --
Other assets........................................................................ 28,856 8,398
------------ ------------
Total assets........................................................................ $ 6,176,817 $ 2,157,654
------------ ------------
------------ ------------
LIABILITIES AND PARENT'S EQUITY
Current liabilities:
Accounts payable.................................................................... $ 184,509 $ --
Accrued liabilities................................................................. 100,241 64,590
Current portion of capital leases (note 4).......................................... 396,428 51,630
------------ ------------
Total current liabilities........................................................... 681,178 116,220
Capital lease obligations, less current portion (note 4).............................. 1,472,196 69,803
------------ ------------
Total liabilities................................................................... 2,153,374 186,023
------------ ------------
Parent's equity:
Investment by Parent................................................................ 4,578,159 6,754,534
Accumulated deficit................................................................. (554,716) (4,782,903)
------------ ------------
Total parent's equity............................................................... 4,023,443 1,971,631
------------ ------------
Total liabilities and parent's equity............................................... $ 6,176,817 $ 2,157,654
------------ ------------
------------ ------------
</TABLE>
See accompanying notes.
F-39
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1996
----------- -------------
<S> <C> <C>
Revenue:
Telecommunications................................................................ $ 58,405 $ 277,409
Other............................................................................. 16,599 75,870
----------- -------------
Total revenue................................................................... 75,004 353,279
Operating costs and expenses:
Network operating costs (note 3).................................................. 37,726 86,825
Selling, general and administrative expenses (note 3)............................. 146,783 430,361
Depreciation and amortization..................................................... 172,765 460,481
Loss on impairment of long-lived assets (note 1).................................. -- 3,446,587
----------- -------------
Operating loss.................................................................... (282,270) (4,070,975)
Interest expense...................................................................... 185,832 157,212
----------- -------------
Net loss.......................................................................... (468,102) (4,228,187)
Accumulated deficit, beginning of period.............................................. (86,614) (554,716)
----------- -------------
Accumulated deficit, end of period.................................................... $ (554,716) $ (4,782,903)
----------- -------------
----------- -------------
</TABLE>
See accompanying notes.
F-40
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1995 1996
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................................................... $ (468,102) $ (4,228,187)
Adjustments to reconcile net loss to cash used by operating activities:
Depreciation and amortization................................................... 172,765 460,481
Provision for impairment of long-lived assets................................... -- 3,446,587
Changes in operating assets and liabilities:
Accounts receivable............................................................. (20,987) (34,393)
Prepaid expenses and deposits................................................... 3,727 1,633
Other assets.................................................................... (23,463) --
Accounts payable and accrued liabilities........................................ 74,351 (220,160)
------------- -------------
Net cash used by operating activities........................................... (261,709) (574,039)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment.......................................................... (2,237,967) (1,301,149)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations............................................. (397,358) (319,220)
Advances from Parent.............................................................. 2,897,034 2,194,408
------------- -------------
Net cash provided by financing activities....................................... 2,499,676 1,875,188
------------- -------------
Net increase (decrease) in cash................................................. -- --
Cash, beginning of period........................................................... 1,000 1,000
------------- -------------
Cash, end of period................................................................. $ 1,000 $ 1,000
------------- -------------
------------- -------------
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Transfer of assets to Parent (note 3)............................................. $ 73,943 $ 1,435,028
------------- -------------
------------- -------------
Assumption of capital lease obligations by Parent (note 3)........................ $ -- $ 1,427,971
------------- -------------
------------- -------------
Equipment acquired under capital lease............................................ $ 713,873 $ --
------------- -------------
------------- -------------
</TABLE>
See accompanying notes.
F-41
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND BASIS OF PRESENTATION
The Melbourne System (the System) is an operating unit of ICG
Communications, Inc. (ICG or the Parent). The System's principal business
activity is providing special access telecommunications service to customers in
the Melbourne, Florida area. The accompanying financial statements include the
assets, liabilities, revenue and expenses of the System on a separate entity
basis.
In July 1997, the assets of the system were acquired by KMC Telecom Inc.,
for total consideration of $2.0 million in a business combination accounted for
using the purchase method of accounting.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
periods. Actual results could differ from those estimates.
EQUIPMENT
Equipment is stated at cost. Equipment held under capital leases is stated
at the lower of the fair value of the asset or the net present value of the
minimum lease payments at the inception of the lease. Depreciation is provided
using the straight-line method over the estimated useful lives of the assets
owned and the related lease term for equipment held under capital leases.
Estimated useful lives of major categories of property and equipment are as
follows:
<TABLE>
<S> <C>
Office furniture and equipment................................. 3 to 5
years
Equipment...................................................... 10 years
Fiber optic transmission system................................ 20 years
</TABLE>
OTHER ASSETS
The Melbourne System assets were acquired by the Parent in 1994 and were
recorded using the purchase method of accounting. Goodwill, resulting from the
excess of the purchase price over the fair market value of the acquired net
assets, was recorded in the accompanying financial statements using push-down
accounting. Amortization of goodwill was provided using the straight-line method
over 20 years.
REVENUE RECOGNITION
The System recognizes revenue as services are provided. Uncollectible trade
receivables are accounted for using the allowance method.
INCOME TAXES
The operations of the System are included in the consolidated income tax
returns of ICG.
F-42
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The System accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES (SFAS 109).
Under the asset and liability method of SFAS 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Under SFAS 109, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. No tax benefit or expense has been allocated to the
System by the Parent due to losses incurred at the consolidated level. A
valuation allowance has been provided for the entire amount of the System's
deferred tax assets relating primarily to its net operating losses.
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 1996, the Parent and the System adopted Statement of
Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF (SFAS 121) which
requires that long-lived assets and certain identifiable intangibles held and
used by an entity be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. An impairment loss is recognized when estimated undiscounted future
cash flows expected to be generated by the asset are less than its carrying
value. Measurement of the impairment loss is based on the fair value of the
asset, which is generally determined using valuation techniques such as the
discounted present value of expected future cash flows or independent appraisal.
During 1996, the Parent began to actively seek a buyer for the System. Based
upon discussions with interested parties, the Parent determined that the net
book value of the System's assets (primarily equipment and goodwill) exceeded
the estimated fair market value of such assets, including the cost of disposal.
As a result, the Parent recorded a loss of $3,446,587 for the impairment of the
System's assets, which amount has been recorded as a charge to operations and as
a reduction in the carrying amount of such assets in the accompanying financial
statements.
(2) EQUIPMENT
Equipment, including assets owned under capital leases is comprised of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
<S> <C> <C>
1995 1996
------------ ------------
Fiber optic transmission system................................... $ 3,660,701 $ 1,416,198
Construction in progress.......................................... 2,102,740 555,768
Furniture, fixtures and office equipment.......................... 69,405 80,638
Equipment......................................................... 39,613 497,280
------------ ------------
$ 5,872,459 $ 2,549,884
------------ ------------
------------ ------------
</TABLE>
F-43
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995 AND 1996
(3) TRANSACTIONS WITH PARENT
ICG typically allocates certain corporate overhead costs, representing
primarily salaries and related benefits for accounting, sales and marketing
personnel, information systems support and executive services to certain of its
systems, divisions and subsidiaries based on revenue and direct operating costs
of the respective entity. The System does not currently have a formal cost
sharing or allocation agreement with ICG. The costs allocated to the System are
not necessarily indicative of the costs that the System would have incurred on a
separate company basis. For the years ended December 31, 1995 and 1996, an
aggregate of $59,456 and $166,249, respectively, of such costs have been
allocated to the System by ICG, which are included in network operating costs
and selling, general and administrative expenses in the accompanying statements
of operations.
During 1995 and 1996, certain assets and associated capital lease
obligations were transferred by the System to the Parent. Such transfers were
reflected as changes in the investment by Parent balance.
(4) CAPITAL LEASE OBLIGATIONS
The System is obligated under various capital lease agreements for equipment
at December 31, 1995 and 1996. The future required payments under the System's
capital lease obligations subsequent to December 31, 1996 are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------------------------------------------------------------------
<S> <C>
1997............................................................................... $ 65,273
1998............................................................................... 69,075
1999............................................................................... 7,676
---------
Total minimum lease payments....................................................... 142,024
Less amounts representing interest................................................. (20,591)
---------
Present value of net minimum lease payments........................................ 121,433
Less current portion............................................................... (51,630)
---------
$ 69,803
---------
---------
</TABLE>
F-44
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
UNAUDITED CONDENSED STATEMENT OF OPERATIONS AND ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 1, 1997
TO
JULY 11, 1997
-----------------
<S> <C>
Revenue:
Telecommunications........................................................................... $ 189,474
Other........................................................................................ 48,339
-----------------
Total revenue............................................................................ 237,813
Operating costs and expenses:
Network operating costs...................................................................... 63,080
Selling, general and administrative expenses................................................. 384,857
Depreciation and amortization................................................................ 138,884
-----------------
Operating loss............................................................................... (349,008)
Interest expense............................................................................... 26,940
-----------------
Net loss..................................................................................... (375,948)
Accumulated deficit, beginning of period....................................................... (4,782,903)
-----------------
Accumulated deficit, end of period............................................................. $ (5,158,851)
-----------------
-----------------
</TABLE>
F-45
<PAGE>
MELBOURNE SYSTEM
(AN OPERATING UNIT OF ICG COMMUNICATIONS, INC.)
UNAUDITED CONDENSED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 1,
1997
TO JULY 11,
1997
-------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................................................................... $ (375,948)
Adjustments to reconcile net loss to cash used by operating activities:
Depreciation and amortization.................................................................. 138,884
Changes in operating assets and liabilities:
Accounts receivable............................................................................ (53,859)
Prepaid expenses and deposits.................................................................. (4,888)
Other assets................................................................................... (2,145)
Accounts payable and accrued liabilities....................................................... (38,927)
-------------
Net cash used by operating activities.......................................................... (336,883)
-------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations............................................................ (25,814)
Advances from Parent............................................................................. 362,697
-------------
Net cash provided by financing activities...................................................... 336,883
-------------
Net increase (decrease) in cash................................................................ --
-------------
Cash, beginning of period........................................................................ 1,000
-------------
Cash, end of period.............................................................................. $ 1,000
-------------
-------------
</TABLE>
F-46
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Available Information........................ 4
Prospectus Summary........................... 5
Risk Factors................................. 17
The Exchange Offer........................... 31
Use of Proceeds.............................. 39
Capitalization............................... 40
Selected Financial Data...................... 41
Unaudited Pro Forma Consolidated Statement of
Operations................................. 43
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................. 45
Business..................................... 54
Management................................... 70
Certain Relationships and Related
Transactions............................... 77
Principal Stockholders....................... 79
Description of Certain Indebtedness.......... 83
Description of the Exchange Notes............ 85
Certain United States Federal Income Tax
Considerations............................. 115
Plan of Distribution......................... 121
Legal Matters................................ 122
Experts...................................... 122
Glossary of Selected Terms................... G-1
Index to Financial Statements................ F-1
</TABLE>
KMC TELECOM
HOLDINGS, INC.
OFFER TO EXCHANGE
12 1/2% SENIOR DISCOUNT NOTES DUE 2008
FOR
ALL OUTSTANDING
12 1/2% SENIOR DISCOUNT NOTES DUE 2008
---------------------
PROSPECTUS
---------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article Seventh of the Certificate of Incorporation, as amended, provides
that a director of the corporation shall not be personally liable to the
corporation or its shareholders for monetary damages for breach of fiduciary
duty as a director except for liability (i) for any breach of the director's
duty of loyalty to the corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) under Section 174 of the Delaware General Corporation
Law, or (iv) for any transaction from which the director derived any improper
personal benefit. No amendment or repeal of this provision shall apply to or
have any effect on the liability or alleged liability of any director for or
with respect to any acts or omissions of such director occurring prior to such
amendment or repeal. Article VI, Section 5 of the By-Laws provides that the
Corporation shall indemnify, to the fullest extent permitted by law, members of
the Board, its officers, employees and agents and any and all persons whom it
shall have power to indemnify against any and all expenses, liabilities or other
matters.
The effect of these provisions is to eliminate the rights of the Company and
its stockholders (through stockholders' derivative suits on behalf of the
Company) to recover monetary damages against a director or officer for breach of
fiduciary duty (including breaches resulting from grossly negligent behavior),
except in the situations described above.
These provisions will not limit the liability of directors or officers under
the federal securities laws of the United States. This discussion of Article
Seventh of the Company's Certificate of Incorporation, as amended, and Article
VI, Section 5 of the By-Laws is qualified in its entirety by reference to the
relevant provisions of the Certificate of Incorporation (filed as Exhibit 3.1)
and the By-Laws (filed as Exhibit 3.3).
See Item 22 for a statement of the Company's undertaking as to the
Securities and Exchange Commission's position respecting indemnification arising
under the Securities Act of 1933.
II-1
<PAGE>
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) See Index of Exhibits.
(b) Financial Statement Schedules.
Report of Independent Auditors (included at page S-1)
Schedule I--Condensed Financial Information of Registrant (included at
pages S-2 to S-7)
ITEM 22. UNDERTAKINGS
A. The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth in
the registration statement. Notwithstanding the foregoing, any increase
or decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering
range may be reflected in the form of prospectus filed with the
Commission pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
herein, and the offering of such securities at that time shall be deemed to
be the initial BONA FIDE offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(4) That prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is part of this registration
statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), such reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other items of the applicable form.
(5) That every prospectus: (i) that is filed pursuant to paragraph (4)
immediately proceeding, or (ii) that purports to meet the requirements of
Section 10(a)(3) of the Act and is used in connection with an offering of
securities subject to Rule 415, will be filed as a part of an amendment to
the registration statement and will not be used until such amendment is
effective, and that, for purposes of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to
be the initial bona fide offering thereof.
II-2
<PAGE>
(6) To respond to requests for information that is incorporated by
reference into the prospectus pursuant to Item 4, 10(b), 11 or 13 of this
form, within one business day of receipt of such request, and to send the
incorporated documents by first class mail or other equally prompt means.
This includes information contained in documents filed subsequent to the
effective date of the registration statement through the date of responding
to the request.
(8) To supply by means of post-effective amendment all information
concerning a transaction, and the company being acquired involved therein,
that was not the subject of and included in the registration statement when
it became effective.
B. Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 to the Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the Town of
Bedminster, State of New Jersey on the 9th day of July, 1998.
<TABLE>
<S> <C> <C>
KMC TELECOM HOLDINGS, INC.
By: /s/ MICHAEL A. STERNBERG
------------------------------------------
Michael A. Sternberg
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed by the following persons in
the capacities indicated on July 9, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------------------- ------------------------------------------------------
<C> <S>
*
--------------------------------------------- President, Chief Executive Officer and Director
Michael A. Sternberg (Principal Executive Officer)
* Chief Financial Officer, Vice President, Secretary and
--------------------------------------------- Treasurer (Principal Financial and Accounting
Cynthia Worthman Officer)
*
--------------------------------------------- Chairman of the Board of Directors
Harold N. Kamine
*
--------------------------------------------- Director, Vice Chairman of the Board of Directors
Gary E. Lasher
*
--------------------------------------------- Director
John G. Quigley
*
--------------------------------------------- Director
Richard H. Patterson
*
--------------------------------------------- Director
Randall A. Hack
*
--------------------------------------------- Director
William H. Stewart
/s/ MICHAEL A. STERNBERG
--------------------------------------------- * Attorney-in-fact
Michael A. Sternberg
</TABLE>
II-4
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
KMC Telecom Holdings, Inc.
We have audited the consolidated balance sheet of KMC Telecom Holdings, Inc.
as of December 31, 1997 and the related consolidated statements of operations,
redeemable and nonredeemable equity and cash flows for the year then ended. Our
audit report issued thereon dated March 11, 1998 is included elsewhere in this
Form S-4. Our audit also included the financial statement schedules listed in
Item 21 of this Form S-4. These schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audit.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
March 11, 1998
S-1
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(PARENT COMPANY)
CONDENSED BALANCE SHEET
(DOLLAR AMOUNTS IN THOUSANDS)
DECEMBER 31, 1997
<TABLE>
<S> <C>
ASSETS
Amounts due from subsidiaries..................................................... $ 25,655
Deferred financing costs.......................................................... 732
---------
$ 26,387
---------
---------
LIABILITIES, REDEEMABLE AND NONREDEEMABLE EQUITY (DEFICIENCY)
Losses of subsidiaries in excess of basis......................................... $ 5,408
Redeemable equity:
Redeemable cumulative convertible preferred stock, par value $.01 per share;
498,800 shares authorized; shares issued and outstanding:
123,800 shares of Series A ($12,380,000 liquidation preference)............. 18,879
150,000 shares of Series C ($15,000,000 liquidation preference)............. 14,667
25,000 shares of Series D ($2,500,000 liquidation preference)............... 2,379
Redeemable common stock, 132,773 shares issued and outstanding.................. 11,187
Redeemable common stock warrants................................................ 540
---------
Total redeemable equity........................................................... 47,652
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 3,000,000 shares authorized, 613,835
shares issued and outstanding................................................. 6
Additional paid-in capital...................................................... (4,819)
Accumulated deficit............................................................. (21,860)
---------
Total nonredeemable equity (deficiency)........................................... (26,673)
---------
$ 26,387
---------
---------
</TABLE>
See accompanying notes.
S-2
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(PARENT COMPANY)
CONDENSED STATEMENT OF OPERATIONS
(DOLLAR AMOUNTS IN THOUSANDS)
PERIOD FROM SEPTEMBER 22, 1997 (FORMATION) TO DECEMBER 31, 1997
<TABLE>
<S> <C>
Equity in net loss of subsidiaries................................................ $ (21,860)
---------
Net loss.......................................................................... (21,860)
Dividends and accretion on redeemable preferred stock............................. (8,904)
---------
Net loss applicable to common shareholders........................................ $ (38,764)
---------
---------
</TABLE>
See accompanying notes.
S-3
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(PARENT COMPANY)
CONDENSED STATEMENT OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
PERIOD FROM SEPTEMBER 22, 1997 (FORMATION)
TO DECEMBER 31, 1997
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net loss.......................................................................... $ (21,860)
Adjustments to reconcile net loss to net cash used in operating activities:
Equity in net loss of subsidiaries.............................................. 21,860
Amounts due from subsidiaries................................................... (25,129)
---------
Net cash used in operating activities............................................. (25,129)
---------
FINANCING ACTIVITIES
Proceeds from issuance of common stock, net of issuance costs..................... 9,363
Proceeds from issuance of preferred stock, net of issuance costs.................. 16,498
Payment of issuance costs related to senior discount notes........................ (732)
---------
Net cash provided by financing activities......................................... 25,129
---------
Cash and cash equivalents, beginning of period.................................... --
---------
Cash and cash equivalents, end of period.......................................... $ --
---------
---------
</TABLE>
See accompanying notes.
S-4
<PAGE>
Schedule I -- Condensed Financial Information of Registrant
KMC Telecom Holdings, Inc.
(Parent Company)
Notes to Condensed Financial Statements
DECEMBER 31, 1997
1. BASIS OF PRESENTATION
In the parent company only financial statements, KMC Telecom Holdings,
Inc.'s (the "Company") investment in subsidiaries is stated at cost less equity
in losses of subsidiaries since date of formation. These Parent Company
financial statements should be read in conjunction with the Company's
consolidated financial statements. The Company's principal operating
subsidiaries are KMC Telecom Inc. ("KMC Telecom") and KMC Telecom II, Inc. ("KMC
Telecom II").
On September 22, 1997, the stockholders of KMC Telecom exchanged all of
their KMC Telecom common and preferred stock for equal numbers of shares of
common and preferred stock of the Company.
2. GUARANTEE
On September 22, 1997, KMC Telecom and KMC Telecom II entered into an
Amended and Restated Loan and Security Agreement (the "AT&T Facility") with AT&T
Commercial Finance Corporation ("AT&T Finance"). Under the AT&T Facility, AT&T
Finance agreed to lend KMC Telecom and KMC Telecom II (the "Borrowers") up to an
aggregate of $70 million to be used for the construction of fiber optic
telecommunications networks in certain markets, subject to certain conditions.
The Company has unconditionally guaranteed the repayment of the AT&T
Facility when such repayment is due, whether at maturity, upon acceleration, or
otherwise. The Company has agreed to pay all amounts outstanding under the AT&T
Facility, on demand, upon the occurrence and during the continuation of any
event of default (as defined therein). The Company has pledged the shares of KMC
Telecom and KMC Telecom II to AT&T Finance to secure its obligations under the
guaranty. In addition, each of the Borrowers has pledged all of its assets to
AT&T Finance. Accordingly, if there were an event of default under the AT&T
Facility, the lenders thereunder would be entitled to payment in full and could
foreclose on the assets of the Borrowers and the holders of the senior discount
notes (issued in January 1998) would have no right to share in such assets. At
December 31, 1997, an aggregate of $51.3 million was outstanding under this
facility, including $10.8 million which had been borrowed by KMC Telecom II (and
which was repaid in full with a portion of the proceeds of the Company's January
1998 issuance of senior discount notes and warrants).
Additionally, the AT&T Facility restricts the ability of KMC Telecom to pay
dividends to, or to pay principal or interest on loans from, the Company. Such
restrictions could adversely affect the Company's liquidity and ability to meet
its cash requirements, including its ability to repay the senior discount notes
(issued in January 1998).
On September 22, 1997, KMC Telecom and KMC Telecom II obtained a
subordinated term loan (the "Supplemental AT&T Facility") from AT&T Finance with
an original principal amount of $10 million. The Supplemental AT&T Facility is
generally subject to the same terms, covenants and restrictions as the AT&T
Facility. On January 29, 1998, the entire $10 million outstanding under this
facility was repaid in full with a portion of the proceeds of the Company's
issuance of senior discount notes and warrants.
S-5
<PAGE>
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
3. REDEEMABLE EQUITY
Pursuant to provisions contained in the Company's Certificate of
Incorporation and in an Amended and Restated Stockholders' Agreement dated as of
October 31, 1997, among the Company, Harold N. Kamine, Nassau Capital Partners
L.P. and NAS Partners I L.L.C. (collectively referred to as "Nassau"), AT&T
Credit Corporation ("AT&T Credit"), General Electric Capital Corporation
("GECC"), and CoreStates Bank, N.A. ("Corestates"), (the "Stockholders'
Agreement"), each of Nassau, CoreStates, AT&T Credit and GECC has a "put right"
entitling it to have the Company repurchase its preferred and common shares for
the fair market value of such shares if no Liquidity Event (defined as (i) an
initial public offering with gross proceeds of at least $40.0 million, (ii) the
sale of substantially all of the stock or assets of the Company or (iii) the
merger or consolidation of the Company with one or more other corporations) has
taken place by the later of (x) October 22, 2003 or (y) 90 days after the final
maturity date of the senior discount notes (issued in January 1998, with a
stated maturity date of January 2008). CoreStates, GECC and AT&T Credit may not
exercise such put rights unless Nassau has exercised its put right. The
restrictive covenants of the senior discount notes limit the Company's ability
to repurchase such shares. All of the shares of preferred and common stock
subject to such "put right" are presented as redeemable equity in the
accompanying condensed balance sheet at December 31, 1997.
The redeemable preferred stock, redeemable common stock and redeemable
common stock warrants (described below) are being accreted up to their fair
market values from their respective issuance dates to their earliest potential
redemption date (October 22, 2003). At December 31, 1997, the aggregate
redemption value of the redeemable equity was approximately $118 million,
reflecting per share redemption amounts of $531 for the Series A Preferred
Stock, $209 for the Series C and D Preferred Stock and $110 for the redeemable
common stock and redeemable common stock warrants.
In connection with the AT&T Facility, warrants to purchase 10,000 shares of
Common Stock were issued to GECC in 1997. These warrants, at an exercise price
of $.01 per share, are exercisable from issuance through January 2005. Pursuant
to the Stockholders' Agreement, GECC may put the shares of Common Stock issuable
upon the exercise of such warrants back to the Company. These warrants have been
presented as redeemable common stock warrants in the accompanying condensed
balance sheet at December 31, 1997.
4. CONTINGENCIES
By letter dated August 29, 1997, KMC Telecom notified I-NET, Inc. ("I-NET")
that KMC Telecom considered I-NET to be in default under a Master
Telecommunications Systems Account Agreement dated as of October 1, 1997 (the
"I-NET Agreement"), pursuant to which I-NET had agreed to manage construction of
telephone systems for KMC Telecom in several cities, including the preparation
of design plans and specifications for each system. KMC Telecom considered I-NET
to be in default as a result of I-NET's failure to provide design plans and
specifications for several systems for which it had agreed to provide such plans
and specifications, to properly supervise construction of the systems or to
provide personnel with the necessary expertise to manage the projects. By letter
dated October 27, 1997, I-NET demanded payment of all amounts it alleged were
due under the I-NET agreement and a related agreement (aggregating $4.1 million)
and stated that it would invoke the arbitration provisions under the I-NET
Agreement if the parties could not agree as to the amount due and payment terms
on or before November 27, 1997. By letter dated December 1, 1997, I-NET extended
its deadline for reaching agreement to December 15, 1997. Although the Company
and I-NET conducted discussions they were
S-6
<PAGE>
SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
4. CONTINGENCIES (CONTINUED)
unable to reach an agreement and on February 12, 1998, the Company received a
demand for arbitration from Wang Laboratories, Inc. "Wang") the successor to
I-NET. The demand seeks at least $4.1 million. The Company believes that it has
meritorious defenses to Wang's claims and has asserted counterclaims seeking in
excess of $2.5 million as a result of I-NET's defaults under the I-NET
Agreement. The Company believes that resolution of this matter will not have a
material adverse impact on its financial condition. No assurance can be given,
however, as to the ultimate resolution of this matter.
5. SUBSEQUENT EVENTS
On January 29, 1998, the Company sold 460,800 units, each consisting of a
12 1/2% senior discount notes with a principal amount at maturity of $1,000 due
2008 (the "Senior Discount Notes") and one warrant to purchase .21785 shares of
Common Stock of the Company at an exercise price of $.01 per share. The gross
and net proceeds of the offering were approximately $250.0 million and $236.4
million, respectively. Upon the closing of the offering, the Company used the
proceeds as follows: $10.8 million to repay all amounts borrowed by KMC Telecom
II under the AT&T Facility; $10.1 million to repay the Supplemental AT&T
Facility (including $100,000 of accrued interest thereon); $5.0 million as a
non-refundable down payment under its agreement with Lucent Technologies, Inc.
for future purchases of switching equipment; and $592,000 to pay dividend
arrearages on the Series A Cumulative Convertible Preferred Stock of KMC Telecom
to Nassau.
The Senior Discount Notes contain covenants that, among other things,
restrict the ability of the Company and its subsidiaries to incur additional
indebtedness, create liens, engage in sale-leaseback transactions, pay dividends
or make distributions in respect of their capital stock , make investments or
certain other restricted payments, sell assets, redeem capital stock, issue or
sell stock of subsidiaries, enter into transactions with stockholders or
affiliates or, with respect to the Company, effect a consolidation or merger.
However, these limitations are subject to a number of qualifications and
exceptions.
S-7
<PAGE>
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
*3.1 Amended and Restated Certificate of Incorporation of KMC Telecom Holdings, Inc.
*3.2 Certificate of Amendment of the Certificate of Incorporation of KMC Telecom Holdings, Inc.
*3.3 By-Laws of KMC Telecom Holdings, Inc.
*4.1 Amended and Restated Stockholders Agreement dated as of October 31, 1997 by and among KMC Telecom
Holdings, Inc., Nassau Capital Partners, L.P., NAS Partners I L.L.C., Harold N. Kamine, KMC
Telecommunications L.P., AT&T Credit Corporation, General Electric Capital Corporation, CoreStates Bank,
N.A. and CoreStates Holdings, Inc.
*4.2 Amendment No. 1 dated as of January 7, 1998 to the Amended and Restated Stockholders Agreement dated as
of October 31, 1997 and among KMC Telecom Holdings, Inc., Nassau Capital Partners, L.P., NAS Partners I
L.L.C. Harold N. Kamine, KMC Telecommunications L.P., AT&T Credit Corporation, General Electric Capital
Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc.
*4.3 Amendment No. 2 dated as of January 26, 1998 to the Amended and Restated Stockholders Agreement dated as
of October 31, 1997 by and among KMC Telecom Holdings, Inc., Nassau Capital Partners, L.P., Partners I
L.L.C. Harold N. Kamine, KMC Telecommunications L.P., AT&T Credit Corporation, General Electric Capital
Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc.
*4.4 Amendment No. 3 dated as of February 25, 1998 to the Amended and Restated Stockholders Agreement dated
as of October 31, 1997 by and among KMC Telecom Holdings, Inc., Nassau Capital Partners, L.P., Partners
I L.L.C. Harold N. Kamine, KMC Telecommunications L.P., AT&T Credit Corporation, General Electric
Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc.
*4.5 Indenture dated as of January 29, 1998 between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank,
as Trustee, including specimen of KMC Telecom Holdings, Inc.'s 12 1/2% Senior Discount Note due 2008.
*4.6 Registration Rights Agreement dated January 26, 1998 between KMC Telecom Holdings, Inc. and Morgan
Stanley & Co. Incorporated.
*4.7 Warrant Agreement between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank, as Warrant Agent,
dated as of January 29, 1998 including a specimen of Warrant Certificate.
*4.8 Warrant Registration Rights Agreement dated as of January 26, 1998 between KMC Telecom Holdings, Inc.
and Morgan Stanley & Co. Incorporated.
*5.1 Opinion of Kelley Drye & Warren LLP regarding legality.
*10.1 Purchase Agreement dated January 26, 1998 by and between KMC Telecom Holdings, Inc. and Morgan Stanley &
Co. Incorporated.
*10.2 Amended and Restated Loan and Security Agreement dated as of September 22, 1997 among KMC Telecom Inc.,
KMC Telecom II, Inc. and AT&T Commercial Finance Corporation.
*10.3 Amendment No. 1 dated as of October 31, 1997 to the Amended and Restated Loan and Security Agreement
dated as of September 22, 1997 among KMC Telecom Inc., KMC Telecom II, Inc. and AT&T Commercial Finance
Corporation.
</TABLE>
- ------------------------
* Exhibits filed previously.
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
*10.4 Amendment No. 2 dated as of January 7, 1998 to the Amended and Restated Loan and
Security Agreement dated as of September 22, 1997 among KMC Telecom Inc., KMC
Telecom II, Inc. and AT&T Commercial Finance Corporation.
*10.5 Pledge by KMC Telecom Holdings, Inc. of the capital stock of KMC Telecom Inc. dated
as of September 29, 1997.
*10.6 Pledge by KMC Telecom Inc. of the membership interests of KMC Telecom Leasing I LLC,
dated as of October 31, 1997.
*10.7 General Agreement between KMC Telecom Inc., KMC Telecom II, Inc. and Lucent
Technologies, Inc. dated September 24, 1997, as amended on October 15, 1997.
*10.8 Professional Services Agreement between KMC Telecom, Inc. and Lucent Technologies,
Inc. dated September 4, 1997.
*10.9 1996 Stock Purchase and Option Plan for Key Employees of KMC Telecom Inc. and
Affiliates.
*10.10 Employment Agreement dated as of July 29, 1996 between KMC Telecom Inc. and Michael
A. Sternberg.
*10.11 Data Processing Services and Support Agreement dated September 29, 1997 between
ACE*COMM Corporation and KMC Telecom Inc., KMC Telecom II, Inc. and KMC Telecom of
Virginia, Inc.
*10.12 Contract for Delivery of Computer System dated as of September 29, 1997 between
ACE*COMM Corporation and KMC Telecom Inc., KMC Telecom II, Inc. and KMC Telecom of
Virginia, Inc.
*12.1 Statement Re: Computation of Ratio of Earnings to Fixed Charges.
*21.1 Subsidiaries of KMC Telecom Holdings, Inc.
23.1 Consent of Kelley Drye & Warren LLP.
23.2 Consent of Ernst & Young LLP.
23.3 Consent of KPMG Peat Marwick LLP.
23.4 Consent of KPMG Peat Marwick LLP.
*25.1 Statement of Eligibility and Qualification under the Trust Indenture Act of 1939 of
The Chase Manhattan Bank (on Form T-1)
*27.1 Financial Data Schedule.
*99.1 Form of Letter of Transmittal.
*99.2 Form of Notice of Guaranteed Delivery.
</TABLE>
- ------------------------
* Exhibits filed previously.
<PAGE>
EXHIBIT 23.1
We hereby consent to the description of our opinion and to the reference to
our firm under the caption "Certain United States Federal Income Tax
Considerations" and to the reference to our firm under the caption "Legal
Matters" in the Prospectus forming part of the KMC Telecom Holdings, Inc.
Registration Statement on Form S-4, and to the filing of this consent as an
exhibit to the Registration Statement. In giving such consent, we do not thereby
admit that we come within the categories of persons whose consent is required
under Section 7 of the Securities Act of 1933.
/s/ KELLEY DRYE & WARREN LLP
July 9, 1998
New York, New York
<PAGE>
EXHIBIT 23.2
We consent to the reference to our Firm under the caption "Experts" and to the
use of our reports dated March 11, 1998, in Amendment No. 2 to the Registration
Statement on Form S-4 (No. 333-50475) and related Prospectus of KMC Telecom
Holdings, Inc. for the registration of 12 1/2% Senior Discount Notes due 2008.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
July 9, 1998
<PAGE>
EXHIBIT 23.3
The Board of Directors
KMC Telecom Holdings, Inc.:
We consent to the inclusion of our report dated April 26, 1996 covering our
audit of the combined statements of operations, redeemable and nonredeemable
equity and cash flows of Kamine Multimedia Corp. and KMC Southeast Corp. for the
year ended December 31, 1995 and to the reference of our firm under the heading
"Experts" in the KMC Telecom Holdings, Inc. Prospectus and Registration
Statement on Form S-4.
/s/ KPMG Peat Marwick LLP
New York, New York
July 9, 1998
<PAGE>
EXHIBIT 23.4
CONSENT OF INDEPENDENT ACCOUNTANTS
The Board of Directors
ICG Communications, Inc.:
We consent to the inclusion of our report dated December 16, 1997 relating
to the balance sheets of the Melbourne System (an operating unit of ICG
Communications, Inc.) as of December 31, 1995 and 1996, and the related
statements of operations and accumulated deficit and cash flows for the years
then ended and to the reference to our firm under the heading "Experts" in the
KMC Telecom Holdings, Inc. Prospectus and Registration Statement on Form S-4.
/s/ KPMG Peat Marwick LLP
Denver, Colorado
July 9, 1998
