<PAGE>
As filed with the Securities and Exchange Commission on September 19, 2000
Registration No. 333-
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------
KMC TELECOM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
--------------
<TABLE>
<CAPTION>
Delaware 4813 22-3545325
<S> <C> <C>
(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)
--------------
William F. Lenahan
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 copies to:
M. Ridgway Barker, James S. Scott, Sr.,
Esq. Esq.
Brian J. Calvey, Shearman & Sterling
Esq. 599 Lexington Avenue
Randi-Jean G. Hedin, New York, New York
Esq. 10022
Kelley Drye & Warren (212) 848-4000
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 any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act of 1933, please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
-----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
<CAPTION>
Proposed Maximum
Title of Each Class of Aggregate Offering Amount of
Securities to be Registered Price(1)(2) Registration Fee
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stock, par value $.01 per share..................................... $200,000,000 $52,800
-----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
</TABLE>
(1)Includes shares subject to an over-allotment option granted to the
Underwriters.
(2)Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(o) under the Securities Act of 1933.
--------------
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>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities, and we are not soliciting offers to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
PROSPECTUS (Subject to Completion)
Issued September 19, 2000
Shares
[LOGO] KMC Telecom
COMMON STOCK
-----------
KMC Telecom Holdings, Inc. is offering shares of its common stock. This is our
initial public offering and no public market currently exists for our shares.
We anticipate that the initial public offering price will be between $ and
$ per share.
-----------
We have applied to list our common stock on the Nasdaq National Market under
the symbol "KMCT."
-----------
Investing in our common stock involves risks. See "Risk Factors" beginning on
page 10.
-----------
PRICE $ A SHARE
-----------
<TABLE>
<CAPTION>
Price Underwriting
to Discounts and Proceeds to
Public Commissions KMC Telecom
------ ------------- -----------
<S> <C> <C> <C>
Per Share...................................... $ $ $
Total.......................................... $ $ $
</TABLE>
KMC Telecom Holdings, Inc. has granted the underwriters the right to purchase
up to an additional shares to cover over-allotments.
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved these securities or determined if this prospectus is
truthful or complete. Any representation to the contrary is a criminal offense.
Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers
on , 2000.
-----------
MORGAN STANLEY DEAN WITTER _________________________________GOLDMAN, SACHS & CO.
CREDIT SUISSE FIRST BOSTON
MERRILL LYNCH & CO.
DRESDNER KLEINWORT BENSON
, 2000
<PAGE>
[Map of the United States indicating the markets in which the company has or is
developing operations.]
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 4
Risk Factors........................ 10
Special Note Regarding Forward-
Looking Statements................. 19
Use of Proceeds..................... 20
Dividend Policy..................... 20
Capitalization...................... 21
Dilution............................ 22
Selected Financial and Operating
Data............................... 23
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 25
Business............................ 34
Management.......................... 53
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Certain Relationships and Related
Transactions...................... 66
Principal Stockholders............. 68
Description of Certain
Indebtedness...................... 71
Description of Capital Stock....... 74
Shares Eligible for Future Sale.... 78
United States Tax Consequences to
Non-U.S. Holders of Common Stock.. 79
Underwriters....................... 82
Legal Matters...................... 84
Experts............................ 84
Where You Can Find More
Information....................... 84
Index to Financial Statements...... F-1
</TABLE>
----------------
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell and seeking offers to buy
shares of common stock only in jurisdictions where such offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
This prospectus includes statistical data and forecasts concerning the
telecommunications industry that we obtained from industry publications. These
publications generally indicate that they have obtained information from
sources that they believe are reliable, but that they do not guarantee the
accuracy and completeness of the information. For example, we do not know what
rate of general economic growth in the areas in which we operate were assumed
in preparing forecasts. Forecasts of developing industries, such as ours, are
not based upon sophisticated analysis of a substantial amount of historical
data as is the case for more mature industries. Often, interviews with
corporate leaders in developing industries, such as ours, form the basis for
much statistical data and forecasts. Thus, statistical data and forecasts for
developing industries, such as ours, are much less likely to be accurate.
Our corporate logo and some of the titles and logos of our services mentioned
in this prospectus, such as "Creative Solutions with a Hometown Touch" and
"ClearStar," are our trademarks or service marks. Each trademark, trade name or
service mark of any other company appearing in the prospectus belongs to its
holder.
3
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company, our common stock being sold in this offering
and our financial statements and the related notes appearing elsewhere in this
prospectus. Except as otherwise noted, all information in this prospectus
assumes the conversion of all outstanding shares of our convertible preferred
stock into shares of our common stock, and a -for- split of our common
stock, all of which will occur automatically upon consummation of this
offering. Unless otherwise indicated, all information contained in this
prospectus assumes that there will be no exercise of the underwriters' over-
allotment option.
KMC Telecom Holdings, Inc.
We are a rapidly growing fiber-based integrated communications provider
offering data, voice and Internet infrastructure services. We offer these
services to businesses, governments and institutional end-users, Internet
service providers, long distance carriers and wireless service providers. Our
business has two distinct components: serving communications-intensive
customers in Tier III markets, and providing data services on a nationwide
basis.
. We provide a full suite of broadband communications services in 35 Tier
III markets, which we define as markets with a population between
100,000 and 750,000. We own and operate robust fiber-based networks and
Lucent switching equipment in all of our Tier III markets, which are
predominantly located in the South, Southeast, Midwest and Mid-Atlantic
United States. We will continue to expand in Tier III markets because we
believe that these markets have attractive growth attributes and are
typically less competitive than larger markets. Our customers in these
markets include: AT&T, Boeing, City of Augusta, Columbia Hospital, NASA,
Pillsbury, State of Wisconsin, Texas A&M University and Wal-Mart.
. We provide nationwide data services under long-term guaranteed revenue
contracts with Qwest and Broadwing. Under these contracts, we provide
local Internet access infrastructure and other enhanced data services.
Currently, we have contracts representing approximately $250 million in
annualized revenues in approximately 140 markets. We expect these
markets to be operational by the first quarter of 2001. The Internet
infrastructure we are deploying includes the latest technology platforms
from Cisco and Nortel, which we believe will result in a cost-effective
and technologically superior solution for our customers. We are
currently testing and expect to pilot next generation Internet Protocol
data and voice services in 2001.
The following table sets forth our recent growth:
<TABLE>
<CAPTION>
June 30,
-------------------------
Percentage
1999 2000 Growth
------------ ------------ ----------
<S> <C> <C> <C>
Revenue (for the six months ended).... $ 26,712,000 $ 68,076,000 155%
Total lines in service................ 190,960 767,992 302%
Fiber miles........................... 82,293 122,376 49%
Customers............................. 4,135 8,513 106%
Gross networks, property and
equipment............................ $406,256,000 $853,651,000 110%
</TABLE>
Full Service Integrated Communications Provider in Tier III Markets
Our objective is to be the preferred data and voice alternative to the
incumbent local exchange carrier in our Tier III markets by emphasizing our
local presence, which includes providing local direct sales, technical, billing
and service personnel. We currently provide on-net local dial tone, Internet
access infrastructure,
4
<PAGE>
integrated services digital network (ISDN), long distance, dedicated access,
private line and a variety of other advanced services and features. Data
services represented over 60% of our revenue for the first six months of 2000.
We intend to increase market penetration and continue to maintain low
customer turnover by offering enhanced services such as digital subscriber
lines (DSL), web hosting, data storage services and application hosting
services. We are installing DSL for data services in all 35 of our markets and
are testing voice over digital subscriber lines (VoDSL) in selected markets. We
expect that these services will be commercially available in 2001.
Through our robust fiber-based network facilities, we intend to become the
leading broadband local access point for data communications services in the
Tier III markets we serve. We believe that, by owning our networks, we are able
to provide high quality services, create capacity to deliver higher-margin
enhanced data and voice services, and effectively control network costs. We
estimate that our networks currently carry more than 95% of our traffic.
We believe that Tier III markets have a number of attractive attributes:
. these markets represent over 20% of all business communications lines in
the U.S.,
. these markets are among the fastest growing population centers in the
U.S. and therefore among the fastest growing markets for communications
services, and
. generally, the incumbent local exchange carriers and competitive local
exchange carriers have focused on Tier I and II markets and, therefore,
have a limited sales presence and a more limited fiber optic
infrastructure in Tier III markets.
Nationwide Data Platform
Our nationwide data platform will initially support the long-term guaranteed
revenue contracts we have with Qwest and Broadwing covering more than one
million ports in approximately 140 markets. In Tier III markets, these carrier
customers serve as anchor tenants for our full service strategy. In Tier I and
II markets, these carrier customers leverage our core strengths in technology
management and infrastructure deployment with their larger sales organizations
to brand and distribute data services. These contracts also provide us with a
platform to develop next generation data services. We are deploying our
nationwide data platform to meet current customer demand while designing into
it the infrastructure and facilities to support rapid and cost-effective future
growth. Because these contracts provide us with guaranteed revenue as we expand
into new markets, we believe that the risks associated with expansion are
significantly reduced.
We plan to capitalize on the convergence of data and voice over a common
Internet Protocol-based packet network by introducing a full suite of carrier-
class services including Voice over Internet Protocol and other broadband data
applications. We believe that these systems will deliver a more cost-effective
approach to providing integrated data and voice applications and services than
those currently deployed. We believe that by providing next generation local
access services in partnership with major carriers we will be positioned as a
leading provider of local access infrastructure nationwide.
Business Strategy
We intend to become a leading competitive provider of data and voice
services in the Tier III markets that we serve directly. We also intend to form
alliances with carriers in Tier I and II markets to deliver next generation
data services. The key components of our strategy are to:
. continue to deploy and operate robust fiber optic networks in Tier III
markets to support broadband applications,
5
<PAGE>
. continue to strengthen our local presence with personalized customer
service in Tier III markets,
. expand our data platform offerings by leveraging our relationships with
major carrier customers and by expanding into new markets,
. enhance our existing infrastructure to deliver next generation voice and
data services, and
. accelerate growth through potential strategic acquisitions.
----------------
We are a Delaware corporation. Our principal executive offices are located
at 1545 Route 206, Suite 300, Bedminster, New Jersey 07921 and our telephone
number at that location is (908) 470-2100.
6
<PAGE>
THE OFFERING
<TABLE>
<C> <S>
Common stock offered by us......................... shares
Common stock to be outstanding after the offering.. shares
Use of proceeds.................................... To fund capital
expenditures in connection
with the expansion of our
networks, for working
capital and other general
corporate purposes,
including to fund net
losses, and potential
strategic acquisitions.
See "Use of Proceeds."
Proposed Nasdaq National Market Symbol............. KMCT
</TABLE>
The number of shares to be outstanding after the offering excludes:
. shares of common stock issuable upon the exercise of options granted
under our stock plan at exercise prices ranging from $ to $ per
share, with a weighted average exercise price of $ .
. shares of common stock issuable upon the exercise of outstanding
warrants at an exercise price of $ per share.
. up to shares of common stock that may be issued to pay accumulated
dividends on our Series G Convertible Preferred Stock upon its
conversion to common stock as a result of this offering.
. up to shares that may be issued to the underwriters to cover over-
allotments.
7
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
The summary historical financial data for the years ended December 31, 1997,
1998 and 1999 presented below were derived from our audited financial
statements. The summary historical consolidated financial data as of June 30,
2000 and for the six months ended June 30, 1999 and 2000 presented below were
derived from our unaudited consolidated financial statements. This data is
unaudited but in the opinion of our management 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 years. You should read this information in conjunction with the
historical financial statements and notes included in the back of this
prospectus and with the section of this prospectus entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
Year Ended Six Months
December 31, Ended June 30,
------------------------------- ----------------------
1997 1998 1999 1999 2000
--------- --------- --------- ---------- ----------
(dollars in
(dollars in thousands) thousands)
(unaudited)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue................. $ 3,417 $ 22,425 $ 64,313 $ 26,712 $ 68,076
Operating expenses:
Network operating
costs:
Non-cash stock
compensation......... 1,110 566 2,387 1,616 1,853
Other network
operating costs ..... 5,482 27,699 81,678 32,560 65,290
Selling, general and
administrative:
Non-cash stock
compensation ........ 12,760 6,514 27,446 18,585 20,819
Other selling, general
and administrative... 12,176 34,171 84,434 38,219 79,050
Depreciation and
amortization.......... 2,506 9,257 29,077 11,636 31,118
--------- --------- --------- ---------- ----------
Total operating
expenses........... 34,034 78,207 225,022 102,616 198,130
--------- --------- --------- ---------- ----------
Loss from operations... (30,617) (55,782) (160,709) (75,904) (130,054)
Other expense........... -- -- (4,297) (4,297) --
Interest income......... 513 8,818 8,701 3,055 4,508
Interest expense........ (2,582) (29,789) (69,411) (26,014) (58,400)
--------- --------- --------- ---------- ----------
Net loss before
cumulative effect of
change in accounting
principle............. (32,686) (76,753) (225,716) (103,160) (183,946)
Cumulative effect of
change in accounting
principle.............. -- -- -- -- (1,705)
--------- --------- --------- ---------- ----------
Net loss............... (32,686) (76,753) (225,716) (103,160) (185,651)
Dividends and accretion
on redeemable preferred
stock.................. (8,904) (18,285) (81,633) (43,415) (58,981)
--------- --------- --------- ---------- ----------
Net loss applicable to
common shareholders... $ (41,590) $ (95,038) $(307,349) $ (146,575) $ (244,632)
========= ========= ========= ========== ==========
Other Financial Data:
Capital expenditures ... $ 61,146 $ 161,803 $ 440,733 $ 170,697 $ 177,360
Adjusted EBITDA(a)...... (14,241) (39,445) (101,799) (44,067) (76,264)
EBITDA(a)............... (28,111) (46,525) (135,929) (68,565) (98,936)
<CAPTION>
As of December 31, As of June 30,
------------------------------- ----------------------
1997 1998 1999 1999 2000
--------- --------- --------- ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Other Operating Data:
Route miles............. 289 714 1,475 1,269 1,989
Fiber miles............. 13,696 47,797 94,119 82,293 122,376
Number of collocations.. -- 35 81 56 124
Number of customers..... 300 1,713 6,060 4,135 8,513
Access lines in
service................ 9,258 48,342 113,750 77,474 197,721
Dedicated circuits in
service................ 32,583 78,621 204,281 113,486 570,271
--------- --------- --------- ---------- ----------
Total lines in
service............... 41,841 126,963 318,031 190,960 767,992
</TABLE>
(see accompanying notes)
8
<PAGE>
<TABLE>
<CAPTION>
As of December 31, As of June 30, 2000
--------------------------- -------------------------------------
Pro Pro Forma,
1997 1998 1999 Actual Forma(b) as Adjusted(c)
------- -------- -------- ---------- --------- --------------
(in thousands) (unaudited, in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash
equivalents............ $15,553 $ 21,181 $ 85,966 $ 60,297 $ 234,469 $
Restricted investments.. -- -- 88,571 77,748 77,748
Working capital......... 3,672 (1,391) (57,007) (2,989) 171,183
Networks, property and
equipment, net......... 71,371 224,890 639,324 785,874 785,874
Total assets ........... 95,943 311,310 886,040 1,182,127 1,356,299
Long-term notes
payable................ 61,277 41,414 235,000 575,190 575,190
Other long-term debt.... -- 267,811 576,137 595,013 595,013
Total nonredeemable
equity (deficiency).... (26,673) (104,353) (384,413) (616,707) (621,353)
</TABLE>
--------
(a) Adjusted EBITDA consists of earnings (loss) before net interest, income
taxes, depreciation and amortization charges, stock option compensation
expense (a non-cash charge), other expense and cumulative effect of change
in accounting principle. EBITDA consists of earnings (loss) before all of
the foregoing items except stock option compensation expense and other
expense. These items are provided because they are measures commonly used
in the telecommunications industry. They are presented to enhance an
understanding of our operating results and they are not intended to
represent cash flow or results of operations in accordance with generally
accepted accounting principles. Adjusted EBITDA and EBITDA are not
calculated under generally accepted accounting principles and are not
necessarily comparable to similarly titled measures of other companies.
(b) Pro forma balance sheet data gives effect to the issuance of $182.5
million of our Series G Convertible Preferred Stock, net of issuance
costs, in July 2000, the issuance of an aggregate of 4,192 shares of
Series E and Series F Preferred Stock in payment for regular quarterly PIK
dividends in July 2000 and the redemption of 2,965 shares of Series F
Preferred Stock in September 2000, as if they had all occurred on June 30,
2000.
(c) Reflects the items referred to in note (b), above, and $ million of
proceeds from this offering at an assumed initial offering price of $
per share (which is the midpoint of the filing range on the cover of this
prospectus) as if they had occurred on June 30, 2000.
9
<PAGE>
RISK FACTORS
Any investment in our common stock involves a high degree of risk. You
should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing us. Additional risks and uncertainties not presently known to
us or that we currently deem immaterial may also impair our business
operations. If any of the following risks actually occur, our business,
financial condition or results of operations could be materially adversely
affected. In such case, the trading price of our common stock could decline,
and you may lose all or part of your investment.
We Have a Limited Operating History and Have Incurred Significant Negative
Cash Flow from Operations and Significant Negative EBITDA Since Inception
We commenced material operations in 1996 and, as a result, we have a
limited operating history and limited revenues. We have only recently
completed the process of building many of our networks. Accordingly, you will
have limited historical financial information upon which to base your
evaluation of our business and an investment in our common stock. You should
consider our prospects for financial and operational success in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stage of development.
In connection with the construction of our networks we have incurred and
expect to continue to incur significant negative cash flow from operations and
significant negative EBITDA while we expand our business and build our
customer base. Our negative cash flow and negative EBITDA have increased in
each of the last four years. Our operating losses, negative EBITDA, cash used
by operations and capital expenditures will increase as a result of the
continuation of our expansion strategy.
For the six months ended June 30, 2000, we had revenues of $68.1 million,
negative cash flow from operations of $149.1 million and negative EBITDA of
$98.9 million. On a pro forma basis giving effect to the increase in interest
expense resulting from the establishment of our new credit facility for our
subsidiary, KMC Telecom IV, Inc., as if it occurred on January 1, 2000, our
free cash flow (EBITDA minus capital expenditures and pro forma interest
expense) for the six months ended June 30, 2000 would have been negative
$336.4 million and would have been insufficient to cover fixed charges by
$191.6 million.
We might not achieve or sustain profitability or generate positive EBITDA
or at any time have sufficient resources to meet our capital expenditure and
working capital requirements. We will need to significantly increase our
revenues and cash flows to meet our debt service obligations.
Our Future Growth May Require Substantial Additional Capital
Our current plans for expansion may require substantial additional cash
from outside sources. We currently anticipate that our capital expenditures
for the second half of 2000, excluding the Internet access infrastructure
equipment with a cost of $168.6 million described below, will be approximately
$200.0 million related to our Tier III markets and $75.0 million related to
our nationwide data platform. We will also have substantial net losses to
fund. Our substantial cash requirements will continue into the foreseeable
future.
In June 2000, we took delivery of $168.6 million of Internet access
infrastructure equipment in association with entering into agreements with
Qwest. We are obligated to make payments of approximately $84.4 million on
November 1, 2000 and $42.1 million on each of January 1 and March 1, 2001 to
pay for this equipment. We have a commitment to finance this equipment which
is subject to satisfactory documentation.
If we are successful in completing the financing for the Qwest equipment
described above, we believe that our cash, investments held for future capital
expenditures, amounts currently available under our credit facilities, the
proceeds of our recent placement of Series G Convertible Preferred Stock and
the proceeds from this offering will fund us until we become EBITDA positive.
10
<PAGE>
However, in the event that:
. our plans change,
. the assumptions upon which our plans are based prove inaccurate,
. we expand or accelerate our business plan, or
. we consummate acquisitions,
the foregoing sources of funds may prove to be insufficient, and we may
require additional financing sooner than we currently expect.
Additional sources of financing may include:
. public or private equity or debt financings,
. capitalized leases, and
. other financing arrangements.
Additional financing may not be available to us on acceptable terms, within
the limitations contained in the documents relating to our indebtedness, or at
all. Failure to obtain such additional financing could result in the delay or
abandonment of some or all of our development and expansion plans and
expenditures.
We Have a Substantial Amount of Indebtedness, Significant Debt Service
Requirements and Refinancing Risks
As of June 30, 2000, we had approximately $1.2 billion of indebtedness
outstanding. In addition, until February 15, 2003, our senior discount notes
accrete in value instead of paying cash interest. The carrying value of the
notes is $320.0 million on our June 30, 2000 balance sheet and will accrete to
a principal amount of $460.8 million as of February 15, 2003. Subsequently, we
will be required to make semi-annual cash interest payments on these notes.
Our substantial indebtedness could have important consequences to you. For
example, it could:
. limit our ability to obtain additional financing in the future,
. require us to dedicate a substantial portion of our cash flow from
operations to make payments on our indebtedness, thereby reducing the
funds available to us for other purposes, including working capital and
capital expenditures,
. limit our flexibility in planning for, or reacting to changes in, our
business or the industry in which we operate,
. make us more highly leveraged than many, if not all, of our competitors,
which could place us at a competitive disadvantage relative to our
competitors that are less leveraged, and
. increase our vulnerability in the event of a downturn in our business.
The documents under which our long-term debt was issued contain a number of
significant covenants. These covenants limit, among other things, our ability
to:
. borrow additional money,
. create liens,
. engage in sale-leaseback transactions,
. pay dividends,
. make investments,
. sell assets,
. issue capital stock,
11
<PAGE>
. redeem capital stock,
. merge or consolidate, and
. enter into transactions with our stockholders and affiliates.
The limitations contained in the documents under which our long-term debt
was issued are subject to a number of important qualifications and exceptions.
In particular, while the indentures applicable to our senior discount notes
and our senior notes restrict our ability to incur additional indebtedness,
they do permit us to incur an unlimited amount of purchase money indebtedness.
If we incur new indebtedness, the related risks that we and our subsidiaries
now face could intensify.
Under our credit facilities, our subsidiaries are required to meet a number
of financial tests at the end of each quarter. In addition, our subsidiaries
are required to obtain at least $35 million in additional equity contributions
from us prior to August 31, 2001. Failure to comply with these tests or to
obtain the required equity contributions could limit their ability to make
further borrowings, or could result in a default under our credit facilities,
allowing the lenders to accelerate the maturity of the loans made thereunder.
Our subsidiaries might not be able to comply with these covenants in the
future.
If we fail to meet our obligations under the documents governing our
indebtedness there could be a default on our indebtedness which would permit
the holders of substantially all of our indebtedness to accelerate the
maturity thereof.
In connection with the build-out of our networks and expansion of our
services, we recorded negative EBITDA and our earnings were insufficient to
cover fixed charges for 1997, 1998, 1999 and the six months ended June 30,
2000. After giving pro forma effect to the increase in interest expense
resulting from the establishment of our new credit facility for our
subsidiary, KMC Telecom IV, Inc., as if it occurred on January 1, 2000, our
earnings would have been insufficient to cover fixed charges by $191.6 million
for the six months ended June 30, 2000. We might not be able to improve our
earnings before fixed charges or EBITDA. If we do not, we will not be able to
meet our debt service obligations.
There Are Risks in Connection With Our Nationwide Data Platform
We have entered into a number of guaranteed revenue contracts with Qwest
and Broadwing whereby we, as the local service provider, will provide data
telecommunications services to these companies for approximately three and
one-half to four years. At the present time we have commitments under these
agreements to provide more than one million ports.
To date, we have principally financed the capital cost of the equipment
associated with the provision of this service through an off balance sheet
operating lease. We are wholly dependent upon payment of fees under agreements
with the customer, Qwest or Broadwing, in order to fund the required
financing.
We do not have an option to renew or extend these agreements. In addition,
while there are purchase options at the end of the term of our operating lease
agreements, given the rapid change in technology in the telecommunications
industry, the equipment may be obsolete at the end of the term.
Currently, more than 96% of the ports comprising our nationwide data
platform are subject to our contracts with Qwest. Any failure by Qwest to make
the contracted payments would have a material adverse effect on our business.
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<PAGE>
Our Industry is Extremely Competitive and Many of Our Competitors Have Greater
Resources Than We Have
The telecommunications industry is extremely competitive, particularly with
respect to price and service. We face competition in all of our markets,
primarily from incumbent local exchange carriers. Generally, our incumbent
local exchange carrier competitor is one of the regional Bell operating
companies. The incumbent local exchange carriers:
. have long-standing relationships with their customers,
. have financial, technical and marketing resources substantially greater
than we have,
. have the potential to fund competitive services with revenues from a
variety of businesses, and
. currently benefit from a number of existing regulations that favor these
carriers.
We do not believe that Tier III markets can profitably support more than
two facilities-based competitors to the incumbent local exchange carrier. In
several of our markets we face competition from two or more facilities-based
competitive local exchange carriers. After establishing and funding a network
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 competitive local exchange carriers, we expect substantial
price competition. We believe that such markets may be unprofitable for one or
more operators.
Potential competitors in our markets include:
. microwave carriers,
. wireless telecommunications providers,
. cable television companies, utilities, regional Bell operating companies
seeking to operate outside their current local service areas,
. independent telephone companies, and
. large long distance carriers, such as AT&T and MCI WorldCom, which have
begun to offer integrated local and long distance telecommunications
services.
Industry consolidation and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies,
could also give rise to significant new competitors for us.
One of the primary purposes of the Telecommunications Act of 1996 is to
promote competition, particularly in local markets. Recent regulatory
initiatives allow competitive local exchange carriers like us to interconnect
with incumbent local exchange carrier facilities. This provides increased
business opportunities for us. However, these regulatory initiatives have been
accompanied by increased pricing flexibility for, and relaxation of regulatory
oversight of, the incumbent local exchange carriers. If the incumbent local
exchange carriers engage in increased volume and discount pricing practices or
charge us increased fees for interconnection to their networks, or if the
incumbent local exchange carriers delay implementation of our interconnection
to their networks, our business may be adversely affected.
To the extent we interconnect with and use incumbent local exchange carrier
networks to serve our customers, we are dependent upon their technology and
capabilities. The Telecommunications Act imposes interconnection obligations
on incumbent local exchange carriers, but we cannot assure you that we will be
able to obtain the interconnections we require at desirable rates, terms and
conditions. In the event that we experience difficulties in obtaining
appropriate and reasonably priced service from the incumbent local exchange
carriers, our ability to serve our customers would be impaired.
Both the long distance and data transmission businesses are extremely
competitive. Prices in both businesses have declined significantly in recent
years and are expected to continue to decline. Our long distance services face
competition from large carriers such as AT&T, MCI WorldCom and Sprint. We will
rely on other carriers to provide transmission and termination for our long
distance traffic and therefore will be dependent on such carriers.
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<PAGE>
Although we expect to experience declining prices and increasing price
competition, we might not be able to achieve or maintain adequate market share
or revenue, or compete effectively, in any of our markets.
Incumbent Local Exchange Carriers Have Disputed the Entitlement of Competitive
Local Exchange Carriers to Reciprocal Compensation for Certain Calls to
Internet Service Providers
In most states in which we provide services, our arrangements with the
incumbent local exchange carriers provide that every time a customer of an
incumbent local exchange carrier connects to an Internet service provider that
is one of our customers, we are entitled to receive payment from the incumbent
local exchange carrier. This payment is called "reciprocal compensation." The
incumbent local exchange carriers have objected to making reciprocal
compensation payments and are seeking to have this changed by legislation,
regulation and litigation. The incumbent local exchange carriers have
threatened to withhold, and in many cases have withheld, reciprocal
compensation for such calls. We recognized reciprocal compensation revenue of
approximately $10.3 million, or 15.1% of our revenue, related to these calls
for the six months ended June 30, 2000. As of June 30, 2000, the receivable
related to these calls was $5.8 million.
In May 2000, we reached a resolution of our claims for payment of certain
reciprocal compensation charges previously disputed by BellSouth Corporation.
Under the agreement, BellSouth made a one-time payment that resolved all
amounts billed through March 31, 2000. In addition, we agreed with BellSouth
on future rates for reciprocal compensation, setting new contractual terms for
payment. Our prior agreement with BellSouth provided for a rate of $.009 per
minute of use for reciprocal compensation. Under the terms of the new
agreement, the rates for reciprocal compensation which will apply to all local
traffic, including Internet service provider-bound traffic, will decrease over
time. The reduction will be phased in over a three year period beginning with
a rate of $.002 per minute of use in year 2000, $.00175 per minute of use in
year 2001 and $.0015 per minute of use in year 2002.
We are currently pursuing resolution of this issue with other incumbent
local exchange carriers. Our goal is to reach mutually acceptable terms for
both outstanding and future reciprocal compensation amounts for all traffic.
We cannot assure you that we will reach new agreements with these carriers on
favorable terms; nor can we assure you that changes in legislation or
regulation will not adversely affect our ability to collect reciprocal
compensation.
We Rely on Incumbent Local Exchange Carriers for Interconnection and
Provisioning
Although the incumbent local exchange carriers are legally required to
"unbundle" their network into discrete elements and permit us to purchase only
the network elements we need to originate and terminate our traffic, thereby
decreasing operating expenses, we cannot assure you that this unbundling will
be timely or result in favorable prices. We cannot service a new customer
unless the incumbent local exchange carrier sends a technician to physically
alter its network (known as provisioning). We have experienced delays in
provisioning unbundled network elements from incumbent local exchange carriers
in the past and these delays have hampered our revenue growth. These delays
may continue to occur.
In January 1999, the Supreme Court overturned the Federal Communications
Commission's rules regarding which network elements must be unbundled by the
incumbent local exchange carriers, and remanded to the Federal Communications
Commission the question of which network elements are "necessary" to competing
carriers like us. The Supreme Court also remanded several issues to the U.S.
Court of Appeals for the 8th Circuit for further consideration.
On November 5, 1999, the Federal Communications Commission issued an order
establishing the network elements that must be offered by incumbent local
exchange carriers as unbundled network elements. The Federal Communications
Commission required that most, but not all, of the network elements specified
in its initial order, as well as some new network elements not included on the
original list, be made available by incumbent local exchange carriers. The
Federal Communications Commission also changed the obligation of incumbent
local
14
<PAGE>
exchange carriers to provide certain combinations of network elements. Various
parties have sought reconsideration and filed appeals of the Federal
Communications Commission's order. Those appeals and petitions are pending and
there can be no assurance as to their ultimate outcome.
On July 18, 2000, the U.S. Court of Appeals for the 8th Circuit issued a
decision in which it upheld the Federal Communication Commission's use of a
forward-looking methodology to establish prices for network elements, but the
Court vacated the agency's rule that the methodology applied should be based
on the use of the most efficient telecommunications technology currently
available and the lowest cost network configuration. Rather, the Court held
that the methodology must be applied based on the costs of the incumbent local
exchange carriers' existing facilities and equipment. The issue was remanded
to the Federal Communications Commission for further consideration. The
Court's ruling may result in efforts by the incumbent local exchange carriers
to initiate cost proceedings in many states and we are unable to provide
assurances as to the outcome of these proceedings or of the remand proceeding
that must be conducted by the Federal Communications Commission.
The 8th Circuit also affirmed its prior decision to vacate the Federal
Communications Commission rule that required incumbent local exchange carriers
to provide combinations of network elements that are not ordinarily combined
in their networks. The Court's decision keeps in place the system whereby
carriers cannot obtain network element combinations unless the incumbent local
exchange carrier has already combined the elements in its network today.
We Must Complete the Installation of Our New Customer Service Systems
Sophisticated information and processing systems are vital to our growth
and our ability to monitor costs, bill customers, provision customer orders
and achieve operating efficiencies. Until recently, our billing and
information systems were designed largely in-house with partial reliance on
third-party vendors. These systems have generally met our needs due in part to
our low volume of bills and orders. As we expand our services and our customer
base, the need for sophisticated billing and information systems has increased
significantly. We have recently embarked upon a program to implement a full
suite of order management, customer service, billing and financial
applications. These applications include electronic order tracking software
developed by Eftia OSS Solutions Inc., a new industry participant, software
providing comprehensive billing functions developed by Billing Concepts
Systems, Inc. and financial software developed by PeopleSoft, Inc. Initial
installation of the new operational support systems was made during the third
quarter of 1999, with development and expansion to continue through the first
quarter of 2001. The initial installation of the new billing and financial
systems was completed during the second quarter of 1999. Additional
development of the billing and financial systems will be phased in over the
remainder of the year 2000. Our failure to:
. implement the new operational support systems on a timely basis,
. adequately identify all of our information and processing needs, or
. upgrade our systems as necessary,
could have a material adverse effect on our business.
There Are Risks in Providing Long Distance Services
We recently began to offer long distance services. As a new entrant in the
long distance business, we expect to generate low gross margins and
substantial start-up expenses as we continue to roll out our long distance
service offerings.
We enter into wholesale agreements with long distance carriers to provide
us with long distance transmission capacity. These 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 our future long distance customers. Should we
fail to
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<PAGE>
meet our minimum volume commitments, if any, pursuant to these agreements, we
may be obligated to pay underutilization charges or we may lose the benefit of
all or a portion of the volume discounts we have negotiated. Likewise, we may
underestimate our need for long distance facilities and therefore be required
to obtain the necessary transmission capacity in "spot markets" which are
often more expensive than longer term contracts. We cannot assure you that we
will acquire long distance capacity on favorable terms or that we can
accurately predict long distance prices and volumes so that we can generate
favorable gross margins from our long distance business.
We Are Subject to Significant Government Regulation Which May Change in an
Adverse Manner
Our 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 competitive local exchange
carrier industry in particular, are undergoing substantial regulatory change
and uncertainty. We cannot assure you that future regulatory, judicial or
legislative changes, or other regulatory activities, will not have a material
adverse effect on our business. For a further discussion of regulatory issues
see the section of this prospectus entitled "Business--Regulation."
We Will Be Dependent Upon KNT Network Technologies LLC For Outside Network
Related Construction and Maintenance Services
We have entered into an exclusive five-year agreement with KNT Network
Technologies LLC, a company owned by Harold N. Kamine, the Chairman of our
board of directors, and an affiliate of Nassau Capital Partners L.P., two of
our principal stockholders, under which KNT will be our exclusive provider of
outside network related construction and maintenance services. The employees
of KNT are primarily individuals who previously worked for our former
construction division. KNT will provide construction and maintenance services
to us in exchange for cost plus certain fees. Accordingly, we will be
dependent upon KNT for performance of our network related construction needs.
We Are Dependent on Agreements with Third Parties for Our Rights-of-Way and
Franchises
We 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 our networks,
some of which may be terminated upon 30 or 60 days' notice to us. We cannot
assure you that we 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 us. If any of our existing franchise or license agreements were
terminated or not renewed and we were forced to remove our fiber optic cables
or abandon our networks in place, such termination could have a material
adverse effect on our business. Our agreements for rights-of-way and similar
matters generally require us to indemnify the party providing such rights.
Such indemnities could make us liable for actions (including negligence of the
other party).
The Telecommunications Industry is Subject to Rapid Technological Change
The telecommunications industry is subject to rapid and significant changes
in technology, and we must rely on third parties for the development of and
access to new technology. We cannot predict the effect of technological
changes on our business. For example, Voice over Internet Protocol technology
is not currently being used to any material extent for many of the purposes
for which we believe it will in the future. There may be significant obstacles
in implementing Voice over Internet Protocol for these purposes. We believe
our future success will depend, in part, on our ability to anticipate or adapt
to these changes and to offer, on a timely basis, services that meet customer
demands. In particular, service offerings in the data transmission sector of
the industry are expanding rapidly. We may not be able to anticipate or adapt
to such changes and to offer, on a timely basis, services that meet customers'
demands.
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<PAGE>
The Future Success of Our Business Depends Upon Key Personnel
We believe that the efforts of a number of key management and operating
personnel will largely determine our success and the loss of any of such
persons could adversely affect us. We do not maintain so-called "key man"
insurance on any of our personnel. We have employment agreements with Mr.
Lenahan, our Chief Executive Officer, Mr. Young, our President and Chief
Operating Officer, and Mr. Stewart, our Chief Financial Officer, which expire
at various times from March 2003 through April 2005. Our success will also
depend in part upon our 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, we may not be able to hire or retain necessary
personnel.
Control by Principal Stockholders
On a fully-diluted basis, after the conversion of our convertible preferred
stock, Nassau Capital Partners L.P. and its affiliates and Mr. Kamine own
approximately 23% and 19% of the outstanding shares of our common stock,
respectively. Following the offering, Nassau and Mr. Kamine will continue to
own approximately % and % of the outstanding shares of our common stock,
respectively, and together with the other existing stockholders, including
Dresdner Kleinwort Benson Equity Partners LP and Lucent Technologies Inc.,
generally will have the collective ability to control all matters requiring
stockholder approval, including the nomination and election of directors. Some
decisions concerning our operations or financial structure may present
conflicts of interest between Nassau, Mr. Kamine, and other existing
stockholders and you as a holder of our common stock. Pursuant to a
stockholders agreement, certain of our existing stockholders have agreed to
vote their shares and take all necessary actions to elect the following
individuals to our board of directors: our Chief Executive Officer, our
President, three individuals designated by Nassau, two individuals designated
by Mr. Kamine, one individual designated by Dresdner and one individual as an
independent director approved by Nassau, Mr. Kamine and other principal
existing stockholders. Lucent or a person to whom Lucent transfers its shares
may be entitled to designate one individual under certain circumstances. The
number of directors each of Nassau, Mr. Kamine and Dresdner is entitled to
designate will decrease as their respective percentages of ownership decrease.
See "Management-Election of Directors."
Some Provisions of Delaware Law, Our Employment Contracts and our Corporate
Documents May Make a Takeover More Difficult Even if a Takeover Would Benefit
Stockholders
Some of the provisions of the Delaware General Corporation Law and some of
our employment agreements may delay, deter or prevent someone from acquiring
us in a transaction that results in stockholders receiving a premium over the
market price for the shares of common stock. Section 203 of the Delaware
General Corporation Law also imposes certain restrictions on mergers and other
business combinations between us and any holder of 15% or more of our common
stock. In addition, the employment agreements between us and each of Messrs.
Lenahan, Young and Stewart contain provisions which require us to make
payments to those officers in some instances if employment is terminated
following specified events.
In addition to the foregoing, under the terms of the instruments governing
our senior discount notes, senior notes, senior secured credit facilities, and
our Series E and Series F Preferred Stock, in the event of a change of control
we must offer to repay that indebtedness and offer to purchase those
outstanding shares at a purchase price equal to up to 101% of the principal
amount or the accreted value of such debt or liquidation preference of such
preferred stock plus all accumulated and unpaid interest or dividends, as
applicable. This requirement may deter third parties from entering into a
merger or similar transaction with us.
The Market Price of Our Common Stock is Likely to be Volatile
The market price of our common stock can be expected to be significantly
affected by factors such as:
. quarterly variations in our results of operations,
. the announcement of new services or service enhancements by us or our
competitors,
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<PAGE>
. technological innovation by us or our competitors,
. changes in earnings estimates or buy/sell recommendations by analysts,
. the operating and stock price performance of other comparable companies,
and
. general market conditions or market conditions specific to particular
industries.
In particular, the stock prices for many companies in the
telecommunications sector have experienced wide fluctuations which have often
been unrelated to the operating performance of such companies.
There Has Not Been a Prior Public Market for Our Common Stock and We Cannot
Assure You That One Will Develop
Our common stock is a new issue of securities for which there is currently
no trading market. Although we expect our common stock to be quoted on the
NASDAQ National Market, an active trading market for our common stock may not
develop or be sustained following this offering. If you purchase shares in
this offering, you may not be able to resell your shares at prices equal to or
greater than the initial public offering price.
Future Sales of Our Common Stock in the Public Market May Depress Our Stock
Price
The market price of our common stock could decline as a result of sales, or
the perception that such sales, by our existing stockholders of a large number
of shares of our common stock in the market after this offering may occur.
These sales might also make it more difficult for us to sell additional equity
securities at a price that we deem appropriate. Certain of our existing
security holders have registration rights. For a description of these
registration rights, see the section of this prospectus entitled "Description
of Capital Stock--Registration Rights."
You Will Experience an Immediate and Substantial Dilution in the Book Value of
Your Investment
Prior investors have paid substantially less per share than the price in
this offering. Investors purchasing shares in this offering will incur
immediate and substantial dilution in net tangible book value per share. To
the extent outstanding options and warrants to purchase common stock are
exercised, there will be further dilution.
We Do Not Expect to Pay Dividends for the Foreseeable Future
We are effectively prohibited from paying cash dividends on our common
stock for the foreseeable future under the terms of our senior credit
facilities, the indentures related to our senior discount notes and senior
notes and by the terms of our Series E and Series F Preferred Stock. Moreover,
we plan to retain all earnings for investment in our business, and do not plan
to pay cash dividends at any time in the foreseeable future.
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<PAGE>
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
This prospectus includes forward-looking statements that reflect our
current estimates, expectations and projections about our future results,
performance, prospects and opportunities. In some cases, you can identify
these statements by forward-looking words such as "anticipate", "believe",
"could", "estimate", "expect", "intend", "may", "should", "will", "would" and
similar expressions. These forward-looking statements are based on all
information currently available to us and subject to a number of risks,
uncertainties and other factors that could cause our actual results,
performance, prospects or opportunities to differ materially from those
expressed in, or implied by, these forward-looking statements. These risks,
uncertainties and other factors include matters related to:
. our operations and prospects,
. our expected financial position,
. our funding needs and financing sources,
. our business and financing plans,
. our network construction and development plans,
. the ability of Tier III markets to profitably support one or more
competitive telecommunications companies,
. regulatory matters, and
. expected competitors in our markets.
You should not place undue reliance on any forward-looking statements.
Except as otherwise required by federal securities laws, we undertake no
obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events, changed circumstances
or any other reason after the date of this prospectus.
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<PAGE>
USE OF PROCEEDS
Our net proceeds from this offering are estimated to be approximately $
million (approximately $ million if the underwriters' over-allotment option
is exercised in full), assuming an offering price of $ per share and after
deducting underwriting discounts, commissions and other expenses of $
million payable by us. We intend to use the net proceeds to us from this
offering to fund:
. capital expenditures in connection with the expansion of our networks,
including continued fiber installation, and the provision of enhanced
data and voice services,
. working capital and other general corporate purposes, including net
losses, and
. potential strategic acquisitions.
Pending their use for these purposes, the net proceeds of this offering
will be invested in short-term, interest bearing investment-grade securities,
certificates of deposit or direct or guaranteed obligations of the United
States government.
DIVIDEND POLICY
We have not paid any dividends on our common stock and do not intend to pay
any dividends on our common stock in the foreseeable future. We currently
intend to retain our future earnings, if any, to finance the further expansion
and continued growth of our business. In addition, our ability to pay cash
dividends is currently restricted under the terms of the indentures related to
our senior discount notes and senior notes and by the terms of our Series E
and Series F Preferred Stock. The terms of our indentures effectively prohibit
the payment of dividends on our common stock for at least several years.
Future dividends, if any, will be determined by our board of directors.
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CAPITALIZATION
The following table sets forth our cash and capitalization as of June 30,
2000:
. on a historical basis, and
. after giving pro forma effect to the issuance of Series G Convertible
Preferred Stock and the issuance of an aggregate of 4,192 shares of
Series E and Series F Preferred Stock in payment for regular quarterly
PIK dividends, all of which occurred in July 2000 and the redemption of
2,965 shares of our Series F Preferred Stock which occurred in September
2000, and
. pro forma, as adjusted to give effect to the items referred to above and
to $ million of net proceeds from the offering of our common stock
made by this prospectus at an assumed initial offering price of $
per share (which is the midpoint of the filing range on the cover of
this prospectus), after deducting discounts, commissions and expenses of
the offering payable by us and the conversion of the outstanding shares
of our Series A, Series C and Series G Convertible Preferred Stock into
common stock.
As of June 30, 2000, our subsidiaries had an additional $159.8 million of
borrowing capacity available from lenders under their credit facilities,
subject to a number of conditions.
<TABLE>
<CAPTION>
As of June 30, 2000
----------------------------------
Pro Forma,
Actual Pro Forma as Adjusted
--------- ---------- ----------- ---
(unaudited, dollars in
thousands)
<S> <C> <C> <C> <C>
Cash and cash equivalents............... $ 60, 297 $ 234,469 $
Restricted investments.................. 77,748 77,748
--------- ---------- -----
Total cash and investments............. $ 138,045 $ 312,217 $
========= ========== =====
Long-term debt:
Senior secured credit facilities....... $ 575,190 $ 575,190 $
Senior discount notes, net of original
issue discount........................ 320,013 320,013
Senior notes........................... 275,000 275,000
--------- ---------- -----
Total long-term debt................. 1,170,203 1,170,203
--------- ---------- -----
Redeemable equity:
Senior redeemable, exchangeable, PIK
preferred stock, par value $.01 per
share; authorized: 630,000 shares;
issued and outstanding:
Series E, 69,815 shares actual and
72,311 shares pro forma and
shares pro forma, as adjusted....... 56,217 58,713
Series F, 47,447 shares actual and
46,178 shares pro forma and
shares pro forma, as adjusted....... 45,936 44,758
Redeemable cumulative convertible
preferred stock, par value $.01 per
share; authorized: 498,800 shares;
issued and outstanding:
Series A, 123,800 shares actual and
pro forma and shares pro forma,
as adjusted......................... 96,792 96,792
Series C, 175,000 shares actual and
pro forma and shares pro forma, as
adjusted............................ 63,826 63,826
Redeemable cumulative convertible
Series G preferred stock, 540,000
shares subscribed and shares pro
forma and pro forma, as adjusted...... 182,500 --
Less: Redeemable cumulative
convertible Series G preferred stock
subscription receivable............... (182,500) --
Redeemable cumulative convertible
preferred stock, par value $.01 per
share; authorized: 2,500,000 shares;
issued and outstanding:
Series G-1, -0- shares actual, 58,881
shares pro forma, and shares pro
forma, as adjusted.................. -- 19,355
Series G-2, -0- shares actual,
481,108 shares pro forma, and
shares pro forma, as adjusted....... -- 158,145
Redeemable common stock; 224,041
shares issued and outstanding actual
and pro forma and shares pro
forma, as adjusted.................... 41,752 41,752
Redeemable common stock warrants;
exercisable for 35,173 shares of
common stock.......................... 15,262 15,262
--------- ---------- -----
Total redeemable equity.............. 319,785 498,603
--------- ---------- -----
Nonredeemable equity (deficiency):
Common stock, par value $.01 per
share; authorized: 3,000,000 shares
actual and pro forma and shares
pro forma, as adjusted: issued and
outstanding: 629,734 shares actual
and pro forma and shares pro
forma, as adjusted.................... 6 6
Additional paid-in capital............. 1,561 --
Unearned compensation.................. (30,638) (30,638)
Accumulated deficit.................... (587,636) (590,721)
--------- ---------- -----
Total nonredeemable equity
(deficiency)........................ (616,707) (621,353)
--------- ---------- -----
Total capitalization............... $ 873,281 $1,047,453 $
========= ========== =====
</TABLE>
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DILUTION
Our pro forma net tangible book value as of June 30, 2000 was $ million,
or $ per share of common stock. We have calculated this amount by:
. subtracting our total liabilities from total tangible assets, and
. then dividing the difference by the pro forma, as adjusted number of
shares of common stock outstanding, including the number of shares of
common stock that will be issued upon the automatic conversion of all
redeemable convertible preferred stock upon the completion of this
offering.
If we give effect to our sale of shares of common stock in this
offering at an assumed initial public offering price of $ per share, after
deducting the estimated underwriting discounts and commissions and the
estimated offering expenses payable by us of $ million, our adjusted pro
forma net tangible book value as of June 30, 2000 would have been $ million,
or $ per share. This amount represents an immediate dilution of $ per
share to new investors. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................. $
Pro forma net tangible book value per share before this
offering..................................................... $
Increase in pro forma net tangible book value per share
attributable to new investors................................
----
Pro forma net tangible book value per share after this
offering.......................................................
-----
Dilution per share to new investors...........................
=====
</TABLE>
The following table summarizes, as of June 30, 2000, after giving effect to
the conversion of the redeemable convertible preferred stock into common
stock, the difference between the number of shares of common stock purchased
from us, the total consideration paid to us, and the average price per share
paid by existing stockholders and by new investors, at an assumed initial
public offering price of $ per share before deducting estimated underwriting
discounts and commissions and estimated offering expenses payable by us:
<TABLE>
<CAPTION>
Shares Total
Purchased Consideration Average
-------------- -------------- Price
Number Percent Amount Percent Per Share
------ ------- ------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders................ % $ % $
New investors........................
---- ----- ----- ----- ------
Total..............................
==== ===== ===== ===== ======
</TABLE>
If the underwriters exercise their over-allotment option in full, the
number of shares held by new investors will increase to shares, or % of
the total shares of common stock outstanding after this offering, the number
of shares held by existing stockholders will be reduced to % of the total
shares of common stock outstanding after this offering, and the dilution to
new investors will be $ per share.
The table above assumes no exercise of stock options or warrants
outstanding on June 30, 2000. As of June 30, 2000, there were options
outstanding to purchase shares of common stock at a weighted average
exercise price of $ per share and warrants outstanding to purchase
shares of common stock at an exercise price of $ per share. To the extent
any of these options or warrants are exercised, there will be further dilution
to new investors. If all of these outstanding options and warrants had been
exercised as of June 30, 2000, pro forma net tangible book value per share
after this offering would have been and total dilution per share to new
investors would have been $ .
22
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
Our selected financial data set forth below as of and for the years ended
December 31, 1995, 1996, 1997, 1998 and 1999 were derived from our audited
financial statements and those of our predecessors. Our selected financial
data as of June 30, 2000 and for the six months ended June 30, 1999 and 2000
are unaudited, but in the opinion of our management, they reflect 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 years. You should read the selected financial data in
conjunction with the financial statements and the notes included in the back
of this prospectus and with the section of this prospectus entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
Six Months
Year Ended December 31, Ended June 30,
------------------------------------------------ --------------------
1995 1996 1997 1998 1999 1999 2000
-------- ------- -------- -------- --------- --------- ---------
(dollars in thousands, except per share amounts)
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenue................. $ -- $ 205 $ 3,417 $ 22,425 $ 64,313 $ 26,712 $ 68,076
Operating expenses:
Network operating
costs:
Non-cash stock
compensation.......... -- 19 1,110 566 2,387 1,616 1,853
Other network operating
costs................. -- 1,361 5,482 27,699 81,678 32,560 65,290
Selling, general and
administrative:
Non-cash stock
compensation.......... -- 221 12,760 6,514 27,446 18,585 20,819
Other selling, general
and administrative.... 1,591 2,216 12,176 34,171 84,434 38,219 79,050
Depreciation and
amortization.......... 6 287 2,506 9,257 29,077 11,636 31,118
-------- ------- -------- -------- --------- --------- ---------
Total operating
expenses............. 1,597 4,104 34,034 78,207 225,022 102,616 198,130
-------- ------- -------- -------- --------- --------- ---------
Loss from operations... (1,597) (3,899) (30,617) (55,782) (160,709) (75,904) (130,054)
Other expense(a)........ -- -- -- -- (4,297) (4,297) --
Interest income......... -- -- 513 8,818 8,701 3,055 4,508
Interest expense(b)..... (23) (596) (2,582) (29,789) (69,411) (26,014) (58,400)
-------- ------- -------- -------- --------- --------- ---------
Net loss before
cumulative effect of
change in accounting
principle............. (1,620) (4,495) (32,686) (76,753) (225,716) (103,160) (183,946)
Cumulative effect of
change in accounting
principle(c)........... -- -- -- -- -- -- (1,705)
-------- ------- -------- -------- --------- --------- ---------
Net loss............... (1,620) (4,495) (32,686) (76,753) (225,716) (103,160) (185,651)
Dividends and accretion
on redeemable preferred
stock.................. -- -- (8,904) (18,285) (81,633) (43,415) (58,981)
-------- ------- -------- -------- --------- --------- ---------
Net loss applicable to
common shareholders... $ (1,620) $(4,495) $(41,590) $(95,038) $(307,349) $(146,575) $(244,632)
======== ======= ======== ======== ========= ========= =========
Net loss per common
share before cumulative
effect of change in
accounting principle... $ (2.70) $ (7.49) $ (64.93) $(114.42) $ (360.88) $ (172.31) $ (284.60)
Cumulative effect of
change in accounting
principle(c)........... -- -- -- -- -- -- (2.00)
-------- ------- -------- -------- --------- --------- ---------
Net loss per common
share................. $ (2.70) $ (7.49) $ (64.93) $(114.42) $ (360.88) $ (172.31) $ (286.60)
======== ======= ======== ======== ========= ========= =========
Pro forma amounts
assuming the change in
accounting principle
was applied
retroactively:
Net loss applicable to
common shareholders... $ (1,620) $(4,495) $(41,746) $(95,424) $(309,054) $(147,195) $(242,927)
Net loss per common
share................. $ (2.70) $ (7.49) $ (65.17) $(114.88) $ (362.88) $ (173.04) $ (284.60)
Weighted average number
of common shares
outstanding............ 600 600 641 831 852 851 854
Other Financial Data:
Capital expenditures(d)
....................... $ 3,498 $ 9,111 $ 61,146 $161,803 $ 440,733 $ 170,697 $ 177,360
Adjusted EBITDA(e)...... (1,591) (3,372) (14,241) (39,445) (101,799) (44,067) (76,264)
EBITDA(e)............... (1,591) (3,612) (28,111) (46,525) (135,929) (68,565) (98,936)
<CAPTION>
As of December 31, As of June 30,
----------------------------- --------------------
1997 1998 1999 1999 2000
-------- -------- --------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Other Operating Data:
Route miles............. 289 714 1,475 1,269 1,989
Fiber miles............. 13,696 47,797 94,119 82,293 122,376
Number of collocations.. -- 35 81 56 124
Number of customers..... 300 1,713 6,060 4,135 8,513
Access lines in
service................ 9,258 48,342 113,750 77,474 197,721
Dedicated circuits in
service................ 32,583 78,621 204,281 113,486 570,271
-------- -------- --------- --------- ---------
Total lines in
service............... 41,841 126,963 318,031 190,960 767,992
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
As of December 31, As of June 30, 2000
-------------------------------- ---------------------------------------
Pro Forma,
1997 1998 1999 Actual Pro Forma(f) as Adjusted(g)
------- -------------- -------- ---------- ------------ --------------
(in thousands) (unaudited, in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash
equivalents............ $15,553 $ 21,181 $ 85,966 $ 60,297 $ 234,469 $
Restricted investments.. -- -- 88,571 77,748 77,748
Working capital......... 3,672 (1,391) (57,007) (2,989) 171,183
Networks, property and
equipment, net......... 71,371 224,890 639,324 785,874 785,874
Total assets............ 95,943 311,310 886,040 1,182,127 1,356,299
Long-term notes
payable................ 61,277 41,414 235,000 575,190 575,190
Other long-term debt.... -- 267,811 576,137 595,013 595,013
Total nonredeemable
equity................. (26,673) (104,353) (384,413) (616,707) (621,353)
</TABLE>
--------
(a) During the second quarter of 1999, we recorded a $4.3 million charge to
other expense in connection with an unfavorable arbitration award. The net
amount due under the terms of the award was paid in full in June 1999.
(b) Excludes capitalized interest of (i) $37,000 for 1995, (ii) $103,000 for
1996, (iii) $854,000 for 1997, (iv) $5.1 million for 1998, (v) $6.6
million for 1999 and (vi) $5.9 million for the six months ended June 30,
2000. During the construction of our networks, the interest costs related
to construction expenditures are capitalized.
(c) In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 provides additional guidance in applying generally
accepted accounting principles to revenue recognition in financial
statements. Through December 31, 1999, we recognized installation revenue
upon completion of the installation. Effective January 1, 2000, in
accordance with the provisions of SAB 101, we are recognizing installation
revenue over the average contract period. The cumulative effect of this
change in accounting principle resulted in a charge of approximately $1.7
million which was recorded in the quarter ended March 31, 2000. For the
six months ended June 30, 2000, the net effect of adopting this change in
accounting principle was a deferral of the recognition of $322,000 of
revenue, which increased net loss for the period by $0.38 per share.
Revenue for the six months ended June 30, 2000 includes $543,000 of
revenues that, prior to the accounting change, had been recognized through
December 31, 1999.
(d) The figure for 1997 includes $2.0 million related to the acquisition of a
network.
(e) Adjusted EBITDA consists of earnings (loss) before net interest, income
taxes, depreciation and amortization charges, stock option compensation
expense (a non-cash charge), other expense and cumulative effect of change
in accounting principle. EBITDA consists of earnings (loss) before all of
the foregoing items except stock option compensation expense and other
expense. These items are provided because they are measures commonly used
in the telecommunications industry. They are presented to enhance an
understanding of our operating results and they are not intended to
represent cash flow or results of operations in accordance with generally
accepted accounting principles. Adjusted EBITDA and EBITDA are not
calculated under generally accepted accounting principles and are not
necessarily comparable to similarly titled measures of other companies.
(f) Pro forma balance sheet data gives effect to the issuance of $182.5
million of our Series G Convertible Preferred Stock, net of issuance
costs, in July 2000, the issuance of an aggregate of 4,192 shares of
Series E and Series F Preferred Stock in payment for regular quarterly PIK
dividends in July 2000 and the redemption of 2,965 shares of Series F
Preferred Stock in September 2000, as if they had all occurred on June 30,
2000.
(g) Reflects the items referred to in note (f), above, and $ million of
proceeds from this offering at an assumed initial offering price of $
per share (which is the midpoint of the filing range on the cover of this
prospectus) as if they had occurred on June 30, 2000.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis together with our
financial statements, including the notes and the other financial information
appearing in the back of this prospectus. Due to our limited operating
history, startup nature and rapid growth, period-to-period comparisons of
financial data are not necessarily indicative, and you should not rely upon
them as an indicator of our future performance. 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 the section of this prospectus entitled "Risk
Factors."
Overview
We are a rapidly growing fiber-based integrated communications provider
offering data, voice and Internet infrastructure services. We offer these
services to businesses, governments and institutional end-users, Internet
service providers, long distance carriers and wireless service providers. Our
business has two distinct components: serving communications-intensive
customers in Tier III markets, and providing data services on a nationwide
basis.
We provide a full suite of broadband communications services in 35 Tier III
markets, which we define as markets with a population between 100,000 and
750,000. We own and operate robust fiber-based networks and Lucent switching
equipment in all of our Tier III markets, which are predominantly located in
the South, Southeast, Midwest and Mid-Atlantic United States. We will continue
to expand in Tier III markets because we believe that these markets have
attractive growth attributes and are typically less competitive than larger
markets. Our customers in these markets include: AT&T, Boeing, City of
Augusta, Columbia Hospital, NASA, Pillsbury, State of Wisconsin, Texas A&M
University and Wal-Mart.
We also provide nationwide data services under long-term guaranteed revenue
contracts with Qwest and Broadwing. Under these contracts, we provide local
Internet access infrastructure and other enhanced data services. Currently, we
have contracts representing approximately $250 million in annualized revenues
in approximately 140 markets. We expect these markets to be operational by the
first quarter of 2001. The Internet infrastructure we are deploying includes
the latest technology platforms from Cisco and Nortel, which we believe will
result in a cost-effective and technologically superior solution for our
customers. We are currently testing and expect to pilot next generation
Internet Protocol data and voice services in 2001.
Tier III Markets. We have installed fiber-based SONET networks, or self-
healing synchronous optical networks, using a Lucent 5ESS(R) switch in each of
our 35 operational markets, and are currently constructing networks in two
additional Tier III markets using a similar architecture. Our fiber optic
networks are initially designed and built to reach approximately 80% of the
business access lines in each of our markets, typically requiring a local
fiber loop of about 30 to 40 miles.
As our switches have become operational, our operating margins have
improved meaningfully. Our operating margins have also improved due to
increased on-network revenues relative to resale revenues. On-network revenues
are revenues earned from services provided on our network, including by direct
connection to our switch, unbundled network element or dedicated circuit.
Resale revenues are generated when traffic is carried completely on the
incumbent local exchange carriers' facilities. Resale revenues have declined
from approximately 56% of our revenues during the first quarter of 1999 to
approximately 7% of our revenues during the second quarter of 2000.
25
<PAGE>
The table below provides selected key operational and financial data as of
the following dates:
<TABLE>
<CAPTION>
Quarter Ended
--------------------------------------------------------------
June June
March 31, 30, September 30, December 31, March 31, 30,
1999 1999 1999 1999 2000 2000
--------- ------- ------------- ------------ --------- -------
<S> <C> <C> <C> <C> <C> <C>
Tier III operational
markets................ 22 23 23 34 35 35
Route miles............. 913 1,269 1,328 1,475 1,724 1,989
Fiber miles............. 60,584 82,293 85,581 94,119 110,335 122,376
Collocations............ 56 56 72 81 111 124
Customers............... 3,069 4,135 4,786 6,060 7,305 8,513
Total buildings
connected.............. 1,167 1,665 2,989 4,108 5,615 7,088
Access lines in
service................ 64,723 77,474 98,431 113,750 148,439 197,721
Dedicated circuits in
service................ 96,035 113,486 169,769 204,281 331,640 570,271
------- ------- ------- ------- ------- -------
Total lines in
service.............. 160,758 190,960 268,200 318,031 480,079 767,992
On-network
revenues(1)(2)......... 44% 62% 69% 87% 88% 93%
Resale revenues(1)(3)... 56% 38% 31% 13% 12% 7%
</TABLE>
--------
(1) As a percentage of total revenues.
(2) On-network revenues are revenues earned from services provided on our
network, including by direct connection to our switch, unbundled network
element or dedicated circuit.
(3) Resale revenues are generated when traffic is carried completely on the
incumbent local exchange carriers' facilities.
Nationwide Data Platform. We currently provide Internet access
infrastructure for Qwest and Broadwing. We provide this service using remote
access servers manufactured by Cisco and Nortel which we are deploying in our
supernodes. Supernodes are concentration points for high-speed connectivity to
the Internet. We will have 32 supernodes, including seven in our existing
markets.
Under the terms of our existing guaranteed revenue contracts, we provide
the routing and ancillary equipment for each supernode, as well as data
transport service from the incumbent local exchange carrier to our supernode
location. Our customers pay us a fixed price per port and compensate us for
certain expenses, including space, power and transport, that we may incur
above an agreed level. This structure provides highly predictable revenues and
costs over the life of each contract, currently ranging from three and one-
half to four years. These contracts began generating revenues during the third
quarter of 2000. Revenues will continue to increase as the contracts are
phased in through the second quarter of 2001. We expect these contracts to
provide positive margins and cash flow beginning with the commencement of
revenues in the third quarter of 2000.
We purchased approximately $134.4 million of equipment relating to these
contracts during the first quarter of 2000. We sold this equipment to General
Electric Credit Corporation and CIT Lending Services Corporation, and leased
it back from them, during the second quarter of 2000. The term of this sale-
leaseback including renewal periods, matches the initial term of these data
contracts. As a result, this equipment was shown on our balance sheet as of
March 31, 2000, but was not reflected on our balance sheet as of June 30,
2000. We purchased an additional $168.6 million of equipment relating to these
contracts during the second quarter of 2000. We have a commitment to finance
this equipment which is subject to satisfactory documentation.
Revenue. Our revenue is derived from the sale of local switched services,
long distance services, Centrex-type services, private line services, special
access services and Internet access infrastructure. Historically, a
significant portion of our revenue has been derived from the resale of
switched services. We have transitioned the majority of our customers on-
network and as a result the portion of our revenue related to the resale of
switched services has decreased from 68% of total revenue for the year ended
1997 to 31% of total revenue for the year ended 1999, and further decreased to
9% of total revenue for the six months ended June 30, 2000. We expect that the
revenue recognized related to the nationwide data platform guaranteed revenue
contracts will continue to increase beginning in the third quarter of 2000 as
they are implemented.
26
<PAGE>
Reciprocal Compensation. We recognized reciprocal compensation revenue of
approximately $9.7 million, or 15.1% of our total revenue for 1999 and
approximately $10.3 million or 15.1% of our total revenue for the six months
ended June 30, 2000. In May 2000, we reached a resolution of our claims for
payment of certain reciprocal compensation charges, previously disputed by
BellSouth Corporation. Under the agreement, BellSouth made a one-time payment
that resolved all amounts billed through March 31, 2000. In addition, we
agreed with BellSouth on future rates for reciprocal compensation, setting new
contractual terms for payment. Our prior agreement with BellSouth provided for
a rate of $.009 per minute of use for reciprocal compensation. Under the terms
of the new agreement, the rates for reciprocal compensation which will apply
to all local traffic, including ISP-bound traffic, will decrease over time.
The reduction will be phased in over a three-year period beginning with a rate
of $.002 per minute of use in year 2000, $.00175 per minute of use in year
2001 and $.0015 per minute of use in year 2002.
We are currently pursuing resolution of this issue with other incumbent
local exchange carriers. Our goal is to reach mutually acceptable terms for
both outstanding and future reciprocal compensation amounts for all traffic.
We cannot assure you that we will reach new agreements with these carriers on
favorable terms.
As of June 30, 2000, we have provided reserves which we believe are
sufficient to cover any amounts which may not be collected, but we cannot
assure you that this will be the case. Our management will continue to
consider the circumstances surrounding this dispute periodically in
determining whether additional reserves against unpaid balances are warranted.
Operating Expenses. Our principal operating expenses consist of network
operating costs, selling, general and administrative expenses, stock option
compensation expense and depreciation and amortization. Network operating
costs include charges from termination and unbundled network element charges;
charges from incumbent local exchange carriers for resale services; charges
from long distance carriers for resale of long distance services; salaries and
benefits associated with network operations, billing and information services
and customer care personnel; franchise fees and other costs. Network operating
costs also include a percentage of both our intrastate and interstate revenues
which we pay as universal service fund charges. National data platform
operating expenses include space, power, transport, maintenance, staffing,
sales, general and administrative and rental expenses under our operating
lease agreements. Certain of these costs are passed through to the carrier
customer which allows us to limit our maintenance and servicing costs to a
predetermined level, and to receive offsetting revenues for any costs in
excess of that level. Selling, general and administrative expenses consist of
sales personnel and support costs, corporate and finance personnel and support
costs and legal and accounting expenses. Depreciation and amortization
includes charges related to plant, property and equipment and amortization of
intangible assets, including franchise acquisition costs. Depreciation and
amortization expense will increase as we place additional networks into
service or expand existing networks.
Interest Expense. Interest expense includes interest charges on our senior
notes, senior discount notes and our senior secured credit facilities.
Interest expense also includes amortization of deferred financing costs.
Results of Operations
Six Months Ended June 30, 2000 Compared To Six Months Ended June 30, 1999
Revenue. On an as reported basis, revenue increased 155% from $26.7 million
for the six months ended June 30, 1999 (the "1999 Six Months") to $68.1
million for the six months ended June 30, 2000 (the "2000 Six Months"). This
increase is primarily attributable to revenues derived from 35 markets we
serviced during the 2000 Six Months compared to the 23 markets we serviced
during the 1999 Six Months. In addition, each of our markets that generated
revenues during the 1999 Six Months generated increased revenues during the
2000 Six Months.
27
<PAGE>
On an as reported basis, on-network revenue increased 321% from $14.7
million in the 1999 Six Months to $61.9 million in the 2000 Six Months, while
resale revenues decreased 48% from $12.0 million to $6.2 million over the same
period primarily as a result of the conversion of resale customers to on-
network. On-network revenues are revenues earned from services provided on our
network, including by direct connection to our switch, unbundled network
element or dedicated ciruit. On-network revenues represented 91% of total
revenue in the 2000 Six Months, compared to 55% of total revenue in the 1999
Six Months. In addition, we recognized reciprocal compensation revenue of $4.6
million and $10.3 million, or 17% and 15% of our total revenues during the
1999 Six Months and 2000 Six Months, respectively.
Network Operating Costs. Network operating costs, excluding non-cash stock
compensation expense, increased 100% from $32.6 million for the 1999 Six
Months to $65.3 million for the 2000 Six Months. This increase of
approximately $32.7 million was due primarily to the increase in the number of
markets in which we operated in the 2000 Six Months as compared to the 1999
Six Months. The components of this increase are $12.2 million in direct costs
associated with providing on-network services, including leasing unbundled
network elements, and resale services, $11.5 million in personnel costs, $4.7
million in network support services, $1.6 million in consulting and
professional services costs, $1.5 million in telecommunications costs and
$1.2 million in other direct operating costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses, excluding non-cash stock compensation expense,
increased 107% from $38.2 million for the 1999 Six Months to $79.0 million in
the 2000 Six Months. This increase of approximately $40.8 million is due
primarily to the increase in the number of markets in which we operated in the
2000 Six Months as compared to the 1999 Six Months. The components of this
increase are $22.0 million in personnel costs, $2.3 million in facility costs,
$1.6 million in telecommunications costs, $1.6 million in travel related
costs, $1.2 million in professional costs, as well as increases in other
marketing and general and administrative costs aggregating approximately $12.1
million.
Stock Option Compensation Expense. Stock option compensation expense, a
non-cash charge, in aggregate increased 12% from $20.2 million in the 1999 Six
Months to $22.7 million for the 2000 Six Months. This increase is due
primarily to an increase in the estimated fair value of our common stock, as
well as the grant of additional option awards as compared to the 1999 Six
Months.
Depreciation and Amortization. Depreciation and amortization expense
increased 167% from $11.6 million for the 1999 Six Months to $31.1 million for
the 2000 Six Months. This increase is due primarily to depreciation expense
associated with the greater number of networks in commercial operation during
the 2000 Six Months.
Interest Income. Interest income increased 45% from $3.1 million in the
1999 Six Months to $4.5 million in the 2000 Six Months. The increase is due
primarily to larger average cash, cash equivalent and restricted cash balances
during the 2000 Six Months as compared to the 1999 Six Months as well as
receiving interest at a higher average rate.
Interest Expense. Interest expense increased 124% from $26.0 million in the
1999 Six Months to $58.4 million in the 2000 Six Months. Of this increase,
$14.9 million is attributable to the issuance of $275 million of 13 1/2%
senior notes in May 1999, $14.3 million is related to higher borrowings under
our senior secured credit facilities and $3.2 million is due to accretion on
our senior discount notes. We capitalized interest related to network
construction projects of $1.3 million during the 1999 Six Months and $5.9
million during the 2000 Six Months.
Net Loss Before Cumulative Effect of Change in Accounting Principle. For
the reasons stated above, net loss before cumulative effect of change in
accounting principle increased from $103.2 million for the 1999 Six Months to
$183.9 million for the 2000 Six Months.
28
<PAGE>
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenue. Revenue increased 187% from $22.4 million for 1998 to $64.3
million for 1999. This increase is primarily attributable to revenues derived
from 23 markets we serviced during 1999, as compared to 1998 when we derived
revenues from only 8 markets during the entire year, and began to derive
revenues from 14 additional markets during the fourth quarter of 1998. In
addition, each of our markets that generated revenues during 1998 generated
increased revenues during 1999.
During 1998 and 1999, we recognized revenue which we believed was due to us
from incumbent local exchange carriers for terminating local traffic of
Internet service providers. We determined to recognize this revenue because we
concluded, based upon all of the facts and circumstances known to us at the
time, including numerous state public service commission and state and federal
court decisions upholding competitive local exchange carriers' entitlement to
reciprocal compensation for such calls, that realization of those amounts was
reasonably assured. On October 13, 1999, however, the Louisiana Public Service
Commission ruled that local traffic to Internet service providers in Louisiana
is not eligible for reciprocal compensation. As a result of that ruling, we
determined that we could no longer conclude that realization of amounts
attributable to termination of local calls to Internet service providers in
Louisiana was reasonably assured. Accordingly, we recorded an adjustment to
reduce revenue in the third quarter of 1999, which reversed all reciprocal
revenue recognized related to Internet service provider traffic in Louisiana
for the entire year of 1998 and the first nine months of 1999. The adjustment
amounted to $4.4 million, of which $1.1 million relates to the year ended
December 31, 1998 and $3.3 million relates to the nine months ended September
30, 1999.
Although incumbent local exchange carriers, such as BellSouth, have
generally withheld payments of amounts due for reciprocal compensation to
competitive local exchange carriers like us for calls to Internet service
providers and disputed the entitlement of competitive local exchange carriers
to reciprocal compensation for such calls in jurisdictions other than
Louisiana as well, we have determined to continue to recognize amounts due to
us for reciprocal compensation for such calls in jurisdictions other than
Louisiana and South Carolina (which is the only other jurisdiction in which we
currently operate that has adopted a similar position) because we have
concluded, based upon all of the facts and circumstances, including numerous
state public service commissions and state and federal court decisions
upholding competitive local exchange carriers' entitlement to reciprocal
compensation for such calls, that realization of such amounts is reasonably
assured.
Revenue for 1998 and 1999 included $14.2 million and $19.7 million,
respectively, derived from resale services and an aggregate of $8.2 million
and $44.6 million (including, after giving effect to the third quarter 1999
$4.4 million adjustment for Louisiana, $9.7 million of revenue related to
reciprocal compensation during 1999), respectively, of revenue derived from
on-network services. Resale services represented 63.2% of revenue in 1998 and
30.6% of revenue in 1999.
Network Operating Costs. Network operating costs, excluding non-cash stock
compensation expense, increased 195% from $27.7 million in 1998 to $81.7
million in 1999. This increase of $54.0 million was due primarily to the
increase in the number of markets in which we operated in 1999. The components
of this increase are $27.7 million in direct costs associated with providing
on-network services, including leasing unbundled network elements, and resale
services, $14.3 million in personnel costs, $4.2 million in network support
services, $5.1 million in consulting and professional services costs, $600,000
in facility costs, $900,000 in travel costs and $1.2 million in
telecommunications and other direct operating costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses, excluding non-cash stock compensation expense,
increased 147% from $34.2 million in 1998 to $84.4 million in 1999. This
increase of approximately $50.2 million resulted primarily from increases of
$25.4 million in personnel costs, $5.1 million in professional costs, $3.4
million in travel related costs, as well as increases in other marketing and
general and administrative costs aggregating approximately $16.4 million.
These increases were due primarily to the greater number of networks in
commercial operation during 1999.
29
<PAGE>
Stock Option Compensation Expense. Stock option compensation expense, a
non-cash charge, increased 320% from an aggregate of $7.1 million for 1998 to
$29.8 million for 1999. This increase primarily resulted from an increase in
the estimated fair value of our common stock, as well as the grant of
additional option awards during 1999.
Depreciation and Amortization. Depreciation and amortization expense
increased from $9.3 million for 1998 to $29.1 million for 1999, primarily as a
result of depreciation expense associated with the greater number of networks
in commercial operation during 1999.
Other Expense. During the second quarter of 1999, we recorded a $4.3
million charge to other expense in connection with an unfavorable arbitration
award. The net amount due under the terms of the award was paid in full in
June 1999.
Interest Income. Interest income remained consistent from $8.8 million in
1998 to $8.7 million in 1999.
Interest Expense. Interest expense increased from $29.8 million in 1998 to
$69.4 million in 1999. The increase resulted primarily from the issuance of
our 13 1/2% senior notes in May 1999, additional accretion of $33.3 million on
our senior discount notes and $6.3 million of interest charges related to
higher borrowings under our senior secured credit facility. We capitalized
interest related to network construction projects of $5.1 million during 1998
and $6.6 million during 1999.
Net Loss. For the reasons stated above, net loss increased from $76.8
million for 1998 to $225.7 million for 1999.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Revenue increased 559% from $3.4 million for 1997 to $22.4 million
for 1998. This increase is primarily attributable to revenues derived from 8
markets during the entire 1998 year, as well as 14 additional markets from
which we began to derive revenues at various points during 1998, as compared
to 1997 when we derived revenues from only 1 market during the entire year,
and began to derive revenues from 7 additional markets at various points
during the year. In addition, each of our markets that generated revenues
during 1997 generated increased revenues during 1998. Revenue for 1997 and
1998 included $2.3 million and $14.2 million, respectively, of revenue derived
from resale services and an aggregate of $1.1 million and $8.2 million
(including $2.9 million of revenue from reciprocal compensation in 1998),
respectively, of revenue derived from on-network services. Resale services
represented 67.6% of revenue in 1997 and 63.2% of revenue in 1998.
Network Operating Costs. Network operating costs, excluding non-cash stock
compensation expense, increased 404% from $5.5 million in 1997 to $27.7
million in 1998. This increase of approximately $22.2 million was due
primarily to the increase in the number of markets in which we operated in
1998 and the related increases of $14.5 million in costs associated with
providing on-network services, including leasing unbundled network elements,
and resale services, $3.3 million in personnel costs, $1.3 million in
consulting and professional services costs, $1.2 million in contracted network
support costs, and $300,000 in facilities related costs, $600,000 in travel
related costs and $1.0 million in other direct operating costs.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses, excluding non-cash stock compensation expense,
increased 180% from $12.2 million in 1997 to $34.2 million in 1998. This
increase of approximately $22.0 million resulted primarily from increases of
$10.5 million in personnel costs and $1.2 million in professional costs
(consisting primarily of legal costs relating to regulatory matters),
$1.6 million in travel related costs, as well as increases in other marketing
and general and administrative costs aggregating approximately $8.7 million.
Stock Option Compensation Expense. Stock option compensation expense, a
non-cash charge, decreased 49% from an aggregate of $13.9 million in 1997 to
$7.1 million in 1998. These charges are directly impacted by changes in the
estimated fair value of our common stock. The increase in the estimated fair
value of such stock
30
<PAGE>
in 1998 was less than the increase in 1997. The expense charge for 1998
includes the net effect of a credit resulting from the termination of the KMC
Telecom Inc. stock option plan, which was substantially offset by a charge
related to the adoption of the KMC Telecom Holdings, Inc., stock option plan,
in September 1998.
Depreciation and Amortization. Depreciation and amortization expense
increased from $2.5 million for 1997 to $9.3 million for 1998, primarily as a
result of depreciation expense associated with the greater number of networks
in commercial operation during 1998, as well as higher amortization of
intangible assets.
Interest Expense. Interest expense increased from $2.6 million in 1997 to
$29.8 million in 1998. This increase resulted primarily from the issuance of
our $460.8 million 12 1/2% senior discount notes during the first quarter of
1998, which generated interest expense of $29.6 million in 1998, as well as
the increased expense attributable to the higher level of borrowings under a
credit facility in 1998. We capitalized interest of $5.1 million related to
network construction projects during 1998 and $854,000 during 1997.
Net Loss. For the reasons stated above, net loss increased from $32.7
million for 1997 to $76.8 million for 1998.
Stock Compensation Plan
During 1996 and 1997, one of our principal operating subsidiaries granted
options to purchase shares of its common stock pursuant to its 1996 Stock
Plan. On June 26, 1998, our board of directors adopted 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 shares of our common stock
and replaced our 1996 Stock Plan. During the third quarter of 1998, we
replaced the options to purchase shares of common stock previously granted
under the 1996 Stock Plan, with options to purchase shares of our common stock
granted under the 1998 Stock Plan. We also granted new options to some
additional employees. Upon cancellation of the outstanding options under the
1996 Stock Plan, we reversed all compensation expense previously recorded with
respect to those options. Additionally, to the extent the fair value of our
common stock exceeded the exercise price of the options granted under the 1998
Stock Plan, we recognized compensation expense related to such options to the
extent vested. The net effect of the cancellation of the options outstanding
under the 1996 Stock Plan and the grant of options under the 1998 Stock Plan
resulted in a credit to compensation expense of approximately $600,000 in
1998.
Some of the provisions in the stock option awards granted under the 1998
Stock Plan will necessitate that the 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 our 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 our future reported net income (loss).
Liquidity and Capital Resources
We have incurred significant operating and net losses as a result of the
development and operation of our networks. We expect that such losses will
continue as we emphasize the development, construction and expansion of our
networks and build our customer base. As a result, we do not expect there to
be any cash provided by operations in the near future. We will also need to
fund the expansion of our networks and the building of new networks as well as
to fund our capital expenditures related to our nationwide data platform
business. We have financed our operating losses and capital expenditures with
equity invested by our founders, preferred stock placements, credit facility
borrowings, operating leases and our 12 1/2% senior discount notes and 13 1/2%
senior notes.
During the first quarter of 2000, we amended, restated and combined our
prior senior secured credit facility and our prior Lucent facility in a single
$700.0 million facility. Under this amended senior secured credit facility,
our subsidiaries which own our 35 existing networks and the two Tier III
networks which are to be completed
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<PAGE>
during 2000 are permitted to borrow up to an aggregate of $700.0 million,
subject to certain conditions, for the purchase of fiber optic cable, switches
and other telecommunications equipment and, once certain financial conditions
are met, for working capital and other general corporate purposes.
During the quarter ended June 30, 2000, our subsidiary, KMC Telecom, IV,
Inc., closed a new senior secured term loan from Lucent Technologies Inc.
Proceeds from this loan may be used to purchase or install Lucent products.
The loan is initially capped at $35.0 million until certain conditions are met
that allow for additional borrowings up to a ceiling of $50.0 million. This
loan will be used to purchase equipment for future expansion.
We agreed, as of June 30, 2000, to issue shares of Series G Convertible
Preferred Stock to Lucent Technologies, Dresdner Kleinwort Benson Private
Equity Partners, CIT Lending Services, Nassau Capital Partners and Harold N.
Kamine, our Chairman, for aggregate gross proceeds of $182.5 million. The
transaction closed and the proceeds were received in early July 2000. The
Series G Convertible Preferred Stock has an aggregate liquidation preference
of $182.5 million and an annual cumulative dividend equal to 7% of the
liquidation preference. Payment of the unpaid dividends is triggered by an
initial public offering in which we receive aggregate gross proceeds of at
least $80.0 million or a merger, consolidation or sale of substantially all of
our assets. In such event, we may elect to pay these dividends with additional
shares of our common stock.
As of August 31, 2000, we had $580.8 million and $34.8 million of
indebtedness outstanding under the amended senior secured credit facility and
the Telecom IV senior secured term loan, respectively. Subject to certain
conditions, as of that date we had an additional $119.2 million and $200,000
in borrowing capacity available under these facilities, respectively. The
amended senior secured credit facility contains a number of affirmative and
negative covenants, one of which requires us to make additional cash capital
contributions to our subsidiaries which are the borrowers thereunder of at
least $35.0 million prior to August 31, 2001. The original covenant required
$185.0 million in cash capital contributions by April 1, 2001. However,
because we contributed $150.0 million of the proceeds of our Series G private
equity financing toward fulfilling this requirement, the lenders amended this
covenant by extending the due date on the remaining $35.0 million of cash
capital contributions to August 31, 2001. Because the entire $185.0 million
cash capital contribution was not made by July 31, 2000, however, the
applicable interest rate associated with the facility has increased by 100
basis points until the remaining $35.0 million amount is contributed.
Net cash provided by financing activities from borrowings was $334.9
million and our net cash used in operating and investing activities was $360.6
million for the six months ended June 30, 2000.
We made capital expenditures of $170.7 million in the 1999 Six Months
versus $177.4 million in the 2000 Six Months. As of August 31, 2000, we had
outstanding purchase commitments aggregating approximately $94.6 million
related to the purchase of fiber optic cable and telecommunications equipment
under our agreements with certain suppliers and service providers. We also had
operating lease commitments of $59.1 million. Continued significant capital
expenditures are expected to be made during the remainder of 2000 and
thereafter. The majority of these expenditures are expected to be made for
network construction and the purchase of switches and related equipment to
facilitate the offering of our services. We expect to continue to incur
operating losses while we expand our business and build our 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 our control, including economic conditions,
competition, regulatory developments and the availability of capital.
In addition to the capital expenditures above, we took delivery of
approximately $134.4 million and $168.6 million of Internet access
infrastructure equipment in March and June 2000, respectively, in association
with entering into agreements with Qwest. We entered into a lease financing
transaction in the quarter ended June 30, 2000 to fund the cost of the $134.4
million of equipment purchased in March and we expect to enter into a
financing transaction to fund the $168.6 million of equipment. We are
obligated to make payments of
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<PAGE>
approximately $84.4 million on November 1, 2000 and $42.1 million on each of
January 1 and March 1, 2001 to pay for the equipment purchased in June 2000.
We have a commitment to finance this equipment which is subject to
satisfactory documentation.
If we are successful in completing the financing for the Qwest equipment
described above, we believe that our cash, investments held for future capital
expenditures, amounts currently available under our credit facilities, the
proceeds of our recent placement of Series G Convertible Preferred Stock and
the proceeds of this offering will fund us until we become EBITDA positive.
However, in the event that our plans change, the assumptions upon which our
plans are based prove inaccurate, we expand or accelerate our business plan or
we determine to consummate acquisitions, the foregoing sources of funds may
prove insufficient and we may be required to seek additional financing sooner
than we currently expect. Additional sources of financing may include public
or private equity or debt financings, leases and other financing arrangements.
We can give no assurance that additional financing will be available to us or,
if available, that it can be obtained on a timely basis and on acceptable
terms.
Quantitative and Qualitative Disclosure About Market Risk
Market risks relating to our operations result primarily from changes in
interest rates. A substantial portion of our long-term debt bears interest at
a fixed rate. However, the fair market value of the fixed rate debt is
sensitive to changes in interest rates. We are subject to the risk that market
interest rates will decline and the interest expense due under the fixed rate
debt will exceed the amounts due based on current market rates. We have
entered into two interest rate swap agreements with commercial banks to reduce
the impact of changes in interest rates on a portion of our outstanding
variable rate debt. The agreements effectively fix the interest rate on $415.0
million of our outstanding variable rate borrowings under our amended senior
secured credit facility due 2007. A $325 million interest rate swap agreement
entered into in April 2000 terminates in April 2004 and a $90 million interest
rate swap agreement entered into in June 2000 terminates in June 2005. For
other information regarding the swap agreements, see Note 11 of the Notes to
Unaudited Condensed Consolidated Financial Statements included in the back of
this prospectus.
The following table provides information about our significant financial
instruments that are sensitive to changes in interest rates (in millions):
<TABLE>
<CAPTION>
Future Principal Payments
Fair Value on --------------------------------------------------
June 30, 2000 2000 2001 2002 2003 2004 Thereafter Total
------------- ------- ------- ------- ------- ------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long-Term Debt:
Fixed Rate:
Senior Discount Notes,
Interest payable at 12
1/2%,
maturing 2008.......... $ 205.9 $ -- $ -- $ -- $ -- $ -- $ 320.0 $ 320.0
Senior Notes, interest
payable at 13 1/2%,
maturing 2009.......... 266.0 -- -- -- -- -- 275.0 275.0
Variable rate:
Amended Senior Secured
Credit Facility,
interest variable
(10.76% at June 30,
2000) (a).............. 540.4 -- -- 0.6 47.6 86.3 405.9 540.4
Telecom IV Senior
Secured Term Loan,
interest variable
(11.31% at June 30,
2000) (a).............. 34.8 -- -- -- 3.5 3.5 27.8 34.8
-------- ------- ------- ------- ------- ------- -------- --------
Interest rate swaps:
Variable rate for fixed
rate .................. (3.6) -- -- -- -- -- -- --
-------- ------- ------- ------- ------- ------- -------- --------
Total.................. $1,043.5 $ -- $ -- $ 0.6 $ 51.1 $ 89.8 $1,028.7 $1,170.2
======== ======= ======= ======= ======= ======= ======== ========
</TABLE>
--------
(a) Interest is based on a variable rate, which at our option, is determined
by either a base rate or LIBOR, plus, in each case, a specified margin.
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BUSINESS
The Company
We are a rapidly growing fiber-based integrated communications provider
offering data, voice and Internet infrastructure services. We offer these
services to businesses, governments and institutional end-users, Internet
service providers, long distance carriers and wireless service providers. Our
business has two distinct components: serving communications-intensive
customers in Tier III markets, and providing data services on a nationwide
basis.
We provide a full suite of broadband communications services in 35 Tier III
markets, which we define as markets with a population between 100,000 and
750,000. We own and operate robust fiber-based networks and Lucent switching
equipment in all of our Tier III markets, which are predominantly located in
the South, Southeast, Midwest and Mid-Atlantic United States. We will continue
to expand in Tier III markets because we believe that these markets have
attractive growth attributes and are typically less competitive than larger
markets. Our customers in these markets include: AT&T, Boeing, City of
Augusta, Columbia Hospital, NASA, Pillsbury, State of Wisconsin, Texas A&M
University and Wal-Mart.
We also provide nationwide data services under long-term guaranteed revenue
contracts with Qwest and Broadwing. Under these contracts, we provide local
Internet access infrastructure and other enhanced data services. Currently, we
have contracts representing approximately $250 million in annualized revenues
in approximately 140 markets. These contracts have a total value of
approximately $900 million. We expect these markets to be operational by the
first quarter of 2001. The Internet infrastructure we are deploying includes
the latest technology platforms from Cisco and Nortel, which we believe will
result in a cost-effective and technologically superior solution for our
customers. We are currently testing and expect to pilot next generation
Internet Protocol data and voice services in 2001.
Market Opportunity
A number of important trends are reshaping the U.S. telecommunications
industry, creating substantial opportunities for growth by competitive local
exchange carriers. These trends are described below.
Expansion of Competitive Local Telecommunications Industry. The
Telecommunications Act of 1996 and certain state regulatory initiatives have
provided increased opportunities in the telecommunications marketplace by
opening all local markets to competition and requiring incumbent local
exchange carriers to provide increased direct interconnection. According to
the Federal Communications Commission's Trends in Telephone Service, local
service providers in the United States generated approximately $113.4 billion
in revenue in 1998 from the provision of local exchange services. Incumbent
local exchange carriers accounted for $108.2 billion of this amount. We
believe that competitive local exchange carriers' market share will continue
to grow rapidly.
Large and Rapidly Growing Market. According to International Data
Corporation, or IDC, the market for regulated, switched and unswitched data
and voice traffic is estimated to have generated a total of $230.0 billion in
revenues in 1999 and is expected to grow to $283.0 billion by 2004. IDC
estimates that U.S. competitive local exchange carrier revenue is expected to
grow from approximately $9.0 billion in 1999 to approximately $18.0 billion in
2004, an approximately 14.9% compound annual growth rate. In particular, data
traffic is expected to experience significant growth. According to Forrester
Research, the total amount of terabits of data attributable to Internet access
by businesses in the United States is expected to grow from approximately 0.3
terabits in 1999 to approximately 3.6 terabits in 2003, an approximately 86%
compound annual growth rate. IDC also estimates that IP-telephony services
revenue is expected to grow from $480 million in 1999 to approximately $19
billion in 2004, a compound annual growth rate of 108%.
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<PAGE>
We believe that the rapid opening of the local telecommunications market to
competition has accelerated the growth in local traffic related to Internet
access and the demand for bundled voice and data service offerings. Currently,
an opportunity exists for new entrants to achieve significant market
penetration through offering a differentiated product. We believe that the
following business products and applications will drive growth for integrated
communications providers:
. digital subscriber line (DSL),
. data storage and backup,
. business/office applications managed by third parties (ASP),
. e-commerce applications,
. voice over packet data networks, and
. advanced data applications such as streaming video.
We believe success in this environment will depend primarily on speed-to-
market, marketing creativity, the ability to provide competitively priced
services rapidly, and customer service and responsiveness. In order to deliver
these services, modern telecommunications facilities, fiber optic cable and
switches are generally used, which require capital.
Growing Demand for High-Speed Data Communications. High-speed connectivity
has become important to businesses due to the dramatic increase in Internet
usage and the proliferation of applications based on the personal computer and
Internet Protocol. According to IDC Internet Commerce Model Version 6.3 June
2000, the number of Internet users worldwide was approximately 266.8 million
in 1999 and is forecasted to grow to approximately 741.6 million by 2004, a
compound annual growth rate of approximately 23%. The popularity of the
Internet with consumers has also driven the rapid adoption of the Internet as
a commercial medium. As a result, businesses have established Web sites,
corporate intranets and extranets and implemented e-commerce applications to
expand their customer reach and improve their communications efficiency.
Importantly, these applications are increasingly required by businesses of all
sizes, making broadband capacity, network quality, an enhanced services
portfolio and technical capability competitive distinctions among service
providers.
Tier III Market Opportunity. Tier III markets, which we define as markets
with a population between 100,000 and 750,000, present a significant growth
opportunity for telecommunications carriers. We believe that Tier III markets
have a number of attractive attributes, including being among the fastest
growing population centers in the U.S. and therefore among the fastest growing
markets for telecommunications services. Incumbent local exchange carriers
have historically focused their resources on larger markets and have generally
neglected Tier III markets. Incumbent local exchange carriers generally
operate a copper infrastructure in Tier III markets which has limited
bandwidth capacity and have typically consolidated their sales and marketing
efforts in Tier I and Tier II markets away from their customers in Tier III
markets. Consequently, business customers in Tier III markets generally do not
have access to the same set of services that are available to business
customers in larger markets, such as high speed Internet access, dedicated
lines, and advanced data applications. We believe the relative size of Tier
III markets serves to discourage new entry from facilities-based integrated
communications providers in markets where one or more integrated
communications providers already have operating networks.
Business customers in Tier III markets demand comprehensive telephony and
data services from their telecommunications providers. As these customers
grow, the sophistication of their telephony and data needs will grow too. This
represents a significant opportunity for fiber-based integrated communications
providers.
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<PAGE>
Business Strategy
We intend to become a leading competitive provider of data and voice
services in the Tier III markets that we serve directly. We also intend to
continue to form alliances with carriers in Tier I and II markets to deliver
next generation data services. To accomplish these objectives we will:
Continue to Deploy and Operate Robust Fiber Optic Networks in Tier III
Markets to Support Broadband Applications. We will continue to build
geographically extensive, full service, fiber-based networks in Tier III
markets to support both voice and broadband data applications. We believe our
networks are generally more technologically advanced than those of the
incumbent local exchange carrier, facilitate the capture of market share, and
are likely to deter other alternative competitive local exchange carriers from
penetrating our markets due to the cost of constructing a competing network of
equal capability. In all of our operational markets, we have completed our
backbone construction connecting the market's central business district with
outlying office parks, large institutions, the locations of long distance
carriers' transmission equipment and major incumbent local exchange carrier
central offices. We intend to continue to expand our networks in response to
customer demand. We expedite network construction and time-to-market through
our "switch-in-the-box" concept which incorporates a turn key process that
allows installation and testing of the switch at the manufacturing facility
before shipment. The switch and its housing are then shipped and placed on-
site for integration into the network.
Continue to Strengthen Our Local Presence with Personalized Customer
Service in Tier III Markets. We seek to capture and retain customers in Tier
III markets through local, personalized sales, marketing and customer service
programs. In order to accomplish this, we will continue to:
. establish local sales offices in each market in which we operate a
network,
. recruit our city directors and sales staff primarily from the local
market,
. rely primarily on a face-to-face direct selling approach, and
. support our sales staff with locally based customer service, billing and
technical support personnel and participation in the local community.
Most of our existing sales personnel are local residents who have previously
worked for the incumbent local exchange carrier or other telecommunications
companies. We believe that our "Creative Solutions with a Hometown Touch(R)"
sales approach is very important to customers in Tier III markets, who do not
typically receive localized sales contact or customer support from the
incumbent local exchange carrier.
Expand Our Data Platform Offerings by Leveraging Our Relationships with
Major Carrier Customers and by Expanding into New Markets. In Tier I, II and
III markets, we are creating a nationwide next generation local broadband
network to provide data communications services through strategic alliances
with major carrier customers, including Qwest and Broadwing. We believe that
these alliances leverage our core strengths in managing technology and
developing infrastructure and use the carriers' larger sales organizations to
brand and distribute these capabilities. We expect to use our guaranteed
revenue contracts with these carriers to reduce the risks associated with
expansion. We will build our networks to meet existing requirements under
these contracts while preserving the flexibility to rapidly and cost-
effectively expand capacity with demand.
Enhance our Existing Infrastructure to Deliver Next Generation Voice and
Data Services. We will expand our existing infrastructure so that we can
continue to offer new voice and data services, thereby enhancing our market
penetration and maintaining low customer turnover. Services we expect to offer
in the future include DSL, web hosting, data storage and application service
hosting. We also intend to become the leading gateway for data communications
services to the Tier III markets we serve. We provide data services directly
to our own customers and to long distance carriers, Internet service providers
and other businesses which require broadband access in our markets but do not
currently have their own facilities or connections in those markets.
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<PAGE>
Accelerate Growth Through Potential Strategic Acquisitions. We intend to
accelerate our growth and expand our presence in our target markets by
acquiring telecommunications companies and related businesses and assets. We
seek acquisition targets that offer similar services to ours which can be
integrated into our existing operations and networks. We also seek acquisition
targets which may allow us to offer additional enhanced or other related
services as well as new technologies that we may seek to implement. We
currently have no agreements relating to any material acquisitions.
Services
We offer a comprehensive suite of data and voice services. Historically, we
have resold switched services which we purchased from incumbent local exchange
carriers. In December 1997, we began providing our own on-network services to
our customers. Our on-network services and resale services account for all of
our revenues. The allocation between on-network revenues and resale revenues
was as follows:
<TABLE>
<CAPTION>
Year Ended Six Months
December 31, Ended
---------------- June 30,
1997 1998 1999 2000
---- ---- ---- ----------
<S> <C> <C> <C> <C>
On-network revenues................................... 32% 37% 69% 91%
Resale revenues....................................... 68% 63% 31% 9%
</TABLE>
Voice Services
For the six months ended June 30, 2000, voice services accounted for
approximately 40% of our revenue. These voice services include:
Local Switched Services. Local switched services allow customers to connect
their key systems and PBX system with the public network through dial tone
lines and trunks. We also offer enhanced services such as call waiting,
conferencing, speed dialing and voice mail to our customers. We currently have
switches commercially operable in each of our existing markets and expect to
have switches commercially operable in two additional Tier III markets by
December 31, 2000. We have added and will continue to add capacity in all
markets to insure services are available when required by our customers.
Long Distance Services. We offer a full range of long distance services
including inter- and intra-LATA, interstate, international, calling card,
prepaid calling card and 800 type services. We offer long distance services to
our customers by entering into wholesale agreements with various long distance
carriers and reselling their transmission services to our customers. We
believe that many of our customers will prefer the option of purchasing long
distance services from us in conjunction with their local switched services as
part of their one-stop telecommunications solution.
Centrex-type Services. Centrex-type services provide customers the
functionality of PBX without the capital expense of installing these systems.
Centrex-type services reduce customers' maintenance expenses and increase
communications reliability. We introduced these services in all our
operational markets during 1999 and the first quarter of 2000. These services
feature call forwarding, speed dialing, conferencing and intercom, transfer
and voice mail capabilities. Centrex-type services can be provided over
standard voice connections or, where voice and data services are required,
ISDN connections.
Private Line and Special Access Services. We currently provide various
types of on-network dedicated services which permit the transmission of voice
and data between two or more specified points and are dedicated to a
particular customer. Private line services are provided over dedicated
circuits and are available in different capacities. DS-1 circuits are
dedicated lines that provide 24 separate channels that transport voice and/or
data.
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<PAGE>
DS-3 circuits provide 672 channels. The use of the channels and capacity of
the service is determined by the needs of the customer. Special access
services are provided to long distance carriers to connect their customers to
the long distance carriers' locations or to multiple locations of the carrier.
The services are provided over DS-1 and DS-3 circuits. If additional capacity
is desired we have the ability to provide OC-3, OC-12 and higher capacities
that deliver multiple DS-3 equivalent capacities. Our private line and special
access services are designed to meet the needs of our customers.
Data Services
Data services represented approximately 60% of our revenue for the six
months ended June 30, 2000. We believe that these services enhance our ability
to provide an integrated turnkey solution to our customers' data, voice and
video transmission requirements. Our current data service offerings include:
Primary Rate ISDN. Primary Rate ISDN provides customers the equivalent of
1.544 megabits per second of digital communications via a T-1 type facility,
with 23 channels for data and voice communications and a 24th channel
providing network signaling and control for the services. We focus our Primary
Rate ISDN sales efforts on Internet service providers who use it as a means of
supporting customer access to their operations, and end-user customers who use
it as a network access facility for their internal telecommunications systems.
Internet Infrastructure. Our Internet infrastructure service provides large
bandwidth users with data switching capability at the network level, allowing
them to acquire capacity as required without investing in data switching
equipment. Internet infrastructure service gives us the ability to provide
data switching to Internet service providers by allowing data calls to be
terminated through port wholesale equipment rather than the switch. This
enables the Internet service provider to more cost effectively manage its data
requirements while, at the same time, increasing the efficiency and capacity
of our Lucent Technologies Series 5ESS(R)-type switches.
Basic Rate ISDN. Basic Rate ISDN, or BRI, provides customers the potential
of 144 kilobits per second of digital communications via a single network
facility interface. We believe it will be attractive to medium and small size
customers, since it provides dial-up access to the Internet, and other dial-up
data applications, while simultaneously providing the ability to integrate
voice traffic on a single network facility.
Frame Relay/ATM. Frame relay and ATM, or asynchronous transfer mode, are
used by some of our data customers as a fast data transport service for Wide
Area Networks. Today we resell these services. In the future we intend to
provide these services over our own network and utilize a third party provider
for transport outside our network.
Our future data service offerings will include:
DSL. DSL, or digital subscriber line, is a method of using existing copper
wire for high bit-rate data transport in the "last mile" connecting our
network backbone ring to the customer's premises. DSL provides the customer
with a choice of bandwidth based upon its particular needs. Beginning in 2001,
we plan to offer HDSL, SDSL and ADSL to provide high bandwidth data and video
service as well as Voice over DSL to medium and small size customers.
We have deployed DSLAMs, or digital subscriber line access multiplexers, in
collocation offices in 18 cities. These DSLAMs are equipped with the
components necessary to support our provisioning of T-1 circuits via DSL.
During the fourth quarter of 2000, we will upgrade these DSLAMs to support
SDSL, ADSL and Voice over DSL applications. Concurrently, we plan to begin
deployment during the fourth quarter of 2000 of DSLAMs which will support all
of these applications from the outset. This deployment will continue in 2001.
Application Service Provider. We plan to host applications and data for
customers on reliable and secure servers. We envision a variety of services
including consulting, installation, software maintenance, Internet access,
monitoring and software subscription. The applications provided will cover e-
mail, accounting/business management and vertical applications.
38
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Web Hosting. We plan to offer web site design services and web hosting on
secured, monitored servers. These services will provide small to medium size
customers a turn key e-commerce solution.
Data Storage and Backup. We plan to offer automatic and secure off-site
storage of enterprise data. These services will include consulting, testing
and hosting, with 24 hours-per-day, seven days-per-week monitoring.
Operations Support System
We continue the implementation of our high quality operations support
system encompassing comprehensive billing, service order, customer care and
electronic bonding capability. The system is expected to support our existing
and contemplated services. Initial installation of the new operational support
system was made during the third quarter of 1999, with development and
expansion to continue through the first quarter of 2001. The system is
designed to provide us with a single "flow-through" order system that will
allow each order to be tracked from service provisioning through installation.
We implemented the service order module and the number tracking module in
all our existing markets in July and August 2000. The implementation included
full testing of capabilities and training of personnel in all markets. All
existing markets are utilizing the system for order entry.
We are currently electronically bonded with two carriers and expect to be
electronically bonded with our remaining carriers by the end of the year.
Electronic bonding is the ability to electronically share customer order
information between us and the incumbent local exchange carrier or
interconnection carrier. Even when we are electronically bonded, we may not
achieve the anticipated efficiencies if the information provided to us by the
incumbent local exchange carrier is not in a format that we can readily use or
if the incumbent local exchange carrier does not promptly provision new lines
for us.
The asset and inventory modules, which will provide each market's
inventory, are currently being loaded with the necessary data including
circuit data. Completion of the data loading, verification process and testing
will conclude the implementation and provide full "flow-through" capability in
the first quarter of 2001.
We believe that our operations support system will allow us to quickly
address customer concerns, and improve operations efficiency which provides us
with a significant competitive advantage.
Tier III Markets
We target Tier III markets, which we define as markets with a population
from 100,000 to 750,000. As part of our market selection process we analyze
the demographic, economic, competitive and telecommunications demand
characteristics of the market. We estimate market demand using data gathered
from long distance carriers, the Federal Communications Commission, local
sources, site visits and specific market studies commissioned by us. We also
analyze the concentration of potential business, government and institutional
end-user customers and the general economic prospects for the area.
We depend upon a detailed business analysis coupled with a "success-based"
return on capital employed analysis to drive our capital deployment. Each year
capital is deployed based on forecasts, and investment is made when the
forecasted investment return exceeds our threshold requirement.
Once we target a Tier III market for development, we design a network to
provide access to approximately 80% of the business customers in that market
either through direct connections to our network or through unbundled network
elements leased from the incumbent local exchange carrier. Typically, we
construct a SONET, or self-healing synchronous optical network, backbone ring
to provide coverage of the major business districts, government offices,
hospitals, office parks and universities, the principal locations of the
transmission equipment of long distance carriers offering services in the
area, and the incumbent local exchange carrier's central office(s). Following
construction of our backbone network, we build additional loops to increase
the size of our addressable market as demand grows.
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<PAGE>
The construction of a network requires us to obtain municipal franchises
and other permits. These rights are typically subject to non-exclusive
agreements of finite duration providing for the payment of fees by us or the
provision of services by us to the municipality without compensation. In
addition, we must secure rights-of-way and other access rights which are also
typically provided under non-exclusive, multi-year agreements and generally
contain renewal options. Generally, these rights are obtained from utilities,
incumbent local exchange carriers, other competitive local exchange carriers,
railroads and long distance carriers. The Telecommunications Act of 1996
requires most utilities to provide rights-of-way to competitive local exchange
carriers on non-discriminatory terms and conditions and at reasonable rates.
Our requirements for a planned network are communicated to KNT Network
Technologies LLC which provides program management for construction of the
outside plant portion of the network. Our own personnel negotiate required
contracts and rights-of-way and test 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. We believe
that a new fiber optic network can be commercially operable within
approximately nine months after construction commences.
During Phase I of our network construction program we completed networks in
eight Tier III markets. We completed networks in 15 Tier III markets during
Phase II of the program and will add networks in 14 additional markets during
Phase III. Twelve of the 14 networks to be added during Phase III have been
completed and the remaining two networks will be completed by the end of 2000.
The markets in which we established or plan to establish networks during each
phase of the program are as follows:
<TABLE>
<CAPTION>
Phase I Phase II Phase III
---------------------- ----------------------------- ---------------------------
<S> <C> <C>
Huntsville, Alabama Daytona Beach, Florida Montgomery, Alabama
Melbourne, Florida Fort Myers, Florida Clearwater/St. Petersburg,
Augusta, Georgia Pensacola, Florida Florida
Savannah, Georgia Sarasota, Florida Monroe, Louisiana
Baton Rouge, Louisiana Tallahassee, Florida Lansing, Michigan
Shreveport, Louisiana Fort Wayne, Indiana Biloxi/Gulfport,
Corpus Christi, Texas Topeka, Kansas Mississippi
Madison, Wisconsin Ann Arbor, Michigan Akron, Ohio
Eden Prairie, Minnesota Dayton, Ohio
Fayetteville, North Carolina Toledo, Ohio
Greensboro, North Carolina Charleston, South Carolina
Winston-Salem, North Carolina Columbia, South Carolina
Longview, Texas Spartanburg, South Carolina
Norfolk, Virginia Chattanooga, Tennessee
Roanoke, Virginia
<CAPTION>
Under Construction
---------------------------
<S> <C> <C>
Rockville/Bethesda/
Frederick, Maryland
Johnson City/Kingsport,
Tennessee
</TABLE>
40
<PAGE>
The following table provides aggregate data as of June 30, 2000 for the
networks placed in operation during Phase I, Phase II and Phase III of our
network construction program, respectively:
<TABLE>
<CAPTION>
Access Dedicated Addressable
Lines In Circuits Route Commercial
Service(1) In Service(2) Miles Buildings(3) Collocations
--- ---------- ------------- ----- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Phase I (8 markets)..... 76,942 221,821 635 14,853 32
Phase II (15 markets)... 102,870 276,240 874 26,214 54
Phase III (14 markets).. 17,909 72,210 480 27,294 38
--- ------- ------- ----- ------ ---
Total................. 197,721 570,271 1,989 68,361 124
</TABLE>
--------
(1) Represents all active switched channels we provide to customers either by
unbundled network elements leased from the incumbent local exchange
carrier, by direct connection to our own network, or by resale via the
incumbent local exchange carrier's network.
(2) Represents all active dedicated circuits we provide to customers expressed
on a DS-0 equivalent basis.
(3) Addressable by either unbundled network elements leased from the incumbent
local exchange carrier or by a direct connection to our own network. We
define a commercial building as one with greater than ten employees.
Tier III Network Architecture
Our networks are designed for high-speed data and voice communications,
using Lucent 5ESS(R) digital switching devices. These devices are deployed in
all of our networks, as part of a total central office configuration that
includes electronic digital cross connect devices, SONET transport equipment
and associated DC power plants and AC emergency power facilities. We currently
offer end-to-end fully protected fiber services using the SONET ring
architecture which routes customer traffic simultaneously in both directions
around the ring to provide protection against fiber cuts. If a line is cut,
traffic is automatically reversed and sent to its destination around the other
side of the ring. In addition, back-up electronics become operational in the
event of failure of the primary components. The switches and associated
transport equipment are deployed in an initial configuration that permits
rapid growth as our business in the local market grows. Our networks provide
access to customers through SONET-based fiber optic rings, for on-network
service and through unbundled network elements which are connected to our
central office through SONET fiber rings between the incumbent local exchange
carrier tandem and at least two incumbent local exchange carrier service
offices. In addition, at least three interexchange carriers are connected from
their points of presence to our central office by SONET rings, for long
distance connectivity.
We expedite new market service installation by deploying our switch-in-the-
box concept using a turn key process that allows installation and testing of
the switch in specially designed portable buildings at the manufacturing
facility before deployment. The switch and its housing are then shipped and
placed on-site for integration into the network.
We have deployed subscriber loop carrier equipment in each incumbent local
exchange carrier collocation for connection to customer premise equipment, and
service is then concentrated for transport to our central office for
distribution. In addition, we are deploying equipment to permit digital
subscriber line (DSL) services to be served on qualifying unbundled network
element copper facilities. The incumbent local exchange carrier collocations
are engineered to provide access to business, institutional, governmental or
other large services. In addition, for large customer services, the fiber
backbone can be extended to provide fiber access all the way to the business
complex or building for on-network services. We provide customer premise
electronic equipment to connect to both unbundled network element and on-
network facilities.
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We have also deployed a nationwide primary rate interface (PRI) capability
that permits the provisioning of Internet infrastructure services to large
Internet service providers without the need to utilize the Class 5 switching
capacity. This capability is managed via two centralized KMC NextGen
SoftSwitch controllers, which permit the growth of Internet services quickly.
This technology provides economical and highly scalable PRI growth and avoids
the higher cost associated with placing additional capacity on the existing
Lucent 5ESS(R) switch in each city.
[Diagram reflecting the principal elements of and connections in our
networks.]
We currently deploy a 72-strand fiber optic network. Our optical bandwidth
capacity in fiber rings ranges from OC-3 to OC-48. We are evaluating the
potential deployment of dense wave division multiplexing (DWDM) to enhance
bandwidth capability.
We monitor our fiber optic networks and electronics 24 hours-per-day, seven
days-per-week, using a combination of local and national network control
centers. Local network monitoring is accomplished by means of an automatic
notification system that monitors for system anomalies. This system provides
instantaneous alarms to an on-call network technician whenever an anomaly is
detected. The local market technician is trained in network problem resolution
and provides on-site corrective procedures when appropriate. A national
Network Knowledge Center, located in Denver, Colorado, acts as the focal point
for all of our operating networks, providing integrated and centralized
network monitoring, correlation and problem management. The Network Knowledge
Center has access to all operating networks and can work independently of the
local systems to effect repair or restoration activities. The Network
Knowledge Center is currently provided by Lucent on a contractual basis.
We manage our network systems both locally and centrally. Customer service
calls and maintenance are primarily handled through the local offices. In
addition, as described above, we contract to provide integrated monitoring of
our networks via Lucent's Network Knowledge Center. This is accomplished by
the use of a sophisticated integrated management system that is connected to
all of our locations, including our operations center which is located in
Lawrenceville, Georgia. With this system the Network Knowledge Center is
capable of accessing all available information regarding the configuration and
operating condition of any network components in use. This proactive
monitoring capability is further augmented by a 24 hours-per-day, seven-days-
per-week call center, also provided by Lucent at the Network Knowledge Center,
that receives, tracks and manages all customer calls and issues to
satisfactory conclusion. The call center works with our own customer care
representatives and engineers in the Lawrenceville facility to ensure that
timely and consistent service is provided.
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Nationwide Data Platform
We are a growing nationwide provider of Internet infrastructure in Tier I,
II and III markets. We currently provide dial-up Internet access and other
data services to carriers such as Qwest and Broadwing using remote access
servers, a type of switch that uses Internet Protocol rather than traditional
circuit-based switching. This technology uses packets to transfer information
and uses bandwidth more efficiently and at a lower cost than similar services
based on circuit switching. We are deploying a nationwide data platform which
we believe will enable us to reach approximately 50% of the U.S. population.
We expect to leverage this network to enable us to offer next generation
services, such as Voice over Internet Protocol, as they become technologically
feasible.
We are deploying a platform that will provide Internet access
infrastructure and remote access service capability in Tier I, II and III
markets across the United States. In the markets in which we currently provide
integrated communications services, connectivity is integrated into our
existing architecture. In the markets in which we do not operate systems, we
establish a point of presence, lease fiber and provide the Internet service
providers with the same basic architecture for their applications. This
provides the capability to create revenue for these major customers beyond our
existing markets.
Under our agreements with Qwest, Qwest monitors the data equipment from its
network operations center in Arlington, Virginia. We provide all circuit pack
replacement, hardware support and any other required support activity for
equipment located in our Tier III cities. Qwest performs all diagnostics,
trouble isolation and analysis from its network operations center. For
equipment located outside of our Tier III cities, maintenance is provided by
collocation facilities that are not manned by us. When Qwest detects a problem
that requires hardware support, they contact the Lucent Network Knowledge
Center in Denver, Colorado and the Network Knowledge Center dispatches the
appropriate personnel. We have service level agreements with both Qwest and
Lucent covering response times, repair times and service availability to
ensure appropriate attention is given to each occurrence.
Going forward, the application of Internet Protocol packet technology to
the public-switched telephone network may provide many distinct advantages
over the current time division multiplexing transport infrastructure,
including:
. much less expensive and demanding deployment, less costly equipment,
lower space and power requirements, and faster implementation,
. the ability for customers to integrate data and voice over the same
networks, saving cost and complexity, as well as the ability to support
new services combining both data and voice communications,
. the opportunity for carriers to leverage the growing volume of data
traffic, and
. DSL, fiber, and other broadband access technologies are particularly
compatible with packet-based transport.
As national and global carriers implement managed Internet Protocol
networks for end-to-end connectivity, they will require local Internet
Protocol infrastructure, including local access devices, packet switches and
routers, SS7 and other gateways, and local softswitches.
We currently have a local infrastructure for dial-up access pursuant to
agreements with several next generation carriers and Internet service
providers. In 2001, we expect to implement Voice over Internet Protocol with
the introduction of a full suite of carrier-class systems. We will introduce
broadband access via DSL technology, including Voice over DSL. Additional
opportunities include broadband Internet Protocol platforms. This initiative
is consistent with our current strategy and infrastructure and will also
position us as a major participant among next-generation telecom providers.
Voice over Internet Protocol is not currently being used to any material
extent for many of the purposes we believe it will serve in the future.
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Our existing contracts require us to provide over one million ports in
approximately 140 markets nationwide by the first quarter of 2001. We are
currently in the process of deploying Cisco and Nortel equipment to provide
these ports through 32 supernodes, or concentration points for high-speed
connectivity to the Internet, located in various cities, including seven in
our existing markets. Our service allows our carrier customers to provide
access to the Internet. These calls originate on the incumbent local exchange
carrier's network and terminate on ours by calling a local dial-up number and
therefore qualify for reciprocal compensation from the incumbent local
exchange carrier. Reciprocal compensation is incremental to the revenues that
we receive from our carrier customers.
All of these contracts to date have been structured so that our customers
pay a fixed amount to us, regardless of their level of usage. These contracts
have terms of three and one-half to four years and have certain cost pass-
throughs which allow us to limit our maintenance and servicing costs to a
predetermined level, and receive offsetting revenues for any costs in excess
of that level.
We currently have a dedicated team devoted to service and maintenance under
these contracts. We expect personnel demands to diminish significantly after
initial deployment, which will reduce our costs associated with this business,
over the remaining lives of these contracts.
New Technology Evaluation
We evaluate and test new concepts and capabilities in our laboratory in
Lawrenceville, Georgia, as well as in field trials. New capabilities for
existing technologies are evaluated, along with converging technologies that
could potentially be used for data oriented services. We are currently
evaluating next generation metropolitan DWDM, evolutionary PRI and modem
pooling technology, fixed wireless network extensions, as well as passive
optical networking. We are currently testing and expect to pilot next
generation Internet Protocol data and voice services in 2001.
Sales
We target our sales activities at three separate customer groups: Tier III
local customers, Tier III national customers and national data platform
customers. Tier III local customers include local governments, hospitals and
educational facilities as well as businesses. Tier III national customers are
usually large corporations which have branches or local offices within our
Tier III markets, but which make their buying decisions centrally from their
corporate offices. National data platform customers include major long
distance carriers and Internet service providers.
Tier III Local. We establish local sales offices in each Tier III market we
serve. Each local sales office is staffed by a city director, sales manager,
six to eight account executives and sales support personnel. The sales support
personnel include customer service, technical, and billing personnel.
We seek to hire local, seasoned telecommunications managers with sales
experience as City Directors. City Directors assist with the initial network
build out and oversee the daily operations of their networks, in addition to
managing sales staff and market development. Their daily operations
responsibilities include management of provisioning, customer service, pricing
decisions and the billing process. City Directors work with senior management
in the strategic planning process, including capital expenditure and budget
planning. They perform cash flow analysis for fiber connections of new
buildings to the network, and participate in planning fiber network extensions
in their markets.
In our Tier III markets, we use a face-to-face direct sales force of 190
account executives managed by 40 sales managers. Most of our sales personnel
are hired locally because we believe that knowledge of, and contacts in, a
local market are key factors for competitive differentiation and commercial
success in a Tier III market. We believe that this local focus will help to
set us apart from the incumbent local exchange carriers, our principal
competitors.
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<PAGE>
Tier III National. While there are few Fortune 500 companies with
headquarters located in our operating cities, there are branches and local
offices of large corporations within our market areas. Often these large
corporations make their buying decisions centrally, either through their
telecommunications or MIS functions, which are normally located at corporate
headquarters. Our national accounts sales organization is structured to assist
them in determining requirements for their various locations within our
markets. We believe that this focus on national accounts will further increase
our market penetration with large companies in our cities. We currently have
10 national account managers.
Nationwide Data Platform. We currently have 10 data customer account
managers who build relationships with major long distance carriers and
Internet service providers. These relationships facilitate initial sales of
our services. We believe, and our contracts with Qwest and Broadwing have
shown, that once national data platform customers experience our service they
will allow us to provide additional services to them and expand the
relationship.
We recruit our sales force and sales managers from several sources
including incumbent local exchange carriers, competitive local exchange
carriers, inter-exchange carriers, cellular companies and interconnect
companies. Once hired, our local Tier III sales force is put through a program
of intense local training and computer based data and voice product training
at the local sales office. All sales personnel participate in consultative
sales and product training at our corporate operations facility. Our sales
force is compensated based on a fixed base salary and variable payments for
the sale of recurring monthly revenue.
Customers
As of June 30, 2000, we had 8,513 customers, which can be broken down into
the following categories:
. Tier III local customers are local to a particular city and include
local governments, hospitals and educational facilities as well as
businesses, including local and regional Internet service providers. Our
business customers range from large businesses to medium and small size
businesses, including medical and insurance offices, car dealerships,
broadcast media outlets and real estate brokerages.
. Tier III national customers consist of Fortune 500 companies, other
large companies, major long distance carriers, wireless service
providers and other competitive local exchange providers that have a
local or branch office in several of our markets.
. Nationwide data platform customers consist of major long distance
carriers and Internet service providers.
Examples of our customers in each of these categories are shown below:
<TABLE>
<CAPTION>
Tier III
Local Nationwide Data Platform
Customers Tier III National Customers Customers
----------- ------------------------------------ ------------------------
<S> <C> <C>
Boeing AT&T Corp. Broadwing
City of
Augusta,
Georgia Burlington Northern Santa Fe Railway Qwest
Columbia
Hospital Krispy Kreme Donuts
NASA Sprint
Pillsbury UUNet
State of Walgreens
Wisconsin
Texas A&M
University Wal-Mart
</TABLE>
Marketing
We market our local services through a combination of media channels and
personal service in each of our local markets. We seek to gain brand awareness
through advertising on local television, radio and print media. We also use
outdoor advertising in prominent locations, customer testimonials, and local
events and sponsorships, such as charity golf tournaments.
45
<PAGE>
Consistent with our "Creative Solutions with a Hometown Touch(R)" motto, we
also seek to actively participate in our local communities. Each City Director
is typically a long-time local resident with extensive telecommunications
experience and is well known and respected in the community. The City Director
typically seeks to hire other local residents, further strengthening our
involvement with and contacts throughout the local market. Each local office
is typically an active member of the local Chamber of Commerce, and
contributes to local charities. We believe that these activities provide us
with a point of differentiation compared to the incumbent local exchange
carriers, who have generally underserved Tier III markets in favor of larger
markets.
Suppliers
We depend on a number of suppliers in order to build and operate our
networks. The following companies are our primary suppliers.
Telecommunications Equipment. We have contracted with Lucent, as our
primary supplier, to purchase switching, transport and digital cross connect
products. Lucent has also agreed to implement and test our switches and
related equipment. In addition, we have entered into an agreement with Lucent
pursuant to which Lucent has agreed to monitor our switches on an on-going
basis. Lucent is an investor in our preferred stock and a lender under our
credit facilities. We also have agreements with Cisco and Nortel under which
they have agreed to provide us with data platform equipment.
Billing Support Systems Implementation. In the second quarter of 1999, we
installed software developed by Billing Concepts Systems, Inc. to provide us
with comprehensive billing functionality, including the ability to capture
call detail records, message rating, bill calculation, invoice generation,
commission tracking, customer care and inquiry, collections management, and
quality assurance. This software enables us to produce a single bill covering
all of the products and services that we provide to a customer. Additional
development of new billing systems will take place over the remainder of the
year 2000.
Operational Support Systems Implementation. We entered into an agreement in
1998 with Eftia OSS Solutions Inc., a new industry participant, to develop our
operational support systems. These systems manage service order processing,
circuit and asset inventory, telephone number inventory and trouble
administration. Initial installation of the operational support systems was
made during the third quarter of 1999, with development and expansion to
continue through the first quarter of 2001.
Outside Network Related Construction. We recently entered into an exclusive
five year agreement with KNT Network Technologies LLC, a company owned by two
of our principal stockholders, pursuant to which KNT will provide outside
construction and maintenance services in connection with the establishment of
our networks. KNT will provide comprehensive program management services for
the construction of new networks and the expansion of existing networks. The
employees of KNT are primarily individuals who previously worked for our
former construction division.
The services and products which we obtained from these principal suppliers
are also available from a number of other sources. If we were forced to change
suppliers for any reason, however, we may experience some difficulties,
particularly with respect to the compatibility of equipment from new suppliers
with our existing Lucent equipment.
Competition
Overview. The telecommunications industry is highly competitive. Our
principal competitors in Tier III markets are the incumbent local exchange
carriers. In most instances the incumbent local exchange carrier is one of the
regional Bell operating companies (such as Verizon, BellSouth or SBC).
Incumbent local exchange carriers presently have a majority of the market
share in those areas we consider our market areas. Because of their relatively
small size, we do not believe that Tier III markets can profitably support
more than two facilities-based competitors in addition to the incumbent local
exchange carrier.
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<PAGE>
Other competitors may include competitive local exchange carriers,
microwave carriers, wireless telecommunications providers and private networks
built by large end-users. Potential competitors (using similar or different
technologies) include cable television companies, utilities, incumbent local
exchange carriers, regional Bell operating companies seeking to operate
outside their current local service areas and independent telephone companies.
In addition, there will be future competition from large long distance
carriers, such as AT&T and MCI WorldCom, which have begun to offer integrated
local and long distance telecommunications services. AT&T also has 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 for us.
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, we will face competition from large carriers such as AT&T, MCI
WorldCom and Sprint. We will rely on other carriers to provide transmission
and termination for our long distance traffic and therefore will be dependent
on such carriers.
A large portion of our nationwide data platform business will be conducted
in larger Tier I and Tier II markets. We expect that our primary competitors
in this business will be both incumbent local exchange carriers and other
competitive local exchange carriers. Because the regional Bell operating
companies and other incumbent local exchange carriers tend to focus their
efforts on Tier I and Tier II markets, they will have a significantly greater
local presence in these markets. In addition, due to the larger size of the
markets, there are a greater number of facilities-based competitive local
exchange carriers competing for data business in these markets than we usually
face in Tier III markets. For this reason, we generally will not enter these
markets to offer nationwide data platform services unless we have a pre-
existing agreement with a significant customer, such as Qwest, justifying our
presence in the market.
Incumbent Local Exchange Carriers. Our principal competitors for local
exchange services are the regional Bell operating companies. As a recent
entrant in the integrated telecommunications services industry, we have not
yet achieved a significant market share for any of our services. In
particular, the incumbent local exchange carriers:
. have long-standing relationships with their customers,
. have financial, technical and marketing resources substantially greater
than ours,
. have the potential to fund competitive services with revenues from a
variety of other businesses, and
. currently benefit from a number of existing regulations that favor the
incumbent local exchange carriers over us in some respects.
Competitive Local Exchange Carriers and Other Competitors. We compete from
time to time with competitive local exchange carriers. In our markets we
generally face competition from two or more competitive local exchange
carriers. However, in many instances, the competitive local exchange carriers
present in our Tier III markets have not established robust fiber-based
networks comparable to ours. 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 fiber-based competitive local exchange carriers,
we expect substantial price competition. We believe that operations in such
markets are likely to be unprofitable for one or more operators.
We face competition in each of our markets. However, we believe that our
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 we target should reduce the number of facilities-based competitors and
drive other entrants to focus on the resale of incumbent local exchange
carrier service or our services or to invest in other markets. We believe that
each market will also see more agent and distributor resale initiatives.
47
<PAGE>
Regulation
Our services are subject to varying degrees of federal, state and local
regulation. The Federal Communications Commission exercises jurisdiction over
facilities of, and interstate and international services offered by,
telecommunications common carriers. 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 competitive local
exchange carriers. The regulatory environment is in a constant state of flux,
and you should be aware that any of the items discussed below are subject to
rapid change due to regulatory action, judicial decision or legislative
initiative.
Federal Regulation
We are 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 of 1996. This legislation is designed to enhance
competition in the local telecommunications marketplace by:
. removing state and local entry barriers,
. requiring incumbent local exchange carriers to provide interconnection
to their facilities,
. facilitating the end-users' choice to switch service providers from
incumbent local exchange carriers to competitive local exchange carriers
like us, and
. requiring access to rights-of-way.
The legislation also is designed to enhance the competitive position of
competitive local exchange carriers and increase local competition by newer
competitors such as long distance carriers, cable television companies and
public utility companies. Under the Telecommunications Act of 1996, regional
Bell operating companies have the opportunity to provide in-region long
distance services if specified conditions are met. In addition, the
Telecommunications Act of 1996 eliminates certain restrictions on utility
holding companies, thus clearing the way for them to diversify into
telecommunications services.
The Telecommunications Act of 1996 specifically requires all
telecommunications carriers (including incumbent local exchange carriers and
competitive local exchange carriers (like us)):
. not to prohibit or unduly restrict resale of their services,
. to provide dialing parity and nondiscriminatory access to telephone
numbers, operator services, directory assistance and directory listings,
. to afford access to poles, ducts, conduits and rights-of-way, and
. to establish reciprocal compensation arrangements for the transport and
termination of telecommunications.
It also requires competitive local exchange carriers and incumbent local
exchange carriers to provide interconnection for the transmission and routing
of telephone exchange service and exchange access. It requires incumbent local
exchange carriers to provide such interconnection:
. at any technically feasible point within the incumbent local exchange
carrier's network,
. that is at least equal in quality to that provided by the incumbent
local exchange carrier to itself, its affiliates or any other party to
which the incumbent local exchange carrier provides interconnection, and
. at rates, terms and conditions that are just, reasonable and
nondiscriminatory.
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<PAGE>
Incumbent local exchange carriers also are required under the law to provide
nondiscriminatory access to network elements on an unbundled basis at any
technically feasible point, to offer their local retail telephone services for
resale at wholesale rates, and to facilitate collocation of equipment
necessary for competitors to interconnect with them or obtain access to their
unbundled network elements.
The Telecommunications Act of 1996 provided for the removal of most
restrictions imposed on AT&T and the regional Bell operating companies
resulting from the consent decree entered in 1982 which provided for
divestiture of the regional Bell operating companies from AT&T in 1984. The
Telecommunications Act establishes procedures under which a regional Bell
operating company can enter the market for long distance service between
specified areas within its in-region local service territory. The
Telecommunications Act of 1996 permitted the regional Bell operating companies
to enter the out-of-region long distance market immediately upon enactment,
and regional Bell operating companies were also permitted to immediately
provide intra-LATA long distance services. Before the regional Bell operating
company can provide in-region inter-LATA services, it must obtain Federal
Communications Commission approval upon a showing that facilities-based
competition is present in its market, that the regional Bell operating company
has entered into interconnection agreements in the states where it seeks
authority, that it has satisfied a 14-point "checklist" of competitive
requirements, and that its entry is in the public interest. To date, such
authority has only been granted to Verizon (formerly Bell Atlantic) for
New York and SBC for Texas. The provision of inter-LATA services by regional
Bell operating companies is expected to reduce the market share of major long
distance carriers, and consequently, may have an adverse effect on the ability
of competitive local exchange carriers to generate access revenues from long
distance carriers.
Federal Communications Commission Rules Implementing the Local Competition
Provisions of the Telecommunications Act of 1996. The Federal Communications
Commission in 1996 established a framework of national rules enabling state
public service commissions and the Federal Communications Commission to begin
implementing many of the local competition provisions of the
Telecommunications Act of 1996. The Federal Communications Commission
prescribed certain minimum points of interconnection necessary to permit
competing carriers to choose the most efficient points at which to
interconnect with the incumbent local exchange carriers' networks. The Federal
Communications Commission also adopted a minimum list of unbundled network
elements that incumbent local exchange carriers 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.
In January 1999, the Supreme Court ruled on a variety of issues addressed
in the Federal Communications Commission's 1996 order. Among other things, the
Supreme Court found that the Federal Communications Commission has authority
to establish national pricing rules for interconnection, unbundled elements
and resale services. However, the Supreme Court overturned the Federal
Communications Commission's rules regarding what network elements must be
unbundled by the regional Bell operating companies, and remanded to the
Federal Communications Commission the question of what network elements are
"necessary" to competing carriers like us. On November 5, 1999, the Federal
Communications Commission issued an order re-establishing the network elements
that must be offered by incumbent local exchange carriers as unbundled network
elements. That decision is currently the subject of various reconsideration
petitions and appeals. We cannot provide any assurances regarding the
disposition of these petitions and appeals and we cannot assure you that we
will be able to maintain interconnection agreements on terms acceptable to us.
On July 18, 2000, the U.S. Court of Appeals for the 8th Circuit issued a
decision in which it upheld the Federal Communication Commission's use of a
forward-looking methodology to establish prices for network elements, but the
Court vacated the agency's rule that the methodology should be applied based
on the use of the most efficient telecommunications technology currently
available and the lowest cost network configuration. Rather, the Court held
that the methodology must be applied based on the costs of the incumbent local
exchange carriers' existing facilities and equipment. The issue was remanded
to the Federal Communications Commission for further consideration. The
Court's ruling, which has been appealed may result in efforts by the incumbent
49
<PAGE>
local exchange carriers to initiate cost proceedings in many states and we are
unable to provide assurances as to the outcome of these proceedings or of the
remand proceeding that must be conducted by the Federal Communications
Commission.
The 8th Circuit also affirmed its prior decision to vacate the Federal
Communications Commission rule that required incumbent local exchange carriers
to provide combinations of network elements that are not ordinarily combined
in their networks. The Court's decision keeps in place the system whereby
carriers cannot obtain network element combinations unless the incumbent local
exchange carrier has already combined the elements in its network today.
On March 17, 2000, the U.S. Court of Appeals for the District of Columbia
Circuit vacated certain Federal Communications Commission rules relating to
collocation of competitors' equipment in incumbent local exchange carriers'
central offices. This decision requires the Federal Communications Commission
to limit collocation to equipment that is "necessary" for interconnection with
the incumbent local exchange carrier or access to the incumbent local exchange
carrier's unbundled network elements. On August 10, 2000, the Federal
Communications Commission responded by issuing an order and request for
further comment. The agency required that incumbent local exchange carriers
provide physical collocation within 90 days after receiving an application and
clarified that an incumbent local exchange carrier must allow a competitive
local exchange carrier to construct a controlled environmental vault or
similar structure on land adjacent to an incumbent local exchange carrier
structure that lacks physical collocation space. The Federal Communications
Commission asked for comment on what equipment incumbent local exchange
carriers should allow competitive local exchange carriers to physically
collocate and how physical collocation space should be assigned, whether
collocators should be permitted to cross-connect with other collocators, and
what rules should apply to collocation at remote local exchange carrier
premises. No assurances can be given regarding the outcome of this further
proceeding.
Other Regulation. In general, the Federal Communications Commission's
policies encourage the entry of new competitors in the telecommunications
industry and are designed to prevent anti-competitive practices. Currently,
large incumbent local exchange carriers, such as the regional Bell operating
companies, are regulated as "dominant" carriers, while competitive local
exchange carriers, like us, are considered "nondominant" carriers. Dominant
carriers face more detailed regulatory scrutiny. As a nondominant carrier, we
are subject to relatively minimal Federal Communications Commission
regulation.
. Tariff. We may install and operate facilities for the transmission of
domestic interstate communications without prior Federal Communications
Commission authorization. The Federal Communications Commission requires
us to file periodic reports concerning our interstate circuits and
deployment of network facilities, and offer interstate services on a
nondiscriminatory basis, at just and reasonable rates. We also remain
subject to Federal Communications Commission complaint procedures.
The Federal Communications Commission adopted an order in 1996 (the
"Detariffing Order") which eliminated the requirement that nondominant
interstate carriers maintain tariffs on file with the Federal
Communications Commission for domestic interstate services. On April 28,
2000, the U.S. Court of Appeals for the D.C. Circuit upheld the
Commission's decision. The Federal Communications Commission
subsequently issued a notice establishing a 9-month transition to
mandatory detariffing. By January 31, 2001, carriers must cancel all
tariffs for interstate domestic interexchange services. After that date,
the terms and conditions pursuant to which domestic providers offer
service to customers will be governed by contract. The Federal
Communications Commission is currently considering whether to expand the
mandatory detariffing requirement to the interstate access services
provided by competitive local exchange carriers.
. Access Charges. The Federal Communications Commission has granted
incumbent local exchange carriers significant flexibility in pricing
their interstate special and switched access services. We anticipate
that this pricing flexibility will result in incumbent local exchange
carriers lowering their prices in high traffic density areas, where our
customers are concentrated.
50
<PAGE>
In late May 2000, the Federal Communications Commission adopted an
order establishing a five-year plan for reforming federal access
charges. The order provides for reductions in the usage-based and flat-
rate charges assessed by incumbent local exchange carriers or long
distance service providers. The order also provided for increases over
time in the flat-rate monthly charges assessed directly by incumbent
local exchange carriers on residential and business subscribers. The
agency concluded that the plan as adopted would result in a more
rational interstate rate structure, which in turn would result in more
efficient competition.
. Universal Service Reform. The Federal Communications Commission
implemented the provisions of the Telecommunications Act of 1996
relating to the preservation and advancement of universal telephone
service in 1997. All telecommunications carriers providing interstate
telecommunications services, including us, must contribute to the
universal service support funds. On October 8, 1999, the Federal
Communications Commission released an order implementing changes to its
universal service rules to comply with a decision of the Fifth Circuit
Court of Appeals. Among other changes, the Federal Communications
Commission revised its rules concerning assessment of carriers'
interstate and international revenues for universal service
contribution. The Federal Communications Commission narrowed the scope
of the contribution base, removing intrastate end-user
telecommunications revenues from the assessment, consistent with the
opinion of the Fifth Circuit Court of Appeals.
State Regulation
We believe that most, if not all, states in which we operate or propose to
operate require a certification or other authorization to offer intrastate and
local services. 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. We have
obtained state authority for the provision of our competitive local exchange
and exchange access services and long distance services in those states where
we currently operate and we plan to obtain additional state authorizations as
our business expansion plans require. In most states, we are required to file
tariffs setting forth the terms, conditions and prices for services that are
classified as intrastate.
Some states also impose reporting, customer service and quality
requirements, as well as unbundling and universal service requirements on
competitive local exchange carriers. In addition, we are subject to the
outcome of proceedings held by state commissions to determine state regulatory
policies with respect to incumbent local exchange carrier and competitive
local exchange carrier competition, geographic build-out, mandatory
detariffing and other issues relevant to competitive local exchange carrier
operations. Some states have adopted state-specific universal service funding
obligations.
In addition to obtaining state certifications, we must negotiate terms of
interconnection with the incumbent local exchange carrier before we can begin
providing local exchange and exchange access services. Our executed agreements
are subject to the approval of the state commissions. The appropriate
commissions have approved each of our existing agreements and we anticipate
state commission approval of our future interconnection agreements.
We believe that, as the degree of local competition increases, the states
will offer the incumbent local exchange carriers increasing pricing
flexibility. This flexibility may present the incumbent local exchange
carriers with an opportunity to subsidize services that compete with our
services with revenues generated from non-competitive services, thereby
allowing incumbent local exchange carriers to offer competitive services at
prices below the cost of providing the service. We cannot predict the extent
to which this may occur, but it could have a material adverse effect on our
business and the price of our common stock.
We also may be subject to requirements in some 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.
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Local Government Authorizations. We are required to obtain street use and
construction permits and licenses and/or franchises to install and expand our
fiber optic networks using municipal rights-of-way. In some municipalities
where we have installed or anticipate constructing networks, we will be
required to pay license or franchise fees based on a percentage of gross
revenues or on a per foot basis, as well as post performance bonds or letters
of credit. We are actively pursuing permits, franchises and other relevant
authorities for use of rights-of-way and utility facilities in a number of
cities.
Legal Proceedings
We are from time to time involved in litigation incidental to the conduct
of our business. There is no pending legal proceeding to which we are a party
which, in the opinion of our management, is likely to have a material adverse
effect on our business, financial condition and results of operations.
Employees
As of August 31, 2000, we had 1,218 full time employees. None of our
employees are represented by a labor union or subject to a collective
bargaining agreement, nor have we experienced any work stoppage due to labor
disputes. We believe that our relations with our employees are good. The labor
market in the telecommunications industry is currently extremely tight and we
compete for qualified personnel with many of our competitors. We believe that
our compensation and benefits package is competitive in the telecommunications
industry. See "Risk Factors -- The Future Success of Our Business Depends Upon
Key Personnel."
Properties
We are headquartered in Bedminster, New Jersey and currently occupy one
full floor in one building of approximately 20,000 square feet of office space
with additional space in this building to be made available to us no later
than February 15, 2001. Once fully occupied, the lease covers approximately
50,000 square feet of office space and expires in 2012. When fully occupied,
KMC will pay an annual base lease rent of approximately $1.0 million (adjusted
periodically for changes in the consumer price index), plus operating
expenses. We rent this space from a company in which a trust for the benefit
of Mr. Kamine's children has a fifty percent ownership interest.
We also maintain an operations center and additional administrative offices
in Lawrenceville and Duluth, Georgia. The Lawrenceville premises is
approximately 104,000 square feet under a lease that expires in 2011. Our
annual base rental obligation for these premises is $1.3 million (adjusted
periodically for changes in the consumer price index), plus operating
expenses. We also own or lease facilities in each of our existing markets for
central offices, sales offices and the location of our switches and related
equipment.
We believe that our facilities are in good condition, are suitable for our
operations and that, if needed, suitable alternative space would be readily
available.
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MANAGEMENT
The following table sets forth information concerning our executive
officers and directors, including their ages as of August 31, 2000.
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Harold N. Kamine........ 44 Chairman of the Board of Directors
Gary E. Lasher.......... 64 Vice Chairman of the Board of Directors
William F. Lenahan...... 50 Chief Executive Officer and Director
Roscoe C. Young II...... 49 President, Chief Operating Officer and Director
William H. Stewart...... 33 Executive Vice President, Chief Financial Officer and Director
Tricia Breckenridge..... 54 Executive Vice President-Business Development
John G. Quigley......... 46 Director
Richard H. Patterson.... 42 Director
Randall A. Hack......... 53 Director
Alexander P. Coleman.... 33 Director
</TABLE>
Harold N. Kamine is our founder and has been the Chairman of our board of
directors since 1994. He is a co-owner of KNT Network Technologies LLC, which
is our exclusive provider of outside network related construction and
maintenance services. Previously, he was the 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. Companies owned by Mr. Kamine owned
substantial interests in and managed six power generation plants in the
Northeastern United States. Mr. Kamine devotes less than half his time to our
affairs.
Gary E. Lasher joined us as Vice Chairman of our board of directors
effective November 1, 1997. He was the founder, Chief Executive Officer and
President of Eastern TeleLogic Corporation from 1987 to 1997. Eastern
TeleLogic was a leading competitive local exchange carrier operating in
greater Philadelphia, Delaware and southern New Jersey before its purchase by
Teleport Communications Group in October 1996. Prior to Eastern TeleLogic,
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 also spent 20 years with Continental Telephone
holding various positions including Corporate Vice President, President of the
International Engineering and Construction Company, and various senior
positions with Continental Telephone's regulated subsidiaries. Mr. Lasher is
one of the founding members of the Association for Local Telecommunications
Services and served for three years as Chairman of the Association. Mr. Lasher
is also Chairman of the Board of Linx Communications, a privately-owned
provider of unified personal communications services.
William F. Lenahan joined us as our Chief Executive Officer effective May
1, 2000 and has been a director since May 2000. He was President and Chief
Executive Officer of BellSouth Wireless Data from October 1994 to April 2000,
and was responsible for financial performance and nationwide wireless data
strategy for this division of BellSouth Corporation. From 1987 to 1993, he was
Vice President/General Manager and then President and Chief Executive Officer
of three Sears divisions--Sears Business Centers, Office Centers and Computer
Services. In 1986, he was named President and Chief Executive Officer of
BellAtlantic's Compushop division, a reseller of PCs and communications
products. Mr. Lenahan has served nearly 30 years in the information
technology, telecommunications and data industries. He began his career at
IBM, where he worked for 12 years in a variety of sales, marketing, operations
and human resources executive assignments, and sat on the IBM Product Review
Board. He later joined United Telecom, the forerunner of Sprint, where he
started Amerisource, a new business that resold PBXs, PCs and systems
integration products. He was a member of the Advisory Councils of IBM, Compaq
and NCR.
Roscoe C. Young II has over 20 years experience in the field of
telecommunications with both new venture and Fortune 500 companies. He has
served as a director since December 1999 and President and Chief Operating
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Officer since March 2000. Previously, he had been our Executive Vice President
and Chief Operating Officer. Prior to joining us 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.
William H. Stewart has served as a director since August 1997. Mr. Stewart
joined us as Executive Vice President and Chief Financial Officer in March
2000. Previously, Mr. Stewart was a Managing Director of Nassau Capital L.L.C.
after joining 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. He
is a Chartered Financial Analyst and a member of the New York Society of
Security Analysts.
Tricia Breckenridge joined us 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 since August 1996. Mr. Quigley is
a founding member of Nassau Capital L.L.C., the independent firm that has
managed Princeton University endowment's $2.0 billion private investment
program since 1995. Nassau Capital L.L.C. is the general partner of Nassau
Capital Partners L.P. and Nassau Capital Partners IV L.P. Mr. Quigley is also
on the board of directors of KNT Network Technologies LLC and an adjunct
faculty member at Columbia Law School.
Richard H. Patterson has served as a director since May 1997. From May 1986
to June 1999, Mr. Patterson served as a partner of Waller Capital Corporation,
a media and communications investment banking firm. Since June 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. Since October 1999, he has served as
Managing Member of Spire Capital Partners, a media and telecommunications fund
providing growth capital to private companies. Mr. Patterson is a member of
the board of directors of Regent Communications, Inc., which owns and operates
radio stations in small-to-mid size markets.
Randall A. Hack has served as a director since August 1996. Mr. Hack is a
founding member of Nassau Capital L.L.C., the independent firm that has
managed Princeton University endowment's $2.0 billion private investment
program since 1995. Nassau Capital L.L.C. is the general partner of Nassau
Capital Partners L.P. and Nassau Capital Partners IV L.P. From 1990 to January
1995, Mr. Hack served as President and Chief Executive Officer of the
Princeton University Investment Company, which has overall management
responsibility for Princeton's $8.0 billion endowment fund. Mr. Hack serves as
a director of CompHealth Inc., Corporate Realty Investment Company LLC, Crown
Castle International Corporation, Cypress Communications, Omni Cell
Technologies, Inc. and Vector esp Inc.
Alexander P. Coleman has served as a director since July 2000. Since
January 1996, Mr. Coleman has served as Vice President and Investment Partner
of Dresdner Kleinwort Benson Private Equity LLC, Dresdner Bank AG's United
States leveraged buyout group. Prior to joining Dresdner Kleinwort Benson
Private Equity LLC, Mr. Coleman served in several corporate finance positions
for Citicorp/Citibank N.A. from 1989 through 1995, and most recently as Vice
President of Citicorp Venture Capital. Mr. Coleman is also a director of
Gardenburger, Inc. and Tritel, Inc.
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.
In October 1998, the bankruptcy court confirmed a plan of liquidation for this
entity.
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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.
Election of Directors
We, along with certain of our existing stockholders, including Nassau, Mr.
Kamine, Dresdner Kleinwort Benson Private Equity Partners, LP, Lucent and
General Electric Capital Corporation are parties to a stockholders agreement.
Pursuant to this agreement, certain of our existing stockholders have agreed
to vote their shares and take all necessary actions to elect the following
individuals to our board of directors: our Chief Executive Officer, our
President, three individuals designated by Nassau, two individuals designated
by Mr. Kamine, one individual designated by Dresdner and one individual as an
independent director approved by Nassau, Mr. Kamine and other principal
existing stockholders. Lucent or a person to whom Lucent transfers its shares
may be entitled to designate one individual under certain circumstances. The
number of directors each of Nassau, Mr. Kamine and Dresdner is entitled to
designate will decrease as their respective percentages of ownership decrease.
If a payment default occurs under our amended senior secured credit
facility and continues uncured for 90 days, the holders of a majority of
shares of Series C Convertible Preferred Stock and common stock into which
such shares have been converted (currently General Electric Capital
Corporation) will be entitled to elect two additional individuals to serve as
directors until the default is cured. In addition, under the certificate of
designations relating to each of our Series E Preferred Stock and Series F
Preferred Stock, if a default occurs under such certificate(s), the holders of
Series E Preferred Stock and/or the holders of the Series F Preferred Stock
will have the right to elect one additional individual each to serve as a
director (for a total of two additional directors), in each case until the
default is cured and all accrued dividends on such preferred stock are paid in
full.
Committees of the Board
Our board of directors has authorized a Compensation Committee to be
composed of three members. The present members of the Compensation Committee
are Messrs. Quigley, Patterson and Coleman. Our board of directors has created
an Executive Committee consisting of Messrs. Kamine, Quigley and Coleman. Our
board of directors has also created an Audit Committee consisting of Messrs.
Lasher, Patterson, Quigley and Coleman.
Compensation Committee Interlocks and Insider Participation
Mr. Kamine, our Chairman, and Messrs. Quigley and Patterson served as
members of the Compensation Committee during 1999. Mr. Quigley is also a
member of Nassau Capital L.L.C. which, through its affiliates, beneficially
owns more than five percent of our voting securities.
The company and certain affiliated companies owned by Mr. Kamine share
certain administrative services. The entity which bears the cost of the
services is reimbursed by the other for the other's proportionate share of
such expenses. In 1999, under a predecessor lease, these shared services did
not include the rent paid by us for our headquarters offices to an affiliate
of Mr. Kamine under the lease described below. We reimbursed Kamine-affiliated
companies for these shared services an aggregate of approximately $60,000, for
1999. During 1999, we purchased approximately $180,000 of office furniture and
leasehold improvements from an entity controlled by Mr. Kamine.
Pursuant to an agreement dated as of January 1, 1999, we are entitled to
use a Citation III business jet chartered by Bedminster Aviation LLC, a
limited liability company wholly owned by Mr. Kamine, for a fixed price of
$2,600 per hour of flight time. During 1999, we paid approximately $210,000
for the use of the Citation III. The Citation III enables up to eight of our
employees, guests or representatives to use local airfields and visit multiple
cities in which we either have an operating network or are building a network,
without the necessity of returning to commercial hubs such as Atlanta, Chicago
or St. Louis. We have agreed to use our best efforts to
55
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use the Citation III fifty hours per quarter during 2000. However, we are
under no obligation to do so and we have not guaranteed any financial
arrangements with respect to the aircraft or to Bedminster Aviation LLC.
On July 1, 1999, we acquired all of the membership interests of KMC
Services LLC from Mr. Kamine and Kathleen Kamine, his spouse, for nominal
consideration. KMC Services LLC offers a leasing program for equipment
physically installed at a customer's premises, known as CPE equipment, for us
to integrate into our ClearStarsm program. As of September 30, 1999, we had
loaned KMC Services LLC an aggregate of approximately $709,000. The loan bore
interest at the rate of 10% per annum and was to have been payable December
31, 1999. The acquisition was accounted for as a combination of entities under
common control, and no changes were made to the historical cost basis of KMC
Services LLC's assets. Accordingly, during the second quarter of 1999, we
reduced the carrying value of our $709,000 loan receivable from KMC Services
LLC to an amount equal to the value of KMC Services LLC's net assets at the
acquisition date.
Effective August 18, 2000, we entered into a 12 year lease for all three
floors of the building (approximately 50,000 square feet) in Bedminster, New
Jersey in which we are presently headquartered, consolidating our headquarters
employees from several different buildings in Bedminster. When all the space
is available for occupancy by us, we will pay an annual base rental of
approximately $1.0 million (adjusted periodically for changes in the consumer
price index) plus operating expenses. The building is owned by a company in
which a trust for the benefit of Mr. Kamine's children owns a fifty percent
interest. Previously, under the terms of a lease initially entered into in
June 1996, we had leased smaller amounts of space in the building in which our
headquarters are located. The earlier lease had provided for a base annual
rental of $217,000 (adjusted periodically for changes in the consumer price
index), plus operating expenses.
KNT Network Technologies LLC, a company owned by Mr. Kamine and an
affiliate of Nassau Capital Partners L.P., two of our principal stockholders,
entered into agreements with us as of June 1, 2000 pursuant to which we have
transferred, or will transfer, to KNT substantially all of the business and
assets of our network construction business which consists of certain
telecommunication equipment and certain related real estate interests. In
exchange, KNT will pay us approximately $300,000 by September 30, 2000,
$800,000 by December 2000, and execute a promissory note due and payable in
February 2002 in the amount of $2.7 million. KNT will be the exclusive
provider of outside network related construction and maintenance services to
us for a term of five years, subject to performance and certain specific
exceptions. We will pay costs plus an annual fixed fee up to $15.0 million for
all construction services and costs plus an annual fixed fee up to $2.0
million for all maintenance services. KNT is seeking to obtain
telecommunications construction business from third parties. In the event KNT
is successful in obtaining this business, KNT must share with us a portion of
the net income it receives from such business. We have the right to terminate
these agreements at any time after March 31, 2003 or in the event Mr. Kamine
and Nassau cease to be our controlling stockholders or at any time in the
event we do not receive certain payments by February 15 of any year of the
term of the agreement.
Pursuant to an agreement between us and Nassau, Nassau was paid $450,000 in
cash as a financial advisory fee for 1999. Nassau will also be paid financial
advisory fees in cash at a rate of $450,000 per annum through September 30,
2000, at which point the fees will be reduced to $100,000 per annum.
Upon the initial closing of our offering of our Series G Convertible
Preferred Stock in July 2000, we paid a fee of $1.0 million in cash to Nassau
Capital L.L.C.
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Summary Compensation Table
The following table sets forth information concerning compensation for
services in all capacities awarded to, earned by, or paid to, our Chief
Executive Officer during 1999, and the other four most highly compensated
executive officers of the company whose aggregate cash and cash equivalent
compensation exceeded $100,000 during the fiscal year ended December 31, 1999
(without giving effect to the -for- split of our common stock).
Summary Compensation Table
<TABLE>
<CAPTION>
Long Term
Annual Compensation Compensation
------------------------------------------ -------------
Securities
Name and Principal Other Annual Underlying
Positions Year Salary($) Bonus($) Compensation($)(1) Options(#)(2)
------------------------ ---- --------- -------- ------------------ -------------
<S> <C> <C> <C> <C> <C>
Harold N. Kamine........ 1999 $450,000 $ -- $ -- --
Chairman of the Board
Michael A.
Sternberg(3)........... 1999 496,539 272,500 -- --
President and Chief
Executive 1998 275,000 407,500 -- 65,000
Officer 1997 240,385 187,500 45,909 9,228
Roscoe C. Young II...... 1999 446,539 362,500 18,750 --
Executive Vice
President 1998 218,270 497,500 52,189 32,500
and Chief Operating
Officer 1997 180,000 182,046 198,180 2,309
James D. Grenfell(4).... 1999 222,692 120,000 55,403 18,000
Executive Vice
President,
Chief Financial Officer
and Secretary
Tricia Breckenridge..... 1999 193,212 86,000 -- 1,000
Executive Vice
President- 1998 155,577 75,000 -- 5,000
Business Development 1997 104,138 49,000 -- 691
</TABLE>
--------
(1) The amount reported in this column for Mr. Sternberg in 1997 includes
relocation related expenses of $39,662 and personal use of a company
automobile of $6,247. The amounts reported in this column for Mr. Young
include relocation related expenses of $18,750 in 1999, relocation
related expenses of $47,377 and personal use of a company automobile of
$4,812 for 1998, and relocation related expenses of $196,029 and personal
use of a company automobile of $2,151 for 1997. The amounts reported in
this column for Mr. Grenfell include relocation related expenses of
$49,265 and personal use of a company automobile of $6,138 for 1999. The
aggregate value of the perquisites and other personal benefits, if any,
received by Mr. Sternberg in 1999 and 1998 and by each of Mr. Kamine and
Ms. Breckenridge in 1999, 1998 and 1997 have not been reflected in this
table because the amount was below the SEC's threshold for disclosure
(i.e., the lesser of $50,000 or 10% of the total of annual salary and
bonus for the executive officer for the year).
(2) The options granted in 1997 were options to purchase shares of common
stock of the company's principal operating subsidiary KMC Telecom Inc.
All of the options shown as granted in 1997 were cancelled during the
third quarter of 1998 and replaced by options to purchase our common
stock. See "--Stock Option Grants." All options granted during 1998 are
options to purchase shares of our common stock.
(3) Mr. Sternberg served in the capacities indicated throughout the year
ended December 31, 1999. Mr. Sternberg's employment terminated effective
March 8, 2000. See "--Separation Agreements."
(4) Mr. Grenfell joined us as Executive Vice President and Chief Financial
Officer in March 1999 and the compensation figures for him are for the
period from that date to the end of the year. Mr. Grenfell's employment
terminated effective March 8, 2000.
Stock Option Grants
KMC Telecom Holdings, Inc. 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 Inc. (now one of our principal operating
subsidiaries) granted options to purchase shares of its common stock, par
value $.01 per share, to employees, including those named in the preceding
table, and selected employees of certain affiliated companies owned by Mr.
Kamine pursuant to the 1996 Stock Plan.
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In order to reflect the establishment of our holding company structure, on
June 26, 1998, our board of directors adopted a new stock option plan, the
1998 Stock Plan, which authorizes the grant of options to purchase shares of
our common stock. During the third quarter of 1998, we replaced the options to
purchase shares of common stock of KMC Telecom Inc. previously granted under
our 1996 Stock Plan (including all options shown as granted during 1997 in the
preceding table) with options to purchase shares of our common stock granted
under the 1998 Stock Plan and granted new options to additional employees,
including Mr. Lasher, our Vice Chairman, under the 1998 Stock Plan. We may
subsequently grant additional options.
The following table sets forth information regarding grants of options to
purchase shares of our common stock made by us during 1999 to each of the
persons named (without giving effect to the -for- split of our common
stock).
Option Grants in Fiscal Year 1999
<TABLE>
<CAPTION>
Individual Grants
-----------------------------------------------------------------------------------------
Potential Realizable Value
Number of Percent of Market Price at Assumed Annual Rates
Securities Total Options of Common of Stock Price Appreciation
Underlying Granted to Exercise or Stock on For Option Term(3)
Options Employees in Base Price Date of Expiration --------------------------------
Name Granted(#)(1) Fiscal 1999 ($/Share) Grant(2) Date 0% 5% 10%
------------------------ ------------- ------------- ----------- ------------ ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Harold N. Kamine........ -- -- -- -- -- -- -- --
Michael A. Sternberg.... -- -- -- -- -- -- -- --
Roscoe C. Young II...... -- -- -- -- -- -- -- --
James D. Grenfell(4).... 18,000 21.9% $125 $130 01/01/09 $90,000 $1,566,000 $3,816,000
Tricia Breckenridge..... 1,000 1.2% 125 130 01/01/09 5,000 87,000 212,000
</TABLE>
--------
(1) 10% of the aggregate amount of each such option vests on each subsequent
six-month anniversary of the date of grant.
(2) There is no active trading market for our common stock. The market price
shown is based upon management's estimate of the fair value of our common
stock on the date in January, 1999 when these options were granted.
(3) 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 our common stock over the term of the options. These assumptions
are based on rules promulgated by the SEC and do not reflect our estimate
of future stock price appreciation. Actual gains, if any, on the stock
option exercises and common stock holdings are dependent on the timing of
such exercises and the future value of our 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
holders.
(4) Pursuant to the terms of a separation agreement entered into in
connection with the termination of his services in March 2000, Mr.
Grenfell has retained only 3,600 of the options shown in the table.
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Option Exercises and Option Year-End Value Table
No options were exercised during 1999 by any of the persons named in the
table below. The following table sets forth information regarding the number
and year-end value of unexercised options to purchase shares of common stock
held at December 31, 1999 by each of the persons named (without giving effect
to the -for- split of our common stock).
Fiscal 1999 Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Shares Options at "In-the-Money"
Acquired On Value December 31, 1999 Options at December 31, 1999
Name Exercise(#) Realized($) Exercisable/Unexercisable Exercisable/Unexercisable(1)
------------------------ ----------- ----------- ------------------------- ----------------------------
<S> <C> <C> <C> <C>
Harold N. Kamine ....... -- -- -- -- /--
Michael A. Sternberg.... -- -- 45,500/19,500 $10,400,000/$4,160,000
Roscoe C. Young II...... -- -- 22,750/ 9,750 5,200,000/ 2,080,000
James D. Grenfell(2).... -- -- 1,800/16,200 225,000/ 2,025,000
Tricia Breckenridge..... -- -- 4,600/ 1,400 1,027,500/ 217,500
</TABLE>
--------
(1) Options are "In-the-Money" if the fair market value of the underlying
securities exceeds the exercise price of the options. There is no active
trading market for our common stock. The fair market value of the option
grants at December 31, 1999 was determined on the basis of management's
estimate of the fair value of our common stock on that date.
(2) Pursuant to the terms of a separation agreement entered into in
connection with the termination of his services in March 2000, Mr.
Grenfell has retained only 3,600 of the options shown in the table.
Director Compensation
Our Directors do not currently receive any compensation for their services
in such capacity, except that Mr. Lasher receives $25,000 per year in
connection with his services as our Vice Chairman and was granted options to
acquire 12,000 shares of our stock and Mr. Patterson receives $25,000 and
options to acquire 1,000 shares of our common stock per year in connection
with his services as a Director.
Executive Employment Contracts
We have an employment contract with Harold N. Kamine, the Chairman of our
board of directors. Our employment agreement with Mr. Kamine provides for a
term of four years, effective as of January 1, 1999. Under the agreement, Mr.
Kamine will be paid a base salary of $450,000 per annum through September 30,
2000. Mr. Kamine's base salary will be reduced to $100,000 per annum effective
on that date. Mr. Kamine is entitled to receive benefits generally received by
our senior executives, including reimbursement of expenses incurred on our
behalf, and participation in group plans. If Mr. Kamine's employment agreement
is terminated as a result of Mr. Kamine's death or permanent disability, or
upon our breach of the agreement, he, or his estate, is entitled to a
severance payment in an amount equal to the lesser of two times his annual
base salary and the aggregate unpaid base salary that would have been paid to
him during the remaining balance of the term of the employment contract,
subject to a minimum of one-half of his annual base salary.
We have an employment contract with William F. Lenahan, Chief Executive
Officer and a member of our board of directors. Our employment agreement with
Mr. Lenahan provides for a term of five years, effective as of May 1, 2000.
However, the term will be automatically extended for successive two year
periods unless either party provides notice to the other, at least ninety days
prior to the end of the term, that the agreement will not be extended. Under
the agreement, Mr. Lenahan's base salary is $500,000 per annum and he is
entitled to be considered for an annual bonus in an amount to be determined by
the Compensation Committee of the board of directors. In addition to the
annual bonus, Mr. Lenahan will be entitled to receive a total of $3.0 million
in bonus payments with $1.0 million payable upon each of the initial public
offering of our common stock and the first
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two public capital equity or debt events subsequent to an initial public
offering. With our agreement, Mr. Lenahan may elect to receive these special
bonuses in common stock in lieu of cash. Mr. Lenahan is also entitled to
receive benefits generally received by our officers, including options to
purchase our common stock, reimbursement of expenses incurred on our behalf,
and a leased automobile. If we terminate Mr. Lenahan's employment without
cause, or if the term of his employment agreement expires, prior to an initial
public offering or upon our change in control, Mr. Lenahan will be entitled to
receive a makeup bonus equal to $5.0 million. Upon termination of the
agreement, Mr. Lenahan is subject to a confidentiality covenant and a twenty-
four month non-competition agreement. Mr. Lenahan is entitled to receive a
severance payment in an amount ranging from 0% to 200% of his base salary upon
termination of his employment depending on the cause of such termination. Upon
payment of the makeup bonus, all stock and stock options which Mr. Lenahan may
have with regard to our equity will be terminated.
We have an employment contract with Roscoe C. Young, II, President, Chief
Operating Officer and a member of our board of directors. The term of Mr.
Young's employment under the employment agreement became effective as of March
6, 2000, and continues until March 31, 2005, unless earlier terminated in
accordance with the employment agreement. Under the agreement, Mr. Young's
base salary is $500,000 per annum and he is entitled to be considered for an
annual bonus in an amount to be determined by the Compensation Committee of
our board of directors. In addition to the annual bonus, Mr. Young will be
entitled to receive a total of $3.0 million in bonus payments with $1.0
million payable upon each of the initial public offering of our common stock
and the first two public capital equity or debt events subsequent to an
initial public offering. However, if we close a private equity issuance of at
least $200 million prior to our initial public offering of common stock, Mr.
Young will be entitled to receive $500,000 which would be credited against the
$1.0 million he would otherwise be entitled to receive upon the closing of our
initial public offering of common stock. With our agreement, Mr. Young may
elect to receive these special bonuses in common stock in lieu of cash.
Mr. Young is entitled to receive benefits generally received by our officers,
including options to purchase our stock, reimbursement of expenses incurred on
our behalf, and a leased automobile. Upon termination of the agreement, Mr.
Young is subject to a confidentiality covenant and a twenty-four month non-
competition agreement. If we terminate Mr. Young's employment without cause,
he is entitled to a severance payment in an amount equal to two times his
annual base salary.
We also have an employment contract with William H. Stewart, our Chief
Financial Officer and Executive Vice President. Our agreement with Mr. Stewart
provides for a term of three years, effective as of March 9, 2000. Under the
agreement, Mr. Stewart's base salary is $350,000 per annum and he is entitled
to be considered for an annual bonus in an amount to be determined by the
Compensation Committee of our board of directors. In addition to the annual
bonus, Mr. Stewart will be entitled to receive a minimum of $700,000 in bonus
payments with $500,000 payable upon the consummation of our initial public
offering of common stock and additional bonuses of not less than $100,000 each
after the first two public capital equity or debt events subsequent to our
initial public offering of common stock. However, if we close a private equity
issuance of at least $200 million prior to our initial public offering of
common stock, Mr. Stewart will be entitled to receive $250,000 which would be
credited against the $500,000 he would otherwise be entitled to receive upon
the closing of our initial public offering of common stock. With our
agreement, Mr. Stewart may elect to receive these special bonuses in common
stock in lieu of cash. Mr. Stewart is entitled to receive benefits generally
received by our officers, including options to purchase our stock,
reimbursement of expenses incurred on our behalf, and a leased automobile.
Upon termination of the agreement, Mr. Stewart is subject to a confidentiality
covenant and a twenty-four month non-competition agreement. If we terminate
Mr. Stewart's employment without cause, he is entitled to a severance payment
in an amount equal to two times his annual base salary.
Separation Agreements
On March 7, 2000, we entered into a separation agreement and release with
Michael A. Sternberg, pursuant to which Mr. Sternberg's employment as our
President and Chief Executive Officer was terminated, by mutual agreement,
effective March 8, 2000. Under the separation agreement, Mr. Sternberg was
paid $500,000 and is
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entitled to an additional $500,000 which will be paid in semi-monthly
installments between April 1, 2000 and March 31, 2001, subject to acceleration
in certain circumstances. Mr. Sternberg was also reimbursed for accrued
vacation time. Pursuant to the agreement, we will pay the costs associated
with Mr. Sternberg's current enrollment in our health care plans through
December 31, 2001. Mr. Sternberg will also retain 65,000 stock options
previously granted to him under our stock option plan. Mr. Sternberg has
agreed to vote any shares of common stock owned by him in accordance with the
shares owned by Mr. Kamine and Nassau. Mr. Sternberg has agreed to make
himself available to consult with us on a non-exclusive basis through December
31, 2001.
On March 7, 2000, we entered into a separation agreement and release with
James D. Grenfell, pursuant to which Mr. Grenfell's employment as our
Executive Vice President, Chief Financial Officer and Secretary was
terminated, by mutual agreement, effective March 8, 2000. Under the separation
agreement, Mr. Grenfell was paid $500,000 and is entitled to an additional
$300,000 which will be paid in semi-monthly installments to be paid over a
twelve month period in accordance with our payroll practices. Mr. Grenfell is
also entitled to a payment of $200,000 on March 1, 2001. Pursuant to the
agreement, we will pay the costs associated with Mr. Grenfell's current
enrollment in our health care plans through December 31, 2001. Mr. Grenfell
will also retain 3,600 stock options previously granted to him under our stock
option plan. Mr. Grenfell has agreed to vote any shares of common stock owned
by him in accordance with the shares owned by Mr. Kamine and Nassau. We will
also pay Mr. Grenfell up to $40,000 for certain relocation and other services.
Employee Equity Incentive Plan
1998 Stock Plan. Employees, directors and other persons having a close
relationship with us or any of our affiliates are eligible to participate in
the 1998 Stock Plan. However, neither Mr. Kamine nor any person employed by
Nassau or any of its affiliates is eligible for grants under the plan. The
1998 Stock Plan is administered by the Compensation Committee of our board of
directors. The Compensation Committee has the power and authority to designate
recipients of grants under the plan, to determine the terms, conditions and
limitations of grants under the plan and to interpret the provisions of the
plan. The Compensation Committee is authorized to grant options, including
incentive stock options and non-qualified stock options, stock appreciation
rights, restricted stock, performance units, performance shares and certain
other types of awards.
Without giving effect to the -for- split of our common stock, the number
of shares of our common stock reserved for issuance under the 1998 Stock Plan
is 600,000. As of July 31, 2000 options to acquire of these shares have
been granted. No participant may acquire more than 75,000 shares of our common
stock under the plan.
The exercise price of all incentive stock options granted under the plan
must be at least equal to the fair market value (as defined in the plan) of
our common stock on the date the options are granted and the exercise price of
all non-qualified options granted under the plan must be at least equal to 50%
of the fair market value of our common stock on the date the options are
granted. The maximum term of each option granted under the plan is 10 years.
Options become exercisable at such times and in such installments as the
Compensation Committee provides in the terms of each individual option. Under
existing option grants, shares of common stock vest at a rate of 10% every six
months from the date of issuance. In the event of a public offering, 10% of
each of the existing option grants will vest to the extent not vested. In the
event of a change in control, 50% of each of the existing option grants will
vest to the extent not vested.
Employee Equity Incentive Plan. In connection with this offering, our
Compensation Committee has approved a new employee equity incentive plan as an
amendment and restatement of the 1998 Stock Plan. The plan is intended to
assist us and our subsidiaries in attracting, retaining and motivating
employees and certain other persons providing services or having a unique
relationship with us or our affiliates and to make our compensation program
competitive with those of other similarly situated employers. This amended and
restated plan becomes effective upon the effective date of this prospectus.
Administration of the Plan. The plan will be administered by our board of
directors. It will have the right to: (i) interpret the plan and award
agreements, (ii) establish, amend and rescind any rules relating to the plan,
(iii) select recipients of awards and grant awards to them, (iv) establish the
terms and conditions of the awards,
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<PAGE>
(v) determine the terms and provisions of any award agreement made pursuant to
the plan and (vi) take any other action necessary for the proper
implementation of the plan. In addition, our board of directors will have the
right to delegate administration of the plan to a committee of our board of
directors or such other persons as the board of directors deems appropriate.
Awards intended to qualify under Section 162(m) of the Internal Revenue Code
as performance-based compensation may only be granted by unanimous consent of
our board of directors or by a committee that qualifies to grant such awards
under Section 162(m).
Participation. All of our employees, and certain other persons providing
services or having a unique relationship with us or our affiliates, will be
eligible to receive awards under the plan. Participants will receive awards to
the extent granted as described above. Outside directors will not be eligible
for awards under the plan.
Shares Available for Awards. Subject to our stockholders' approval, a total
of 19.95% of our outstanding shares of common stock, on a fully diluted basis,
will be reserved for issuance under the plan (including shares currently
reserved for issuance under the existing 1998 Stock Plan), subject to
adjustment for stock splits, stock dividends, recapitalizations and similar
events. These shares may consist in whole or in part of authorized and
unissued shares or treasury shares. If an award expires unexercised or is
forfeited, surrendered or cancelled, the shares previously used for such
awards will be available for future awards under the plan. No individual may
be granted awards under the plan which in the aggregate cover more than 50,000
shares in any one calendar year, subject to adjustment for stock splits, stock
dividends, recapitalizations and similar events.
Awards. The plan will permit grants of awards of such type and subject to
such terms and conditions as our board of directors may determine, including
the following types of awards:
. options, including incentive stock options and non-qualified stock
options,
. stock appreciation rights,
. restricted stock,
. stock equivalent units,
. performance units, and
. dividend equivalent units.
Vesting. Under the plan, new option grants will vest at the rate of 6.25%
every three months from the date of issuance, unless there is a change in
control, as described below.
Award Terms. To the extent that any award has an exercise price, the
exercise price cannot be lower than the fair market value of our common stock
on the date of grant. In the case of an option granted retroactively or in
tandem with or as a substitution for another award, the exercise price cannot
be less than the fair market value of a share of our common stock on the date
of the original grant. The duration of each option under the plan cannot be
greater than 10 years from the award date. Awards of incentive stock options,
however, can only be granted within 10 years from the date the plan is adopted
by the board or approved by the shareholders.
Under the plan, our board of directors can grant incentive stock options or
non-statutory stock options to purchase shares of our common stock. The
exercise price of all incentive stock options must be at least equal to the
fair market value (as defined in the plan) of our common stock on the date the
options are granted. However, no incentive stock option can be granted to a
participant who already has the maximum amount of incentive stock options
permitted under Section 422(d) of the Internal Revenue Code in any calendar
year. An award of an incentive stock option may also provide that the option
may be exercised not later than three months following termination of the
participant's employment with us. Payment of the option price for either an
incentive stock option or a non-statutory stock option must be made in cash or
in shares of our common stock, or a combination of both.
If a stock appreciation right is awarded, upon exercise of the stock
appreciation right the participant will receive an amount equal to the excess
of the fair market value of a share of our common stock on the settlement
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date over the award price of the stock appreciation right for the number of
stock appreciation rights exercised. Stock appreciation rights may be awarded
either separately or in conjunction with another award. The award price for
stock appreciation rights awarded separately is the fair market value of a
share of our common stock on the date the stock appreciation right is awarded
and a stock appreciation right awarded in conjunction with any other award is
the fair market value of a share of our common stock on the date the
associated award was made. However, where a stock appreciation right is
granted retroactively in tandem with or in substitution for another award, the
award price of the stock appreciation right will not be less than the fair
market value of a share of our common stock on the date such other award was
made.
The exercise of a stock appreciation right granted in conjunction with
another award terminates that other award to the extent of the number of
shares as to which the stock appreciation right is exercised. Conversely, the
exercise of that other award terminates the associated stock appreciation
right to the extent of the shares as to which that other award is exercised.
The exercise of a stock appreciation right awarded separately has no effect on
the exercisability of any other award and the exercise of any other award has
no effect on the exercisability of a stock appreciation right awarded
separately.
In addition to options and stock appreciation rights, our board of
directors may grant restricted stock, stock equivalent units, dividend
equivalent units and performance units. A restricted stock award is an award
of our common stock in which the shares granted are subject to restrictions on
transfer, conditions of forfeiture or any other limitations our board of
directors may determine appropriate. A stock equivalent unit is an award in an
amount equivalent to the fair market value of a share of our common stock. A
performance unit is a cash award based on the attainment over specified
periods of individual performance targets or other parameters.
Awards may accrue dividend equivalents in the amount of and at such times
as cash dividends are paid on our common stock or, instead of dividend
equivalents, may provide for automatic awards of stock equivalent units on
each date that cash dividends are paid on our common stock. These stock
equivalent units will have a value equal to the product of the dividend per
share times the total number of shares subject to awards held by the
participant, divided by the fair market value of our common stock on the
dividend payment date.
Awards of restricted stock, stock equivalent units or performance units
that are intended to qualify as performance-based compensation under Section
162(m) of the Internal Revenue Code will be conditioned on the achievement of
one or more performance measures selected by our board of directors.
Awards, other than awards of options, may be settled in cash, shares of our
common stock, other awards or combinations thereof. Our board of directors may
also require or permit participants to defer the issuance or vesting of shares
or the settlement of awards in cash. Our board of directors may also provide
that deferred settlements include the payment or crediting of interest on the
deferred amounts or the payment of dividend
equivalent units on deferred settlements denominated in shares of our common
stock. Our board of directors may determine the manner in which federal, state
or local tax withholding obligations will be satisfied, where applicable,
including the reduction in the amount of shares or cash to be delivered or
paid to the participant or reimbursement by the participant in cash or with
shares of common stock at the fair market value on the settlement date. Our
board of directors may also, in its discretion, provide in an award agreement
for the accelerated vesting and exercisability of awards and the lapse of any
or all restrictions on restricted stock upon the occurrence of: a
participant's termination of employment on account of death or disability, a
change in control, and a participant's termination of employment by us without
cause or a participant's resignation for good reason.
The plan provides that, if a participant is terminated for cause or
breaches any confidentiality or noncompete provision to which the participant
is otherwise subject, then the participant will immediately forfeit the right
to exercise any option, stock appreciation right or similar award, or to
become vested in any restricted stock or similar award, outstanding at the
time of the violation and will be obligated to pay us liquidated damages in an
amount equal to the gross amount of any gains realized in the year prior to
such termination or violation upon the exercise of any option, stock
appreciation right or similar award, plus any increase in value recognized in
connection with any restricted stock or similar award, at any time after the
first date of the violation. Our board of directors may, in its discretion,
waive this provision.
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Unless otherwise determined by our board of directors, in the event of a
change in control of us, 100% of a participant's unvested awards will vest if,
after a change in control, the participant terminates his or her employment
because the participant is not offered a comparable job, at comparable
compensation, within fifty (50) miles of the participant's current job
location.
Vested awards may be exercised within thirty (30) days from a participant's
voluntary termination of employment. Alternatively, vested awards may be
exercised within six (6) months from the date of termination, if a participant
is terminated due to death, disability, retirement after attainment of age
sixty (60) or a change in control.
Federal Income Tax Consequences. The federal income tax consequences of
awards granted pursuant to the plan under the Internal Revenue Code of 1986,
as amended, are summarized below.
The grant of a stock option or stock appreciation right will create no
immediate tax consequences for the participant or us. The participant will
have no taxable income upon exercising an incentive stock option, except that
an alternative minimum tax may apply, and we will not receive a deduction when
an incentive stock option is exercised. If the participant does not dispose of
the shares acquired on exercise of an incentive stock option within the two
year period beginning on the day after the grant of the incentive stock option
or within one year after the transfer of the shares to the participant, the
gain or loss on a subsequent sale will be a capital gain or loss. If the
participant disposes of the shares within the two year or one year period
described above, the participant generally will realize ordinary income and we
will be entitled to a corresponding deduction. Upon exercising a stock
appreciation right or stock option other than an incentive stock option, the
participant must recognize ordinary income in an amount equal to the
difference between the exercise price and the fair market value of the common
stock on the exercise date, unless the shares are subject to restrictions
contained in the plan. We will receive a deduction for the same amount on the
exercise date, or the date the restrictions lapse.
With respect to the other grants under the plan that are settled in cash or
shares of common stock that are either transferable or not subject to a
substantial risk of forfeiture, the participant must recognize ordinary income
in an amount equal to the cash or the excess of the fair market value of the
shares received over any amount paid for such shares. With respect to other
grants under the plan that are settled in shares of common stock that are
subject to restrictions as to transferability and subject to a substantial
risk of forfeiture, the participant must recognize ordinary income in an
amount equal to the fair market value of the shares received at the first time
the shares become transferable or not subject to a substantial risk of
forfeiture, whichever occurs earlier. A participant may elect, under Section
83(b) of the Internal Revenue Code, to include the excess of the property's
fair market value over any amount paid for the property in income in the year
in which the property is received.
If a valid election is made, then subsequent appreciation in the value of the
property does not result in additional compensation. We will receive a
deduction for the amount recognized as income by the participant if certain
reporting requirements are satisfied, subject to the provisions of Section
162(m) of the Internal Revenue Code which provides for a possible denial of a
tax deduction to us for compensation for any named executive officer in excess
of $1 million in any year. The plan is designed so that grants intended to
qualify for the performance-based compensation exemption to the $1 million cap
on tax deductibility under Section 162(m), including stock options, should
qualify for the exemption.
The tax treatment to us upon disposition of shares acquired under the plan
will depend on how long the shares have been held. In the case of shares
acquired through exercise of an option, the tax treatment will also depend on
whether or not the shares were acquired by exercising an incentive stock
option. There will be no tax consequences to us upon the disposition of shares
acquired under the plan, except that we may receive a deduction in the case of
disposition of shares acquired under an incentive stock option before the
applicable holding period has been satisfied.
Deferred Compensation Plan
We expect to adopt a deferred compensation plan. The plan will be effective
for compensation that would otherwise be payable on or after January 1, 2001.
Under the plan, participants will be able to defer a portion of
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their base salary and variable compensation. Distributions from the plan
generally will be made upon retirement or other termination of employment,
unless further deferred by the participant.
401(k) Plan
We sponsor the KMC Telecom Employees' 401(k) Plan, a defined contribution
plan that is intended to qualify under Sections 401(a) and 401(k) of the
Internal Revenue Code. All employees who have been employed by us for two
months are eligible to participate in our 401(k) Plan. An eligible employee
may begin to participate in our 401(k) Plan on the first day of the month
after satisfying the eligibility requirements. An eligible employee may make
pre-tax contributions of a percentage (not less than 1% and not more than 15%)
of his or her eligible compensation, subject to the limitations under the
Federal tax laws.
The 401(k) Plan features a discretionary employer matching contribution,
effective January 1, 2001. Prior to the start of each calendar year, our Chief
Executive Officer will determine whether we will provide a matching
contribution under the 401(k) Plan and, if one will be provided, the amount of
such match. In no event will the matching contribution exceed 50% of the
amount contributed by the employee to the extent that the employee contributes
between 1% and 6% of the employee's compensation. Each eligible employee who
elects to participate in the plan and makes a contribution thereto will be
eligible to receive the matching contribution, if one is so provided, in the
form of shares of our common stock. The matching contribution will vest 6.25%
for every three calendar months of service earned by the employee.
Employee contributions and the investment earnings thereon are fully vested
at all times. Contributions to the 401(k) Plan by the employees or by us, and
the income earned on these contributions, are generally not taxable to the
employees until withdrawn. Contributions by us are generally deductible by us
when made. Employee and company contributions are held in trust as required by
law. Individual employees may direct the trustee to invest their accounts in
authorized investment alternatives, including our common stock. Distributions
from the 401(k) Plan generally are made only upon retirement or other
termination of employment, unless deferred by the participant.
We intend to register on a registration statement on Form S-8 the shares to
be offered under our common stock fund and employer matching contributions in
the 401(k) Plan.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The company and certain affiliated companies owned by Harold N. Kamine, our
Chairman of the Board, share certain administrative services. The entity which
bears the cost of the services is reimbursed by the other for the other's
proportionate share of such expenses. In 1999, under a predecessor lease,
these shared services did not include the rent paid by us for our headquarters
offices to an affiliate of Mr. Kamine under the lease described below. We
reimbursed Kamine-affiliated companies for these shared services an aggregate
of approximately $60,000 for 1999. During 1999, we purchased approximately
$180,000 of office furniture and leasehold improvements from an entity
controlled by Mr. Kamine.
In February, 1998, we loaned to Roscoe C. Young II, our President and 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 June 1998, we
loaned Mr. Young an additional $110,000. Mr. Young repaid $55,000 of this loan
within thirty (30) days and repaid the $55,000 balance in December 1999. The
largest aggregate amount of loans outstanding to Mr. Young at any time during
1999 was $405,000. In June, 2000, we loaned Mr. Young an additional $318,000.
The loan is evidenced by a promissory rate which bears interest at the rate of
6.43% per annum. Principal and interest are payable at maturity on December
31, 2000. The aggregate amount of loans outstanding to Mr. Young at August 31,
2000 was $668,000.
Pursuant to an agreement dated as of January 1, 1999, we are entitled to
use a Citation III business jet chartered by Bedminster Aviation LLC, a
limited liability company wholly owned by Mr. Kamine, for a fixed price of
$2,600 per hour of flight time. During 1999, we paid approximately $210,000
for the use of the Citation III. The Citation III will enable up to eight of
our employees, guests or representatives to use local airfields and visit
multiple cities in which we either have an operating network or are building a
network, without the necessity of returning to commercial hubs such as
Atlanta, Chicago or St. Louis. We have agreed to use our best efforts to use
the Citation III fifty hours per quarter during 2000. However, we are under no
obligation to do so and we have not guaranteed any financial arrangements with
respect to the aircraft or to Bedminster Aviation LLC.
On July 1, 1999, we acquired all of the membership interests of KMC
Services LLC from Mr. Kamine and Kathleen Kamine, his spouse, for nominal
consideration. KMC Services LLC offers a leasing program for equipment
physically installed at a customer's premises, known as CPE equipment, for us
to integrate into our ClearStarsm program. As of September 30, 1999, we had
loaned KMC Services LLC an aggregate of approximately $709,000. The loan bore
interest at the rate of 10% per annum and was to have been payable December
31, 1999. The acquisition was accounted for as a combination of entities under
common control, and no changes were made to the historical cost basis of KMC
Services LLC's assets. Accordingly, during the second quarter of 1999, we
reduced the carrying value of our $709,000 loan receivable from KMC Services
LLC to an amount equal to the value of KMC Services LLC's net assets at the
acquisition date.
Effective August 18, 2000, we entered into a 12 year lease for all three
floors of the building (approximately 50,000 square feet) in Bedminster, New
Jersey in which we are presently headquartered, consolidating our headquarters
employees from several different buildings in Bedminster. When all the space
is available for occupancy by us, we will pay an annual base rental of
approximately $1.0 million (adjusted periodically for changes in the consumer
price index) plus operating expenses. The building is owned by a company in
which a trust for the benefit of Mr. Kamine's children owns a fifty percent
interest. Previously, under the terms of a lease initially entered into in
June 1996, we had leased smaller amounts of space in the building in which our
headquarters are located. The earlier lease had provided for a base annual
rental of $217,000 (adjusted periodically for changes in the consumer price
index), plus operating expenses.
KNT Network Technologies LLC, a company owned by Mr. Kamine and an
affiliate of Nassau Capital Partners, L.P., two of our principal stockholders,
entered into agreements with us as of June 1, 2000 pursuant to which we have
transferred, or will transfer, to KNT substantially all of the business and
assets of our network construction business which consists of certain
telecommunication equipment and certain related real estate interests. In
exchange, KNT will pay us approximately $300,000 by September 30, 2000,
$800,000 by December 2000 and execute a promissory note due and payable in
February 2002 in the amount of $2.7 million. KNT
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will be the exclusive provider of outside network related construction and
maintenance services to us for a term of five years, subject to performance
and certain specific exceptions. We will pay costs plus an annual fixed fee up
to $15.0 million for all construction services and costs plus an annual fixed
fee up to $2.0 million for all maintenance services. KNT is seeking to obtain
telecommunications construction business from third parties. In the event KNT
is successful in obtaining this business, KNT must share with us a portion of
the net income it receives from such business. We have the right to terminate
these agreements at any time after March 31, 2003 or in the event Mr. Kamine
and Nassau cease to be our controlling stockholders or at any time in the
event we do not receive certain payments by February 15 of any year of the
term of the agreement.
CIT Lending Services Corporation (an affiliate of The CIT Group), one of
our principal stockholders, has provided financing to us as one of the lenders
under our amended senior secured credit facility. The lenders under the
amended senior secured credit facility have agreed to make available, subject
to certain conditions, up to a total of $700.0 million, for construction and
development of our existing networks. We have paid CIT and its affiliates
aggregate cash payments for fees, discounts and commissions of $5.0 million
and $450,000, during the year ended December 31, 1999 and the six months ended
June 30, 2000, respectively. This amount does not include the $400,000 in fees
we paid to CIT in connection with our offering of Series G Convertible
Preferred Stock described below.
Pursuant to an agreement between us and Nassau, Nassau was paid $450,000 in
cash as a financial advisory fee for 1999. Nassau will also be paid financial
advisory fees in cash at a rate of $450,000 per annum through September 30,
2000, at which point the fees will be reduced to $100,000 per annum.
In June, 2000 we paid General Electric Capital Corporation, one of our
principal stockholders, a fee of $1.0 million in cash for their services in
connection with arranging the lease financing transaction which funded the
cost of the $134.4 million of equipment we purchased from Qwest in March 2000.
Upon the initial closing of our offering of our Series G Convertible
Preferred Stock in July 2000, we paid a fee of $2.0 million in cash to
Dresdner Kleinwort Benson Private Equity LLC, an affiliate of one of our
principal stockholders, a fee of $1.0 million in cash to Nassau Capital L.L.C.
and a fee of $400,000 in cash to CIT.
In April 2000, we entered into a letter agreement with Alan M. Epstein
pursuant to which Mr. Epstein agreed to serve as our General Counsel,
Executive Vice President and Corporate Secretary until the earlier of a change
of control of our company or March 15, 2003. As compensation for his services,
we agreed to grant Mr. Epstein vested options to acquire 17,500 shares of our
common stock. In addition, we agreed to grant Kelley Drye & Warren LLP, the
law firm of which Mr. Epstein remains an active partner, vested options to
acquire 7,500 shares of our common stock. Upon exercise of the options by Mr.
Epstein or Kelley Drye & Warren, 25% of the stock received is non-callable and
75% becomes non-callable in 12.5% increments on the six month anniversary of
March 15, 2000, concluding March 15, 2003. In the event of a change of control
of our company, Mr. Epstein's death or permanent disability or the termination
of Mr. Epstein as General Counsel, except for cause, all call features on
shares issued, or shares underlying unexercised options granted, to Mr.
Epstein or Kelley Drye & Warren automatically become null and void. The option
grants to Mr. Epstein and Kelley Drye & Warren were made under our 1998 Stock
Plan. Kelley Drye & Warren exercised its options in July 2000.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us regarding the
beneficial ownership of our common stock at the date of this prospectus, before
and after giving effect to the conversion of our convertible preferred stock,
the -for- split of our common stock and this offering, by (i) each person
known by us to own beneficially 5% or more of our outstanding common stock,
(ii) each of our directors, (iii) each of our most highly compensated executive
officers during 1999, and (iv) all of our executive officers and directors as
a group.
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Offering(1) Owned After Offering(1)
------------------------------ ----------------------------
Name and Address of
Beneficial Owner Number Percentage Number Percentage
------------------- -------------- --------------- ----------- -------------
<S> <C> <C> <C> <C>
Harold N. Kamine........ 581,232 66.9%
c/o Kamine Development
Corp.
1545 Route 206
Bedminster, NJ 07921
Nassau Capital Partners
L.P. (2)............... 702,693 45.3%
c/o Nassau Capital
L.L.C.
22 Chambers Street
Princeton, NJ 08542
CIT Lending Services
Corporation (3)........ 250,210 26.3%
44 Whippany Road
Morristown, NJ 07960
First Union Corp. (4)... 170,044 16.6%
301 South College
Street
Charlotte, NC 28288
General Electric Capital
Corporation (5)........ 247,079 22.3%
120 Long Ridge Road
Stamford, CT 06927
CIBC Inc................ 44,104 5.1%
425 Lexington Avenue
New York, New York
10017
Lucent Technologies Inc.
(6).................... 295,885 25.6%
600-700 Mountain Avenue
Murray Hill, NJ 07974
Dresdner Kleinwort
Benson Private Equity
Partners LP (7)........ 147,942 14.7%
75 Wall Street
New York, NY 10005
William F. Lenahan (8).. 18,750 2.1%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminister, New Jersey
07921
Michael A. Sternberg
(8).................... 65,000 7.1%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminster, New Jersey
07921
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Shares Beneficially Shares Beneficially
Owned Prior to Offering(1) Owned After Offering(1)
------------------------------- ----------------------------
Name and Address of
Beneficial Owner Number Percentage Number Percentage
------------------- --------------- --------------- ----------- -------------
<S> <C> <C> <C> <C>
Gary E. Lasher (8)...... 12,000 1.4%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminster, New Jersey
07921
John G. Quigley (9)..... 702,693 45.3%
c/o Nassau Capital
L.L.C.
22 Chambers Street
Princeton, NJ 08542
Richard H. Patterson
(8).................... 7,000 0.8%
c/o Spire Capital
Management
30 Rockefeller Center
Suite 4350
New York, NY 10112
Randall A. Hack (9)..... 702,693 45.3%
c/o Nassau Capital
L.L.C.
22 Chambers Street
Princeton, NJ 08542
Alexander P. Coleman
(10)................... 147,942 14.7%
c/o Dresdner Kleinwort
Benson
Private Equity Partners
L.P.
75 Wall Street
New York, New York
10004
Roscoe C. Young II (8).. 35,812 4.0%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminster, NJ 07921
William H. Stewart (8).. 13,125 1.5%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminster, NJ 07921
James D. Grenfell (8)... 3,600 0.4%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminster, NJ 07925
Tricia Breckenridge
(8).................... 5,200 0.6%
c/o KMC Telecom
Holdings, Inc.
1545 Route 206, Suite
300
Bedminster, NJ 07921
Our Directors and
Officers as a Group
(10 persons) (2)....... 1,608,105 85.5%
</TABLE>
--------
(1) Beneficial ownership is determined in accordance with the rules of the
SEC. 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 the date of determination are
deemed outstanding. Such shares, however, are not deemed
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<PAGE>
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 shares of common stock which Nassau Capital Partners L.P.
and NAS Partners I L.L.C. have the right to acquire upon conversion of
122,708 and 1,092 shares of Series A Convertible Preferred Stock,
respectively, shares of common stock which Nassau and NAS Partners I,
L.L.C. have the right to acquire upon conversion of 24,778 and 222 shares
of Series C Convertible Preferred Stock, respectively and shares of
common stock which NAS Partners I, L.L.C. and Nassau Capital Partners IV
L.P. have the right to acquire upon conversion of 411 shares and 29,178
shares of Series G Convertible Preferred Stock, respectively. These are
the same shares listed for Messrs. Quigley and Hack.
(3) Includes 159,184 shares of common stock held by Newcourt Communications
Finance Corporation, a subsidiary of CIT Lending Services Corporation,
31,848.7 shares of common stock which Newcourt Commercial Finance
Corporation, also a subsidiary of CIT Lending Services Corporation, has
the right to acquire upon the exercise of warrants and shares of
common stock which CIT Lending Services Corporation has the right to
acquire upon conversion of 59,177 shares of Series G Convertible Preferred
Stock.
(4) Includes 95,238 shares of common stock which First Union Corp. (the
successor to CoreStates Holdings, Inc.) has the right to acquire upon
conversion of 50,000 shares of Series C Convertible Preferred Stock and
44,587 shares which First Union Corp. has the right to acquire upon the
exercise of warrants.
(5) Includes 190,476 shares of common stock which General Electric Capital
Corporation has the right to acquire upon conversion of 100,000 shares of
Series C Convertible Preferred Stock and 10,000 shares of common stock
which General Electric Capital Corporation has the right to acquire upon
exercise of a warrant.
(6) Represents shares of common stock which Lucent has the right to acquire
upon conversion of 295,885 shares of Series G Convertible Preferred Stock.
(7) Represents shares of common stock which Dresdner Kleinwort Benson Private
Equity Partners LP and its affiliate, 75 Wall Street Associates, have the
right to acquire upon conversion of 147,942 shares of Series G Convertible
Preferred Stock. These are the same shares listed for Mr. Coleman.
(8) Represents shares of common stock which the holder has the right to
acquire upon the exercise of options that are exerciseable within sixty
days pursuant to our stock option plan.
(9) Messrs. Quigley and Hack, directors of the company, are members of Nassau
Capital L.L.C., the general partner of Nassau Capital Partners L.P. and
Nassau Capital Partners IV L.P.; 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 Partners I,
L.L.C.; 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.
(10) All of the shares indicated as owned by Mr. Coleman are owned directly or
indirectly by Dresdner Kleinwort Benson Private Equity Partners LP of
which Mr. Coleman is a Vice President and Investment Partner.
Accordingly, Mr. Coleman may be deemed to be a beneficial owner of such
shares and for purposes of this table they are included. Mr. Coleman
disclaims beneficial ownership of all such shares within the meaning of
Rule 13d-3 under the Exchange Act. The shares set forth represent shares
of common stock which Dresdner Kleinwort Benson Private Equity Partners
LP and 75 Wall Street Associates have the right to acquire upon
conversion of 133,148 and 14,794 shares of Series G Convertible Preferred
Stock, respectively.
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<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
Senior Notes
On May 24, 1999 we issued $275.0 million aggregate principal amount of 13
1/2% Senior Notes due 2009. On December 30, 1999, we exchanged those notes for
$275.0 million aggregate principal amount of notes that had been registered
under the Securities Act of 1933. Interest on the senior notes is payable
semi-annually in cash on May 15 and November 15 of each year, beginning
November 15, 1999. A portion of the proceeds from the offering of the senior
notes was used to purchase a portfolio of U.S. government securities that were
pledged as security for the first six interest payments on the senior notes.
The senior notes were guaranteed by KMC Telecom Financing, Inc., our wholly
owned subsidiary. The senior notes are senior unsecured obligations of KMC
Telecom Holdings, Inc. and rank pari passu in right of payment with all our
existing and future senior indebtedness and senior in right of payment to all
of our existing and future subordinated indebtedness.
The indenture pursuant to which our senior notes were issued contains
certain covenants that, among other things, limit our ability to incur
additional indebtedness, engage in sale-leaseback transactions, pay dividends
or make certain other distributions, sell assets, redeem capital stock, effect
a consolidation or merger of KMC Telecom Holdings, Inc. and enter into
transactions with stockholders and affiliates and create liens on our assets.
We have the option to redeem the senior notes at any time after May 15, 2004,
at redemption prices ranging from 106.75% to 100% of their principal amount,
plus any accrued and unpaid interest. Before May 15, 2002, we may also redeem
up to 35% of the aggregate principal amount of the senior notes with the
proceeds from sales of our common equity at a redemption price equal to 113.5%
of their principal amount on such date plus accrued and unpaid interest. We do
not intend to use any portion of the proceeds of this offering to redeem the
senior notes. Upon a change of control, we are required to make an offer to
purchase the senior notes at a purchase price equal to 101% of their principal
amount, plus accrued interest.
Senior Discount Notes
On January 29, 1998 we issued $460.8 million aggregate principal amount at
maturity of 12 1/2% Senior Discount Notes due 2008. On August 11, 1998, we
exchanged those notes for $460.8 million aggregate principal amount at
maturity of notes that had been registered under the Securities Act of 1933.
Our senior discount notes are unsecured, unsubordinated obligations and
were sold for aggregate net proceeds of $236.4 million which represents a
substantial discount from their principal amount at maturity. We are not
required to make any payment of interest on the senior discount notes prior to
August 15, 2003. The senior discount notes will fully accrete to face value on
February 15, 2003. From and after February 15, 2003, the senior discount notes
will bear interest, which will be payable in cash, at the rate of 12 1/2% per
annum on February 15 and August 15 of each year, commencing August 15, 2003.
The indenture pursuant to which the senior discount notes were issued
contains certain covenants that, among other things, limit our ability to
incur additional indebtedness, pay dividends or make certain other
distributions, enter into transactions with stockholders and affiliates and
create liens on our assets. We have the option to redeem the senior discount
notes at any time after February 15, 2003, at redemption prices ranging from
106.25% to 100% of their principal amount at maturity, plus any accrued and
unpaid interest. We do not intend to use any portion of the proceeds of this
offering to redeem the senior discount notes. Upon a change of control, we are
required to make an offer to purchase the senior discount notes at a purchase
price equal to 101% of their accreted value.
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<PAGE>
Amended Senior Secured Credit Facility
During the first quarter of 2000, KMC Telecom, KMC Telecom II, KMC Telecom
of Virginia, KMC Telecom III and certain of our other subsidiaries amended,
restated and combined our former senior secured credit facility and our former
Lucent facility by entering into a $700 million Loan and Security Agreement
with a group of lenders led by Newcourt Commercial Finance Corporation,
General Electric Capital Corporation, Canadian Imperial Bank of Commerce,
First Union National Bank and Lucent Technologies Inc.
This amended senior secured credit facility includes a $175 million
reducing revolver facility, a $75 million term loan (the "Term Loan") and a
$450 million term loan facility, (the "Lucent Term Loan").
The revolver will mature on April 1, 2007. Proceeds from the revolver can
be used to finance the purchase of certain equipment, transaction costs and,
upon attainment of certain financial conditions, for working capital and other
general corporate purposes. The aggregate commitment of the lenders under the
revolver will be reduced on each quarterly payment date beginning April 1,
2003. The initial quarterly commitment reduction is 5.0%, reducing to 3.75% on
July 1, 2003, then increasing to 6.25% on July 1, 2004, and further increasing
to 7.50% on July 1, 2006. Commencing with the fiscal year ending December 31,
2001, the aggregate revolver commitment will be further reduced by an amount
equal to 50% of excess operating cash flows (as defined in the facility) for
the prior fiscal year until the subsidiary borrowers achieve certain financial
conditions. Our subsidiary borrowers must pay an annual commitment fee on the
unused portion of the revolver ranging from .75% to 1.25%.
The Term Loan is payable in twenty consecutive quarterly installments of
$188,000 beginning on April 1, 2002 and two final installments of $35.6
million each on April 1, 2007 and July 1, 2007. Proceeds from the Term Loan
can be used to finance the purchase of certain equipment, transaction costs,
working capital and other general corporate purposes.
The Lucent Term Loan provides for an aggregate commitment of up to $450
million. Proceeds from the Lucent Term Loan can be used to purchase Lucent
products or to reimburse our subsidiary borrowers for Lucent products
previously purchased with cash or other sources of liquidity. The Lucent Term
Loan will mature on July 1, 2007 and has required quarterly principal payments
beginning on July 1, 2003 of 5%. The principal payment decreases to 3.75% per
quarter beginning on October 1, 2003, increases to 6.25% on October 1, 2004
and further increases to 7.50% on October 1, 2006. An annual commitment fee of
1.50% is payable for any unused portion of the Lucent Term Loan.
Borrowings under the amended senior secured credit facility will bear
interest payable, at our subsidiary borrowers' option, at either (a) the
"Applicable Base Rate Margin" (which generally ranges from 2.00% to 3.25%)
plus the greater of (i) the administrative agent's prime rate or (ii) the
overnight federal funds rate plus .5% or (b) the applicable LIBOR margin
(which generally ranges from 3.00% to 4.25%) plus LIBOR, as defined.
Applicable base rate margin interest is payable quarterly while applicable
LIBOR margin interest is payable at the end of each applicable interest period
or at least every three months. If a payment default were to occur, the
interest rate will be increased by four percentage points. If any other event
of default were to occur, the interest rate will be increased by two
percentage points.
We have unconditionally guaranteed the repayment of the amended senior
secured credit facility when such repayment is due, whether at maturity, upon
acceleration, or otherwise. We have pledged the shares of each of our
subsidiary borrowers to the lenders to collateralize its obligations under the
guaranty. In addition, our subsidiary borrowers have each pledged all of their
assets to the lenders.
The amended senior secured credit facility contains a number of affirmative
and negative covenants, including a covenant requiring our subsidiary
borrowers to obtain cash capital contributions from us of at least $185
million prior to April 1, 2001. KMC Holdings contributed $150 million of the
proceeds of our recent placement of Series G Convertible Preferred Stock
toward fulfilling this requirement and the lenders amended this covenant by
extending the due date on the remaining $35 million of cash capital
contributions to August 31,
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<PAGE>
2001. We anticipate raising the $35 million balance through private or public
sales of securities in the capital markets. Because the entire $185 million
cash capital contribution was not made by July 31, 2000, the applicable
interest rate associated with the facility increased by 100 basis points until
the $185 million amount is fully funded. Additional affirmative and negative
covenants include, among others, covenants restricting the ability of our
subsidiary 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 KMC Holdings, create
subsidiaries, transfer any permits or licenses, or incur additional
indebtedness or act as guarantor for the debt of any person, subject to
certain conditions.
Our subsidiary borrowers are required to comply with certain financial
tests and maintain certain financial ratios, including, among others, a ratio
of total debt to contributed capital, certain minimum revenues, maximum EBITDA
losses and minimum EBITDA, maximum capital expenditures and minimum access
lines, a maximum total leverage ratio, a minimum debt service coverage ratio,
a minimum fixed charge coverage ratio and a maximum consolidated leverage
ratio. The covenants become more restrictive upon the earlier of (i) June 30,
2002 and (ii) after our subsidiary borrowers achieve positive EBITDA on a
combined basis for two consecutive fiscal quarters and a total leverage ratio
(as defined) equal to or less than 9 to 1.
Failure to satisfy any of the financial covenants will constitute an event
of default under the amended senior secured credit facility permitting the
lenders, after notice, to terminate the commitment and/or accelerate payment
of outstanding indebtedness thereunder. The amended senior secured credit
facility also includes other customary events of default, including, without
limitation, a cross-default to other material indebtedness, material
undischarged judgments, bankruptcy, loss of a material franchise or material
license, breach of representations and warranties, a material adverse change,
and the occurrence of a change of control.
Telecom IV Senior Secured Term Loan
During the quarter ended June 30, 2000, KMC Telecom, IV, Inc., entered into
a new senior secured term loan agreement with Lucent Technologies Inc. The
loan is initially capped at $35 million until certain conditions are met that
allow for additional borrowings up to a ceiling of $50 million. Proceeds from
the loan may be used to purchase or install Lucent products and will be used
to purchase equipment for future expansion. The loan will mature on October 1,
2007 and requires quarterly principal payments beginning on January 1, 2003 of
2.5% of the outstanding principal balance, with the percentage increasing to
5% on January 1, 2005, 6.25% on October 1, 2005, 7.5% on October 1, 2006, with
the balance due on October 1, 2007. As of June 30, 2000, the outstanding loan
balance on this term loan was approximately $35 million.
Borrowings under the loan will bear interest payable, at our option, at
either (a) the applicable base rate margin (which generally ranges from 2.25%
to 3.50% based on our total debt to total contributed capital ratio) plus the
greater of (i) the administrative agent's prime rate or (ii) the overnight
federal funds rate plus .5% or (b) the LIBOR rate plus the applicable margin
(which generally ranges from 3.25% to 4.50% based on our debt to contributed
capital ratio). Applicable base rate margin interest is payable quarterly
while applicable LIBOR margin interest is payable at the end of each
applicable interest period, or at least every three months. We were being
charged a weighted average interest rate of 11.31% at June 30, 2000. There are
no financial covenants on the loan. However, there are affirmative and
negative covenants that, generally, are no more restrictive to us than our
other debt agreements. If any event of default were to occur, the interest
rate will increase by two percentage points.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
We are authorized to issue up to 7,950,000 shares of capital stock,
consisting of 4,250,000 shares of common stock, $.01 par value, of which
861,145 shares have been issued and are outstanding and 3,700,000 shares of
preferred stock, $.01 par value, of which 957,278 shares are issued and
outstanding.
The following summary description of our capital stock does not purport to
be complete. The rights of the holders of our capital stock will be set forth
in our restated certificate of incorporation, the form of which is filed as an
exhibit to the registration statement of which this prospectus forms a part.
The summary set forth below is qualified by reference to such exhibit and to
the applicable provisions of the Delaware General Corporation Law.
Common Stock
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders. Except as otherwise required by
law, the affirmative vote of a majority of the shares represented at a meeting
at which a quorum is present constitutes an action of the stockholders. There
is no cumulative voting. Holders of common stock are entitled, subject to the
preferences of preferred stock, to receive such dividends, if any, as may be
declared by our board of directors out of funds legally available for that
purpose. After giving effect to this offering, without the prior consent of
two-thirds of the shares of the Series E Preferred Stock and two-thirds of the
shares of Series F Preferred Stock, we may not declare or pay any dividends on
our common stock. The holders of common stock have no preemptive, redemption
or conversion rights. Upon the liquidation, dissolution or winding up of KMC
Telecom Holdings, Inc., the holders of our common stock are entitled to
receive pro rata all of our assets that are legally available for distribution
after payment of all debts and other liabilities and subject to the prior
rights of any holders of preferred stock then outstanding.
Preferred Stock
Our board of directors has authority, subject to certain consent rights of
holders of preferred stock, to authorize the issuance of classes of preferred
stock from time to time in one or more series, with such designations,
preferences and relative rights within the limits prescribed by the Delaware
General Corporation Law, as may be determined by the board of directors. The
designations, preferences and rights of our existing preferred stock
outstanding after giving effect to the conversion of our convertible preferred
stock in connection with this offering are set forth below:
Series E Preferred Stock. We are authorized to issue 575,000 shares of
Series E Senior Redeemable, Exchangeable, PIK Preferred Stock, of which 72,311
are currently outstanding. Series E Preferred Stock has a liquidation
preference of $1,000 per share and an annual dividend equal to 14.5% of the
liquidation preference, payable quarterly. On or before January 15, 2004, we
may pay dividends in cash or in additional fully-paid and nonassessable shares
of Series E Preferred Stock. After January 15, 2004, we must pay dividends in
cash, subject to certain exceptions. Unpaid dividends accrue at the dividend
rate of the Series E Preferred Stock, compounded quarterly.
The Series E Preferred Stock must be redeemed on February 1, 2011, out of
funds legally available for that purpose, at a redemption price, payable in
cash, equal to the liquidation preference thereof on the redemption date, plus
all accumulated and unpaid dividends to the date of redemption. We have the
option to redeem the Series E Preferred Stock, in whole or in part, at any
time after April 15, 2004, at redemption prices beginning at 110% and
declining to 100% of the liquidation preference of the Series E Preferred
Stock, plus all accrued and unpaid dividends to the date of redemption.
Before April 15, 2002, we may also redeem up to 35% of the aggregate
liquidation preference of Series E Preferred Stock with the proceeds of one or
more sales of our capital stock at a redemption price equal to 110% of the
liquidation preference on the redemption date. We do not intend to use any
portion of the proceeds of this offering to redeem the Series E Preferred
Stock.
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Upon a change of control, we are required to make an offer to repurchase
the Series E Preferred Stock for cash at a purchase price of 101% of the
liquidation preference thereof, together with all accumulated and unpaid
dividends to the date of purchase.
The Series E Preferred Stock is not convertible into common stock. We may,
at the sole option of our board of directors, out of funds legally available
for that purpose, exchange all, but not less than all, of the Series E
Preferred Stock then outstanding for a new series of subordinated debentures
issued pursuant to an exchange debenture indenture. The holders of Series E
Preferred Stock are entitled to receive on the date of any such exchange,
exchange debentures having an aggregate principal amount equal to the total of
the liquidation preference for each share of Series E Preferred Stock
exchanged, plus an amount equal to all accrued but unpaid dividends payable on
such share.
Series F Preferred Stock. We are authorized to issue 55,000 shares of
Series F Senior Redeemable, Exchangeable, PIK Preferred Stock, of which 46,178
are currently outstanding. Series F Preferred Stock has a liquidation
preference of $1,000 per share and an annual dividend equal to 14.5% of the
liquidation preference, payable quarterly. On or before January 15, 2004, we
may pay dividends in cash or in additional fully-paid and nonassessable shares
of Series F Preferred Stock. After January 15, 2004, we must pay dividends in
cash, subject to certain exceptions. Unpaid dividends accrue at the dividend
rate of the Series F Preferred Stock, compounded quarterly.
We have the option to redeem the Series F Preferred Stock, in whole or in
part, at a redemption price equal to 110% of the liquidation preference on the
redemption date, plus an amount in cash equal to all accrued and unpaid
dividends to the date of redemption.
Upon a change of control, we are required to make an offer to repurchase
the Series F Preferred Stock for cash at a purchase price of 101% of the
liquidation preference thereof, together with all accumulated and unpaid
dividends to the date of purchase.
Upon the earlier of the date that is sixty days after the date on which we
close an underwritten primary offering of at least $200 million of our common
stock, pursuant to an effective registration statement under the Securities
Act or February 4, 2001, any outstanding Series F Preferred Stock will
automatically convert into Series E Preferred Stock, on a one for one basis.
We may, at the sole option of our board of directors, out of funds legally
available for that purpose, exchange all, but not less than all, of the Series
F Preferred Stock then outstanding for a new series of subordinated debentures
issued pursuant to an exchange debenture indenture. The holders of Series F
Preferred Stock are entitled to receive on the date of any such exchange,
exchange debentures having an aggregate principal amount equal to the total of
the liquidation preference for each share of Series F Preferred Stock
exchanged, plus an amount equal to all accrued but unpaid dividends payable on
such share.
Warrants
After the completion of this offering, warrants exercisable for an
aggregate of shares of our common stock will be outstanding at an
exercise price of $.01 per share.
Registration Rights
Stockholders Agreement. Certain of our stockholders holding common stock
prior to this offering or preferred stock convertible into common stock
(including Nassau and Mr. Kamine) and certain warrantholders have registration
rights under our stockholders agreement. Each stockholder that is a party to
this agreement may "piggyback" on primary or secondary registered public
offerings of our equity securities, other than offerings registered on Form S-
8 or Form S-4. In addition, after the earlier of 180 days after this offering
or June 30, 2002, each of Nassau and Mr. Kamine is entitled to demand two
long-form registrations, such as a registration
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on Form S-1, and two short-form registrations, such as a registration on Form
S-3, and each of The CIT Group or its affiliates or its transferees and the
holders of a majority of the Series C Convertible Preferred Stock and common
stock issued upon conversion of such preferred stock (currently General
Electric Capital Corporation), is entitled to demand two registrations (which
may be short-forms at our option if we are eligible to use short-forms). We
have agreed to pay the registration expenses in connection with these
piggyback and demand registrations. Under this agreement, each party to this
agreement is subject to holdback restrictions in the event of a public
offering of our equity securities, including in connection with this offering.
We anticipate that each stockholder that is a party to this agreement will
agree to waive its or his piggyback registration rights in connection with
this offering.
Manager Stockholders Agreements. We granted some of our employees who hold
options to purchase our common stock piggyback registration rights similar to
those we granted to our stockholders under the stockholders agreement. We
anticipate that our employees will agree to waive these rights in connection
with this offering.
Warrant Registration Rights Agreements. We granted some of our warrant
holders piggyback and shelf registration rights under several warrant
registration rights agreements. Each warrantholder that is a party to one of
these agreements may piggyback on primary or secondary registered public
offerings of our equity securities, other than offerings registered on Form S-
8 or Form S-4 or other than a primary initial public offering, including this
offering. If we do not include the shares subject to these warrants in our
initial public offering or those shares are not otherwise sold in a public
offering, we have agreed to use our reasonable best efforts to file a shelf
registration statement for these shares and to cause it to become effective
within 180 days after the closing of this offering. We have agreed to pay the
registration expenses in connection with these piggyback and shelf
registrations. We anticipate that the holders of these piggyback and shelf
registration rights will agree to waive these rights in connection with this
offering.
Series E and Series F Preferred Stock. We granted demand registration
rights to holders of our Series E and Series F Preferred Stock under a
Preferred Stock Registration Rights Agreement, dated as of April 30, 1999, as
amended. Each of First Union, The CIT Group and Lucent are entitled to demand
two long-form registrations and two short-form registrations to the extent
such holder believes it cannot sell its redeemable preferred stock in the
public marketplace on equally favorable terms without registering its shares.
We are not required to register any of our redeemable preferred stock within
six months after the effective date of a prior registration of our redeemable
preferred stock. Under this agreement, we and the holders of our redeemable
preferred stock are subject to holdback restrictions in the event of a
registration under this agreement, and we have agreed to use our best efforts
to cause each holder of at least 5% of our fully-diluted equity securities to
agree to holdback restrictions, unless the underwriters otherwise agree. We
have agreed to pay the registration expenses in connection with these demand
registrations.
Anti-Takeover Effects of Certain Provisions of Delaware Law
We are currently subject to the provisions of Section 203 of the Delaware
General Corporation Law, or the DGCL. Section 203 of the DGCL generally
prohibits a publicly-held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years
after the date of the transaction in which the person became an interested
stockholder, unless the interested stockholder attained that status with the
approval of the board or unless the business combination is approved in a
prescribed manner. A "business combination" includes mergers, asset sales and
other transactions resulting in a financial benefit to the interested
stockholder. Subject to exceptions, an "interested stockholder" is a person
who, together with affiliates and associates, owns, or within three years did
own, fifteen percent (15%) or more of a corporation's voting stock. This
statute could prohibit or delay mergers or other takeover or change in control
attempts with respect to us and, accordingly, may discourage attempts to
acquire us.
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Limitations on Liability and Indemnification of Officers and Directors
Our amended and restated certificate of incorporation limits the liability
of directors to the fullest extent permitted by the Delaware General
Corporation Law. In addition, the restated certificate of incorporation
provides that the company shall indemnify directors and officers of the
company to the fullest extent permitted by that law. We anticipate entering
into separate indemnification agreements with our current directors and
executive officers prior to the completion of the offering which will have the
effect of providing such persons indemnification protection in the event the
restated certificate of incorporation is subsequently amended.
NASDAQ Trading
We have applied to have our common stock quoted on the NASDAQ National
Market of the NASDAQ Stock Market under the symbol "KMCT."
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is .
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, shares of common stock will be
outstanding, excluding shares reserved for issuance upon exercise of
options that have been granted under our stock purchase and option plan (
of which are currently vested) and shares reserved for issuance upon
exercise of presently exercisable warrants. Of these shares, shares of
common stock sold in the offering will be freely tradable without restriction
or further registration under the Securities Act, except for any shares which
may be acquired by an affiliate of ours as that term is defined in Rule 144
under the Securities Act, which will be subject to the resale limitations of
Rule 144. The remaining shares of common stock outstanding will be restricted
securities, as that term is defined in Rule 144, and may in the future be sold
without restriction under the Securities Act to the extent permitted by Rule
144 or any applicable exemption under the Securities Act.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned its, his or her shares
of common stock for at least one year from the date such securities were
acquired from us or an affiliate of ours would be entitled to sell within any
three-month period a number of shares that does not exceed the greater (i) one
percent of the then outstanding shares of the common stock and (ii) the
average weekly trading volume of the common stock during the four calendar
weeks preceding a sale by such person. Sales under Rule 144 are also subject
to certain manner-of-sale provisions, notice requirements and the availability
of current public information about us. Under Rule 144, however, a person who
has held restricted securities for a minimum of two years from the later of
the date such securities were acquired from us or an affiliate of ours and who
is not, and for the three months prior to the sale of such restricted
securities has not been, an affiliate of ours, is free to sell such shares of
common stock without regard to the volume, manner-of-sale and the other
limitations contained in Rule 144. The foregoing summary of Rule 144 is not
intended to be a complete discussion thereof.
We and our directors and executive officers who will beneficially own, as
of the completion of this offering, an aggregate of shares of common stock
(or presently exercisable options or warrants to purchase common stock) have
each agreed not to offer, sell or contract to sell, or otherwise dispose of,
directly or indirectly, or announce an offering of, any shares of common stock
or any securities convertible into, or exchangeable for, shares of common
stock for a period of 180 days from the date of this prospectus, without the
prior written consent of Morgan Stanley & Co. Incorporated except under
limited circumstances.
Promptly upon completion of the offering, we intend to file a registration
statement on Form S-8 with the SEC to register shares of common stock
reserved for issuance or sale under our employee equity incentive plan. As of
June 30, 2000, there were outstanding options to purchase a total of
shares of common stock, of which were vested. Shares of common stock
issuable upon the exercise of options granted under our employee equity
incentive plan will be freely tradable without restriction under the
Securities Act, unless such shares are held by an affiliate of ours.
For a description of registration rights held by certain of our security
holders see the section of this prospectus entitled "Description of Capital
Stock--Registration Rights."
Prior to the offering, there has been no established market for our common
stock, and no predictions can be made about the effect, if any, that market
sales of shares of common stock or the availability of such shares for sale
will have on the market price prevailing from time to time. Nevertheless, the
actual sale of, or the perceived potential for the sale of, common stock in
the public market may have an adverse effect on the market price for the
common stock.
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UNITED STATES TAX CONSEQUENCES TO NON-U.S. HOLDERS OF COMMON STOCK
General
The following is a general discussion of the principal U.S. federal income
and estate tax consequences of the ownership and disposition of our common
stock that may be relevant to you if you are a non-U.S. holder. For purpose of
this discussion, a non-U.S. holder is a beneficial owner of common stock that
is any of the following for U.S. federal income tax purposes:
. a nonresident alien individual,
. a foreign corporation or other foreign entity taxable as a corporation
under U.S. federal income tax law, or
. a foreign estate or trust.
If an entity treated as a partnership for U.S. federal income tax purposes
holds shares of common stock, the tax treatment of a partner will generally
depend on the status of the partner and upon the activities of the
partnership. If you are a partner of a partnership holding shares of common
stock, we suggest you consult your own tax advisor.
This discussion does not address all aspects of U.S. federal income and
estate taxation that may be relevant to you in light of your particular
circumstances, and does not address any foreign, state or local tax
consequences. Furthermore, this discussion does not consider specific facts
and circumstances that may be relevant to a particular non-U.S. holder's tax
position, specific rules that may apply to certain non-U.S. holders, including
banks, insurance companies, dealers and traders in securities, or special tax
rules that may apply to a non-U.S. holder that holds our common stock as part
of a straddle, hedge or conversion transaction. This discussion is based on
provisions of the Internal Revenue Code, Treasury regulations and
administrative and judicial interpretations as of the date of this prospectus.
All of these are subject to change, possibly with retroactive effect, or
different interpretations. If you are considering buying common stock, you
should consult your own tax advisor about current and possible future tax
consequences of holding and disposing of common stock in your particular
situation.
Distributions
If distributions are paid on the shares of our common stock, these
distributions generally will constitute dividends for U.S. federal income tax
purposes to the extent paid from our current or accumulated earnings and
profits, as determined under U.S. federal income tax principles, and then will
constitute a return of capital that is applied against your basis in the
common stock to the extent these distributions exceed those earnings and
profits. Distributions in excess of our current or accumulated earnings and
profits and your basis in the common stock will be treated as a gain from the
sale or exchange of the common stock. Dividends paid to a non-U.S. holder that
are not effectively connected with a U.S. trade or business of the non-U.S.
holder will be subject to U.S. federal withholding tax at a 30% rate or, if a
tax treaty applies, a lower rate specified by the treaty. Non-U.S. holders
should consult their tax advisors regarding their entitlement to benefits
under a relevant tax treaty.
Currently, withholding is generally imposed on the gross amount of a
distribution, regardless of whether we have sufficient earnings and profits to
cause the distribution to be a dividend for U.S. federal income tax purposes.
However, withholding on distributions made after December 31, 2000 may be
computed on less than the gross amount of the distribution if the distribution
exceeds a reasonable estimate made by us of our accumulated and current
earnings and profits.
Dividends that are effectively connected with a non-U.S. holder's conduct
of a trade or business within the U.S. and, if a tax treaty applies,
attributable to a non-U.S. holder's U.S. permanent establishment, are exempt
from U.S. federal withholding tax if the non-U.S. holder furnishes to us or
our paying agent the appropriate Internal Revenue Service form. However,
dividends exempt from U.S. federal withholding tax because they are
"effectively connected" or attributable to a U.S. permanent establishment
under an applicable tax treaty are
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subject to U.S. federal income tax on a net income basis at the regular
graduated U.S. federal income tax rates. Any such effectively connected
dividends received by a foreign corporation may, under certain circumstances,
be subject to an additional "branch profits tax" at a 30% rate or a lower rate
specified by an applicable tax treaty.
Dividends paid before January 1, 2001 to an address outside the United
States are presumed, absent actual knowledge to the contrary, to be paid to a
resident of the country of address for purposes of the withholding rules
discussed above and for purposes of determining the applicability of a tax
treaty rate. For dividends paid after December 31, 2000, a non-U.S. holder
that claims the benefit of an applicable tax treaty rate generally will be
required to satisfy applicable certification and other requirements.
A non-U.S. holder eligible for a reduced rate of U.S. federal withholding
tax under a tax treaty may obtain a refund of any excess amounts withheld by
filing an appropriate claim for a refund together with the required
information with the Internal Revenue Service.
Gain on Disposition of Common Stock
A non-U.S. holder generally will not be subject to U.S. federal income tax
with respect to gain recognized on a sale or other disposition of our common
stock unless one of the following applies:
. The gain is effectively connected with a non-U.S. holder's conduct of a
trade or business within the United States and, if a tax treaty applies,
the gain is attributable to a non-U.S. holder's U.S. permanent
establishment. The non-U.S. holder will, unless an applicable treaty
provides otherwise, generally be taxed on its net gain derived from the
sale at regular graduated U.S. federal income tax rates, and in the case
of a foreign corporation, may also be subject to the branch profits tax
described above.
. A non-U.S. holder who is an individual and holds our common stock as a
capital asset is present in the United States for 183 or more days in
the taxable year of the sale or other disposition, and specified other
conditions are met. In such a case, the non-U.S. holder will be subject
to a flat 30% tax on the gain derived from the sale, which may be offset
by certain U.S. capital losses.
. We are or have been a "U.S. real property holding corporation" for U.S.
federal income tax purposes at any time during the shorter of the five-
year period ending on the date of the disposition or the period during
which the non-U.S. holder held the common stock. In general, a
corporation is a "U.S. real property holding corporation" if the fair
market value of its "U.S. real property interests" equals or exceeds 50%
of the sum of the fair market value of its worldwide real property
interests plus its other assets used or held for use in a trade or
business. If we are, or were to become, a U.S. real property holding
corporation, any gain recognized by a non-U.S. holder still would not be
subject to U.S. tax if the shares of our common stock were considered to
be "regularly traded on an established securities market" under
applicable provisions of the Internal Revenue Code and Treasury
regulations and the non-U.S. holder did not own, actually or
constructively, at any time during the shorter of the periods described
above, more than five percent of our common stock.
. A non-U.S. holder is subject to tax pursuant to the provisions of U.S.
tax law applicable to some U.S. expatriates.
Information Reporting and Backup Withholding Tax
We must report annually to the Internal Revenue Service and to each non-
U.S. holder the amount of dividends paid to that holder and the tax withheld
with respect to those dividends. These information reporting requirements
apply even if withholding was not required because the dividends were
effectively connected dividends or withholding was reduced or eliminated by an
applicable tax treaty. Pursuant to an applicable tax treaty, that information
may also be made available to the tax authorities in the country in which the
non-U.S. holder resides.
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Under certain circumstances, Treasury regulations require information
reporting and backup withholding at a rate of 31% on certain payments on
common stock. Under currently applicable law, non-U.S. holders of common stock
generally will be exempt from these information reporting requirements and
from backup withholding on dividends paid prior to January 1, 2001 to an
address outside the United States. For dividends paid after December 31, 2000,
however, a non-U.S. holder of common stock that fails to certify its non-U.S.
holder status in accordance with applicable Treasury regulations may be
subject to backup withholding at a rate of 31% on payments of dividends.
Payment by or through a U.S. office of a broker of the proceeds of a sale
of our common stock is subject to both backup withholding and information
reporting unless the holder certifies to the payor in the manner required as
to its non-U.S. status under penalties of perjury or otherwise establishes an
exemption.
As a general matter, information reporting and backup withholding will not
apply to a payment by or through a foreign office of a foreign broker of the
proceeds of a sale of our common stock effected outside the United States.
However, information reporting requirements, but not backup withholding, will
apply to a payment by or through a foreign office of a broker of the proceeds
of a sale of our common stock effected outside the United States if that
broker:
. is a U.S. person,
. is a foreign person that derives 50% or more of its gross income for
specified periods from the conduct of a trade or business in the United
States,
. is a "controlled foreign corporation" as defined in the Internal Revenue
Code, or
. is a foreign partnership with specified U.S. connections, for payments
made after December 31, 2000.
Information reporting requirements will not apply in the above cases if the
broker receives a statement from the owner, signed under penalty of perjury,
certifying as to such owner's non-U.S. status or the broker has documentary
evidence in its records that the beneficial owner is a non-U.S. holder and the
broker has no actual knowledge to the contrary or, for payments made after
December 31, 2000, reason to know that such evidence is false.
Effective after December 31, 2000, backup withholding may apply to the
payment of sale or disposition proceeds by or through a non-U.S. office of a
broker described above unless certification requirements are satisfied or an
exemption is otherwise established and the broker has no actual knowledge that
the holder is a U.S. person. Non-U.S. holders should consult their own tax
advisors regarding the application of the information reporting and backup
withholding rules to them, including changes to these rules that will become
effective after December 31, 2000.
Amounts withheld under the backup withholding rules do not constitute a
separate U.S. federal income tax. Rather, any amounts withheld under the
backup withholding rules will be refunded or allowed as a credit against the
holder's U.S. federal income tax liability, if any, provided the required
information or appropriate claim for refund is filed with the Internal Revenue
Service.
Federal Estate Tax
Common stock owned or treated as owned by an individual who is not a
citizen or resident, as defined for U.S. federal estate tax purposes, of the
United States at the time of death will be included in that individual's gross
estate for U.S. federal estate tax purposes, unless an applicable estate tax
treaty provides otherwise and, therefore, may be subject to U.S. federal
estate tax.
The foregoing discussion is a summary of the principal tax consequences of
the ownership, sale or other disposition of our common stock by non-U.S.
holders for U.S. federal income and estate tax purposes. You are urged to
consult your own tax advisor with respect to the particular tax consequences
to you of ownership and disposition of our common stock, including the effect
of any state, local, foreign or other tax laws.
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UNDERWRITERS
Under the terms and subject to the conditions contained in the underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated is acting as representative, have
severally agreed to purchase, and the company has agreed to sell to them,
severally, the respective numbers of shares of common stock indicated below:
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Morgan Stanley & Co. Incorporated..................................
Goldman, Sachs & Co................................................
Credit Suisse First Boston Corporation.............................
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...............................................
Kleinwort Benson Limited...........................................
---
Total............................................................
===
</TABLE>
The underwriters are offering the shares of common stock subject to their
acceptance of the shares from us and subject to prior sale. The underwriting
agreement provides that the obligations of the several underwriters to pay for
and accept delivery of the shares of our common stock offered by this
prospectus are subject to the approval of certain legal matters by their
counsel and to certain other conditions. The underwriters are obligated to
take and pay for all of the shares of common stock offered by this prospectus
if any such shares are taken. However, the underwriters are not required to
take or pay for the shares covered by the underwriters' over-allotment option
described below.
The underwriters initially propose to offer part of shares of common stock
directly to the public at the public offering price listed on the cover page
of this prospectus and part to certain dealers at a price that represents a
concession not in excess of $ a share under the public offering price. The
underwriters may allow, and such dealers may reallow, a concession not in
excess of $ a share to other underwriters or to other dealers. After the
initial offering of the shares of common stock, the offering price and other
selling terms may from time to time be varied by the representatives.
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to an aggregate of additional
shares of common stock at the public offering price set forth on the cover
page of this prospectus, less underwriting discounts and commissions. The
underwriters may exercise this option solely for the purpose of covering over-
allotments, if any, made in connection with the offering of the shares of
common stock offered by this prospectus. To the extent such option is
exercised, each underwriter will become obligated, subject to specified
conditions, to purchase approximately the same percentage of additional shares
of common stock as the number set forth next to such underwriter's name in the
preceding table bears to the total number of shares of common stock set forth
next to the names of all underwriters in the preceding table. If the
underwriters' option is exercised in full, the total price to the public would
be $ million, the total underwriters' discounts and commissions would be
$ million and total proceeds to the company would be $ million.
The underwriters have informed us that they do not intend sales to
discretionary accounts to exceed five percent of the total number of shares
offered by them.
We have filed an application for our common stock to be quoted on the
Nasdaq National Market under the symbol "KMCT."
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Each of us and our directors, executive officers and certain other
stockholders of ours has agreed that, without the prior written consent of
Morgan Stanley & Co. Incorporated, on behalf of the underwriters, it will not
during the period ending 180 days after the date of this prospectus:
. offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend, or otherwise transfer or dispose of
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock; or
. enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the
shares of common stock,
whether any such transaction described above is to be settled by delivery of
common stock or other securities, in cash or otherwise.
These restrictions do not apply to, among others, the sale of shares to the
underwriters.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may over-allot in
connection with the offering, creating a short position in the common stock
for their own account. In addition, to cover over-allotments or to stabilize
the price of the common stock, the underwriters may bid for, and purchase,
shares of common stock in the open market. Finally, the underwriting syndicate
may reclaim selling concessions allowed to an underwriter or a dealer for
distributing the common stock in the offering, if the syndicate repurchases
previously distributed common stock in transactions to cover syndicate short
positions, in stabilization transactions or otherwise. Any of these activities
may stabilize or maintain the market price of the common stock above
independent market levels. The underwriters are not required to engage in
these activities, and may end any of these activities at any time.
From time to time, Morgan Stanley & Co. Incorporated and Dresdner Kleinwort
Benson have provided, and continue to provide, certain financial advisory
services to the company and certain existing stockholders for which they
receive customary fees and commissions. Affiliates of Morgan Stanley & Co.
Incorporated, Credit Suisse First Boston and Dresdner Kleinwort Benson are
also lenders in one of our credit facilities.
We and the underwriters have agreed to indemnify each other against a
variety of liabilities, including liabilities under the Securities Act.
Directed Share Program
At our request, the underwriters have reserved for sale, at the initial
offering price, up to shares of common stock offered by this prospectus to
our employees, officers, directors, customers, business associates, and
related persons. We will pay all fees and disbursements of counsel incurred by
the underwriters in connection with offering the shares to such persons. The
numbers of shares available for sale to the general public will be reduced to
the extent such persons purchase such reserved shares. Any reserved shares
which are not so purchased will be offered by the underwriters to the general
public on the same basis as the other shares offered by this prospectus.
Pricing of the Offering
Prior to this offering, there has been no public market for the common
stock. The initial public offering price will be determined by negotiations
between us and the representatives. Among the factors to be considered in
determining the initial public offering price will be the future prospects of
the company and its industry in general, sales, earnings, and certain other
financial operating information of the company in recent periods, and the
price-earnings ratios, price-sales ratios, market prices of securities and
certain financial and operating information of companies engaged in activities
similar to ours. The estimated initial public offering price listed on the
cover page of this prospectus may change as a result of market conditions and
other factors.
83
<PAGE>
LEGAL MATTERS
Kelley Drye & Warren LLP, New York, New York and Stamford, Connecticut will
pass upon the validity of the shares and certain other legal matters. Shearman
& Sterling, New York, New York, counsel for the underwriters, will pass upon
certain legal matters. Certain attorneys in the firm of Kelley Drye & Warren
LLP invested an aggregate of $385,000 in KMC Telecommunications L.P. which
owns 40,000 shares of our common stock. Kelley Drye & Warren also owns 7,500
shares of our common stock. Alan M. Epstein, a member of the firm of Kelley
Drye & Warren, is also our Executive Vice President and General Counsel.
EXPERTS
The consolidated financial statements of KMC Telecom Holdings, Inc. and its
subsidiaries as of December 31, 1999 and 1998 and for each of the three years
in the period ended December 31, 1999 appearing in this prospectus and
registration statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports thereon appearing elsewhere herein,
and are included in reliance upon such reports given upon the authority of
such firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 under the Securities Act
to register with the SEC the shares offered by this prospectus. The term
"registration statement" means the original registration statement and any and
all amendments thereto, including the schedules and exhibits to the original
registration statement or any amendment. This prospectus is part of that
registration statement. This prospectus does not contain all of the
information set forth in the registration statement or the exhibits to the
registration statement. We refer you to the registration statement for any
information in the registration statement that is not included in this
prospectus. In addition, each statement made in this prospectus concerning a
document filed as an exhibit to the registration statement is qualified in its
entirety by reference to that exhibit for a complete statement of its
provisions.
We are currently subject to some of the informational requirements of the
Securities Exchange Act of 1934, as amended, and file periodic reports, and
other information relating to our business, financial statements and other
matters with the SEC. We are not yet, however, subject to the SEC's proxy
rules and do not currently file proxy statements with the SEC. Upon completion
of this offering, we will become subject to the SEC's proxy rules. Our SEC
filings are available to the public over the Internet at the SEC's web site at
http://www.sec.gov. You may also read and copy any document we file at the
SEC's public reference room located at 450 Fifth Street, N.W., Washington,
D.C. 20549, as well as at the regional offices of the SEC located at 7 World
Trade Center, New York, New York 10048 and Citicorp Center, 500 West Madison
Street, Chicago, Illinois 60661. Please call the SEC at 1-800-SEC-0330 for
further information on the public reference rooms and their copy charges.
We intend to distribute to all holders of the shares of common stock
offered in the offering annual reports containing audited consolidated
financial statements together with a report by our independent certified
public accountants.
84
<PAGE>
KMC TELECOM HOLDINGS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Unaudited Condensed Consolidated Balance Sheets, December 31, 1999 and
June 30, 2000........................................................... F-2
Unaudited Condensed Consolidated Statements of Operations, Six Months
Ended June 30, 1999
and 2000................................................................ F-3
Unaudited Condensed Consolidated Statements of Cash Flows, Six Months
Ended June 30, 1999 and 2000............................................ F-4
Notes to Unaudited Condensed Consolidated Financial Statements........... F-5
Report of Independent Auditors........................................... F-13
Consolidated Balance Sheets, December 31, 1998 and 1999.................. F-14
Consolidated Statements of Operations, Years Ended December 31, 1997,
1998 and 1999........................................................... F-15
Consolidated Statements of Redeemable and Nonredeemable Equity, Years
Ended December 31,
1997, 1998 and 1999..................................................... F-16
Consolidated Statements of Cash Flows, Years Ended December 31, 1997,
1998 and 1999........................................................... F-18
Notes to Consolidated Financial Statements............................... F-19
</TABLE>
F-1
<PAGE>
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------ ----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................. $ 85,966 $ 60,297
Restricted investments................................ 37,125 37,125
Accounts receivable, net of allowance for doubtful
accounts of $5,551 and $6,401 in 1999 and 2000,
respectively......................................... 27,373 36,906
Prepaid expenses and other current assets............. 1,375 171,529
---------- ----------
Total current assets................................... 151,839 305,857
Long term restricted investments....................... 51,446 40,623
Networks, property and equipment, net.................. 639,324 785,874
Intangible assets, net................................. 3,602 4,045
Deferred financing costs, net.......................... 38,816 44,486
Other assets........................................... 1,013 1,242
---------- ----------
$ 886,040 $1,182,127
========== ==========
Liabilities, redeemable and nonredeemable equity
(deficiency)
Current liabilities:
Accounts payable...................................... $ 167,490 $ 235,870
Accrued expenses...................................... 37,047 58,511
Deferred revenue...................................... 4,309 14,465
---------- ----------
Total current liabilities.............................. 208,846 308,846
Notes payable.......................................... 235,000 575,190
Senior discount notes payable.......................... 301,137 320,013
Senior notes payable................................... 275,000 275,000
---------- ----------
Total liabilities...................................... 1,019,983 1,479,049
Commitments and contingencies
Redeemable equity:
Senior redeemable, exchangeable, PIK preferred stock,
par value $.01 per share; authorized: 630 shares in
1999 and 2000; shares issued and outstanding:
Series E, 65 shares in 1999 and 69 shares in 2000
($69,815 liquidation preference).................... 50,770 56,217
Series F, 44 shares in 1999 and 48 shares in 2000
($47,447 liquidation preference).................... 41,370 45,936
Redeemable cumulative convertible preferred stock, par
value $.01 per share; 499 shares authorized; shares
issued and outstanding:
Series A, 124 shares in 1999 and 2000 ($12,380
liquidation preference)............................. 71,349 96,792
Series C, 175 shares in 1999 and 2000 ($17,500
liquidation preference)............................. 40,301 63,826
Redeemable cumulative convertible Series G preferred
stock, 540 shares subscribed......................... -- 182,500
Less: Redeemable cumulative convertible Series G
preferred stock subscription receivable.............. -- (182,500)
Redeemable common stock, 224 shares issued and
outstanding.......................................... 33,755 41,752
Redeemable common stock warrants...................... 12,925 15,262
---------- ----------
Total redeemable equity................................ 250,470 319,785
---------- ----------
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share; 3,000 shares
authorized, 629 shares and 630 shares
issued and outstanding in 1999 and 2000,
respectively......................................... 6 6
Additional paid-in capital............................ -- 1,561
Unearned compensation................................. (9,163) (30,638)
Accumulated deficit................................... (375,256) (587,636)
---------- ----------
Total nonredeemable equity (deficiency)................ (384,413) (616,707)
---------- ----------
$ 886,040 $1,182,127
========== ==========
</TABLE>
See accompanying notes.
F-2
<PAGE>
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1999 2000
--------- ---------
<S> <C> <C>
Revenue................................................. $ 26,712 $ 68,076
Operating expenses:
Network operating costs:
Non-cash stock compensation......................... 1,616 1,853
Other network operating costs....................... 32,560 65,290
Selling, general and administrative:
Non-cash stock compensation......................... 18,585 20,819
Other selling, general and administrative costs..... 38,219 79,050
Depreciation and amortization......................... 11,636 31,118
--------- ---------
Total operating expenses............................ 102,616 198,130
--------- ---------
Loss from operations.................................... (75,904) (130,054)
Other expense........................................... (4,297) --
Interest income......................................... 3,055 4,508
Interest expense........................................ (26,014) (58,400)
--------- ---------
Net loss before cumulative effect of change in
accounting principle................................... (103,160) (183,946)
Cumulative effect of change in accounting principle..... -- (1,705)
--------- ---------
Net loss................................................ (103,160) (185,651)
Dividends and accretion on redeemable preferred stock... (43,415) (58,981)
--------- ---------
Net loss applicable to common shareholders.............. $(146,575) $(244,632)
========= =========
Net loss per common share before cumulative effect of
change in accounting principle......................... $ (172.31) $ (284.60)
Cumulative effect of change in accounting principle..... -- (2.00)
--------- ---------
Net loss per common share............................... $ (172.31) $ (286.60)
========= =========
Weighted average number of common shares outstanding.... 850,632 853,553
========= =========
Pro forma amounts assuming the change in accounting
principle was applied retroactively:
Net loss applicable to common shareholders.............. $(147,195) $(242,927)
========= =========
Net loss per common share............................... $ (173.04) $ (284.60)
========= =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
KMC TELECOM HOLDINGS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1999 2000
--------- ---------
<S> <C> <C>
Operating Activities
Net loss................................................. $(103,160) $(185,651)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 11,636 31,118
Non-cash interest expense............................... 22,834 17,150
Non-cash stock option compensation expense.............. 20,201 22,672
Changes in assets and liabilities:
Accounts receivable.................................... (11,950) (9,533)
Prepaid expenses and other current assets.............. (228) (1,818)
Other assets........................................... 653 10,525
Accounts payable....................................... 6,888 (60,696)
Accrued expenses....................................... 4,999 16,972
Deferred revenue....................................... 2,922 10,156
--------- ---------
Net cash used in operating activities.................... (45,205) (149,105)
--------- ---------
Investing Activities
Construction of networks and purchases of equipment...... (83,725) (210,720)
Acquisitions of franchises, authorizations and related
assets.................................................. (230) (751)
Purchases of investments, net............................ (36,080) --
--------- ---------
Net cash used in investing activities.................... (120,035) (211,471)
--------- ---------
Financing Activities
Proceeds from issuance of preferred stock and related
warrants, net of issuance costs......................... 91,235 --
Proceeds from exercise of stock options.................. 333 --
Proceeds from issuance of senior notes, net of issuance
costs and purchase of portfolio of restricted
investments............................................. 159,942 --
Proceeds from credit facilities, net of issuance costs... 80,541 334,907
--------- ---------
Net cash provided by financing activities................ 332,051 334,907
--------- ---------
Net increase (decrease) in cash and cash equivalents..... 166,811 (25,669)
Cash and cash equivalents, beginning of period........... 21,181 85,966
--------- ---------
Cash and cash equivalents, end of period................. $ 187,992 $ 60,297
========= =========
Supplemental disclosure of cash flow information
Cash paid during the period for interest, net of amounts
capitalized............................................. $ 3,180 $ 35,779
========= =========
</TABLE>
See accompanying notes.
F-4
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
1. Basis of Presentation and Organization
KMC Telecom Holdings, Inc. and its subsidiaries, KMC Telecom Inc., KMC
Telecom II, Inc., KMC Telecom III, Inc., KMC Telecom IV, Inc., KMC Telecom IV
Holdings, Inc., KMC Telecom of Virginia, Inc., KMC Telecom IV of Virginia,
Inc., KMC Telecom V, Inc., KMC Telecom V of Virginia, Inc., KMC Telecom VI,
Inc., KMC Telecom VI of Virginia, Inc., KMC Telecom Financial Services LLC,
KMC Telecom.com, Inc. and KMC Telecom Financing, Inc., are collectively
referred to herein as the Company. All significant intercompany accounts and
transactions have been eliminated in consolidation.
The Company is a fiber-based integrated communications provider providing
data and voice services to its customers, principally business, government and
institutional end-users, as well as Internet service providers, long distance
companies and wireless service providers, primarily in the South, Southeast,
Midwest and Mid-Atlantic United States.
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.
as of and for the year ended December 31, 1999.
The unaudited interim financial statements reflect all adjustments
(consisting only of normal recurring 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, 1999 was
derived from the audited consolidated balance sheet at that date.
Certain reclassifications have been made to the 1999 unaudited condensed
consolidated financial statements to conform with the 2000 presentation.
2. Accounting Change
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 provides additional guidance in applying generally
accepted accounting principles to revenue recognition in financial statements.
Through December 31, 1999, the Company recognized installation revenue upon
completion of the installation. Effective January 1, 2000, in accordance with
the provisions of SAB 101, the Company is recognizing installation revenue
over the average contract period. The cumulative effect of this change in
accounting principle resulted in a charge of approximately $1.7 million which
was recorded in the quarter ended March 31, 2000. For the six months ended
June 30, 2000, the net effect of adopting this change in accounting principle
was a deferral of the recognition of $322,000 of revenue, which increased net
loss for the period by $0.38 per share. Revenue for the six months ended June
30, 2000 includes $543,000 of revenues that, prior to the accounting change,
had been recognized through December 31, 1999.
F-5
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Networks, Property and Equipment
Networks and equipment are comprised of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------ --------
(in thousands)
<S> <C> <C>
Fiber optic systems...................................... $164,985 $227,314
Telecommunications equipment............................. 421,718 470,846
Furniture and fixtures................................... 21,397 25,399
Leasehold improvements................................... 1,811 1,866
Construction-in-progress................................. 66,380 128,226
-------- --------
676,291 853,651
Less accumulated depreciation............................ (36,967) (67,777)
-------- --------
$639,324 $785,874
======== ========
</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 for the six months ended June 30, 1999 and 2000 amounted to $1.3
million and $5.9 million, respectively.
4. Intangible Assets
Intangible assets are comprised of the following:
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------ --------
(in thousands)
<S> <C> <C>
Franchise costs........................................... $2,015 $2,472
Authorizations and rights-of-way.......................... 2,052 2,355
Building access agreements................................ 637 624
Other..................................................... 401 402
------ ------
5,105 5,853
Less accumulated amortization............................. (1,503) (1,808)
------ ------
$3,602 $4,045
====== ======
</TABLE>
F-6
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Accrued Expenses
Accrued expenses are comprised of the following:
<TABLE>
<CAPTION>
June
December 31, 30,
1999 2000
------------ -------
(in thousands)
<S> <C> <C>
Accrued compensation................................ $ 11,423 $17,020
Accrued costs related to financing activities....... 7,316 10,156
Accrued interest payable............................ 8,544 10,741
Accrued telecommunications costs.................... 3,794 5,361
Other accrued expenses.............................. 5,970 15,233
-------- -------
$ 37,047 $58,511
======== =======
</TABLE>
6. Senior Secured Credit Facilities
Telecom IV Senior Secured Term Loan
During the quarter ended June 30, 2000, KMC Telecom, IV, Inc., closed a new
senior secured term loan (the "Telecom IV Loan") from Lucent Technologies Inc.
The Telecom IV Loan is initially capped at $35 million until certain
conditions are met that allow for additional borrowings up to a ceiling of $50
million. Proceeds from the Telecom IV Loan may be used to purchase or install
Lucent products and will be used to purchase equipment for future expansion.
The Telecom IV Loan will mature on October 1, 2007 and requires quarterly
principal payments beginning on January 1, 2003 of 2.5% of the outstanding
principal balance, with the percentage increasing to 5% on January 1, 2005,
6.25% on October 1, 2005, 7.5% on October 1, 2006, with the balance due on
October 1, 2007. As of June 30, 2000, the outstanding loan balance on this
term loan was approximately $35 million.
Borrowings under the Telecom IV Loan will bear interest payable, at the
Company's option, at either (a) the Applicable Base Rate Margin (which
generally ranges from 2.25% to 3.50% based on the Company's total debt to
total contributed capital ratio) plus the greater of (i) the administrative
agent's prime rate or (ii) the overnight federal funds rate plus .5% or (b)
the LIBOR Rate plus the Applicable Margin (which generally ranges from 3.25%
to 4.50% based on the Company's debt to contributed capital ratio).
"Applicable Base Rate Margin" interest is payable quarterly while "Applicable
LIBOR Margin" interest is payable at the end of each applicable interest
period, or at least every three months. The Company was being charged a
weighted average interest rate of 11.31% at June 30, 2000. There are no
financial covenants on the loan. However, there are affirmative and negative
covenants that, generally, are no more restrictive to the Company than the
Company's other debt agreements. If any event of default were to occur, the
interest rate will increase by two percentage points.
Amended Senior Secured Credit Facility
During the quarter ended March 31, 2000, KMC Telecom, Inc., KMC Telecom II,
Inc., KMC Telecom of Virginia, Inc. and KMC Telecom III, Inc. (collectively,
the "Borrowers"), amended, restated and combined the Senior Secured Credit
Facility and the Lucent Facility, in a single facility by entering into a $700
million Loan and Security Agreement (the "Amended Senior Secured Credit
Facility") with a group of lenders led by Newcourt Commercial Finance
Corporation, GE Capital Corporation, Canadian Imperial Bank of Commerce, First
Union National Bank and Lucent Technologies Inc. (collectively, the
"Lenders").
The Amended Senior Secured Credit Facility includes a $175 million reducing
revolver facility (the "Revolver"), a $75 million term loan (the "Term Loan")
and a $450 million term loan facility (the "Lucent
F-7
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Term Loan"). At June 30, 2000, the outstanding loan balances on the Revolver,
the Term Loan and the Lucent Term Loan, were approximately $164 million, $75
million, and $301 million, respectively.
The Revolver will mature on April 1, 2007. Proceeds from the Revolver can
be used to finance the purchase of certain equipment, transaction costs and,
upon attainment of certain financial conditions, for working capital and other
general corporate purposes. The aggregate commitment of the Lenders under the
Revolver will be reduced on each quarterly payment date beginning April 1,
2003. The initial quarterly commitment reduction is 5.0%, reducing to 3.75% on
July 1, 2003, then increasing to 6.25% on July 1, 2004, and further increasing
to 7.50% on July 1, 2006. Commencing with the fiscal year ending December 31,
2001, the aggregate Revolver commitment will be further reduced by an amount
equal to 50% of excess operating cash flows (as defined in the Amended Senior
Secured Credit Facility) for the prior fiscal year until the Borrowers achieve
certain financial conditions. The Borrowers must pay an annual commitment fee
on the unused portion of the Revolver ranging from .75% to 1.25%.
The Term Loan is payable in twenty consecutive quarterly installments of
$188,000 beginning on April 1, 2002 and two final installments of $35.6
million each on April 1, 2007 and July 1, 2007. Proceeds from the Term Loan
can be used to finance the purchase of certain equipment, transaction costs,
working capital and other general corporate purposes.
The Lucent Term Loan provides for an aggregate commitment of up to $450
million. Proceeds from the Lucent Term Loan can be used to purchase Lucent
products or to reimburse the Borrowers for Lucent products previously
purchased with cash or other sources of liquidity. The Lucent Term Loan will
mature on July 1, 2007 and requires quarterly principal payments beginning on
July 1, 2003 of 5%. The principal payment decreases to 3.75% per quarter
beginning on October 1, 2003, increases to 6.25% on October 1, 2004 and
further increases to 7.50% on October 1, 2006. An annual commitment fee of
1.50% is payable for any unused portion of the Lucent Term Loan.
Borrowings under the Amended Senior Secured Credit Facility will bear
interest payable, at the Borrowers' option, at either (a) the "Applicable Base
Rate Margin" (which generally ranges from 2.00% to 3.25%) plus the greater of
(i) the administrative agent's prime rate or (ii) the overnight federal funds
rate plus .5% or (b) the "Applicable LIBOR Margin" (which generally ranges
from 3.00% to 4.25%) plus LIBOR, as defined. "Applicable Base Rate Margin"
interest is payable quarterly while "Applicable LIBOR Margin" interest is
payable at the end of each applicable interest period or at least every three
months. The Borrowers were being charged a weighted average interest rate of
10.76% at June 30, 2000. If a payment default were to occur, the interest rate
will be increased by four percentage points. If any other event of default
were to occur, the interest rate will be increased by two percentage points.
KMC Holdings has unconditionally guaranteed the repayment of the Amended
Senior Secured Credit Facility when such repayment is due, whether at
maturity, upon acceleration, or otherwise. KMC Holdings has pledged the shares
of each of the Borrowers to the Lenders to collateralize its obligations under
the guaranty. In addition, the Borrowers have each pledged all of their assets
to the Lenders.
The Amended Senior Secured Credit Facility contains a number of affirmative
and negative covenants, including a covenant requiring the Borrowers to obtain
cash capital contributions from KMC Holdings of at least $185 million prior to
April 1, 2001. KMC Holdings has agreed to contribute $150 million of the
proceeds of its Series G private equity financing (see Note 13) towards
fulfilling this requirement, and the Lenders have amended this covenant by
extending the due date on the remaining $35 million of cash capital
contributions to August 31, 2001. KMC Holdings anticipates raising this
additional capital through private or public sales of securities in the
capital markets. Because the entire $185 million cash capital contribution was
not made by July 31, 2000, the applicable interest rate associated with the
facility increases by 100 basis points until the $185
F-8
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
million amount is fully funded. Additional affirmative and negative covenants
include, 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 KMC Holdings, create subsidiaries, transfer
any permits or licenses, or incur additional indebtedness or act as guarantor
for the debt of any person, subject to certain conditions.
The Borrowers are required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a ratio of total
debt to contributed capital, certain minimum revenues, maximum EBITDA losses
and minimum EBITDA, maximum capital expenditures and minimum access lines, a
maximum total leverage ratio, a minimum debt service coverage ratio, a minimum
fixed charge coverage ratio and a maximum consolidated leverage ratio. The
covenants become more restrictive upon the earlier of (i) June 30, 2002 and
(ii) after the Borrowers achieve positive EBITDA on a combined basis for two
consecutive fiscal quarters and a total leverage ratio (as defined) equal to
or less than 9 to 1.
Failure to satisfy any of the financial covenants will constitute an event
of default under the Amended Senior Secured Credit Facility permitting the
Lenders, after notice, to terminate the commitment and/or accelerate payment
of outstanding indebtedness thereunder. The Amended Senior Secured Credit
Facility also includes other customary events of default, including, without
limitation, a cross-default to other material indebtedness, material
undischarged judgments, bankruptcy, loss of a material franchise or material
license, breach of representations and warranties, a material adverse change,
and the occurrence of a change of control.
7. Service Revenues
The Company provides on-network services and resells switched services
previously purchased from the incumbent local exchange carrier. On-network
services include services provided through direct connections to our own
networks, services provided by means of unbundled network elements leased from
the incumbent local exchange carrier and dedicated circuits.
The Company's service revenues consist of the following:
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------
1999 2000
-------- --------
(in thousands)
<S> <C> <C>
On-network................................................ $ 14,721 $ 61,890
Resale.................................................... 11,991 6,186
-------- --------
Total..................................................... $ 26,712 $ 68,076
======== ========
</TABLE>
8. Commitments and Contingencies
Purchase Commitments
As of June 30, 2000, the Company has outstanding commitments aggregating
approximately $59 million related to purchases of telecommunications equipment
and fiber optic cable and its obligations under its agreements with certain
suppliers.
Redemption Rights
Pursuant to a stockholders agreement, certain of the Company's stockholders
and warrant holders have "put rights" entitling them to have the Company
repurchase their preferred and common shares and redeemable
F-9
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
common stock warrants for the fair value of such securities if no Liquidity
Event (defined as (i) an initial public offering with gross proceeds of at
least $40 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. The
restrictive covenants of the Senior Discount Notes limit the Company's ability
to repurchase such securities. All of the securities subject to such "put
rights" are presented as redeemable equity in the accompanying balance sheets.
The redeemable preferred stock, redeemable common stock and redeemable
common stock warrants, which are subject to the stockholders agreement, are
being accreted up to their fair market values from their respective issuance
dates to their earliest potential redemption date (October 22, 2003). At June
30, 2000, the aggregate redemption value of the redeemable equity was
approximately $415 million, reflecting per share redemption amounts of $1,454
for the Series A Preferred Stock, $711 for the Series C Preferred Stock and
$300 for the redeemable common stock and redeemable common stock warrants.
9. Net Loss Per Common Share
The following table sets forth the computation of net loss per common
share-basic (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1999 2000
--------- ---------
<S> <C> <C>
Numerator:
Net loss before cumulative effect of change in
accounting principle.................................. $(103,160) $(183,946)
Cumulative effect of change in accounting principle.... -- (1,705)
--------- ---------
Net loss............................................... (103,160) (185,651)
Dividends and accretion on redeemable preferred stock.. (43,415) (58,981)
--------- ---------
Numerator for net loss applicable to common
shareholders.......................................... $(146,575) $(244,632)
========= =========
Denominator:
Denominator for net loss per common share--weighted
average number of common shares outstanding........... 850,632 853,553
Net loss per common share before cumulative effect of
change in accounting principle--basic................... $ (172.31) $ (284.60)
Cumulative effect of change in accounting principle...... -- (2.00)
--------- ---------
Net loss per common share--basic......................... $ (172.31) $ (286.60)
========= =========
</TABLE>
Options and warrants to purchase an aggregate of 483,273 and 655,819 shares
of common stock were outstanding as of June 30, 1999 and 2000, respectively,
but a computation of diluted net loss per common share has not been presented,
as the effect would be anti-dilutive.
10. Significant Contracts
In March 2000, the Company entered into an agreement with Qwest
Communications Corporation, pursuant to which (i) the Company took delivery of
approximately $134 million of Internet infrastructure equipment from the
provider and (ii) the Company agreed to install and maintain this equipment,
in over 90 cities throughout the United States, principally to handle Internet
service provider traffic on behalf of the provider. The services
F-10
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
agreement is for a term of 42 months, commencing August 1, 2000 and expiring
on January 31, 2004. The Company entered into a lease financing transaction in
June 2000 to fund the entire cost of this equipment.
In June 2000, the Company entered into a second agreement with Qwest
Communications Corporation, pursuant to which (i) the Company took delivery of
approximately $168 million of Internet infrastructure equipment from the
provider and (ii) the Company agreed to install and maintain this equipment
throughout the United States, principally to handle Internet service provider
traffic on behalf of the provider. The services agreement commences in
November 2000 and expires in August 2004. The Company expects to enter into a
financing transaction to fund the cost of this equipment. This equipment is
recorded in other current assets and accounts payable in the accompanying
balance sheet at June 30, 2000.
11. Interest Rate Swap Agreements
June 2000 Swap
In June 2000, the Company entered into an interest rate swap agreement (the
"June 2000 Swap") with a commercial bank to reduce the impact of changes in
interest rates on its outstanding variable rate debt. The June 2000 Swap
effectively fixes the Company's interest rate on $90 million of its long-term
debt for a period of 5 years. The Company is exposed to credit loss in the
event of nonperformance by the other party to the interest rate swap
agreement. However, the Company does not anticipate nonperformance by the
counterparty.
Amended and Restated Interest Rate Swap Agreement
In April 2000, the Company entered into an amended and restated interest
rate swap agreement (the "Amended Swap") with a commercial bank to reduce the
impact of changes in interest rates on its outstanding variable rate debt. The
Amended Swap effectively fixes the Company's interest rate on $325 million of
outstanding variable rate borrowings under the Amended Senior Secured Credit
Facility (see Note 6) through April 2003 after which time the Amended Swap is
reduced to $225 million through January 2004 and then finally reduced to $100
million until termination of the Amended Swap in April 2005. The Company is
exposed to credit loss in the event of nonperformance by the other party to
the interest rate swap agreement. However, the Company does not anticipate
nonperformance by the counterparty.
12. BellSouth Reciprocal Compensation Settlement
In May 2000, the Company reached a resolution of its claims for payment of
certain reciprocal compensation charges, previously disputed by BellSouth
Corporation. Under the agreement, BellSouth made a one-time payment that
resolved all amounts billed through March 31, 2000.
In addition, BellSouth and the Company agreed to future rates for
reciprocal compensation, setting new contractual terms for payment. Under the
terms of the agreement, the rates for reciprocal compensation will be
reduced, and will apply to all local traffic, including ISP-bound traffic,
thereby eliminating the principal area of dispute between the parties. The
reduction will be phased in over a three-year period beginning with a rate of
$.002 per minute of use in year 2000, $.00175 per minute of use for 2001 and
$.0015 per minute of use for 2002.
13. Series G Preferred Equity
The Company agreed, as of June 30, 2000, to issue 58,881 and 481,108 shares
of Series G-1 Voting and G-2 Non-Voting Convertible Preferred Stock (the
"Series G Preferred Stock"), respectively, to Lucent Technologies, Dresdner
Kleinwort Benson Private Equity Partners, CIT Lending Services, Nassau Capital
F-11
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Partners and Harold N. Kamine, its Chairman of the Board, for aggregate gross
proceeds of $182.5 million. The transaction closed and the proceeds were
received in early July 2000. The Series G Preferred Stock has a liquidation
preference of $337.97 per share and an annual cumulative dividend equal to 7%
of the liquidation preference. Payment of the unpaid dividends is triggered by
(i) an initial public offering in which the Company receives aggregate gross
proceeds of at least $80 million or (ii) a merger, consolidation or sale of
substantially all assets.
Each share of Series G Preferred Stock is convertible into a number of
shares of common stock equal to the liquidation preference of each share
divided by the conversion price then in effect. Initially, the conversion
price is $337.97. However, this price is adjustable, subject to certain
exceptions, upon the occurrence of certain events including (i) the issuance
or sale of common stock for a consideration per share less than the conversion
price, (ii) the issuance of rights or options to acquire common stock or
convertible securities with an exercise price less than the conversion price
and (iii) the issuance or sale of other convertible securities with a
conversion or exchange price lower than the conversion price. The Series G
Preferred Stock will be automatically converted into common stock upon (i) a
Qualified Public Offering, defined as sale of common stock pursuant to a
registration statement in which the Company receives aggregate gross proceeds
of at least $80 million, provided that the per share price at which such
shares are sold in such offering is not less than the liquidation preference
then in effect, or (ii) the election of holders of at least two-thirds of the
outstanding shares of Series G Preferred Stock.
The Series G Preferred Stock ranks senior to the common stock, Series A
Convertible Preferred Stock and Series C Convertible Preferred Stock, on a
parity with the Series F Senior Redeemable, Exchangeable, PIK Preferred Stock
and junior to the Series E Senior Redeemable, Exchangeable, PIK Preferred
Stock. The Series G-1 shareholders are entitled to vote on all matters before
the common holders, as a single class with the common, on an as if converted
basis.
Subject to certain limitations and conditions, at the request of the
holders of at least two-thirds of the Series G Preferred Stock, the Company
may be required to redeem the Series G Preferred Stock upon (i) a change of
control or sale of the Company, or (ii) August 15, 2009.
F-12
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
KMC Telecom Holdings, Inc.
We have audited the consolidated balance sheets of KMC Telecom Holdings,
Inc. as of December 31, 1998 and 1999, and the related consolidated statements
of operations, redeemable and nonredeemable equity and cash flows for each of
the three years in the period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of KMC Telecom Holdings, Inc. as of December 31, 1998 and 1999, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
MetroPark, New Jersey
January 31, 2000, except for Note 18
as to which the date is March 28, 2000
F-13
<PAGE>
KMC TELECOM HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
December 31
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents............................... $ 21,181 $ 85,966
Restricted investments.................................. -- 37,125
Accounts receivable, net of allowance for doubtful
accounts of $350 and $5,551 in 1998 and 1999,
respectively........................................... 7,539 27,373
Prepaid expenses and other current assets............... 1,315 1,375
--------- ---------
Total current assets...................................... 30,035 151,839
Investments held for future capital expenditures.......... 27,920 --
Long-term restricted investments.......................... -- 51,446
Networks and equipment, net............................... 224,890 639,324
Intangible assets, net.................................... 2,829 3,602
Deferred financing costs, net............................. 20,903 38,816
Other assets.............................................. 4,733 1,013
--------- ---------
$311,310 $ 886,040
========= =========
Liabilities, redeemable and nonredeemable equity
(deficiency)
Current liabilities:
Accounts payable........................................ $ 21,052 $ 167,490
Accrued expenses........................................ 9,187 37,047
Deferred revenue........................................ 1,187 4,309
--------- ---------
Total current liabilities................................. 31,426 208,846
Notes payable............................................. 41,414 235,000
Senior notes payable...................................... -- 275,000
Senior discount notes payable............................. 267,811 301,137
--------- ---------
Total liabilities......................................... 340,651 1,019,983
Commitments and contingencies
Redeemable equity:
Senior redeemable, exchangeable, PIK preferred stock,
par value $.01 per share; authorized:
-0- shares in 1998 and 630 shares in 1999; shares
issued and outstanding:
Series E, -0- in 1998 and 65 shares in 1999 ($65,004
liquidation preference)............................... -- 50,770
Series F, -0- in 1998 and 44 shares in 1999 ($44,177
liquidation preference)............................... -- 41,370
Redeemable cumulative convertible preferred stock, par
value $.01 per share; 499 shares authorized; shares
issued and outstanding:
Series A, 124 shares in 1998 and 1999 ($12,380
liquidation preference)............................... 30,390 71,349
Series C, 175 shares in 1998 and 1999 ($17,500
liquidation preference)............................... 21,643 40,301
Redeemable common stock, shares issued and outstanding,
224 in 1998 and 1999................................... 22,305 33,755
Redeemable common stock warrants........................ 674 12,925
--------- ---------
Total redeemable equity................................... 75,012 250,470
Nonredeemable equity (deficiency)
Common stock, par value $.01 per share; 3,000 shares
authorized, issued and outstanding, 614 shares in 1998
and 629 shares in 1999................................. 6 6
Additional paid-in capital.............................. 13,750 --
Unearned compensation................................... (5,824) (9,163)
Accumulated deficit..................................... (112,285) (375,256)
--------- ---------
Total nonredeemable equity (deficiency)................... (104,353) (384,413)
--------- ---------
$ 311,310 $ 886,040
========= =========
</TABLE>
See accompanying notes.
F-14
<PAGE>
KMC TELECOM HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31
-----------------------------
1997 1998 1999
-------- -------- ---------
<S> <C> <C> <C>
Revenue........................................ $ 3,417 $ 22,425 $ 64,313
Operating expenses:
Network operating costs:
Non-cash stock compensation................ 1,110 566 2,387
Other network operating costs.............. 5,482 27,699 81,678
Selling, general and administrative:
Non-cash stock compensation................ 12,760 6,514 27,446
Other selling, general and administrative.. 12,176 34,171 84,434
Depreciation and amortization................ 2,506 9,257 29,077
-------- -------- ---------
Total operating expenses....................... 34,034 78,207 225,022
-------- -------- ---------
Loss from operations........................... (30,617) (55,782) (160,709)
Other expense.................................. -- -- (4,297)
Interest income................................ 513 8,818 8,701
Interest expense............................... (2,582) (29,789) (69,411)
-------- -------- ---------
Net loss....................................... (32,686) (76,753) (225,716)
Dividends and accretion on redeemable preferred
stock......................................... (8,904) (18,285) (81,633)
-------- -------- ---------
Net loss applicable to common shareholders..... $(41,590) $(95,038) $(307,349)
======== ======== =========
Net loss per common share...................... $ (64.93) $(114.42) $ (360.88)
======== ======== =========
Weighted average number of common shares
outstanding................................... 641 831 852
======== ======== =========
</TABLE>
See accompanying notes.
F-15
<PAGE>
KMC TELECOM HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE EQUITY
Years ended December 31, 1997, 1998 and 1999
(in thousands)
<TABLE>
<CAPTION>
Redeemable Equity
-------------------------------------------------------------------------------------------------------------
Preferred Stock
-------------------------------------------------------------------------
Series A Series C Series D Series E Series F Common Stock
-------------- -------------- -------------- ------------- ------------- -----------------------
Total
Redeemable
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Warrants Equity
------ ------- ------ ------- ------ ------- ------ ------ ------ ------ ------ ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31,
1996............ -- $ -- -- $ -- -- $ -- -- $-- -- $-- -- $ -- $ -- $ --
Conversion of
convertible
notes payable to
Series A
Preferred
Stock........... 124 11,519 11,519
Issuance of
warrants........ 2,025 2,025
Issuance of
common stock and
exercise of
warrants........ 133 10,863 (1,500) 9,363
Issuance of
Series C
Preferred
Stock........... 150 14,199 14,199
Issuance of
Series D
Preferred
Stock........... 25 2,299 2,299
Accretion on
redeemable
equity.......... 7,360 468 80 324 14 8,246
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............ 124 18,879 150 14,667 25 2,379 -- -- -- -- 133 11,187 539 47,651
Conversion of
Series D
Preferred Stock
to Series C
Preferred
Stock........... 25 2,379 (25) (2,379) --
Issuance of
common stock.... 91 9,500 9,500
Accretion on
redeemable
equity.......... 11,511 4,597 1,618 135 17,861
Payment of
dividends on
preferred stock
of subsidiary...
Issuance of
warrants........
Cancellation of
KMC Telecom
stock options...
Issuance and
adjustment to
fair value of
stock options to
employees.......
Issuance and
adjustment to
fair value of
stock options to
non-employees...
Amortization of
unearned
compensation....
Net loss........
--- ------- --- ------- --- ------- --- --- --- --- --- ------- ------- --------
Balance,
December 31,
1998............ 124 $30,390 175 $21,643 -- $ -- -- $-- -- $-- 224 $22,305 $ 674 $ 75,012
=== ======= === ======= === ======= === === === === === ======= ======= ========
<CAPTION>
Nonredeemable Equity (Deficiency)
--------------------------------------------------------------
Common Stock Total
------------- Non-
Additional redeemable
Paid-in Unearned Accumulated Equity
Shares Amount Capital Compensation Deficit (Deficiency)
------ ------ ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance,
December 31,
1996............ 600 $6 $ 4,468 $(1,239) $ (2,846) $ 389
Conversion of
convertible
notes payable to
Series A
Preferred
Stock........... --
Issuance of
warrants........ --
Issuance of
common stock and
exercise of
warrants........ 14 --
Issuance of
Series C
Preferred
Stock........... --
Issuance of
Series D
Preferred
Stock........... --
Accretion on
redeemable
equity.......... (8,246) (8,246)
Issuance and
adjustment to
fair value of
stock options to
employees....... 14,296 (14,296) --
Amortization of
unearned
compensation.... 9,014 9,014
Increase in fair
value of stock
options issued
to non-
employees....... 4,856 4,856
Net loss........ (32,686) (32,686)
------ ------ ---------- ------------ ----------- ------------
Balance,
December 31,
1997............ 614 6 15,374 (6,521) (35,532) (26,673)
Conversion of
Series D
Preferred Stock
to Series C
Preferred
Stock........... --
Issuance of
common stock.... --
Accretion on
redeemable
equity.......... (17,861) (17,861)
Payment of
dividends on
preferred stock
of subsidiary... (592) (592)
Issuance of
warrants........ 10,446 10,446
Cancellation of
KMC Telecom
stock options... (26,191) 4,845 (21,346)
Issuance and
adjustment to
fair value of
stock options to
employees....... 27,906 (27,906) --
Issuance and
adjustment to
fair value of
stock options to
non-employees... 4,668 4,668
Amortization of
unearned
compensation.... 23,758 23,758
Net loss........ (76,753) (76,753)
------ ------ ---------- ------------ ----------- ------------
Balance,
December 31,
1998............ 614 $ 6 $ 13,750 $ (5,824) $(112,285) $ (104,353)
====== ====== ========== ============ =========== ============
</TABLE>
See accompanying notes.
F-16
<PAGE>
KMC TELECOM HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE EQUITY
Years ended December 31, 1997, 1998 and 1999
(in thousands)
<TABLE>
<CAPTION>
Redeemable Equity
-------------------------------------------------------------------------------------------------------------
Preferred Stock
-------------------------------------------------------------------------
Series A Series C Series D Series E Series F Common Stock
-------------- -------------- ------------- -------------- -------------- -----------------------
Total
Redeemable
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Warrants Equity
------ ------- ------ ------- ------ ------ ------ ------- ------ ------- ------ ------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December
31, 1998
(carried
forward)........ 124 $30,390 175 $21,643 -- $-- -- $ -- $ 224 $22,305 $ 674 $ 75,012
Issuance of
Series E
Preferred Stock.. 60 44,829 44,829
Issuance of
Series F
Preferred Stock.. 40 34,817 34,817
Stock dividend of
Series E
Preferred
Stocks........... 5 5,004 5,004
Stock dividend of
Series F
Preferred Stock.. 4 4,177 4,177
Issuance of
warrants......... 10,606 10,606
Reclassification
of warrants
related to "put
rights".......... (249) (249)
Exercise of
warrants.........
Accretion on
redeemable
equity........... 40,959 18,658 937 2,376 11,450 1,894 76,274
Issuance and
adjustment to
fair value of
stock option to
employees........
Adjustment to
fair value of
stock options to
non-employees....
Amortization of
unearned
compensation.....
Exercise of stock
options..........
Reclassification
of additional
paid-in capital
deficiency.......
Net loss.........
--- ------- --- ------- --- --- --- ------- --- ------- --- ------- ------- --------
Balance, December
31, 1999......... 124 71,349 175 40,301 -- $-- 65 $50,770 44 $41,370 224 $33,755 $12,925 $250,470
=== ======= === ======= === === === ======= === ======= === ======= ======= ========
<CAPTION>
Nonredeemable Equity (Defiency)
------------------------------------------------------------------
Common Stock Total
------------- Non-
Additional redeemable
Paid-in Unearned Accumulated Equity
Shares Amount Capital Compensation Deficit (Deficiency)
------ ------ ---------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December
31, 1998
(carried
forward)........ 614 $ 6 $ 13,750 $(5,824) $(112,285) $(104,353)
Issuance of
Series E
Preferred Stock.. --
Issuance of
Series F
Preferred Stock.. --
Stock dividend of
Series E
Preferred
Stocks........... (5,004) (5,004)
Stock dividend of
Series F
Preferred Stock.. (4,177) (4,177)
Issuance of
warrants......... 749 749
Reclassification
of warrants
related to "put
rights".......... 249 249
Exercise of
warrants......... 1 1
Accretion on
redeemable
equity........... (76,274) (76,274)
Issuance and
adjustment to
fair value of
stock option to
employees........ 27,286 (27,286) --
Adjustment to
fair value of
stock options to
non-employees.... 5,832 5,832
Amortization of
unearned
compensation..... 23,947 23,947
Exercise of stock
options.......... 15 333 333
Reclassification
of additional
paid-in capital
deficiency....... 37,255 (37,255) --
Net loss......... (225,716) (226,716)
------ ------ ---------- ------------ ----------- ------------
Balance, December
31, 1999......... 629 $ 6 $ -- $(9,163) $(375,526) $(384,413)
====== ====== ========== ============ =========== ============
</TABLE>
See accompanying notes.
F-17
<PAGE>
KMC TELECOM HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31
------------------------------
1997 1998 1999
-------- --------- ---------
<S> <C> <C> <C>
Operating activities
Net loss....................................... $(32,686) $ (76,753) $(225,716)
Adjustments to reconcile net loss to net cash
used in
operating activities:
Depreciation and amortization................. 2,506 9,257 29,077
Provision for doubtful accounts............... 34 370 5,263
Non-cash interest expense..................... 610 25,356 31,141
Non-cash stock option compensation expense.... 13,870 7,080 29,833
Changes in assets and liabilities:
Accounts receivable.......................... (1,330) (6,591) (25,097)
Prepaid expenses and other current assets.... (346) (826) (60)
Accounts payable............................. 2,934 7,449 29,319
Accrued expenses............................. 6,062 2,953 24,227
Due to affiliates............................ (35) (47) --
Other assets................................. (295) (1,821) 3,720
-------- --------- ---------
Net cash used in operating activities.......... (8,676) (33,573) (98,293)
-------- --------- ---------
Investing activities
Construction of networks and purchases of
equipment..................................... (59,146) (148,580) (318,536)
Acquisitions of franchises, authorizations and
related assets................................ (1,846) (1,147) (1,992)
Cash paid for acquisition of Melbourne
Network....................................... (2,000) -- --
Deposit on purchase of equipment............... -- (2,551) --
Purchase of investments, net................... -- (27,920) --
Redemption of investments...................... -- -- 43,450
-------- --------- ---------
Net cash used in investing activities.......... (62,992) (180,198) (277,078)
-------- --------- ---------
Financing activities
Proceeds from notes payable, net of issuance
costs......................................... 59,873 938 --
Proceeds from issuance of common stock and
warrants, net of issuance costs............... 9,363 20,446 --
Proceeds from issuance of preferred stock and
related warrants, net of issuance costs....... 16,498 -- 91,001
Issuance costs of credit facilities............ -- (6,515) (2,300)
Proceeds from exercise of stock options........ -- -- 333
Proceeds from issuance of senior notes, net of
issuance costs and purchase of portfolio of
restricted investments........................ -- -- 158,286
Proceeds from senior secured credit facility,
net of issuance costs......................... -- -- 192,836
Repayment of notes payable..................... -- (20,801) --
Proceeds from issuance of senior discount
notes, net of issuance costs.................. -- 225,923 --
Dividends on preferred stock of subsidiary..... -- (592) --
-------- --------- ---------
Net cash provided by financing activities...... 85,734 219,399 440,156
-------- --------- ---------
Net increase in cash and cash equivalents...... 14,066 5,628 64,785
Cash and cash equivalents, beginning of year... 1,487 15,553 21,181
-------- --------- ---------
Cash and cash equivalents, end of year......... $ 15,553 $ 21,181 $ 85,966
======== ========= =========
Supplemental disclosure of cash flow information
Cash paid during the year for interest, net of
amounts capitalized........................... $ 766 $ 4,438 $ 29,182
======== ========= =========
</TABLE>
See accompanying notes.
F-18
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
1. Organization
KMC Telecom Holdings, Inc. ("KMC Holdings") is a holding company formed
during 1997 primarily to own all of the shares of its operating subsidiaries,
KMC Telecom Inc. ("KMC Telecom"), KMC Telecom II, Inc. ("KMC Telecom II"), KMC
Telecom III, Inc. ("KMC Telecom III") and KMC Telecom of Virginia, Inc. 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 Telecom Holdings, Inc. and its subsidiaries, KMC Telecom, Inc., KMC
Telecom II, Inc., KMC Telecom III, Inc., KMC Telecom IV, Inc., KMC Telecom of
Virginia, Inc., KMC Telecom Financial Services LLC, KMC Telecom.com, and KMC
Telecom Financing, Inc. are collectively referred to herein as the Company.
The Company is a fiber-based integrated communications provider providing
data and voice services to its customers, principally businesses, governments
and institutional end users, as well as Internet service providers, long
distance companies and wireless service providers, primarily in the South,
Southeast, Midwest and Mid-Atlantic United States.
2. Summary of Significant Accounting Policies
Basis of Presentation
As noted above, 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. All
significant intercompany transactions and balances have been eliminated.
On July 1, 1999, the Company acquired all of the membership interests of
KMC Services LLC from Harold N. Kamine, the Chairman of the Board of
Directors, for nominal consideration. KMC Services LLC was formed to provide
services to the Company and its customers, initially offering a leasing
program for equipment physically installed at the customer's premises. The
acquisition was accounted for as a combination of entities under common
control, and no changes were made to the historical cost basis of KMC Services
LLC's assets. During the second quarter of 1999, the Company had reduced the
carrying value of its $709,000 loan receivable from KMC Services LLC to an
amount equal to the value of KMC Services LLC's net assets at the acquisition
date. KMC Services LLC has been consolidated with the Company since July 1,
1999.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of
three months or less when purchased to be cash equivalents.
Investments Held for Future Capital Expenditures
In 1998, the Company has designated certain amounts as investments held for
future capital expenditures. As of December 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 $11.2 million and debt securities (U.S. government obligations and
commercial bonds due within 1 year) of $16.7 million. All debt securities have
been designated by the Company as held-to-maturity. Accordingly, such
securities are recorded in the accompanying December 31, 1998 financial
statements at amortized cost.
F-19
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(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 capitalized and amortized over the initial term of the agreements, which
generally range from 2 to 7 years. Costs incurred to obtain city franchises
are capitalized by the Company and amortized over the initial term of the
franchises, which generally range from 2 to 7 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.
The related amortization is included as a component of interest expense, and
amounted to $561,000, $2,279,000 and $3,814,000 for the years ended December
31, 1997, 1998 and 1999, respectively.
Other Assets
Other assets are comprised principally of employee loans, security deposits
and other deposits and, at December 31, 1998, non-refundable deposits for the
purchase of switching equipment.
Revenue Recognition
Revenue is recognized in the period the service is provided. The Company
generally invoices customers one month in advance for recurring services
resulting in deferred revenue. Unbilled revenue included in accounts
receivable represents revenue earned for services which will be billed in the
succeeding month and totaled $1,272,000 and $5,305,000 at December 31, 1998
and 1999, respectively.
Net Loss Per Common Share
Earnings per share are calculated in accordance with FASB Statement No.
128, Earnings per Share ("Statement 128"). All earnings per share amounts for
all periods have been presented in accordance with the provisions of Statement
128. Diluted earnings per share have not been presented for any period, as the
impact of including outstanding options and warrants would be anti-dilutive.
Income Taxes
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.
Advertising Costs
Advertising costs are included in selling, general and administrative
expenses and charged to expense as incurred. For the years ended December 31,
1997, 1998 and 1999, such costs were $66,000, $2,769,000 and $4,080,000,
respectively.
F-20
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
Impairment of Long-Lived Assets
The Company records impairment losses on long-lived assets used in
operations or expected to be disposed of when impairment indicators are
present and the cash flows expected to be derived from those assets are less
than the carrying amounts of those assets. An impairment loss is measured as
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. 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-
based compensation. 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, the Company's outstanding stock options are not
considered fixed options under APB 25. The Company accounts for non-employee
stock-based compensation in accordance with Statement 123.
Segment Reporting
In 1998, the Company adopted FASB Statement No. 131, Disclosures About
Segments of an Enterprise and Related Information ("Statement 131"). Statement
131 uses a management approach to report financial and descriptive information
about an entity's operating segments. Operating segments are revenue-producing
components of an enterprise for which separate financial information is
produced internally for the entity's chief operating decision maker. Under
this definition, the Company operated within a single segment for all periods
presented.
Start-up Activities
In 1999, the Company adopted Statement of Position 98-5, Reporting on the
Costs of Start-Up Activities, which requires costs of start-up activities to
be expensed as incurred. This statement had no effect on the Company's results
of operations or financial position, because the Company expensed such costs
in prior years.
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("Statement 133"), Accounting for Derivative Instruments and Hedging
Activities, which will require the Company to recognize all derivatives on the
balance sheet at fair value. The Company will be required to adopt Statement
133, as amended by Statement No. 137 which defers the effective date, as of
January 1, 2001. Derivatives that are not hedges must be adjusted to fair
value through income. If the derivative is a hedge, depending on the nature of
the hedge, changes in the fair value of derivatives will either be offset
against the change in fair value of the hedged assets, liabilities, or firm
commitments through earnings or recognized in other comprehensive income until
the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value will be immediately recognized in earnings.
The Company has not yet determined what the effect of Statement 133 will be on
the earnings and financial position of the Company.
F-21
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 provides additional guidance in applying generally
accepted accounting principles to revenue recognition in financial statements.
In 1999 and previous years, the Company recognized installation revenue upon
completion of the installation. Effective January 1, 2000, in accordance with
the provisions of SAB 101, the Company will begin deferring installation
revenue over the life of the contract. The Company estimates the effect of
this change will be a reduction of revenue of approximately $2.2 million and
will be reported as a cumulative effect of a change in accounting principle in
the Company's interim unaudited consolidated financial statements for the
period ended March 31, 2000.
Reclassifications
Certain reclassifications have been made to the 1997 and 1998 consolidated
financial statements to conform with the 1999 presentation.
3. Networks and Equipment
Networks and equipment are comprised of the following:
<TABLE>
<CAPTION>
December 31
------------------
1998 1999
-------- --------
(in thousands)
<S> <C> <C>
Fiber optic systems..................................... $ 99,502 $164,985
Telecommunications equipment............................ 115,769 421,718
Furniture and fixtures.................................. 7,340 21,397
Leasehold improvements.................................. 1,177 1,811
Construction-in-progress................................ 11,770 66,380
-------- --------
235,558 676,291
Less accumulated depreciation........................... (10,668) (36,967)
-------- --------
$224,890 $639,324
======== ========
</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, 1997, 1998 and 1999 amounted to,
$854,000, $5,133,000 and $6,635,000, respectively.
For the years ended December 31, 1997, 1998 and 1999, depreciation expense
was $2,122,000, $8,284,000 and $27,723,000, respectively.
4. Intangible Assets
Intangible assets are comprised of the following:
<TABLE>
<CAPTION>
December 31
----------------
1998 1999
------- -------
(in thousands)
<S> <C> <C>
Franchise costs........................................... $ 1,690 $ 2,015
Authorizations and rights-of-ways......................... 1,455 2,052
Building access agreements and other...................... 480 637
Other..................................................... 582 401
------- -------
4,207 5,105
Less accumulated amortization............................. (1,378) (1,503)
------- -------
$ 2,829 $ 3,602
======= =======
</TABLE>
F-22
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Accrued Expenses
Accrued expenses are comprised of the following:
<TABLE>
<CAPTION>
December 31
--------------
1998 1999
------ -------
(in thousands)
<S> <C> <C>
Accrued compensation............................................ $4,436 $11,423
Accrued costs related to financing activities................... 380 7,316
Accrued interest payable........................................ 162 8,544
Accrued telecommunications costs................................ 565 3,794
Other accrued expenses.......................................... 3,644 5,970
------ -------
$9,187 $37,047
====== =======
</TABLE>
6. Long-Term Debt
Senior Secured Credit Facility
On December 22, 1998, KMC Telecom, KMC Telecom II and KMC Telecom of
Virginia (the "Subsidiary Borrowers"), refinanced and expanded the Amended and
Restated Loan and Security Agreement (the "AT&T Facility") by entering into a
Loan and Security Agreement (the "Senior Secured Credit Facility") with
Newcourt Commercial Finance Corp. ("Newcourt"), First Union National Bank,
General Electric Capital Corporation ("GECC") and Canadian Imperial Bank of
Commerce (the "Creditors"). Under the Senior Secured Credit Facility, the
Creditors agreed to lend the Subsidiary Borrowers up to an aggregate of $250
million initially to be used for the construction and expansion of fiber optic
telecommunications networks in certain markets and for payment of transaction
fees and expenses and, subject to the attainment of certain financial
conditions, for working capital and general corporate purposes.
The Senior Secured Credit Facility includes a $175 million eight year
revolving loan and a $75 million eight and one half year term loan. At
December 31, 1998 and 1999, an aggregate of $41.4 and $235.0 million,
respectively, was outstanding under this facility.
As discussed further in Note 18, the Subsidiary Borrowers and KMC Telecom
III amended, restated and combined the Senior Secured Credit Facility and the
Lucent Loan and Security Agreement during the first quarter of 2000.
Borrowings under the Senior Secured Credit Facility bear interest payable
at the Subsidiary Borrowers' option, at (a) the "Applicable Base Rate Margin"
(which generally ranges from 1.75% to 3.25%) plus the greater of (i) the
administrative agent's prime rate or (ii) the overnight federal funds rate
plus .5% or (b) the "Applicable LIBOR Margin" (which generally ranges from
2.75% to 4.25%) plus LIBOR, as defined. Interest on borrowings outstanding at
December 31, 1999 was based on both the base rate and LIBOR. The Subsidiary
Borrowers were being charged a weighted-average interest rate of 9.38% and
10.26% at December 31, 1998 and 1999, respectively. The Subsidiary Borrowers
must pay an annual commitment fee on the unused portion of the Senior Secured
Credit Facility ranging from .75% to 1.25%.
The Senior Secured Credit Facility contains a number of affirmative and
negative covenants including, among others, covenants restricting the ability
of the Subsidiary 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 KMC
Holdings, create subsidiaries, transfer any permits or licenses, or incur
additional indebtedness or act as guarantor for the debt of any person,
subject to certain conditions.
F-23
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Subsidiary Borrowers are required to comply with certain financial
tests and maintain certain financial ratios, including, among others, a ratio
of total debt to contributed capital, certain minimum revenues, maximum EBITDA
losses and minimum EBITDA, maximum capital expenditures and minimum access
lines, a maximum total leverage ratio, a minimum debt service coverage ratio,
a minimum fixed charge coverage ratio and a maximum consolidated leverage
ratio.
The Company obtained a waiver of compliance, for the quarter ended
September 30, 1999, with certain financial covenants (related to revenue and
EBITDA) contained in the Senior Secured Credit Facility. In addition, the
EBITDA covenant was amended for the fourth quarter of 1999 through the fourth
quarter of 2000 and the revenue covenant was amended for the fourth quarter of
1999 through the first quarter of 2001 to less restrictive amounts. As of
December 31, 1999, the Subsidiary Borrowers were in compliance with the
covenants, as amended.
Lucent Loan and Security Agreement
KMC Telecom III entered into a Loan and Security Agreement (the "Lucent
Facility") dated February 4, 1999 with Lucent Technologies Inc. ("Lucent")
which provides for borrowings to be used to fund the acquisition of certain
telecommunications equipment and related expenses. The Lucent Facility
provides for an aggregate commitment of up to $600 million, of which $250
million is available at December 31, 1999 to purchase Lucent products.
Further, up to an additional $350 million will be available upon (a)
additional lenders participating in the Lucent Facility and making commitments
to make loans so that Lucent's aggregate commitment does not exceed $250
million and (b) the Company satisfying certain other requirements, the most
significant of which is KMC Holdings raising and contributing at least $300
million in high yield debt or equity (other than disqualified stock) to KMC
Telecom III. The Lucent Facility places certain restrictions upon KMC Telecom
III's ability to purchase non-Lucent equipment with proceeds from such
facility. At December 31, 1999, no amounts had been borrowed under the Lucent
Facility.
As discussed further in Note 18, the Subsidiary Borrowers and KMC Telecom
III amended, restated and combined the Senior Secured Credit Facility and the
Lucent Loan and Security Agreement during the first quarter of 2000.
Interest on borrowings under the Lucent Facility is charged, at the option
of KMC Telecom III, at a floating rate of LIBOR plus the "Applicable LIBOR
Margin", or at an alternative base rate plus the "Applicable Base Rate Margin"
(as defined). Such margins will be increased by 0.25% until KMC Telecom III
and its subsidiaries have completed systems in fourteen markets.
The Lucent Facility contains a number of affirmative and negative covenants
including, among others, covenants restricting the ability of KMC Telecom III
to consolidate or merge with any person, sell or lease assets not in the
ordinary course of business, sell or enter into any long-term leases of dark
fiber, redeem stock, pay dividends or make any other payments (including
payments of principal or interest on loans) to KMC Holdings, create
subsidiaries, transfer any permits or licenses, or incur additional
indebtedness or act as guarantor for the debt of any other person, subject to
certain conditions.
KMC Telecom III is required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a ratio of total
debt to contributed capital, certain minimum revenues, maximum EBITDA losses
and minimum EBITDA, maximum capital expenditures and minimum access lines, a
maximum total leverage ratio, a minimum debt service coverage ratio, a minimum
fixed charge coverage ratio and a maximum consolidated leverage ratio.
F-24
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 pursuant to the Senior Discount Note Indenture between KMC
Holdings and the Chase Manhattan Bank, as trustee (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. The gross and net proceeds of
the offering were approximately $250 million and $236.4 million, respectively.
A substantial portion of the net proceeds of the offering have been loaned by
KMC Holdings to its subsidiaries. On August 11, 1998, KMC Holdings exchanged
the notes issued on January 29, 1998 for $460.8 million aggregate principal
amount at maturity of notes that had been registered under the Securities Act
of 1933 (as used below and elsewhere herein, "Senior Discount Notes" includes
the original notes and the exchange notes).
The Senior Discount Notes are unsecured, unsubordinated obligations of the
Company and mature on February 15, 2008. The Senior Discount Notes were sold
at a substantial discount from their principal amount at maturity, and there
will not be any payment of interest on the Senior Discount Notes prior to
August 15, 2003. The Senior Discount Notes will fully accrete to face value on
February 15, 2003. From and after February 15, 2003, the Senior Discount Notes
will bear interest, which will be payable in cash, at the rate of 12.5% per
annum on February 15 and August 15 of each year, commencing August 15, 2003.
The Company is accreting the initial carrying value of the Senior Discount
Notes to their aggregate face value over the term of the debt at its effective
interest rate of 13.7%.
The Senior Discount Notes are redeemable, at the Company's option, in whole
or in part, on or after February 15, 2003 and prior to maturity, at redemption
prices equal to 106.25% of the aggregate principal amount at maturity, plus
accrued and unpaid interest, if any, to the redemption date, declining to 100%
of the aggregate principal amount at maturity, plus accrued and unpaid
interest as of February 15, 2006.
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 Senior Discount
Notes with the net proceeds from the sale of common equity at a redemption
price of 112.50% of their accreted value on the redemption date.
The indebtedness evidenced by the Senior Discount Notes ranks pari passu in
right of payment with all existing and future unsubordinated, unsecured
indebtedness of KMC Holdings and senior in right of payment to all existing
and future subordinated indebtedness of KMC Holdings. However, KMC Holdings is
a holding company and the Senior Discount Notes are, therefore, effectively
subordinated to all existing and future liabilities (including trade payables)
of its subsidiaries.
Within 30 days of the occurrence of a Change of Control (as defined in the
Senior Discount Note Indenture), the Company must offer to purchase for cash
all Senior Discount Notes then outstanding at a purchase price equal to 101%
of the accreted value thereof, plus accrued interest. The Company's ability to
comply with this requirement is subject to certain restrictions contained in
the Senior Secured Credit Facility.
The Senior Discount Note Indenture contains events of default, including,
but not limited to, (i) defaults in the payment of principal, premium or
interest, (ii) defaults in compliance with covenants contained in the Senior
Discount Note Indenture, (iii) cross defaults on more than $5 million of other
indebtedness, (iv) failure to pay more than $5 million of judgments that have
not been stayed by appeal or otherwise and (v) the bankruptcy of KMC Holdings
or certain of its subsidiaries.
The Senior Discount Note Indenture restricts, among other things, the
ability of KMC Holdings to incur additional indebtedness, create liens, engage
in sale-leaseback transactions, pay dividends or make distributions in respect
of capital stock, make investments or certain other restricted payments, sell
assets of KMC Holdings,
F-25
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
redeem capital stock, issue or sell stock of restricted subsidiaries, enter
into transactions with stockholders or affiliates or effect a consolidation or
merger. The Senior Discount Note Indenture permits KMC Holdings' subsidiaries
to be deemed unrestricted subsidiaries and, thus, not subject to the
restrictions of the Senior Discount Note Indenture.
The Senior Discount Notes are "applicable high yield discount obligations"
("AHYDOs"), as defined in the Internal Revenue Code of 1986, as amended. 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. Any remaining OID on the Senior Discount Notes will
not be deductible by the Company until such OID is paid.
Senior Notes
On May 24, 1999, KMC Holdings issued $275.0 million aggregate principal
amount of 13 1/2% Senior Notes due 2009. On December 30, 1999, KMC Holdings
exchanged the notes issued on May 24, 1999 for $275.0 million aggregate
principal amount of notes that had been registered under the Securities Act of
1933 (as used below and elsewhere herein, "Senior Notes" includes the original
notes and the exchange notes). Interest on the Senior Notes is payable semi-
annually in cash on May 15 and November 15 of each year, beginning November
15, 1999. A portion of the proceeds from the offering of the Senior Notes was
used to purchase a portfolio of U.S. government securities that were pledged
as security for the first six interest payments on the Senior Notes.
The Senior Notes are redeemable, at the Company's option, in whole or in
part, on or after May 15, 2004 and prior to maturity, at redemption prices
equal to 106.75% of the aggregate principal amount at maturity, plus accrued
and unpaid interest, if any, to the redemption date, declining to 100% of the
aggregate principal amount at maturity, plus accrued and unpaid interest as of
May 15, 2007.
In addition, at any time prior to May 15, 2002, the Company may redeem up
to 35% of the aggregate principal amount at maturity of the Senior Notes with
the net proceeds from the sale of common equity at a redemption price of
113.5% of the principal amount on such date plus accrued and unpaid interest.
Upon a change of control (as defined in the Senior Note Indenture), the
Company must offer to purchase for cash the Senior Notes at a purchase price
equal to 101% of the principal amount, plus accrued interest. The Company's
ability to comply with this requirement is subject to certain restrictions
contained in the Senior Secured Credit Facility.
The Senior Notes were guaranteed by KMC Telecom Financing, Inc., a wholly-
owned subsidiary. The Senior Notes are senior, unsecured unsubordinated
obligations of KMC Holdings and rank pari passu in right of payment with all
existing and future unsubordinated, unsecured indebtedness of KMC Holdings and
senior in right of payment to all of existing and future subordinated
indebtedness of KMC Holdings. However, KMC Holdings is a holding company and
the Senior Notes are, therefore, effectively subordinated to all existing and
future liabilities (including trade payables), of its subsidiaries.
The Senior Note Indenture contains certain covenants that, among other
things, limit the Company's ability to incur additional indebtedness, engage
in sale-leaseback transactions, pay dividends or make certain other
distributions, sell assets, redeem capital stock, effect a consolidation or
merger of KMC Telecom Holdings, Inc. and enter into transactions with
stockholders and affiliates and create liens on our assets.
7. Interest Rate Swap Agreement
The Company has entered into an interest rate swap agreement with a
commercial bank to reduce the impact of changes in interest rates on a portion
of its outstanding variable rate debt. The agreement effectively fixes the
F-26
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company's interest rate on $125 million of the outstanding variable rate
borrowings under the Senior Secured Credit Facility due 2007. The interest
rate swap agreement terminates in April 2004. The Company is exposed to credit
loss in the event of nonperformance by the other party to the interest rate
swap agreement. However, the Company does not anticipate nonperformance by the
counterparty.
8. Redeemable and Nonredeemable Equity
KMC Telecom Preferred Stock
On January 21, 1997, certain 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 of KMC
Telecom were exchanged for an equal 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 E Preferred Stock
On February 4, 1999, the Company issued 25,000 shares of Series E Senior
Redeemable, Exchangeable, PIK Preferred Stock (the "Series E Preferred Stock")
to Newcourt Finance, generating aggregate gross proceeds of $22.9 million. On
April 30, 1999, the Company issued an additional 35,000 shares of Series E
Preferred Stock for gross proceeds of $25.9 million. The Series E Preferred
Stock has a liquidation preference of $1,000 per share and an annual dividend
equal to 14.5% of the liquidation preference, payable quarterly. On or before
January 15, 2004, the Company may pay dividends in cash or in additional fully
paid and nonassessable shares of Series E Preferred Stock. After January 15,
2004, dividends must be paid in cash, subject to certain conditions. Unpaid
dividends accrue at the dividend rate of the Series E Preferred Stock,
compounded quarterly. During 1999, the Company issued 5,004 shares of Series E
Preferred Stock to pay the dividends due.
The Series E Preferred Stock must be redeemed on February 1, 2011, subject
to the legal availability of funds therefor, at a redemption price, payable in
cash, equal to the liquidation preference thereof on the redemption date, plus
all accumulated and unpaid dividends to the date of redemption. After April
15, 2004, the Series E Preferred Stock may be redeemed, in whole or in part,
at the option of the Company, at a redemption price equal to 110% of the
liquidation preference of the Series E Preferred Stock plus all accrued and
unpaid dividends to the date of redemption. The redemption price declines to
an amount equal to 100% of the liquidation preference as of April 15, 2007.
In addition, on or prior to April 15, 2002, the Company may, at its option,
redeem up to 35% of the aggregate liquidation preference of Series E Preferred
Stock with the proceeds of sales of its capital stock at a redemption price
equal to 110% of the liquidation preference on the redemption date plus
accrued and unpaid dividends.
The holders of Series E Preferred Stock have voting rights in certain
circumstances. Upon the occurrence of a change of control, the Company will be
required to make an offer to repurchase the Series E Preferred Stock for cash
at a purchase price of 101% of the liquidation preference thereof, together
with all accumulated and unpaid dividends to the date of purchase.
The Series E Preferred Stock is not convertible. The Company may, at the
sole option of the Board of Directors (out of funds legally available),
exchange all, but not less than all, of the Series E Preferred Stock then
F-27
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
outstanding, including any shares of Series E Preferred Stock issued as
payment for dividends, for a new series of subordinated debentures (the
"Exchange Debentures") issued pursuant to an exchange debenture indenture. The
holders of Series E Preferred Stock are entitled to receive on the date of any
such exchange, Exchange Debentures having an aggregate principal amount equal
to (i) the total of the liquidation preference for each share of Series E
Preferred Stock exchanged, plus (ii) an amount equal to all accrued but unpaid
dividends payable on such share.
Series F Preferred Stock
On February 4, 1999, the Company issued 40,000 shares of Series F Senior
Redeemable, Exchangeable, PIK Preferred Stock (the "Series F Preferred Stock")
to Lucent and Newcourt Finance, generating aggregate gross proceeds of $38.9
million. The Series F Preferred Stock has a liquidation preference of $1,000
per share and an annual dividend equal to 14.5% of the liquidation preference,
payable quarterly. The Company may pay dividends in cash or in additional
fully paid and nonassessable shares of Series F Preferred Stock. During 1999,
the Company issued 4,177 shares of Series F Preferred Stock to pay the
dividends due for such period.
The Series F Preferred Stock may be redeemed at any time, in whole or in
part, at the option of the Company, at a redemption price equal to 110% of the
liquidation preference on the redemption date plus an amount in cash equal to
all accrued and unpaid dividends thereon to the redemption date. Upon the
occurrence of a change of control, the Company will be required to make an
offer to purchase the Series F Preferred Stock for cash at a purchase price of
101% of the liquidation preference thereof, together with all accumulated and
unpaid dividends to the date of purchase.
The holders of Series F Preferred Stock have voting rights under certain
circumstances.
Upon the earlier of (i) the date that is sixty days after the date on which
the Company closes an underwritten primary offering of at least $200 million
of its Common Stock, pursuant to an effective registration statement under the
Securities Act or (ii) February 4, 2001, any outstanding Series F Preferred
Stock will automatically convert into Series E Preferred Stock, on a one for
one basis.
The Company may, at the sole option of the Board of Directors (out of funds
legally available), exchange all, but not less than all, of the Series F
Preferred Stock then outstanding, including any shares of Series F Preferred
Stock issued as payment for dividends, for Exchange Debentures. The holders of
Series F Preferred Stock are entitled to receive on the date of any such
exchange, Exchange Debentures having an aggregate principal amount equal to
(i) the total of the liquidation preference for each share of Series F
Preferred Stock exchanged, plus (ii) an amount equal to all accrued but unpaid
dividends payable on such share.
Series A Preferred Stock
There are 123,800 shares of Series A Cumulative Convertible Preferred Stock
of KMC Holdings ("Series A Preferred Stock") authorized and outstanding. Such
stock was issued to two entities, Nassau Capital Partners, L.P. and NAS
Partners I L.L.C. ("Nassau Capital" and "Nassau Partners", respectively,
collectively referred to as "Nassau") in January 1997 upon the conversion of
certain notes payable and related accrued interest due to Nassau aggregating
$12,380,000. 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 assets or stock of the Company
or the merger or consolidation
F-28
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of the Company into one or more other corporations). As of December 31, 1999,
dividends in arrears on the Series A Preferred Stock aggregated $2,116,000.
Notwithstanding the foregoing, pursuant to an agreement among Nassau and the
Company, 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. Upon conversion, subject
to the aforementioned agreement 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 of 1933 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 Preferred Stock
There are 350,000 shares of Series C Cumulative Convertible Preferred Stock
of KMC Holdings ("Series C Preferred Stock") authorized, of which 175,000
shares are outstanding at December 31, 1999. 150,000 of such shares were
issued in November 1997, generating aggregate gross proceeds of $15 million
and the remaining 25,000 shares were issued in January 1998 upon the
conversion of an equal number of shares of Series D Preferred Stock. 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, 1999, dividends in arrears on the Series C Preferred Stock
aggregated $2,821,000. Notwithstanding the foregoing, pursuant to the Purchase
Agreement among the Company, Nassau, GECC and First Union Corp. ("First
Union"), 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 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 the date which is 30
months after the date of such initial issuance, $52.50 per share of Common
Stock and (ii) from and after the date which is 30 months after the date of
initial issuance, $42.18; provided that both such amounts are subject to
adjustment upon the occurrence of certain events. Holders of
F-29
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Series C Preferred Stock may convert all or part of such shares to Common
Stock. Upon conversion, subject to the aforementioned agreement 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 Preferred Stock
There are 25,000 shares of Series D Cumulative Convertible Preferred Stock
of KMC Holdings ("Series D Preferred Stock") authorized, none of which are
outstanding at December 31, 1999. There were 25,000 of such shares issued to
Nassau in November 1997, generating aggregate gross proceeds of $2.5 million.
In January 1998, Nassau exercised its conversion rights and converted all of
its shares of Series D Preferred Stock into an equal number of shares of
Series C Preferred Stock.
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. The Senior Discount Note Indenture and the Company's other
indebtedness restrict the ability of the Company to pay dividends on its
Common Stock. 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, Newcourt Communications
Finance Corp., GECC, and First Union (the "Stockholders' Agreement"), until
Kamine and Nassau cease to own Common Stock or preferred stock convertible
into Common Stock representing
F-30
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
at least five percent of the outstanding shares of Common Stock, assuming all
convertible securities are converted, Kamine and Nassau have special rights
entitling each 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. The number of Directors which 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, 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 percentages. 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 Senior Secured
Credit Facility and continues uncured for 90 days, the holders of Series C
Preferred Stock (currently Nassau, GECC and First Union) are entitled to elect
two additional Directors, who will serve until the default is cured.
Redemption Rights
Pursuant to a stockholders agreement, certain of the Company's stockholders
and warrant holders have "put rights" entitling them to have the Company
repurchase their preferred and common shares and redeemable common stock
warrants for the fair value of such securities if no Liquidity Event (defined
as (i) an initial public offering with gross proceeds of at least $40 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. The
restrictive covenants of the Senior Discount Notes limit the Company's ability
to repurchase such securities. All of the securities subject to such "put
rights" are presented as redeemable equity in the accompanying balance sheets.
The redeemable preferred stock, redeemable common stock and redeemable
common stock warrants, which are subject to the stockholders agreement, 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, 1999, the aggregate redemption value of the redeemable equity was
approximately $320 million, reflecting per share redemption amounts of $1,212
for the Series A Preferred Stock, $476 for the Series C Preferred Stock and
$250 for the redeemable common stock and redeemable common stock warrants.
Warrants
In connection with KMC Telecom's 1996 Loan and Security Agreement, warrants
representing a 2.5% ownership interest in the fully diluted common voting
capital stock of KMC Telecom, including anti-dilution protection, were granted
to the lenders. 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 redeemable equity in January 1997. On September 22, 1997, such
warrants were exercised, and an aggregate of 28,000 shares of Class A Common
Stock of KMC Telecom were issued to the warrant holders. These shares were
subsequently exchanged for an equal number of shares of Common Stock of KMC
Holdings.
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
F-31
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
charge to deferred financing costs and credited to redeemable 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, 1999.
In connection with the sale of Senior Discount Notes in January 1998, the
Company issued warrants to purchase an aggregate of 100,385 shares of Common
Stock at an exercise price of $.01 per share. The net proceeds of $10,446,000
represented the fair value of the warrants at the date of issuance. The
warrants are exercisable through January 2008.
In connection with the February 4, 1999 issuances of the Series E Preferred
Stock and the Series F Preferred Stock, warrants to purchase an aggregate of
24,660 shares of Common Stock were sold to Newcourt Finance and Lucent. The
aggregate gross proceeds from the sale of these warrants was approximately
$3.2 million. These warrants, at an exercise price of $.01 per share, are
exercisable from February 4, 2000 through February 1, 2009.
In addition, the Company also delivered to the Warrant Agent certificates
representing warrants to purchase an aggregate of an additional 107,228 shares
of Common Stock at an exercise price of $.01 per share (the "Springing
Warrants"). The Springing Warrants may become issuable under the circumstances
described in the following paragraph.
If the Company fails to redeem all shares of Series F Preferred Stock prior
to the date (the "Springing Warrant Date") which is the earlier of (i) the
date that is sixty days after the date on which the Company closes an
underwritten primary offering of at least $200 million of its Common Stock
pursuant to an effective registration statement under the Securities Act or
(ii) February 4, 2001, the Warrant Agent is authorized to issue the Springing
Warrants to the Eligible Holders (as defined in the warrant agreement) of the
Series E and Series F Preferred Stock. In the event the Company has redeemed
all outstanding shares of Series F Preferred Stock prior to the Springing
Warrant Date, the Springing Warrants will not be issued and the Warrant Agent
will return the certificates to the Company. To the extent the Company
exercises its option to exchange all of the Series F Preferred Stock for
Exchange Debentures prior to the Springing Warrant Date, the Springing
Warrants will not become issuable. Therefore, as the future issuance of the
Springing Warrants is entirely within the control of the Company and the
likelihood of their issuance is deemed to be remote, no value has been
ascribed to the Springing Warrants.
In connection with the April 30, 1999 issuance of additional shares of the
Series E Preferred Stock, warrants to purchase an aggregate of 60,353 shares
of Common Stock were issued to Newcourt Finance and First Union. The aggregate
gross proceeds from the sale of these warrants was approximately $9.1 million.
These warrants, at an exercise price of $.01 per share, are exercisable from
February 4, 2000 through February 1, 2009.
Options
Prior to the establishment of the present holding company structure, during
1996 and 1997, KMC Telecom granted options to purchase shares of its common
stock, par value $.01 per share ("KMC Telecom Common Stock"), to employees
pursuant to the KMC Telecom Stock Option Plan.
In order to reflect the establishment of the holding company structure, on
June 26, 1998, the Board of Directors adopted a new stock option plan, the KMC
Holdings Stock Option Plan (the "1998 Plan"), which authorizes the grant of
options to purchase Common Stock of the Company. The 1998 Plan was approved by
the stockholders, effective July 15, 1998. In September 1998, the Company
replaced the options to purchase KMC Telecom Common Stock previously granted
under the KMC Telecom Stock Option Plan with options to purchase
F-32
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Common Stock of the Company granted under the 1998 Plan and granted options to
additional employees of the Company under the 1998 Plan.
The 1998 Plan, which is administered by the Compensation Committee of the
Board of Directors of KMC Holdings, 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, performance shares 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 1998 Plan, options to purchase 600,000 shares of Common Stock of
KMC Holdings are available for grant, all of which were allocated to the Plan
as of December 31, 1999. No individual may receive options for more than
75,000 shares. The exercise price of all incentive stock options granted under
the 1998 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 1998 Plan must be at least 50% of the fair market value of
the shares on the date of grant.
Options granted pursuant to the 1998 Plan will have terms not to exceed 10
years and become exercisable over a vesting period as specified in such
options. The 1998 Plan will terminate no later than 2008. Options granted
under the 1998 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 1998 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 1998 Plan, the greater of 25% of the shares granted or fifty percent
of all unvested options granted become fully vested upon a change-in-control
of the Company, as defined. Under certain circumstances, such percentages may
increase.
The holders of options to acquire shares of Common Stock of KMC Holdings
are required to enter into agreements with KMC Holdings 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 the Company or
the affiliates, the Company 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.
F-33
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Information on stock options is as follows:
<TABLE>
<CAPTION>
Weighted
Number of Shares Average Exercise
----------------------- ----------------
Outstanding Exercisable Price of Options
----------- ----------- ----------------
<S> <C> <C> <C>
Balances, January 1, 1997........... 95,385 -- $ 65
Granted........................... 63,115 -- $ 65
Became exercisable................ -- 22,000
Cancelled......................... (17,000) (3,000) $(65)
-------- -------
Balances, December 31, 1997......... 141,500 19,000 $ 65
Granted........................... 262,500 -- $ 26
Became exercisable................ -- 117,000
Cancelled......................... (141,500) (19,000) $(65)
-------- -------
Balances, December 31, 1998......... 262,500 117,000 $ 26
Granted........................... 82,342 -- $147
Became exercisable................ -- 51,669
Exercised......................... (15,600) (15,600) $ 22
Cancelled......................... (27,200) (2,000) $(26)
-------- -------
Balances, December 31, 1999......... 302,042 151,069 $ 59
======== =======
</TABLE>
The weighted-average exercise price of options exercisable at December 31,
1997, 1998 and 1999 is $50, $22 and $26, respectively, and the weighted-
average fair value of options granted during 1997, 1998 and 1999 were $49,
$114 and $134 per share, respectively.
The range of exercise prices, number of shares and the weighted-average
remaining contractual life for options outstanding as of December 31, 1999
were as follows:
<TABLE>
<CAPTION>
Number Number of Weighted- Weighted-Average
Range of of Shares Average Remaining
Exercise Prices Shares Exercisable Exercise Price Contractual Life
--------------- ------- ----------- -------------- ----------------
<S> <C> <C> <C> <C>
$20 - $40 219,700 144,025 $ 21 8.66 years
$125 67,509 6,751 125 9.00 years
$225 - $250 14,833 293 225 9.70 years
------- -------
Total 302,042 151,069 26 8.79 years
======= =======
</TABLE>
During the year ended December 31, 1999, non-qualified options to purchase
an aggregate of 82,342 shares were granted to employees at exercise prices of
$125 (67,509), $225 (2,933) and $250 (11,900). All options have 10 year terms
and become exercisable over a five year period in equal six month increments.
During the year ended December 31, 1998, non-qualified options to purchase
an aggregate of 262,500 shares were granted at exercise prices of $20 (157,500
options), $30 (52,500 options) and $40 (52,500 options). The options granted
during 1998 are comprised of 230,500 options granted to employees and 32,000
options granted to individuals employed by certain affiliates of the Company.
All such options have 10 year terms. The $20 options become exercisable over a
three year period in six month intervals commencing six months after the grant
date in increments of 26,250 options each. The $30 options become exercisable
in two increments of 26,250 options each, forty-two and forty-eight months
after the grant date. The $40 options become exercisable in two increments of
26,250 options each, fifty-four and sixty months after the grant date. For
purposes of vesting, options granted in 1998 under the 1998 Plan to replace
options granted in 1997 and 1996 under the KMC Telecom Stock Option Plan are
deemed to have been granted on the date of grant of the options which they
replace.
F-34
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 was required to account for the KMC Telecom Stock Option Plan as a
variable stock option plan. Additionally, as a result of restrictions upon the
holders of options granted under the 1998 Plan, including their ability to
sell or otherwise transfer the related shares, the 1998 Plan is required to be
accounted for as a variable stock option plan. Generally accepted accounting
principles for variable stock option plans require the recognition of 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. 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.
The Company, upon cancellation of the outstanding options under the KMC
Telecom Stock Option Plan, reversed all compensation expense previously
recorded with respect to such options. Additionally, to the extent the fair
value of the Common Stock of the Company exceeded the exercise price of the
options granted under the 1998 Plan, the Company recognized compensation
expense related to such options over their vesting period.
Based on the estimated fair value of the Common Stock of KMC Telecom at
December 31, 1997 and KMC Holdings at December 31, 1998 and December 31, 1999,
cumulative deferred compensation obligations of $15,579,000, $27,906,000 and
$50,972,000, respectively, have been established. The Company has recognized
compensation expense aggregating $13,870,000, $7,080,000 and $29,833,000, for
the years ended December 31, 1997, 1998 and 1999, respectively. The 1998 stock
option compensation expense of $7,080,000 reflects charges of $7,236,000 under
the KMC Telecom Stock Option Plan through its termination in September 1998
and charges of $21,190,000 related to the 1998 Plan, partially offset by a
credit as a result of the September 1998 cancellation of the KMC Telecom stock
options, reflecting the reversal of $21,346,000 of cumulative compensation
previously recognized for options granted under the KMC Telecom Stock Option
Plan.
In accordance with the provisions of Statement 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 the grant date as prescribed by Statement 123, net
loss and net loss per common share would have been the following:
<TABLE>
<CAPTION>
December 31
-----------------------------
1997 1998 1999
-------- -------- ---------
(in thousands,
except per share amounts)
<S> <C> <C> <C>
Net loss:
As reported................................ $(32,685) $(76,753) $(225,716)
======== ======== =========
Pro forma.................................. $(20,542) $(76,869) $(219,599)
======== ======== =========
Net loss per common share:
As reported................................ $ (64.93) $(114.42) $ (360.88)
======== ======== =========
Pro forma.................................. $ (45.97) $(114.56) $ (353.70)
======== ======== =========
</TABLE>
F-35
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Expected dividend yield.............................. 0% 0% 0%
Expected stock price volatility...................... 50% 50% 70%
Risk-free interest rate.............................. 6% 6% 6.5%
Expected life of options............................. 7 years 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 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. Service Revenues
The Company provides on-network services and resells switched services
previously purchased from the incumbent local exchange carrier. On-network
services include services provided through direct connections to our own
networks, services provided by means of unbundled network elements leased from
the incumbent local exchange carrier and dedicated circuits.
The Company's service revenues consist of the following:
<TABLE>
<CAPTION>
Year ended December 31
----------------------
1997 1998 1999
------ ------- -------
<S> <C> <C> <C>
(in thousands)
On-network............................................ $1,093 $ 8,248 $44,615
Resale................................................ 2,324 14,177 19,698
------ ------- -------
Total................................................. $3,417 $22,425 $64,313
====== ======= =======
</TABLE>
10. Income Taxes
As of December 31, 1999, the Company and its subsidiaries had consolidated
net operating loss carryforwards for United States income tax purposes
("NOLs") of approximately $215 million which expire through 2013. Under
Section 382 of the Internal Revenue Code of 1986, as amended, 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 $109 million and $311 million of loss carryforwards and net
temporary differences at December 31, 1998 and 1999, respectively. At existing
federal and state tax rates, the future benefit of these items approximates
$42 million at December 31,
F-36
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 and $121 million at December 31, 1999. Valuation allowances have been
established equal to the entire net tax benefit associated with all
carryforwards and temporary differences at both December 31, 1998 and 1999 as
their realization is uncertain.
The composition of expected future tax benefits at December 31, 1998 and
1999 is as follows:
<TABLE>
<CAPTION>
1998 1999
-------- ---------
(in thousands)
<S> <C> <C>
Net operating loss carryforwards........................ $ 22,914 $ 83,762
Temporary differences:
Stock option compensation............................. 8,264 19,528
Interest accretion.................................... 9,797 21,127
Other, net............................................ 1,513 (3,244)
-------- ---------
Total deferred tax assets............................... 42,488 121,173
Less valuation allowance................................ (42,488) (121,173)
-------- ---------
Net deferred tax assets................................. $ -- $ --
======== =========
</TABLE>
A reconciliation of the expected tax benefit at the statutory federal rate
of 35% is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Expected tax benefit at
statutory rate......... (35.0)% (35.0)% (35.0)%
State income taxes, net
of federal benefit..... (2.9) (2.6) (3.8)
Non-deductible interest
expense................ -- 2.0 1.1
Other................... .1 .1 .1
Change in valuation
allowance.............. 37.8 35.5 37.6
----- ----- -----
--% --% --%
===== ===== =====
</TABLE>
11. Commitments and Contingencies
Leases
The Company leases various facilities and equipment under operating leases.
Minimum rental commitments are as follows (in thousands):
<TABLE>
<CAPTION>
Year ending December 31:
------------------------
<S> <C>
2000............................................................... $ 4,434
2001............................................................... 5,317
2002............................................................... 4,754
2003............................................................... 4,145
2004............................................................... 3,302
Thereafter......................................................... 13,219
-------
$35,171
=======
</TABLE>
Rent expense under operating leases was $478,000, $1,299,000 and
$3,815,000, for the years ended December 31, 1997, 1998 and 1999,
respectively.
F-37
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Litigation
There are a number of lawsuits and regulatory proceedings related to the
Telecommunications Act of 1996, decisions of the Federal Communications
Commission related thereto and rules and regulations issued thereunder which
may affect the rights, obligations and business of incumbent local exchange
carriers, competitive local exchange carriers and other participants in the
telecommunications industry in general, including the Company.
Purchase Commitments
As of December 31, 1999, the Company has outstanding commitments
aggregating approximately $96.5 million related to purchases of
telecommunications equipment and fiber optic cable and its obligations under
its agreements with certain suppliers and service providers.
Employment Agreements
The Company has entered into employment agreements with certain of its
executives. In addition to a base salary, these agreements also provide 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.
Arbitration Award
During the second quarter of 1999, the Company recorded a $4.3 million
charge to other expense in connection with an unfavorable arbitration award.
The net amount due under the terms of the award was paid in full in June 1999.
12. Acquisition
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.
13. Related Party Transactions
The Company and certain affiliated companies owned by Kamine share certain
administrative services. The entity which bears the cost of the service is
reimbursed by the other for the other's proportionate share of such expenses.
The Company reimbursed Kamine-affiliated companies for these shared services
an aggregate of approximately $281,000, $136,000 and $60,000, of expense for
the years ended December 31, 1997, 1998 and 1999, respectively. During 1999,
the Company purchased approximately $180,000 of office furniture and leasehold
improvements from an entity controlled by Kamine.
From May 1, 1996 through January 29, 1998, an affiliate of the Company was
paid a fee at an annual rate of $266,000 as reimbursement for the services of
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 and it was terminated
effective December 31, 1998. The fees paid for these services are included in
the shared services payment described in the immediately preceding paragraph.
The Company leases its headquarters office through January 2007 from an
entity controlled by Kamine. The lease provides for a base annual rental cost
of approximately $217,000, adjusted periodically for changes in
F-38
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the consumer price index, plus operating expenses. Rent expense recognized
under this lease for the years ended December 31, 1997, 1998 and 1999 was
$207,000, $217,000 and $217,000, respectively.
Effective January 1, 1999, the Company is entitled to utilize a Citation
III business jet, chartered by Bedminster Aviation, LLC, a limited liability
company wholly-owned by Kamine, for a fixed price per hour of flight time.
During 1999, the Company paid approximately $210,000 for the use of the
Citation III. The Company has agreed to use its best efforts to utilize the
Citation III fifty hours per quarter during 2000. The Company is under no
obligation to do so and has not guaranteed any financial arrangements with
respect to the aircraft or to Bedminster Aviation, LLC.
Pursuant to an agreement among the Company, Kamine and Nassau, for 1997,
1998 and 1999 Nassau received $100,000, $100,000 and $450,000, respectively,
as a financial advisory fee and as compensation for the Nassau designees who
served on the Board of Directors of the Company. Nassau will be paid $450,000
as a financial advisory fee for 2000.
As of December 31, 1998 and 1999, the Company has made loans aggregating
$760,000 and $575,000, respectively, to certain of its executives. Such loans
bear interest at a rate of 6% per annum and are included in other assets.
14. Net Loss Per Common Share
The following table sets forth the computation of net loss per common
share:
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- ---------
<S> <C> <C> <C>
(in thousands, except per
share amounts)
Numerator:
Net loss...................................... $(32,686) $(76,753) $(225,716)
Dividends and accretion on redeemable
preferred stock.............................. (8,904) (18,285) (81,633)
-------- -------- ---------
Numerator for net loss per common share....... $(41,590) $(95,038) $(307,349)
======== ======== =========
Denominator:
Denominator for net loss per common share--
weighted average
number of common shares outstanding.......... 641 831 852
======== ======== =========
Net loss per common share..................... $ (64.93) $(114.42) $ (360.88)
======== ======== =========
</TABLE>
Options and warrants to purchase an aggregate of 242,768, 372,885 and
496,729 shares of common stock were outstanding as of December 31, 1997, 1998
and 1999, respectively, but a computation of diluted net loss per common share
has not been presented, as the effect of such securities would be anti-
dilutive.
15. Supplemental Disclosure of Noncash Investing and Financing Activities
Information with respect to noncash investing and financing activities is
as follows:
In connection with the Senior Discounts Notes, the Company recognized
noncash interest expense of $29.6 and $36.4 million in 1998 and 1999,
respectively.
During 1999, the Company issued stock dividends to the holders of the
Series E Preferred Stock and Series F Preferred Stock of 5,004 shares and
4,177 shares, respectively.
In 1997, certain 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.
F-39
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1997, warrants with a fair value of $1.5 million were granted to
Newcourt and warrants with a fair value of $525,000 were granted to GECC.
In connection with options granted to employees under the KMC Holdings
Stock Option Plan in 1998 and 1999, and under the KMC Telecom Stock Option
Plan in 1997, cumulative deferred compensation obligations of $15,579,000,
$27,906,000 and $50,972,000, have been established in 1997, 1998 and 1999,
respectively, with offsetting credits to additional paid-in capital.
Noncash compensation expense of $9,014,000, $23,758,000 and $23,947,000 in
1997, 1998 and 1999, respectively, was recognized in connection with such
options. In connection with options granted to individuals employed by
certain affiliates of the Company in 1997, 1998 and 1999, the Company
recognized noncash compensation expense of $4,856,000, $4,668,000 and
$5,886,000, respectively. In addition, during 1998 the Company cancelled
all of the then outstanding options granted under the KMC Telecom Stock
Option Plan, resulting in the reversal of previously recognized
compensation expense of $21. 3 million.
16. Financial Instruments
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.
Investments Held for Future Capital Expenditures
The carrying amounts and fair value are reported at amortized cost since
these securities are to be held to maturity.
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 flows at the Company's incremental borrowing rates.
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 flows.
Interest Rate Swap
At December 31, 1999, the Company had an interest rate swap agreement to
reduce the impact on interest expense of fluctuations in interest rates on a
portion of its variable rate debt. The effect of this agreement is to limit
the Company's interest rate exposure on a notional amount of debt of $125
million. The fair value was estimated as the amount the Company would receive
if the swap agreement was terminated at December 31, 1999.
F-40
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Estimated Fair Values
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows (in millions):
<TABLE>
<CAPTION>
1998 1999
--------------- ---------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- ------
<S> <C> <C> <C> <C>
Cash and cash equivalents.................. $ 21.1 $ 21.1 $ 86.0 $ 86.0
Investments held for future capital
expenditures.............................. 27.9 27.9 -- --
Long-term debt:
Floating rate............................. 41.4 41.4 235.0 235.0
Fixed rate--Senior Discount Notes......... 267.8 249.6 301.1 275.7
Fixed rate--Senior Notes.................. -- -- 275.0 263.5
Redeemable equity instruments:
Series E Preferred Stock.................. -- -- 50.8 57.7
Series F Preferred Stock.................. -- -- 41.4 39.2
Series A Preferred Stock.................. 30.4 38.9 71.3 86.5
Series C Preferred Stock.................. 21.6 21.6 40.3 48.0
Redeemable common stock................... 22.3 14.5 33.8 34.4
Redeemable common stock warrants.......... .7 .7 12.9 13.7
Interest rate swap (asset)................. -- -- -- 3.9
</TABLE>
Concentrations of Credit Risk
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 accounted for
more than 10% of revenue, excluding reciprocal compensation revenue, as
described below, for any of the years ended December 31, 1997, 1998 or 1999.
The Company maintains interconnection agreements with the major incumbent
local exchange carriers ("ILECs") in each state in which it operates. Among
other things, these contracts govern the reciprocal amounts to be billed by
competitive carriers for terminating local traffic of Internet service
providers ("ISPs") in each state. ILECs around the country have been
contesting whether the obligation to pay reciprocal compensation to
competitive local exchange carriers should apply to local telephone calls from
an ILEC's customers to ISPs served by competitive local exchange carriers. The
ILECs claim that this traffic is interstate in nature and therefore should be
exempt from compensation arrangements applicable to local intrastate calls.
Competitive local exchange carriers have contended that the interconnection
agreements provide no exception for local calls to ISPs and reciprocal
compensation is therefore applicable. The ILECs have threatened to withhold,
and in many cases have withheld, reciprocal compensation to competitive local
exchange carriers for the transport and termination of these calls. During
1998 and 1999, the Company recognized revenue from these ILECs of
approximately $2.9 million and $9.7 million, or 12.9% and 15.1% of 1998 and
1999 revenue, respectively, for these services. Payments of approximately
$135,000 and $1.6 million were received from the ILECs during 1998 and 1999,
respectively.
The Company determined to recognize this revenue because management
concluded, based upon all of the facts and circumstances available to them at
the time, including numerous state public service commission and state and
federal court decisions upholding competitive local exchange carriers'
entitlement to reciprocal
F-41
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
compensation for such calls, that realization of those amounts was reasonably
assured. On October 13, 1999, however, the Louisiana Public Service Commission
ruled that local traffic to Internet service providers in Louisiana is not
eligible for reciprocal compensation. As a result of that ruling, management
determined that the Company could no longer conclude that realization of
amounts attributable to reciprocal compensation for termination of local calls
to Internet service providers in Louisiana was reasonably assured.
Accordingly, the Company recorded an adjustment to reduce revenue in the
quarter ended September 30, 1999, which reversed all reciprocal compensation
revenue previously recognized related to Internet service provider traffic in
Louisiana for the entire year of 1998 and for the first nine months of 1999.
The adjustment amounted to $4.4 million, of which $1.1 million relates to the
year ended December 31, 1998 and $3.3 million relates to the nine months ended
September 30, 1999.
South Carolina has also ruled that ILECs are not obligated to pay
reciprocal compensation for termination of local calls to ISPs. As a result,
unless that decision is reversed we will not recognize revenue for such calls
in South Carolina.
Currently, over 30 state commissions and several federal and state courts
have ruled that reciprocal compensation arrangements do apply to calls to
ISPs, while four jurisdictions have ruled to the contrary. A number of these
rulings are subject to appeal. Additional disputes over the appropriate
treatment of ISP traffic are pending in other states. On February 26, 1999,
the Federal Communications Commission issued a declaratory ruling determining
that ISP traffic is interstate for jurisdictional purposes, but that its
current rules neither require nor prohibit the payment of reciprocal
compensation for such calls. In the absence of a federal rule, the Federal
Communications Commission determined that state commissions have authority to
interpret and enforce the reciprocal compensation provisions of existing
interconnection agreements, and to determine the appropriate treatment of ISP
traffic in arbitrating new agreements. The Federal Communications Commission
also requested comment on alternative federal rules to govern compensation for
such calls in the future. In response to the Federal Communications Commission
ruling some ILECs have asked state commissions to reopen previous decisions
requiring the payment of reciprocal compensation on ISP calls. Some ILECs and
some competitive local exchange carriers appealed the Federal Communications
Commission's declaratory ruling to the United States Court of Appeals for the
District of Columbia Circuit, which issued a decision on March 24, 2000,
vacating the declaratory ruling. The court stated that the Federal
Communications Commission had not adequately explained its conclusion that
calls to ISPs should not be treated as local traffic for reciprocal
compensation purposes. Management views this decision as favorable, but the
court's direction to the Federal Communications Commission to re-examine the
issue will likely result in further delay in the resolution of pending
compensation disputes, and there can be no assurance as to the ultimate
outcome of these proceedings.
The Company accounts for reciprocal compensation with the ILECs, including
the activity associated with the disputed ISP traffic, as local traffic
pursuant to the terms of its interconnection agreements in all jurisdictions
other than Louisiana and South Carolina. Accordingly, revenue is recognized in
the period that the traffic is terminated. The circumstances surrounding the
disputes are considered by management periodically in determining whether
reserves against unpaid balances are warranted. As of December 31, 1999, no
reserves have been considered necessary by management.
17. Supplemental Guarantor Information
In May 1999, KMC Holdings sold $275 million aggregate principal amount of
Senior Notes. KMC Telecom Financing Inc. (the "Guarantor"), a wholly-owned
subsidiary of the Company, has fully and unconditionally guaranteed the
Company's obligations under these notes. Separate financial statements and
other disclosures of the Guarantor are not presented because management
determined the information is not material to investors. No
F-42
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
restrictions exist on the ability of the Guarantor to make distributions to
the Company except to the extent provided by law generally (adequate capital
to pay dividends under corporate laws) and restrictions contained in the
Company's credit facilities.
The following condensed consolidating financial information presents the
results of operations, financial position and cash flows of KMC Holdings (on a
stand alone basis), the guarantor subsidiary (on a stand alone basis), the
non-guarantor subsidiaries (on a combined basis) and the eliminations
necessary to arrive at the consolidated results for the Company at December
31, 1999 and for the year then ended. The non-guarantor subsidiaries include
KMC Telecom, KMC Telecom II, KMC Telecom III, KMC Telecom Virginia, Inc. and
KMC Telecom Financial Services LLC (collectively, the "Non-Guarantor
Subsidiaries").
F-43
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Guarantor/Non-Guarantor Consolidating Balance Sheet
December 31, 1999
(in thousands)
<TABLE>
<CAPTION>
KMC Telecom
Holdings, Non- Consolidated
Inc. Guarantor KMC Telecom
Parent Co. Guarantor Subsidiaries Eliminations Holdings, Inc.
----------- --------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash
equivalents
(overdraft)........... $ (833) $ -- $ 86,799 $ -- $ 85,966
Restricted
investments........... -- 37,125 -- -- 37,125
Accounts receivable,
net................... 6 -- 27,367 -- 27,373
Prepaid expenses and
other current
assets................ 1,249 -- 126 -- 1,375
Amounts due from
subsidiaries.......... 72,972 -- (72,972) -- --
--------- -------- --------- --------- ---------
Total current assets.... 73,394 37,125 41,320 -- 151,839
Long-term restricted
investments............ -- 51,446 -- -- 51,446
Networks and equipment,
net.................... 58,531 -- 580,793 -- 639,324
Intangible assets, net.. 1,388 -- 2,214 -- 3,602
Deferred financing
costs, net............. 21,031 -- 17,785 -- 38,816
Loans receivable from
subsidiaries........... 590,103 (85,329) (504,774) -- --
Other assets............ 825 -- 188 -- 1,013
--------- -------- --------- --------- ---------
Total assets............ $ 745,272 $ 3,242 $ 137,526 $ -- $ 886,040
========= ======== ========= ========= =========
Liabilities, redeemable
and nonredeemable
equity (deficiency)
Current liabilities:
Accounts payable....... $ 40,984 $ -- $ 126,506 $ -- $ 167,490
Accrued expenses....... 14,967 -- 22,080 -- 37,047
Deferred revenue....... -- -- 4,309 -- 4,309
--------- -------- --------- --------- ---------
Total current
liabilities............ 55,951 -- 152,895 -- 208,846
Notes payable........... -- -- 235,000 -- 235,000
Senior notes payable.... 275,000 -- -- -- 275,000
Senior discount notes
payable................ 301,137 -- -- -- 301,137
Losses of subsidiaries
in excess of basis..... 247,127 -- -- (247,127) --
--------- -------- --------- --------- ---------
Total liabilities....... 879,215 -- 387,895 (247,127) 1,019,983
Redeemable equity:
Senior redeemable,
exchangeable, PIK
preferred stock:
Series E............. 50,770 -- -- -- 50,770
Series F............. 41,370 -- -- -- 41,370
Redeemable cumulative
convertible preferred
stock:
Series A............. 71,349 -- -- -- 71,349
Series C............. 40,301 -- -- -- 40,301
Redeemable common
stock................. 33,755 -- -- -- 33,755
Redeemable common
stock warrants........ 12,925 -- -- -- 12,925
--------- -------- --------- --------- ---------
Total redeemable
equity................. 250,470 -- -- -- 250,470
Nonredeemable equity
(deficiency):
Common stock........... 6 -- -- 6
Additional paid-in
capital............... -- -- -- -- --
Unearned
compensation.......... (9,163) -- -- -- (9,163)
Accumulated deficit.... (375,256) 3,242 (250,369) 247,127 (375,256)
--------- -------- --------- --------- ---------
Total nonredeemable
equity (deficiency).... (384,413) 3,242 (250,369) 247,127 (384,413)
--------- -------- --------- --------- ---------
$ 745,272 $ 3,242 $ 137,526 $ -- $ 886,040
========= ======== ========= ========= =========
</TABLE>
F-44
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Guarantor/Non-Guarantor Consolidating Statement of Operations
Year Ended December 31, 1999
(in thousands)
<TABLE>
<CAPTION>
Consolidated
KMC Telecom Non- KMC Telecom
Holdings, Inc. Guarantor Holdings,
Parent Co. Guarantor Subsidiaries Eliminations Inc.
-------------- --------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenue................. $ -- $ -- $ 64,352 $ (39) $ 64,313
Operating expenses:
Network operating
costs:
Non-cash stock
compensation....... 2,387 -- -- -- 2,387
Other network
operating costs.... -- -- 81,717 (39) 81,678
Selling, general and
administrative:
Non-cash stock
compensation....... 27,446 -- -- -- 27,446
Other selling,
general and
administrative
costs.............. 40,714 -- 43,720 -- 84,434
Depreciation and
amortization......... 3,104 -- 25,973 -- 29,077
--------- ------ --------- -------- ---------
Total operating
expenses............... 73,651 -- 151,410 (39) 225,022
--------- ------ --------- -------- ---------
Loss from operations.... (73,651) -- (87,058) -- (160,709)
Intercompany charges.... 72,972 -- (72,972) -- --
Other expense........... (4,297) -- -- -- (4,297)
Interest income......... 1,872 3,242 3,587 -- 8,701
Interest expense........ (36,729) -- (32,682) -- (69,411)
Equity in net loss of
subsidiaries........... (185,883) -- -- 185,883 --
--------- ------ --------- -------- ---------
Net income (loss)....... (225,716) 3,242 (189,125) 185,883 (225,716)
Dividends and accretion
on redeemable preferred
stock.................. (81,633) -- -- -- (81,633)
--------- ------ --------- -------- ---------
Net income (loss)
applicable to common
shareholders........... $(307,349) $3,242 $(189,125) $185,883 $(307,349)
========= ====== ========= ======== =========
</TABLE>
F-45
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Guarantor/Non-Guarantor Consolidating Statement of Cash Flows
Year Ended December 31, 1999
(in thousands)
<TABLE>
<CAPTION>
Consolidated
KMC Telecom Non- KMC Telecom
Holdings, Inc. Guarantor Holdings,
Parent Co. Guarantor Subsidiaries Eliminations Inc.
-------------- --------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Operating activities
Net loss................ $(225,716) $ 3,242 $(189,125) $ 185,883 $(225,716)
Adjustments to reconcile
net loss to net cash
used in operating
activities:
Equity in net loss of
subsidiaries......... 185,883 -- -- (185,883) --
Depreciation and
amortization......... 3,104 -- 25,973 -- 29,077
Non-cash interest
expense.............. 36,963 -- (5,822) -- 31,141
Non-cash stock option
compenstion expense.. 29,833 -- -- -- 29,833
Changes in assets and
liabilities:
Accounts
receivable......... (6) -- (19,828) -- (19,834)
Prepaid expense and
other current
assets............. (917) -- 857 -- (60)
Accounts payable.... 441 -- 28,878 -- 29,319
Accrued expenses.... 9,075 -- 15,152 -- 24,227
Amounts due from
subsidiaries....... (52,050) -- 52,050 -- --
Other assets........ 1,128 -- 2,592 -- 3,720
--------- ------- --------- --------- ---------
Net cash provided by
(used in) operating
activities............. (12,262) 3,242 (89,273) -- (98,293)
--------- ------- --------- --------- ---------
Investing activities
Loans receivable from
subsidiaries........... (324,390) 85,329 239,061 -- --
Construction of networks
and purchases of
equipment.............. (18,327) -- (300,209) -- (318,536)
Acquisitions of
franchises,
authorizations and
related assets......... (796) -- (1,196) -- (1,992)
Redemption (purchase) of
investments............ -- (88,571) 27,920 104,101 43,450
--------- ------- --------- --------- ---------
Net cash used in
investing activities... (343,513) (3,242) (34,424) 104,101 (277,078)
--------- ------- --------- --------- ---------
Financing activities
Proceeds from issuance
of preferred stock and
related warrants, net
of issuance costs...... 91,001 -- -- -- 91,001
Proceeds from exercise
of stock options....... 333 -- -- -- 333
Proceeds from issuance
of senior notes, net of
issuance costs and
purchase of portfolio
of restricted
investments............ 262,387 -- -- (104,101) 158,286
Proceeds from senior
secured credit
facility, net of
issuance costs......... -- -- 192,836 -- 192,836
Issuance costs of Lucent
facility............... -- -- (2,300) -- (2,300)
--------- ------- --------- --------- ---------
Net cash provided by
financing activities... 353,721 -- 190,536 (104,101) 440,156
--------- ------- --------- --------- ---------
Net increase (decrease)
in cash and cash
equivalents............ (2,054) -- 66,839 -- 64,785
Cash and cash
equivalents, beginning
of year................ 1,221 -- 19,960 -- 21,181
--------- ------- --------- --------- ---------
Cash and cash
equivalents, end of
year................... $ (833) $ -- $ 86,799 $ -- $ 85,966
========= ======= ========= ========= =========
</TABLE>
F-46
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
18. Subsequent Events
Amended Senior Secured Credit Facility
During the first quarter of 2000, KMC Telecom, KMC Telecom II, KMC Telecom
of Virginia and KMC Telecom III (the "Borrowers"), amended, restated and
combined the Senior Secured Credit Facility and the Lucent Facility by
entering into a $700 million Loan and Security Agreement (the "Amended Senior
Secured Credit Facility") with a group of lenders led by Newcourt Commercial
Finance Corporation, GE Capital, Canadian Imperial Bank of Commerce ("CIBC"),
First Union National Bank and Lucent Technologies, Inc. (the "Lenders").
The Amended Senior Secured Credit Facility includes a $175 million reducing
revolver facility (the "Revolver"), a $75 million term loan (the "Term Loan")
and a $450 million term loan facility (the "Lucent Term Loan").
The Revolver will mature on April 1, 2007. Proceeds from the Revolver can
be used to finance the purchase of certain equipment, transaction costs and,
upon attainment of certain financial conditions, for working capital and other
general corporate purposes. The aggregate commitment of the Lenders under the
Revolver will be reduced on each payment date beginning April 1, 2003. The
initial quarterly commitment reduction is 5.0%, reducing to 3.75% on July 1,
2003 and increasing to 6.25% on July 1, 2004, and further increasing to 7.50%
on July 1, 2006. Commencing with the fiscal year ending December 31, 2001, the
aggregate Revolver commitment will be further reduced by an amount equal to
50% of excess operating cash flows (as defined in the Facility) for the prior
fiscal year until the Borrowers achieve certain financial conditions. The
Borrowers must pay an annual commitment fee on the unused portion of the
Revolver ranging from .75% to 1.25%.
The Term Loan is payable in twenty consecutive quarterly installments of
$188,000 beginning on April 1, 2002 and two final installments of $35.6
million each on April 1, 2007 and July 1, 2007. Proceeds from the Term Loan
can be used to finance the purchase of certain equipment, transaction costs,
working capital and other general corporate purposes.
The Lucent Term Loan provides for an aggregate commitment of up to $450
million. Proceeds from the Lucent Term Loan can be used to purchase Lucent
products or to reimburse the Borrowers for Lucent products previously
purchased with cash or other sources of liquidity. The Lucent Term Loan will
mature on July 1, 2007 and has required quarterly amortization beginning on
July 1, 2003 of 5%. The amortization decreases to 3.75% per quarter beginning
on October 1, 2003, increases to 6.25% on October 1, 2004 and further
increases to 7.50% on October 1, 2006. An annual commitment fee of 1.50% is
payable for any unused portion of the Lucent Term Loan.
The Amended Senior Secured Credit Facility will bear interest payable at
the Borrowers' option, at (a) the "Applicable Base Rate Margin" (which
generally ranges from 2.00% to 3.25%) plus the greater of (i) the
administrative agent's prime rate or (ii) the overnight federal funds rate
plus .5% or (b) the "Applicable LIBOR Margin" (which generally ranges from
3.00% to 4.25%) plus LIBOR, as defined. "Applicable Base Rate Margin" interest
is payable quarterly while "Applicable LIBOR Margin" interest is payable at
the end of each applicable interest period or at least every three months. If
a payment default were to occur, the interest rate will be increased by four
percentage points. If any other event of default shall occur, the interest
rate will be increased by two percentage points.
KMC Holdings has unconditionally guaranteed the repayment of the Amended
Senior Secured Credit Facility when such repayment is due, whether at
maturity, upon acceleration, or otherwise. KMC Holdings has pledged the shares
of each of the Borrowers to the Lenders to collateralize its obligations under
the guaranty. In addition, the Borrowers have each pledged all of their assets
to the Lenders.
F-47
<PAGE>
KMC TELECOM HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Amended Senior Secured Credit Facility contains a number of affirmative
and negative covenants, including a covenant requiring the Borrowers to obtain
cash capital contributions from KMC Holdings of at least $185 million prior to
April 1, 2001. KMC Holdings has secured a financing commitment from Lucent for
$100 million in PIK Preferred Stock towards this requirement and currently
contemplates raising the $85 million balance through private or public sales
of securities in the capital markets. Additional affirmative and negative
covenants include, among others, 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 KMC Holdings, create subsidiaries, transfer
any permits or licenses, or incur additional indebtedness or act as guarantor
for the debt of any person, subject to certain conditions.
The Borrowers are required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a ratio of total
debt to contributed capital, certain minimum revenues, maximum EBITDA losses
and minimum EBITDA, maximum capital expenditures and minimum access lines, a
maximum total leverage ratio, a minimum debt service coverage ratio, a minimum
fixed charge coverage ratio and a maximum consolidated leverage ratio. The
covenants become more restrictive upon the earlier of (i) March 31, 2002 and
(ii) after the Borrowers achieve positive EBITDA on a combined basis for two
consecutive fiscal quarters and a total leverage ratio (as defined) equal to
or less than 8 to 1.
Failure to satisfy any of the financial covenants will constitute an event
of default under the Amended Senior Secured Credit Facility permitting the
Lenders, after notice, to terminate the commitment and/or accelerate payment
of outstanding indebtedness. The Amended Senior Secured Credit Facility also
includes other customary events of default, including, without limitation, a
cross-default to other material indebtedness, material undischarged judgments,
bankruptcy, loss of a material franchise or material license, breach of
representations and warranties, a material adverse change, and the occurrence
of a change of control.
F-48
<PAGE>
[Diagram of our Huntsville, Alabama network, our most mature market]
<PAGE>
[LOGO OF KMC TELECOM]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than
underwriting discounts and commissions. All the amounts shown are estimated
except the SEC registration fee, the National Association of Securities
Dealers filing fee and the Nasdaq National Market listing fee.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee................. $52,800
NASD filing fee..................................................... 20,500
Nasdaq National Market listing fee.................................. *
Printing and engraving expenses..................................... *
Legal fees and expenses............................................. *
Accounting fees and expenses........................................ *
Blue Sky fees and expenses (including legal fees)................... *
Transfer agent and registrar fees and expenses...................... *
Miscellaneous....................................................... *
-------
Total........................................................... $ *
=======
</TABLE>
--------
* To be filed by amendment.
Item 14. Indemnification of Directors and Officers
Section 102 of the Delaware General Corporation Law ("DGCL"), as amended,
allows a corporation to eliminate the personal liability of directors of a
corporation to the corporation or its stockholders for monetary damages for a
breach of fiduciary duty as a director, except where the director breached his
duty of loyalty, failed to act in good faith, engaged in intentional
misconduct or knowingly violated a law, authorized the payment of a dividend
or approved a stock repurchase in violation of Delaware corporate law or
obtained an improper personal benefit.
Section 145 of the DGCL provides, among other things, that we may indemnify
any person who was or is a party or is threatened to be made a party to any
threatened, pending or completed action, suit or proceeding (other than an
action by or in our right) by reason of the fact that the person is or was a
director, officer, agent or employee of ours or is or was serving at our
request as a director, officer, agent, or employee of another corporation,
partnership, joint venture, trust or other enterprise, against expenses,
including attorneys' fees, judgment, fines and amounts paid in settlement
actually and reasonably incurred by the person in connection with such action,
suit or proceeding. The power to indemnify applies (a) if such person is
successful on the merits or otherwise in defense of any action, suit or
proceeding, or (b) if such person acted in good faith and in a manner he
reasonably believed to be in our best interest, or not opposed to our best
interest, and with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful. The power to indemnify
applies to actions brought by or in our right as well, but only to the extent
of defense expenses (including attorneys' fees but excluding amounts paid in
settlement) actually and reasonably incurred and not to any satisfaction of
judgment or settlement of the claim itself, and with the further limitation
that in such actions no indemnification shall be made in the event of any
adjudication of negligence or misconduct in the performance of his duties to
us, unless the court believes that in light of all the circumstances
indemnification should apply.
Section 174 of the DGCL provides, among other things, that a director, who
willfully or negligently approves of an unlawful payment of dividends or an
unlawful stock purchase or redemption, may be held liable for such actions. A
director who was either absent when the unlawful actions were approved or
dissented at the time, may avoid liability by causing his or her dissent to
such actions to be entered in the books containing the minutes of the meetings
of the board of directors at the time such action occurred or immediately
after such absent director receives notice of the unlawful acts.
II-1
<PAGE>
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 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 beach
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 officer 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).
Prior to the completion of this Offering, we intend to enter into indemnity
agreements with each of our directors and executive officers to give them
additional contractual assurances regarding the scope of the indemnification
described above and to provide additional procedural protections. In addition,
we intend to obtain directors' and officers' insurance in the amount of
$ million providing indemnification for our directors, officers and
certain employees for certain liabilities. We believe that these
indemnification provisions and agreements are necessary to attract and retain
qualified directors and officers.
The limitation of liability and indemnification provisions in our Amended
and Restated Certificate of Incorporation and Amended and Restated Bylaws may
discourage stockholders from bringing a lawsuit against directors for breach
of their fiduciary duty. They may also have the effect of reducing the
likelihood of derivative litigation against directors and officers, even
though such an action, if successful, might otherwise benefit us and our
stockholders. Furthermore, a stockholder's investment may be adversely
affected to the extent we pay the costs of settlement and damage awards
against directors and officers pursuant to these indemnification provisions.
At present, there is no pending material litigation or proceeding involving
any of our directors, officers or employees regarding which indemnification is
sought, nor are we aware of any threatened litigation that may result in
claims for indemnification.
Item 15. Recent Sales of Unregistered Securities
In the last three years, we sold the following securities:
On September 22, 1997, KMC Telecom Holdings, Inc. sold to AT&T Credit
Corporation 91,268 shares of its Common Stock. In the purchase agreement in
respect of such sale, AT&T Credit Corporation represented that the shares were
being acquired for the Purchaser's own investment and not with a present view
to or for sale in connection with any distribution thereof and that the
Purchaser is an "institutional accredited investor" as defined in Regulation D
under the Securities Act.
On September 22, 1997, AT&T Credit Corporation exercised a warrant to
purchase 20,752.5 shares of Class A Common Stock of KMC Telecom Inc. Also on
September 22, 1997, CoreStates Bank, N.A. exercised a warrant to purchase
6,917.5 shares of Class A Common Stock of KMC Telecom Inc. 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.
II-2
<PAGE>
Pursuant to a Stock Purchase Agreement dated September 22, 1997, KMC
Telecom Holdings, Inc. sold to each of Harold N. Kamine and Nassau 13,835
shares of Common Stock.
On October 31, 1997, KMC Telecom Holdings sold 100,000 and 50,000 shares of
its Series C Cumulative Convertible Preferred Stock to General Electric
Capital Corporation and CoreStates Holdings, Inc., respectively. Also on
October 31, 1997, KMC Telecom Holdings, Inc. sold 25,000 shares of its Series
D Cumulative Convertible Preferred Stock to Nassau. In the purchase agreement
in respect of such sales, such purchasers represented that the shares were
being acquired for such purchaser's own investment and not with a present view
to or for sale in connection with any distribution thereof and that each
purchaser is an "institutional accredited investor" as defined in Regulation D
under the Securities Act. In January 1998, Nassau exercised its conversion
rights and converted all of its shares of Series D Preferred Stock into an
equal number of Series C Preferred Stock.
On January 29, 1998, we sold 460,800 units to Morgan Stanley & Co.
Incorporated, as Placement Agent. Each unit consisted of one 12 1/2% Senior
Discount Note due 2008, with a principal amount at maturity of $1,000, and one
warrant to purchase 0.21785 shares of common stock. The exercise price of the
warrants is $.01 per share of common stock. The aggregate number of shares of
common stock subject to the warrants is 100,385. The aggregate offering price
of the units was $249,965,568 and the aggregate underwriting discounts and
commissions were $9,998,623. Of the aggregate net proceeds of the offering of
the units, after underwriting discounts, commissions and certain expenses of
the offering, approximately $10,446,000 was attributed to the warrants. The
sale of the units to the Placement Agent was made in reliance upon the
exemption from the registration requirements of the Securities Act of 1933, as
amended, provided by Section 4(2) of that Act, on the basis that the
transaction did not involve a public offering. The Placement Agent agreed that
any resales which it made would be made only (i) to qualified institutional
buyers as defined in Rule 144A under the Securities Act, (ii) to institutional
accredited investors as defined in Rule 501(a)(1), (2), (3) or (7) under the
Securities Act, or (iii) outside the United States to persons other than U.S.
persons in reliance upon Regulation S under the Securities Act.
In September 1998, we granted options to purchase an aggregate of 262,500
shares of our common stock to our employees and employees of certain of our
affiliates under the 1998 Stock Purchase and Option Plan for Key Employees of
KMC Telecom Holdings, Inc. and Affiliates. The majority of these options were
issued to replace options to purchase shares of common stock of our
subsidiary, KMC Telecom Inc., which had been issued in earlier years, prior to
our organization and the establishment of the present holding company
structure. No consideration was received by us for the issuance of the
options. The options have various exercise prices with 157,500 exercisable at
an exercise price of $20 per share, 52,500 exercisable at an exercise price of
$30 per share, and 52,500 exercisable at an exercise price of $40 per share.
The issuance of the options was made in reliance upon the exemption from the
registration requirements of the Securities Act provided by Section 4(2) of
that Act, on the basis that the transaction did not involve a public offering.
On January 1, 1999, July 1, 1999 and October 1, 1999, we granted options to
purchase an aggregate of 82,342 shares of our Common Stock to our employees
and employees of certain of our affiliates under the 1998 Stock Purchase and
Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates. No
consideration was received by us for the issuance of the options. The options
have various exercise prices with 67,509 exercisable at an exercise price of
$125 per share, 2,933 exercisable at an exercise price of $225 per share, and
11,900 exercisable at an exercise price of $250 per share. The issuance of the
options was made in reliance upon the exemption from the registration
requirements of the Securities Act provided by Section 4(2) of that Act, on
the basis that the transaction did not involve a public offering.
On January 25, 1999, one individual exercised stock options to purchase
14,800 shares of common stock previously granted to that individual under the
1998 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings,
Inc. and Affiliates for aggregate gross proceeds of $333,000. The sale was
made in
II-3
<PAGE>
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act, on the basis that the transaction did not involve a public
offering. An Option Exercise and Investment Representation Statement signed by
the individual contains representations as to his investment intent and
imposes substantial restrictions upon transfer of the securities.
On February 4, 1999, we issued units (the "Units") consisting of an
aggregate of 25,000 shares of Series E Senior Redeemable, Exchangeable, PIK
Preferred Stock, par value $.01 per share (the "Series E Preferred Stock"),
and 40,000 shares of Series F Senior Redeemable, Exchangeable, PIK Preferred
Stock, par value $.01 per share (the "Series F Preferred Stock"), and warrants
(the "Warrants") to purchase approximately 24,660 shares of our Common Stock,
par value $.01 per share, for aggregate gross proceeds of $65.0 million.
Newcourt Commercial Finance Corporation ("Newcourt Finance"), a subsidiary of
Newcourt Capital, Inc. ("Newcourt"), acquired all of the Series E Preferred
Stock, 10,000 shares of the Series F Preferred Stock and Warrants to purchase
18,227 shares of common stock. Lucent Technologies Inc. ("Lucent") acquired
30,000 shares of the Series F Preferred Stock and Warrants to purchase 6,433
shares of Common Stock.
The sale of the Units to Newcourt Finance and Lucent was made in reliance
on the exemption from registration provided by Section 4(2) of the Securities
Act, on the basis that the transaction did not involve a public offering. The
offer and sale was made to only two institutional investors. In the Securities
Purchase Agreement applicable to the transaction, Newcourt Finance and Lucent
each made representations as to their investment intent. The Securities
Purchase Agreement places substantial restrictions upon transfer of the
securities and the certificates representing the securities have been legended
to that effect.
The Warrants issued as part of the Units entitle the holders of the
Warrants to purchase an aggregate of 24,660 shares of Common Stock and are
exercisable from February 4, 2000 through February 1, 2009 at a price of $.01
per share.
On April 30, 1999, we issued units (the "Units") consisting of an aggregate
of 35,000 shares of Series E Senior Redeemable, Exchangeable PIK Preferred
Stock, par value $.01 per share (the "Series E Preferred Stock") and an
aggregate of 127,932 warrants (the "Warrants"), each to purchase 0.471756
shares of our Common Stock, par value $.01 per share, to an institutional
investor for aggregate gross proceeds of $35.0 million.
The sale of the Units was made in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act, on the basis that
the transaction did not involve a public offering. The offer and sale was made
to only one institutional investor. In the Securities Purchase Agreement
applicable to the transaction, such institutional investor made
representations as to its investment intent. The Securities Purchase Agreement
places substantial restrictions upon transfer of the securities and the
certificates representing the securities have been legended to that effect.
The Warrants issued as part of the Units entitle the holders of the Warrants
to purchase an aggregate of 60,353 shares of Common Stock and are exercisable
from February 4, 2000 through February 1, 2009 at a price of $.01 per share.
On May 24, 1999, we sold $275.0 million aggregate principal amount of 13%
Senior Notes due 2009 to Morgan Stanley & Co. Incorporated, as representative
of certain initial purchasers. The sale of the Senior Notes to the initial
purchasers was made in reliance upon the exemption from the registration
requirements of the Securities Act of 1933, as amended, provided by Section
4(2) of that Act, on the basis that the transaction did not involve a public
offering. The initial purchasers agreed that any resales which they made would
be made only (i) to qualified institutional buyers as defined in Rule 144A
under the Securities Act, (ii) to institutional accredited investors as
defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act, or (iii)
outside the United States to persons other than U.S. persons in reliance upon
Regulation S under the Securities Act.
On December 16, 1999, one institutional investor exercised 50 warrants to
purchase an aggregate of 10 shares of our common stock for aggregate gross
proceeds of $0.10. The issuance of the shares upon exercise of the warrants
was made in reliance on the exemption from registration provided by Section
4(2) of the Securities
II-4
<PAGE>
Act, on the basis that the transaction did not involve a public offering. The
Warrant Agreement applicable to the warrants contains representations as to
such investor's investment intent and imposes substantial restrictions upon
transfer of the securities.
On February 1, 2000, an institutional investor exercised 4,250 warrants to
purchase 925 shares of Common Stock pursuant to a Warrant Agreement dated as
of January 29, 1998. The issuance of the shares upon exercise of the warrants
was made in reliance on the exemption from registration provided by Section
4(2) of the Securities Act, on the basis that the transaction did not involve
a public offering. The Warrant Agreement imposes substantial restrictions upon
transfer of the securities and the certificates representing the securities
have been legended to that effect.
On February 28, 2000, an institutional investor exercised 700 warrants to
purchase 152 shares of Common Stock pursuant to a Warrant Agreement dated as
of January 29, 1998. The issuance of the shares upon exercise of the warrants
was made in reliance on the exemption from registration provided by Section
4(2) of the Securities Act, on the basis that the transaction did not involve
a public offering. The Warrant Agreement imposes substantial restrictions upon
transfer of the securities and the certificates representing the securities
have been legended to that effect.
On July 7, 2000, we issued an aggregate of 539,989 shares of Series G
Convertible Preferred Stock, par value $.01 per share (the "Series G Preferred
Stock") to 7 accredited investors for aggregate gross proceeds of $182.5
million.
The sale of the Series G Preferred Stock was made in reliance on the
exemption from registration provided by Rule 506 of Regulation D and Section
4(2) of the Securities Act, on the basis that the transaction did not involve
a public offering. The offer and sale was made only to accredited investors.
In the Securities Purchase Agreement applicable to the transaction, each
investor made representations as to their investment intent. The Securities
Purchase Agreement places substantial restrictions upon transfer of the
securities and the certificates representing the securities have been legended
to that effect.
Item 16. Exhibits and Consolidated Financial Statement Schedules
(a) Exhibits
See Exhibit Index.
(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-10).
Schedule II -- Valuation and Qualifying Accounts (Included at page 11)
All other schedules are omitted because they are inapplicable or the
requested information is shown in the consolidated financial statements or
related notes.
Item 17. Undertakings
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreements certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
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
II-5
<PAGE>
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.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus 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-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement on Form S-1 to be signed on its
behalf by the undersigned, thereunto duly authorized, in the Town of
Bedminster, State of New Jersey, on the 19th day of September, 2000.
KMC TELECOM HOLDINGS, INC.
/s/ William F. Lenahan
By: _________________________________
William F. Lenahan
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS that each individual whose signature
appears below hereby constitutes and appoints William F. Lenahan and William
Stewart and each of them individually, his true and lawful agent, proxy and
attorney-in-fact, with full power of substitution and resubstitution, for him
and in his name, place and stead, in any and all capacities, to (i) act on,
sign and file with the Securities and Exchange Commission any and all
amendments to this registration statement (which includes any additional
registration statement under Rule 462(b)) together with all schedules and
exhibits thereto, (ii) act on, sign and file with the Securities and Exchange
Commission any and all exhibits to this registration statement and any and all
exhibits and schedules thereto, (iii) act on, sign and file any and all
applications, registration statements, notices, reports and other documents
necessary or appropriate in connection with the registration or qualification
under foreign and state securities laws of the securities described in this
registration statement or any amendment thereto, or obtain an exemption
therefrom, in connection with the offering described therein, (iv) act on,
sign and file any and all applications, notices, reports and other documents
necessary or appropriate in connection with listing the common stock described
in this registration statement or any amendment thereto on The Nasdaq National
Market or any other stock market or securities exchange in connection with
such offering, (v) act on, sign and file any and all such certificates,
instruments, agreements and other documents as may be necessary or appropriate
in connection therewith and (vi) take any and all such actions which may be
necessary or appropriate in connection therewith, granting unto such agents,
proxies and attorneys-in-fact, and each of them individually, full power and
authority to do and perform each and every act and thing necessary or
appropriate to be done, as fully for all intents and purposes as he might or
could do in person, hereby approving, ratifying and confirming all that such
agents, proxies and attorneys-in-fact, any of them or any of his or their
substitute or substitutes may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons on
behalf of the Registrant and in the capacities indicated on the 19th day of
September, 2000.
<TABLE>
<CAPTION>
Signature Title(s)
--------- --------
<S> <C>
/s/ William F. Lenahan Chief Executive Officer and Director
___________________________________________ (Principal Executive Officer)
William F. Lenahan
/s/ William H. Stewart Executive Vice President, Chief Financial
___________________________________________ Officer and Director (Principal Financial
William H. Stewart Officer)
/s/ Robert F. Hagan Senior Vice President, Finance
___________________________________________ (Principal Accounting Officer)
Robert F. Hagan
</TABLE>
II-7
<PAGE>
<TABLE>
<CAPTION>
Signature Title(s)
--------- --------
<S> <C>
/s/ Harold N. Kamine Chairman of the Board of Directors
___________________________________________
Harold N. Kamine
/s/ Gary E. Lasher Vice Chairman of the Board of Directors
___________________________________________
Gary E. Lasher
/s/ Roscoe C. Young, II President, Chief Operating Officer and
___________________________________________ Director
Roscoe C. Young, II
/s/ John G. Quigley Director
___________________________________________
John G. Quigley
/s/ Richard H. Patterson Director
___________________________________________
Richard H. Patterson
/s/ Randall A. Hack Director
___________________________________________
Randall A. Hack
/s/ Alexander P. Coleman Director
___________________________________________
Alexander P. Coleman
</TABLE>
II-8
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
KMC Telecom Holdings, Inc.
We have audited the consolidated balance sheets of KMC Telecom Holdings,
Inc. as of December 31, 1998 and 1999 and the related consolidated statements
of operations, redeemable and nonredeemable equity and cash flows for the
years then ended. Our audit report issued thereon dated January 31, 2000,
except for Note 18, as to which the date is March 28, 2000, is included
elsewhere in this Registration Statement.
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
January 31, 2000, except for
Note 8, as to which the date
is March 28, 2000
S-1
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
CONDENSED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
December 31
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents (overdraft)................... $ 1,221 $ (833)
Amounts due from subsidiaries........................... 20,922 72,972
Prepaid expenses and other current assets............... 332 1,255
--------- ---------
Total current assets...................................... 22,475 73,394
Loans receivable from subsidiaries........................ 265,713 590,103
Networks and equipment, net............................... 4,775 58,531
Intangible assets, net.................................... 625 1,388
Deferred financing costs.................................. 12,055 21,031
Other assets.............................................. 1,952 825
--------- ---------
$307,595 $ 745,272
========= =========
Liabilities, redeemable and nonredeemable equity
(deficiency)
Current liabilities:
Accounts payable........................................ $ 2,043 $ 40,984
Accrued expenses........................................ 5,838 14,967
--------- ---------
Total current liabilities................................. 7,881 55,951
Senior notes payable...................................... -- 275,000
Senior discount notes payable............................. 267,811 301,137
Losses of subsidiaries in excess of basis................. 61,244 247,127
--------- ---------
Total liabilities......................................... 336,936 879,215
Redeemable equity:
Senior redeemable, exchangeable, PIK preferred stock,
par value $.01 per share; authorized: -0- shares in
1998 and 630 shares in 1999; shares issued and
outstanding:
Series E, -0- in 1998 and 65 shares in 1999 ($65,004
liquidation preference).............................. -- 50,770
Series F, -0- in 1998 and 44 shares in 1999 ($44,177
liquidation preference).............................. -- 41,370
Redeemable cumulative convertible preferred stock, par
value $.01 per share; 499 shares authorized; shares
issued and outstanding:
Series A, 124 shares in 1998 and 1999 ($12,380
liquidation preference).............................. 30,390 71,349
Series C, 175 shares in 1998 and 1999 ($17,500
liquidation preference).............................. 21,643 40,301
Redeemable common stock, shares issued and outstanding,
224 in 1998 and in 1999................................ 22,305 33,755
Redeemable common stock warrants........................ 674 12,925
--------- ---------
Total redeemable equity................................... 75,012 250,470
Nonredeemable equity (deficiency):
Common stock, par value $.01 per share, 3,000 shares
authorized; shares issued and outstanding: 614 shares
in 1998 and 629 shares in 1999......................... 6 6
Additional paid-in capital.............................. 13,750 --
Unearned compensation................................... (5,824) (9,163)
Accumulated deficit..................................... (112,285) (375,256)
--------- ---------
Total nonredeemable equity (deficiency)................... (104,353) (384,413)
--------- ---------
$307,595 $ 745,272
========= =========
</TABLE>
See accompanying notes.
S-2
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
CONDENSED STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
September 22,
1997 Year Ended
(formation) December 31
to December -------------------
31, 1997 1998 1999
------------- -------- ---------
<S> <C> <C> <C>
Operating expenses:
Network Operating Costs:
Non-cash stock compensation.............. $ -- $ 1,695 $ 2,387
Other network operating costs............ -- -- --
Selling, general and administrative:
Non-cash stock compensation.............. -- 19,495 27,446
Other selling, general and administrative
costs................................... -- 19,624 40,714
Depreciation and amortization.............. -- 1,197 3,104
-------- -------- ---------
Total operating expenses................... -- 42,011 73,651
-------- -------- ---------
Loss from operations....................... -- (42,011) (73,651)
Other expense.............................. -- -- (4,297)
Intercompany charges....................... -- 20,922 72,972
Interest income............................ -- 8,575 1,872
Interest expense........................... -- (23,104) (36,729)
Equity in net loss of subsidiaries......... (21,860) (41,135) (185,883)
-------- -------- ---------
Net loss................................... (21,860) (76,753) (225,716)
Dividends and accretion on redeemable
preferred stock........................... (8,904) (18,285) (81,633)
-------- -------- ---------
Net loss applicable to common
shareholders.............................. $(30,764) $(95,038) $(307,349)
======== ======== =========
</TABLE>
See accompanying notes.
S-3
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
September 22,
1997
(formation) Year Ended
to December 31,
December 31, -------------------
1997 1998 1999
------------- -------- ---------
<S> <C> <C> <C>
Operating activities
Net loss.................................... $(21,860) $(76,753) $(225,716)
Adjustments to reconcile net loss to net
cash used in operating activities:
Equity in net loss of subsidiaries...... 21,860 41,135 185,883
Depreciation and amortization........... -- 1,197 3,104
Non-cash interest expense............... -- 23,104 36,963
Non-cash stock option compensation
expense................................ -- 21,190 29,833
Changes in assets and liabilities:
Prepaid expenses and other current
assets............................... -- (332) (923)
Accounts payable...................... -- 2,043 441
Accrued expenses...................... -- 5,838 9,075
Amounts due from subsidiaries......... -- (20,922) (52,050)
Other assets.......................... -- (1,952) 1,128
-------- -------- ---------
Net cash provided by (used in) operating
activities................................. -- (5,452) (12,262)
-------- -------- ---------
Investing activities
Loans receivable from subsidiaries.......... (24,623) (233,685) (324,390)
Purchases of equipment...................... -- (5,845) (18,327)
Acquisitions of intangible assets........... (506) (166) (796)
-------- -------- ---------
Net cash used in investing activities....... (25,129) (239,696) (343,513)
-------- -------- ---------
Financing activities
Proceeds from issuance of preferred stock
and related warrants, net of issuance
costs...................................... 16,498 -- 91,001
Proceeds from exercise of stock options..... -- -- 333
Proceeds from issuance of senior notes, net
of issuance costs and purchase of portfolio
of restricted investments.................. -- -- 262,387
Proceeds from issuance of common stock and
warrants, net of issuance costs............ 9,363 20,446 --
Proceeds from issuance of senior discount
notes, net of issuance costs............... (732) 225,923 --
-------- -------- ---------
Net cash provided by financing activities... 25,129 246,369 353,721
-------- -------- ---------
Net increase (decrease) in cash and cash
equivalents................................ -- 1,221 (2,054)
Cash and cash equivalents, beginning of
year....................................... -- -- 1,221
-------- -------- ---------
Cash and cash equivalents, end of year...... $ -- $ 1,221 $ (833)
======== ======== =========
</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, 1999
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 operating subsidiaries are
KMC Telecom Inc. ("KMC Telecom"), KMC Telecom II, Inc. ("KMC Telecom II"), KMC
Telecom III, Inc. ("KMC Telecom III") and KMC Telecom of Virginia, Inc.
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.
Pursuant to a management agreement among the Company and its subsidiaries,
the Company provides management and other services and incurs certain
operating expenses on behalf of its subsidiaries. Such costs are allocated to
the subsidiaries by the Company and reimbursed on a current basis. At December
31, 1998 and 1999, an aggregate of $20.9 and $73.0 million, respectively, was
due from the subsidiaries for such costs and is included in the accompanying
condensed balance sheet at December 31, 1998 and 1999 as a current receivable.
Such reimbursements are permitted under the debt agreements of the Company's
subsidiaries.
2. Senior Secured Credit Facility
On December 22, 1998, KMC Telecom, KMC Telecom II and KMC Telecom of
Virginia (the "Subsidiary Borrowers"), refinanced and expanded the Amended and
Restated Loan and Security Agreement (the "AT&T Facility") by entering into a
Loan and Security Agreement (the "Senior Secured Credit Facility") with AT&T
Commercial Finance Corporation ("AT&T Finance"), First Union National Bank,
General Electric Capital Corporation ("GECC") and Canadian Imperial Bank of
Commerce (the "Creditors").
The Company has unconditionally guaranteed the repayment of the Senior
Secured Credit Facility when such repayment is due, whether at maturity, upon
acceleration, or otherwise. The Company has agreed to pay all amounts
outstanding under the Senior Secured Credit 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 each of the Subsidiary
Borrowers to the Creditors to collateralize its obligations under the
guaranty. In addition, the Subsidiary Borrowers have pledged all of their
assets to the Creditors. Accordingly, if there were an event of default under
the Senior Secured Credit Facility, the lenders thereunder would be entitled
to payment in full and could foreclose on assets of the Subsidiary Borrowers,
and the holders of the Senior Discount Notes and Senior Notes would have no
right to share in such assets. At December 31, 1999, an aggregate of $235.0
million was outstanding under this facility.
Additionally, the Senior Secured Credit Facility restricts the ability of
the Subsidiary Borrowers 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 meets its cash requirements, including its
ability to repay the Senior Discount Notes and the Senior Notes.
At December 31, 1999, an aggregate of $504.8 million has been loaned by the
Company to the Subsidiary Borrowers to be used for the construction and
expansion of fiber optic telecommunications networks and for working capital
and general corporate purposes.
As discussed further in Note 8, the Subsidiary Borrowers amended, restated
and combined the Senior Secured Credit Facility and the Lucent Loan and
Security Agreement during the first quarter of 2000.
S-5
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
3. Senior Discount Notes
On January 29, 1998, the Company sold 460,800 units, each consisting of 12
1/2% senior discount notes with a principal amount at maturity of $1,000 due
2008 pursuant to the Senior Discount Note Indenture between KMC Holdings and
the Chase Manhattan Bank, as trustee (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. A
substantial portion of the net proceeds of the offering have been loaned by
the Company to its subsidiaries. On August 11, 1998, KMC Holdings consummated
an offer to exchange the notes issued on January 29, 1998 for $460.8 million
aggregate principal amount at maturity of notes that had been registered under
the Securities Act of 1933 (as used below and elsewhere herein, "Senior
Discount Notes" includes the original notes and the exchange notes).
The Senior Discount Notes are unsecured, unsubordinated obligations of the
Company and mature on February 15, 2008. The Senior Discount Notes will fully
accrete to face value on February 15, 2003. From and after February 15, 2003,
the Senior Discount Notes will bear interest, which will be payable in cash,
at the rate of 12.5% per annum on February 15 and August 15 of each year,
commencing August 15, 2003. The Company is accreting the initial carrying
value of the Senior Discount Notes to their aggregate face value over the term
of the debt at its effective interest rate of 13.7%.
The indebtedness evidenced by the Senior Discount Notes ranks pari passu in
right of payment with all existing and future unsubordinated, unsecured
indebtedness of KMC Holdings and senior in right of payment to all existing
and future subordinated indebtedness of KMC Holdings. However, KMC Holdings is
a holding company and the Senior Discount Notes are, therefore, effectively
subordinated to all existing and future liabilities (including trade payables)
of its subsidiaries.
The Senior Discount Note Indenture restricts, among other things, the
ability of the Company to incur additional indebtedness, create liens, engage
in sale-leaseback transactions, pay dividends or make distributions in respect
of capital stock, make investments or certain other restricted payments, sell
assets of the Company, redeem capital stock, issue or sell stock of restricted
subsidiaries, enter into transactions with stockholders or affiliates or
effect a consolidation or merger.
4. Lucent Loan and Security Agreement
KMC Telecom III entered into a Loan and Security Agreement (the "Lucent
Facility") dated February 4, 1999 with Lucent Technologies Inc. ("Lucent")
which provides for borrowings to be used to fund the acquisition of certain
telecommunications equipment and related expenses.
The Company has unconditionally guaranteed the repayment of the Lucent
Facility when such repayment is due, whether at maturity, upon acceleration,
or otherwise. The Company has agreed to pay all amounts outstanding under the
Lucent 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 III to Lucent to collateralize its obligations under the
guaranty. In addition, KMC Telecom III has pledged all of its assets to
Lucent. Accordingly, if there were an event of default under the Lucent
Facility, Lucent thereunder would be entitled to payment in full and could
foreclose on the assets of KMC Telecom III and the holders of the Senior
Discount Notes and Senior Notes would have no right to share in such assets.
At December 31, 1999, no amounts were outstanding under this facility.
Additionally, the Lucent Facility restricts the ability of KMC Telecom III
to pay dividends to, or to pay principal or interest on loans from, the
Company. Such restrictions could adversely affect the Company's
S-6
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
liquidity and ability to meet its cash requirements, including its ability to
repay the Senior Discount Notes and the Senior Notes.
5. Senior Notes
On May 24, 1999, the Company issued $275.0 million aggregate principal
amount of 13 1/2% Senior Notes due 2009. On December 30, 1999, the Company
exchanged the notes issued on May 24, 1999 for $275.0 million aggregate
principal amount of notes that had been registered under the Securities Act of
1933 (as used below, "Senior Notes" includes the original notes and the
exchange notes). Interest on the Senior Notes is payable semi-annually in cash
on May 15 and November 15 of each year, beginning November 15, 1999. A portion
of the proceeds from the offering of the Senior Notes was used to purchase a
portfolio of U.S. government securities that were pledged as security for the
first six interest payments on the Senior Notes.
The Senior Notes are guaranteed by KMC Telecom Financing, Inc., a wholly-
owned subsidiary. The Senior Notes are senior, unsubordinated unsecured
obligations of KMC Holdings and rank pari passu in right of payment with all
existing and future unsubordinated, unsecured indebtedness of KMC Holdings and
senior in right of payment to all of existing and future subordinated
indebtedness of KMC Holdings. However, KMC Holdings is a holding company and
the Senior Notes are, therefore, effectively subordinated to all existing and
future liabilities (including trade payables) of its subsidiaries.
The Senior Note Indenture contains certain covenants that, among other
things, limit the Company's ability to incur additional indebtedness, engage
in sale-leaseback transactions, pay dividends or make certain other
distributions, sell assets, redeem capital stock, effect a consolidation or
merger of KMC Telecom Holdings, Inc. and enter into transactions with
stockholders and affiliates and create liens on our assets.
6. Redeemable Equity
Series E Preferred Stock
On February 4, 1999, the Company issued 25,000 shares of Series E Senior
Redeemable, Exchangeable PIK Preferred Stock (the "Series E Preferred Stock")
to Newcourt Commercial Finance Corporation ("Newcourt Finance"), generating
aggregate gross proceeds of $22.9 million. The Series E Preferred Stock has a
liquidation preference of $1,000 per share and an annual dividend equal to
14.5% of the liquidation preference, payable quarterly. On or before January
15, 2004, the Company may pay dividends in cash or in additional fully paid
and nonassessable shares of Series E Preferred Stock. After January 15, 2004,
dividends must be paid in cash, subject to certain conditions. Unpaid
dividends accrue at the dividend rate of the Series E Preferred Stock,
compounded quarterly. During 1999, the Company issued 5,004 shares of Series E
Preferred Stock to pay the dividends due.
The Series E Preferred Stock must be redeemed on February 1, 2011, subject
to the legal availability of funds therefor, at a redemption price, payable in
cash, equal to the liquidation preference thereof on the redemption date, plus
all accumulated and unpaid dividends to the date of redemption.
The Series E Preferred Stock is not convertible. The Company may, at the
sole option of the Board of Directors (out of funds legally available),
exchange all, but not less than all, of the Series E Preferred Stock then
outstanding, for a new series of subordinated debentures (the "Exchange
Debentures") issued pursuant to an exchange debenture indenture.
S-7
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
Series F Preferred Stock
On February 4, 1999, the Company issued 40,000 shares of Series F Senior
Redeemable, Exchangeable PIK Preferred Stock (the "Series F Preferred Stock")
to Lucent and Newcourt Finance, generating aggregate gross proceeds of $38.9
million. The Series F Preferred Stock has a liquidation preference of $1,000
per share and an annual dividend equal to 14.5% of the liquidation preference,
payable quarterly. The Company may pay dividends in cash or in additional
fully paid and nonassessable shares of Series F Preferred Stock. During 1999,
the Company issued 4,177 shares of Series F Preferred Stock to pay the
dividends due for such period.
Upon the earlier of (i) the date that is sixty days after the date on which
the Company closes an underwritten primary offering of at least $200 million
of its Common Stock, pursuant to an effective registration statement under the
Securities Act or (ii) February 4, 2001, any outstanding Series F Preferred
Stock will automatically convert into Series E Preferred Stock, on a one for
one basis.
The Company may, at the sole option of the Board of Directors (out of funds
legally available), exchange all, but not less than all, of the Series F
Preferred Stock then outstanding for Exchange Debentures.
Warrants
In connection with the February 4, 1999 issuances of the Series E Preferred
Stock and the Series F Preferred Stock, warrants to purchase an aggregate of
24,660 shares of Common Stock were sold to Newcourt Finance and Lucent. The
aggregate gross proceeds from the sale of these warrants was approximately
$3.2 million. These warrants, at an exercise price of $.01 per share, are
exercisable from February 4, 2000 through February 1, 2009.
In addition, the Company also delivered to the Warrant Agent certificates
representing warrants to purchase an aggregate of an additional 107,228 shares
of Common Stock at an exercise price of $.01 per share (the "Springing
Warrants"). The Springing Warrants may become issuable under the circumstances
described in the following paragraph.
If the Company fails to redeem all shares of Series F Preferred Stock prior
to the date (the "Springing Warrant Date") which is the earlier of (i) the
date that is sixty days after the date on which the Company closes an
underwritten primary offering of at least $200 million of its Common Stock
pursuant to an effective registration statement under the Securities Act or
(ii) February 4, 2001, the Warrant Agent is authorized to issue the Springing
Warrants to the Eligible Holders (as defined in the warrant agreement) of the
Series E and Series F Preferred Stock. In the event the Company has redeemed
all outstanding shares of Series F Preferred Stock prior to the Springing
Warrant Date, the Springing Warrants will not be issued and the Warrant Agent
will return the certificates to the Company. To the extent the Company
exercises its option to exchange all of the Series F Preferred Stock for
Exchange Debentures prior to the Springing Warrant Date, the Springing
Warrants will not become issuable. Therefore, as the future issuance of the
Springing Warrant is entirely within the control of the Company and the
likelihood of their issuance is deemed to be remote, no value has been
ascribed to the Springing Warrants.
Redemption Rights
Pursuant to a stockholders agreement, certain of the Company's stockholders
and warrant holders have "put rights" entitling them to have the Company
repurchase their preferred and common shares and redeemable common stock
warrants for the fair value of such securities if no Liquidity Event (defined
as (i) an initial public offering with gross proceeds of at least $40 million,
(ii) the sale of substantially all of the stock or assets of the
S-8
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
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. The
restrictive covenants of the Senior Discount Notes limit the Company's ability
to repurchase such securities. All of the securities subject to such "put
rights" are presented as redeemable equity in the accompanying balance sheets.
The redeemable preferred stock, redeemable common stock and redeemable
common stock warrants, which are subject to the stockholders agreement, 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, 1999, the aggregate redemption value of the redeemable equity was
approximately $320 million, reflecting per share redemption amounts of $1,212
for the Series A Preferred Stock, $476 for the Series C Preferred Stock and
$250 for the redeemable common stock and redeemable common stock warrants.
7. Arbitration Award
During the second quarter of 1999, the Company recorded a $4.3 million
charge to other expense in connection with an unfavorable arbitration award.
The net amount due under the terms of the award was paid in full in June 1999.
8. Subsequent Events
On February 15, 2000, KMC Telecom, KMC Telecom II, KMC Telecom of Virginia
and KMC Telecom III (the "Borrowers"), amended, restated and combined the
Senior Secured Credit Facility and the Lucent Facility by entering into a $700
million Loan and Security Agreement (the "Amended Senior Secured Credit
Facility") with a group of lenders led by Newcourt Commercial Finance
Corporation, GE Capital, Canadian Imperial Bank of Commerce ("CIBC"), First
Union National Bank and Lucent Technologies, Inc. (the "Lenders").
The Amended Senior Secured Credit Facility includes a $175 million reducing
revolver facility (the "Revolver"), a $75 million term loan (the "Term Loan")
and a $450 million term loan facility (the "Lucent Term Loan").
The Revolver will mature on April 1, 2007. Proceeds from the Revolver can
be used to finance the purchase of certain equipment, transaction costs and
upon attainment of certain financial condition, for working capital and other
general corporate purposes. The aggregate commitment of the Lenders under the
Revolver will be reduced on each payment date beginning April 1, 2003. The
initial quarterly commitment reduction is 5.0%, reducing to 3.75% on July 1,
2003 and increasing to 6.25% on July 1, 2004, and further increasing to 7.50%
on July 1, 2006. Commencing with the fiscal year ending December 31, 2001, the
aggregate Revolver commitment will be further reduced by an amount equal to
50% of excess operating cash flows (as defined in the Facility) for the prior
fiscal year until the Borrowers achieve certain financial conditions. The
Borrowers must pay an annual commitment fee on the unused portion of the
Revolver ranging from .75% to 1.25%.
The Term Loan is payable in twenty consecutive quarterly installments of
$188,000 beginning on April 1, 2002 and two final installments of $35.6
million each on April 1, 2007 and July 1, 2007. Proceeds from the Term Loan
can be used to finance the purchase of certain equipment, transaction costs,
working capital and other general corporate purposes.
The Lucent Term Loan provides for an aggregate commitment of up to $450
million. Proceeds from the Lucent Term Loan can be used to purchase Lucent
products or to reimburse the Borrowers for Lucent products
S-9
<PAGE>
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC TELECOM HOLDINGS, INC.
(Parent Company)
NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)
previously purchased with cash or other sources of liquidity. The Lucent Term
Loan will mature on July 1, 2007 and has required quarterly amortization
beginning on July 1, 2003 of 5%. The amortization decreases to 3.75% per
quarter beginning on October 1, 2003, increases to 6.25% on October 1, 2004
and further increases to 7.50% on October 1, 2006. An annual commitment fee of
1.50% is payable for any unused portion of the Lucent Term Loan.
The Amended Senior Secured Credit Facility will bear interest payable at
the Borrowers' option, at (a) the "Applicable Base Rate Margin" (which
generally ranges from 2.00% to 3.25%) plus the greater of (i) the
administrative agent's prime rate or (ii) the overnight federal funds rate
plus .5% or (b) the "Applicable LIBOR Margin" (which generally ranges from
3.00% to 4.25%) plus LIBOR, as defined. "Applicable Base Rate Margin" interest
is payable quarterly while "Applicable LIBOR Margin" interest is payable at
the end of each applicable interest period or at least every three months. If
a payment default were to occur, the interest rate will be increased by four
percentage points. If any other event of default shall occur, the interest
rate will be increased by two percentage points.
KMC Holdings has unconditionally guaranteed the repayment of the Amended
Senior Secured Credit Facility when such repayment is due, whether at
maturity, upon acceleration, or otherwise. KMC Holdings has pledged the shares
of each of the Borrowers to the Lenders to collateralize its obligations under
the guaranty. In addition, the Borrowers have each pledged all of their assets
to the Lenders.
The Amended Senior Secured Credit Facility contains a number of affirmative
and negative covenants including, a covenant requiring the Borrowers to obtain
cash capital contributions from KMC Holdings of at least $185 million prior to
April 1, 2001. KMC Holdings has secured a financing commitment for $100
million in PIK preferred stock from Lucent towards this requirement and
currently contemplates raising the balance of $85 million through sales of
private and public securities in the capital markets. Additional affirmative
and negative covenants include, among others, 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 KMC Holdings, create
subsidiaries, transfer any permits or licenses, or incur additional
indebtedness or act as guarantor for the debt of any person, subject to
certain conditions.
The Borrowers are required to comply with certain financial tests and
maintain certain financial ratios, including, among others, a ratio of total
debt to contributed capital, certain minimum revenues, maximum EBITDA losses
and minimum EBITDA, maximum capital expenditures and minimum access lines, a
maximum total leverage ratio, a minimum debt service coverage ratio, a minimum
fixed charge coverage ratio and a maximum consolidated leverage ratio. The
covenants become more restrictive upon the earlier of (i) March 31, 2002 and
(ii) after the Borrowers achieve positive EBITDA on a combined basis for two
consecutive fiscal quarters and a total leverage ratio (as defined) equal to
or less than 8 to 1.
Failure to satisfy any of the financial covenants will constitute an event
of default under the Amended Senior Secured Credit Facility permitting the
Lenders, after notice, to terminate the commitment and/or accelerate payment
of outstanding indebtedness. The Amended Senior Secured Credit Facility also
includes other customary events of default, including, without limitation, a
cross-default to other material indebtedness, material undischarged judgments,
bankruptcy, loss of a material franchise or material license, breach of
representations and warranties, a material adverse change, and the occurrence
of a change of control.
S-10
<PAGE>
KMC TELECOM HOLDINGS, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Additions
---------------------
Charged to
Balance at Charged to Other
Beginning Costs and Accounts-- Deductions-- Balance at
Description of Period Expenses Describe Describe End of Period
----------- ---------- ---------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Year ended December 31,
1997:
Allowance for doubtful
accounts............... $-- $ 34 $-- $-- $ 34
==== ====== ==== ==== ======
Year ended December 31,
1998:
Allowance for doubtful
accounts............... $ 34 $ 370 $-- $ 54(1) $ 350
==== ====== ==== ==== ======
Year ended December 31,
1999:
Allowance for doubtful
accounts............... $350 $5,263 $-- $ 62(1) $5,551
==== ====== ==== ==== ======
</TABLE>
--------
(1) Uncollectible accounts written-off.
S-11
<PAGE>
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1 Amended and Restated Certificate of Incorporation of KMC Telecom
Holdings, Inc. dated as of September 22, 1997 (incorporated herein by
reference to Exhibit 3.1 to KMC Telecom Holdings, Inc.'s Registration
Statement on Form S-4 (Registration No. 333-50475) filed on April 20,
1998 (hereinafter referred to as the "KMC Holdings' S-4")).
3.2 Certificate of Amendment of the Certificate of Incorporation of KMC
Telecom Holdings, Inc. filed on November 5, 1997 (incorporated herein
by reference to Exhibit 3.2 to KMC Holdings' S-4).
3.3 Certificate of Amendment of the Certificate of Incorporation of KMC
Telecom Holdings, Inc. dated as of February 4, 1999 (incorporated
herein by reference to Exhibit 3.3 to KMC Telecom Holdings, Inc.'s
Form 10-K for the fiscal year ended December 31, 1998).
3.4 Certificate of Amendment of the Certificate of Incorporation of KMC
Telecom Holdings, Inc. dated as of April 30, 1999 (incorporated herein
by reference to Exhibit 3.1 to KMC Telecom Holdings, Inc.'s Form 10-Q
for the quarterly period ended June 30, 1999).
3.5** Certificate of Amendment of the Amended and Restated Certificate of
Incorporation of KMC Telecom Holdings, Inc. dated July 7, 2000.
3.6* Certificate of Amendment of the Amended and Restated Certificate of
Incorporation of KMC Telecom Holdings, Inc. dated , 2000.
3.7 KMC Telecom Holdings, Inc. Amended and Restated Certificate of the
Powers, Designations, Preferences and Rights of the Series A
Cumulative Convertible Preferred Stock, Par Value $.01 per Share,
dated November 4, 1997 (incorporated herein by reference to Exhibit
3.4 to KMC Telecom Holdings, Inc.'s Form 10-K for the fiscal year
ended December 31, 1998).
3.8 Certificate of Amendment to the Certificate of Powers, Designations,
Preferences and Rights of the Series A Cumulative Convertible
Preferred Stock, Par Value $.01 Per Share, dated as of April 30, 1999
(incorporated herein by reference to Exhibit 3.2 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
3.9 Certificate of Amendment to the Certificate of the Powers,
Designations, Preferences and Rights of the Series A Cumulative
Convertible Preferred Stock, Par Value $.01 Per Share, dated as of
June 29, 2000 (incorporated herein by reference to Exhibit 3.1 to KMC
Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended June
30, 2000).
3.10** Certificate of Amendment to the Certificate of the Powers,
Designations, Preferences and Rights of the Series A Cumulative
Convertible Preferred Stock, Par Value $.01 Per Share, dated July 7,
2000.
3.11 KMC Telecom Holdings, Inc. Certificate of the Powers, Designations,
Preferences and Rights of the Series C Cumulative Convertible
Preferred Stock, Par Value $.01 per Share, dated November 4, 1997
(incorporated herein by reference to Exhibit 3.5 to KMC Telecom
Holdings, Inc.'s Form 10-K for the fiscal year ended December 31,
1998).
3.12 Certificate of Amendment to the Certificate of Powers, Designations,
Preferences and Rights of the Series C Cumulative Convertible
Preferred Stock, Par Value $.01 Per Share, dated as of April 30, 1999
(incorporated herein by reference to Exhibit 3.3 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
3.13 Certificate of Amendment to the Certificate of the Powers,
Designations, Preferences and Rights of the Series C Cumulative
Convertible Preferred Stock, Par Value $.01 Per Share, dated as of
June 29, 2000 (incorporated herein by reference to Exhibit 3.2 to KMC
Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended June
30, 2000).
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
3.14** Certificate of Amendment to the Certificate of the Powers,
Designations, Preferences and Rights of the Series C Cumulative
Convertible Preferred Stock, Par Value $.01 Per Share, dated July 7,
2000.
3.15 KMC Telecom Holdings, Inc. Certificate of the Powers, Designations,
Preferences and Rights of the Series D Cumulative Convertible
Preferred Stock, Par Value $.01 per Share, dated November 4, 1997
(incorporated herein by reference to Exhibit 3.6 to KMC Telecom
Holdings, Inc.'s Form 10-K for the fiscal year ended December 31,
1998).
3.16 Certificate of Amendment to the Certificate of Powers, Designations,
Preferences and Rights of the Series D Cumulative Convertible
Preferred Stock, Par Value $.01 Per Share, dated as of April 30, 1999
(incorporated herein by reference to Exhibit 3.4 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
3.17 Certificate of Voting Powers, Designations, Preferences and Relative
Participating, Optional or Other Special Rights and Qualifications,
Limitations and Restrictions Thereof of the Series E Senior,
Redeemable, Exchangeable, PIK Preferred Stock of KMC Telecom Holdings,
Inc., dated as of February 4, 1999 (incorporated herein by reference
to Exhibit 3.7 to KMC Telecom Holdings, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998).
3.18 Certificate of Amendment to the Certificate of Voting Powers,
Designations, Preferences and Relative Participating, Optional or
Other Special Rights and Qualifications, Limitations and Restrictions
Thereof of the Series E Senior Redeemable, Exchangeable, PIK Preferred
Stock, dated as of April 30, 1999 (incorporated herein by reference to
Exhibit 3.5 to KMC Telecom Holdings, Inc.'s Form 10-Q for the
quarterly period ended June 30, 1999).
3.19 Certificate of Amendment to the Certificate of Voting Powers,
Designations, Preferences and Relative Participating, Optional or
Other Special Rights and Qualifications, Limitations and Restrictions
Thereof of the Series E Senior Redeemable, Exchangeable, PIK Preferred
Stock, dated as of June 30, 2000 (incorporated herein by reference to
Exhibit 3.3 to KMC Telecom Holdings, Inc.'s Form 10-Q for the
quarterly period ended June 30, 2000).
3.20** Certificate of Amendment to the Certificate of Voting Powers,
Designations, Preferences and Relative Participating, Optional or
Other Special Rights and Qualifications, Limitations and Restrictions
Thereof of the Series E Senior Redeemable, Exchangeable, PIK Preferred
Stock, dated July 7, 2000.
3.21 Certificate of Voting Powers, Designations, Preferences and Relative
Participating, Optional or Other Special Rights and Qualifications,
Limitations and Restrictions Thereof of the Series F Senior,
Redeemable, Exchangeable, PIK Preferred Stock of KMC Telecom Holdings,
Inc., dated as of February 4, 1999 (incorporated herein by reference
to Exhibit 3.8 to KMC Telecom Holdings, Inc.'s Form 10-K for the
fiscal year ended December 31, 1998).
3.22 Certificate of Amendment to the Certificate of Voting Powers,
Designations, Preferences and Relative Participating, Optional or
Other Special Rights and Qualifications, Limitations and Restrictions
Thereof of the Series F Senior Redeemable, Exchangeable, PIK Preferred
Stock, dated as of June 1, 1999 (incorporated herein by reference to
Exhibit 3.6 to KMC Telecom Holdings, Inc.'s Form 10-Q for the
quarterly period ended June 30, 1999).
3.23 Certificate of Amendment to the Certificate of Voting Powers,
Designations, Preferences and Relative Participating, Optional or
Other Special Rights and Qualifications, Limitations and Restrictions
Thereof of the Series F Senior Redeemable, Exchangeable, PIK Preferred
Stock, dated as of June 30, 2000 (incorporated herein by reference to
Exhibit 3.4 to KMC Telecom Holdings, Inc.'s Form 10-Q for the
quarterly period ended June 30, 2000).
3.24** Certificate of Amendment to the Certificate of Voting Powers,
Designations, Preferences and Relative Participating, Optional or
Other Special Rights and Qualifications, Limitations and Restrictions
Thereof of the Series F Senior Redeemable, Exchangeable, PIK Preferred
Stock, dated July 7, 2000.
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
3.25 Certificate of the Powers, Designations, Preferences and Rights of the
Series G-1 Voting Convertible Preferred Stock and Series G-2 Non-
Voting Convertible Preferred Stock, Par Value $.01 Per Share, dated as
of July 5, 2000 (incorporated herein by reference to Exhibit 3.5 to
KMC Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended
June 30, 2000).
3.26 Amended and Restated By-Laws of KMC Telecom Holdings, Inc., adopted as
of April 1, 2000 (incorporated herein by reference to Exhibit 3.6 to
KMC Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended
June 30, 2000).
3.27** Amendment No. 1 to the Amended and Restated By-Laws of KMC Telecom
Holdings, Inc., amended as of July 5, 2000.
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., Newcourt Commercial Finance Corporation (formerly known as AT&T
Credit Corporation), General Electric Capital Corporation, CoreStates
Bank, N.A. and CoreStates Holdings, Inc. (incorporated herein by
reference to Exhibit 4.1 to KMC Holdings' S-4).
4.2 Amendment No. 1 dated as of January 7, 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., NAS
Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P.,
Newcourt Commercial Finance Corporation (formerly known as AT&T Credit
Corporation), General Electric Capital Corporation, CoreStates Bank,
N.A. and CoreStates Holdings, Inc. (incorporated herein by reference
to Exhibit 4.2 to KMC Holdings' S-4).
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., NAS
Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P.,
Newcourt Commercial Finance Corporation (formerly known as AT&T Credit
Corporation), General Electric Capital Corporation, CoreStates Bank,
N.A. and CoreStates Holdings, Inc. (incorporated herein by reference
to Exhibit 4.3 to KMC Holdings' S-4).
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., NAS
Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P.,
Newcourt Commercial Finance Corporation (formerly known as AT&T Credit
Corporation), General Electric Capital Corporation, CoreStates Bank,
N.A. and CoreStates Holdings, Inc. (incorporated herein by reference
to Exhibit 4.4 to KMC Holdings' S-4).
4.5 Amendment No. 4 dated as of February 4, 1999 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., NAS
Partners I L.L.C., Harold N. Kamine, Newcourt Commercial Finance
Corporation (formerly known as AT&T Credit Corporation), General
Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates
Holdings, Inc. (incorporated herein by reference to Exhibit 4.5 to KMC
Telecom Holdings, Inc.'s Form 10-K for the fiscal year ended December
31, 1998).
4.6 Amendment No. 5 dated as of April 30, 1999 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., NAS Partners I
L.L.C., Harold N. Kamine, Newcourt Commercial Finance Corporation
(formerly known as AT&T Credit Corporation), General Electric Capital
Corporation, First Union National Bank (as successor to CoreStates
Bank, N.A.) and CoreStates Holdings, Inc. (incorporated herein by
reference to Exhibit 4.11 to KMC Telecom Holdings, Inc.'s Form 10-Q
for the quarterly period ended June 30, 1999).
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
4.7 Amendment No. 6 dated as of June 1, 1999 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., NAS Partners I
L.L.C., Harold N. Kamine, Newcourt Commercial Finance Corporation
(formerly known as AT&T Credit Corporation), General Electric Capital
Corporation, First Union National Bank (as successor to CoreStates
Bank, N.A.) and CoreStates Holdings, Inc. (incorporated herein by
reference to Exhibit 4.12 to KMC Telecom Holdings, Inc.'s Form 10-Q
for the quarterly period ended June 30, 1999).
4.8 Amendment No. 7 dated as of January 1, 2000 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., NAS
Partners I L.L.C., Harold N. Kamine, Newcourt Commercial Finance
Corporation (formerly known as AT&T Credit Corporation), General
Electric Capital Corporation, First Union National Bank (as successor
to CoreStates Bank, N.A.) and CoreStates Holdings, Inc. (incorporated
herein by reference to Exhibit 4.8 to KMC Telecom Holdings, Inc.'s
Form 10-K for the fiscal year ended December 31, 1999).
4.9 Amendment No. 8 dated as of April 1, 2000 to the Amended and Restated
Stockholders Agreement, dated as of October 31, 1997, among KMC
Telecom Holdings, Inc., Nassau Capital Partners L.P., NAS Partners I
L.L.C., Harold N. Kamine, General Electric Capital Corporation, First
Union National Bank (as successor to CoreStates Bank, N.A.),
CoreStates Holdings, Inc. and CIT Lending Services Corporation
(formerly known as Newcourt Commercial Finance Corporation)
(incorporated herein by reference to Exhibit 4.1 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
2000).
4.10 Amendment No. 9 dated as of June 30, 2000 to the Amended and Restated
Stockholders Agreement, dated as of October 31, 1997, among KMC
Telecom Holdings, Inc., Nassau Capital Partners L.P., NAS Partners I
L.L.C., Harold N. Kamine, General Electric Capital Corporation, First
Union National Bank (as successor to CoreStates Bank, N.A.),
CoreStates Holdings, Inc., Dresdner Kleinwort Benson Private Equity
Partners LP, 75 Wall Street Associates, LLC, Lucent Technologies Inc.
and CIT Lending Services Corporation (formerly known as Newcourt
Commercial Finance Corporation) (incorporated herein by reference to
Exhibit 4.2 to KMC Telecom Holdings, Inc.'s Form 10-Q for the
quarterly period ended June 30, 2000).
4.11 Indenture dated as of January 29, 1998 between KMC Telecom Holdings,
Inc. and The Chase Manhattan Bank, as Trustee (incorporated herein by
reference to Exhibit 4.5 to KMC Holdings' S-4).
4.12 First Supplemental Indenture dated as of May 24, 1999 among KMC
Telecom Holdings, Inc., KMC Telecom Financing, Inc. and The Chase
Manhattan Bank, as Trustee, to the Indenture dated as of January 29,
1998 between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank,
as Trustee (incorporated herein by reference to Exhibit 4.1 to KMC
Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended
September 30, 1999).
4.13 Indenture dated as of May 24, 1999 among KMC Telecom Holdings, Inc.,
KMC Telecom Financing, Inc. and The Chase Manhattan Bank, as Trustee
(incorporated herein by reference to Exhibit 4.2 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended September
30, 1999).
4.14 Registration Rights Agreement dated as of January 26, 1998, between
KMC Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated
(incorporated herein by reference to Exhibit 4.6 to KMC Holdings' S-
4).
4.15 Registration Rights Agreement dated as of May 19, 1999 among KMC
Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated, Credit
Suisse First Boston Corporation, First Union Capital Markets Corp.,
CIBC World Markets Corp., BancBoston Robertson Stephens Inc. and
Wasserstein Perella Securities, Inc. (incorporated herein by reference
to Exhibit 4.5 to KMC Telecom Holdings, Inc.'s Form 10-Q for the
quarterly period ended September 30, 1999).
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
4.16 Warrant Agreement dated as of January 29, 1998 between KMC Telecom
Holdings, Inc. and The Chase Manhattan Bank, as Warrant Agent
(incorporated herein by reference to Exhibit 4.7 to KMC Holdings'
S-4).
4.17 Warrant Agreement dated as of February 4, 1999 among KMC Telecom
Holdings, Inc., The Chase Manhattan Bank, as Warrant Agent, Newcourt
Commercial Finance Corporation and Lucent Technologies Inc.
(incorporated herein by reference to Exhibit 10.2 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended March 31,
1999).
4.18 Warrant Agreement dated as of April 30, 1999 among KMC Telecom
Holdings, Inc., The Chase Manhattan Bank, as Warrant Agent, First
Union Investors, Inc., Harold N. Kamine and Nassau Capital Partners
L.P. (incorporated herein by reference to Exhibit 4.4 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
4.19 Amendment No. 1 dated as of April 30, 1999 to the Warrant Agreement
dated as of February 4, 1999, among KMC Telecom Holdings, Inc., The
Chase Manhattan Bank, as Warrant Agent, Newcourt Commercial Finance
Corporation, Lucent Technologies Inc. and First Union Investors, Inc.
(incorporated herein by reference to Exhibit 4.7 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
4.20 Amendment No. 2 dated as of June 1, 1999 to the Warrant Agreement
dated as of February 4, 1999, among KMC Telecom Holdings, Inc., The
Chase Manhattan Bank, as Warrant Agent, Newcourt Commercial Finance
Corporation, Lucent Technologies Inc. and First Union Investors, Inc.
(incorporated herein by reference to Exhibit 4.8 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
4.21 Warrant Registration Rights Agreement dated as of January 26, 1998
between KMC Telecom Holdings, Inc. and Morgan Stanley & Co.
Incorporated (incorporated herein by reference to Exhibit 4.8 to KMC
Holdings' S-4).
4.22 Warrant Registration Rights Agreement dated as of February 4, 1999
among KMC Telecom Holdings, Inc., Newcourt Commercial Finance
Corporation and Lucent Technologies Inc. (incorporated herein by
reference to Exhibit 10.3 to KMC Telecom Holdings, Inc.'s Form 10-Q
for the quarterly period ended March 31, 1999).
4.23 Warrant Registration Rights Agreement dated as of April 30, 1999
between KMC Telecom Holdings, Inc. and First Union Investors, Inc.
(incorporated herein by reference to Exhibit 4.5 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
4.24 Amendment No. 1 dated as of April 30, 1999 to Warrant Registration
Rights Agreement among KMC Telecom Holdings, Inc., Newcourt Commercial
Finance Corporation and Lucent Technologies Inc. (incorporated herein
by reference to Exhibit 4.6 to KMC Telecom Holdings, Inc.'s Form 10-Q
for the quarterly period ended June 30, 1999).
4.25 Preferred Stock Registration Rights Agreement dated as of April 30,
1999 between KMC Telecom Holdings, Inc. and First Union Investors,
Inc. (incorporated herein by reference to Exhibit 4.9 to KMC Telecom
Holdings, Inc.'s Form 10-Q for the quarterly period ended June 30,
1999).
4.26 Amendment No. 1 dated as of June 1, 1999 to Preferred Stock
Registration Rights Agreement among KMC Telecom Holdings, Inc., First
Union Investors, Inc., Newcourt Commercial Finance Corporation and
Lucent Technologies Inc. (incorporated herein by reference to Exhibit
4.10 to KMC Telecom Holdings, Inc.'s Form 10-Q for the quarterly
period ended June 30, 1999).
4.27 Securities Purchase Agreement dated as of June 30, 2000 among KMC
Telecom Holdings, Inc., Nassau Capital Partners IV, L.P., NAS Partners
I L.L.C., Dresdner Kleinwort Benson Private Equity Partners LP, 75
Wall Street Associates, Harold N. Kamine, CIT Lending Services
Corporation and Lucent Technologies Inc. (incorporated herein by
reference to Exhibit 4.3 to KMC Telecom Holdings, Inc.'s Form 10-Q for
the quarterly period ended June 30, 2000).
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
5.1* Opinion of Kelley Drye & Warren LLP regarding legality.
10.1 Amended and Restated Loan and Security Agreement dated as of February
15, 2000 by and among KMC Telecom Inc., KMC Telecom II, Inc., KMC
Telecom III, Inc., KMC Telecom of Virginia, Inc., KMC Telecom Leasing
I LLC, KMC Telecom Leasing II LLC, KMC Telecom Leasing III LLC, KMC
Telecom.com, Inc., KMC III Services LLC, the financial institutions
from time to time parties thereto as "Lenders", First Union National
Bank as Administrative Agent for the Lenders, First Union National
Bank, as Administrative Agent for the Lenders and Newcourt Commercial
Finance Corporation (formerly known as AT&T Commercial Finance
Corporation), an affiliate of The CIT Group, Inc., as Collateral Agent
for the Lenders (incorporated herein by reference to Exhibit 10.6 to
KMC Telecom Holdings, Inc.'s Form 10-K for the fiscal year ended
December 31, 1999).
10.2 Amendment No. 1, dated as of March 28, 2000, to Amended and Restated
Loan and Security Agreement dated as of February 15, 2000 by and among
KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom III, Inc., KMC
Telecom of Virginia, Inc., KMC Telecom Leasing I LLC, KMC Telecom
Leasing II LLC, KMC Telecom Leasing III LLC, KMC Telecom.com, Inc.,
KMC III Services LLC, the financial institutions from time to time
parties thereto as "Lenders", First Union National Bank as
Administrative Agent for the Lenders, First Union National Bank, as
Administrative Agent for the Lenders and Newcourt Commercial Finance
Corporation (formerly known as AT&T Commercial Finance Corporation),
an affiliate of The CIT Group, Inc., as Collateral Agent for the
Lenders (incorporated herein by reference to Exhibit 10.1 to KMC
Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended
March 31, 2000).
10.3* Loan and Security Agreement, dated as of June 30, 2000, among KMC
Telecom IV, Inc., KMC IV Services LLC and KMC Telecom Leasing IV LLC,
the financial institutions from time to time parties thereto as
"Lenders", Lucent Technologies Inc., as Agent for the Lenders, and
State Street Bank and Trust Company, as Collateral Agent for the
Lenders.
10.4 General Agreement by and among KMC Telecom Inc., KMC Telecom II, Inc.
and Lucent Technologies Inc. dated September 24, 1997, as amended on
October 15, 1997 (incorporated herein by reference to Exhibit 10.7 to
KMC Holdings' S-4).
10.5 Amendment Number Two to the General Agreement by and among KMC Telecom
Inc., KMC Telecom II, Inc., KMC Telecom Leasing I LLC, KMC Telecom
Leasing II LLC and Lucent Technologies Inc. dated as of December 22,
1998 (incorporated herein by reference to Exhibit 10.8 to KMC Telecom
Holdings, Inc.'s Form 10-K for the fiscal year ended December 31,
1999).
10.6 Amendment Number Three to the General Agreement by and among KMC
Telecom Inc., KMC Telecom II, Inc., KMC Telecom III, Inc., KMC Telecom
of Virginia, Inc., KMC Telecom Leasing I LLC, KMC Telecom Leasing II
LLC, KMC Telecom Leasing III LLC and Lucent Technologies Inc. dated as
of November 15, 1999 (incorporated herein by reference to Exhibit 10.9
to KMC Telecom Holdings, Inc.'s Form 10-K for the fiscal year ended
December 31, 1999).
10.7 Amendment Number Four to the General Agreement by and among KMC
Telecom Inc., KMC Telecom II, Inc., KMC Telecom III, Inc., KMC Telecom
IV, Inc., KMC Telecom of Virginia, Inc., KMC Telecom Leasing I LLC,
KMC Telecom Leasing II LLC, KMC Telecom Leasing III LLC, KMC Telecom
Leasing IV LLC, KMC III Services LLC and Lucent Technologies Inc.
dated as of February 15, 2000 (incorporated herein by reference to
Exhibit 10.10 to KMC Telecom Holdings, Inc.'s Form 10-K for the fiscal
year ended December 31, 1999).
10.8 Professional Services Agreement between KMC Telecom Inc. and Lucent
Technologies, Inc. dated September 4, 1997 (incorporated herein by
reference to Exhibit 10.8 to KMC Holdings' S-4).
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
10.9 Memorandum of Agreement between KMC Telecom Holdings, Inc. and EFTIA
OSS Solutions Inc., dated as of October 26, 1998 (incorporated herein
by reference to Exhibit 10.6 to KMC Telecom Holdings, Inc.'s Form 10-
K for the fiscal year ended December 31, 1998).
10.10 Master License Agreement dated December 31, 1998 by and between
Billing Concepts Systems, Inc. and KMC Telecom Holdings, Inc.
(incorporated herein by reference to Exhibit 10.7 to KMC Telecom
Holdings, Inc.'s Form 10-K for the fiscal year ended December 31,
1998).
10.11 Lease Agreement dated January 1, 1996 between Cogeneration Services
Inc. (now known as Kamine Development Corp.) and KMC Telecom Inc.
(incorporated herein by reference to Exhibit 10.8 to KMC Telecom
Holdings, Inc.'s Form 10-K for the fiscal year ended December 31,
1998).
10.12 1998 Stock Purchase and Option Plan for Key Employees of KMC Telecom
Holdings, Inc. and Affiliates (incorporated herein by reference to
Exhibit 4 to KMC Holdings, Inc.'s Form 10-Q for the quarterly period
ended September 30, 1998).
10.13 Specimen of Non-Qualified Stock Option Agreement for options granted
under the 1998 Stock Purchase and Option Plan for Key Employees of
KMC Telecom Holdings, Inc. and Affiliates (incorporated herein by
reference to Exhibit 10.10 to KMC Holdings, Inc.'s Form 10-Q for the
quarterly period ended September 30, 1998).
10.14 Amendment No. 1 made as of June 7, 1999 to 1998 Stock Purchase and
Option Plan for Key Employees of KMC Telecom Holdings, Inc. and
Affiliates (incorporated herein by reference to Exhibit 10.1 to KMC
Telecom Holdings, Inc.'s Form 10-Q for the quarterly period ended
June 30, 1999).
10.15** Participation Agreement, dated as of June 28, 2000, among KMC Telecom
V, Inc., Telecom V Investor Trust 2000-A, Wilmington Trust Company,
in its individual capacity and as trustee of the Lessor, and the
Investors party thereto.
10.16** Employment Agreement, dated as of April 17, 2000, by and between KMC
Telecom Holdings, Inc. and William F. Lenahan.
10.17** Employment Agreement, dated as of March 9, 2000, by and between KMC
Telecom Holdings, Inc. and William H. Stewart.
10.18** Amended and Restated Employment Agreement, dated as of March 6, 2000,
by and between KMC Telecom Holdings, Inc. and Roscoe C. Young II.
10.19*** Amended and Restated Media Gateway Services Agreement II between KMC
Telecom V Inc. and Qwest Communications Corporation, effective as of
March 31, 2000.
10.20*** Media Gateway Services Agreement III between KMC Telecom VI Inc. and
Qwest Communications Corporation, effective as of June 30, 2000.
10.21*** Amendment No. 1 to the Media Gateway Services Agreement III between
KMC Telecom VI Inc. and Qwest Communications Corporation, effective
as of August 31, 2000.
10.22* Pledge and Security Agreement, dated as of June 1, 2000 by and among
Harold N. Kamine, KNT Partners, LP, KNT Network Technologies, LLC and
KMC Telecom Holdings, Inc.
10.23* Secured Promissory Note, dated as of June 1, 2000, delivered by KNT
Network Technologies, LLC to KMC Telecom Holdings, Inc.
10.24* Real Estate Agreement, dated as of June 1, 2000 between KMC Telecom
Holdings, Inc. and KNT Network Technologies, LLC.
10.25* Maintenance Agreement, dated as of June 1, 2000, by and between KMC
Telecom Holdings, Inc. and KNT Network Technologies, LLC.
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
10.26* Master Engineering, Procurement and Construction Contract, dated as of
June 1, 2000, by and between KMC Telecom Holdings, Inc. and KNT
Network Technologies, LLC.
10.27* KNT Asset Transfer and Proceeds Sharing Agreement, dated as of June 1,
2000 between KNT Network Technologies, LLC and KMC Telecom Holdings,
Inc.
21.1** Subsidiaries of KMC Telecom Holdings, Inc.
23.1** Consent of Ernst & Young LLP.
23.2* Consent of Kelley Drye & Warren LLP (contained in Exhibit 5.1).
24.1** Powers of Attorney (included on signature page of this Registration
Statement).
</TABLE>
--------
* To be filed by amendment.
** To be filed herewith.
*** Filed herewith with information omitted. Confidential treatment has been
requested as to certain portions, and the omitted portions have been
separately filed.
8
