-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, U+4kIzUS+4OERq33atinNFqBfk4MiS7ehZUjs9ARpx258TqQi+i6jBqjRl/VPSIU WoKPyoVUJhG1UMQeUx4boQ== 0000932440-99-000089.txt : 19990413 0000932440-99-000089.hdr.sgml : 19990413 ACCESSION NUMBER: 0000932440-99-000089 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 DATE AS OF CHANGE: 19990412 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KMC TELECOM HOLDINGS INC CENTRAL INDEX KEY: 0001059851 STANDARD INDUSTRIAL CLASSIFICATION: 4899 IRS NUMBER: 223545925 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-50475 FILM NUMBER: 99584935 BUSINESS ADDRESS: STREET 1: 1545 ROUTE 206 STREET 2: SUITE 300 CITY: BEDMINSTER STATE: NJ ZIP: 07921 BUSINESS PHONE: 9084702100 MAIL ADDRESS: STREET 1: 1545 ROUTE 206 STREET 2: SUITE 300 CITY: BEDMINSTER STATE: NJ ZIP: 07921 10-K 1 FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 333-50475 KMC TELECOM HOLDINGS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 22-3545325 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) (INCORPORATION OR ORGANIZATION) 1545 ROUTE 206, SUITE 300 BEDMINSTER, NEW JERSEY 07921 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) Registrant's telephone number, including area code: (908) 470-2100 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) of the Act: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) of the Act: None Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [X]. The aggregate market value of the voting common stock held by non-affiliates of the registrant as of March 24, 1999 was approximately $34,450,780, based upon an estimate of the fair value thereof by management of the registrant. There is no established trading market for the voting common stock of the registrant and no sales have occurred within the past sixty days. As of March 24,1999, 852,676 shares of the registrant's Common Stock, $0.01 par value, were outstanding. There is no established trading market for the Common Stock. DOCUMENTS INCORPORATED BY REFERENCE. None. ================================================================================ CAUTIONARY STATEMENT REGARDING FORWARD - LOOKING STATEMENTS STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, HOPES, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS INCLUDE: STATEMENTS REGARDING THE ANTICIPATED DEVELOPMENT AND EXPANSION OF OUR BUSINESS, THE MARKETS IN WHICH OUR SERVICES ARE CURRENTLY OFFERED, OR WILL BE OFFERED IN THE FUTURE, ANTICIPATED CAPITAL EXPENDITURES AND REGULATORY REFORM, THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF THE COMPANY, OUR DIRECTORS OR OFFICERS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE AND OTHER MATTERS, AND OTHER STATEMENTS REGARDING MATTERS THAT ARE NOT HISTORICAL FACTS. ALL FORWARD-LOOKING STATEMENTS IN THIS REPORT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY AS OF THE DATE THIS REPORT IS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, THE FACTORS SET FORTH IN "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CERTAIN FACTORS WHICH MAY AFFECT THE COMPANY'S FUTURE RESULTS." PART I ITEM 1. BUSINESS. BACKGROUND The initial predecessors of KMC Telecom Holdings, Inc. were founded in 1994 and 1995, respectively, by Harold N. Kamine, the Company's Chairman of the Board. These predecessors were merged in 1996 and renamed KMC Telecom Inc. KMC Telecom Holdings, Inc. was formed during 1997 primarily to own, directly or indirectly, all of the shares of its operating subsidiaries, KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom III, Inc., and KMC Telecom of Virginia, Inc. The principal equity investors in the Company currently include Mr. Kamine, Nassau Capital Partners, L.P., Newcourt Capital, Inc., CoreStates Holdings, Inc. (an affiliate of First Union National Bank), General Electric Capital Corporation and Lucent Technologies, Inc. COMPANY OVERVIEW The Company is a facilities-based competitive local exchange carrier providing telecommunications and data services in Tier III Markets (population from 100,000 to 750,000). The markets in which we operate are predominately located in the Southeastern and Midwestern United States. We target business, government and institutional end-users, as well as Internet service providers, long distance carriers and wireless service providers. Our objective is to provide our customers with a complete solution for their communications needs. We currently provide on-net local dial tone, special access, private line, Internet access, ISDN and a variety of other advanced services and features. We currently operate in twenty-three Tier III Markets. We have constructed robust fiber optic networks in each of our markets, typically of 25 to 35 miles in length, which we believe allow us to insure quality services, facilitate the delivery of value-added and enhanced services, and effectively control our costs. We currently have Lucent Technologies Series 5ESS(R)-type switches in commercial operation in twenty-two of our existing markets. We intend to install a Lucent switch in our remaining existing network no later than the second quarter of 1999. We also intend to install Lucent switches in any future networks which we may build. Over time, we expect to transition the majority of our customers to our own networks by means of either unbundled network elements leased from the incumbent local exchange carrier (i.e. the established local telephone company, such as Bell Atlantic, BellSouth, Ameritech or one of the subsidiaries of GTE Corporation) or direct connections to our own networks. We presently plan to construct networks in approximately ten additional Tier III Markets. We currently anticipate that these new networks will be completed and placed in commercial operation by the end of the second quarter of 2000. BUSINESS STRATEGY The principal elements of our business strategy include: FOCUS ON TIER III MARKETS. We intend to operate in Tier III Markets. We believe that incumbent local exchange carriers tend to focus their efforts on larger markets and generally underserve and underinvest in Tier III Markets. We also believe that there is generally significantly less competition from other facilities-based competitive local exchange carriers in Tier III Markets, which allows us to gain market share more rapidly than we could expect to in Tier I and Tier II Markets. A facilities-based competitive local exchange carrier is one which operates its own network, including switching equipment and transmission lines, rather than one which resells the services of others utilizing the network of the incumbent local exchange carrier. In addition, network construction is less expensive in Tier III Markets than in Tier I and Tier II Markets. Generally, labor costs and the costs of obtaining rights of way are lower in Tier III Markets. Further, many Tier III Markets permit significant aerial deployment of fiber optic cable which is less expensive than the buried deployment required in many Tier I and Tier II Markets. We estimate that approximately 70% of our fiber is deployed aerially. We target markets which we believe offer attractive demographic, economic, competitive and demand characteristics. We select target markets from among the approximately 250 Tier III Markets in the United States by first identifying those markets that do not yet have significant, established competitors to the existing incumbent local exchange carrier, and by then reviewing the specific demographic, economic, competitive and telecommunications demand characteristics of such markets to determine their suitability for the types of services which we offer. We estimate market demand on the basis of the concentration of potential business, government and institutional end-user customers in the market and the general economic prospects for the area. EARLY TO MARKET ADVANTAGE. We strive to be the first facilities-based competitive local exchange carrier in a geographic area to actively market and provide services. We believe that by effecting early entry into Tier III Markets with a facilities-based strategy, we will be able to limit significant competition from other competitive local exchange carriers which may focus on Tier III Markets where no competitive local exchange carrier has yet established operations, although we can give no assurance in this regard. COMPREHENSIVE FIBER NETWORKS. We build geographically extensive, full service, facilities-based networks. We believe such networks provide greater operating leverage, facilitate the capture of market share, and are likely to deter other competitive local exchange carriers from attempting to penetrate our markets due to the cost of constructing a competing network of equal capability. Prior to both the initial construction of our network backbone and any subsequent network expansion, we perform detailed rate of return analyses to justify the capital expenditures involved. In each of our existing twenty-three 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. In addition, we intend to continue to expand our existing networks in response to anticipated customer demand. LOCAL PRESENCE. We intend to capture and retain customers through effective local, personalized sales, marketing and customer service programs. To this end, we: o establish sales offices in each market in which we operate a network, o strive to recruit our city directors and sales staff from the local market, o rely principally on a face-to-face selling approach, and o support our sales staff with locally based customer service and technical support personnel. 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"(TM) sales approach is very important to customers in Tier III Markets, who do not typically receive focused local sales contact or customer support from the incumbent local exchange carrier. We seek to build long-term relationships with our customers by responding rapidly and creatively to their telecommunications needs. FOCUS ON VALUE-ADDED ENHANCED SERVICE.S We believe it is strategically important to offer these services because: o they are a competitive differentiator, o they provide a substantial margin opportunity, o the incumbent local exchange carriers' prices for these services are relatively high and are regulated, o incumbent local exchange carriers have underinvested in facilities and sales force related to these services, and o we are able to offer these services without a significant marginal cost. LOW COST CONSTRUCTION. It is our practice to use innovative "switch-in-a-box" construction and deployment techniques for many of our networks. Using these techniques, transmission, switching and power equipment are pre-installed by Lucent Technologies, Inc. under controlled factory conditions in portable, weatherproof, storm-proof concrete buildings delivered to the Lucent facility by our contractor. The completed buildings are then shipped to the appropriate city for final installation, reducing costs, installation risks and time to market. QUALITY OPERATIONS SUPPORT SYSTEM. We are developing a high quality operations support system to provide us with comprehensive billing, order processing and customer care software for all existing and contemplated services we will market. This system is designed to provide us with a single "flow-through" order form that will entail several components, allowing each order to be tracked from service provisioning through to complete installation. We believe that this system will allow us to quickly address customer concerns and provide us with a competitive advantage in customer service and operations efficiency. EXPERIENCED MANAGEMENT TEAM. The Company's management team includes individuals with over 250 years of experience, collectively, in the telecommunications industry. It is led by Harold N. Kamine, Chairman of the Board of Directors, and Michael A. Sternberg, the Company's President and Chief Executive Officer. Other members of the team include Roscoe C. Young II, Chief Operating Officer, James D. Grenfell, Executive Vice President, Chief Financial Officer and Secretary, and James L. Barwick, Senior Vice President-Technology. SERVICES GENERAL. We have historically provided dedicated access service and have also resold switched services which we purchased from incumbent local exchange carriers. In December 1997, we began providing our own on-net switched services to our customers. For 1997 on-net switched services accounted for 32% of our revenue and resale services accounted for 68% of our revenue. For 1998 on-net switched services accounted for 37% of our revenue and resale services accounted for 63% of our revenue. PRIVATE LINE AND SPECIAL ACCESS SERVICES. We currently provide various types of on-net dedicated service which permit the transmission of voice and data between two points over circuits dedicated to the requirements of a particular customer. Private line service involves the provision of a private, dedicated telecommunications connection among different locations of the same customer. For these services we offer several types of dedicated circuits that have different capacities. DS-1 and DS-3 circuits are dedicated lines that can carry up to 24 and 672 simultaneous voice and data transmissions, respectively. Special access service involves the leasing, to long distance carriers, of private, dedicated telecommunications lines running along our networks. The long distance carriers use these lines to connect different locations where they have installed transmission equipment within the market, to connect locations where they have installed transmission equipment to the transmission equipment locations of other long distance carriers within the market, or to connect large customers directly to the locations of their transmission equipment. For these services we offer OC3, OC12 and OC48 circuits. These OC-N services provide the fastest transmission available for carriers and large business users. SWITCH-BASED SERVICES. We have added and continue to add capability to provide local dial tone services and switched access origination and termination services to our networks. Switches are currently in commercial operation in twenty-two of our existing markets and we expect to have a switch in commercial operation in our remaining existing network no later than the second quarter of 1999. Over time, we expect to transition the majority of our customers to our own networks by means of either unbundled network elements leased from the incumbent local exchange carrier or direct connections. We have entered into interconnection agreements with incumbent local exchange carriers for all of our existing networks. ISDN. ISDN, or integrated services digital network, is an internationally agreed upon standard which, through special equipment, allows two-way, simultaneous voice and data transmission in digital formats over the same transmission line. ISDN permits videoconferencing over a single line, for example, and also supports a multitude of value-added networking capabilities. This service targets sophisticated business customers whose applications require integration of services such as Internet access, video, voice or other communications services, including high speed data transfer. By integrating multiple applications, customers receive increased capability and may not have any increase in costs to achieve that capability. The principal purchasers of this service are currently Internet service providers. LONG DISTANCE. We offer a full range of long distance products including inter-LATA, intra-LATA, interstate, international, calling card and 800-number services. During the first quarter of 1999, we plan to introduce KMC-branded operator services, directory services and prepaid phone cards. We offer these services both on-net and off-net. We offer long distance services on a resale basis by entering into wholesale agreements with various long distance carriers to deliver these services. We believe that many of our customers will prefer the option of purchasing long distance services from us as part of a one-stop telecommunications solution. CENTREX-TYPE SERVICES. We intend to provide Centrex-type services. By using Centrex-type services instead of a PBX (which requires the customer to purchase and install a switching system on its own premises), customers can substantially reduce their capital expenditures and the fixed costs associated with maintaining a PBX network infrastructure. We currently plan to introduce our ClearStarsm Advantage service in all of our operational markets during the first quarter of 1999. It has been designed to support multiple applications, ranging from basic access services to services focused on desktop applications. The basic access service will connect to a customer's key system or PBX and will be equipped with up to 14 features including call forwarding, speed dialing and call transfer capabilities. More sophisticated levels of service are designed to replace customers' existing key systems or PBXs. At the high end of service offerings is ClearStarsm Advantage Plus, a packaged, end-to-end offering which combines all of the basic features with Basic Rate ISDN network access, advanced feature functionality, voice messaging and third party-provided ISDN electronic terminal sets. NEW ENHANCED DATA SERVICES OFFERINGS. We introduced ISDN services in late 1998. We currently plan to expand our capabilities by introducing additional enhanced data services in 1999. We believe that these services will enhance our ability to provide an integrated turnkey solution to our customers' voice, data and video transmission requirements. These enhanced services will include: o BASIC RATE ISDN. Basic Rate ISDN, or BRI, provides customers the potential of 144 kilobits of digital communications via a single network facility interface. We believe it will be attractive to small and medium 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. o PRIMARY RATE ISDN. Primary Rate ISDN, or PRI, provides customers the equivalent of 1.544 megabits of digital communications via a channelized T-1 type facility, with 23 bearer channels for voice and data communications and a 24th channel providing network signaling and control for the services. We focus our PRI sales efforts on (i) Internet service providers who use Primary Rate ISDN as a means of supporting customer access to their operations, and (ii) end-user customers who use Primary Rate ISDN as a network access facility for PBXs and other premise-based switches. o PORT WHOLESALE. Port wholesale terminates a switched data call directly in our central office on behalf of an Internet service provider (for end-user Internet access) or other corporate customer (for employee remote access). As a result, it eliminates the need for an Internet service provider or other corporate customer, which has many customers or employees accessing its system via modems, to maintain an equally large number of modems to permit interface, since that function is performed directly in our central office. Although port wholesale technology is still under development, we believe it will prove very attractive once the technology is generally available. o HDSL. HDSL is a method of using unconditioned, copper wire pairs for high bit rate data transport for use in the "last mile" connecting our network backbone ring to the customer's premises. We plan to utilize HDSL to provide high bandwidth data and video service to small and medium size customers. o FRAME RELAY/ATM. Frame relay and ATM 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. o CLEAR STARSM ADVANTAGE PLUS. This service provides a customer with Centrex-type functionality from our central office switch to each of the customer's desktops. It is a packaged, end-to-end offering which provides a combination of Basic Rate ISDN network access, advanced Centrex feature functionality, voice messaging, ISDN terminal sets and support for premise wiring configuration. We plan to remain flexible in responding to evolving customer demands for enhanced data services. LOCAL NETWORKS As part of determining the economic viability of a network in a particular market, we review 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 the Company, on the basis of the concentration of potential business, government and institutional end-user customers and the general economic prospects for the area. Once we target a market for development, we design a network to provide access to approximately 70% 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 25-35 mile "self-healing" synchronous optical network ("SONET") architecture backbone ring to provide coverage of the major business districts, government offices, hospitals, office parks and universities, the principal 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 expect to build additional loops to increase the size of our addressable market. The following table presents information, as of February 28, 1999, concerning our existing twenty-three networks:
EXISTING NETWORKS ADDRESSABLE DS-0 COMMERCIALLY ROUTE COMMERCIAL ACCESS EQUIVALENT LOCATION OPERATIONAL(1)(6) MILES(2)(6) BUILDINGS(3) LINES(4) DEDICATED LINES(5) - - -------- ----------------- ----------- ------------ -------- ------------------ Huntsville, AL.................... November 1997 99 1,286 13,954 40,928 Baton Rouge, LA................... November 1997 38 1,774 3,696 5,880 Shreveport, LA.................... December 1997 26 1,126 7,261 12,760 Corpus Christi, TX................ December 1997 49 1,105 5,804 2,713 Savannah, GA...................... December 1997 43 1,069 6,176 1,112 Madison, WI....................... December 1997 41 1,322 2,719 11,009 Augusta, GA....................... March 1998 37 1,023 5,910 2,911 Melbourne, FL..................... May 1998 45 2,184 2,290 6,517 Greensboro, NC.................... September 1998 25 1,900 673 - Winston-Salem, NC................. September 1998 24 1,208 1,344 - Tallahassee, FL................... October 1998 29 1,032 922 97 Roanoke, VA....................... November 1998 22 981 989 6 Ann Arbor, MI..................... December 1998 23 1,355 559 28 Topeka, KS........................ December 1998 38 847 534 1,368 Fort Wayne, IN.................... December 1998 27 1,411 902 144 Eden Prairie, MN.................. December 1998 94 3,509 295 - Daytona Beach, FL................. December 1998 31 1,114 629 23 Fort Myers, FL.................... December 1998 23 814 509 1,344 Longview, TX...................... December 1998 31 688 150 - Sarasota, FL...................... December 1998 24 1,200 1,670 48 Pensacola, FL..................... December 1999 31 1,463 2,089 - Fayetteville, NC.................. December 1999 23 822 26 - Norfolk, VA....................... Second Quarter 1999 149 2,505 - - --- ------ ------ ------ TOTAL 972 31,738 59,101 86,888
- - ----------- (1) Refers to the date on which testing is completed and the switch is first available to carry customer traffic. Fiber optic networks typically become commercially operational for non-switched traffic in the quarter before the switch is available to carry customer traffic. (2) Represents current owned operational route miles except with respect to the Norfolk network (see, Note 6, below). (3) Addressable by either unbundled network elements leased from the incumbent local exchange carrier or by a direct connection to the Company's own network. We define a commercial building as one with greater than ten employees. (4) Represents all active digital switched channels provided to customers either by resale via the incumbent local exchange carrier's network, direct connection to the Company's network, or by unbundled network elements leased from the incumbent local exchange carrier. (5) Represents all dedicated DS-0, DS-1 and DS-3 service provided by the Company expressed on a DS-0 basis. (6) The quarter presented for the Norfolk network represents the Company's estimate of the calendar quarter in which the switch for this network will become commercially operational, although we can give no assurance in this regard. Route miles presented for the Norfolk network represents the number of miles currently estimated to be owned and operational at the time the network becomes commercially operational. The Company's requirements for a planned network are communicated to its engineering group which finalizes the route and completes the network's design. Independent construction and installation contractors are selected through a competitive bidding process. Our own personnel negotiate required contracts and rights-of-way and supervise the construction, installation and testing of network components prior to commencing commercial service. Cable, equipment and supplies required for the networks are available from a variety of sources at competitive rates. The construction period for a new network varies depending upon such factors as the number of backbone route miles to be installed, the relative use of aerial as opposed to buried cable deployment, the initial number of buildings targeted for connection to the network backbone and other factors. Based upon our experience with our operational networks, we believe that a new fiber optic network can be made commercially operational within approximately six months after construction commences. In a typical Tier III Market, selected office buildings are connected by network backbone extensions or unbundled network elements leased from the incumbent local exchange carrier to one of a number of physical rings of fiber optic cable, which originate and terminate at our local central office. Within each building, customer equipment is connected to Company-provided electronic equipment where customer transmissions are digitized, combined and converted to an optical signal. The traffic is then transmitted through the network backbone to the Company's local central office where it can be routed to its ultimate destination. We are able to expand our reach in a market by collocating equipment in an incumbent local exchange carrier's central office and leasing unbundled network elements from that incumbent local exchange carrier in order to reach customers located in buildings which are not directly connected to our own backbone ring. We attempt to place collocation equipment in a sufficient number of incumbent local exchange carrier central offices to allow us to reach approximately 70% of the business customers in a given market, either by means of such unbundled network elements or direct connections to our network. The decision as to whether to collocate in a specific central office is based upon the number of business lines, number and type of businesses, number of households and the location of the central office within the market. Our networks consist of digital fiber optic communications paths which allow for high speed, high quality transmission of voice, data and video communications. We typically install backbone fiber optic cables containing 48 to 144 fiber strands which have significantly greater bandwidth carrying capacity than other media. Our OC-48 SONET networks support up to 32,256 simultaneous voice conversations over a single pair of glass fibers. We expect that continuing developments in compression technology and multiplexing equipment will increase the capacity of each fiber, thereby providing more bandwidth carrying capacity at relatively low incremental costs. We currently offer end-to-end fully protected fiber services utilizing SONET ring architecture which routes customer traffic simultaneously in both directions around the ring to provide protection against fiber cuts. If a line is cut, traffic can be simply reversed and sent to its destination around the other side of the ring. Back-up electronics become operational in the event of failure of the primary components, adding further redundancy to our systems. We monitor our fiber optic networks and electronics seven days per week, 24 hours per day, 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 any system anomaly. 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 Reliability Center, located in Denver, Colorado, acts as the focal point for all of our operating networks, providing integrated and centralized network monitoring, and correlation and problem management. The Network Reliability Center has access to all operating networks and can work independently of the local systems to effect repair or restoration activities. The Network Reliability Center is currently provided by Lucent Technologies, Inc. on a contractual basis. In the future, we may develop our own national center. 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 National Reliability Center. This is accomplished by the use of a sophisticated integrated management system that is connected via the public network to all of our locations, including our Duluth, Georgia, operations center. With this system the National Reliability 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 hour a day, seven day a week call center, also provided by Lucent at the National Reliability Center, that receives, tracks and manages all customer calls and issues to satisfactory conclusion. The call center works with the Company's own customer care representatives and engineers in the Duluth facility to ensure that timely and consistent service is provided. SALES AND MARKETING We target our sales and marketing activities at two separate customer groups: retail and wholesale. Retail customers are composed of business, government and institutional telecommunications and data services end-users. Wholesale customers typically consist of long distance carriers, wireless service providers and Internet service providers. We currently have approximately 180 employees engaged in sales and marketing activities. RETAIL CUSTOMERS. We target retail customer segments such as business, government, healthcare and educational institutions. We target all business customers in our markets. WHOLESALE CUSTOMERS. We currently target the major long distance carriers such as AT&T, MCI WorldCom and Sprint, as well as Internet service providers. We believe that we can effectively compete to provide access to these customers based on price, reliability, technology, route diversity, ease-of-ordering and customer service. Historically, long distance carriers have paid significant charges to incumbent local exchange carriers to access the incumbent local exchange carriers' networks. We provide these services at a discount. In addition, to the extent that incumbent local exchange carriers begin to compete with long distance carriers in providing long distance services, the long distance carriers have a competitive incentive to move access business away from incumbent local exchange carriers to competitive local exchange carriers such as the Company. Wireless service providers, who need network backbone to back haul calls, are an active customer base, as are other competitive local exchange carriers as wholesale users. Revenues from access services may decline in future years due to a change in pricing proposed by the Federal Communications Commission. SALES PERSONNEL. We establish local sales offices in each market that we serve. Initially, each local sales office is staffed by a City Director and two or three salespersons with the number of sales personnel expected to increase to between four and six as our operations in the market expand. All sales personnel are hired locally since 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. CITY DIRECTORS. We seek to hire local, seasoned telecommunications managers, with sales experience, as City Directors. City Directors assist with the initial network buildout and oversee the daily operations of their network, in addition to managing sales staff and market development. Daily operations responsibilities include monitoring provisioning, customer service, pricing decisions and the billing process. A City Director works with senior management in the strategic planning process, including capital expenditures and budget planning. They review the costs to bring customers on-net, perform cash flow analysis for fiber connections of new buildings to the network, and participate in planning fiber network extensions in their markets. SUPPLIERS LUCENT. We have contracted with Lucent Technologies, Inc., 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, Lucent and the Company have entered into an agreement pursuant to which Lucent has agreed to monitor the Company's switches on an on-going basis. BILLING SUPPORT SYSTEMS IMPLEMENTATION. We have entered into an agreement with Billing Concepts Systems, Inc. to provide the Company with comprehensive billing functionality, including the ability to collect call detail records, message rating, bill calculation, invoice generation, commission tracking, customer care and inquiry, accounts receivable and collections management, and quality/revenue assurance. We anticipate that the agreement with Billing Concepts will result in our ability to produce a single bill covering all of the products and services that we provide to a customer. We have begun implementation of the new system and expect to have it implemented in all of our markets by the end of 1999. OPERATIONAL SUPPORT SYSTEMS IMPLEMENTATION. We have entered into an agreement with Eftia OSS Solutions Inc. to develop operational support systems. These systems will manage service order processing, circuit and asset inventory, telephone number inventory and trouble administration. The operational support system's capabilities will be expanded during the later phases of the project to include workforce management, local number portability management, network management, service bureau interfaces and web-based service inquiry. We anticipate the system will automate operational support activities and provide a means of managing operational performance of our business. We have begun this multi-phased project and will be implementing portions of it over the next twelve to eighteen months. COMPETITION OVERVIEW. The telecommunications industry is highly competitive. Our principal competitors in Tier III Markets will be the incumbent local exchange carriers. In most instances the incumbent local exchange carrier is one of the Regional Bell Operating Companies (such as Bell Atlantic, BellSouth or Ameritech), one of GTE Corporation's subsidiaries or one of Sprint Corporation's subsidiaries. Incumbent local exchange carriers presently have almost 100% of the market share in those areas the Company considers its market areas. Because of their relatively small size, the Company does not believe that Tier III Markets can profitably support more than two competitors to the incumbent local exchange carrier. Other competitors may include other competitive local exchange carriers, microwave and satellite carriers, wireless telecommunications providers and private networks built by large end-users. Potential competitors (using similar or different technologies) include cable television companies, utilities and Regional Bell Operating Companies seeking to operate outside their current local service areas. In addition, there may be future competition from large long distance carriers, such as AT&T 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 to the Company. 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. We expect to experience declining prices and increasing price competition. INCUMBENT LOCAL EXCHANGE CARRIERS. The Company's principal competitors for local exchange services are the Regional Bell Operating Companies, the GTE companies or Sprint. 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 those of the Company, have the potential to fund competitive services with revenues from a variety of businesses and currently benefit from certain existing regulations that favor the incumbent local exchange carriers over the Company in certain respects. While recent regulatory initiatives, which allow competitive local exchange carriers such as the Company to interconnect with incumbent local exchange carrier facilities, provide increased business opportunities for the Company, such regulatory initiatives have been accompanied by increased pricing flexibility for, and relaxation of regulatory oversight of, the incumbent local exchange carriers. If the incumbent local exchange carriers engage in increased volume and discount pricing practices or charge competitive local exchange carriers increased fees for interconnection to their networks, or if the incumbent local exchange carriers seek to delay implementation of interconnection to their networks, our business, financial condition and results of operations could be adversely affected. To the extent that we interconnect with and use incumbent local exchange carrier networks to serve our customers, we are dependent upon the technology and capabilities of the incumbent local exchange carriers. We will become increasingly dependent on interconnection with incumbent local exchange carriers as switched services become a greater percentage of our business. The Telecommunications Act of 1996 imposes interconnection obligations on incumbent local exchange carriers, but there can be no assurance that we will be able to obtain the interconnection we require at rates, and on terms and conditions, that permit us to offer switched services at rates that are both competitive and profitable. In the event that we experience difficulties in obtaining high quality, reliable and reasonably priced service from the incumbent local exchange carriers, the attractiveness of the Company's services to our customers could be impaired. COMPETITIVE LOCAL EXCHANGE CARRIER AND OTHER COMPETITORS. We will compete from time to time with other competitive local exchange carriers. It is likely that in one or more of our markets we will face competition from two or more facilities-based competitive local exchange carriers. After the investment and expense of establishing a network and support services in a given market, the marginal cost of carrying an additional call is negligible. Accordingly, in Tier III Markets where there are three or more facilities-based 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 expect to 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 the Company's services, or search for other market opportunities. We believe that each market will also see more agent and distributor resale initiatives. REGULATION Our services are subject to varying degrees of federal, state and local regulation. The Federal Communications Commission exercises jurisdiction over all facilities of, and services offered by, telecommunications common carriers to the extent those facilities are used to provide, originate or terminate interstate or international communications. The state regulatory commissions retain jurisdiction over the same facilities and services to the extent they are used to originate or terminate intrastate communications. Local governments sometimes impose franchise or licensing requirements on competitive local exchange carriers. 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, which was signed into law by the President on February 8, 1996. This legislation provides for comprehensive reform of the nation's telecommunications laws and is designed to enhance competition in, among other markets, the local telecommunications marketplace by: (i) removing state and local entry barriers, (ii) requiring incumbent local exchange carriers to provide interconnections to their facilities, (iii) facilitating the end-users' choice to switch service providers from incumbent local exchange carriers to competitive local exchange carriers such as the Company and (iv) requiring access to rights-of-way. The legislation also is designed to enhance the competitive position of the 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, Regional Bell Operating Companies have the opportunity to provide in-region inter-LATA long distance services if certain conditions are met and are no longer prohibited from providing certain cable television services. In addition, the Telecommunications Act eliminates certain restrictions on utility holding companies, thus clearing the way for them to diversify into telecommunications services. The Telecommunications Act specifically requires all telecommunications carriers (including incumbent local exchange carriers and competitive local exchange carriers (such as the Company)): (i) not to prohibit or unduly restrict resale of their services; (ii) to provide dialing parity and nondiscriminatory access to telephone numbers, operator services, directory assistance and directory listings; (iii) to afford access to poles, ducts, conduits and rights-of-way; and (iv) to establish reciprocal compensation arrangements for the transport and termination of telecommunications. It also requires incumbent local exchange carriers and competitive 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 interconnection (a) at any technically feasible point within the incumbent local exchange carrier's network, (b) 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 (c) at rates, terms and conditions that are just, reasonable and nondiscriminatory. Incumbent local exchange carriers also are required under the new law to provide nondiscriminatory access to network elements on an unbundled basis at any technically feasible point, to offer their local telephone services for resale at wholesale rates, and to facilitate collocation of equipment necessary for competitors to interconnect with or access the unbundled network elements. The Telecommunications Act also removed on a prospective basis most restrictions from AT&T and the Regional Bell Operating Companies resulting from the Modified Final Judgement, which was the consent decree entered in 1982 providing 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 "in-region" inter-LATA (i.e., long distance between specified areas) services, within the area where it provides local exchange service. The Telecommunications Act permitted the Regional Bell Operating Companies to enter the out-of-region long distance market immediately upon enactment, and Regional Bell Operating Companies can provide intra-LATA long distance services. Before the Regional Bell Operating Company can provide in-region inter-LATA services, it must obtain FCC approval upon a showing that facilities-based competition is present in its market, that the Regional Bell Operating Company has entered into interconnection agreements in the states where it seeks authority, that the interconnection agreements satisfy a 14-point "checklist" of competitive requirements, and that such entry is in the public interest. To date, such authority has not been granted, but requests by Regional Bell Operating Companies are the subject of pending appeals. 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 the long distance carriers. FCC RULES IMPLEMENTING THE LOCAL COMPETITION PROVISIONS OF THE TELECOMMUNICATIONS ACT OF 1996. On August 8, 1996, the Federal Communications Commission released the Interconnection Decision which established a framework of minimum, national rules enabling state public service commissions and the FCC to begin implementing many of the local competition provisions of the Telecommunications Act of 1996. The Interconnection Decision promulgated rules to implement Congress' statutory directive concerning the interconnection obligations of all telecommunications carriers, including obligations of competitive local exchange carrier and incumbent local exchange carrier networks. The FCC prescribed certain minimum points of interconnection necessary to permit competing carriers to choose the most efficient points at which to interconnect with the incumbent local exchange carriers' networks. The FCC 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. The FCC also adopted a methodology for states to use when applying the Telecommunications Act's "avoided cost standard" for setting wholesale prices with respect to retail services. In July and October of 1997 the U.S. Court of Appeals for the Eighth Circuit vacated certain portions of the Interconnection Decision, ruling that the State public service commissions, not the Federal Communications Commission, have jurisdiction over the pricing of interconnection, unbundled network elements and resale services. The Eighth Circuit Court also ruled that the FCC's interpretation of Section 252(i) of the Telecommunications Act of 1996, the so-called "pick and choose" provision, was incorrect. The Eighth Circuit Court held that the Telecommunications Act allows competitive local exchange carriers to adopt whole interconnection agreements negotiated by other competitors, but not to "pick and choose" pieces of existing agreements. In January 1999, the United States Supreme Court reversed the Eighth Circuit's decisions, upholding the FCC's authority to establish national pricing rules for interconnection, unbundled elements and resale services. The Supreme Court also upheld the FCC's interpretation of the "pick and choose" provisions. However, the Supreme Court overturned the FCC's rules regarding what network elements must be unbundled by the Regional Bell Operating Companies, and remanded to the FCC the question of what network elements are "necessary" to competing carriers such as the Company. In addition, the Supreme Court's decision creates some uncertainty regarding the legal status of complaints filed at the FCC to enforce interconnection agreements. There can be no assurance that the Company will be able to obtain or enforce interconnection agreements on terms acceptable to the Company. On December 31, 1997, the U.S. District Court for the Northern District of Texas issued the SBC Decision finding that Sections 271 to 275 of the Telecommunications Act of 1996 are unconstitutional. These sections of the Telecommunications Act impose restrictions on the lines of business in which the Regional Bell Operating Companies may engage, including establishing the conditions the Regional Bell Operating Companies must satisfy before they may provide inter-LATA long distance telecommunications services. Under the SBC Decision, the Regional Bell Operating Companies would be able to provide inter-LATA long distance telecommunications services immediately without satisfying the statutory conditions. The SBC Decision has been reversed by the U.S. Fifth Circuit Court of Appeals. Three Regional Bell Operating Companies sought review by the U.S. Supreme Court. Petitions for certiorari were denied on January 19, 1999. Therefore, the Regional Bell Operating Companies must continue to comply with the statutory provisions of the Telecommunications Act in order to obtain authority to provide in-region inter-LATA long distance services. OTHER REGULATION. In general, the Federal Communications Commission has a policy of encouraging the entry of new competitors, such as the Company, in the telecommunications industry and preventing anti-competitive practices. Therefore, the FCC has established different levels of regulation for dominant carriers and nondominant carriers. For domestic common carrier telecommunications regulation, large incumbent local exchange carriers such as the Regional Bell Operating Companies and GTE Corporation are currently considered dominant carriers, while competitive local exchange carriers such as the Company are considered nondominant carriers. As a nondominant carrier, the Company is subject to relatively minimal FCC regulation. o TARIFF. As a nondominant carrier, the Company may install and operate facilities for the transmission of domestic interstate communications without prior FCC authorization. Services of nondominant carriers have been subject to relatively limited regulation by the FCC, primarily consisting of the filing of tariffs and periodic reports concerning the carrier's interstate circuits and deployment of network facilities. However, nondominant carriers like the Company must offer interstate services on a nondiscriminatory basis, at just and reasonable rates, and remain subject to FCC complaint procedures. In October 1996, the FCC adopted an order (the "Detariffing Order") which eliminated the requirement that nondominant interstate carriers maintain tariffs on file with the FCC for domestic interstate services. The order provided that, after a nine-month transition period, relationships between interstate carriers and their customers would be set by contract. Several parties requested reconsideration and/or filed appeals of the Detariffing Order. On February 13, 1997, the United States Court of Appeals for the District of Columbia Circuit stayed implementation of the Detariffing Order. If the Detariffing Order becomes effective, nondominant interstate services providers will no longer be able to rely on the filing of tariffs with the FCC as a means of providing notice to customers of prices, terms and conditions under which they offer their interstate services. If the Company cancels its FCC tariffs as a result of the Detariffing Order, it will need to implement replacement contracts which could result in substantial legal and administrative expense. o ACCESS CHARGES. The FCC has granted incumbent local exchange carriers significant flexibility in pricing their interstate special and switched access services on a specific central office by central office basis. Under this pricing scheme, incumbent local exchange carriers may establish pricing zones based on access traffic density and charge different prices for each zone. We anticipate that this pricing flexibility will result in incumbent local exchange carriers lowering their prices in high traffic density areas, the probable area of competition with the Company. We also anticipate that the FCC will grant incumbent local exchange carriers increasing pricing flexibility as the number of interconnections and competitors increases. On May 16, 1997, the FCC took action in its CC Docket No. 96-262 to reform the current interstate access charge system. The FCC adopted an order which makes various reforms to the existing rate structure for interstate access that are designed to move access charges, over time, to more cost based rate levels and structures. These changes will reduce access charges and will shift charges currently based on minutes to flat-rate, monthly per line charges. As a result, the aggregate amount of access charges paid by long distance carriers to access providers in the United States may decrease. The FCC also announced that it intends in the future to issue a Report and Order providing detailed rules for implementing a market-based approach to further access charge reform. That process will give incumbent local exchange carriers progressively greater flexibility in setting rates as competition develops, gradually replacing regulation with competition as the primary means of setting prices. The FCC also adopted a "prescriptive safeguard" to bring access rates to competitive levels in the absence of competition. This series of decisions is likely to have a significant impact on the operations, expenses, pricing and revenue of the Company. The access charge order has been affirmed by the Eighth Circuit U.S. Court of Appeals on August 19, 1998. The FCC released a Public Notice on October 6, 1998 asking the parties to refresh the record on access charge reform. The FCC specifically requested comment on pricing flexibility proposals submitted by two Regional Bell Operating Companies. UNIVERSAL SERVICE REFORM. On May 8, 1997, the Federal Communications Commission issued an order to implement the provisions of the Telecommunications Act of 1996 relating to the preservation and advancement of universal telephone service. The Universal Service order affirmed Congress' policy principles for universal telephone service, including quality service, affordable rates, access to advanced services, access in rural and high-cost areas, equitable and nondiscriminatory contributions, specific and predictable support mechanisms and access to advanced telecommunications services for schools, health care providers and libraries. The order added "competitive neutrality" to the FCC's universal service principles by providing that universal service support mechanisms and rules should not unfairly advantage or disadvantage one provider or technology over another. All telecommunications carriers providing interstate telecommunications services, including the Company, must contribute to the universal service support fund. The contribution factors for first quarter 1999 contributions are 3.18% for the high cost and low income fund (to be derived from the Company's estimated quarterly interstate and international gross end-user telecommunications revenue) and .58% for the schools and libraries and healthcare fund (to be derived from the Company's estimated quarterly intrastate, interstate and international gross end-user telecommunications revenue). STATE REGULATION The Company believes that most, if not all, states in which it operates or proposes to operate will require a certification or other authorization to offer intrastate services. Many of the states in which the Company operates or intends to operate are in the process of addressing issues relating to the regulation of competitive local exchange carriers. The Company will also be subject to tariff filing requirements. These certifications generally require a showing that the carrier has adequate financial, managerial and technical resources to offer the proposed services in a manner consistent with the public interest. The Company, through its subsidiaries, KMC Telecom Inc. and KMC Telecom II, Inc., has obtained intrastate authority for the provision of its dedicated services and a full range of local switched services and long distance services. In most states, the Company is required to file tariffs setting forth the terms, conditions and prices for services that are classified as intrastate. The Company, through its subsidiaries, KMC Telecom Inc., KMC Telecom II, Inc., and KMC Telecom III, Inc., plans to obtain additional state authorities to accommodate its business and network expansion. Some states impose, in addition to tariff filing requirements, reporting, customer service, and quality requirements, as well as unbundling and universal service requirements. In addition, the Company will be subject to the outcome of generic proceedings held by state utility commissions to determine state regulatory policies with respect to 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. Certain states have adopted 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 switched services. Our executed agreements are subject to the approval of the state commissions. State commissions have approved our agreements. We anticipate state commission approval of our other interconnection agreements. We believe that, as the degree of intrastate 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 the Company's 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. We actively participate in various regulatory proceedings before the states, the outcome of which may establish policies that affect our competitive and/or economic position in the local and other telecommunications services markets. We also may be subject to requirements in certain states to obtain prior approval for, or notify the state commission of, any transfers of control, sales of assets, corporate reorganizations, issuances of stock or debt instruments and related transactions. Local Government Authorizations. 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 linear 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 . FRANCHISES AND PERMITS The construction of a network requires the Company to obtain municipal franchises and other permits. These rights are typically the subject of non-exclusive agreements of finite duration providing for the payment of fees or the provision of services by the Company to the municipality without compensation. In addition, the Company must secure rights-of-way and other access rights which are typically provided under non-exclusive multi-year agreements, which generally contain renewal options. Generally, these rights are obtained from utilities, incumbent local exchange carriers, other competitive local exchange carriers, railroads and long distance carriers. The Telecommunications Act of 1996 requires most utilities to afford access to rights-of-way to competitive local exchange carriers on non-discriminatory terms and conditions and at reasonable rates. However, there can be no assurance that delays and disputes will not occur. The Company's agreements for rights-of-way and similar matters generally require the Company to indemnify the party providing such rights. Such indemnities could make the Company liable for actions (including negligence) of the other party. CUSTOMERS No single customer accounted for more than 10% of our consolidated revenues in 1998. Our five largest customers accounted for 32% of our consolidated revenues in 1997 and 11% of our consolidated revenues in 1998. We expect customer concentration to continue to decrease as we expand into additional markets and increase full scale marketing of an integrated service package. In the near term, however, the loss of, or decrease of business from, one or more of our principal customers could have a material adverse effect on our business, financial condition and results of operations. Although they are not our customers, we did recognize revenue of approximately $2.9 million, or 12.9% of our 1998 revenue, from incumbent local exchange carriers primarily related to reciprocal compensation for terminating local calls from customers of the incumbent local exchange carriers to Internet service providers which are our customers. Of this amount approximately 99% is attributable to reciprocal compensation due to the Company from BellSouth. See Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview - Revenue" for a discussion of a dispute which has arisen between incumbent local exchange carriers, such as BellSouth, and competitive local exchange carriers, such as the Company, with respect to the obligation of incumbent local exchange carriers to make reciprocal compensation payments to competitive local exchange carriers with respect to the termination of local calls to Internet service providers. EMPLOYEES As of February 28, 1999, we had approximately 559 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. GEOGRAPHIC AREAS We have no foreign operations. All of our networks are located in, and all of our revenues are attributable to, the United States. ITEM 2. PROPERTIES. The Company is headquartered in Bedminster, New Jersey in approximately 10,000 square feet of office space, approximately 7,200 of which it leases from Kamine Development Corp. (an entity controlled by Mr. Kamine, the Company's Chairman of the Board). The lease with Kamine Development Corp., which expires in January 2007, provides for a base annual rental of approximately $217,000 (adjusted periodically for changes in the consumer price index), plus operating expenses. The Company also maintains an operations center in an aggregate of approximately 41,000 square feet of leased space in Duluth, Georgia under leases which expire at various dates from June 2001 through February 2003. The Company also owns or leases facilities in each of its existing markets for central offices, sales offices and the location of its 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. ITEM 3. LEGAL PROCEEDINGS. By letter dated August 29, 1997, the Company notified I-NET, Inc. that the Company considered I-NET to be in default under a Master Telecommunications System Rollout Agreement dated as of October 1, 1996 as a result of I-NET's failure to provide design plans and specifications for several systems for which it had agreed to provide such plans and specifications, to properly supervise construction of the systems or to provide personnel with the necessary expertise to manage the projects. By letter dated October 27, 1997, I-NET demanded payment of all amounts it alleged were due under that agreement and a related agreement (aggregating $4.1 million) and stated that it would invoke the arbitration provisions under the agreement if the parties could not agree as to the amount due and payment terms on or before November 27, 1997. By letter dated December 1, 1997, I-NET extended its deadline for reaching agreement to December 15, 1997. Although the Company and I-NET conducted discussions, they were unable to reach an agreement and, on February 12, 1998, the Company received a demand for arbitration from Wang Laboratories, Inc., the successor to I-NET. The demand seeks at least $4.1 million. The Company believes that it has meritorious defenses to Wang's claims and has asserted counterclaims seeking in excess of $2.5 million as a result of I-NET's defaults under the Master Telecommunications System Rollout Agreement. The arbitration proceedings are currently underway. The Company believes that resolution of this matter will not have a material adverse impact on its financial condition. No assurance can be given, however, as to the ultimate resolution of this matter. The Company is from time to time involved in other litigation incidental to the conduct of its business. There is no other pending legal proceeding to which the Company is a party, however, which, in the opinion of the Company's management, is likely to have a material adverse effect on the Company's business, financial condition and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the fourth quarter of 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. There is currently no established trading market for the Company's Common Stock, $0.01 par value per share. As of March 24, 1999 there were six holders of record of the Company's Common Stock. The Company has never declared nor paid cash dividends on its Common Stock and does not presently anticipate paying any cash dividends on its Common Stock in the foreseeable future. The Company currently expects that earnings, if any, will be retained for growth and development of the Company's business. The Company, as a holding company, depends upon the receipt of dividends and other cash payments from its operating subsidiaries in order to meet the Company's cash requirements. Pursuant to the terms of a Loan and Security Agreement, dated as of December 22, 1998, among our subsidiaries, KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom Leasing I, LLC, KMC Telecom Leasing II, LLC and KMC Telecom of Virginia, Inc. and a group of lenders led by First Union National Bank and Newcourt Commercial Finance Corporation (the "Senior Secured Credit Facility"), those subsidiaries are restricted in their ability to pay dividends on their capital stock. Pursuant to the terms of a Loan and Security Agreement, dated as of February 4, 1999, among our subsidiary, KMC Telecom III, Inc., Lucent Technologies, Inc. and the collateral agent thereunder (the "Lucent Facility"), KMC Telecom III, Inc. is restricted in its ability to pay dividends on its capital stock. The indenture applicable to the Company's 12 1/2% Senior Discount Notes due 2008, imposes certain restrictions upon the Company's ability to pay dividends on its capital stock. Subject to the foregoing and to any restrictions which may be contained in future indebtedness of the Company, the payment of cash dividends on the Common Stock will be within the sole discretion of the Company's Board of Directors, and will depend upon the earnings, capital requirements and financial position of the Company, applicable requirements of law, general economic conditions and other factors considered relevant by the Company's Board of Directors. On January 29, 1998, the Company 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 of the Company. 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, the Company granted options to purchase an aggregate of 262,500 shares of its Common Stock to employees of the Company and employees of certain affiliates of the Company 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 the Company's subsidiary, KMC Telecom Inc., which had been issued in earlier years, prior to the organization of the Company and the establishment of the present holding company structure. No consideration was received by the Company 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. ITEM 6. SELECTED FINANCIAL DATA. The selected financial data set forth below for the period from May 10, 1994 (date of inception) to December 31, 1994 and for the years ended December 31, 1995, 1996, 1997 and 1998 were derived from the audited financial statements of the Company and its predecessors. The data presented below should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto included elsewhere in this Report.
MAY 10, 1994 (DATE OF INCEPTION) TO DECEMBER 31, YEAR ENDING DECEMBER 31 ---------------------------------------------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF OPERATIONS DATA: Revenue........................................... $ - $ - $ 205 $ 3,417 $ 22,425 Operating expenses: Network operating costs........................ - - 1,361 7,735 37,336 Selling, general and administrative............ 4 1,591 2,216 9,923 24,534 Stock option compensation expense.............. - - 240 13,870 7,080 Depreciation and amortization.................. - 6 287 2,506 9,257 --------- ---------- ---------- ---------- ---------- Total operating expenses.................... 4 1,597 4,104 34,034 78,207 --------- ---------- ---------- ---------- ---------- Loss from operations.............................. (4) (1,597) (3,899) (30,617) (55,782) Interest income................................... - - - 513 8,818 Interest expense (a).............................. - (23) (596) (2,582) (29,789) --------- ---------- ---------- ---------- ---------- Net loss.......................................... (4) (1,620) (4,495) (32,686) (76,753) Dividends and accretion on redeemable preferred stock.......................................... - - - (8,904) (18,285) --------- ---------- ---------- ---------- ---------- Net loss applicable to common shareholders........ $ (4) $ (1,620) $ (4,495) $ (41,590) $ (95,038) ========= ========== ========== ========== ========== Net loss per common share......................... $ (0.01) $ (2.70) $ (7.49) $ (64.93) $ (114.42) ========= ========== ========== ========== ========== Weighted average common shares outstanding........ 600 600 600 641 831 ========= ========== ========== ========== ========== Other Data: Capital expenditures (including acquisition)...... $ - $ 3,498 $ 9,111 $ 61,146 $ 161,803 EBITDA(b)......................................... (4) (1,591) (3,613) (28,111) (46,525) Cash used in operating activities................. 4 (779) (2,687) (8,676) (33,573) Cash used in investing activities................. - (1,920) (10,174) (62,992) (180,198) Cash provided in financing activities............. 1 2,728 14,314 85,734 219,399 Ratio of earnings to fixed charges (c)............ - - - - -
AS OF DECEMBER 31, ------------------------------------------------------------------------- 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- (IN THOUSANDS) -------------- BALANCE SHEET DATA: Cash and cash equivalents...................... $ 6 $ 34 $ 1,487 $ 15,553 $ 21,181 Investments held for future capital expenditures - - - - 27,920 Networks and equipment, net.................... - 3,496 12,347 71,371 224,890 Total assets................................... 8 3,704 16,715 95,943 311,310 Long-term debt................................. - 2,727 12,330 61,277 309,225 Redeemable preferred stock..................... - - - 35,925 52,033 Redeemable common stock and warrants........... - - - 11,726 22,979 Total nonredeemable equity (deficiency)........ (3) (1,623) 389 (26,673) (104,353)
ACCOMPANYING NOTES ARE ON FOLLOWING PAGE. (a) Excludes capitalized interest of (i) $37,000 for 1995, (ii) $103,000 for 1996, (iii) $854,000 for 1997 and (iv) $5.1 million for 1998. During the construction of the Company's networks, the interest costs related to construction expenditures are capitalized. (b) EBITDA consists of earnings (loss) before net interest, income taxes, depreciation and amortization. EBITDA is provided because it is a measure commonly used in the telecommunications industry. It is presented to enhance an understanding of the Company's operating results and is not intended to represent cash flow or results of operations in accordance with GAAP. EBITDA is not calculated under GAAP and is not necessarily comparable to similarly titled measures of other companies. For a presentation of cash flows calculated under GAAP, see the Company's historical financial statements contained in "Item 8. Financial Statements and Supplementary Data." (c) The ratio of earnings to fixed charges is computed by dividing pretax income from continuing operations before fixed charges (other than capitalized interest) by fixed charges. Fixed charges consist of interest charges, dividend obligations and amortization of debt expense and discount or premium related to indebtedness, whether expensed or capitalized, and that portion of rental expense the Company believes to be representative of interest. For 1994, 1995, 1996, 1997 and 1998, earnings were insufficient to cover fixed charges by $4,475, $1.8 million, $4.6 million, $33.5 million, and $81.9 million, respectively. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This Management's Discussion and Analysis of Financial Condition and Results of Operations reflects the historical results of the Company. Due to the limited operating history, startup nature and rapid growth of the Company, period-to-period comparisons of financial data are not necessarily indicative, and you should not rely upon them as an indicator of the future performance of the Company. The following discussion includes forward-looking statements. OVERVIEW GENERAL. We are a facilities-based competitive local exchange carrier providing telecommunications and data services in Tier III Markets. The markets in which we operate are predominately located in the Southeastern and Midwestern United States. We target business, government and institutional end-users, as well as Internet service providers, long distance carriers and wireless service providers. Our objective is to provide our customers with a complete solution for their communications needs. We currently provide on-net local dial tone, special access, private line, Internet access, ISDN and a variety of other advanced services and features. We have invested significant capital and effort in developing our telecommunications business. This capital has been invested in the development of our networks, the hiring of an experienced management team, the development and installation of operating systems, the introduction of services, marketing and sales efforts, and acquisitions. We expect to make increasing capital expenditures to build additional networks, to expand current networks to additional customer buildings, long distance carrier points of presence and incumbent local exchange carrier central offices, and to broaden our service offerings, and may consummate acquisitions. Proper management of the Company's growth will require us to maintain cost controls, continue to assess market potential, ensure quality control in implementing our services as well as to expand our internal management, customer care and billing and information systems, all of which will require substantial investment. The development, construction and expansion of our networks requires significant capital, a large portion of which is invested before any revenue is generated. We have incurred, and expect to continue to incur, significant and increasing operating losses, negative EBITDA and net cash outflows for operating and investing activities while we expand our network operations and build our customer base. Based on our experience to date and that of our competitors, we estimate that a new network will begin to generate positive EBITDA within 24 to 36 months after commencement of commercial operations. Construction periods and operating results will vary from network to network. There can be no assurance that we will be able to establish a sufficient revenue-generating customer base or gross margins in any particular market or on a consolidated basis. The facilities-based competitive local exchange carrier business is capital intensive. We estimate that the total initial costs associated with the purchase and installation of fiber optic cable and transmission and switching equipment, including capitalized engineering costs, will average approximately $8.0 million to $10.0 million for each standard Tier III network, depending upon the size of the market served, the scope and complexity of the network, and the proportion of aerial to underground fiber deployment. Our actual costs could vary significantly from this range. The amounts and timing of these expenditures are subject to a variety of factors that may vary significantly with the geographic and demographic characteristics of each market. In addition to equipment and construction expenditure requirements, upon commencement of the construction phase of a network we begin to incur direct operating costs for such items as salaries and rent. As network construction progresses, we incur costs associated with construction, including preparation of rights-of-way, and increased sales, marketing, operating and administrative expenses. We capitalize certain direct costs related to network planning and construction costs for new networks. The initial construction of a network takes approximately six months, depending upon the size and complexity of the network. The time required during the construction phase is also significantly influenced by the number of route miles involved, the mix of aerial versus underground fiber deployment, possible delays in preparing rights-of-way, provisioning fiber optic cable and electronic equipment, and required construction permits and other factors, including weather. LOCAL SERVICES. To facilitate our entry into local services, we plan to install switching equipment in all of our markets. Switches are in commercial operation in twenty-two of our existing markets. We expect to have a switch in commercial operation in our remaining existing network no later than the second quarter of 1999. We intend to install Lucent Technologies, Inc. switches in any future networks which we may build. Once a switch is commercially operational, we offer local dial tone and value-added enhanced services such as ISDN, Centrex-type, voice mail and other custom calling features, and switched data services. We expect operating margins to improve as switching becomes operational and switched services are provided on-net, the network is expanded (primarily by adding buildings to the network), and larger volumes of traffic are carried on the Company's network. Although under the Telecommunications Act of 1996 the incumbent local exchange carriers are required to unbundle local network elements, thereby decreasing operating expenses by permitting us to purchase only the origination and termination services we need, we cannot assure you that such unbundling will be effected in a timely manner and result in prices favorable to the Company. REVENUE. Historically, we have derived our revenue primarily from resale of switched services, along with special access, private line and Internet access services provided on our facilities. Future revenues will include increasing amounts of on-net switch-based services, long distance services and value-added enhanced services, such as ISDN, Centrex-type services, BRI, PRI and port wholesale. The Company maintains interconnection agreements with incumbent local exchange carriers 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 in each state. The Regional Bell Operating Companies have advised competitive local exchange carriers, such as the Company, that they do not consider calls in the same local calling area which are placed by their customers to competitive local exchange carrier customers which are Internet service providers to be local calls under the interconnection agreements. The Regional Bell Operating Companies claim that these calls should be classified as exchange access calls, even though the Federal Communications Commission exempted local calls for Internet service providers from payment of access charges. The Regional Bell Operating Companies claim that, as a result, they do not owe any compensation to competitive local exchange carriers for transporting and terminating these calls. The Regional Bell Operating Companies 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, the Company recognized revenue from incumbent local exchange carriers of approximately $2.9 million, or 12.9% of 1998 revenue, for these services. Payments of approximately $135,000 were received from the incumbent local exchange carriers during 1998. Management believes reciprocal compensation for Internet traffic to be an industry-wide matter that will ultimately be resolved on a state-by-state basis. To date, twenty-nine state commissions have ruled on the issue and found that incumbent local exchange carriers must pay compensation to competitive carriers for local calls to Internet service providers located on competitive carriers' networks. A number of other state commissions currently have proceedings pending to consider this matter. The Federal Communications Commission has concluded that calls to Internet service providers are interstate calls and are therefore exempt from local termination charges. However, the FCC also stated that existing interconnection agreements providing for such termination charges must be honored by the incumbent local exchange carriers. The Company accounts for reciprocal compensation with the incumbent local exchange carriers, including the activity associated with the disputed Internet service provider traffic, as local traffic pursuant to the terms of its interconnection agreements. Accordingly, revenue is recognized in the period that the traffic is terminated. The circumstances surrounding the dispute are considered by management periodically in determining whether reserves against unpaid balances are warranted. As of December 31, 1998, no reserves have been considered necessary by management. OPERATING EXPENSES. Our principal operating expenses consist of network operating costs, selling, general and administrative expenses, stock option compensation expense, depreciation and amortization, and interest expense. Network operating costs include charges from incumbent local exchange carriers for resale services, termination and unbundled network element charges; 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, including direct city administration costs. Network operating costs also include a percentage of both our intrastate and interstate revenues which we pay as universal service fund charges. Selling, general and administrative expenses consist of sales personnel and support costs, corporate and finance personnel and support costs, legal and accounting expenses. Depreciation and amortization includes charges related to plant, property and equipment and amortization of intangible assets, including franchise acquisition costs. We expect depreciation and amortization expense to increase as we place additional networks into service. Interest expense includes interest charges on our 12 1/2% Senior Discount Notes and our Senior Secured Credit Facility and, in the future, will include interest charges on the Lucent Facility. Interest expense also includes amortization of deferred financing costs. Interest expense will increase substantially in future periods as a result of the issuance of the 12 1/2% Senior Discount Notes and increased borrowings under the expanded Senior Secured Credit Facility and the Lucent Facility, discussed below, to finance network build-out. RESULTS OF OPERATIONS 1998 COMPARED TO 1997 REVENUE. Revenue increased from $3.4 million for 1997 to $22.4 million for 1998. This increase is primarily attributable to the fact that for 1998 we had eight systems in commercial operation during the entire period, as well as 14 additional systems which became commercially operational at various points during the period, as compared to 1997 when we had only one system in commercial operation during the entire period, with 7 systems becoming commercially operational at various points during the period. In addition, each of our networks that was commercially operational during 1997 generated increased revenues during 1998. Revenue for 1997 and 1998 included $2.3 million and $14.2 million (including $2.9 million of revenue from reciprocal compensation in 1998), respectively, of revenue derived from resale of switched services and an aggregate of $1.1 million and $8.2 million, respectively, of revenue derived from on-net special access, private line and switched services. NETWORK OPERATING COSTS. Network operating costs increased from $7.7 million in 1997 to $37.3 million in 1998. This increase of approximately $29.6 million was due primarily to the increase in the number of systems in commercial operation in 1998 and the related increases of $14.5 million in costs associated with providing resale and unbundled network element services, $5.3 million in personnel costs, $1.6 million in consulting and professional services costs, $3.4 million in contracted network support costs, and $1.1 million in facilities related costs, $1.0 million in travel related costs and $2.7 million in other direct operating costs. Costs associated with providing on-net services were greater than revenue generated from on-net services because we were required to hire personnel and staff local offices prior to generating revenue and obtaining sufficient revenue volume to cover such fixed operating costs. Costs associated with providing resale services are greater than the revenues currently generated because of narrow discounts on ongoing resale services provided to us by the incumbent local exchange carriers and because initial installation charges by the incumbent local exchange carrier to us are greater than our installation charges to our customers. Resale is primarily an interim strategy for us to create a backlog of customers to be transitioned to our on-net switched facilities once our own switches become commercially operational. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased from $9.9 million in 1997 to $24.5 million in 1998. This increase of approximately $14.6 million resulted primarily from increases of $8.5 million in personnel costs, $900,000 in professional costs (consisting primarily of legal costs), and $1.2 million in travel related costs, as well as increases in other marketing and general and administrative costs aggregating approximately $4.0 million. STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a non-cash charge, decreased from $13.9 million in 1997 to $7.1 million in 1998. This decrease reflects reduced charges in 1998 related to changes in the fair value of the Company's Common Stock and lower amortization expense related to the vesting terms of the options during 1998, as compared to the level of such charges 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 the 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 the predecessor to the Senior Secured Credit Facility in 1998. The Company 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. 1997 COMPARED TO 1996 REVENUE. Revenue increased from $205,000 for 1996 to $3.4 million for 1997. Revenue increased primarily because we began aggressively marketing our services in our first market, Huntsville, Alabama, which generated $1.6 million of revenue for 1997. In addition, the network in Melbourne, Florida, which we purchased during 1997, and the six other systems which became commercially operational during 1997, generated an aggregate of $1.8 million in revenue during 1997. Furthermore, we initiated marketing efforts in May 1997 in all of the markets in which our networks had become commercially operational or in which we were constructing networks. For 1997, out of total revenues of $3.4 million, we derived $2.3 million from resale of switched services and $1.1 million from special access and private line services, of which $943,000 was generated by on-net services. NETWORK OPERATING COSTS. Network operating costs increased from $1.4 million for 1996 to $7.7 million for 1997. The increase was due primarily to costs of $2.4 million associated with hiring personnel and staffing local offices, $1.8 million in selling, customer care, insurance, facilities and other direct operating costs and $2.1 million in costs associated with providing resale services which we initiated in May 1997. Costs associated with providing on-net services were greater than revenue generated from on-net services because we were required to hire personnel and staff local offices prior to generating revenue and obtaining sufficient revenue volume to cover such fixed operating costs. Costs associated with providing resale services are greater than the revenues currently generated because of narrow discounts on ongoing resale services provided to us by the incumbent local exchange carriers and because initial installation charges by the incumbent local exchange carrier to us are greater than our installation charges to our customers. Resale is primarily an interim strategy for us to create a backlog of customers to be transitioned to our on-net switched facilities once our own switches become commercially operational. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased from $2.2 million for 1996 to $9.9 million for 1997. The increase was due primarily to increases of $4.3 million attributable to hiring additional personnel in all categories, particularly in senior management and sales and marketing, $1.1 million in consulting costs (primarily related to marketing services), and $1.2 million in legal expenditures (primarily incurred in connection with vendor contracts and regulatory activities). We expect that selling, general and administrative expenses will continue to increase in absolute terms as we continue to expand our network services and marketing activities, but that they will decline as an overall percentage of revenue. STOCK OPTION COMPENSATION EXPENSE. Stock option compensation expense, a non-cash charge, increased from $240,000 in 1996 to $13.9 million in 1997. The increase was due primarily to an increase in the fair value of KMC Telecom Inc.'s common stock. DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased from $287,000 for 1996 to $2.5 million for 1997. The increase reflected the six networks that became commercially operational and the one network that was purchased during 1997 as well as higher amortization of intangible assets. INTEREST EXPENSE. Interest expense increased from $596,000 for 1996 to $2.6 million for 1997, primarily reflecting borrowings under the predecessor to the Senior Secured Credit Facility in 1997, as well as amortization of deferred financing costs of $561,000. We capitalized interest of $854,000 related to network construction projects during 1997. Interest expense will continue to increase as a result of the issuance of the 12 1/2% Senior Discount Notes and to the extent that we increase our borrowings under the Senior Secured Credit Facility. NET LOSS. For the reasons stated above, net loss increased from $4.5 million for 1996 to $32.7 million for 1997. STOCK COMPENSATION PLAN During 1996 and 1997, KMC Telecom Inc., now one of the Company's principal operating subsidiaries, granted options to purchase shares of KMC Telecom Common Stock pursuant to its 1996 Stock Purchase and Option Plan for Key Employees of KMC Telecom Inc. and Affiliates (the "KMC Telecom Stock Option Plan"). On June 26, 1998, the Board of Directors of the Company adopted, effective upon stockholder approval, the 1998 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates which authorizes the grant of options to purchase Common Stock of the Company (the "KMC Holdings Stock Option Plan"). During the third quarter of 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 Common Stock of the Company granted under the KMC Holdings Stock Option Plan and granted options to certain additional employees of the Company. 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 exceeds the exercise price of the options granted under the KMC Holdings Stock Option Plan, the Company will recognize compensation expense related to such options over their vesting period. The net effect of the cancellation of the options outstanding under the KMC Telecom Stock Option Plan and the grant of options under the KMC Holdings Stock Option Plan resulted in a credit to compensation expense of approximately $600,000 in 1998. Certain provisions in the stock option awards granted under the KMC Holdings Stock Option Plan will necessitate that such awards be treated as variable stock compensation awards pursuant to Accounting Principles Board Opinion No. 25. Accordingly, compensation expense will be charged or credited periodically through the date of exercise or cancellation of such stock options, based on changes in the value of the Company's stock as well as the vesting schedule of such options. These compensation charges or credits are non-cash in nature, but could have a material effect on the Company's future reported results of operations. LIQUIDITY AND CAPITAL RESOURCES 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, and that we will generate operating losses. As a result, cash provided by operations will not be sufficient to fund the expansion of our networks and service capabilities. We have financed our operating losses and capital expenditures with equity invested by our founders, preferred stock placements, credit facility borrowings and the 12 1/2% Senior Discount Notes. In February, 1999, we issued 25,000 shares of Series E Senior Redeemable, Exchangeable, PIK Preferred Stock, 40,000 shares of Series F Senior Redeemable, Exchangeable, PIK Preferred Stock and warrants to purchase 24,660 shares of our Common Stock for aggregate gross proceeds of $65.0 million. In February 1999, our subsidiary, KMC Telecom III, Inc., which will own the approximately ten additional networks which we currently plan to construct by the end of the second quarter of 2000, entered into a secured vendor financing facility with Lucent Technologies, Inc. (the "Lucent Facility"). Under this facility, KMC Telecom III, Inc. will be permitted to borrow, subject to certain conditions, up to an aggregate of $600.0 million, primarily for the purchase from Lucent of switches and other telecommunications equipment. At the present time, only $125.0 million is available under this facility. An additional $125.0 million will become available when KMC Telecom III, Inc. receives an additional $35.0 million of funded equity or qualified intercompany loans, as defined in the facility. The balance of $350.0 million will become available only upon (a) additional lenders agreeing to participate in the facility so that Lucent's own aggregate commitment does not exceed $250.0 million and (b) the Company satisfying certain other requirements, the most significant of which is the Company raising, and contributing to KMC Telecom III, Inc., at least $300.0 million from the sale of high yield debt or equity. In December 1998, we refinanced and expanded our $70.0 million senior secured credit facility with Newcourt Commercial Finance Corporation (which was formerly known as AT&T Commercial Finance Corporation). Under the refinanced and expanded facility, which is with a group of lenders led by First Union National Bank and Newcourt Finance (the "Senior Secured Credit Facility"), our subsidiaries KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom Leasing I, LLC, KMC Telecom Leasing II, LLC and KMC Telecom of Virginia, Inc., which own our existing twenty-three networks, are permitted to borrow up to an aggregate of $250.0 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. In January 1998, the Company sold 460,800 units, each unit consisting of one 12 1/2% Senior Discount Note due 2008, with an aggregate principal at maturity of $1,000, and one warrant to purchase 0.21785 shares of Common stock 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. The 12 1/2% Senior Discount Notes are unsecured, unsubordinated obligations of KMC Telecom Holdings, Inc. and mature on February 15, 2008. Net cash provided by financing activities from borrowings and equity issuances was $219.4 million for 1998. The Company's net cash used in operating and investment activities was $213.8 million for 1998. The Company made capital expenditures of $9.1 million in 1996, $61.1 million in 1997 (including the acquisition of the Melbourne, Florida network for a purchase price of $2.0 million) and $161.8 million in 1998. The Company currently plans to make additional capital expenditures of approximately $200.0 million during 1999. Continued significant capital expenditures are expected to be made thereafter. The majority of these expenditures is expected to be made for network construction and the purchase of switches and related equipment to facilitate the offering of the Company's services. In addition, the Company expects to continue to incur operating losses while it expands its business and builds its customer base. Actual capital expenditures and operating losses will depend on numerous factors, including the nature of future expansion and acquisition opportunities and factors beyond the Company's control, including economic conditions, competition, regulatory developments and the availability of capital. At December 31, 1998 the Company had outstanding commitments aggregating approximately $30.6 million related to the purchase of fiber optic cable and telecommunications equipment as well as engineering services, principally under the Company's agreements with Lucent Technologies, Inc. At December 31, 1998, the Company had $41.4 million of indebtedness outstanding under the Senior Secured Credit Facility, and had $208.6 million in borrowing capacity available under the Senior Secured Credit Facility, subject to certain conditions. We believe that our cash, investments held for future capital expenditures and borrowings available under the Senior Secured Credit Facility and the Lucent Facility, together with the net proceeds from our February 1999 issuance of our Series E and Series F Senior Redeemable, Exchangeable, PIK Preferred Stock, will be sufficient to meet our liquidity needs through the completion of our existing twenty-three networks and the approximately ten additional networks currently planned for completion by the end of the second quarter of 2000, although we can give no assurance in this regard. Thereafter, the Company will require additional financing. 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 to complete all such networks, and we may be required to seek additional financing. Additional sources of financing may include public or private equity or debt financings by the Company, capitalized leases and other financing arrangements. Pursuant to certain provisions of our Series A Cumulative Convertible Preferred Stock and Series C Cumulative Convertible Preferred Stock, we may not increase the authorized number of shares of our preferred stock or common stock without the consent of the holders of two-thirds of the shares of both those series. The Company has only three million shares of common stock authorized. We can give no assurance that additional financing will be available to the Company or, if available, that it can be obtained on a timely basis and on acceptable terms or within the limitations contained in our Senior Secured Credit Facility, the Lucent Facility, the indenture applicable to our 12 1/2% Senior Discount Notes, the terms of our preferred stock or any future financing arrangements. Failure to obtain such financing could result in the delay or abandonment of some or all of our development and expansion plans and expenditures, which would have a material adverse effect on our business, financial condition and results of operations. Such a failure could also limit our ability to make principal and interest payments on our outstanding indebtedness and meet our dividend and redemption obligations with respect to our preferred stock. The Company has no working capital or other credit facility under which it may borrow for working capital and other general corporate purposes. We can give no assurance that such financing will be available to the Company in the future or that, if such financing were available, it would be available on terms and conditions acceptable to the Company. As of December 31, 1998, the Company and its subsidiaries had consolidated net operating loss carryforwards for United States income tax purposes of approximately $59.0 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 pre-ownership change net operating loss carryforwards (net operating loss carryforwards accrued through the date of the ownership change) would generally be limited annually to an amount equal to the product of (i) the long-term tax-exempt rate for ownership changes prescribed monthly by the Treasury Department and (ii) the value of the Company's outstanding equity immediately before the ownership change excluding certain capital contributions. Any allowable portion of the pre-ownership change net operating loss carryforwards that is not used in a particular taxable year following the ownership change could be carried forward to subsequent taxable years until the net operating loss carryforwards 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 Inc. has undergone an ownership change. For financial reporting purposes, the Company has an aggregate of approximately $109.0 million of loss carryforwards and net temporary differences at December 31, 1998. At existing tax rates the future benefit of these items approximates $42.0 million. A valuation allowance has been established equal to the entire net tax benefit associated with all carryforwards and temporary differences at December 31, 1998 as their realization is uncertain. YEAR 2000 COMPLIANCE Similar to all businesses, the Company may be affected by the inability of certain computer software to distinguish between the years 1900 and 2000 due to a commonly-used programming convention. Unless such programs are modified or replaced prior to January 1, 2000, calculations based on date arithmetic or logical operations performed by such programs may be incorrect. Management's plan to address the effect of the Year 2000 issue focuses on the following areas: applications systems (including the Company's billing system and financial software), infrastructure (including personal computers and servers used throughout the Company), and other third party business partners, vendors and suppliers. Management's analysis and review of these areas is comprised primarily of the following phases: developing an inventory of hardware, software and embedded chips; assessing the degree to which each area is currently compliant with Year 2000 requirements; performing renovations, repairs and replacements as needed to attain compliance; testing to ensure compliance; and, developing a contingency plan for each area if the Company's initial efforts to attain compliance are either unsuccessful or untimely. Management completed the inventory and assessment phases of the project during the fourth quarter of 1998. The renovation, repair and replacement phase and the testing phase have commenced; however, the Company expects to continue these phases throughout 1999. Further, the Company is currently in the process of implementing new billing software systems, operational software systems and financial and personnel software systems. Although these implementations were made necessary by the expansion of the Company's business and were not directly related to Year 2000 issues, they have enabled the Company to utilize new software for these purposes which the respective suppliers have certified as Year 2000 compliant. Costs incurred to date have primarily consisted of labor from the redeployment of existing information services and operational resources. The Company expects to spend approximately $150,000 for these Year 2000 compliance efforts which will be expensed as incurred. Such amount does not include the costs of the new billing software, operational software and financial and personnel software systems which are being implemented as a result of the expansion of the Company's business. If the software applications of the local exchange carriers, long distance carriers or others on whose services the Company depends or with which the Company's systems interact are not Year 2000 compliant, it could affect the Company's systems which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has formed a contingency team to develop a work plan in the event that certain programs and hardware are not fully compliant and operational before January 1, 2000. The costs associated with this effort are currently being evaluated and cannot yet be determined. In the event that certain, or all, of the contingency plans are deployed, the Company will incur additional costs; however, as contingency plans are not yet developed, these costs are indeterminable at present. Although the Company does not presently anticipate a material business interruption as a result of the Year 2000 issue, the worst case scenario if all of the Company's Year 2000 efforts fail would result in a daily loss of revenues of approximately $100,000 calculated based upon 1998 revenues. CERTAIN FACTORS WHICH MAY AFFECT THE COMPANY'S FUTURE RESULTS LIMITED OPERATING HISTORY; NEGATIVE GROSS PROFITS, OPERATING LOSSES AND NEGATIVE CASH FLOW The Company was formed in September 1997 as a holding company. The Company's subsidiaries commenced operations in 1994 and, as a result, the Company has a limited operating history and limited revenues. We have only recently completed the process of building many of our networks. Our prospects must be considered in the light of the risks, expenses and difficulties frequently encountered by companies in the early stage of development. In connection with the construction of our networks we have incurred and expect to continue to incur significant and increasing negative gross profits, operating losses and negative EBITDA while we expand our business and build our customer base. We can give no assurance that an adequate customer base with respect to any or all of our services will be obtained or sustained. Our negative gross profits, operating losses, negative EBITDA, cash used by operations and capital expenditures are expected to increase as a result of the continuation of our expansion strategy. We can give no assurance that we will achieve or sustain profitability or generate positive EBITDA or at any time have sufficient resources to meet our capital expenditure and working capital requirements or make payments on our indebtedness. We must significantly increase our revenues and cash flows to meet our debt service and preferred stock dividend obligations. SUBSTANTIAL INDEBTEDNESS At December 31, 1998, we had outstanding approximately $309.2 million of indebtedness. Our indebtedness could have important consequences including the following: o our ability to obtain any necessary financing in the future for working capital, capital expenditures, debt service requirements or other purposes will be limited, o a substantial portion of our cash flow from operations will be required to make debt service payments, o our leverage could limit our flexibility in planning for, or reacting to changes in, our business, making us more highly leveraged than some of our competitors, which may place us at a competitive disadvantage, and o our vulnerability in the event of a downturn in our business will be increased. Failure by the Company to meet its obligations could result in a default on our indebtedness which would permit the holders of all of our indebtedness to accelerate the maturity thereof. In connection with the buildup of our networks and expansion of our services, we have been experiencing increasing negative EBITDA and our earnings were insufficient to cover fixed charges for 1996, 1997 and 1998. We can give no assurance that we will be able to improve our earnings before fixed charges or EBITDA or that we will be able to meet our debt service obligations. We cannot assure you that our cash flow from operations and capital resources will be sufficient to repay our 12 1/2% Senior Discount Notes, Senior Secured Credit Facility and Lucent Facility in full and a substantial portion of our indebtedness will need to be refinanced. We can give no assurance that we will be able to effect such refinancings. You should be aware that our ability to repay or refinance our current debt depends on our successful financial and operating performance and our ability to successfully implement our business strategy. Unfortunately, we cannot assure you that we will be successful in implementing our strategy or in realizing our anticipated financial results. You should also be aware that our financial and operational performance depends upon a number of factors, many of which are beyond our control. These factors include: o the economic and competitive conditions in the telecommunications network industry, o any operating difficulties, increased operating costs or pricing pressure we may experience, o the passage of legislation or other regulatory developments that may adversely affect us, o any delays in implementing any strategic projects, and o our ability to complete our networks on time and in a cost-effective manner. The Senior Secured Credit Facility, the Lucent Facility and the indenture applicable to our 12 1/2% Senior Discount Notes contain a number of significant covenants. These covenants limit our ability to, among other things: o borrow additional money, o make capital expenditures and other investments, o pay dividends, o merge, consolidate, or dispose of our assets, and o enter into transactions with our affiliates. Under the Senior Secured Credit Facility and the Lucent Facility, our subsidiaries are required to meet certain financial tests at the end of each quarter. Failure to comply with these covenants could limit our ability to make further borrowings, or could result in a default under the Senior Secured Credit Facility and/or the Lucent Facility, allowing the lenders to accelerate the maturity of the loans made thereunder. There can be no assurance that we will be able to comply with such covenants in the future. SIGNIFICANT CAPITAL REQUIREMENTS Our current plans for expansion of existing networks, the development of new networks, the further development of our products and services and the continued funding of operating losses will require substantial additional cash from outside sources. We anticipate that our capital expenditures for 1999 will be approximately $200.0 million, that we will have substantial net losses to fund in 1999 and future years and that our substantial cash requirements will continue into the foreseeable future. We believe that our cash, investments held for future capital expenditures, borrowings available under our Senior Secured Credit Facility and the Lucent Facility, together with the net proceeds from our February 1999 issuance of our Series E and Series F Senior Redeemable, Exchangeable, PIK Preferred Stock, will provide sufficient funds for us to expand our business as currently planned and to fund our currently anticipated expenses through the completion of our twenty-three existing networks and the approximately ten additional networks currently planned for completion by the end of the second quarter of 2000. Thereafter, we will require additional financing. 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 to be insufficient to complete all such networks and we may require additional financing. Additional sources of financing may include public or private equity or debt financings by the Company, capitalized leases and other financing arrangements. Pursuant to certain provisions of our Series A Cumulative Convertible Preferred Stock and Series C Cumulative Convertible Preferred Stock we may not increase the authorized number of shares of preferred stock or common stock of the Company without the consent of the holders of two-thirds of the shares of both those Series. The Company has only three million shares of Common Stock authorized. 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 or within the limitations contained in our Senior Secured Credit Facility, the Lucent Facility, the indenture applicable to our 12 1/2% Senior Discount Notes, the terms of our preferred stock or in any future financing arrangements. Failure to obtain such financing could result in the delay or abandonment of some or all of our development and expansion plans and expenditures, which would have a material adverse effect on our business prospects. HOLDING COMPANY'S RELIANCE ON SUBSIDIARIES' FUNDS; PRIORITY OF OTHER CREDITORS We are a holding company whose sole material asset is the common stock of our subsidiaries. We have pledged all of the common stock of KMC Telecom Inc., KMC Telecom II, Inc. and KMC Telecom of Virginia, Inc., which own our twenty-three existing networks, to the collateral agent under our Senior Secured Credit Facility. In addition, all of the common stock of KMC Telecom III, Inc., which will own the approximately ten new networks currently planned for completion by the end of the second quarter of 2000, has been pledged to the collateral agent under the Lucent Facility. We also loaned or contributed a substantial portion of the net proceeds from the offering of our 12 1/2% Senior Discount Notes to certain of our subsidiaries. We must rely upon dividends and other payments from our subsidiaries to generate the funds necessary to meet our obligations. The subsidiaries are legally distinct from the Company and have no obligation, contingent or otherwise, to make funds available for such obligations, except to the extent that they may be obliged to repay loans made to them by the Company. The ability of our subsidiaries to make such payments to the Company will be subject to, among other things, the availability of funds, the terms of each subsidiary's indebtedness and applicable state laws. In particular, our Senior Secured Credit Facility and the Lucent Facility prohibit our subsidiaries which are borrowers thereunder from paying dividends and principal and interest on intercompany borrowings unless they meet certain financial performance standards. Accordingly, we can give no assurance that we will be able to obtain any funds from our subsidiaries. Claims of creditors of the Company's subsidiaries, including trade creditors, will generally have priority as to the assets of such subsidiaries over the claims of the Company and the holders of the Company's indebtedness and capital stock. We have unconditionally guaranteed the repayment of the Senior Secured Credit Facility and a portion of the Lucent Facility when such repayment is due, whether at maturity, upon acceleration, or otherwise. We have agreed to pay all amounts outstanding under the Senior Secured Credit Facility and up to $250.0 million under the Lucent Facility on demand, upon the occurrence and during the continuation of any event of default thereunder. COMPETITION The telecommunications industry is extremely competitive, particularly with respect to price and service. We face competition in all of our markets. Generally, our incumbent local exchange carrier competitor is one of the Regional Bell Operating Companies, one of GTE Corporation's subsidiaries or one of Sprint Corporation's subsidiaries. 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 businesses and currently benefit from certain existing regulations that favor the incumbent local exchange carriers over us in certain respects. We do not believe that Tier III markets can profitably support more than two competitors to the incumbent local exchange carrier. Accordingly, we believe that once we have completed the construction of our network backbone and the installation of our switch in a given market, potential new entrants in that market are likely to seek to deploy their capital elsewhere. We will generally continue to build in our markets after initial backbone construction and switch installation. We expect that this demonstration of our commitment to our markets will further deter new entrants. However, it is likely that in one or more of our markets we will face competition from two or more facilities-based competitive local exchange carriers. After the investment and expense of establishing a network and support services in a given market, the marginal cost of carrying an additional call is negligible. Accordingly, in Tier III Markets where there are three or more facilities-based 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. Potential competitors in our markets include microwave and satellite carriers, wireless telecommunications providers, cable television companies, utilities and Regional Bell Operating Companies seeking to operate outside their current local service areas. In particular, utilities and cable companies are likely competitors given their existing rights of way. In addition, there may be future competition from large long distance carriers, such as AT&T and MCI WorldCom, which have begun to offer integrated local and long distance telecommunications services. AT&T, TCI and Teleport also recently announced their intention to offer local services. Consolidation of telecommunications companies and the formation of strategic alliances within the telecommunications industry, as well as the development of new technologies, could give rise to significant new competitors to the Company. One of the primary purposes of the Telecommunications Act of 1996 is to promote competition, particularly in local markets. We believe that Tier III Markets will also see more agent and distributor resale initiatives. While recent regulatory initiatives, which allow competitive local exchange carriers such as the Company to interconnect with incumbent local exchange carrier facilities, provide increased business opportunities for us, 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 competitive local exchange carriers increased fees for interconnection to their networks, or if the incumbent local exchange carriers delay implementation of interconnection to their networks, our business, financial condition and results of operations could be adversely affected. To the extent we interconnect with and use incumbent local exchange carrier networks to service our customers, we will be dependent upon the technology and capabilities of the incumbent local exchange carriers to provide services and to maintain our service standards. We will become increasingly dependent on interconnection with incumbent local exchange carriers as switched services become a greater percentage of our business. The Telecommunications Act of 1996 imposes interconnection obligations on incumbent local exchange carriers, but we can give no assurance that we will be able to obtain the interconnections we require at rates, and on terms and conditions, that permit us to offer switched services at rates that are both competitive and profitable. In the event that we experience difficulties in obtaining high quality, reliable and reasonably priced service from the incumbent local exchange carriers, the attractiveness of our services to our customers could be impaired. Both the long distance business and 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. We expect to experience declining prices and increasing price competition. We can give no assurance that we will be able to achieve or maintain adequate market share or revenue, or compete effectively, in any of our markets. Any of the foregoing factors could have a material adverse effect on our business, financial condition and results of operations. RISKS RELATED TO RECIPROCAL COMPENSATION Beginning in June, 1997, every Regional Bell Operating Company advised competitive local exchange carriers that they did not consider calls in the same local calling area from their customers to competitive local exchange carrier customers which are Internet service providers to be local calls under the interconnection agreements between the Regional Bell Operating Companies and the competitive local exchange carriers. The Regional Bell Operating Companies claim that the calls should be classified as exchange access calls even though the Federal Communications Commission exempted these calls from payment of access charges so that no compensation is owed to the competitive local exchange carriers for transporting and terminating such calls. As a result, the Regional Bell Operating Companies threatened to withhold, and in many cases did withhold, reciprocal compensation for the transport and termination of such calls. To date, twenty-nine state commissions have ruled on this issue in the context of state commission arbitration proceedings or enforcement proceedings. In every state, to date, the state commission has determined that reciprocal compensation is owed for such calls. Several of these cases are presently on appeal. We cannot predict the outcome of these appeals, or of additional pending cases. If these calls were to be determined not to be local calls and not subject to access charges, it could have an adverse effect on our business, financial condition and results of operations. DEVELOPMENT AND EXPANSION RISK; NEED TO MANAGE GROWTH We must achieve substantial growth in order to meet our payment obligations under our indebtedness and our dividend and redemption obligations with respect to our capital stock. Our networks have only recently become commercially operational and we have only recently deployed switches in our networks. Our success will depend, among other things, upon our ability to: o assess potential markets, o design fiber optic backbone routes that provide ready access to a substantial customer base, o achieve a sufficient customer base, o secure financing, o install facilities, o obtain required rights-of-way, building access and governmental permits, o implement interconnection and collocation with facilities owned by incumbent local exchange carriers, and o obtain unbundled network elements from incumbent local exchange carriers. Our success will also depend upon subsequent developments in state and federal regulations. In addition, we may make additional acquisitions of existing operating systems. Any such acquisitions could divert our resources and management time and will require integration with our management information, payroll and other systems, existing networks and service offerings. We can give no assurance that any networks to be developed or further developed will be completed on schedule, at a commercially reasonable cost or within our specifications. Our growth may place a significant strain on our financial, management and operational resources. Our future performance will depend, in part, upon our ability to manage our growth effectively, monitor operations, control costs and maintain effective quality control which will require us to continue to implement and improve our operating, financial and accounting systems, to expand, train and manage our employee base and to effectively manage the integration of acquired businesses. In addition, the establishment of new operations or acquisitions will involve significant expenses in advance of anticipated revenues and may cause fluctuations in our operating results. IMPLEMENTATION RISKS We are deploying high capacity digital switches in our markets. This will enable us to offer a variety of switched access services, enhanced services and local dial tone. We expect to incur negative gross profits and negative EBITDA from our switched services in any given market during the 24 to 36 month period after the switch is deployed. We expect operating margins to improve as each network is expanded and larger volumes of traffic are carried on our network. In each of our markets, we rely on incumbent local exchange carriers to originate and terminate all of our switched services traffic until our own switch becomes operational. Although under the Telecommunications Act of 1996 the incumbent local exchange carriers will be required to unbundle local network elements and to permit us to purchase only the origination and termination services we need, thereby decreasing operating expenses, we can give no assurance that such unbundling will be effected in a timely manner and result in favorable prices. To date, we have experienced some difficulty working with incumbent local exchange carriers to transition our resale customers to our own networks. Certain incumbent local exchange carriers have proven unable or unwilling to provide requisite unbundled network elements and collocation facilities on a prompt basis. We are using Federal Communications Commission arbitration procedures to compel these incumbent local exchange carriers to act in conformity with the Telecommunications Act of 1996. The effect of these delays is to temporarily reduce margins for our services (as the transition from lower margin resale to higher margin on-net services is delayed) and to delay the development of positive EBITDA. We are a recent entrant into the newly created competitive local telecommunications services industry. The local dial tone services market was opened to competition by the Telecommunications Act of 1996, and related regulatory rulings. There are numerous operating complexities associated with providing these services. We will be required to develop new products, services and systems and will need to develop new marketing initiatives to sell these services. Our services may not be profitable due to, among other factors, lack of customer demand, inability to secure access to incumbent local exchange carrier facilities at acceptable rates, competition and pricing pressure from incumbent local exchange carriers and other competitive local exchange carriers and cost overruns in connection with network build-outs. We expect to face significant competitive product and pricing pressure from the incumbent local exchange carriers in our markets. We have limited experience providing switched access and local dial tone services and there can be no assurance that we will be able to successfully implement our switched and enhanced services strategy. Implementation of our switched and enhanced services is also subject to equipment manufacturers' ability to meet our switch deployment schedule. There can be no assurance that all of such switches will be deployed on the schedule that we contemplate or that, if deployed, such switches will be utilized to the degree that we contemplate. Any of the foregoing risks could have a material adverse effect on our business, financial condition and results of operations. Franchises obtained by the Company may require us to complete the build-out of our network within a period specified in the franchise grant. If we are unable to complete the build-out of a network within the specified period, or obtain an extension of time in which to complete the build-out, our franchise agreement may be terminable by the local authority. Any such termination of a franchise agreement could have a material adverse effect on our business, financial condition and results of operations. RISKS OF ENTRY INTO LONG DISTANCE BUSINESS In order to offer our end-user customers a complete package of telecommunications services, we recently began to offer long distance services on a resale basis. As a new entrant in the long distance business, we expect to generate low gross margins and substantial start-up expenses as we roll out our long distance service offerings. Long distance telecommunications services will involve the origination of traffic from end-user customers, either directly connected to our network or through facilities leased from incumbent local exchange carriers, to our telecommunications switches. We will rely on other carriers to provide transmission and termination services for our long distance traffic and will therefore be dependent on such carriers. We enter into resale agreements with long distance carriers to provide us with long distance transmission services. Such agreements typically provide for the resale of long distance services on a per minute basis (some with minimum volume commitments or volume discounts). The negotiation of these agreements involves estimates of future supply and demand for long distance telecommunications transmission capacity as well as estimates of the calling pattern and traffic levels of our future long distance customers. Should we fail to meet our minimum volume commitments, if any, pursuant to these resale agreements, we may be obligated to pay underutilization charges. Likewise, we may underestimate our need for long distance facilities and therefore be required to obtain the necessary transmission capacity through more expensive means. We can give no assurance 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. Our success in entering into the long distance business will be dependent upon, among other things, our ability to select new equipment and software and integrate these into our networks, hire and train qualified personnel, enhance our billing, back-office and information systems to accommodate long distance services and the acceptance by potential customers of our long distance service offerings. If our long distance transmission business fails to generate favorable gross margins or if we fail in any of the foregoing respects, such failure may have a material adverse effect on our business, financial condition and results of operations. RISKS OF ENTRY INTO DATA TRANSMISSION BUSINESS To complement our telecommunications services offerings, we began offering data transmission services in certain of our markets in 1997. We now offer ISDN, Internet access, Local Area Network-to-Local Area Network interconnect and wide-area network services and are developing product applications for Centrex-type, BRI, PRI, port wholesale, frame relay and ATM services to complement our existing data services. These services are primarily targeted at large and medium sized businesses with substantial data communications requirements. We do not expect data transmission services to generate a material portion of our revenues over the near term. In providing these services, we will be dependent upon vendors for assistance in the planning and deployment of initial data product offerings, as well as ongoing training and support. The success of our entry into the data transmission business will be dependent upon, among other things: o our ability to select new equipment and software and integrate these into our networks, o our ability to hire and train qualified personnel, o our ability to enhance our billing, back-office and information systems to accommodate data transmission services, and o the acceptance by potential customers of our service offerings. We cannot assure you that we will be successful with respect to these matters. If we are not successful with respect to these matters, there may be a material adverse effect on our business, financial condition and results of operations. GOVERNMENT REGULATION 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. Delays in receiving required regulatory approvals, new court decisions or the enactment of new adverse regulations or regulatory requirements may have a material adverse effect on our business, financial condition and results of operations. The Telecommunications Act of 1996 was enacted to promote competition in the domestic telecommunications industry, including the local exchange, long distance and cable television industries. The Telecommunications Act remains subject to judicial review and additional Federal Communications Commission and state public service commission rulemaking, and thus it is difficult to predict what effect the legislation will have on the Company and our operations. There are currently many regulatory actions underway and being contemplated by federal and state authorities regarding interconnection pricing and other issues that could result in significant changes to the business conditions in the telecommunications industry. We may be required to cancel our federal interstate tariff filings at the Federal Communications Commission and implement replacement contractual arrangements, which could result in substantial legal and administrative expenses. We cannot assure you that these changes will not have a material adverse effect on our business, financial condition and results of operations. In addition to requirements placed on incumbent local exchange carriers, the Telecommunications Act of 1996 subjects the Company to certain federal regulatory requirements regarding the provision of local exchange services. All incumbent local exchange carriers and competitive local exchange carriers must offer reciprocal compensation for termination of traffic and provide dialing parity. However, negotiations with incumbent local exchange carriers have sometimes involved considerable delays and the agreements may not be on terms and conditions that are favorable to us. In May 1997, the Federal Communications Commission adopted a rule that will require us and other competitive local exchange carriers to contribute to a universal service fund provided for in the Telecommunications Act of 1996. At the same time, the Federal Communications Commission adopted rules that will change how access charges are calculated. These changes will reduce access charge levels closer to their cost and will shift certain charges currently based on minutes to flat-rate, monthly per-line charges. As a result, the aggregate access revenue paid to access providers in the United States is expected to decrease. In addition, the Federal Communications Commission has also adopted rules that will give incumbent local exchange carriers pricing flexibility with respect to access charges. We cannot assure you that the changes to current regulations or the adoption of new regulations (pursuant to the Telecommunications Act of 1996 or otherwise) by the Federal Communications Commission or state public service commissions will not have a material adverse effect on our business, financial condition and results of operations. On December 31, 1997, the U.S. District Court for the Northern District of Texas issued the SBC Decision finding that Sections 271 to 275 of the Telecommunications Act of 1996 are unconstitutional. These sections of the Telecommunications Act impose restrictions on the lines of business in which the Regional Bell Operating Companies may engage, including establishing the conditions the Regional Bell Operating Companies must satisfy before they may provide inter-LATA long distance telecommunications services. The SBC Decision has been reversed upon review by the U.S. Fifth Circuit Court of Appeals and the U.S. Supreme Court has denied all petitions for certiorari. State regulatory commissions exercise jurisdiction over our Company to the extent we provide intrastate services. As such a provider, we are required to obtain regulatory authorization and/or file tariffs or rate schedules at state agencies in all of the states in which we operate. Local authorities regulate our access to municipal rights-of-way. The networks are also subject to numerous local regulations such as building codes and licensing. Such regulations vary on a city by city and county by county basis. If authority is not obtained or if tariffs are not filed, or are not updated, or otherwise do not fully comply with the tariff filing rules of the Federal Communications Commission or state regulatory agencies, third parties or regulators could challenge these actions. Such challenges could cause an interruption or termination of our services and could cause us to incur substantial legal and administrative expenses. Many states also regulate transfers of control or assets, and issuances of stock or debt instruments, by authorized carriers. Accordingly, we may be subject to prior approval or other filing requirements for such transactions. DEPENDENCE ON RIGHTS-OF-WAY AND OTHER THIRD PARTY AGREEMENTS 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 the Company. We can give no assurance 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, financial condition and results of operations. DEPENDENCE ON BILLING, CUSTOMER SERVICES AND INFORMATION 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. Our existing billing and information systems have been produced largely in-house with partial reliance on third-party vendors. To date, these systems have generally met our needs due in part to our low volume of bills and orders. As we expand the volume of our dial tone services, the need for sophisticated billing and information systems is increased significantly. However, because our existing provisioning system is not electronic, it constrains our ability to grow our business at a faster rate. We have recently embarked upon a program to implement a full suite of order management, customer service, billing and financial applications. These applications will include electronic order tracking software developed by Eftia OSS Solutions Inc. and software providing comprehensive billing functionality developed by Billing Concepts Systems, Inc. The new operational support systems will be phased in over the next twelve to eighteen months with initial installation expected by the end of the first quarter of 1999 and electronic bonding expected by the end of the second quarter. The new billing system will be phased in over the next twelve months. Our failure to (i) implement the new operational support systems, convergent billing systems and financial applications on a timely basis, (ii) adequately identify all of our information and processing needs, or (iii) upgrade our systems as necessary, could have a material adverse effect on our business, financial condition and results of operations. RAPID TECHNOLOGICAL CHANGE The telecommunications industry is subject to rapid and significant changes in technology, with the Company relying on third parties for the development of and access to new technology. The effect of technological changes on our business cannot be predicted. We believe our future success will depend, in part, on our ability to anticipate or adapt to such changes and to offer, on a timely basis, services that meet customer demands. We cannot assure you that we will be able to anticipate or adapt to such changes and to offer, on a timely basis, services that meet customers' demands. A failure to do so would have a material adverse effect on our business, financial condition and results of operations. DEPENDENCE ON KEY PERSONNEL We believe that the efforts of a small number of key management and operating personnel will largely determine our success and the loss of any such persons could adversely affect the Company. We do not maintain so-called "key man" insurance on any of our personnel. We have employment agreements with Mr. Kamine, the Chairman of our Board of Directors, Mr. Sternberg, our President and Chief Executive Officer, and Mr. Young, our Chief Operating Officer, all of which currently run through December 31, 2002. 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 cannot assure you that we will be able to hire or retain necessary personnel. Our failure to hire or retain necessary personnel could have a material adverse effect on our business, financial condition and results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market risks relating to the Company's operations result primarily from changes in interest rates. The substantial majority of the Company's 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. The Company is 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. Under its current policies, the Company does not utilize any interest rate derivative instruments to manage its exposure to interest rate changes. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The following statements are filed as part of this Annual Report on Form 10-K:
FORM 10-K PAGE NO. -------- Report of Independent Auditors.................................................... 35 Consolidated Balance Sheets as of December 31, 1997 and 1998...................... 36 Consolidated Statements of Operations for the years ended December 31, 1996, 1997, and 1998................................................................... 37 Consolidated Statements of Redeemable and Nonredeemable Equity for the years ended December 31, 1996, 1997 and 1998............................................ 38 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998.............................................................. 39 Notes to Consolidated Financial Statements........................................ 40 Independent Auditors' Report on Schedules......................................... 61 Schedule I - Condensed Financial Information of Registrant........................ 62 Schedule II - Valuation and Qualifying Accounts................................... 69
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 1997, 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, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 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 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP MetroPark, New Jersey February 2, 1999
KMC TELECOM HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) DECEMBER 31 ---------------------------- 1997 1998 ---- ---- ASSETS Current assets: Cash and cash equivalents.............................................. $ 15,553 $ 21,181 Accounts receivable, net of allowance for doubtful accounts of $34 and $350 in 1997 and 1998, respectively................................. 1,318 7,539 Prepaid expenses and other current assets.............................. 489 1,315 --------- ---------- Total current assets...................................................... 17,360 30,035 Investments held for future capital expenditures.......................... -- 27,920 Networks and equipment, net............................................... 71,371 224,890 Intangible assets, net.................................................... 2,655 2,829 Deferred financing costs, net............................................. 4,196 20,903 Other assets.............................................................. 361 4,733 --------- ---------- $ 95,943 $ 311,310 ========= ========== LIABILITIES, REDEEMABLE AND NONREDEEMABLE EQUITY (DEFICIENCY) Current Liabilities: Accounts payable....................................................... $ 5,513 $ 21,052 Accrued expenses....................................................... 8,128 10,374 Due to affiliates...................................................... 47 -- --------- ---------- Total current liabilities................................................. 13,688 31,426 Notes payable............................................................. 51,277 41,414 Subordinated notes payable................................................ 10,000 -- Senior discount notes payable............................................. -- 267,811 --------- ---------- Total liabilities......................................................... 74,965 340,651 Commitments and contingencies Redeemable equity: Redeemable cumulative convertible preferred stock, par value $.01 per share; 599 shares authorized; shares issued and outstanding: Series A, 124 shares in 1997 and 1998 ($12,380 liquidation preference).................................................. 18,879 30,390 Series C, 150 shares in 1997 and 175 shares in 1998 ($17,500 liquidation preference in 1998)................................. 14,667 21,643 Series D, 25 shares in 1997 and - 0 - shares in 1998.............. 2,379 -- Redeemable common stock, shares issued and outstanding, 133 in 1997 and 224 in 1998....................................... 11,187 22,305 Redeemable common stock warrants..................................... 539 674 --------- ---------- Total redeemable equity ................................................ 47,651 75,012 Nonredeemable equity (deficiency) Common stock, par value $.01 per share; 3,000 shares authorized, 614 shares issued and outstanding................................. 6 6 Additional paid-in capital.......................................... 15,374 13,750 Unearned compensation............................................... (6,521) (5,824) Accumulated deficit................................................. (35,532) (112,285) --------- ---------- Total nonredeemable equity (deficiency)................................... (26,673) (104,353) --------- ---------- $ 95,943 $ 311,310 ========= ========== See accompanying notes.
KMC TELECOM HOLDINGS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) YEAR ENDED DECEMBER 31 ------------------------------------------------- 1996 1997 1998 ---- ---- ---- Revenue................................................................ $ 205 $ 3,417 $ 22,425 Operating expenses: Network operating costs............................................. 1,361 7,735 37,336 Selling, general and administrative................................ 2,216 9,923 24,534 Stock option compensation expense................................... 240 13,870 7,080 Depreciation and amortization....................................... 287 2,506 9,257 ---------- ---------- ---------- Total operating expenses............................................... 4,104 34,034 78,207 ---------- ---------- ---------- Loss from operations ................................................ (3,899) (30,617) (55,782) Interest income......................................................... -- 513 8,818 Interest expense........................................................ (596) (2,582) (29,789) ---------- ---------- ---------- Net loss................................................................ (4,495) (32,686) (76,753) Dividends and accretion on redeemable preferred stock................... -- (8,904) (18,285) ---------- ---------- ---------- Net loss applicable to common shareholders.............................. $ (4,495) $ (41,590) $ (95,038) ========== ========== ========== Net loss per common share............................................... $ (7.49) $ (64.93) $ (114.42) ========== ========== ========== Weighted average number of common shares outstanding.................... 600 641 831 ========== ========== ========== See accompanying notes.
KMC TELECOM HOLDINGS, INC. (SEE NOTE 1) CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE EQUITY YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (IN THOUSANDS) Redeemable Equity ------------------------------------------------------------------------------------------ Preferred Stock ---------------------------------------------------- Series A Series C Series D Common Stock Total ------------------------------------------------------------------------------- Redeemable Shares Amount Shares Amount Shares Amount Shares Amount Warrants Equity ------------------------------------------------------------------------------------------ Balance, December 31, - $ - - $ - - $ - - $ - $ - $ - 1995................ Change in authorized capital............. Conversion of stockholder's loan and related imputed interest to equity.. Issuance of common stock............... Issuance of stock options to employees Amortization of unearned compensation... Fair value of stock options issued to non-employees....... Reclassification of deficit accumulated through date of termination of Subchapter S election............ Net loss.............. -------------------------------------------------------------------------------------------- Balance, December 31, - - - - - - - - - - 1996................ Conversion of convertible notes payable to Series A Preferred Stock..... 124 11,519 11,519 Issuance of warrants.. 2,025 2,025 Issuance of common stock and exercise 133 10,863 (1,500) 9,363 of warrants......... 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, 124 $30,390 175 $21,643 - $- 224 $22,305 $674 $75,012 1998................ ============================================================================================
KMC TELECOM HOLDINGS, INC. (SEE NOTE 1) CONSOLIDATED STATEMENTS OF REDEEMABLE AND NONREDEEMABLE EQUITY YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998 (IN THOUSANDS) Nonredeemable Equity ------------------------------------------------------------------------ Total Common Stock Additional Equity Nonredeemable ------------------ Paid-in Unearned Accumulated Equity Shares Amount Capital Compensation Deficit (Deficiency) ------------------------------------------------------------------------ Balance, December 31, - $ - $ 2 $ - $ (1,625) $ (1,623) 1995................ Change in authorized 560 6 (6) - capital............. Conversion of stockholder's loan 2,267 2,267 and related imputed interest to equity.. Issuance of common 40 4,000 4,000 stock............... Issuance of stock 1,283 (1,283) - options to employees Amortization of 44 44 unearned compensation.. Fair value of stock options issued to 196 196 non-employees....... Reclassification of deficit accumulated through date of termination of Subchapter S election............ (3,274) 3,274 - Net loss.............. (4,495) (4,495) ------------------------------------------------------------------------- Balance, December 31, 600 6 4,468 (1,239) (2,846) 389 1996................ Conversion of convertible notes payable to Series A Preferred Stock..... Issuance of warrants.. Issuance of common stock and exercise 14 of warrants......... 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, 614 $6 $ 13,750 $(5,824) $(112,285) $(104,353) 1998................ ========================================================================
See accompanying notes.
KMC TELECOM HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year ended December 31 1996 1997 1998 ---- ---- ---- Operating activities Net loss...................................................... $ (4,495) $ (32,686) $ (76,753) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.............................. 287 2,506 9,257 Non-cash interest expense.................................. 698 610 25,356 Non-cash stock option compensation expense................. 240 13,870 7,080 Changes in assets and liabilities: Accounts receivable...................................... (23) (1,296) (6,221) Prepaid expenses and other current assets................ (138) (346) (826) Accounts payable......................................... 789 2,934 7,449 Accrued expenses......................................... 417 6,062 2,953 Due to affiliates........................................ (410) (35) (47) Other assets............................................. (52) (295) (1,821) --------------- --------------- --------------- Net cash used in operating activities......................... (2,687) (8,676) (33,573) --------------- --------------- --------------- Investing activities Construction of networks and purchases of equipment........... (9,111) (59,146) (148,580) Acquisitions of franchises, authorizations and related assets. (1,063) (1,846) (1,147) Cash paid for acquisition of Melbourne Network................ - (2,000) - Deposit on purchase of equipment.............................. - - (2,551) Purchase of investments, net.................................. - - (27,920) --------------- --------------- --------------- Net cash used in investing activities......................... (10,174) (62,992) (180,198) --------------- --------------- --------------- Financing activities Proceeds from stockholder loans............................... 3,542 - - Repayment of stockholder loans................................ (4,181) - - Proceeds from notes payable, net of issuance costs............ 10,953 59,873 938 Proceeds from issuance of common stock and warrants, net of issuance costs....................................... 4,000 9,363 20,446 Proceeds from issuance of preferred stock, net of issuance costs.............................................. - 16,498 - Issuance costs of senior secured credit facility.............. - - (6,515) 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..................... 14,314 85,734 219,399 --------------- --------------- --------------- Net increase in cash and cash equivalents..................... 1,453 14,066 5,628 Cash and cash equivalents, beginning of year.................. 34 1,487 15,553 --------------- --------------- --------------- Cash and cash equivalents, end of year........................ $ 1,487 $ 15,553 $ 21,181 =============== =============== =============== Supplemental disclosure of cash flow information Cash paid during the year for interest, net of amounts capitalized................................................... $ 97 $ 766 $ 4,438 =============== =============== =============== See accompanying notes.
KMC TELECOM HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Holdings and its direct and indirect wholly-owned subsidiaries, KMC Telecom, KMC Telecom II, KMC Telecom III and KMC Telecom of Virginia, Inc. are collectively referred to herein as the Company. The predecessors to KMC Telecom, Kamine Multimedia Corp. and KMC Southeast Corp. (the "Predecessors") were incorporated in the state of Delaware on May 10, 1994 and April 19, 1995, respectively, and all of the outstanding common stock of each company was owned by Harold N. Kamine ("Kamine"). Effective May 23, 1996, Kamine Multimedia Corp. was merged into KMC Southeast Corp., and the surviving corporation was renamed KMC Telecom Inc. The merger was accounted for as a combination of entities under common control, and the net assets of Kamine Multimedia Corp. were transferred at their historical cost in a manner similar to that in pooling of interests accounting. The Company is a facilities-based competitive local exchange carrier ("CLEC") providing telecommunications and data 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 Southeastern and Midwestern United States. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION As noted above, effective May 23, 1996, KMC Telecom was the successor resulting from the merger of the Predecessors, and effective September 22, 1997, KMC Telecom became a wholly-owned subsidiary of KMC Holdings. The accompanying financial statements include the consolidated financial position and results of operations of KMC Holdings and its subsidiaries subsequent to September 22, 1997, the results of operations of KMC Telecom from May 23, 1996, and the combined results of operations of the Predecessors from January 1, 1996. All significant intercompany transactions and balances have been eliminated. 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 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. At December 31, 1998, the carrying value of such held-to-maturity debt securities approximated their fair value. 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: Networks: Fiber optic systems..............................................20 years Telecommunications equipment.....................................10 years Furniture and fixtures.............................................5 years Leasehold improvements.............................................Life of lease 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 15 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 15 years. DEFERRED FINANCING COSTS The Company capitalizes issuance costs related to its debt. Such costs are amortized utilizing the interest method over the lives of the related debt. The related amortization is included as a component of interest expense, and amounted to $189,000, $561,000 and $2,279,000 for the years ended December 31, 1996, 1997 and 1998, respectively. OTHER ASSETS Other assets are comprised principally of non-refundable deposits for the purchase of switching equipment, employee loans, security deposits and other deposits. REVENUE RECOGNITION Revenue is recognized in the period the service is provided. Unbilled revenue included in accounts receivable represents revenue earned for services which will be billed in the succeeding month and totaled $1,272,000 at December 31, 1998. The Company generally invoices customers one month in advance for recurring services resulting in deferred revenue of $1,187,000 at December 31, 1998. 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. The Predecessors' earnings per share have been computed as if the May 23, 1996 merger had occurred as of January 1, 1996. 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. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 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 and 1998, such costs were $66,000 and $2,769,000, respectively. 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 events and circumstances indicate that the cash flows expected to be derived from those assets are less than the carrying amounts of those assets. No such events and circumstances have occurred. STOCK-BASED COMPENSATION As permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation ("Statement 123"), the Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related interpretations in accounting for its employee stock-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 7, 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. COMPREHENSIVE INCOME In 1998, the Company adopted FASB Statement No. 130, Reporting Comprehensive Income, which established new rules for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. This statement has no effect on the Company's financial statement presentation because the Company presently has no items of comprehensive income. 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 management. Under this definition, the Company operated within a single segment for all periods presented. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In January 1998, the Accounting Standards Executive Committee of the AICPA issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities, which is effective for fiscal years beginning after December 15, 1998. This statement requires costs of start-up activities to be expensed as incurred. The Company does not anticipate that the adoption of this statement will have any effect on its results of operations or financial position, because the Company currently expenses such costs. In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The Company expects to adopt the new Statement effective January 1, 2000. This statement will require the Company to recognize all derivatives on the balance sheet at fair value. The Company does not anticipate that the adoption of this statement will have a significant effect on its results of operations or financial position, because the Company presently has no derivatives. 3. NETWORKS AND EQUIPMENT Networks and equipment are comprised of the following:
December 31 1997 1998 -------------------------------- (in thousands) Fiber optic systems........................... $29,837 $ 99,502 Telecommunications equipment.................. 18,052 115,769 Furniture and fixtures........................ 1,518 7,340 Leasehold improvements........................ 792 1,177 Construction-in-progress...................... 23,556 11,770 -------------------------------- 73,755 235,558 Less accumulated depreciation................ (2,384) (10,668) -------------------------------- $71,371 $224,890 ================================
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, 1996, 1997 and 1998 amounted to $103,000, $854,000 and $5,133,000, respectively. For the years ended December 31, 1996, 1997 and 1998, depreciation expense was $260,000, $2,122,000 and $8,284,000, respectively. 4. INTANGIBLE ASSETS Intangible assets are comprised of the following:
December 31 1997 1998 ------------------------------- (in thousands) Franchise costs............................... $ 1,342 $ 1,690 Authorizations and rights-of-ways............. 1,151 1,455 Building access agreements and other.......... 567 1,062 ------------------------------- 3,060 4,207 Less accumulated amortization................. (405) (1,378) ------------------------------- $ 2,655 $ 2,829 ===============================
5. ACCRUED EXPENSES Accrued expenses are comprised of the following:
December 31 1997 1998 ------------------------------- (in thousands) Accrued compensation.......................... $ 1,179 $ 4,138 Deferred revenue.............................. 498 1,187 Other accrued expenses........................ 6,451 5,049 ------------------------------- $ 8,128 $10,374 ===============================
6. LONG-TERM DEBT SENIOR SECURED CREDIT FACILITY On September 22, 1997, KMC Telecom and KMC Telecom II entered into an Amended and Restated Loan and Security Agreement (the "AT&T Facility") with AT&T Commercial Finance Corporation ("AT&T Finance") which provided for borrowings up to an aggregate of $70 million. On December 22, 1998, KMC Telecom, KMC Telecom II and KMC Telecom of Virginia (the "Borrowers"), refinanced and expanded the AT&T Facility by entering into a Loan and Security Agreement (the "Senior Secured Credit Facility") with AT&T Finance, First Union National Bank, General Electric Capital Corporation ("GECC") and Canadian Imperial Bank of Commerce (the "Lenders"). Under the Senior Secured Credit Facility, the Lenders agreed to lend the 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 (the "Revolver") and a $75 million eight and one half year term loan (the "Term Loan"). At December 31, 1998, an aggregate of $41.4 million was outstanding under this facility. The Senior Secured Credit Facility will mature no later than July 1, 2007. The outstanding principal balance of 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. The aggregate commitment of the Lenders under the Revolver will be reduced on each payment date beginning April 1, 2002. The initial quarterly commitment reductions are 2.5%, increasing to 5% on April 1, 2003 and further increasing to 7.5% on April 1, 2006. Commencing on April 1, 2002, 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 and maintain for at least two consecutive fiscal quarters certain financial conditions. Additionally, in the event certain principal amounts due under the Revolver are repaid and not reborrowed within 120 days of such repayment, then the aggregate commitment under the Revolver will be reduced by such amount. Borrowings under the Senior Secured Credit Facility will bear interest payable at the 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. If the Borrowers default on any interest or principal payment due under the Senior Secured Credit Facility, the interest rate will increase by four percentage points. If any other event of default shall occur, the interest rate will be increased by two percentage points. Interest on each LIBOR loan is payable on each LIBOR interest payment date in arrears and interest on each base rate loan is payable quarterly in arrears. Interest on borrowings outstanding at December 31, 1998 was based on LIBOR, and the Borrowers were being charged at an annual rate of 9.38%. The Borrowers must pay an annual commitment fee on the unused portion of the Senior Secured Credit Facility ranging from .75% to 1.25%. KMC Holdings has unconditionally guaranteed the repayment of the 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 Senior Secured Credit Facility contains a number of affirmative and negative covenants including, among others, covenants restricting the ability of the Borrowers to consolidate or merge with any person, sell or lease assets not in the ordinary course of business, sell or enter into long term leases of dark fiber, redeem stock, pay dividends or make any other payments (including payments of principal or interest on loans) to 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, 2001 and (ii) after the Borrowers achieve positive EBITDA on a combined basis for two consecutive fiscal quarters. Failure to satisfy any of the financial covenants will constitute an event of default under the Senior Secured Credit Facility permitting the Lenders, after notice, to terminate the commitment and/or accelerate payment of outstanding indebtedness. The 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. 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 $250.0 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 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 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, 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. OTHER INDEBTEDNESS On September 22, 1997, KMC Telecom and KMC Telecom II obtained a subordinated term loan (the "Supplemental AT&T Facility") from AT&T Finance with an original principal amount of $10 million. The Supplemental AT&T Facility was, by its terms, due in full upon the closing of a debt offering with gross cash proceeds of at least $50 million. On January 29, 1998, the entire $10 million outstanding under this facility was repaid in full with a portion of the proceeds of the Company's issuance of Senior Discount Notes and warrants. During 1996, KMC Telecom issued convertible secured notes payable aggregating $11,894,000 and $106,000 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") (such notes are collectively referred to herein as the "Convertible Notes".) On January 21, 1997, the Convertible Notes, including accrued interest through that date, aggregating approximately $12,380,000 were converted into 123,800 shares of Series A Cumulative Convertible Preferred Stock of KMC Telecom (such stock was subsequently exchanged for an equal number of shares of Series A Preferred Stock of KMC Holdings on September 22, 1997). 7. REDEEMABLE AND NONREDEEMABLE EQUITY KMC TELECOM PREFERRED STOCK On January 21, 1997, the Convertible Notes were converted into 123,800 shares of Series A Cumulative Convertible Preferred Stock of KMC Telecom with an aggregate liquidation value of $12,380,000. Effective September 22, 1997, all of the shares of Series A Cumulative Convertible Preferred Stock 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 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. 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 of the Company into one or more other corporations). As of December 31, 1998, dividends in arrears on the Series A Preferred Stock aggregated $1,144,000. 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, 1998. 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, 1998, dividends in arrears on the Series C Preferred Stock aggregated $1,458,000. Notwithstanding the foregoing, pursuant to the Purchase Agreement among the Company, Nassau, GECC and CoreStates Holdings, Inc. ("CoreStates"), 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 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, 1998. 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, AT&T Credit Corporation ("AT&T Credit"), GECC, and CoreStates (the "Stockholders' Agreement"), until Kamine and Nassau cease to own Common Stock or preferred stock convertible into Common Stock representing at least five percent of the outstanding shares of Common Stock, assuming all convertible securities are converted, Kamine and Nassau have special rights 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 CoreStates) are entitled to elect two additional Directors, who will serve until the default is cured. REDEMPTION RIGHTS Pursuant to the Stockholders' Agreement, each of Nassau, AT&T Credit, GECC and CoreStates has a "put right" entitling it to have the Company repurchase its preferred and common shares for the fair market value of such shares if no Liquidity Event (defined as (i) an initial public offering with gross proceeds of at least $40 million, (ii) the sale of substantially all of the stock or assets of the Company or (iii) the merger or consolidation of the Company with one or more other corporations) has taken place by the later of (x) October 22, 2003 or (y) 90 days after the final maturity date of the Senior Discount Notes (issued in January 1998, with a stated maturity date of February 15, 2008). CoreStates, GECC and AT&T Credit may not exercise such put rights unless Nassau has exercised its put right. The Senior Discount Note Indenture limits the Company's ability to repurchase such shares. All of the shares of preferred and common stock subject to such "put right" are presented as redeemable equity in the accompanying balance sheets. The redeemable preferred stock, redeemable common stock and redeemable common stock warrants (described below) are being accreted to their fair market values from their respective issuance dates to their earliest potential redemption date (October 22, 2003). At December 31, 1998, the aggregate redemption value of the redeemable equity was approximately $152 million, reflecting per share redemption amounts of $630 for the Series A Preferred Stock, $248 for the Series C Preferred Stock and $130 for the redeemable common stock and redeemable common stock warrants. Accordingly, $8,246,000 and $17,861,000 of accretion have been charged to additional paid-in-capital in 1997 and 1998, respectively. 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 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, 1998. 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. 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 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 262,750 shares of Common Stock of KMC Holdings are available for grant, all of which were allocated to the Plan as of December 31, 1998. 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. Information on stock options is as follows:
Weighted Number of Shares Average Exercise -------------------------------------------------------- Outstanding Exercisable Price of Options -------------------------------------------------------- Balances, January 1, 1996.. - - Granted.................. 95,385 - $65 Became exercisable....... - - --------------------------- Balances, December 31, 1996 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 ===========================
The weighted-average exercise price of options exercisable at December 31, 1997 and 1998 is $50 and $22, respectively, and the weighted-average fair value of options granted during 1996, 1997 and 1998 were $30, $49 and $114 per share, respectively. Exercise prices for options outstanding as of December 31, 1998 ranged from $20 to $40. The weighted-average remaining contractual life of those options is 9.7 years. 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. 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, 1996 and 1997, and KMC Holdings at December 31, 1998, cumulative deferred compensation obligations of $1,283,000, $15,579,000 and $27,906,000, respectively, have been established. The Company has recognized compensation expense aggregating $240,000, $13,870,000 and $7,080,000 for the years ended December 31, 1996, 1997 and 1998, 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 grant date as prescribed by Statement 123, net loss and net loss per common share would have been the following: December 31 1996 1997 1998 ------------------------------------------ (In thousands) Net loss: As reported....................... $(4,495) $(32,685) $(76,753) =========================================== Pro forma......................... $(4,453) $(20,542) $(76,869) =========================================== Net loss per common share: As reported....................... $(7.49) $(64.93) $(114.42) ============================================ Pro forma......................... $(7.42) $(45.97) $(114.56) ============================================ 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: 1996 1997 1998 ------------------------------------------ Expected dividend yield............. 0% 0% 0% Expected stock price volatility..... 50% 50% 50% Risk-free interest rate............. 6% 6% 6% Expected life of options............ 7 years 7 years 7 years 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. 8. INCOME TAXES As of December 31, 1998, the Company and its subsidiaries had consolidated net operating loss carryforwards for United States income tax purposes ("NOLs") of approximately $59 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 $38 million and $109 million of loss carryforwards and net temporary differences at December 31, 1997 and 1998, respectively. At existing federal and state tax rates, the future benefit of these items approximates $15 million at December 31, 1997 and $42 million at December 31, 1998. Valuation allowances have been established equal to the entire net tax benefit associated with all carryforwards and temporary differences at both December 31, 1997 and 1998 as their realization is uncertain. The composition of expected future tax benefits at December 31, 1997 and 1998 is as follows: 1997 1998 ------------------------------ (in thousands) Net operating loss carryforwards.................. $ 8,894 $ 22,914 Temporary differences Stock option compensation...................... 5,502 8,264 Interest accretion............................. - 9,797 Other, net..................................... 523 1,513 ------------------------------ Total deferred tax assets......................... 14,919 42,488 Less valuation allowance.......................... (14,919) (42,488) ------------------------------ Net deferred tax assets........................... $ - $ - ============================== A reconciliation of the expected tax benefit at the statutory federal rate of 34% is as follows:
1996 1997 1998 --------------------------------------------- Expected tax benefit at statutory rate....... (34.0)% (34.0)% (34.0)% State income taxes, net of federal benefit... (4.0) (2.9) (2.6) Non-deductible interest expense.............. - - 2.0 S Corporation losses not benefited........... 4.1 - - Other........................................ .1 .1 .1 Change in valuation allowance................ 33.8 36.8 34.5 ------------------------------------------- -% -% -% ===========================================
9. COMMITMENTS AND CONTINGENCIES LEASES The Company leases various facilities and equipment under operating leases. Minimum rental commitments are as follows (in thousands): Year ending December 31: 1999............................... $ 2,247 2000............................... 2,222 2001............................... 2,169 2002............................... 2,120 2003............................... 1,615 Thereafter........................... 1,334 ----------------- $11,707 ================= Rent expense under operating leases was $98,000, $478,000 and $1,299,000 for the years ended December 31, 1996, 1997 and 1998, respectively. LITIGATION By letter dated August 29, 1997, KMC Telecom notified I-Net, Inc. ("I-NET") that KMC Telecom considered I-NET to be in default under a Master Telecommunications System Rollout Agreement, dated as of October 1, 1996 (the "I-Net Agreement"), as a result of I-NET's failure to provide design plans and specifications for several systems for which it had agreed to provide such plans and specifications, to properly supervise construction of the systems or to provide personnel with the necessary expertise to manage the projects. On February 12, 1998, the Company received a demand for arbitration from Wang Laboratories, Inc. ("Wang"), the successor to I-NET. The demand seeks at least $4.1 million. The Company believes that it has meritorious defenses to Wang's claims and has asserted counterclaims seeking in excess of $2.5 million as a result of I-NET's defaults under the I-NET Agreement. The arbitration proceedings are currently underway. The Company believes that resolution of this matter will not have a material adverse impact on its financial condition. No assurance can be given, however, as to the ultimate resolution of this matter. 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 businesses 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, 1998, the Company has outstanding commitments aggregating approximately $30.6 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. 10. 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. 11. RELATED PARTY TRANSACTIONS During 1996, KMC Telecom had borrowings from Kamine. The proceeds of such loans were used to fund the construction of the network in Huntsville, Alabama, and to fund operating cash flow requirements. These loans were payable on demand and, through April 30, 1996, bore interest at the prime rate. Interest expense charged by Kamine under these loans amounted to $120,000 for the year ended December 31, 1996. Effective May 1, 1996, Kamine elected not to charge interest on these loans. However, for financial reporting purposes, $180,000 of interest expense was imputed on these loans for the period from May 1, 1996 to their repayment on November 12, 1996, and a corresponding credit has been recorded to additional paid-in capital. 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 $488,000, $281,000 and $136,000 of expense for the years ended December 31, 1996, 1997 and 1998, respectively. 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. Effective January 1, 1999, Kamine became an employee of the Company and he is currently paid a salary at the rate of $450,000 per annum for his services as Chairman of the Board. 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 the consumer price index, plus operating expenses. Rent expense recognized under this lease for the years ended December 31, 1996, 1997 and 1998 was $97,000, $207,000 and $217,000, respectively. As of December 31, 1998, the Company has made loans aggregating $760,000, to certain of its executives. Such loans bear interest at a rate of 6% per annum and are included in other assets. KMC Services LLC, a limited liability company wholly-owned by Kamine ("KMC Services"), has entered into a five year agreement with the Company pursuant to which KMC Services will offer to the Company financial and energy services which are related to the Company's business. KMC Services may also offer its services to third parties in jurisdictions in which the Company is not offering telecommunications services; provided that such third parties are not competitors of the Company. Initially, KMC Services will offer a leasing program for equipment physically installed at a customer's premises ("CPE Equipment") for the Company to integrate into its ClearStarSM Advantage program, whereby the Company will be able to offer CPE Equipment for lease or sale to its customers. The equipment will be owned by KMC Services, and the Company will have no liability for the cost of the equipment, the financing related to it or the obligation for any lease charges. Any such sale or lease will be between the Company's customer and KMC Services. The Company will advance to KMC Services each year on a monthly basis, pursuant to an approved annual budget, KMC Services' estimated operating expenses for the year. In exchange, the Company will receive, on a quarterly basis, eighty percent (80%) of the net pre-tax cash flow received by KMC Services (after payment of all costs of KMC Services other than those advanced by the Company). For 1999, the estimated operating expenses of KMC Services are approximately $1.2 million. The Company is not responsible for KMC Services' capital costs or financing costs. The Company will invoice KMC Services for its allocable costs incurred in connection with this program, including such items as sales commissions and administrative support, and recover these costs, together with any amounts advanced to KMC Services for its annual operating costs, from the Company's eighty percent (80%) share of the net pre-tax cash flow received from KMC Services. The Company and KMC Services have mutual rights of audit to insure proper allocation of costs and accounting. If at any time Mr. Kamine, including his immediate family, and Nassau collectively own less than twenty percent (20%) of the Company, the Company has the right to cancel this agreement; subject to either a buyout of the Company's customer portfolio from KMC Services or the assumption or guarantee by the Company of eighty percent (80%) of the outstanding financing relating to the equipment previously purchased by KMC Services. 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. The Company has agreed to use its best efforts to utilize the Citation III fifty hours per quarter during 1999. 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 and 1998 Nassau received $100,000 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 1999. 12. NET LOSS PER COMMON SHARE The following table sets forth the computation of net loss per common share:
1996 1997 1998 -------------------------------------------------------- (in thousands) Numerator: Net loss................................ $(4,495) $(32,686) $(76,753) Dividends and accretion on redeemable preferred stock........................ - (8,904) (18,285) -------------------------------------------------------- Numerator for net loss per common share $(4,495) $(41,590) $(95,038) ======================================================== Denominator: Denominator for net loss per common share - weighted average number of common shares outstanding.............. 600 641 831 ======================================================== Net loss per common share............... $ ( 7.49) $(64.93) $(114.42) ========================================================
Options and warrants to purchase an aggregate of 242,768 and 372,885 shares of common stock were outstanding as of December 31, 1997 and 1998, 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. 13. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES Information with respect to noncash investing and financing activities is as follows: In 1996, Kamine contributed a loan and related imputed interest totaling $2,267,000 to equity. In 1997, the Convertible Notes, including accrued interest, aggregating approximately $12,380,000 were converted into 123,800 shares of Series A Cumulative Convertible Preferred Stock of KMC Telecom. In 1997, warrants with a fair value of $1.5 million were granted to Newcourt Capital and warrants with a fair value of $525,000 were granted to GECC. In connection with the Senior Discounts Notes, the Company recognized noncash interest expense of $29.6 million in 1998. In connection with options granted to employees under the KMC Telecom Stock Option Plan in 1996 and 1997, and under the KMC Holdings Stock Option Plan in 1998, cumulative deferred compensation obligations of $1,283,000, $15,579,000 and $27,906,000 have been established in 1996, 1997 and 1998, respectively, with offsetting credits to additional paid-in capital. Noncash compensation expense of $44,000, $9,014,000 and $23,758,000 in 1996, 1997 and 1998, respectively, was recognized in connection with such options. In connection with options granted to individuals employed by certain affiliates of the Company in 1996, 1997 and 1998, the Company recognized noncash compensation expense of $196,000, $4,856,000 and $4,668,000, 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. 14. 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 values 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. The carrying amounts and estimated fair values of the Company's financial instruments are as follows (in millions):
1997 1998 --------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------------------------------------------------- Cash and cash equivalents...................... $15.6 $ 15.6 $ 21.1 $ 21.1 Investments held for future capital expenditures - - 27.9 27.9 Long-term debt: Floating rate................................ 61.3 61.3 41.4 41.4 Fixed rate................................... - - 267.8 249.6 Redeemable equity instruments: Series A Preferred Stock..................... 18.9 28.4 30.4 38.9 Series C Preferred Stock..................... 14.7 13.5 21.6 21.6 Series D Preferred Stock..................... 2.4 2.3 - - Redeemable common stock...................... 11.2 6.3 22.3 14.5 Redeemable common stock warrants............. .5 .5 .7 .7
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 the years ended December 31, 1997 and 1998. The Company maintains interconnection agreements with 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. The Regional Bell Operating Companies have advised competitive local exchange carriers, such as the Company, that they do not consider calls in the same local calling area which are placed by their customers to competitive local exchange carrier customers which are Internet service providers to be local calls under the interconnection agreements. The Regional Bell Operating Companies claim that these calls are exchange access calls, which the Federal Communications Commission exempted from payment of access charges. The Regional Bell Operating Companies claim that, as a result, they do not owe any compensation to competitive local exchange carriers for transporting and terminating these calls. The Regional Bell Operating Companies 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, the Company recognized revenue from these ILECs of approximately $2.9 million, or 12.9% of 1998 revenue, for these services. Payments of approximately $135,000 were received from the ILECs during 1998. Management believes reciprocal compensation for Internet traffic to be an industry-wide matter that will ultimately be resolved on a state-by-state basis. To date, twenty-nine state commissions have ruled on the issue and found that ILECs must pay compensation to competitive carriers for local calls to ISPs located on competitive carriers' networks. A number of other state commissions currently have proceedings pending to consider this matter. The Federal Communications Commission has concluded that calls to ISPs are interstate calls and therefore exempt from local termination charges. However, the Commission also stated that existing interconnection agreements providing for such termination charges must be honored by the ILECs. 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. 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, 1998, no reserves have been considered necessary by management. 15. SUBSEQUENT EVENTS LUCENT 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 $125 million is immediately available to purchase Lucent products and an additional $125 million will become available upon KMC Telecom III's receipt of an additional $35 million of funded equity or qualified intercompany loans, as defined in the agreement. 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. 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. If KMC Telecom III defaults on any payment due under the Lucent Facility, the interest rate will increase by four percentage points. If any other event or default shall occur, the interest rate will be increased by two percentage points. Interest on each LIBOR loan is payable on each LIBOR interest payment date in arrears and interest on each base rate loan is payable quarterly in arrears. KMC Telecom III must pay an annual commitment fee on the unused portion of the Lucent Facility of 1.25%. Loans borrowed under the Lucent Facility amortize in amounts based upon the following percentages of the aggregate amount of the loans drawn under the Lucent Facility: Payment Dates Amortization - - --------------------------------------------- --------------------- May 1, 2002 - February 1, 2003 2.5% per quarter May 1, 2003 - February 1, 2006 5.0% per quarter May 1, 2006 - February 1, 2007 7.5% per quarter KMC Holdings has unconditionally guaranteed the repayment of up to $250.0 million under the Lucent Facility when such repayment is due, whether at maturity, upon acceleration, or otherwise. KMC Telecom III Holdings, Inc., which owns the shares of KMC Telecom III and is wholly-owned by KMC Holdings, 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. 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. The covenants become more restrictive upon the earlier of (i) July 1, 2002 and (ii) after KMC Telecom III achieves positive EBITDA for two consecutive fiscal quarters. Failure to satisfy any of the financial covenants will constitute an event of default under the Lucent Facility, permitting the lenders to terminate the commitment and/or accelerate payment of outstanding indebtedness. The Lucent 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. 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. 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 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. 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. 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 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. Independent Auditors' Report on Schedules 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, 1997 and 1998 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 February 2, 1999 is included elsewhere in this Form 10-K. Our audit also included the financial statement schedules listed in Item 14(a) of this Form 10-K. These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. 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 February 2, 1999 SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT KMC Telecom Holdings, Inc. (Parent Company) Condensed Balance Sheets (in thousands) December 31 --------------------------- 1997 1998 ---- ---- ASSETS Current assets: Cash and cash equivalents...................... $ -- $ 1,221 Amounts due from subsidiaries.................. -- 20,922 Prepaid expenses and other current assets...... -- 332 --------------------------- Total current assets.............................. -- 22,475 Loans receivable from subsidiaries................ 25,148 265,713 Networks and equipment, net....................... -- 4,775 Intangible assets, net............................ 506 625 Deferred financing costs.......................... 732 12,055 Other assets...................................... -- 1,952 --------------------------- $26,386 $307,595 =========================== LIABILITIES, REDEEMABLE AND NONREDEEMABLE EQUITY (deficiency) Current liabilities: Accounts payable.............................. $ -- $ 2,043 Accrued expenses.............................. -- 5,838 --------------------------- Total current liabilities........................ -- 7,881 Senior discount notes payable.................... -- 267,811 Losses of subsidiaries in excess of basis........ 5,408 61,244 --------------------------- Total liabilities................................ 5,408 336,936 Redeemable equity: Redeemable cumulative convertible preferred stock, par value $.01 per share; 599 shares authorized; shares issued and outstanding: Series A, 124 shares in 1997 and 1998 ($12,380 liquidation preference).. 18,879 30,390 Series C, 150 shares in 1997 and 175 shares in 1998 ($17,500 liquidation preference in 1998).. 14,667 21,643 Series D, 25 shares in 1997 and 0 shares in 1998. 2,379 -- Redeemable common stock, shares issued and outstanding, 133 in 1997 and 224 in 1998....... 11,187 22,305 Redeemable common stock warrants................. 539 674 ------------------------ Total redeemable equity............................. 47,651 75,012 Nonredeemable equity (deficiency): Common stock, par value $.01 per share, 3,000 shares authorized, 614 shares issued and outstanding................................... 6 6 Additional paid-in capital....................... 8,853 13,750 Unearned compensation............................ -- (5,824) Accumulated deficit.............................. (35,532) (112,285) -------------------------- Total nonredeemable equity (deficiency)............. (26,673) (104,353) -------------------------- $ 26,386 $307,595 ========================== SEE ACCOMPANYING NOTES. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC Telecom Holdings, Inc. (Parent Company) Condensed Statements of Operations (in thousands) September 22, 1997 Year ended (formation) to December December 31, 31, 1998 1997 ---------------------------- Operating expenses: Selling, general and administrative.................... $ -- $ 19,624 Stock option compensation expense...................... -- 21,190 Depreciation and amortization.......................... -- 1,197 ---------------------------- Total operating expenses.................................. -- 42,011 ---------------------------- Loss from operations...................................... -- (42,011) Intercompany charges...................................... -- 20,922 Interest income........................................... -- 8,575 Interest expense.......................................... -- (23,104) Equity in net loss of subsidiaries........................ (21,860) (41,135) ---------------------------- Net loss.................................................. (21,860) (76,753) Dividends and accretion on redeemable preferred stock..... (8,904) (18,285) ---------------------------- Net loss applicable to common shareholders................ $ (30,764) $(95,038) ============================ SEE ACCOMPANYING NOTES.
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
KMC Telecom Holdings, Inc. (Parent Company) Condensed Statements of Cash Flows (in thousands) September 22, 1997 Year (formation) ended to December December 31, 1997 31, 1998 ---------------------------- OPERATING ACTIVITIES Net loss................................................................. $ (21,860) $ (76,753) Adjustments to reconcile net loss to net cash used in operating activities: Equity in net loss of subsidiaries.................................. 21,860 41,135 Depreciation and amortization....................................... -- 1,197 Non-cash interest expense........................................... -- 23,104 Non-cash stock option compensation expense.......................... -- 21,190 Changes in assets and liabilities: Prepaid expenses and other current assets........................ -- (332) Accounts payable................................................. -- 2,043 Accrued expenses................................................. -- 5,838 Amounts due from subsidiaries.................................... -- (20,922) Other assets..................................................... -- (1,952) ---------------------------- Net cash used in operating activities.................................... -- (5,452) ---------------------------- INVESTING ACTIVITIES Loans receivable from subsidiaries....................................... (24,623) (233,685) Purchases of equipment................................................... -- (5,845) Acquisitions of intangible assets........................................ (506) (166) ---------------------------- Net cash used in investing activities.................................... (25,129) (239,696) ---------------------------- FINANCING ACTIVITIES Proceeds from issuance of common stock and warrants, net of issuance costs 9,363 20,446 Proceeds from issuance of preferred stock, net of issuance costs......... 16,498 -- Proceeds from issuance of senior discount notes, net of issuance costs... (732) 225,923 ---------------------------- Net cash provided by financing activities................................ 25,129 246,369 ---------------------------- Net increase in cash and cash equivalents................................ -- 1,221 Cash and cash equivalents, beginning of year............................. -- -- ---------------------------- Cash and cash equivalents, end of year................................... $ -- $ 1,221 ============================ SEE ACCOMPANYING NOTES.
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT KMC Telecom Holdings, Inc. (Parent Company) Notes to Financial Statements December 31, 1998 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, an aggregate of $20.9 million was due from the subsidiaries for such costs and is included in the accompanying condensed balance sheet at December 31, 1998 as a current receivable. Such reimbursements are permitted under the debt agreements of the Company's subsidiaries. 2. GUARANTEE On December 22, 1998, KMC Telecom, KMC Telecom II and KMC Telecom of Virginia, Inc. (the "Borrowers"), entered into a Loan and Security Agreement (the "Senior Secured Credit Facility") with AT&T Commercial Finance Corporation, First Union National Bank, General Electric Capital Corporation and Canadian Imperial Bank of Commerce (the "Lenders"). 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 Borrowers to the Lenders to collateralize its obligations under the guaranty. In addition, the Borrowers have pledged all of their assets to the Lenders. 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 the assets of the Borrowers, and the holders of the Senior Discount Notes would have no right to share in such assets. At December 31, 1998, an aggregate of $41.4 million was outstanding under this facility. Additionally, the Senior Secured Credit Facility restricts the ability of the 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 meet its cash requirements, including its ability to repay the Senior Discount Notes. At December 31, 1998, an aggregate of $265.7 million has been loaned by the Company to the Borrowers to be used for the construction and expansion of fiber optic telecommunications networks and for working capital and general corporate purposes. 3. SENIOR DISCOUNT NOTES On January 29, 1998, the Company sold 460,800 units, each 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 the Company 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, the Company consummated an offer to exchange SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT 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 the Company and senior in right of payment to all existing and future subordinated indebtedness of the Company. However, the Company 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 Notes restrict, 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. REDEEMABLE EQUITY 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, Harold N. Kamine, Nassau Capital Partners L.P. and NAS Partners I L.L.C. (collectively referred to as "Nassau"), AT&T Credit Corporation ("AT&T Credit"), General Electric Capital Corporation ("GECC"), and CoreStates Bank, N.A. ("CoreStates"), (the "Stockholders' Agreement"), each of Nassau, CoreStates, AT&T Credit and GECC has a "put right" entitling it to have the Company repurchase its preferred and common shares for the fair market value of such shares if no Liquidity Event (defined as (i) an initial public offering with gross proceeds of at least $40.0 million, (ii) the sale of substantially all of the stock or assets of the Company or (iii) the merger or consolidation of the Company with one or more other corporations) has taken place by the later of (x) October 22, 2003 or (y) 90 days after the final maturity date of the Senior Discount Notes (issued in January 1998, with a stated maturity date of February 15, 2008). CoreStates, GECC and AT&T Credit may not exercise such put rights unless Nassau has exercised its put right. The restrictive covenants of the Senior Discount Notes limit the Company's ability to repurchase such shares. All of the shares of preferred and common stock subject to such "put right" are presented as redeemable equity in the accompanying condensed balance sheets at December 31, 1997 and 1998. The redeemable preferred stock, redeemable common stock and redeemable common stock warrants (described below) are being accreted up to their fair market values from their respective issuance dates to their earliest potential redemption date (October 22, 2003). At December 31, 1998, the aggregate redemption value of the redeemable equity was approximately $152 million, reflecting per share redemption amounts of $630 for the Series A Preferred Stock, $248 for the Series C Preferred Stock and $130 for the redeemable common stock and redeemable common stock warrants. Warrants to purchase 10,000 shares of Common Stock were issued to GECC in 1997. These warrants, at an exercise price of $.01 per share, are exercisable from issuance through January 2005. Pursuant to the Stockholders' Agreement, GECC may put the shares of Common Stock issuable upon the exercise of such warrants back to the Company. These warrants have been presented as redeemable common stock warrants in the accompanying condensed balance sheets at December 31, 1997 and 1998. 5. CONTINGENCIES By letter dated August 29, 1997, KMC Telecom notified I-NET, Inc. ("I-NET") that KMC Telecom considered I-NET to be in default under a Master Telecommunications Systems Rollout Agreement dated as of October 1, 1996 (the "I-NET Agreement"), as a result of I-NET's failure to provide design plans and specifications for several systems for which it had agreed to provide such plans and specifications, to properly supervise construction of the systems or to provide SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT personnel with the necessary expertise to manage the projects. On February 12, 1998, the Company received a demand for arbitration from Wang Laboratories, Inc. ("Wang") the successor to I-NET. The demand seeks at least $4.1 million. The Company believes that it has meritorious defenses to Wang's claims and has asserted counterclaims seeking in excess of $2.5 million as a result of I-NET's defaults under the I-NET Agreement. The arbitration proceedings are currently underway. The Company believes that resolution of this matter will not have a material adverse impact on its financial condition. No assurance can be given, however, as to the ultimate resolution of this matter. 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 businesses of incumbent local exchange carriers, competitive local exchange carriers and other participants in the telecommunications industry in general, including the Company. 6. SUBSEQUENT EVENTS LUCENT AGREEMENT KMC Telecom III entered into a Loan and Security Agreement (the "Lucent Facility") dated February 4, 1999 with Lucent Technologies, Inc. ("Lucent") which provided for borrowings up to $600 million (of which $125 million is immediately available) to be used to fund the acquisition of certain telecommunications equipment and related expenses. The Company has unconditionally guaranteed the repayment of up to $250 million under the Lucent Facility when such repayment is due, whether at maturity, upon acceleration, or otherwise. KMC Telecom III Holdings, Inc., which owns the shares of KMC Telecom III and is wholly-owned by 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 the Borrower and the holders of the Senior Discount Notes would have no right to share in such assets. 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 liquidity and ability to meet its cash requirements, including its ability to repay the Senior Discount Notes. 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. 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. 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. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT 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 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.
KMC Telecom Holdings, Inc. SCHEDULE II - Valuation and Qualifying Accounts (in thousands) Additions ---------------------------------- Charged to Balance at Charged to Other Beginning Costs and Accounts - Deductions - Balance at Description of Period Expenses Describe Describe End of Period - - ----------------------------------------- ----------------- ---------------- ----------------- ---------------- ----------------- Year ended December 31, 1996: Allowance for doubtful accounts $ -- $ -- $ -- $ -- $-- ================= ================ ================= ================ ================= 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 ================= ================ ================= ================ =================
(1) Uncollectible accounts written-off. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The following table sets forth certain information with respect to the persons who are members of the Board of Directors or are executive officers of the Company as of March 24, 1999. Name Age Position ---- --- -------- Harold N. Kamine...... 42 Chairman of the Board of Directors Gary E. Lasher........ 63 Vice Chairman of the Board of Directors Michael A. Sternberg.. 54 President, Chief Executive Officer and Director Roscoe C. Young II... 48 Chief Operating Officer James D. Grenfell..... 47 Executive Vice President, Chief Financial Officer and Secretary Charles Rosenblum..... 48 Senior Vice President - Human Resources James L. Barwick...... 66 Senior Vice President - Technology Tricia Breckenridge... 52 Senior Vice President - Business Development John G. Quigley....... 45 Director Richard H. Patterson.. 40 Director Randall A. Hack....... 51 Director William H. Stewart.... 32 Director The business experience of each of the directors and executive officers of the Company is as follows: HAROLD N. KAMINE is the Chairman of the Board of the Company and its founder and has been a director of the Company since 1994. He is also chief executive officer and sole owner of Kamine Development Corp. and associated companies in the independent power industry. Mr. Kamine has successfully financed a number of unregulated non-utility power generation projects. Companies owned by Mr. Kamine owned substantial interests in and managed six power generation plants in the Northeastern United States. Mr. Kamine devotes approximately eighty percent of his time to the affairs of the Company. Mr. Kamine and Mr. Rosenblum are first cousins. GARY E. LASHER joined the Company as its Vice Chairman of the Board effective November 1, 1997. He was the founder, Chief Executive Officer and President of Eastern TeleLogic Corporation ("ETC") from 1987 to 1997. ETC was a leading competitive local exchange carrier operating in greater Philadelphia, Delaware and southern New Jersey before its purchase by TCG (Teleport Communications Group) in October 1996. Prior to ETC, from 1984-1986, Mr. Lasher was Chief Operating Officer of Private Satellite Network, a company which built and operated video satellite networks for major corporations. Mr. Lasher spent 20 years with Continental Telephone ("Contel") holding various positions including Corporate Vice President, President of the International Engineering and Construction Company, and various senior positions with Contel's regulated subsidiaries. Mr. Lasher is one of the founding members of the Association for Local Telecommunications Services ("ALTS") and served for three years as Chairman of the Association. MICHAEL A. STERNBERG has spent 29 years in telecommunications, including business development, marketing, sales and general management. Prior to joining the Company in July 1996 as President and Chief Executive Officer, Mr. Sternberg was a co-founder and Chief Operating Officer, from April 1991 to July 1996, of RimSat, a privately owned satellite company which from January 1993 to July 1996 owned and operated two Russian-built satellites which provided television, voice and data capacity to Asian operators. From March 1990 to April 1991, Mr. Sternberg served as Chief Executive Officer of Sternberg & Associates, Inc., a company he founded. From 1988 to 1990, Mr. Sternberg served as Senior Vice President-Marketing and Sales with MFS Communications. Previously, Mr. Sternberg had served as President of Stantel Telecommunications, a division of STC, a digital telecommunications transmissions products company based in Falls Church, Virginia; Senior Vice President-Marketing and Corporate Development at CIT-Alcatel in Reston, Virginia; Vice President-Marketing at General Dynamics Communications Company in St. Louis; Executive Vice President-Marketing and Sales of OKI Electronics of America in Fort Lauderdale; and Chief Operating Officer of National Telephone Company in Hartford, Connecticut. He has served as a director of the Company since August 1996. Mr. Sternberg is a member of the Executive Committee of ALTS. ROSCOE C. YOUNG II has approximately 20 years experience in the field of telecommunications with both new venture and Fortune 500 companies. Prior to joining the Company in November 1996, Mr. Young served as Vice President, Network Component Services for Ameritech Corporation from June 1994 to October 1996. From March 1988 to June 1994, Mr. Young served as Senior Vice President, Network Services for MFS Communications. From October 1977 to March 1988, Mr. Young served in a number of senior operations, sales and marketing, engineering, financial management, and human resource positions for AT&T Corp. JAMES D. GRENFELL has over 20 years experience in the telecommunications industry. He joined the Company as its Executive Vice President, Chief Financial Officer and Secretary in March 1999. From August 1998 to March 1999 he was an independent consultant. Previously, he served as Executive Vice President and Chief Financial Officer of ICG Communications, Inc., a competitive local exchange carrier headquartered in Denver, Colorado from November 1995 to July 1998. Prior to joining ICG, Mr. Grenfell served as Director of Financial Planning for BellSouth Corporation and Vice President and Assistant Treasurer of BellSouth Capital Funding. He was with BellSouth from 1985 through November 1995, serving previously as Finance Manager of Mergers and Acquisitions. Prior to BellSouth, Mr. Grenfell spent two years as a Project Manager with Utility Financial Services and six years with GTE of the South, a subsidiary of GTE Corporation, including four years as Assistant Treasurer. Mr. Grenfell is a Chartered Financial Analyst. CHARLES ROSENBLUM has over 20 years experience in human resources, primarily in human resources planning, staffing and development. He joined the Company in January 1997. From May 1995 to January 1997 he served as Vice President-Human Resources of Kamine Development Corp. Previously he had held the positions of Director, Management Development with KPMG Peat Marwick and Manager of Management Education with Dun & Bradstreet Corporation. Earlier he had served in various human resource positions with Allstate Insurance Company. Mr. Rosenblum and Mr. Kamine are first cousins. JAMES L. BARWICK has 39 years of experience in the telecommunications industry. Mr. Barwick joined the Company in March 1997. Prior to joining the Company, Mr. Barwick had been self-employed since 1986 as a telecommunications consultant with expertise in equipment application engineering, radio path engineering, analog and digital Mux, switching and transport systems in the long distance carrier and incumbent local exchange carrier areas, technical writing, project management and computer assisted design systems. TRICIA BRECKENRIDGE joined the Company in April 1995. From January 1993 to April 1995 she was Vice President and General Manager of FiberNet USA's Huntsville, Alabama operations. Previously she had served as Vice President, External Affairs and later Vice President, Sales and Marketing of Diginet, Inc. She was co-founder of Chicago Fiber Optic Corporation, the predecessor of Metropolitan Fiber Systems. Earlier she was Director of Regulatory Affairs for Telesphere Corporation. JOHN G. QUIGLEY has served as a director of the Company since August 1996. Mr. Quigley is a founding member of Nassau Capital L.L.C., which is the general partner of Nassau Capital Partners. Between 1980 and the formation of Nassau Capital in 1995, Mr. Quigley was an attorney with the law firm of Kirkland & Ellis in Chicago; a partner at Adler & Shaykin; and a partner at Clipper Capital Partners. RICHARD H. PATTERSON has served as a director of the Company since May 1997. From May 1986 to January 1999, Mr. Patterson served as a Partner of Waller Capital Corporation, a media and communications investment banking firm. Since August 1997, he has served as a Vice President of Waller-Sutton Media LLC and Vice President of Waller-Sutton Management Group, Inc., two entities which manage a media and telecommunications private equity fund. Mr. Patterson is a member of the Board of Directors of Regent Communications, Inc., which owns and operates radio stations in mid-to-small size markets. RANDALL A. HACK has served as a director of the Company since August 1996. Since January 1995, Mr. Hack has been a member of Nassau Capital L.L.C., an investment management firm. From 1990 to 1994, he was the President and Chief Executive Officer of Princeton University Investment Company, which manages the endowment for Princeton University. Mr. Hack also serves on the Boards of Directors of Sweetwater, Inc., OmniCell Technologies, Inc., Castle Tower Holding Corp., Mezzanine Capital Property Investors, Inc. and Shape Global Technologies, Inc. WILLIAM H. STEWART has served as a director of the Company since August 1997. Mr. Stewart is Managing Director of Nassau Capital L.L.C. and joined that firm in June 1995. From 1989 until joining Nassau, Mr. Stewart was a portfolio manager and equity analyst at the Bank of New York. Mr. Stewart also serves on the board of Signius Corporation. He is a Chartered Financial Analyst and a member of the New York Society of Security Analysts. Pursuant to provisions contained in both the Company's certificate of incorporation and an 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 Communications Finance Corporation (then known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc., Mr. Kamine and the Nassau entities are currently entitled to elect all of the Directors, three of whom are nominated by Mr. Kamine (one of whom must be the President and Chief Executive Officer), three of whom are nominated by Nassau and one of whom is nominated by agreement of Mr. Kamine, Nassau and either Newcourt Communications Finance Corporation or the holders of a majority of the outstanding shares of the Company's Series C Cumulative Convertible Preferred Stock. The number of Directors which Mr. Kamine is entitled to elect would be reduced to two if the number of shares owned by him were to fall below two-thirds of the number of shares of the Company initially issued to him, and to one if the number of shares owned by him were to fall below one-third of the number of shares initially issued to him. If his ownership were to fall below 5% of the number of shares initially issued to him, Mr. Kamine would no longer be entitled to elect any Directors pursuant to such provisions. Comparable reductions would be made to the number of Directors which Nassau is entitled to elect if its ownership were to fall below the specified fractions. If a default relating to payment occurs under our Senior Secured Credit Facility, and continues uncured for 90 days, the holders of Series C Cumulative Convertible Preferred Stock (currently Nassau, General Electric Capital Corporation and CoreStates) will be entitled to elect two additional Directors, who will serve until the default is cured. Kamine/Besicorp Allegany L.P., an independent power company 50% owned by corporations which Mr. Kamine owns, filed a voluntary petition to reorganize its business under Chapter 11 of the Federal Bankruptcy Code in November 1995. In October 1998, the bankruptcy court confirmed a plan of liquidation for this entity. The United States Bankruptcy Court for the Northern District of Indiana appointed a receiver for RimSat, a company which Mr. Sternberg co-founded and for which he formerly served as Chief Operating Officer, and a petition for bankruptcy under Chapter 11 of the Federal Bankruptcy Code with respect to RimSat was filed in 1996. That proceeding is ongoing. Directors hold office until the next Annual Meeting of stockholders or until their successors are duly elected and qualified. Executive officers are elected annually by the Board of Directors and serve at the discretion of the Board of Directors. COMMITTEES OF THE BOARD The Board of Directors of the Company has authorized a Compensation Committee to be composed of three members. The present members of the Compensation Committee are Messrs. Kamine, Quigley and Patterson. The Board of Directors has created an Executive Committee consisting of Mr. Kamine and Mr. Quigley, or, in Mr. Quigley's absence, Mr. Stewart. The Board of Directors has also created an Audit Committee consisting of Messrs. Lasher, Patterson and Quigley. Item 11. EXECUTIVE COMPENSATION. SUMMARY COMPENSATION TABLE The following table sets forth information concerning compensation for services in all capacities awarded to, earned by, or paid to, any person acting as the Company's Chief Executive Officer during 1998, regardless of the amount of compensation paid, and the other four most highly compensated executive officers of the Company whose aggregate cash and cash equivalent compensation exceeded $100,000 during the fiscal year ended December 31, 1998 (collectively, the "Named Executive Officers"):
Annual Compensation Long Term Compensation ------------------------------------------------------ ------------ Other Annual Securities Compensation Underlying Name and Position Year Salary ($) Bonus ($) ($)(1) Options (#)(2) - - ----------------- ---- ---------- --------- ------ -------------- Michael A. Sternberg .............. 1998 $275,000 $407,500 - 65,000 President and Chief Executive 1997 $240,385 $187,500 $45,909 9,228 Officer Roscoe C. Young II................ 1998 $218,270 $497,500 $52,189 32,500 Chief Operating Officer 1997 $180,000 $182,046 $198,180 2,309 Cynthia Worthman(3)................ 1998 $200,000 $187,500 - 32,500 Vice President, Chief Financial 1997 $175,000 $200,000 - 3,461 Officer, Secretary and Treasurer Charles Rosenblum.................. 1998 $168,270 $96,750 - 5,000 Senior Vice President - Human 1997 $150,000 $77,500 - 691 Resources Tricia Breckenridge................ 1998 $155,577 $75,000 - 5,000 Senior Vice President - 1997 $104,138 $49,000 - 691 Business Development
- - ----------------------- (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 $47,344 and personal use of a Company automobile of $6,919 for 1998, and relocation related expenses of $196,029 and personal use of a Company automobile of $2,151 for 1997. The aggregate value of the perquisites and other personal benefits, if any, received by Mr. Sternberg in 1998 and by each of Ms. Worthman, Mr. Rosenblum and Ms. Breckenridge in 1998 and 1997 have not been reflected in this table because the amount was below the Securities and Exchange Commission'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 Common Stock of the Company. See "Stock Option Grants." All options granted during 1998 are options to purchase shares of Common Stock of the Company. (3) Ms. Worthman served in the capacities indicated throughout the year ended December 31, 1998. James D. Grenfell became Executive Vice President, Chief Financial Officer and Secretary in March, 1999. STOCK OPTION GRANTS The Company was formed as a holding company in September 1997. Prior to the establishment of the present holding company structure, during 1996 and 1997, KMC Telecom Inc. (now one of the Company's principal operating subsidiaries) granted options to purchase shares of its common stock, par value $.01 per share, to employees, including the Named Executive Officers, and selected employees of certain affiliated companies owned by Mr. Kamine pursuant to the KMC Telecom Stock Option Plan. In order to reflect the establishment of the Company's holding company structure, on June 26, 1998, the Board of Directors of the Company adopted, effective upon stockholder approval, a new stock option plan, the KMC Holdings Stock Option Plan, which authorizes the grant of options to purchase Common Stock of the Company. During the third quarter of 1998, the Company replaced the options to purchase shares of KMC Telecom Inc. Common Stock previously granted under the KMC Telecom Stock Option Plan (including all options shown as granted during 1997 in the preceding table) with options to purchase shares of Common Stock of the Company granted under the KMC Holdings Stock Option Plan and granted options to additional employees of the Company, including Mr. Lasher, under the KMC Holdings Stock Option Plan. The Company may subsequently grant additional options, although it has no specific plans in this regard. The following table sets forth information regarding grants of options to purchase shares of Common Stock made by the Company during 1998 to each of the Named Executive Officers.
Option Grants in Fiscal Year 1998 Individual Grants --------------------------------------------------------- Percent of Number of Total Potential Realizable Value At Securities Options Assumed Annual Rates of Stock Underlying Granted to Market Price Price Appreciation For Options Employees Exercise or Of Common Option Term(3) Granted In Fiscal Base Price Stock on Date Expiration ------------------------------------------ Name (#)(1) 1998 ($/Share) Of Grant (2) Date (0%) (5%) (10%) - - ---- ------ ---- --------- ------------ ---- ---- ---- ----- Michael A. Sternberg ..... 39,000 $20.00 $130 9/30/08 $4,290,000 $7,478,496 $12,370,274 13,000 24.8% $30.00 $130 9/30/08 $1,300,000 $2,362,832 $ 3,993,425 13,000 $40.00 $130 9/30/08 $1,170,000 $2,232,832 $ 3,863,425 Roscoe C. Young II....... 19,500 $20.00 $130 9/30/08 $2,145,000 $3,739,248 $ 6,185,137 6,500 12.4% $30.00 $130 9/30/08 $ 650,000 $1,181,416 $ 1,996,712 6,500 $40.00 $130 9/30/08 $ 585,000 $1,116,416 $ 1,931,712 Cynthia Worthman.......... 19,500 $20.00 $130 9/30/08 $2,145,000 $3,739,248 $ 6,185,137 6,500 12.4% $30.00 $130 9/30/08 $ 650,000 $1,181,416 $ 1,996,712 6,500 $40.00 $130 9/30/08 $ 585,000 $1,116,416 $ 1,931,712 Charles Rosenblum......... 3,000 $20.00 $130 9/30/08 $ 330,000 $ 575,269 $ 951,560 1,000 1.9% $30.00 $130 9/30/08 $ 100,000 $ 181,756 $ 307,187 1,000 $40.00 $130 9/30/08 $ 90,000 $ 171,756 $ 297,187 Tricia Breckenridge....... 3,000 $20.00 $130 9/30/08 $ 330,000 $ 575,269 $ 951,560 1,000 1.9% $30.00 $130 9/30/08 $ 100,000 $ 181,756 $ 307,187 1,000 $40.00 $130 9/30/08 $ 90,000 $ 171,756 $ 297,187
- - ----------- (1) 10% of the aggregate amount of each such option vests on each subsequent six-month anniversary of the date of grant with options with the lowest exercise price vesting first followed by others in ascending order of exercise price. For purposes of vesting, options granted in 1998 under the KMC Holdings Stock Option Plan to replace options granted in 1996 or 1997 under the KMC Telecom Stock Option Plan are deemed to have been granted on the date of grant of the options which they replace. (2) There is no active trading market for the Company's Common Stock. The market price shown is based upon management's estimate of the fair value of the Company's Common Stock on the date in September 1998 when these options were granted under the new KMC Holdings Stock Option Plan. The grant prices were based on the grant prices of the options previously granted in 1996 and 1997 under the KMC Telecom Stock Option plan which were cancelled and replaced by the options reflected in this table. The grant prices of the options granted in 1996 and 1997 had been based on the fair value of the shares of KMC Telecom common stock on the respective dates of their grants. (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 Common Stock over the term of the options. These assumptions are based on rules promulgated by the Securities and Exchange Commission and do not reflect the Company's 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 the 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. OPTION EXERCISES AND OPTION YEAR-END VALUE TABLE No options were exercised during 1998 by any of the Named Executive Officers. 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, 1998 by each of the Named Executive Officers.
Fiscal 1998 Year-End Option Values Number of Securities Value of Unexercised Underlying Unexercised "In-the-Money" Shares Value Options at Options at Acquired On Realized December 31, 1998 December 31, 1998 Name Exercise(#) ($) Exercisable/Unexercisable Exercisable/Unexercisable(1) ---- ----------- --- ------------------------- ---------------------------- Michael A. Sternberg -- -- 32,500/32,500 $3,575,000/$3,185,000 Roscoe C. Young II -- -- 16,250/16,250 $1,787,500/$1,592,500 Cynthia Worthman -- -- 16,250/16,250 $1,787,500/$1,592,500 Charles Rosenblum -- -- 3,500/1,500 $380,000/$140,000 Tricia Breckenridge -- -- 3,500/1,500 $380,000/$140,000
- - ----------- (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 the Company's Common Stock. The fair market value of the option grants at December 31, 1998 was determined on the basis of management's estimate of the fair value of the Company's Common Stock on that date. DIRECTOR COMPENSATION The Company's Directors do not currently receive any compensation for their services in such capacity, except that Mr. Lasher receives $40,000 per year in connection with his services as Vice Chairman of the Board and Mr. Patterson receives $25,000 per year in connection with his services as a Director. EXECUTIVE EMPLOYMENT CONTRACTS The Company has an employment contract with Harold N. Kamine, the Chairman of its Board of Directors. The Company's employment agreement with Mr. Kamine provides for a term of four years, effective as of January 1, 1999. Under the agreement, Mr. Kamine's base salary is $450,000 per annum, and Mr. Kamine is required to devote at least fifty percent of his time and attention to the performance of his duties under the agreement. Mr. Kamine is entitled to receive benefits generally received by senior executives of the Company, including reimbursement of expenses incurred on behalf of the Company, 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 the Company's breach of the agreement, he, or his estate, is entitled to a severance payment in an amount equal to the lesser of (i) two times his annual base salary and (ii) 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. The Company has an employment contract with Michael A. Sternberg, its President and Chief Executive Officer. The Company's employment agreement with Mr. Sternberg provides for a term of four years, effective as of January 1, 1999. Under the agreement, Mr. Sternberg'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 Company's Board of Directors. Mr. Sternberg is entitled to receive benefits generally received by Company officers, including options to purchase Company stock, reimbursement of expenses incurred on behalf of the Company, and a leased automobile. Upon termination of the agreement, Mr. Sternberg is subject to a confidentiality covenant and a twenty-four month non-competition agreement. If the Company terminates Mr. Sternberg's employment without cause, he is entitled to a severance payment in an amount equal to the lesser of (i) two times his annual base salary and (ii) 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. The Company has an employment contract with Roscoe C. Young, II, its Executive Vice President and Chief Operating Officer. The Company's employment agreement with Mr. Young provides for a term of four years, effective as of January 1, 1999. Under the agreement, Mr. Young's base salary is $450,000 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 Company's Board of Directors. Mr. Young is entitled to receive benefits generally received by Company officers, including options to purchase Company Stock, reimbursement of expenses incurred on behalf of the Company, and a leased automobile. Upon termination of the agreement, Mr. Young is subject to a confidentiality covenant and a twenty-four month non-competition agreement. If the Company terminates Mr. Young's employment without cause, he is entitled to a severance payment in an amount equal to the lesser of (i) two times his annual base salary and (ii) 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. EMPLOYEE PLANS KMC HOLDINGS STOCK OPTION PLAN. Employees, directors or other persons having a unique relationship with the Company or any of its affiliates are eligible to participate in the KMC Holdings Stock Option Plan. However, neither Mr. Kamine nor any person employed by Nassau or any affiliate of Nassau is eligible for grants under the plan. The KMC Holdings Stock Option Plan is administered by the Compensation Committee of the Board of Directors of the Company. The Compensation Committee is authorized to grant (i) options intended to qualify as Incentive Options, (ii) Non-Qualified Options, (iii) stock appreciation rights, (iv) restricted stock, (v) performance units, (vi) performance shares and (vii) certain other types of awards. The number of shares of Company Common Stock available for grant under the KMC Holdings Stock Option Plan is 262,750. No participant may receive more than 75,000 shares of Company Common Stock under the KMC Holdings Stock Option Plan. The Compensation Committee has the power and authority to designate recipients of grants under the KMC Holdings Stock Option Plan, to determine the terms, conditions and limitations of grants under the plan and to interpret the provisions of the plan. The exercise price of all Incentive Options granted under the KMC Holdings Stock Option Plan must be at least equal to the Fair Market Value (as defined in the plan) of Company Common Stock on the date the options are granted and the exercise price of all Nonqualified Options granted under the KMC Holdings Stock Option Plan must be at least equal to 50% of the Fair Market Value of Company Common Stock on the date the options are granted. The maximum term of each Option granted under the KMC Holdings Stock Option Plan will be 10 years. Options will become exercisable at such times and in such installments as the Compensation Committee provides in the terms of each individual Option. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Mr. Kamine, the Chairman of the Board of the Company, and Mr. John G. Quigley, a Director of the Company, served as members of the Compensation Committee of the Board of Directors during 1998. Mr. Quigley is also a member of Nassau Capital Partners L.P. which, through its affiliates, beneficially owns more than five percent (5%) of the Company's voting securities. The Company and certain affiliated companies owned by Mr. 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. These shared services do not include the rent paid by the Company for its headquarters offices to an affiliate of Mr. Kamine under the lease described in the next succeeding paragraph. The Company reimbursed Kamine-affiliated companies for these shared services an aggregate of approximately $136,000, for 1998. From May 1, 1996 through January 29, 1998, Kamine Development Corp., an affiliate of the Company, was paid a fee at an annual rate of $266,000 as reimbursement for the services of Mr. Kamine as Chairman of the Board of the Company. The amount of this fee was reduced to $100,000 per annum as of January 29, 1998 and it was terminated effective December 31, 1998. The amount of the fee paid in 1998 is included in the shared services payment described in the first paragraph above. Effective January 1, 1999, Mr. Kamine became an employee of the Company and he is currently paid a salary at the rate of $450,000 per annum for his services as Chairman of the Board. Effective June 1, 1996, the Company entered into a lease agreement with Kamine Development Corp. (an entity controlled by Mr. Kamine) pursuant to which the Company leases its headquarters office in Bedminster, New Jersey. The lease expires in January 2007. The lease provides for a base annual rental of approximately $217,000 (adjusted periodically for changes in the consumer price index), plus operating expenses. KMC Services LLC, a limited liability company wholly owned by Mr. Kamine, has entered into a five year agreement with the Company pursuant to which KMC Services LLC will offer to the Company financial and energy services which are related to the Company's business. KMC Services LLC may also offer its services to third parties in jurisdictions in which the Company is not offering telecommunications services; provided that such third parties are not competitors of the Company. Initially, KMC Services LLC will offer a leasing program for equipment physically installed at a customer's premises, known as CPE Equipment, for the Company to integrate into its ClearStarsm Advantage program, whereby the Company will be able to offer CPE Equipment for lease or sale to its customers. The equipment will be owned by KMC Services LLC and the Company will have no liability for the cost of the equipment, the financing related to it or the obligation for any lease charges. Any such sale or lease will be between the Company's customer and KMC Services LLC. The Company will advance to KMC Services LLC each year on a monthly basis, pursuant to an approved annual budget, KMC Services LLC's estimated operating expenses for the year. In exchange, the Company will receive, on a quarterly basis, eighty percent (80%) of the net pre-tax cash flow received by KMC Services LLC (after payment of all costs of KMC Services LLC other than those advanced by the Company). For 1999 the estimated operating expenses of KMC Services LLC are approximately $1.2 million. The Company is not responsible for KMC Services LLC's capital costs or financing costs. The Company will invoice KMC Services LLC for its allocable costs incurred in connection with this program, including such items as sales commissions and administrative support, and recover these costs, together with any amounts advanced to KMC Services LLC for its annual operating costs, from the Company's eighty percent (80%) share of the net pre-tax cash flow received from KMC Services LLC. The Company and KMC Services LLC have mutual rights of audit to insure proper allocation of costs and accounting. If at any time Mr. Kamine, including his immediate family, and Nassau collectively own less than twenty percent (20%) of the Company, the Company has the right to cancel this agreement; subject to either a buyout of the Company's customer portfolio from KMC Services LLC or the assumption or guarantee by the Company of eighty percent (80%) of the outstanding financing relating to the equipment previously purchased by KMC Services LLC. Pursuant to an agreement dated as of 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 Mr. Kamine, for a fixed price of $2,600 per hour of flight time. The Citation III will enable up to eight employees, guests or representatives of the Company to utilize local airfields and visit multiple cities in which the Company either has an operating system or is building a system, without the necessity of returning to commercial hubs such as Atlanta or St. Louis. The Company has agreed to use its best efforts to utilize the Citation III fifty hours per quarter during 1999. However, 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. Upon closing of its offering of 12 1/2% Senior Discount Notes in January 1998, the Company paid to Nassau approximately $600,000 for dividend arrearages on the Series A Cumulative Convertible Preferred Stock of KMC Telecom, Inc. which Nassau had exchanged for its shares of Series A Cumulative Convertible Preferred Stock of the Company. Pursuant to an Agreement among the Company, Mr. Kamine and Nassau, for 1998 Nassau received $100,000 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 1999. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth certain information regarding the beneficial ownership of the Common Stock, as of March 24, 1999, by (i) each person known to the Company to be the beneficial owner of more than 5% of the Common Stock, (ii) each of the Company's directors, (iii) each of the Named Executive Officers, and (iv) all directors and executive officers as a group. All information with respect to beneficial ownership has been furnished to the Company by the respective stockholders of the Company. Number of Percentage Name and Address of Beneficial Owner Shares (1) Ownership (1) ------------------------------------ ---------- ------------- Harold N. Kamine.............................. 573,835 67.3% c/o Kamine Development Corp. 1545 Route 206 Bedminster, NJ 07921 Nassau Capital Partners L.P................... 661,454(2) 44.1% c/o Nassau Capital L.L.C. 22 Chambers Street Princeton, NJ 08542 Newcourt Capital, Inc......................... 221,515.5(3) 25.4% 2 Gate Hall Drive Parsipany, NJ 07054 CoreStates Holdings, Inc...................... 102,155.5(4) 10.8% 1339 Chestnut St. Philadelphia, PA 19107 General Electric Capital Corporation.......... 200,476(5) 19.0% 120 Long Ridge Road Stamford, CT 06927 Michael A. Sternberg ......................... 32,500(6) 3.7% c/o KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, New Jersey 07921 Gary E. Lasher................................ 4,000(6) 0.5% c/o KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, New Jersey 07921 John G. Quigley............................... 661,454(7) 44.1% c/o Nassau Capital L.L.C. 22 Chambers Street Princeton, NJ 08542 Richard H. Patterson.......................... 1,200(6) 0.1% c/o Waller Capital Corporation 30 Rockefeller Center Suite 4350 New York, NY 10112 Randall A. Hack............................... 661,454(7) 44.1% c/o Nassau Capital L.L.C. 22 Chambers Street Princeton, NJ 08542 William H. Stewart............................ 661,454(8) 44.1% c/o Nassau Capital L.L.C. 22 Chambers Street Princeton, NJ 08542 Roscoe C. Young II........................... 16,250(6) 1.9% c/o KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, NJ 07921 Cynthia Worthman.............................. 16,250(6) 1.9% c/o KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, NJ 07921 Charles Rosenblum............................. 3,500(6) 0.4% c/o KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, NJ 07925 Tricia Breckenridge........................... 3,500(6) 0.4% c/o KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, NJ 07921 Directors and Officers of the Company as a Group (11 persons)...................... 1,313,989(2) 83.2% - - ----------- (1) Beneficial ownership is determined in accordance with the rules of the Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares subject to options, warrants and convertible securities held by that person that are currently exercisable or exercisable within 60 days of March 24, 1999 are deemed outstanding. Such shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as indicated in the footnotes to this table, each shareholder named in the table has sole voting and investment power with respect to the shares set forth opposite such shareholder's name. (2) Includes 600,000 shares of Common Stock which Nassau and NAS Partners I L.L.C., of which Messrs. Quigley, Hack and Stewart are members, have the right to acquire upon conversion of 122,708 and 1,092 shares of Series A Cumulative Convertible Preferred Stock, respectively, and 47,619 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 Cumulative Convertible Preferred Stock, respectively. These are the same shares listed for Messrs. Quigley, Hack and Stewart. (3) Includes 203,288.5 shares of Common Stock held by Newcourt Communications Finance Corporation, a subsidiary of Newcourt Capital, Inc. and 18,227 shares of Common Stock which Newcourt Commercial Finance Corporation, also a subsidiary of Newcourt Capital, Inc., has the right to acquire upon the exercise of warrants. (4) Includes 95,238 shares of Common Stock which CoreStates has the right to acquire upon conversion of 50,000 shares of Series C Cumulative Convertible Preferred Stock of the Company. (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 Cumulative Convertible Preferred Stock of the Company 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 the holder has the right to acquire upon the exercise of options that are exerciseable within sixty days of March 24, 1999 pursuant to the KMC Holdings Stock Option Plan. (7) Messrs. Quigley and Hack, Directors of the Company, are members of Nassau Capital L.L.C., the general partner of Nassau; accordingly Messrs. Quigley and Hack may be deemed to be beneficial owners of such shares and for purposes of this table they are included. Messrs. Quigley and Hack disclaim beneficial ownership of all such shares within the meaning of Rule 13d-3 under the Exchange Act. Messrs. Quigley and Hack are also members of NAS 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. (8) All of the shares indicated as owned by Mr. Stewart are owned directly or indirectly by Nassau and are included because of Mr. Stewart's affiliation with Nassau. Mr. Stewart is also a member of NAS Partners I, L.L.C.; accordingly, Mr. Stewart may be deemed to be the beneficial owner of such shares and for purposes of this table they are included. Mr. Stewart disclaims beneficial ownership of all of these shares within the meaning of Rule 13d-3 under the Exchange Act. STOCKHOLDERS AGREEMENT. The Amended and Restated Stockholders Agreement, dated as of October 31, 1997, restricts the ability of the parties to that agreement to transfer shares in the Company to persons not affiliated with or related to such parties. Pursuant to such Stockholders Agreement and the Company's certificate of incorporation, Mr. Kamine and Nassau are currently entitled to elect all of the Directors, three of whom are nominated by Mr. Kamine (one of whom must be the President and Chief Executive Officer), three of whom are nominated by Nassau and one of whom is nominated by agreement of Mr. Kamine, Nassau and either Newcourt Communications Finance Corporation or the holders of a majority of the outstanding shares of the Company's Series C Cumulative Convertible Preferred Stock. The number of Directors which Mr. Kamine is entitled to elect would be reduced to two if the number of shares owned by him were to fall below two-thirds of the number of shares of the Company initially issued to him, and to one if the number of shares owned by him were to fall below one-third of the number of shares initially issued to him. If his ownership were to fall below 5% of the number of shares initially issued to him, Mr. Kamine would no longer be entitled to elect any Directors pursuant to such provisions. Comparable reductions would be made to the number of Directors which Nassau is entitled to elect if its ownership were to fall below the specified percentages. If a default relating to payment occurs under the Senior Secured Credit Facility, and continues uncured for 90 days, the holders of Series C Cumulative Convertible Preferred Stock (currently Nassau, NAS Partners I, L.L.C., General Electric Capital Corporation and CoreStates) will be entitled to elect two additional Directors, who will serve until the default is cured. Each of Nassau, NAS Partners I, L.L.C, CoreStates, General Electric Capital Corporation and Newcourt Communications Finance Corporation has a "put right" entitling it to have the Company repurchase its shares for the fair market value of such shares if no Liquidity Event (defined as (i) an initial public offering with gross proceeds of at least $40.0 million, (ii) the sale of substantially all of the stock or assets of the Company or (iii) the merger or consolidation of the Company with one or more other corporations) has taken place by the later of (x) October 22, 2003 or (y) 90 days after the final maturity date of the Company's 12 1/2% Senior Discount Notes. CoreStates, General Electric Capital Corporation and Newcourt Communications Finance Corporation may not exercise such put rights unless Nassau has exercised its put right. The indenture applicable to the Company's 12 1/2% Senior Discount Notes and the Company's other indebtedness will limit the Company's ability to repurchase such shares. Certain of the current stockholders have demand registration rights with respect to their shares of Common Stock of the Company commencing on the earlier of June 5, 2000 (in the case of Mr. Kamine or Nassau) and the date on which the Company completes an initial public offering of Common Stock (and any related holdback period expires). Each of the holders of registrable securities also has certain piggyback registration rights. The parties to the Stockholders Agreement have agreed not to effect any public sale or distribution of Common Stock of the Company, or securities convertible into such Common Stock, within 180 days of the effective date of any demand or piggyback registration. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. In February, 1998, the Company loaned to Roscoe C. Young II, the Company's Chief Operating Officer, the principal sum of $350,000. The loan is evidenced by a promissory note which bears interest at the rate of 6% per annum. Interest and principal are payable at maturity on February 13, 2003. In June 1998, the Company loaned Mr. Young an additional $110,000, of which $55,000 was repaid within thirty (30) days. The balance of this loan is evidenced by a promissory note which bears interest at the rate of 6% per annum. It is payable in July 1999. The largest aggregate amount of loans outstanding to Mr. Young at any time during 1998 was $460,000. The aggregate amount of loans outstanding to Mr. Young at March 24, 1999 was $405,000. In March, 1998, the Company made a bridge loan to Tricia Breckenridge in the principal amount of $150,000. Mrs. Breckenridge is Senior Vice President-Business Development of the Company. The loan which bore interest at the rate of 6% per annum, was repaid in full in 1998 and no amount was outstanding at March 24, 1999. Pursuant to agreements entered into in September and October 1997, between the Company and each of the holders of Series A Cumulative Convertible Preferred Stock and Series C Cumulative Convertible Preferred Stock each such holder has agreed to forego the payment of accumulated dividends on its shares of Series A Cumulative Convertible Preferred Stock and Series C Cumulative Convertible Preferred Stock of the Company from the date of such Dividend Agreement through the date on which such holder disposes of its interest in the Company; provided, that, upon such disposition, such holder realizes not less than a ten percent (10%) compound rate of return on its investment for the period from the date of such Dividend Agreement to the date of such disposition. Mr. Kamine, Nassau, Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), CoreStates and General Electric Capital Corpoation are parties to the Stockholders Agreement. Pursuant to the Stockholder's Agreement and the Company's certificate of incorporation, Mr. Kamine and Nassau are currently entitled to elect all of the Company's seven Directors, with each entitled to nominate three Directors, and the seventh to be nominated by agreement of Mr. Kamine, Nassau and either Newcourt Communications Finance Corporation or the holders of a majority of the outstanding shares of the Company's Series C Cumulative Convertible Preferred Stock. The number of Directors which Mr. Kamine is entitled to elect would be reduced to two if the number of shares owned by him were to fall below two-thirds of the number of shares of the Company initially issued to him, and to one if the number of shares owned by him were to fall below one-third of the number of shares initially issued to him. If his ownership were to fall below 5% of the number of shares initially issued to him, Mr. Kamine would no longer be entitled to elect any Directors pursuant to such provisions. Comparable reductions would be made to the number of Directors which Nassau is entitled to elect if its ownership were to fall below the specified fractions. Newcourt Commercial Finance Corporation (an affiliate of Newcourt Capital, Inc. ) has provided financing for the Company as one of the lenders under the Senior Secured Credit Facility. Pursuant to the Senior Secured Credit Facility, the lenders have agreed to make available, subject to certain conditions, up to a total of $250.0 million, for construction and development of the Company's twenty-three existing networks. The Company paid Newcourt Capital and its affiliates an aggregate of $1,717,000 in fees, discounts and commissions during the year ended December 31, 1998. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (A) 1. FINANCIAL STATEMENTS. The financial statements are included in Part II, Item 8. of this Report. 2. FINANCIAL STATEMENT SCHEDULES AND SUPPLEMENTARY INFORMATION REQUIRED TO BE SUBMITTED. Independent Auditors' Report on Schedules Schedule I - Condensed Financial Information of Registrant Schedule II - Valuation and Qualifying Accounts These schedules are included in Part II, Item 8. of this Report. All other schedules have been omitted because they are inapplicable or the required information is shown in the consolidated financial statements or notes. (B) REPORTS ON FORM 8-K. None. (C) INDEX TO EXHIBITS. The following is a list of all Exhibits filed as part of this Report: EXHIBIT NUMBER DESCRIPTION OF DOCUMENT ------ ----------------------- *3.1 Amended and Restated Certificate of Incorporation of KMC Telecom Holdings, Inc. (incorporated herein by reference to Exhibit 3.1 to KMC Telecom Holdings, Inc.'s Registration Statement on Form S-4, dated April 20, 1998, Registration No. 333-50475 ("KMC Holdings' S-4") *3.2 Certificate of Amendment of the Certificate of Incorporation of KMC Telecom Holdings, Inc. (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 **3.4 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. **3.5 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. **3.6 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. **3.7 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 **3.8 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 *3.9 By-Laws of KMC Telecom Holdings, Inc. (incorporated herein by reference to Exhibit 3.6 to KMC Holdings' S-4). *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 Communications 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 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 Communications 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 Communications 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 Communications 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 among KMC Telecom Holdings, Inc., Nassau Capital Partners, L.P., NAS Partners I L.L.C., Harold N. Kamine, Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc. *4.6 Indenture dated as of January 29, 1998 between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank, as Trustee, including specimen of KMC Telecom Holdings, Inc.'s 12 1/2% Senior Discount Note due 2008 (incorporated herein by reference to Exhibit 4.5 to KMC Holdings' S-4). *4.7 Registration Rights Agreement dated 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). *4.8 Warrant Agreement between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank, as Warrant Agent, dated as of January 29, 1998 including a specimen of Warrant Certificate (incorporated herein by reference to Exhibit 4.7 to KMC Holdings' S-4). *4.9 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). *10.1 Purchase Agreement dated January 26, 1998 by and between KMC Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated (incorporated herein by reference to Exhibit 10.1 to KMC Holdings' S-4). **10.2 Loan and Security Agreement dated as of December 22, 1998 among KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom of Virginia, Inc., KMC Telecom Leasing I, LLC, KMC Telecom Leasing II, LLC, the additional subsidiaries from time to time parties thereto, the financial institutions signatory thereto from time to time as "Lenders", First Union National Bank as Administrative Agent for the Lenders and Newcourt Commercial Finance Corporation (formerly known as AT&T Commercial Corporation), as Collateral Agent for the Lenders. **10.3 Amendment No. 1, dated as of March 3, 1999, to Loan and Security Agreement dated as of December 22, 1998, among KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom of Virginia, Inc., KMC Telecom Leasing I, LLC, KMC Telecom Leasing II, LLC, the additional subsidiaries from time to time parties thereto, the financial institutions signatory thereto from time to time as "Lenders", First Union National Bank as Administrative Agent for the Lenders and Newcourt Commercial Finance Corporation (formerly known as AT&T Commercial Corporation), as Collateral Agent for the Lenders. *10.4 General Agreement between 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 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). **10.6 Memorandum of Agreement between KMC Telecom Holdings, Inc. and EFTIA OSS Solutions Inc., dated as of October 26, 1998. **10.7 Master License Agreement dated December 31, 1998 by and between Billing Concepts Systems, Inc. and KMC Telecom Holdings, Inc. **10.8 Lease Agreement dated January 1, 1996 between Cogeneration Services Inc. (now known as Kamine Development Corp.) and KMC Telecom Inc. *10.9 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 fiscal quarter ended September 30, 1998).+ **10.10 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 Affiiliates.+ **21.1 Subsidiaries of KMC Telecom Holdings, Inc. **24.1 Powers of Attorney (Appears on signature page). **27.1 Financial Data Schedule. - - ------------------------ * Incorporated herein by reference. ** Filed herewith. + Management contract or compensatory plan or arrangement. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the Town of Bedminster, State of New Jersey, on the 31st day of March, 1999. KMC TELECOM HOLDINGS, INC. By: /s/ MICHAEL A. STERNBERG --------------------------------------- Michael A. Sternberg President and Chief Executive Officer KNOW BY ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Michael A. Sternberg and James D. Grenfell his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent or their or his substitutes or substitute, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 31st day of March, 1999. Signature Title(s) --------- -------- President, Chief Executive Officer /s/ MICHAEL A. STERNBERG and Director (Principal Executive - - ---------------------------------- Officer) Michael A. Sternberg Executive Vice President, Chief /s/ JAMES D. GRENFELL Financial Officer (Principal - - ---------------------------------- Financial Officer) James D. Grenfell /s/ ROBERT F. HAGAN Vice President, Controller - - ---------------------------------- (Principal Accounting Officer) Robert F. Hagan /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/ RICHARD H. PATTERSON - - --------------------------------- Director Richard H. Patterson /s/ RANDALL A. HACK Director - - --------------------------------- Randall A. Hack /s/ WILLIAM H. STEWART Director - - --------------------------------- William H. Stewart INDEX OF EXHIBITS Exhibit Number Description - - ------ ----------- *3.1 Amended and Restated Certificate of Incorporation of KMC Telecom Holdings, Inc. *3.2 Certificate of Amendment of the Certificate of Incorporation of KMC Telecom Holdings, Inc. 3.3 Certificate of Amendment of the Certificate of Incorporation of KMC Telecom Holdings, Inc. dated as of February 4, 1999. 3.4 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. 3.5 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. 3.6 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. 3.7 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. 3.8 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. *3.9 By-Laws of KMC Telecom Holdings, Inc. *4.1 Amended and Restated Stockholders Agreement dated as of October 31, 1997 by and among KMC Telecom Holdings, Inc., Nassau Capital Partners, L.P., NAS Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P., Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc. *4.2 Amendment No. 1 dated as of January 7, 1998 to the Amended and Restated Stockholders Agreement dated as of October 31, 1997 and among KMC Telecom Holdings, Inc., Nassau Capital Partners, L.P., NAS Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P., Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc. *4.3 Amendment No. 2 dated as of January 26, 1998 to the Amended and Restated Stockholders Agreement dated as of October 31, 1997 by and among KMC Telecom Holdings, Inc. , Nassau Capital Partners, L.P., NAS Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P., Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc. *4.4 Amendment No. 3 dated as of February 25, 1998 to the Amended and Restated Stockholders Agreement dated as of October 31, 1997 by and among KMC Telecom Holdings, Inc. , Nassau Capital Partners, L.P., NAS Partners I L.L.C., Harold N. Kamine, KMC Telecommunications L.P., Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc. 4.5 Amendment No. 4 dated as of February 4, 1999 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, Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation), General Electric Capital Corporation, CoreStates Bank, N.A. and CoreStates Holdings, Inc. *4.6 Indenture dated as of January 29, 1998 between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank, as Trustee, including specimen of KMC Telecom Holdings, Inc.'s 12 1/2% Senior Discount Note due 2008. *4.7 Registration Rights Agreement dated January 26, 1998 between KMC Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated. *4.8 Warrant Agreement between KMC Telecom Holdings, Inc. and The Chase Manhattan Bank, as Warrant Agent, dated as of January 29, 1998 including a specimen of Warrant Certificate. *4.9 Warrant Registration Rights Agreement dated as of January 26, 1998 between KMC Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated. *10.1 Purchase Agreement dated January 26, 1998 by and between KMC Telecom Holdings, Inc. and Morgan Stanley & Co. Incorporated. 10.2 Loan and Security Agreement dated as of December 22, 1998 among KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom of Virginia, Inc., KMC Telecom Leasing I, LLC, KMC Telecom Leasing II, LLC, the additional subsidiaries from time to time parties thereto, the financial institutions signatory thereto from time to time as "Lenders", First Union National Bank as Administrative Agent for the Lenders and Newcourt Commercial Finance Corporation (formerly known as AT&T Commercial Corporation), as Collateral Agent for the Lenders. 10.3 Amendment No. 1, dated as of March 3, 1999, to Loan and Security Agreement dated as of December 22, 1998, among KMC Telecom Inc., KMC Telecom II, Inc., KMC Telecom of Virginia, Inc., KMC Telecom Leasing I, LLC, KMC Telecom Leasing II, LLC, the additional subsidiaries from time to time parties thereto, the financial institutions signatory thereto from time to time as "Lenders", First Union National Bank as Administrative Agent for the Lenders and Newcourt Commercial Finance Corporation (formerly known as AT&T Commercial Corporation), as Collateral Agent for the Lenders. *10.4 General Agreement between KMC Telecom Inc., KMC Telecom II, Inc. and Lucent Technologies, Inc. dated September 24, 1997, as amended on October 15, 1997. *10.5 Professional Services Agreement between KMC Telecom Inc. and Lucent Technologies, Inc. dated September 4, 1997. 10.6 Memorandum of Agreement between KMC Telecom Holdings, Inc. and EFTIA OSS Solutions Inc., dated as of October 26, 1998. 10.7 Master License Agreement dated December 31, 1998 by and between Billing Concepts Systems, Inc. and KMC Telecom Holdings, Inc. 10.8 Lease Agreement dated January 1, 1996 between Cogeneration Services Inc. (now known as Kamine Development Corp.) and KMC Telecom Inc. *10.9 1998 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates. 10.10 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. 21.1 Subsidiaries of KMC Telecom Holdings, Inc. 24.1 Powers of Attorney (Appears on signature page). 27.1 Financial Data Schedule. - - ------------------------ * Exhibits filed previously. EX-3.3 2 CERTIFICATE OF AMENDMENT CERTIFICATE OF AMENDMENT OF THE CERTIFICATE OF INCORPORATION OF KMC TELECOM HOLDINGS, INC. PURSUANT TO SECTION 242 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE Filed by: Kelley Drye & Warren LLP 101 Park Avenue New York, New York 10178 CERTIFICATE OF AMENDMENT OF THE CERTIFICATE OF INCORPORATION OF KMC TELECOM HOLDINGS, INC. PURSUANT TO SECTION 242 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE KMC TELECOM HOLDINGS, INC., a corporation organized and existing under and by virtue of General Corporation Law of the State of Delaware (the "CORPORATION"), does hereby certify as follows: FIRST: That the name of the Corporation is KMC TELECOM HOLDINGS, INC. SECOND: That the original Certificate of Incorporation of the Corporation was filed with the Secretary of State of Delaware on September 17, 1997, and that an Amended and Restated Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware at 12:00 p.m. on September 22, 1997, and that a Certificate of Amendment of the Amended and Restated Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware at 10:00 a.m. on November 5, 1997 THIRD: That the Board of Directors of the Corporation, at a special meeting duly called and held on February 1, 1999, adopted a resolution proposing that Article FOURTH, Section A of the Amended and Restated Certificate of Incorporation of the Corporation be further amended by amending and restating the first sentence thereof (the "Article Fourth Amendment"). The stockholders of the Corporation duly approved the Article Fourth Amendment by written consent in accordance with Sections 228 and 242 of the General Corporation of the State of Delaware. The resolution setting forth the Article Fourth Amendment is as follows: RESOLVED, that Article FOURTH, Section A of the Amended and Restated Certificate of Incorporation of the Corporation be amended by amending and restating the first sentence thereof to read as follows: "The total number of shares of all classes of capital stock which the Corporation shall have the authority to issue is 3,748,800 shares, consisting of 3,000,000 shares of Common Stock with a par value of $0.01 per share ("Common Stock") and 748,800 shares of Preferred Stock with a par value of $0.01 per share ("Preferred Stock")." IN WITNESS WHEREOF, KMC TELECOM HOLDINGS, INC. has caused this certificate to be duly executed by its Vice President this 2nd day of February, 1999. KMC TELECOM HOLDINGS, INC. By:/s/Cynthia Worthman ------------------------- Name: Cynthia Worthman Title: Vice President, Chief Financial Officer and Secretary EX-3.4 3 AMENDED AND RESTATED CERTIFICATE Execution Copy 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 $.0l PER SHAPE Pursuant to Sections 141 and 242 of the General Corporation Law of the State of Delaware As contemplated by sections 141 and 242 of the general corporation law of the state of delaware (the "dgcl"), the following resolution was duty adopted by the board of directors of kmc telecom inc., A delaware corporation (the "corporation"), by unanimous written consent, dated october 31, 1997: WHEREAS, the Board of Directors of the Corporation is authorized, within the limitations and restrictions stated in the Certificate of Incorporation of the Corporation, to propose by resolution or resolutions for the amendment of outstanding series of preferred stock, par value $.0l per share, of the Corporation, to contain such voting powers, full or limited, or without voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions as shall be stated and expressed in the resolution or resolutions providing for the amendment thereof adopted by the Board of Directors, and as are not stated and expressed in the Amended and Restated Certificate of Incorporation, or any amendment thereto, including (but without limiting the generality of the foregoing) such provisions as may be desired concerning voting, redemption, dividends, dissolution or the distribution of assets and such other subjects or matters as may be fixed by resolution or resolutions of the Board of Directors under the DGCL; WHEREAS, the Board of Directors of the Corporation, pursuant to its authority under Section 242 of the DGCL, deems it advisable to amend and restated the terms of its Series A Cumulative Convertible Preferred Stock; NOW, THEREFORE, BE IT RESOLVED: 1. DESIGNATION AND NUMBERS OF SHARES. There shall be hereby established a series of preferred stock designated as "Series A Cumulative Convertible Preferred Stock" (such Series being hereinafter referred to as the "Series A Preferred Stock"). The authorized number of shares of Series A Preferred Stock shall be 123,800. The liquidation preference of the Series A Preferred Stock shall be $100 per share (the "Liquidation Preference"). 2. RANK. The Series A Preferred Stock shall, with respect to dividend distributions and distributions of assets and rights upon the liquidation, winding-up and dissolution of the Corporation, rank senior to the Common Stock, par value $.01 per share, of the Corporation (the "Common Stock") and to each other class or series of Capital Stock of the Corporation (other than the Parity Preferred Stock) hereafter created (the Common Stock and such other class or series of Capital Stock of the Corporation other than Parity Preferred Stock are hereinafter collectively referred to as the "Junior Stock"). 3. DIVIDENDS. (a) Beginning on the date of issuance of the Series A Preferred Stock, the holders of the outstanding shares of Series A Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors of the Corporation, out of funds legally available therefor, cash dividends on each share of Series A Preferred Stock at an annual rate equal to 7.0% of the Liquidation Preference, payable quarterly in arrears on the applicable Dividend Payment Date or the next succeeding Business Day, if the applicable Dividend Payment Date is not a Business Day. Notwithstanding the foregoing, the dividend payable on each share of Series A Preferred Stock with respect to the Initial Dividend Period shall be equal to (i) 7.0% of the Liquidation Preference multiplied by (ii) a fraction equal to (A) the number of days from (and including) the Series A Preferred Stock Issue Date to (but excluding) the Dividend Payment Date with respect to the Initial Dividend Period divided by (B) 365. All dividends shall be cumulative, whether or not earned or declared, from the date of issuance of the Series A Preferred Stock and shall be payable quarterly in arrears on each Dividend Payment Date, commencing on the first Dividend Payment Date after the date of issuance of the Series A Preferred Stock. If any dividend (or portion thereof) payable on any Dividend Payment Date is not declared or paid in full on such Dividend Payment Date, the amount of such dividend payable that is not paid on such date shall increase at the rate of 7.0% per annum (compounded quarterly on each subsequent Dividend Payment Date) from such Dividend Payment Date until paid in full. Each distribution on the Series A Preferred Stock shall be payable to holders of record as they appear on the stock books of the Corporation on such record dates, not less than ten (10) nor more than sixty (60) days preceding the related Dividend Payment Date, as shall be fixed by the Board of Directors of the Corporation. (b) All accumulated and unpaid dividends on the Series A Preferred Stock shall be paid by the Corporation upon the occurrence of a Realization Event, without reference to any regular Dividend Payment Date, to holders of record on such date. The Corporation shall send by first class, postage prepaid mail a notice of the Realization Event to all holders of Series A Preferred Stock that are entitled to receive such dividends. In the case of a Realization Event which is an initial public offering, if any such holder gives written notice to the Corporation that such holder wishes to receive such accumulated unpaid dividends in the form of shares of Common Stock in lieu of cash, the Corporation, in lieu of a cash payment, shall issue to such holder on such Dividend Payment Date, a number of shares of Common Stock equal to the quotient obtained by dividing (x) the aggregate accumulated and unpaid dividends on the shares of Series A Preferred Stock held by such holder by (y) the price at which shares of Common Stock are sold in such offering (before deduction of underwriting discounts and expenses of sale). (c) All dividends paid with respect to shares of Series A Preferred Stock pursuant to Section 3(a) shall be paid pro rata and in like manner to all of the holders entitled thereto. (d) Nothing herein contained shall in any way or under any circumstances be construed or deemed to require the Board of Directors of the Corporation to declare, or the Corporation to pay or set apart for payment, any dividends on shares of the Series A Preferred Stock at any time. 2 4. LIQUIDATION PREFERENCE. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the affairs of the Corporation, the holders of shares of Parity Preferred Stock (including the Series A Preferred Stock) then outstanding shall be entitled to be paid for each share held thereby, out of the assets of the Corporation available for distribution to its stockholders, an amount in cash equal to the Liquidation Preference plus an amount in cash equal to all accumulated and unpaid dividends thereon (calculated pursuant to Paragraph 3(a)) to the date fixed for liquidation, dissolution or winding-up (including an amount equal to a prorated dividend for the period from the last Dividend Payment Date to the date fixed for liquidation, dissolution or winding-up), before any payment shall be made or any assets distributed to the holders of any shares of Junior Stock. Except as provided in the preceding sentence, holders of the Parity Preferred Stock (including the Series A Preferred Stock) shall not be entitled to any distribution in the event of any liquidation, dissolution or winding-up of the affairs of the Corporation. If the assets of the Corporation are not sufficient to pay in full the foregoing liquidation payments payable to the holders of outstanding shares of the Parity Preferred Stock (including the Series A Preferred Stock), then the holders of all shares of Parity Preferred Stock (including the Series A Preferred Stock) shall share ratably in such distribution of assets in accordance with the amount that would be payable on such distribution if the amounts to which the holders of outstanding shares of Parity Preferred Stock (including the Series A Preferred Stock) are entitled were paid in full. If all of the foregoing liquidation payments with respect to any share of Series A Preferred Stock have been made, such share may not be converted into Common Stock pursuant to Section 5. (b) For the purposes of this Section 4, neither the voluntary sale, conveyance, exchange or transfer (for cash, shares of stocks, securities or other consideration) of all or substantially all or part of the property or assets of the Corporation nor the consolidation or merger of the Corporation with one or more other corporations shall be deemed to be a liquidation, dissolution or winding-up, voluntary or involuntary, of the affairs of the Corporation (unless such sale, conveyance, exchange or transfer is in connection with a liquidation, dissolution or winding-up of the affairs of the Corporation). 5. CONVERSION. (a) CONVERSION PRICE. Shares of Series A Preferred Stock to be converted into shares of Common Stock shall be so converted initially at a conversion price equal to $20.633333 per share of Common Stock, which price shall be adjusted as hereinafter provided (and, as so adjusted, is hereinafter sometimes referred to as the "Conversion Price"), with each share of Series A Preferred Stock being valued at $100.00 for such purpose (that is, a conversion rate initially equivalent to 4.8465266 shares of Common Stock for each share of Series A Prefer-red Stock so converted, which is subject to adjustment (to the nearest fourth decimal place) as the Conversion Price is adjusted as hereinafter provided); PROVIDED, HOWEVER, that in no event shall the Conversion Price be less than the par value, if any, of the Common Stock. (b) AUTOMATIC CONVERSION UPON A QUALIFIED PUBLIC OFFERING. Upon a Qualified Public Offering, each share of Series A Preferred Stock shall automatically convert, without any action on the part of the holder thereof, into shares of Common Stock at the Conversion Price in effect at such time, plus the right to receive an amount of cash equal to the accumulated unpaid dividends on such share of Series A Preferred Stock to and including such date (or the right to receive additional shares of Common Stock in lieu of cash dividends pursuant to Section 3(b)). 3 (c) CONVERSION AT THE OPTION OF THE HOLDER. At any time and from time to time prior to a Qualified Public Offering, the holders of Series A Preferred Stock shall have the right to convert, in whole or in part, each share of Series A Preferred Stock into shares of Common Stock at the Conversion Price in effect at such time, plus the right to receive an amount of cash equal to the accumulated unpaid dividends on each share of Series A Preferred Stock to and including the Conversion Date (as defined below); provided that, if such Conversion Date is prior to a Realization Event, the Corporation may, in lieu of making a payment in cash equal to such amount, deliver a number of shares of Common Stock equal to such amount divided by the Fair Market Value of one share of Common Stock. In order to convert shares of Series A Preferred Stock pursuant to this Section 5(c) the holder thereof shall surrender at the office of the Corporation the certificate or certificates therefor, duly endorsed to the Corporation in blank, and give written notice to the Corporation that such holder elects to convert such shares and shall state in writing therein the name or names (with addresses) in which such holder wishes the certificate or certificates of Common Stock to be issued. Shares of Series A Preferred Stock shall be deemed to have been converted on the date of surrender of such certificate or certificates as provided above (the "Conversion Date"), and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Common Stock on such date. As soon as practicable on or after the Conversion Date, the Corporation shall issue and deliver a certificate or certificates for the number of shares of Common Stock issuable upon conversion. (d) FRACTIONAL SHARES; PARTIAL-CONVERSION. No fractional shares shall be issued upon conversion of shares of Series A Preferred Stock into Common Stock. In case the number of shares of Series A Preferred Stock represented by the certificate or certificates surrendered pursuant to this Section 5 exceeds the number of shares converted, the Corporation shall, upon such conversion, execute and deliver to the holder, at the expense of the Corporation, a new certificate or certificates for the number of shares of Series A Preferred Stock represented by the certificate or certificates surrendered which are not to be converted. If any fractional share of Common Stock would, except for the provisions of the first sentence of this Section 5(d), be delivered upon such conversion, the Corporation, in lieu of delivering such fractional share, shall pay to the holder surrendering the Series A Preferred Stock for conversion an amount in cash equal to the current market price of such fractional share as determined in good faith by the Board of Directors. (e) ADJUSTMENT OF CONVERSION PRICE UPON ISSUANCE OF COMMON STOCK. Except as provided in Section 5(f), if and whenever the Corporation shall hereafter issue or sell, or is, in accordance with subsection 5(e)(1) through 5(e)(6), deemed to have issued or sold, any shares of Common Stock for a consideration per share less than the Conversion Price in effect immediately prior to the time of such issue or sale, then, forthwith upon such issue or sale, the Conversion Price shall be reduced to the price determined by dividing (i) an amount equal to the sum of (a) the number of shares of Common Stock outstanding immediately prior to such issue or sale (determined on a Fully Diluted basis) multiplied by the then existing Conversion Price and (b) the consideration, if any, received by the Corporation upon such issue or sale, by (ii) the total number of shares of Common Stock outstanding immediately after such issue or sale (determined on a Fully Diluted basis). For purposes of this Section 5(e), the following subsections 5(e)(1) to 5(e)(6) shall also be applicable: 4 5(e)(1) ISSUANCE OF RIGHTS OR OPTIONS. In case at any time hereafter the Corporation shall in any manner grant (whether directly or by assumption in a merger or otherwise) any Options to purchase Common Stock or any Convertible Securities, whether or not such Options or the right to convert or exchange any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such Options or upon the conversion or exchange of such Convertible Securities (determined by dividing (i) the total amount, if any, received or receivable by the Corporation as consideration for the granting of such Options, plus the minimum aggregate amount of additional consideration payable to the Corporation upon the exercise of all such Options, plus, in the case of such Options which relate to Convertible Securities, the minimum aggregate amount of additional consideration, if any, payable upon the issue or sale of such Convertible Securities and upon the conversion or exchange thereof, by (ii) the total maximum number of shares of Common Stock issuable upon the exercise of such Options or upon the conversion or exchange of all such Convertible Securities issuable upon the exercise of such Options) shall be less than the Conversion Price in effect immediately prior to the time of the granting of such Options, then the total maximum number of shares of Common Stock issuable upon the exercise of such Options or upon conversion or exchange of the total maximum amount of such Convertible Securities issuable upon the exercise of such Options shall be deemed to have been issued for such price per share as of the date of granting of such Options or the issuance of such Convertible Securities and thereafter shall be deemed to be outstanding. Except as otherwise provided in subsection 5(e)(3), no adjustment of the Conversion Price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such Options or upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities. 5(e)(2) ISSUANCE OF CONVERTIBLE SECURITIES. In case the Corporation shall hereafter in any manner issue (whether directly or by assumption in a merger or otherwise) or sell any Convertible Securities, whether or not the rights to exchange or convert any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon such conversion or exchange (determined by dividing (i) the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion or exchange thereof, by (ii) the total maximum number of shares of Common Stock issuable upon the conversion or exchange of all such Convertible Securities) shall be less than the Conversion Price in effect immediately prior to the time of such issue or sale, then the total maximum number of shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities shall be deemed to have been issued for such price per share as of the date of the issue or sale of such Convertible Securities and thereafter shall be deemed to be outstanding, provided that (a) except as otherwise provided in subparagraph 5(e)(3), no adjustment of the Conversion Price should be made upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities and (b) if any such issue or sale of such Convertible Securities is made upon exercise of any Options to purchase any such Convertible Securities for which adjustments of the Conversion Price have been or are to be made pursuant to other provisions of this Section 5(e), no further adjustment of the Conversion Price shall be made by reason of such issue or sale. 5 5(e)(3) CHANGE IN OPTION PRICE OR CONVERSION RATE. Upon the happening of any of the following events, namely, if the purchase price provided for in any Option referred to in subsection 5(e)(1), the additional consideration, if any, payable upon the conversion or exchange of any Convertible Securities referred to in subsection 5(e)(1) or 5(e)(2) or the rate at which Convertible Securities referred to in subsection 5(e)(1) or 5(e)(2) are convertible into or exchangeable for Common Stock shall change at any time (including, but not limited to, changes under or by reason of provisions designed to protect against dilution), the Conversion Price in effect at the time of such event shall forthwith be readjusted to the Conversion Price which would have been in effect at such time had such Options or Convertible Securities still outstanding provided for such changed purchase price, additional consideration or conversion rate, as the case may be, at the time initially granted, issued or sold, put only if as a result of such adjustment the Conversion Price then in effect hereunder is thereby reduced; and on the termination of any such Option or any such right to convert or exchange such Convertible Securities, the Conversion Price then in effect hereunder shall forthwith be increased to the Conversion Price which would have been in effect at the time of such termination had such Option or Convertible Securities, to the extent outstanding immediately prior to such termination, never been issued. 5(e)(4) CONSIDERATION FOR STOCK. In case any shares of Common Stock, Options or Convertible Securities shall be issued or sold for cash, the consideration received therefor shall be deemed to be the amount received by the Corporation therefor, without deduction therefrom of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Corporation in connection therewith. In case any shares of Common Stock, Options or Convertible Securities shall be issued or sold for a consideration other than cash, the amount of the consideration other than cash received by the Corporation shall be deemed to be the fair value of such consideration as determined in good faith by the Board of Directors, without deduction of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Corporation in connection therewith. In case any Options shall be issued in connection with the issue and sale of other securities of the Corporation, together comprising one integral transaction in which no specific consideration is allocated to such Options by the parties thereto, such Options shall be deemed to have been issued for such consideration as determined in good faith by the Board of Directors of the Corporation. 5(e)(5) RECORD DATE. In case the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them (i) to receive a dividend or other distribution payable in Common Stock, Options or Convertible Securities or (ii) to subscribe for or purchase Common Stock, options or Convertible Securities, then such record date shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. 5(e)(6) TREASURY SHARES. The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Corporation, and the disposition of any such shares shall be considered an issue or sale of Common Stock for the purpose of this Section 5(e). 6 (f) EXCEPTIONS TO CONVERSION PRICE ADJUSTMENT. Notwithstanding the foregoing, no adjustment to the Conversion Price shall be made pursuant to this Section 5 in connection with the grant, issuance or sale of Common Stock, Convertible Securities, warrants, options or other rights to subscribe for or purchase Common Stock or Convertible Securities: (i) pursuant to employee stock purchase or stock option ownership plans adopted by the Corporation for employees, consultants and/or directors of the Corporation and its affiliates; (ii) pursuant to the terms of any Convertible Securities, warrants, options or other rights to subscribe for or purchase granted, issued or sold pursuant to clause (ii) above; (iii) pursuant to the High Yield Debt and Equity Offering (as defined in a Subordinated Loan and Security Agreement, dated as of September 22, 1997, among KMC Telecom Inc. ("KMC") and KMC Telecom II, Inc. and AT&T Commercial Finance Corporation, as in effect on the Series C Preferred Stock Issue Date) or a subsequent debt offering occurring prior to December 31, 1998; (iv) pursuant to the terms of any Convertible Securities, warrants, options or other rights to subscribe for or purchase granted, issued or sold pursuant to clauses (iii) above; (v) pursuant to Section 10C of the Amended and Restated Note Purchase and Investment Agreement, dated as of October 22, 1996, as amended, by and among the Corporation, Nassau Capital Partners L.P., NAS Partners I L.L.C. and Harold N. Kamine; or (vi) pursuant to the issuance of Series C Cumulative Convertible Preferred Stock and Series D Cumulative Convertible Preferred Stock pursuant to a Purchase Agreement, by and among the Corporation, General Electric Capital Corporation, CoreStates Holdings, Inc., Nassau Capital Partners L.P., NAS Partners I L.L.C. and the issuance of any shares of Common Stock issued in conversion thereof, PROVIDED that the aggregate number of shares of Common Stock issued or issuable pursuant to clauses (i) and (ii) above shall not exceed 15% of the Common Stock (on a Fully Diluted basis) outstanding from time to time and the aggregate number of shares of Common Stock issued or issuable pursuant to clause (iii) and (iv) above shall not exceed 11% of the Common Stock (on a Fully Diluted basis) outstanding from time to time; and FURTHER PROVIDED that for the purposes of this Section 5(f): (a) 221,500 shares of Common Stock initially allocated under the 1997 Stock Option Plan will be deemed outstanding regardless of the number of shares actually granted and exercisable thereunder and (b) shares of Common Stock issued or issuable upon exercise of options not among the 221,500 shares initially allocated pursuant to the 1997 Stock Option Plan and which, when issued, were subject to clause (i) or (ii) above, will not be deemed outstanding, regardless of whether or not they have been granted or are exercisable. (g) SUBDIVISION OR COMBINATION OF COMMON STOCK. In case the Corporation shall at any time subdivide (by any stock split, stock dividend or otherwise) its outstanding shares of Common Stock into a greater number of shares, the Conversion Price in effect immediately prior to such subdivision shall be proportionately reduced, and, conversely, in case the outstanding shares of Common Stock shall be combined into a smaller number of shares, the Conversion Price in effect immediately prior to such combination shall be proportionately increased. (h) REORGANIZATION OR RECLASSIFICATION. If any capital reorganization or reclassification of the capital stock of the Corporation shall be effected in such a way that holders of Conunon Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization or reclassification, lawful and adequate provisions shall be made whereby each holder of a share or shares of Series A Preferred Stock shall thereupon have the right to receive, upon the basis and upon the terms and conditions specified herein and in lieu of the shares of Common Stock immediately theretofore receivable upon the conversion of such share or shares of Series A Preferred Stock, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such Common Stock immediately theretofore receivable upon such conversion had such reorganization or reclassification not taken place, and in any such case appropriate provisions shall be made with respect to the rights and interests of such holder to the end that the provisions hereof (including, without limitation, provisions for adjustments of the Conversion Price) shall thereafter be applicable, as nearly as may be, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise of such conversion rights. 7 (i) CARRYOVER. Notwithstanding any other provisions of this Section 5, the Corporation shall not be required to make any adjustment to the Conversion Price unless such adjustment would require an increase or decrease of at least one percent (1%) in the Conversion Price. Any lesser adjustment shall be carried forward and shall be made no later than the time of, and together with, the next subsequent adjustment which, together with any adjustment or adjustments so carried forward, shall amount to an increase or decrease of at least one percent (1%) in the Conversion Price. 6. OTHER EVENTS. If the Corporation shall make any dividend (excluding cash dividends payable out of accumulated earnings and profits) or distribution on the Common Stock or issue any Common Stock, other capital stock or other security of the Corporation or any rights or warrants to purchase or acquire any such security, which transaction does not result in an adjustment to the Conversion Price pursuant to the foregoing provisions of this Section 5, the Board of Directors may consider whether such action is of such a nature that an adjustment to the Conversion Price should equitably be made in respect of such transaction. If the Board of Directors of the Corporation determines that an adjustment to the Conversion Price should be made, an adjustment shall be made effective as of such date, as determined by the Board of Directors of the Corporation. The determination of the Board of Directors of the Corporation as to whether such an adjustment to the Conversion Price should be made, and, if so, as to what adjustment should be made and when, shall be final and binding on the Corporation and all stockholders of the Corporation. The Corporation shall be entitled to make such additional adjustments in the Conversion Price, in addition to those required by the foregoing provisions of this Section 5, as shall be necessary in order that any dividend or distribution in shares of capital stock of the Corporation, subdivision, reclassification or combination of shares of stock of the Corporation or any recapitalization of the Corporation shall not be taxable to the holders of the Common Stock. (k) NOTICE OF ADJUSTMENT. Upon any adjustment of the Conversion Price, then and in each such case the Corporation shall give written notice thereof, by delivery in person, certified or registered mail, return receipt requested, or facsimile addressed to each holder of shares of Series A Preferred Stock affected by such adjustment at the address of such holder as shown on the books of the Corporation, which notice shall state the Conversion Price resulting from such adjustment, setting forth in reasonable detail the method upon which such calculation is based. 6. VOTING RIGHTS. (a) The holders of Series A Preferred Stock, except as otherwise required under Delaware law or as set forth below in this Section 6, shall not be entitled or permitted to vote on any matter required or permitted to be voted upon by the stockholders of the Corporation. (b) So long as the Series A Preferred Stock is outstanding, each share of Series A Preferred Stock shall entitle the holder thereof to vote, in person or by proxy, at a special or annual meeting of stockholders or by written consent, on all matters voted on by holders of Common Stock voting together as a single class with other shares entitled to vote thereon, except as otherwise provided in Articles EIGHTH and NINTH of the Corporation's Amended and Restated Certificate of Incorporation. With respect to any such vote, each share of Series A Preferred Stock shall entitle the holder thereof to cast a number of votes equal to the number of votes entitled to be cast by such holder had such holder converted such share of Series A Preferred Stock into Common Stock prior to such vote (or, if earlier, the record date with respect to such vote). (c) Without the prior consent of the holders of two-thirds of the shares of the Series A Preferred Stock then outstanding, voting as a separate class, the Corporation shall not: (i) increase the number of shares of the Corporation's Series A Cumulative Convertible Preferred Stock, par value $.0l per share, outstanding at any time to more than $12,800,000 of aggregate liquidation preference; 8 (ii) increase the number of shares of Preferred Stock (of whatever series) authorized or Common Stock authorized for issuance; (iii) merge or consolidate with or into any other company, person or entity, unless holders of each share of Series A Preferred Stock receive consideration in an amount equal to at least the greater of (A) the product of (x) the number of shares of Common Stock into which such shares of Series A Preferred Stock is then convertible and (y) the consideration to be received by holders of each share of Common Stock pursuant to such merger or consolidation and (B) the Liquidation Preference, of such share of Series A Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared); (iv) amend, modify or repeal the powers, preferences or rights of or the restrictions provided for the benefit of holders of the Series A Preferred Stock or the Common Stock if such action would affect the Series A Preferred Stock or the Common Stock adversely; (v) sell or otherwise dispose of all or substantially all of the assets of the Corporation in any single transaction or series of related transactions unless the holders of each share of Series A Preferred Stock receive consideration in an amount equal to at least the Liquidation Preference of such share of Series A Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared); (vi) declare or pay any dividend on shares of Common Stock or other equity securities of the Corporation ranking junior to the Parity Preferred Stock (excluding dividends payable solely in shares of Common Stock or other equity securities of the Corporation ranking junior to the Parity Preferred Stock); (vii) authorize or enter into any transaction or series of transactions (excluding transactions authorized by the Corporation or its subsidiaries prior to the Series C Preferred Stock Issue Date and any amendments thereto that do not alter the economic value of such transactions) with any director or executive officer of the Corporation or any Person directly or indirectly controlling the Corporation (or any affiliate thereof other than a subsidiary of the Corporation) if the aggregate amount involved in such transaction or series of transactions involves the payment by or to the Corporation or its subsidiaries of more than $100,000 in any one fiscal year of the Corporation; or (viii) issue Common Stock or Convertible Securities as consideration for assets comprising a business that is not within the lines of business conducted by the Corporation or any of its subsidiaries (or operations reasonably ancillary thereto) on the Series C Preferred Stock Issue Date. (d) Without the consent of each holder of Series A Preferred Stock affected thereby, the Corporation shall not reduce the Liquidation Preference of the Series A Preferred Stock or the rate at which dividends accumulate thereon, or modify the dividend cumulation provisions of the Series A Preferred Stock or the times and prices at which the Series A Preferred Stock may be redeemed in a manner that would be adverse to the holders of Series A Preferred Stock. 7. REISSUANCE OF SERIES A PREFERRED STOCK. Shares of Series A Preferred Stock that have been issued and reacquired in any manner including shares purchased or redeemed or exchanged or converted, shall (upon compliance with any applicable provisions of the laws of Delaware) have the status of authorized and unissued shares of preferred stock undesignated as to series and may be redesignated and reissued as part of any series of preferred stock (other than Series A Preferred Stock). 9 8. BUSINESS DAY. If any payment or conversion shall be required by the terms hereof to be made on a day that is not a Business Day, such payment or conversion shall be made on the immediately succeeding Business Day. 9. DEFINITIONS. As used in this Certificate of Designation, the following terms shall have the following meanings (with terms defined in the singular having comparable meanings when used in the plural and vice versa), unless the context otherwise requires: "1997 Stock Option Plan" shall mean the 1997 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings, Inc. and affiliates, as the same may be amended from time to time. "Board of Directors" shall have the meaning ascribed to it in the first paragraph of this Resolution. "Business Day" means any day except a Saturday, a Sunday, or other day on which commercial banks in the State of New York or New Jersey are authorized or required by law or executive order to close. "Capital Stock" means, with respect to any Person, any and all shares, interests, participations, rights in, or other equivalents (however designated and whether voting or non-voting) of, such Person's capital stock (but excluding any debt security that is exchangeable for or convertible into such capital stock). "Conunon Stock" shall have the meaning ascribed to it in Section 2 hereof. "Convertible Securities" shall mean any evidences of indebtedness, shares or securities convertible into or exchangeable for Common Stock. "Corporation" shall have the meaning ascribed to it in the first paragraph of this Resolution. "Dividend Payment Date" means March 31, June 30, September 30 and December 31 of each year. "Dividend Period" means the Initial Dividend Period and, thereafter, each Quarterly Dividend Period. "Fair Market Value" per share of Common Stock as of a particular date (the "Determination Date") shall mean: (i) if the Common Stock is listed or admitted for trading on a national securities exchange, then the Fair Market Value shall be the average of the last 30 "daily sales prices" of the Common Stock on the principal national securities exchange on which the Common Stock is listed or admitted for trading on the last 30 Business Days prior to the Determination Date, or if not listed or traded on any such exchange, then the Fair Market Value shall be the average of the last 30 "daily sales prices" of the Common Stock on the Nasdaq National Market on the last 30 Business Days prior to the Determination Date (the "daily sales price" shall be the closing price for bona fide transactions of the Common Stock at the end of each day); or (ii) if the Common Stock is not so listed or admitted to unlisted trading privileges or if no such sale is made on at least 25 of such days, then the Fair Market Value shall be as reasonably determined in good faith by the Company's Board of Directors or a duly appointed committee of the Board of Directors (which determination shall be reasonably described in the written notice delivered, and shall be reasonably acceptable, to the holders of the Series A Preferred Stock). 10 "Fully Diluted" shall mean at any date as of which the number of shares of Common Stock is to be determined, all shares of Common Stock outstanding at such date and the maximum number of shares of Common Stock issuable in respect of Convertible Securities and warrants, options and other rights to purchase (directly or indirectly) shares of Common Stock or Convertible Securities (giving effect to the then current respective conversion prices) outstanding on such date (to the extent the rights to convert, exchange or exercise thereunder are presently exercisable). "High Yield Debt and Equity Offering" shall have the meaning ascribed to it in Section 5 hereof. "Initial Dividend Period" means the dividend period commencing on, and including, the Series A Prefer-red Stock Issue Date and ending on, and excluding, the first Dividend Payment Date to occur thereafter. "Junior Stock" shall have the meaning ascribed to it in Section 2 hereof. "Liquidation Preference" shall have the meaning ascribed to it in Section 1 hereof. "Option" shall mean rights, options, or warrants to subscribe for purchase or otherwise acquire Convertible Securities or Common Stock. "Parity Preferred Stock" means, collectively, the Series A Preferred Stock, the Series B Cumulative Convertible Preferred Stock, par value $.01 per share, the Corporation's Series C Cumulative Convertible Preferred Stock, par value $.0l per share, the Corporation's Series D Cumulative Convertible Preferred Stock, par value $.0l per share and any other series of preferred stock which is determined to be "Parity Preferred Stock" by the Board of Directors. "Person" means any individual, firm, corporation, partnership, limited liability company, trust, incorporated or unincorporated association, joint venture, joint stock company, governmental body or other entity of any kind. "Qualified Public Offering" shall mean the first offer for sale of Common Stock pursuant to an effective registration statement filed by the Corporation under the Securities Act of 1933, as amended, in which the Corporation receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000; provided that the per share price at which such shares are sold in the offering (before deduction of underwriting discounts and expenses of sale) is at least four (4) times the Conversion Price then in effect. "Quarterly" shall mean the quarterly periods commencing on, and including, each Dividend Payment Date and ending on, and excluding, each next Dividend Payment Date occurring immediately thereafter, respectively. "Realization Event" shall mean the occurrence of (i) the sale of all or substantially all of the stock or assets of the Corporation, the consolidation or merger of the Corporation with one or more other corporations or (ii) the closing of an initial public offering of Common Stock in which the Corporation receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000. "Series A Preferred Stock" shall have the meaning ascribed to it in Section 1 hereof. "Series A Preferred Stock Issue Date" means the first date on which the Series A Preferred Stock is issued by the Corporation. 11 IN WITNESS WHEREOF, KMC TELECOM HOLDINGS, INC. has caused this certificate to be duly executed by its Chief Financial Officer this 4th day of November, 1997. KMC TELECOM HOLDINGS, INC By: /S/ Cynthia Worthman ------------------------------ Name: Cynthia Worthman Title: Chief Financial Officer 12 EX-3.5 4 CERTIFICATE Execution Copy KMC TELECOM HOLDINGS, INC. CERTIFICATE OF THE POWERS, DESIGNATIONS, PREFERENCES AND RIGHTS OF THE SERIES C CUMULATIVE CONVERTIBLE PREFERRED STOCK, PAR VALUE $.0l PER SHARE Pursuant to Sections 141 and 151 of the General Corporation Law of the State of Delaware As contemplated by Section 141 of the General Corporation Law of the State of Delaware (the "DGCL"), the following resolution was duly adopted by the Board of Directors of KMC Telecom Holdings, Inc., a Delaware corporation (the "Corporation"), by unanimous written consent, dated October 31, 1997: WHEREAS, the Board of Directors of the Corporation is authorized, within the limitations and restrictions stated in the Amended and Restated Certificate of Incorporation of the Corporation, to provide by resolution or resolutions for the issuance of shares of preferred stock, par value $.0l per share, of the Corporation, in one or more series with such voting powers, full or limited, or without voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions as shall be stated and expressed in the resolution or resolutions providing for the issuance thereof adopted by the Board of Directors, and as are not stated and expressed in the Certificate of Incorporation, or any amendment thereto, including (but without limiting the generality of the foregoing) such provisions as may be desired concerning voting, redemption, dividends, dissolution or the distribution of assets and such other subjects or matters as may be fixed by resolution or resolutions of the Board of Directors under the DGCL; 1 WHEREAS, the Board of Directors of the Corporation, pursuant to its authority under Section 151 of the DGCL, desires to authorize and fix the terms of its Series C Cumulative Convertible Preferred Stock; and WHEREAS, the Board of Directors of the Corporation has determined that such Series C Cumulative Convertible Preferred Stock shall constitute "Parity Preferred Stock" within the meaning of the Certificates of the Powers, Designations, Preferences and Rights of the Corporation's Series A Cumulative Convertible Preferred Stock, Series B Cumulative Convertible Preferred Stock and Series D Cumulative Convertible Preferred Stock; NOW, THEREFORE, BE IT RESOLVED: 1. DESIGNATION AND NUMBER OF SHARES. There shall be hereby established a series of preferred stock designated as "Series C Cumulative Convertible Preferred Stock" (such Series being hereinafter referred to as the "Series C Preferred Stock"). The authorized number of shares of Series C Preferred Stock shall be 350,000. The liquidation preference of the Series C Preferred Stock shall be $100 per share (the "Liquidation Preference"). 2. RANK. The Series C Preferred Stock shall, with respect to dividend distributions and distributions of assets and rights upon the liquidation, winding-up and dissolution of the Corporation, rank senior to the Common Stock, par value $.0l per share, of the Corporation (the "Common Stock") and to each other class or series of Capital Stock of the Corporation (other than the Parity Preferred Stock) hereafter created (the Common Stock and such other class or series of Capital Stock of the Corporation other than Parity Preferred Stock are hereinafter collectively referred to as the "Junior Stock"). 3. DIVIDENDS. (a) Beginning on the date of issuance of the Series C Preferred Stock, the holders of the outstanding shares of Series C Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors of the Corporation, out of funds legally available therefor, cash dividends on each share of Series C Preferred Stock at an annual rate equal to 7.0% of the Liquidation Preference, payable quarterly in arrears on the applicable Dividend Payment Date or the next succeeding Business Day, if the applicable Dividend Payment Date is not a Business Day. Notwithstanding the foregoing, the dividend payable on each share of Series C Preferred Stock with respect to the Initial Dividend Period shall be equal to (i) 7.0% of the Liquidation Preference 2 multiplied by (ii) a fraction equal to (A) the number of days from (and including) the Series C Preferred Stock Issue Date to (but excluding) the Dividend Payment Date with respect to the Initial Dividend Period divided by (B) 365. All dividends shall be cumulative, whether or not earned or declared, from the date of issuance of the Series C Preferred Stock and shall be payable quarterly in arrears on each Dividend Payment Date, commencing on the first Dividend Payment Date after the date of issuance of the Series C Preferred Stock. If any dividend (or portion thereof) payable on any Dividend Payment Date is not declared or paid in full on such Dividend Payment Date, the amount of such dividend payable that is not paid on such date shall increase at the rate of 7.0% per annum (compounded quarterly on each subsequent Dividend Payment Date) from such Dividend Payment Date until paid in full. Each distribution on the Series C Preferred Stock shall be payable to holders of record as they appear on the stock books of the Corporation on such record dates, not less than ten (10) nor more than sixty (60) days preceding the related Dividend Payment Date, as shall be fixed by the Board of Directors of the Corporation. (b) All accumulated and unpaid dividends on the Series C Preferred Stock shall be paid by the Corporation upon the occurrence of a Realization Event, without reference to any regular Dividend Payment Date, to holders of record on such date. The Corporation shall send by first class, postage prepaid mail a notice of the Realization Event to all holders of Series C Preferred Stock that are entitled to receive such dividends. In the case of a Realization Event which is an initial public offering, if any such holder gives written notice to the Corporation that such holder wishes to receive such accumulated unpaid dividends in the form of shares of Common Stock in lieu of cash, the Corporation, in lieu of a cash payment, shall issue to such holder on such Dividend Payment Date, a number of shares of Common Stock equal to the quotient obtained by dividing (x) the aggregate accumulated and unpaid dividends on the shares of Series C Preferred Stock held by such holder by (y) the price at which shares of Common Stock are sold in such offering (before deduction of underwriting discounts and expenses of sale). (c) All dividends paid with respect to shares of Series C Preferred Stock pursuant to Section 3(a) shall be paid pro rata and in like manner to all of the holders entitled thereto. (d) Except as otherwise provided in paragraph (b) above, nothing herein contained shall in any way or under any circumstances be construed or deemed to require the Board of Directors of the Corporation to declare, or the Corporation to pay or set apart for payment, any dividends on shares of the Series C Preferred Stock at any time. (e) Whenever the provisions hereof require that the amount of dividends with respect to the Series C Preferred Stock be determined for less than a full quarterly period ending on a Dividend Payment Date, the amount of dividends for such period shall be equal to 7.0% of the Liquidation Preference multiplied by a fraction equal to (i) the number of days from (and including) the most recent Dividend Payment Date to (but excluding) the last day of the period in respect of which such determination is being made divided by (ii) 365. 3 4. LIQUIDATION PREFERENCE. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the affairs of the Corporation, the holders of shares of Parity Preferred Stock (including the Series C Preferred Stock) then outstanding shall be entitled to be paid for each share held thereby, out of the assets of the Corporation available for distribution to its stockholders, an amount in cash equal to the Liquidation Preference plus an amount in cash equal to all accumulated and unpaid dividends thereon (calculated pursuant to Paragraph 3(a)) to the date fixed for liquidation, dissolution or winding-up (including an amount equal to a prorated dividend for the period from the last Dividend Payment Date to the date fixed for liquidation, dissolution or winding-up), before any payment shall be made or any assets distributed to the holders of any shares of Junior Stock. Except as provided in the preceding sentence, holders of the Parity Preferred Stock (including the Series C Preferred Stock) shall not be entitled to any distribution in the event of any liquidation, dissolution or winding-up of the affairs of the Corporation. If the assets of the Corporation are not sufficient to pay in full the foregoing liquidation payments payable to the holders of outstanding shares of the Parity Preferred Stock (including the Series C Preferred Stock), then the holders of all shares of Parity Preferred Stock (including the Series C Preferred Stock) shall share ratably in such distribution of assets in accordance with the amount that would be payable on such distribution if the amounts to which the holders of outstanding shares of Parity Preferred Stock (including the Series C Preferred Stock) are entitled were paid in full. If all of the foregoing liquidation payments with respect to any share of Series C Preferred Stock have been made, such share may not be converted into Common Stock pursuant to Section 5. (b) For the purposes of this Section 4, neither the voluntary sale, conveyance, exchange or transfer (for cash, shares of stocks, securities or other consideration) of all or substantially all or part of the property or assets of the Corporation nor the consolidation or merger of the Corporation with one or more other corporations shall be deemed to be a liquidation, dissolution or winding-up, voluntary or involuntary, of the affairs of the Corporation (unless such sale, conveyance, exchange or transfer is in connection with a liquidation, dissolution or winding-up of the affairs of the Corporation). 5. CONVERSION. (a) CONVERSION PRICE. Shares of Series C Preferred-Stock to be converted into shares of Common Stock shall be so converted at a conversion price (which price shall be adjusted to the nearest fourth decimal place as hereinafter provided and, as so adjusted, is hereinafter referred to as the "Conversion Price") equal to: (i) from the date of initial issuance of shares of Series C Preferred Stock to but excluding the 30-month anniversary of such issuance, $52.50 per share of Common Stock, with each share of Series C Preferred Stock being valued at $100.00 for such purpose; PROVIDED, HOWEVER, that if a Realization Event shall occur during such 30-month period the Conversion Price shall equal to a fraction, the numerator of which is (A) the consideration per share of Common Stock (on a Fully Diluted basis) received in connection with such Realization Event, and the denominator of which is (B) 1.30 raised to a number equal to the number of years (or fraction thereof) from the date of initial issuance of shares of Series C Preferred Stock until the date of such Realization Event, but in no case shall be greater than $52.50 per share of 4 Common Stock nor less than $42.18 per share of Common Stock; and (ii) from and after the thirty-month anniversary of the date of initial issuance of shares of Series C Preferred Stock (subject to paragraph (b) below), $42.18 per share of Common Stock, with each share of Series C Preferred Stock being valued at $100.00 for such purpose; provided, however, that in no event shall the Conversion Price be less than the par value, if any, of the Common Stock. (b) AUTOMATIC CONVERSION UPON A QUALIFIED PUBLIC OFFERING. Upon a Qualified Public Offering, each share of Series C Preferred Stock shall automatically convert, without any action on the part of the holder thereof, into shares of Common Stock at the Conversion Price in effect at such time, plus the right to receive an amount of cash equal to the accumulated unpaid dividends on such share of Series C Preferred Stock to and including such date (or the right to receive additional shares of Common Stock in lieu of cash dividends pursuant to Section 3(b)). (c) CONVERSION AT THE OPTION OF THE HOLDER. At any time and from time to time prior to a Qualified Public Offering, each holder of Series C Preferred Stock shall have the right to convert such holder's shares of Series C Preferred Stock, in whole or in part, into shares of Common Stock at the Conversion Price in effect at such time, plus the right to receive an amount of cash equal to the accumulated unpaid dividends on the shares of Series C Preferred Stock so converted to and including the Conversion Date (as defined below); provided that, if such Conversion Date is prior to a Realization Event, the Corporation may, in lieu of making a payment in cash equal to such amount, deliver a number of shares of Common Stock equal to such amount divided by the Fair Market Value of one share of Common Stock. In order to convert shares of Series C Preferred Stock pursuant to this Section 5(c) the holder thereof shall surrender at the office of the Corporation the certificate or certificates therefor, duty endorsed to the Corporation in blank, and give written notice to the Corporation that such holder elects to convert such shares and shall state in writing therein the name or names (with addresses) in which such holder wishes the certificate or certificates of Common Stock to be issued. Shares of Series C Preferred Stock shall be deemed to have been converted on the date of surrender of such certificate or certificates as provided above (the "Conversion Date"), and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Common Stock on such date. As soon as practicable on or after the Conversion Date, the Corporation shall issue and deliver a certificate or certificates for the number of shares of Common Stock issuable upon conversion. (d) FRACTIONAL SHARES; PARTIAL CONVERSION. No fractional shares shall be issued upon conversion of shares of Series C Preferred stock into Common Stock. In case the number of shares of Series C Preferred Stock represented by the certificate or certificates surrendered pursuant to this Section 5 exceeds the number of shares converted, the Corporation shall, upon such conversion, execute and deliver to the holder, at the expense of the Corporation, a new certificate or certificates for the number of shares of Series C Preferred Stock represented by the certificate or certificates surrendered which are not to be converted. If any fractional share of Common Stock would, except for the provisions of the first sentence of this Section 5(d), be delivered upon such 5 conversion, the Corporation, in lieu of delivering such fractional share, shall pay to the holder surrendering the Series C Preferred Stock for conversion an amount in cash equal to the current market price of such fractional share as determined in good faith by the Board of Directors. (e) ADJUSTMENT OF CONVERSION PRICE UPON ISSUANCE OF COMMON STOCK. Except as provided in Section 5(f), if and whenever the Corporation shall hereafter issue or sell, or is, in accordance with subsection 5(e)(1) through 5(e)(6), deemed to have issued or sold, any shares of Common Stock for a consideration per share less than the Conversion Price in effect immediately prior to the time of such issue or sale, then, forthwith upon such issue or sale, the Conversion Price shall be reduced to the price determined by dividing (i) an amount equal to the sum of (a) the number of shares of Common Stock outstanding immediately prior to such issue or sale (determined on a Fully Diluted basis) multiplied by the then existing Conversion Price and (b) the consideration, if any, received by the Corporation upon such issue or sale, by (ii) the total number of shares of Common Stock outstanding immediately after such issue or sale (determined on a Fully Diluted basis). For purposes of this Section 5(e), the following subsections 5(e)(1) to 5(e)(6) shall also be applicable: 5(e)(1) ISSUANCE OF RIGHTS OR OPTIONS. In case at any time hereafter the Corporation shall in any manner grant (whether directly or by assumption in a merger or otherwise) any Options to purchase Common Stock or any Convertible Securities, whether or not such Options or the right to convert or exchange any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such Options or upon the conversion or exchange of such Convertible Securities (determined by dividing (i) the total amount, if any, received or receivable by the Corporation as consideration for the granting of such Options, plus the minimum aggregate amount of additional consideration payable to the Corporation upon the exercise of all such Options, plus, in the case of such Options which relate to Convertible Securities, the minimum aggregate amount of additional consideration, if any, payable upon the issue or sale of such Convertible Securities and upon the conversion or exchange thereof, by (ii) the total maximum number of shares of Common Stock issuable upon the exercise of such Options or upon the conversion or exchange of all such Convertible Securities issuable upon the exercise of such Options) shall be less than the Conversion Price in effect immediately prior to the time of the granting of such Options, then the total maximum number of shares of Common Stock issuable upon the exercise of such Options or upon conversion or exchange of the total maximum amount of such Convertible Securities issuable upon the exercise of such Options shall be deemed to have been issued for such price per share as of the date of granting of such Options or the issuance of such Convertible Securities and thereafter shall be deemed to be outstanding. Except as otherwise provided in subsection 5(e)(3), no adjustment of the Conversion Price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such Options or upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities. 5(e)(2) ISSUANCE OF CONVERTIBLE SECURITIES. In case the Corporation shall hereafter in any manner issue (whether directly or by assumption in a 6 merger or otherwise) or sell any Convertible Securities, whether or not the rights to exchange or convert any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon such conversion or exchange (determined by dividing (i) the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion or exchange thereof, by (ii) the total maximum number of shares of Common Stock issuable upon the conversion or exchange of all such Convertible Securities) shall be less than the Conversion Price in effect immediately prior to the time of such issue or sale, then the total maximum number of shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities shall be deemed to have been issued for such price per share as of the date of the issue or sale of such Convertible Securities and thereafter shall be deemed to be outstanding, provided that (a) except as otherwise provided in subparagraph 5(e)(3), no adjustment of the Conversion Price shall be made upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities and (b) if any such issue or sale of such Convertible Securities is made upon exercise of any Options to purchase any such Convertible Securities for which adjustments of the Conversion Price have been or are to be made pursuant to other provisions of this Section 5(e), no further adjustment of the Conversion Price shall be made by reason of such issue or sale. 5(e)(3) CHANGE IN OPTION PRICE-OR CONVERSION RATE. Upon the happening of any of the following events, namely, if the purchase price provided for in any Option referred to in subsection 5(e)(1), the additional consideration, if any, payable upon the conversion or exchange of any Convertible Securities referred to in subsection 5(e)(1) or 5(e)(2) or the rate at which Convertible Securities referred to in subsection 5(e)(1) or 5(e)(2) are convertible into or exchangeable for Common Stock shall change at any time (including, but not limited to, changes under or by reason of provisions designed to protect against dilution), the Conversion Price in effect at the time of such event shall forthwith be readjusted to the Conversion Price which would have been in effect at such time had such Options or Convertible Securities still outstanding provided for such changed purchase price, additional consideration or conversion rate, as the case may be, at the time initially granted, issued or sold, but only if as a result of such adjustment the Conversion Price then in effect hereunder is thereby reduced; and on the termination of any such Option or any such right to convert or exchange such Convertible Securities, the Conversion Price then in effect hereunder shall forthwith be increased to the Conversion Price which would have been in effect at the time of such termination had such Option or Convertible Securities, to the extent outstanding immediately prior to such termination, never been issued. 5(e)(4) CONSIDERATION FOR STOCK. In case any shares of Common Stock, Options or Convertible Securities shall be issued or sold for cash, the consideration received therefor shall be deemed to be the amount received by the Corporation therefor, without deduction therefrom of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Corporation in connection therewith. In case any shares of Common Stock, Options or Convertible Securities shall be issued or sold for a consideration other than cash, the amount of the consideration other than cash received by the 7 Corporation shall be deemed to be the fair value of such consideration as determined in good faith by the Board of Directors, without deduction of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Corporation in connection therewith. In case any Options shall be issued in connection with the issue and sale of other securities of the Corporation, together comprising one integral transaction in which no specific consideration is allocated to such Options by the parties thereto, such Options shall be deemed to have been issued for such consideration as determined in good faith by the Board of Directors of the Corporation. 5(e)(5) RECORD DATE. In case the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them (i) to receive a dividend or other distribution payable in Common Stock, Options or Convertible Securities or (ii) to subscribe for or purchase Common Stock, options or Convertible Securities, then such record date shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. 5(e)(6) TREASURY SHARES. The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Corporation, and the disposition of any such shares shall be considered an issue or sale of Common Stock for the purpose of this Section 5(e). (f) EXCEPTIONS TO CONVERSION PRICE ADJUSTMENT. Notwithstanding the foregoing, no adjustment to the Conversion Price shall be made pursuant to this Section 5 in connection with the grant, issuance or sale of Common Stock, Convertible Securities, warrants, options or other rights to subscribe for or purchase Common Stock or Convertible Securities: (i) pursuant to employee stock purchase or stock option ownership plans adopted by the Corporation for employees, consultants and/or directors of the Corporation and its affiliates; (ii) pursuant to the terms of any Convertible Securities, warrants, options or other rights to subscribe for or purchase granted, issued or sold pursuant to clause (ii) above; (iii) pursuant to the High Yield Debt and Equity Offering (as defined in a Subordinated Loan and Security Agreement, dated as of September 22, 1997, among KMC Telecom Inc. ("KMC") and KMC Telecom II, Inc. and AT&T Commercial Finance Corporation, as in effect on the Series C Preferred Stock Issue Date) or a subsequent debt offering occurring prior to December 31, 1998; (iv) pursuant to the terms of any Convertible Securities, warrants, options or other rights to subscribe for or purchase granted, issued or sold pursuant to clause (iii) above; or (v) pursuant to Section 10C of the Amended and Restated Note Purchase and Investment Agreement, dated as of October 22, 1996, as amended, by and among the Corporation, Nassau Capital Partners L.P., NAS Partners I L.L.C. and Harold N. Kamine; PROVIDED that the aggregate number of shares of Common Stock issued or issuable pursuant to clauses (i) and (ii) above shall not exceed 15% of the Common Stock (on a Fully Diluted basis) outstanding from time to time and the aggregate number of shares of Common Stock issued or issuable pursuant to clauses (iii) and (iv) above shall not exceed 11% of the Common Stock (on a Fully Diluted basis) outstanding from time to time; and FURTHER PROVIDED that for the purposes of this Section 5(f): (a) 221,500 shares of Common Stock initially allocated under the 1997 Stock Option Plan will be deemed outstanding regardless of the number of shares actually granted and 8 exercisable thereunder and (b) shares of Common Stock issued or issuable upon exercise of options not among the 221,500 shares initially allocated pursuant to the 1997 Stock Option Plan and which, when issued, were subject to clauses (i) or (ii) above, will not be deemed outstanding, regardless of whether or not they have been granted or are exercisable. (g) SUBDIVISION OR COMBINATION OF COMMON STOCK. In case the Corporation shall at any time subdivide (by any stock split, stock dividend or otherwise) its outstanding shares of Common Stock into a greater number of shares, the Conversion Price in effect immediately prior to such subdivision shall be proportionately reduced, and, conversely, in case the outstanding shares of Common Stock shall be combined into a smaller number of shares, the Conversion Price in effect immediately prior to such combination shall be proportionately increased. (h) REORGANIZATION OR RECLASSIFICATION. If any capital reorganization or reclassification of the capital stock of the Corporation shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization or reclassification (but subject to Section 7), lawful and adequate provisions shall be made whereby each holder of a share or shares of Series C Preferred Stock shall thereupon have the right to receive, upon the basis and upon the terms and conditions specified herein and in lieu of the shares of Common Stock immediately theretofore receivable upon the conversion of such share or shares of Series C Preferred Stock, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such Common Stock immediately theretofore receivable upon such conversion had such reorganization or reclassification not taken place, and in any such case appropriate provisions shall be made with respect to the rights and interests of such holder to the end that the provisions hereof (including, without limitation, provisions for adjustments of the Conversion Price) shall thereafter be applicable, as nearly as may be, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise of such conversion rights. (i) CARRYOVER. Notwithstanding any other provisions of this Section 5, the Corporation shall not be required to make any adjustment to the Conversion Price unless such adjustment would require an increase or decrease of at least one percent (1%) in the Conversion Price. Any lesser adjustment shall be carried forward and shall be made no later than the time of, and together with, the next subsequent adjustment which, together with any adjustment or adjustments so carried forward, shall amount to an increase or decrease of at least one percent (1%) in the Conversion Price. (j) OTHER EVENTS. If the Corporation shall make any dividend (excluding cash dividends payable out of accumulated earnings and profits) or distribution on the Common Stock or issue any Common Stock, other capital stock or other security of the Corporation or any rights or warrants to purchase or acquire any such security, which transaction does not result in an adjustment to the Conversion Price pursuant to the foregoing provisions of this Section 5, the Board of Directors may consider whether such action is of such a nature that an adjustment to the Conversion Price should equitably be made in respect of such 9 transaction. If the Board of Directors of the Corporation determines that an adjustment to the Conversion Price should be made, an adjustment shall be made effective as of such date, as determined by the Board of Directors of the Corporation. The determination of the Board of Directors of the Corporation as to whether such an adjustment to the Conversion Price should be made, and, if so, as to what adjustment should be made and when, shall be final and binding on the Corporation and all stockholders of the Corporation. The Corporation shall be entitled to make such additional adjustments in the Conversion Price, in addition to those required by the foregoing provisions of this Section 5, as shall be necessary in order that any dividend or distribution in shares of capital stock of the Corporation, subdivision, reclassification or combination of shares of stock of the Corporation or any recapitalization of the Corporation shall not be taxable to the holders of the Common Stock. (k) NOTICE OF ADJUSTMENT. Upon any adjustment of the Conversion Price, then and in each such case the Corporation shall give written notice thereof, by delivery in person, certified or registered mail, return receipt requested, or facsimile addressed to each holder of shares of Series C Preferred Stock affected by such adjustment at the address of such holder as shown on the books of the Corporation, which notice shall state the Conversion Price resulting from such adjustment, setting forth in reasonable detail the method upon which such calculation is based. 6. VOTING RIGHTS. (a) The holders of Series C Preferred Stock, except as otherwise required under Delaware law or as set forth below in this Section 6, shall not be entitled or permitted to vote on any matter required or permitted to be voted upon by the stockholders of the Corporation. (b) So long as the Series C Preferred Stock is outstanding, each share of Series C Preferred Stock shall entitle the holder thereof to vote, in person or by proxy, at a special or annual meeting of stockholders or by written consent, on all matters voted on by holders of Common Stock voting together as a single class with other shares entitled to vote thereon except as otherwise provided in Articles EIGHTH and NINTH of the Corporation's Amended and Restated Certificate of Incorporation. With respect to any such vote, each share of Series C Preferred Stock shall entitle the holder thereof to cast a number of votes equal to the number of votes entitled to be cast by such holder had such holder converted such share of Series C Preferred Stock into Common Stock prior to such vote (or, if earlier, the record date with respect to such vote). (c) Subject to Section 7, without the prior consent of the holders of two-thirds of the shares of the Series C Preferred Stock then outstanding, voting as a separate class, the Corporation shall not: (i) increase the number of shares of Series C Preferred Stock outstanding at any time to more than $35,000,000 of aggregate Liquidation Preference; (ii) increase the number of shares of Preferred Stock (of whatever series) authorized for issuance; (iii) merge or consolidate with or into any other company, person or entity, unless holders of each share of Series C Preferred Stock receive consideration in an amount equal to at least the greater of (A) the product of 10 (x) the number of shares of Common Stock into which such share of Series C Preferred Stock is then convertible and (y) the consideration to be received by holders of each share of Common Stock pursuant to such merger or consolidation and (B) the Liquidation Preference of such share of Series C Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared); (iv) amend, modify or repeal the powers, preferences or rights of or the restrictions provided for the benefit of holders of the Series C Preferred Stock or the Common Stock if such action would affect the Series C Preferred Stock or the Common Stock adversely; (v) sell or otherwise dispose of all or substantially all of the assets of the Corporation in any single transaction or series of related transactions unless the holders of each share of Series C Preferred Stock receive consideration in an amount equal to at least the Liquidation Preference of such share of Series C Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared); (vi) declare or pay any dividend on shares of Common Stock or other equity securities of the Corporation ranking junior to the Parity Preferred Stock (excluding dividends payable solely in shares of Common Stock or other equity securities of the Corporation ranking junior to the Parity Preferred Stock); (vii) authorize or enter into any transaction or series of transactions (excluding transactions authorized by the Corporation or its subsidiaries prior to the Series C Preferred Stock Issue Date and any amendments thereto that do not alter the economic value of such transactions) with any director or executive officer of the Corporation or any Person directly or indirectly controlling the Corporation (or any affiliate thereof other than a subsidiary of the Corporation) if the aggregate amount involved in such transaction or series of transactions involves the payment by or to the Corporation or its subsidiaries of more than $100,000 in any one fiscal year of the Corporation; or (viii) issue Common Stock or Convertible Securities as consideration for assets comprising a business that is not within the lines of business conducted by the Corporation or any of its subsidiaries (or operations reasonably ancillary thereto) on the Series C Preferred Stock Issue Date. (d) Without the consent of each holder of Series C Preferred Stock affected thereby, the Corporation shall not reduce the Liquidation Preference of the Series C Preferred Stock or the rate at which dividends accumulate thereon, or modify the dividend cumulation provisions of the Series C Preferred Stock or the times and prices at which the Series C Prefer-red Stock may be redeemed in a manner that would be adverse to the holders of Series C Preferred Stock. (e) In the event that a Default (as such term is defined in the Loan Agreement (as defined below) as in effect as of the date hereof) relating to payment obligations of principal and interest thereunder has occurred and continued for a period of 90 days under the Amended and Restated Loan and Security Agreement, dated as of September 22, 1997, among KMC Telecom Inc., KMC Telecom II, Inc. and AT&T Commercial Finance Corporation (the "Loan Agreement"), 11 the number of directors constituting the entire Board of Directors shall be increased by two individuals and the persons holding, from time to time, greater than 50% of the combined voting power of the outstanding shares of Series C Preferred Stock and the outstanding shares of Common Stock into which shares of Series C Preferred Stock theretofore have been converted (the "Majority Series C Holders") (for themselves and on behalf of all stockholders holding shares of Common Stock into which shares of Series C Convertible Preferred Stock have been, or may be, converted) shall be entitled to elect two individuals (the "Series C Directors") to the Board of Directors. Immediately upon the cure of such Default, the number of directors constituting the entire Board of Directors shall be reduced by two individuals and the two individuals elected by the Majority Series C Holders shall resign or automatically be removed from the Board of Directors. 7. OPTIONAL REDEMPTION. (a) The outstanding shares of Series C Preferred Stock shall be subject to redemption, as hereinafter provided, at the option of the Corporation, in whole but not in part, in connection with an Acquisition Event. For purposes hereof, "Acquisition Event" shall mean any merger or consolidation of the Corporation with any other company, person or entity (whether or not the Corporation is the entity surviving in such transaction) as a result of which the holders of shares of Common Stock (determined on a fully diluted basis) will hold less than a majority of the outstanding shares of common stock or other equity interests of the company, person or entity resulting from such transaction (or any parent of such entity). (b) For each share of Series C Preferred Stock redeemed pursuant to this Section 7, the Corporation shall be obligated on the date fixed for such redemption (the "Redemption Date"), which date shall not be earlier than the date of consummation of the applicable Acquisition Event, to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duty endorsed in blank or accompanied by an appropriate form of assignment) an amount (the "Redemption Price") equal to the greater of (A) the product of (x) the number of shares of Common Stock into which such share of Series C Preferred Stock is then convertible and (y) the consideration to be received by holders of each share of Common Stock pursuant to such Acquisition Event and (B) the Liquidation Preference of such share of Series C Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared). (c) Notice of any redemption of the Series C Preferred Stock pursuant to this Section 7 (specifying the time and place of redemption, the Redemption Price, the Conversion Price and the date on and after which shares of Series C Preferred Stock may no longer be converted) shall be mailed by certified or registered mail, return receipt requested, to each holder of Series C Preferred Stock, at the address of such holder shown on the Corporation's records, not less than 30 nor more than 45 days prior to the Redemption Date. (d) If the Corporation holds and sets aside money sufficient to Pay the Redemption Price of the Series C Preferred Stock on the Redemption Date, then on and after the Redemption Date: (i) the shares of Series C Preferred Stock shall no longer be convertible into shares of Common Stock; (ii) the shares of Series C Preferred Stock will cease to be outstanding and dividends on the Series C Preferred Stock will cease to be declared and paid, whether or not certificates representing the Series C Preferred Stock have been delivered to 12 the Corporation; and (iii) all other rights of the holder in respect thereof shall terminate (other than the right to receive the Redemption Price upon delivery of such Series C Preferred Stock). 8. REISSUANCE OF SERIES C PREFERRED STOCK. Shares of Series C Preferred Stock that have been issued and reacquired in any manner, including shares purchased or redeemed or exchanged or converted, shall (upon compliance with any applicable provisions of the laws of Delaware) have the status of authorized and unissued shares of preferred stock undesignated as to series and may be redesignated and reissued as part of any series of preferred stock (other than Series C Preferred Stock). 9. BUSINESS DAY. If any payment or conversion shall be required by the terms hereof to made on a day that is not a Business Day, such payment or conversion shall be made on the immediately succeeding Business Day. 10. DEFINITIONS. As used in this Certificate of Designation, the following terms shall have the following meanings (with terms defined in the singular having comparable meanings when used in the plural and vice versa unless the context otherwise requires: "1997 Stock Option Plan" shall mean the 1997 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates, as the same may be amended from time to time. "Board of Directors" shall have the meaning ascribed to it in the first paragraph of this Resolution. "Business Day" means any day except a Saturday, a Sunday, or other day on which commercial banks in the State of New York or New Jersey are authorized or required by law or executive order to close. "Capital Stock" means, with respect to any Person, any and all shares, interests, participations, rights in, or other equivalents (however designated and whether voting or non-voting) of, such Person's capital stock (but excluding any debt security that is exchangeable for or convertible into such capital stock). "Common Stock" shall have the meaning ascribed to it in Section 2 hereof. "Convertible Securities" shall mean any evidences of indebtedness, shares or securities convertible into or exchangeable for Common Stock. "Corporation" shall have the meaning ascribed to it in the first paragraph of this Resolution. "Dividend Payment Date" means March 31, June 30, September 30 and December 31 of each year. "Dividend Period" means the Initial Dividend Period and, thereafter, each Quarterly Dividend Period. 13 "Fair Market Value" per share of Common Stock as of a particular date (the "Determination Date") shall mean: (i) if the Common Stock is listed or admitted for trading on a national securities exchange, then the Fair Market Value shall be the average of the last 30 "daily sales prices" of the Common Stock on the principal national securities exchange on which the Common Stock is listed or admitted for trading on the last 30 Business Days prior to the Determination Date, or if not listed or traded on any such exchange, then the Fair Market Value shall be the average of the last 30 "daily sales prices" of the Common Stock on the Nasdaq National Market on the last 30 Business Days prior to the Determination Date (the "daily sales price" shall be the closing price for bona fide transactions of the Common Stock at the end of each day); or (ii) if the Common Stock is not so listed or admitted to unlisted trading privileges or if no such sale is made on at least 25 of such days, then the Fair Market Value shall be as reasonably determined by an investment banking firm of recognized national standing selected in good faith by the Company's Board of Directors or a duly appointed committee of the Board of Directors (which determination shall be reasonably described in the written notice delivered to the holders of the Series C Preferred Stock). "Fully Diluted" shall mean at any date as of which the number of shares of Common Stock is to be determined, all shares of Common Stock outstanding at such date and the maximum number of shares of Common Stock issuable in respect of Convertible Securities and warrants, options and other rights to purchase (directly or indirectly) shares of Common Stock or Convertible Securities (giving effect to the then current respective conversion prices) outstanding on such date (to the extent the fights to convert, exchange or exercise thereunder are presently exercisable). "High Yield Debt and Equity Offering" shall have the meaning ascribed to it in Section 5 hereof "Initial Dividend Period" means the dividend period commencing on, and including, the Series C Preferred Stock Issue Date and ending on, and excluding, the first Dividend Payment Date to occur thereafter. "Junior Stock" shall have the meaning ascribed to it in Section 2 hereof. "Liquidation Preference" shall have the meaning ascribed to it in Section 1 hereof. "Loan Agreement" shall have the meaning ascribed to it in Section 6 hereof. "Majority Series C Holders" shall have the meaning ascribed to in Section 6 hereof. "Option" shall mean rights, options, or warrants to subscribe for purchase or otherwise acquire Convertible Securities or Common Stock. "Parity Preferred Stock" means, collectively, the Series A Preferred Stock the Corporation's Series B Cumulative Convertible Preferred Stock, par value $.0l per share, the Series C Preferred Stock, the Corporation's Series D 14 Cumulative Convertible Preferred Stock, par value $.0l per share, and any other series of preferred stock which is determined to be "Parity Preferred Stock" by the Board of Directors. "Person" means any individual, firm, corporation, partnership, limited liability company, trust, incorporated or unincorporated association, joint venture, joint stock company, governmental body or other entity of any kind. "Qualified Public Offering" shall mean the offer for sale of Common Stock pursuant to an effective registration statement filed by the Corporation under the Securities Act of 1933, as amended, in any single transaction or series of related transactions, in which the Corporation receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000 in the aggregate; provided that the per share price at which such shares are sold in the offering (before deduction of underwriting discounts and expenses of sale) is at least four times the conversion price of the Series A Preferred Stock which would then be in effect if determined pursuant to the terms of the Series A Preferred Stock in effect on the initial issuance date of the Series C Preferred Stock (whether or not any shares of Series A Preferred Stock are then outstanding). "Quarterly" shall mean the quarterly periods commencing on, and including, each Dividend Payment Date and ending on, and excluding, each next Dividend Payment Date occurring immediately thereafter, respectively. 15 "Realization Event" shall mean the occurrence of (i) the sale of all or substantially all of the Common Stock or assets of the Corporation or the consolidation or merger of the Corporation with one or more other corporations, in any single transaction or series of related transactions, or (ii) the closing of one or more public offerings of Common Stock in which the Corporation receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000. "Series A Preferred Stock" means the Corporation's Series A Cumulative Convertible Preferred Stock, par value, $.0l per share. "Series C Directors" shall have the meaning ascribed to it in Section 6 hereof. "Series C Preferred Stock" shall have the meaning ascribed to it in Section 1 hereof. "Series C Preferred Stock Issue Date" means the first date on which the Series C Preferred Stock is issued by the Corporation. 16 IN WITNESS WHEREOF, KMC TELECOM HOLDINGS, INC. has caused this certificate to be duly executed by its Chief Financial Officer this 4th day of November, 1997. KMC TELECOM HOLDINGS. INC. By:/s/ Cynthia Worthman ---------------------------- Name: Cynthia Worthman Title: Chief Financial Officer EX-3.6 5 CERTIFICATE OF THE POWER Execution Copy KMC TELECOM HOLDINGS, INC. CERTIFICATE OF THE POWERS, DESIGNATIONS, PREFERENCES AND RIGHTS OF THE SERIES D CUMULATIVE CONVERTIBLE PREFERRED STOCK, PAR VALUE $.0l PER SHARE Pursuant to Sections 141 and 151 of the General Corporation Law of the State of Delaware As contemplated by Section 141 of the General Corporation Law of the State of Delaware (the "DGCL"), the following resolution was duly adopted by the Board of Directors of KMC Telecom Holdings, Inc., a Delaware corporation (the "Corporation"), by unanimous written consent, dated October 31, 1997: WHEREAS, the Board of Directors of the Corporation is authorized, within the limitations and restrictions stated in the Amended and Restated Certificate of Incorporation of the Corporation, to provide by resolution or resolutions for the issuance of shares of preferred stock, par value $.01 per share, of the Corporation, in one or more series with such voting powers, full or limited, or without voting powers, and such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations or restrictions as shall be stated and expressed in the resolution or resolutions providing for the issuance thereof adopted by the Board of Directors, and as are not stated and expressed in the Certificate of Incorporation, or any amendment thereto, including (but without limiting the generality of the foregoing) such provisions as may be desired concerning voting, redemption, dividends, dissolution or the distribution of assets and such other subjects or matters as may be fixed by resolution or resolutions of the Board of Directors under the DGCL; WHEREAS, the Board of Directors of the Corporation, pursuant to its authority under Section 151 of the DGCL, desires to authorize and fix the terms of its Series D Cumulative Convertible Preferred Stock; and WHEREAS, the Board of Directors of the Corporation has determined that such Series D Cumulative Convertible Preferred Stock shall constitute "Parity Preferred Stock" within the meaning of the Certificates of the Powers, Designations, Preferences and Rights of the Corporation's Series A Cumulative Convertible Preferred Stock, Series B Cumulative Convertible Preferred Stock and Series C Preferred Stock; NOW, THEREFORE, BE IT RESOLVED: 1. DESIGNATION AND NUMBER OF SHARES. There shall be hereby established a series of preferred stock designated as "Series D Cumulative Convertible Preferred Stock" (such Series being hereinafter referred to as the "Series D Preferred Stock"). The authorized number of shares of Series D Preferred Stock shall be 25,000. The liquidation preference of the Series D Preferred Stock shall be $100 per share (the "Liquidation Preference"). 2. RANK. The Series D Preferred Stock shall, with respect to dividend distributions and distributions of assets and rights upon the liquidation, winding-up and dissolution of the Corporation, rank senior to the Common Stock, par value $.0l per share, of the Corporation (the "Common Stock") and to each other class or series of Capital Stock of the Corporation (other than the Parity Preferred Stock) hereafter created (the Common Stock and such other class or series of Capital Stock of the Corporation other than Parity Preferred Stock are hereinafter collectively referred to as the "Junior Stock"). 3. DIVIDENDS. (a) Beginning on the date of issuance of the Series D Preferred Stock, the holders of the outstanding shares of Series D Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors of the Corporation, out of funds legally available therefor, cash dividends on each share of Series D Preferred Stock at an annual rate equal to 7.0% of the Liquidation Preference, payable quarterly in arrears on the applicable Dividend Payment Date or the next succeeding Business Day, if the applicable Dividend Payment Date is not a Business Day. Notwithstanding the foregoing, the dividend payable on each share of Series D Preferred Stock with respect to the Initial Dividend Period shall be equal to (i) 7.0% of the Liquidation Preference multiplied by (ii) a fraction equal to (A) the number of days from (and including) the Series D Preferred Stock Issue Date to (but excluding) the Dividend Payment Date with respect to the Initial Dividend Period divided by (B) 365. All dividends shall be cumulative, whether or not earned or declared, from the date of issuance of the Series D Preferred Stock and shall be payable quarterly in arrears on each Dividend Payment Date, commencing on the first Dividend Payment Date after the date of issuance of the Series D Preferred Stock. If any dividend (or portion thereof) payable on any Dividend Payment Date is not declared or paid in full on such Dividend Payment Date, the amount of such dividend payable that is not paid on such date shall increase at the rate of 7.0% per annum (compounded quarterly on each subsequent Dividend Payment Date) from such Dividend Payment Date until paid in full. Each distribution on the Series D Preferred Stock shall be payable to holders of record as they appear on the stock books of the Corporation on such record dates, not less than ten (10) nor more than sixty (60) days preceding the related Dividend Payment Date, as shall be fixed by the Board of Directors of the Corporation. (b) All accumulated and unpaid dividends on the Series D Preferred Stock shall be paid by the Corporation upon the occurrence of a Realization Event, without reference to any regular Dividend Payment Date, to holders of record on such date. The Corporation shall send by first class, postage prepaid mail a notice of the Realization Event to all holders of Series D Preferred Stock that are entitled to receive such dividends. In the case of a Realization Event which is an initial public offering, if any such holder gives written notice to the Corporation that such holder wishes to receive such accumulated unpaid dividends in the form of shares of Common Stock in lieu of cash, the Corporation, in lieu of a cash payment, shall issue to such holder on such Dividend Payment Date, a number of shares of Common Stock equal to the quotient obtained by dividing (x) the aggregate accumulated and unpaid dividends on the shares of Series D Preferred Stock held by such holder by (y) the price at which shares of Common Stock are sold in such offering (before deduction of underwriting discounts and expenses of sale). (c) All dividends paid with respect to shares of Series D Preferred Stock pursuant to Section 3(a) shall be paid pro rata and in like manner to all of the holders entitled thereto. 2 (d) Except as otherwise provided in paragraph (b) above, nothing herein contained shall in any way or under any circumstances be construed or deemed to require the Board of Directors of the Corporation to declare, or the Corporation to pay or set apart for payment, any dividends on shares of the Series D Preferred Stock at any time. (e) Whenever the provisions hereof require that the amount of dividends with respect to the Series D Preferred Stock be determined for less than a full quarterly period ending on a Dividend Payment Date, the amount of dividends for such period shall be equal to 7.0% of the Liquidation Preference multiplied by a fraction equal to (i) the number of days from (and including) the most recent Dividend Payment Date to (but excluding) the last day of the period in respect of which such determination is being made divided by (ii) 365. 4. LIQUIDATION PREFERENCE. (a) In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the affairs of the Corporation, the holders of shares of Parity Preferred Stock (including the Series D Preferred Stock) then outstanding shall be entitled to be paid for each share held thereby, out of the assets of the Corporation available for distribution to its stockholders, an amount in cash equal to the Liquidation Preference plus an amount in cash equal to all accumulated and unpaid dividends thereon (calculated pursuant to Paragraph 3(a)) to the date fixed for liquidation, dissolution or winding-up (including an amount equal to a prorated dividend for the period from the last Dividend Payment Date to the date fixed for liquidation, dissolution or winding-up), before any payment shall be made or any assets distributed to the holders of any shares of Junior Stock. Except as provided in the preceding sentence, holders of the Parity Preferred Stock (including the Series D Preferred Stock) shall not be entitled to any distribution in the event of any liquidation, dissolution or winding-up of the affairs of the Corporation. If the assets of the Corporation are not sufficient to pay in full the foregoing liquidation payments payable to the holders of outstanding shares of the Parity Preferred Stock (including the Series D Preferred Stock), then the holders of all shares of Parity Preferred Stock (including the Series D Preferred Stock) shall share ratably in such distribution of assets in accordance with the amount that would be payable on such distribution if the amounts to which the holders of outstanding shares of Parity Preferred Stock (including the Series D Preferred Stock) are entitled were paid in full. If all of the foregoing liquidation payments with respect to any share of Series D Preferred Stock have been made, such share may not be converted into Common Stock pursuant to Section 5. (b) For the purposes of this Section 4, neither the voluntary sale, conveyance, exchange or transfer (for cash, shares of stocks, securities or other consideration) of all or substantially all or part of the property or assets of the Corporation nor the consolidation or merger of the Corporation with one or more other corporations shall be deemed to be a liquidation, dissolution or winding-up, voluntary or involuntary, of the affairs of the Corporation (unless such sale, conveyance, exchange or transfer is in connection with a liquidation, dissolution or winding-up of the affairs of the Corporation). 4A. CONVERSION INTO SERIES C PREFERRED STOCK At any time prior to a Qualified Public Offering, each holder of Series D Preferred Stock shall have the right to convert all, but not less than all, of such holder's shares of Series D Preferred Stock (together with all accumulated unpaid dividends thereon to the date of conversion) into an equal number of shares of Series C Preferred Stock (together with all accumulated unpaid dividends thereon to the date of conversion). In order to convert shares of Series D Preferred Stock pursuant to this Section 4A the holder thereof shall surrender at the office of the Corporation the certificate or certificates therefor, duty endorsed to the Corporation in blank, and give written notice to the Corporation that such holder elects to convert such shares and shall state in writing therein the name or names (with addresses) in which such holder wishes the certificate or certificates of Series C Preferred Stock to be issued. Shares of Series D Preferred Stock shall be deemed to have been converted on the date of surrender of such certificate or certificates as provided above, and the person or persons entitled to receive the shares of Series C Preferred Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Series C Preferred Stock on such date. As soon as practicable on or after such conversion date, the Corporation shall issue and deliver a certificate or certificates for the number of shares of Series C Preferred Stock issuable upon conversion. 3 5. CONVERSION. (a) CONVERSION PRICE. Shares of Series D Preferred Stock to be converted into shares of Common Stock shall be so converted at a conversion price (which price shall be adjusted to the nearest fourth decimal place as hereinafter provided and, as so adjusted, is hereinafter referred to as the "Conversion Price") equal to: (i) from the date of initial issuance of shares of Series D Preferred Stock to but excluding the 30-month anniversary of such issuance, $52.50 per share of Common Stock, with each share of Series D Preferred Stock being valued at $100.00 for such purpose; PROVIDED, HOWEVER, that if a Realization Event shall occur during such 30-month period the Conversion Price shall equal to a fraction, the numerator of which is (A) the consideration per share of Common Stock (on a Fully Diluted basis) received in connection with such Realization Event, and the denominator of which is (B) 1.30 raised to a number equal to the number of years (or fraction thereof) from the date of initial issuance of shares of Series D Preferred Stock until the date of such Realization Event, but in no case shall be greater than $52.50 per share of Common Stock nor less than $42.18 per share of Common Stock; and (ii) from and after the thirty month anniversary of the date of initial issuance of shares of Series D Preferred Stock (subject to paragraph (b) below), $42.18 per share of Common Stock, with each share of Series D Preferred Stock being valued at $100.00 for such purpose; PROVIDED, HOWEVER, that in no event shall the Conversion Price be less than the par value, if any, of the Common Stock. (b) AUTOMATIC CONVERSION UPON A QUALIFIED PUBLIC OFFERING. Upon a Qualified Public Offering, each share of Series D Preferred Stock shall automatically convert, without any action on the part of the holder thereof, into shares of Common Stock at the Conversion Price in effect at such time, plus the right to receive an amount of cash equal to the accumulated unpaid dividends on such share of Series D Preferred Stock to and including such date (or the right to receive additional shares of Common Stock in lieu of cash dividends pursuant to Section 3(b)). (c) CONVERSION AT THE OPTION OF THE HOLDER. At any time and from time to time prior to a Qualified Public Offering, each holder of Series D Preferred Stock shall have the right to convert such holder's shares of Series D Preferred Stock, in whole or in part, into shares of Common Stock at the Conversion Price in effect at such time, plus the right to receive an amount of cash equal to the accumulated unpaid dividends on the shares of Series D Preferred Stock so converted to and including the Conversion Date (as defined below); provided that, if such Conversion Date is prior to a Realization Event, the Corporation may, in lieu of making a payment in cash equal to such amount, deliver a number of shares of Common Stock equal to such amount divided by the Fair Market Value of one share of Common Stock. In order to convert shares of Series D Preferred Stock pursuant to this Section 5(c) the holder thereof shall surrender at the office of the Corporation the certificate or certificates therefor, duly endorsed to the Corporation in blank, and give written notice to the Corporation that such holder elects to convert such shares and shall state in writing therein the name or names (with addresses) in which such holder wishes the certificate or certificates of Common Stock to be issued. Shares of Series D Preferred Stock shall be deemed to have been converted on the date of surrender of such certificate or certificates as provided above (the "Conversion Date"), and the person or persons entitled to receive the shares of Common Stock issuable upon such conversion shall be treated for all purposes as the record holder or holders of such Common Stock on such date. As soon as practicable on or after the Conversion Date, the Corporation shall issue and deliver a certificate or certificates for the number of shares of Common Stock issuable upon conversion. 4 (d) FRACTIONAL SHARES, PARTIAL CONVERSION. No fractional shares shall be issued upon conversion of shares of Series D Preferred Stock into Common Stock. In case the number of shares of Series D Preferred Stock represented by the certificate or certificates surrendered pursuant to this Section 5 exceeds the number of shares converted, the Corporation shall, upon such conversion, execute and deliver to the holder, at the expense of the Corporation, a new certificate or certificates for the number of shares of Series D Preferred Stock represented by the certificate or certificates surrendered which are not to be converted. If any fractional share of Common Stock would, except for the provisions of the first sentence of this Section 5(d), be delivered upon such conversion, the Corporation, in lieu of delivering such fractional share, shall pay to the holder surrendering the Series D Preferred Stock for conversion an amount in cash equal to the current market price of such fractional share as determined in good faith by the Board of Directors. (e) ADJUSTMENT OF CONVERSION PRICE UPON ISSUANCE OF COMMON STOCK. Except as provided in Section 5(f), if and whenever the Corporation shall hereafter issue or sell, or is, in accordance with subsection 5(e)(1) through 5(e)(6), deemed to have issued or sold, any shares of Common Stock for a consideration per share less than the Conversion Price in effect immediately prior to the time of such issue or sale, then, forthwith upon such issue or sale, the Conversion Price shall be reduced to the price determined by dividing (i) an amount equal to the sum of (a) the number of shares of Common Stock outstanding immediately prior to such issue or sale (determined on a Fully Diluted basis) multiplied by the then existing Conversion Price and (b) the consideration, if any, received by the Corporation upon such issue or sale, by (ii) the total number of shares of Common Stock outstanding immediately after such issue or sale (deter-mined on a Fully Diluted basis). For purposes of this Section 5(e), the following subsections 5(e)(1) to 5(e)(6) shall also be applicable: 5(e)(1) ISSUANCE OF RIGHTS OR OPTIONS. In case at any time hereafter the Corporation shall in any manner grant (whether directly or by assumption in a merger or otherwise) any Options to purchase Common Stock or any Convertible Securities, whether or not such Options or the right to convert or exchange any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such Options or upon the conversion or exchange of such Convertible Securities (determined by dividing (i) the total amount, if any, received or receivable by the Corporation as consideration for the granting of such Options, plus the minimum aggregate amount of additional consideration payable to the Corporation upon the exercise of all such Options, plus, in the case of such Options which relate to Convertible Securities, the minimum aggregate amount of additional consideration, if any, payable upon the issue or sale of such Convertible Securities and upon the conversion or exchange thereof, by (ii) the total maximum number of shares of Common Stock issuable upon the exercise of such Options or upon the conversion or exchange of all such Convertible Securities issuable upon the exercise of such Options) shall be less than the Conversion Price in effect immediately prior to the time of the granting of such Options, then the total maximum number of shares of Common Stock issuable upon the exercise of such Options or upon conversion or exchange of the total maximum amount of such Convertible Securities issuable upon the exercise of such Options shall be deemed to have been issued for such price per share as of the date of granting of such Options or the issuance of such Convertible Securities and thereafter shall be deemed to be outstanding. Except as otherwise provided in subsection 5(e)(3), no adjustment of the Conversion Price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such Options or upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities. 5 5(e)(2) ISSUANCE OF CONVERTIBLE SECURITIES. In case the Corporation shall hereafter in any manner issue (whether directly or by assumption in a merger or otherwise) or sell any Convertible Securities, whether or not the rights to exchange or convert any such Convertible Securities are immediately exercisable, and the price per share for which Common Stock is issuable upon such conversion or exchange (determined by dividing (i) the total amount received or receivable by the Corporation as consideration for the issue or sale of such Convertible Securities, plus the minimum aggregate amount of additional consideration, if any, payable to the Corporation upon the conversion or exchange thereof, by (ii) the total maximum number of shares of Common Stock issuable upon the conversion or exchange of all such Convertible Securities) shall be less than the Conversion Price in effect immediately prior to the time of such issue or sale, then the total maximum number of shares of Common Stock issuable upon conversion or exchange of all such Convertible Securities shall be deemed to have been issued for such price per share as of the date of the issue or sale of such Convertible Securities and thereafter shall be deemed to be outstanding, provided that (a) except as otherwise provided in subparagraph 5(e)(3), no adjustment of the Conversion Price shall be made upon the actual issue of such Common Stock upon conversion or exchange of such Convertible Securities and (b) if any such issue or sale of such Convertible Securities is made upon exercise of any Options to purchase any such Convertible Securities for which adjustments of the Conversion Price have been or are to be made pursuant to other provisions of this Section 5(e), no further adjustment of the Conversion Price shall be made by reason of such issue or sale. 5(e)(3) CHANGE IN OPTION PRICE OR CONVERSION RATE. Upon the happening of any of the following events, namely, if the purchase price provided for in any Option referred to in subsection 5(e)(1), the additional consideration, if any, payable upon the conversion or exchange of any Convertible Securities referred to in subsection 5(e)(1) or 5(e)(2) or the rate at which Convertible Securities referred to in subsection 5(e)(1) or 5(e)(2) are convertible into or exchangeable for Common Stock shall change at any time (including, but not limited to, changes under or by reason of provisions designed to protect against dilution), the Conversion Price in effect at the time of such event shall forthwith be readjusted to the Conversion Price which would have been in effect at such time had such Options or Convertible Securities still outstanding provided for such changed purchase price, additional consideration or conversion rate, as the case may be, at the time initially granted, issued or sold, but only if as a result of such adjustment the Conversion Price then in effect hereunder is thereby reduced; and on the termination of any such Option or any such right to convert or exchange such Convertible Securities, the Conversion Price then in effect hereunder shall forthwith be increased to the Conversion Price which would have been in effect at the time of such termination had such Option or Convertible Securities, to the extent outstanding immediately prior to such termination, never been issued. 5(e)(4) CONSIDERATION FOR STOCK. In case any shares of Common Stock, Options or Convertible Securities shall be issued or sold for cash, the consideration received therefor shall be deemed to be the amount received by the Corporation therefor, without deduction therefrom of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Corporation in connection therewith. In case any shares of Common Stock, Options or Convertible Securities shall be issued or sold for a consideration other than cash, the amount of the consideration other than cash received by the Corporation shall be deemed to be the fair value of such consideration as determined in good faith by the Board of Directors, without deduction of any expenses incurred or any underwriting commissions or concessions paid or allowed by the Corporation in connection therewith. In case any Options shall be issued in connection with the issue and sale of other securities of the Corporation, together comprising one integral transaction in which no specific consideration is allocated to such Options by the parties thereto, such Options shall be deemed to have been issued for such consideration as determined in good faith by the Board of Directors of the Corporation. 5(e)(5) RECORD DATE. In case the Corporation shall take a record of the holders of its Common Stock for the purpose of entitling them (i) to receive a dividend or other distribution payable in Common Stock, Options or Convertible Securities or (ii) to subscribe for or purchase Common Stock, options or Convertible Securities, then such record date shall be deemed to be the date of the issue or sale of the shares of Common Stock deemed to have been issued or sold upon the declaration of such dividend or the making of such other distribution or the date of the granting of such right of subscription or purchase, as the case may be. 6 5(e)(6) TREASURY SHARES. The number of shares of Common Stock outstanding at any given time shall not include shares owned or held by or for the account of the Corporation, and the disposition of any such shares shall be considered an issue or sale of Common Stock for the purpose of this Section 5(e). (f) EXCEPTIONS TO CONVERSION PRICE ADJUSTMENT. Notwithstanding the foregoing, no adjustment to the Conversion Price shall be made pursuant to this Section 5 in connection with the grant, issuance or sale of Common Stock, Convertible Securities, warrants, options or other fights to subscribe for or purchase Common Stock or Convertible Securities: (i) pursuant to employee stock purchase or stock option ownership plans adopted by the Corporation for employees, consultants and/or directors of the Corporation and its affiliates; (ii) pursuant to the terms of any Convertible Securities, warrants, options or other rights to subscribe for or purchase granted, issued or sold pursuant to clause (ii) above; (iii) pursuant to the High Yield Debt and Equity Offering (as defined in a Subordinated Loan and Security Agreement, dated as of September 22, 1997, among KMC Telecom Inc. ("KMC") and KMC Telecom II, Inc. and AT&T Commercial Finance Corporation, as in effect on the Series C Preferred Stock Issue Date) or a subsequent debt offering occurring prior to December 31, 1998; (iv) pursuant to the terms of any Convertible Securities, warrants, options or other rights to subscribe for or purchase granted, issued or sold pursuant to clauses (iii) above; or (v) pursuant to Section 10C of the Amended and Restated Note Purchase and Investment Agreement, dated as of October 22, 1996, as amended, by and among the Corporation, Nassau Capital Partners L.P., NAS Partners I L.L.C. and Harold N. Kamine; PROVIDED that the aggregate number of shares of Common Stock issued or issuable pursuant to clauses (i) and (ii) above shall not exceed 15% of the Common Stock (on a Fully Diluted basis) outstanding from time to time and the aggregate number of shares of Common Stock issued or issuable pursuant to clause (iii) and (iv) above shall not exceed 11% of the Common Stock (on a Fully Diluted basis) outstanding from time to time; and FURTHER PROVIDED that for the purposes of this Section 5(f): (a) 221,500 shares of Common Stock initially allocated under the 1997 Stock Option Plan will be deemed outstanding regardless of the number of shares actually granted and exercisable thereunder and (b) shares of Common Stock issued or issuable upon exercise of options not among the 221,500 shares initially allocated pursuant to the 1997 Stock Option Plan and which, when issued, were subject to clause (i) or (ii) above, will not be deemed outstanding, regardless of whether or not they have been granted or are exercisable. (g) SUBDIVISION OR COMBINATION OF COMMON STOCK. In case the Corporation shall at any time subdivide (by any stock split, stock dividend or otherwise) its outstanding shares of Common Stock into a greater number of shares, the Conversion Price in effect immediately prior to such subdivision shall be proportionately reduced, and, conversely, in case the outstanding shares of Common Stock shall be combined into a smaller number of shares, the Conversion Price in effect immediately prior to such combination shall be proportionately increased. (h) REORGANIZATION OR RECLASSIFICATION. If any capital reorganization or reclassification of the capital stock of the Corporation shall be effected in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganization or reclassification (but subject to Section 7), lawful and adequate provisions shall be made whereby each holder of a share or shares of Series D Preferred Stock shall thereupon have the right to receive, upon the basis and upon the terms and conditions specified herein and in lieu of the shares of Common Stock immediately theretofore receivable upon the 7 conversion of such share or shares of Series D Preferred Stock, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of such Common Stock equal to the number of shares of such Common Stock immediately theretofore receivable upon such conversion had such reorganization or reclassification not taken place, and in any such case appropriate provisions shall be made with respect to the rights and interests of such holder to the end that the provisions hereof (including, without limitation, provisions for adjustments of the Conversion Price) shall thereafter be applicable, as nearly as may be, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise of such conversion rights. (i) CARRYOVER. Notwithstanding any other provisions of this Section 5, the Corporation shall not be required to make any adjustment to the Conversion Price unless such adjustment would require an increase or decrease of at least one percent (1%) in the Conversion Price. Any lesser adjustment shall be carried forward and shall be made no later than the time of, and together with, the next subsequent adjustment which, together with any adjustment or adjustments so carried forward, shall amount to an increase or decrease of at least one percent (1%) in the Conversion Price. (j) OTHER EVENTS. If the Corporation shall make any dividend (excluding cash dividends payable out of accumulated earnings and profits) or distribution on the Common Stock or issue any Common Stock, other capital stock or other security of the Corporation or any rights or warrants to purchase or acquire any such security, which transaction does not result in an adjustment to the Conversion Price pursuant to the foregoing provisions of this Section 5, the Board of Directors may consider whether such action is of such a nature that an adjustment to the Conversion Price should equitably be made in respect of such transaction. If the Board of Directors of the Corporation determines that an adjustment to the Conversion Price should be made, an adjustment shall be made effective as of such date, as determined by the Board of Directors of the Corporation. The determination of the Board of Directors of the Corporation as to whether such an adjustment to the Conversion Price should be made, and, if so, as to what adjustment should be made and when, shall be final and binding on the Corporation and all stockholders of the Corporation. The Corporation shall be entitled to make such additional adjustments in the Conversion Price, in addition to those required by the foregoing provisions of this Section 5, as shall be necessary in order that any dividend or distribution in shares of capital stock of the Corporation, subdivision, reclassification or combination of shares of stock of the Corporation or any recapitalization of the Corporation shall not be taxable to the holders of the Common Stock. (k) NOTICE OF ADJUSTMENT. Upon any adjustment of the Conversion Price, then and in each such case the Corporation shall give written notice thereof, by delivery in person, certified or registered mail, return receipt requested, or facsimile addressed to each holder of shares of Series D Preferred Stock affected by such adjustment at the address of such holder as shown on the books of the Corporation, which notice shall state the Conversion Price resulting from such adjustment, setting forth in reasonable detail the method upon which such calculation is based. 6. VOTING RIGHTS. (a) The holders of Series D Preferred Stock, except as otherwise required under Delaware law or as set forth below in this Section 6, shall not be entitled or permitted to vote on any matter required or permitted to be voted upon by the stockholders of the Corporation. 8 (b) Subject to Section 7, without the prior consent of the holders of two-thirds of the shares of the Series D Preferred Stock then outstanding, voting as a separate class, the Corporation shall not: (i) increase the number of shares of Series D Preferred Stock authorized for issuance; (ii) merge or consolidate with or into any other company, person or entity, unless holders of each share of Series D Preferred Stock receive consideration in an amount equal to at least the greater of (A) the product of (x) the number of shares of Common Stock into which such share of Series D Preferred Stock is then convertible and (y) the consideration to be received by holders of each share of Common Stock pursuant to such merger or consolidation and (B) the Liquidation Preference of such share of Series D Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared); (iii) amend, modify or repeal the powers, preferences or rights of or the restrictions provided for the benefit of holders of the Series D Preferred Stock or the Common Stock if such action would affect the Series D Preferred Stock or the Common Stock adversely; (c) Without the consent of each holder of Series D Preferred Stock affected thereby, the Corporation shall not reduce the Liquidation Preference of the Series D Preferred Stock or the rate at which dividends accumulate thereon, or modify the dividend cumulation provisions of the Series D Preferred Stock or the times and prices at which the Series D Preferred Stock may be redeemed in a manner that would be adverse to the holders of Series D Preferred Stock. 7. OPTIONAL REDEMPTION. (a) The outstanding shares of Series D Preferred Stock shall be subject to redemption, as hereinafter provided, at the option of the Corporation, in whole but not in part, in connection with an Acquisition Event. For purposes hereof, "Acquisition Event" shall mean any merger or consolidation of the Corporation with any other company, person or entity (whether or not the Corporation is the entity surviving in such transaction) as a result of which the holders of shares of Common Stock (determined on a fully diluted basis) will hold less than a majority of the outstanding shares of common stock or other equity interests of the company, person or entity resulting from such transaction (or any parent of such entity). (b) For each share of Series D Preferred Stock redeemed pursuant to this Section 7, the Corporation shall be obligated on the date fixed for such redemption (the "Redemption Date"), which date shall not be earlier than the date of consummation of the applicable Acquisition Event, to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount (the "Redemption Price") equal to the greater of (A) the product of (x) the number of shares of Common Stock into which such share of Series D Preferred Stock is then convertible and (y) the consideration to be received by holders of each share of Common Stock pursuant to such Acquisition Event and (B) the Liquidation Preference of such share of Series D Preferred Stock plus all accumulated but unpaid dividends thereon (whether or not declared). (c) Notice of any redemption of the Series D Preferred Stock pursuant to this Section 7 (specifying the time and place of redemption, the Redemption Price, the Conversion Price and the date on and after which shares of Series D Preferred Stock may no longer be converted) shall be mailed by certified or registered mail, return receipt requested, to each holder of Series D Preferred Stock, at the address of such holder shown on the Corporation's records, not less than 30 nor more than 45 days prior to the Redemption Date. 9 (d) If the Corporation holds and sets aside money sufficient to pay the Redemption Price of the Series D Preferred Stock on the Redemption Date, then on and after the Redemption Date: (i) the shares of Series D Preferred Stock shall no longer be convertible into shares of Common Stock; (ii) the shares of Series D Preferred Stock will cease to be outstanding and dividends on the Series D Preferred Stock will cease to be declared and paid, whether or not certificates representing the Series D Preferred Stock have been delivered to the Corporation; and (iii) all other rights of the holder in respect thereof shall terminate (other than the right to receive the Redemption Price upon delivery of such Series D Preferred Stock). 8. REISSUANCE OF SERIES D PREFERRED STOCK. Shares of Series D Preferred Stock that have been issued and reacquired in any manner, including shares purchased or redeemed or exchanged or converted, shall (upon compliance with any applicable provisions of the laws of Delaware) have the status of authorized and unissued shares of preferred stock undesignated as to series and may be redesignated and reissued as part of any series of preferred stock (other than Series D Preferred Stock). 9. BUSINESS DAY. If any payment or conversion shall be required by the terms hereof to be made on a day that is not a Business Day, such payment or conversion shall be made on the immediately succeeding Business Day. 10. DEFINITIONS. As used in this Certificate of Designation, the following terms shall have the following meanings (with terms defined in the singular having comparable meanings when used in the plural and VICE VERSA), unless the context otherwise requires: "1997 Stock option plan" shall mean the 1997 stock purchase and option plan for key employees of kmc telecom holdings, inc. And affiliates, as the same may be amended from time to time. "Board of Directors" shall have the meaning ascribed to it in the first paragraph of this Resolution. "Business Day" means any day except a Saturday, a Sunday, or other day on which commercial banks in the State of New York or New Jersey are authorized or required by law or executive order to close. "Capital Stock" means, with respect to any Person, any and all shares, interests, participations, rights in, or other equivalents (however designated and whether voting or non-voting) of, such Person's capital stock (but excluding any debt security that is exchangeable for or convertible into such capital stock). "Common Stock" shall have the meaning ascribed to it in Section 2 hereof. "Convertible Securities" shall mean any evidences of indebtedness, shares or securities convertible into or exchangeable for Common Stock. 10 "Corporation" shall have the meaning ascribed to it in the first paragraph of this Resolution. "Dividend Payment Date" means March 31, June 30, September 30 and December 31 of each year. "Dividend Period" means the Initial Dividend Period and, thereafter, each Quarterly Dividend Period. "Fair Market Value" per share of Common Stock as of a particular date (the "Determination Date") shall mean: (i) if the Common Stock is listed or admitted for trading on a national securities exchange, then the Fair Market Value shall be the average of the last 30 "daily sales prices" of the Common Stock on the principal national securities exchange on which the Common Stock is listed or admitted for trading on the last 30 Business Days prior to the Determination Date, or if not listed or traded on any such exchange, then the Fair Market Value shall be the average of the last 30 "daily sales prices" of the Common Stock on the Nasdaq National Market on the last 30 Business Days prior to the Determination Date (the "daily sales price" shall be the closing price for bona fide transactions of the Common Stock at the end of each day); or (ii) if the Common Stock is not so listed or admitted to unlisted trading privileges or if no such sale is made on at least 25 of such days, then the Fair Market Value shall be as reasonably determined by an investment banking firm of recognized national standing selected in good faith by the Company's Board of Directors or a duly appointed committee of the Board of Directors (which determination shall be reasonably described in the written notice delivered to the holders of the Series D Preferred Stock). "Fully Diluted" shall mean at any date as of which the number of shares of Common Stock is to be determined, all shares of Common Stock outstanding at such date and the maximum number of shares of Common Stock issuable in respect of Convertible Securities and warrants, options and other rights to purchase (directly or indirectly) shares of Common Stock or Convertible Securities (giving effect to the then current respective conversion prices) outstanding on such date (to the extent the rights to convert, exchange or exercise thereunder are presently exercisable). "High Yield Debt and Equity Offering" shall have the meaning ascribed to it in Section 5 hereof. "Initial Dividend Period" means the dividend period commencing on, and including, the Series D Preferred Stock Issue Date and ending on, and excluding, the first Dividend Payment Date to occur thereafter. "Junior Stock" shall have the meaning ascribed to it in Section 2 hereof. "Liquidation Preference" shall have the meaning ascribed to it in Section 1 hereof. "Option" shall mean rights, options, or warrants to subscribe for purchase or otherwise acquire Convertible Securities or Common Stock. "Parity Preferred Stock" means, collectively, the Series A Preferred Stock, the Corporation's Series B Cumulative Convertible Preferred Stock, par value $.01 per share, the Series C Preferred Stock, the Series D Preferred Stock and any other series of preferred stock which is determined to be "Parity Preferred Stock" by the Board of Directors. "Person" means any individual, firm, corporation, partnership, limited liability company, trust, incorporated or unincorporated association, joint venture, joint stock company, governmental body or other entity of any kind. 11 "Qualified Public Offering" shall mean the offer for sale of Common Stock pursuant to an effective registration statement filed by the Corporation under the Securities Act of 1933, as amended, in any single transaction or series of related transactions, in which the Corporation receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000 in the aggregate; provided that the per share price at which such shares are sold in the offering (before deduction of underwriting discounts and expenses of sale) is at least four times the conversion price of the Series A Preferred Stock which would then be in effect if determined pursuant to the terms of the Series A Preferred Stock in effect on the initial issuance date of the Series D Preferred Stock (whether or not any shares of Series A Preferred Stock are then outstanding). "Quarterly" shall mean the quarterly periods commencing on, and including, each Dividend Payment Date and ending on, and excluding, each next Dividend Payment Date occurring immediately thereafter, respectively. "Realization Event" shall mean the occurrence of (i) the sale of all or substantially all of the Common Stock or assets of the Corporation or the consolidation or merger of the Corporation with one or more other corporations, in any single transaction or series of related transactions, or (ii) the closing of one or more public offerings of Common Stock in which the Corporation receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000. "Series A Preferred Stock" means the Corporation's Series A Cumulative Convertible Preferred Stock, par value, $.0l per share. "Series C Preferred Stock" means the Corporation's Series C Cumulative Convertible Preferred Stock, par value, $.0l per share. "Series D Preferred Stock" shall have the meaning ascribed to it in Section 1 hereof. "Series D Preferred Stock Issue Date" means the first date on which the Series D Preferred Stock is issued by the Corporation. IN WITNESS WHEREOF, KMC TELECOM HOLDINGS, INC., has caused this certificate to be duly executed by its Chief Financial Officer this 4th day of November, 1997. KMC TELECOM HOLDINGS, INC. By: /S/ CYNTHIA WORTHMAN -------------------------- Name: Cynthia Worthman Title: Chief Financial Officer 12 EX-3.7 6 CERTIFICATE 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. -------------------------- Pursuant to Section 151 of the General Corporation Law of the State of Delaware -------------------------- I, Cynthia Worthman, Corporate Secretary of KMC Telecom Holdings, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, in accordance with the provisions of Section 151 of the General Corporation Law of the State of Delaware, DO HEREBY CERTIFY: That, pursuant to authority conferred upon the Board of Directors by the Certificate of Incorporation, as amended, of said Corporation (the "Certificate of Incorporation"), said Board of Directors, at a meeting duly called and held on February 1, 1999, adopted a resolution providing for the issuance of 175,000 authorized shares of Series E Senior Redeemable, Exchangeable, PIK Preferred Stock (the "Series E Preferred Stock"), which resolution is as follows: WHEREAS, the Board of Directors is authorized, within the limitations and restrictions stated in the Certificate of Incorporation, as amended, to fix by resolution or resolutions the designation of each series of preferred stock and the powers, designations, preferences and relative participating, optional or other rights, if any, or the qualifications, limitations or restrictions thereof, including, without limiting the generality of the foregoing, such provisions as may be desired concerning voting, redemption, dividends, dissolution or the distribution of assets, conversion or exchange, and such other subjects or matters as may be fixed by resolution or resolutions of the Board of Directors under the General Corporation Law of Delaware; and WHEREAS, it is the desire of the Board of Directors, pursuant to its authority as aforesaid, to authorize and fix the terms of a series of preferred stock and the number of shares constituting such series; NOW, THEREFORE, BE IT RESOLVED, that there is hereby authorized such series of preferred stock on the terms and with the provisions herein set forth: I. Certain Definitions. As used herein, the following terms shall have the following meanings (with terms defined in the singular having comparable meanings when used in the plural and vice versa), unless the context otherwise requires: "Acquired Indebtedness" means Indebtedness of a Person existing at the time such Person becomes a Restricted Subsidiary or assumed in connection with an Asset Acquisition by the Corporation or a Restricted Subsidiary and not Incurred in connection with, or in anticipation of, such Person becoming a Restricted Subsidiary or such Asset Acquisition; provided that Indebtedness of such Person which is redeemed, defeased, retired or otherwise repaid at the time of or immediately upon consummation of the transactions by which such Person becomes a Restricted Subsidiary or upon consummation of such Asset Acquisition shall not be Acquired Indebtedness. "Adjusted Consolidated Net Income" means, for any period, the aggregate net income (or loss) of the Corporation and its Restricted Subsidiaries for such period determined in conformity with GAAP; provided that the following items shall be excluded in computing Adjusted Consolidated Net Income (without duplication): (i) the net income (or loss) of any Person that is not a Restricted Subsidiary (or is an Unrestricted Subsidiary), except to the extent of the amount of dividends or other distributions actually paid to the Corporation or any of its Restricted Subsidiaries by such Person or an Unrestricted Subsidiary during such period; (ii) solely for the purposes of calculating the amount of Restricted Payments that may be made pursuant to clause (iii)(B) of the first paragraph of Section XI(B) (and in such case, except to the extent includable pursuant to clause (i) above), the net income (or loss) of any Person accrued prior to the date it becomes a Restricted Subsidiary or is merged into or consolidated with the Corporation or any of its Restricted Subsidiaries or all or substantially all of the property and assets of such Person are acquired by the Corporation or any of its Restricted Subsidiaries; (iii) the net income of any Restricted Subsidiary to the extent that the declaration or payment of dividends or similar distributions by such Restricted Subsidiary of such net income is not at the time permitted by the operation of the terms of its charter or any agreement, instrument, judgment, decree, order, statute, rule or governmental regulation applicable to such Restricted Subsidiary (except to the extent such restriction has been legally waived); (iv) any gains or losses (on an after-tax basis) attributable to Asset Sales including for purposes hereof the items referred to in clauses (b), (c) and (e) of the definition of "Asset Sale" or the termination of discontinued operations; (v) except for purposes of calculating the amount of Restricted Payments that may be made pursuant to clause (iii)(B) of the first paragraph of Section XI(B), any amount paid or accrued as dividends on Preferred Stock (including the Series E Preferred Stock) of the Corporation or any Restricted Subsidiary owned by Persons other than the Corporation and any of its Restricted Subsidiaries; (vi) all extraordinary gains and extraordinary losses; (vii) the cumulative effect of a change in accounting principles since the High Yield Closing Date; and (viii) at the irrevocable election of the Corporation for each occurrence, any net after-tax income (loss) from discontinued operations; provided that for purposes of any subsequent Investment in the entity conducting such discontinued operations pursuant to Section XI(B), such entity shall be treated as an Unrestricted Subsidiary until such discontinued operations have actually been disposed of. "Adjusted Consolidated Net Tangible Assets" means the total amount of assets of the Corporation and its Restricted Subsidiaries (less applicable depreciation, amortization and other valuation reserves), except to the extent resulting from write-ups of capital assets (excluding write-ups in connection with accounting for acquisitions in conformity with GAAP), after deducting therefrom (i) all current liabilities of the Corporation and its Restricted Subsidiaries (excluding intercompany items) and (ii) all goodwill, trade names, trademarks, patents, unamortized debt discount and expense and other like intangibles, all as set forth on the most recent quarterly or annual consolidated balance sheet of the Corporation and its Restricted Subsidiaries, prepared in conformity with GAAP. "Affiliate" means, as applied to any Person, any other Person directly or indirectly controlling, controlled by, or under direct or indirect common control with, such Person. For purposes of this definition, "control" (including, with correlative meanings, the terms "controlling," "controlled by" and "under common control with"), as applied to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. "Asset Acquisition" means (i) an investment by the Corporation or any of its Restricted Subsidiaries in any other Person pursuant to which such Person shall become a Restricted Subsidiary or shall be merged into or consolidated with the Corporation or any of its Restricted Subsidiaries or (ii) an acquisition by the Corporation or any of its Restricted Subsidiaries of the property and assets of any Person other than the Corporation or any of its Restricted Subsidiaries that constitute substantially all of a division or line of business of such Person. "Asset Sale" means any sale, transfer or other disposition (including by way of merger, consolidation or sale-leaseback transaction) in one transaction or a series of related transactions by the Corporation or any of its Restricted Subsidiaries to any Person other than the Corporation or any of its Restricted Subsidiaries of (i) all or any of the Capital Stock of any Restricted Subsidiary, (ii) all or substantially all of the property and assets of an operating unit or business of the Corporation or any of its Restricted Subsidiaries or (iii) any other property and assets (other than the Capital Stock or other Investment in an Unrestricted Subsidiary) of the Corporation or any of its Restricted Subsidiaries outside the ordinary course of business of the Corporation or such Restricted Subsidiary and, in each case, that is not governed by Section IX; provided that "Asset Sale" shall not include (a) sales or other dispositions of inventory, receivables and other current assets, (b) sales or other dispositions of assets for consideration at least equal to the fair market value of the assets sold or disposed of, to the extent that the consideration received would constitute property or assets of the kind described in clause (i)(B) of Section XI(F), (c) a disposition of cash or Temporary Cash Investments, (d) any Restricted Payment that is permitted to be made, and is made, in accordance with Section XI(B), (e) sales or other dispositions of assets with a fair market value (as certified in an Officers' Certificate) not in excess of $2 million (provided that any series of related sales or dispositions in excess of $2 million shall be considered "Asset Sales"), (f) the lease, assignment of a lease or sub-lease of any real or personal property in the ordinary course of business, (g) foreclosures on assets, (h) pledges of assets or stock by the Corporation or any of its Restricted Subsidiaries otherwise permitted under this Certificate of Designations, including such pledges securing Indebtedness under the Newcourt Facility or under the Lucent Facility, (i) the issuance of the Warrants to Newcourt Finance and Lucent by the Corporation and (j) the exercise of the Warrants by Newcourt Finance and Lucent and the exercise of common stock warrants by Newcourt Finance in respect of KMC Telecom. "Average Life" means, at any date of determination with respect to any debt security, the quotient obtained by dividing (i) the sum of the products of (a) the number of years from such date of determination to the dates of each successive scheduled principal payment of such debt security and (b) the amount of such principal payment by (ii) the sum of all such principal payments. "Board of Directors" means the Board of Directors of the Corporation. "Board Resolution" means a copy of a resolution, certified by the Secretary or Assistant Secretary of the Corporation as required by the context to have been duly adopted by the Board of Directors and to be in full force and effect on the date of such certification, and delivered to the Transfer Agent. "Business Day" means a day other than a Saturday, Sunday or other day on which commercial banks in New York City are authorized or required by law to close. "Capital Stock" means, with respect to any Person, any and all shares, interests, participations or other equivalents (however designated, whether voting or non-voting) in equity of such Person, whether outstanding on the Closing Date or issued thereafter, including, without limitation, all Common Stock, Preferred Stock (including the Series E Preferred Stock), partnership or membership interests and any other right to receive a share of the profits and losses of, or distributions of assets of, the issuing Person. "Capitalized Lease" means, as applied to any Person, any lease of any property (whether real, personal or mixed) of which the discounted present value of the rental obligations of such Person as lessee, in conformity with GAAP, is required to be capitalized on the balance sheet of such Person. "Capitalized Lease Obligations" means the amount of the liability in respect of a Capitalized Lease that would at such time be required to be capitalized and reflected as a liability on a balance sheet prepared in accordance with GAAP. "Change of Control" means such time as (i) a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) becomes the ultimate "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) of more than 50% of the total voting power of the Voting Stock of the Corporation on a fully diluted basis and such ownership represents a greater percentage of the total voting power of the Voting Stock of the Corporation, on a fully diluted basis, than is held by the Existing Stockholders on such date; or (ii) individuals who on the Closing Date constitute the Board of Directors (together with any new directors whose election by the Board of Directors or whose nomination by the Board of Directors for election by the Corporation's stockholders was approved by a vote of at least a majority of the members of the Board of Directors then in office who either were members of the Board of Directors on the Closing Date or whose election or nomination for election was so previously approved) cease for any reason to constitute a majority of the members of the Board of Directors then in office. "Closing Date" means February 4, 1999. "Commission" means the Securities and Exchange Commission and any successor agency having similar powers. "Common Stock" means the Common Stock, par value $.01 per share, of the Corporation and any other class of common stock hereafter authorized by the Corporation from time to time. "Consolidated EBITDA" means, for any period, Adjusted Consolidated Net Income for such period plus, to the extent such amount was deducted in calculating such Adjusted Consolidated Net Income, (i) Consolidated Interest Expense, (ii) income taxes (other than income taxes (either positive or negative) attributable to extraordinary and non-recurring gains or losses or sales of assets), (iii) depreciation expense, (iv) amortization expense and (v) all other non-cash items reducing Adjusted Consolidated Net Income (other than items that will require cash payments and for which an accrual or reserve is, or is required by GAAP to be, made), less all non-cash items increasing (or, in the case of a loss, decreasing) Adjusted Consolidated Net Income, determined, with respect to clauses (ii), (iii) and (iv), on a consolidated basis for the Corporation and its Restricted Subsidiaries in conformity with GAAP; provided that, if any Restricted Subsidiary is not a Wholly Owned Restricted Subsidiary, Consolidated EBITDA shall be reduced (to the extent not otherwise reduced in accordance with GAAP) by an amount equal to (A) the amount of the Adjusted Consolidated Net Income attributable to such Restricted Subsidiary multiplied by (B) the percentage ownership interest in the income of such Restricted Subsidiary not owned on the last day of such period by the Corporation or any of its Restricted Subsidiaries. "Consolidated Interest Expense" means, for any period, the aggregate amount (without duplication) of interest in respect of Indebtedness (including, without limitation, amortization of original issue discount on any Indebtedness and the interest portion of any deferred payment obligation, calculated in accordance with the effective interest method of accounting; all commissions, discounts and other fees and charges owed with respect to letters of credit and bankers' acceptance financing; the net costs associated with Interest Rate Agreements; and Indebtedness that is Guaranteed or secured by the Corporation or any of its Restricted Subsidiaries) and the interest component of Capitalized Lease Obligations paid, accrued or scheduled to be paid or to be accrued by the Corporation and its Restricted Subsidiaries during such period; excluding, however, (i) any amount of such interest of any Restricted Subsidiary if the net income of such Restricted Subsidiary is excluded in the calculation of Adjusted Consolidated Net Income pursuant to clause (iii) of the definition thereof (but only in the same proportion as the net income of such Restricted Subsidiary is excluded from the calculation of Adjusted Consolidated Net Income pursuant to clause (iii) of the definition thereof) and (ii) any premiums, fees and expenses (and any amortization thereof) payable in connection with the Lucent Facility, the Newcourt Facility and the offering of the Series E Preferred Stock, the Series F Preferred Stock and the Senior Discount Notes, all as determined on a consolidated basis (without taking into account Unrestricted Subsidiaries) in conformity with GAAP. "Consolidated Leverage Ratio" means, on any Transaction Date, the ratio of (i) the aggregate amount of Indebtedness of the Corporation and its Restricted Subsidiaries on a consolidated basis outstanding on such Transaction Date to (ii) the aggregate amount of Consolidated EBITDA for the then most recent four fiscal quarters for which financial statements of the Corporation have been provided to the Transfer Agent (such four fiscal quarter period being the "Four Quarter Period"); provided that, in making the foregoing calculation, pro forma effect shall be given to the following events which occur from the beginning of the Four Quarter Period through the Transaction Date (the "Reference Period"): (i) the Incurrence of the Indebtedness with respect to which the computation is being made and (if applicable) the application of the net proceeds therefrom, including to refinance other Indebtedness, as if such Indebtedness was incurred, and the application of such proceeds occurred, at the beginning of the Four Quarter Period; (ii) the Incurrence, repayment or retirement of any other Indebtedness by the Corporation and its Restricted Subsidiaries since the first day of the Four Quarter Period as if such Indebtedness was incurred, repaid or retired at the beginning of the Four Quarter Period; (iii) in the case of Acquired Indebtedness, the related acquisition, as if such acquisition occurred at the beginning of the Four Quarter Period; (iv) any acquisition or disposition by the Corporation and its Restricted Subsidiaries of any corporation or any business or any assets out of the ordinary course of business, whether by merger, stock purchase or sale or asset purchase or sale or any related repayment of Indebtedness, in each case since the first day of the Four Quarter Period, assuming such acquisition or disposition had been consummated on the first day of the Four Quarter Period and after giving pro forma effect to net cost savings that the Corporation reasonably believes in good faith could have been achieved during the Four Quarter Period as a result of such acquisition or disposition (provided that both (A) such cost savings were identified and quantified in an Officers' Certificate delivered to the Transfer Agent at the time of the consummation of the acquisition or disposition and (B) with respect to each acquisition or disposition completed prior to the 90th day preceding such date of determination, actions were commenced or initiated by the Corporation within 90 days of such acquisition or disposition to effect such cost savings identified in such Officers' Certificate and with respect to any other acquisition or disposition, such Officers' Certificate sets forth the specific steps to be taken within the 90 days after such acquisition or disposition to accomplish such cost savings); and provided further that (x) in making such computation, the Consolidated Interest Expense attributable to interest on any Indebtedness computed on a pro forma basis and (A) bearing a floating interest rate shall be computed as if the rate in effect on the date of computation had been the applicable rate for the entire period and (B) which was not outstanding during the period for which the computation is being made but which bears, at the option of the Corporation, a fixed or floating rate of interest shall be computed by applying, at the option of the Corporation, either the fixed or floating rate, and (y) in making such computation, the Consolidated Interest Expense of the Corporation attributable to interest on any Indebtedness under a revolving credit facility computed on a pro forma basis shall be computed based upon the pro forma average daily balance of such Indebtedness during the applicable period; and (v) the occurrence of any of the events described in clauses (i)-(iv) above by any Person that has become a Restricted Subsidiary or has been merged with or into the Corporation or any Restricted Subsidiary during such Reference Period. "Consolidated Net Worth" means, at any date of determination, stockholders' equity as set forth on the most recently available quarterly or annual consolidated balance sheet of the Corporation and its Restricted Subsidiaries (which shall be as of a date not more than 90 days prior to the date of such computation, and which shall not take into account Unrestricted Subsidiaries), less any amounts attributable to Disqualified Stock or any equity security convertible into or exchangeable for Indebtedness, the cost of treasury stock and the principal amount of any promissory notes receivable from the sale of the Capital Stock of the Corporation or any of its Restricted Subsidiaries, each item to be determined in conformity with GAAP (excluding the effects of foreign currency exchange adjustments under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 52). "Corporation" means KMC Telecom Holdings, Inc., a Delaware corporation. "Currency Agreement" means any foreign exchange contract, currency swap agreement or other similar agreement or arrangement. "Disqualified Stock" means any class or series of Capital Stock of any Person that by its terms or otherwise is (i) required to be redeemed prior to the Mandatory Redemption Date, (ii) redeemable at the option of the holder of such class or series of Capital Stock at any time prior to the Mandatory Redemption Date or (iii) convertible into or exchangeable for Capital Stock referred to in clause (i) or (ii) above or Indebtedness having a scheduled maturity prior to the Mandatory Redemption Date; provided that any Capital Stock that would not constitute Disqualified Stock but for provisions thereof giving holders thereof the right to require such Person to repurchase or redeem such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) upon the occurrence of an "asset sale" or "change of control" occurring prior to the Mandatory Redemption Date shall not constitute Disqualified Stock if the "asset sale" or "change of control" provisions applicable to such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) are no more favorable to the holders of such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) than the provisions contained in Section XI(F) and Article VIII below and such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) specifically provides that such Person will not repurchase or redeem any such stock pursuant to such provision prior to the Corporation's repurchase of such Series E Preferred Stock as are required to be repurchased pursuant to Section XI(F) and Article VIII below. "Dividend Payment Date" means any Redemption Date, January 15, April 15, July 15 and October 15 and any other date on which dividends are payable or may be paid, as determined by the Board of Directors. "Dividend Record Date" means, with respect to each Dividend Payment Date, the close of business on the date set forth next to such Dividend Payment Date below: DIVIDEND PAYMENT DATE DIVIDEND RECORD DATE January 15 January 1 April 15 April 1 July 15 July 1 October 15 October 1 or such other record date as may be designated by the Board of Directors with respect to dividends payable on such other Dividend Payment Date; provided, however, that such record date may not be more than 60 days or less than ten days prior to such Dividend Payment Date. If any scheduled Dividend Record Date is not a Business Day, then such Dividend Record Date shall be the Business Day immediately preceding such scheduled Dividend Record Date. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Existing Stockholders" means Harold N. Kamine, his Affiliates and Nassau. "fair market value" means the price that would be paid in an arm's-length transaction between an informed and willing seller under no compulsion to sell and an informed and willing buyer under no compulsion to buy, as determined in good faith by the Board of Directors, whose determination shall be conclusive if evidenced by a Board Resolution; provided that for purposes of clause (vii) of the second paragraph of Section XI(A), (x) the fair market value of any security registered under the Exchange Act shall be the average of the closing prices, regular way, of such security for the 20 consecutive trading days immediately preceding the sale of Capital Stock and (y) in the event the aggregate fair market value of any other property (other than cash or cash equivalents) received by the Corporation exceeds $100 million, the fair market value of such property shall be determined by a nationally recognized investment banking firm or a nationally recognized firm having expertise in the specific area which is the subject of such determination and set forth in their written opinion which shall be delivered to the Transfer Agent. "GAAP" means generally accepted accounting principles in the United States of America as in effect as of the High Yield Closing Date, including, without limitation, those set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as approved by a significant segment of the accounting profession. All ratios and computations contained or referred to in this Certificate of Designations shall be computed in conformity with GAAP applied on a consistent basis, except that calculations made for purposes of determining compliance with the terms of the covenants and with other provisions of this Certificate of Designations shall be made without giving effect to (i) the amortization of any expenses incurred in connection with the Lucent Facility, the Newcourt Facility, the offering of the Senior Discount Notes, the Series E Preferred Stock and the Series F Preferred Stock and (ii) except as otherwise provided, the amortization of any amounts required or permitted by Accounting Principles Board Opinion Nos. 16 and 17. "Guarantee" means any obligation, contingent or otherwise, of any Person directly or indirectly guaranteeing any Indebtedness of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness of such other Person (whether arising by virtue of partnership arrangements, or by agreements to keep-well, to purchase assets, goods, securities or services (unless such purchase arrangements are on arm's-length terms and are entered into in the ordinary course of business), to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for purposes of assuring in any other manner the obligee of such Indebtedness of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part); provided that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. "High Yield Closing Date" means January 29, 1998. "Holder" means a registered holder of shares of Series E Preferred Stock. "Incur" means, with respect to any Indebtedness, to incur, create, issue, assume, Guarantee or otherwise become liable for or with respect to, or become responsible for, the payment of, contingently or otherwise, such Indebtedness, including an "Incurrence" of Acquired Indebtedness; provided that neither the accrual of interest nor the accretion of original issue discount shall be considered an Incurrence of Indebtedness. "Indebtedness" means, with respect to any Person at any date of determination (without duplication), (i) all indebtedness of such Person for borrowed money, (ii) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (iii) all obligations of such Person in respect of letters of credit or other similar instruments (including reimbursement obligations with respect thereto, but excluding trade letters of credit), (iv) all obligations of such Person to pay the deferred and unpaid purchase price of property or services, which purchase price is due more than six months after the date of placing such property in service or taking delivery and title thereto or the completion of such services, except Trade Payables and accrued current liabilities arising in the ordinary course of business, (v) all Capitalized Lease Obligations of such Person, (vi) all Indebtedness referred to in clauses (i) through (v) hereof of other Persons secured by a Lien on any asset of such Person, whether or not such Indebtedness is assumed by such Person; provided that the amount of such Indebtedness shall be the lesser of (A) the fair market value of such asset at such date of determination and (B) the amount of such Indebtedness, (vii) all Indebtedness of other Persons Guaranteed by such Person to the extent such Indebtedness is Guaranteed by such Person and (viii) to the extent not otherwise included in this definition, obligations under Currency Agreements and Interest Rate Agreements. The amount of Indebtedness of any Person at any date shall be the outstanding balance at such date (or, in the case of a revolving credit or other similar facility, the total amount of funds outstanding on the date of determination) of all unconditional obligations as described above and, with respect to contingent obligations, the maximum liability upon the occurrence of the contingency giving rise to the obligation of the types described above, provided (A) that the amount outstanding at any time of any Indebtedness issued with original issue discount is the original issue price of such Indebtedness, (B) that money borrowed and set aside at the time of the Incurrence of any Indebtedness in order to prefund the payment of the interest on such Indebtedness shall not be deemed to be "Indebtedness" and (C) that Indebtedness shall not include any liability for federal, state, local or other taxes. "Interest Rate Agreement" means any interest rate protection agreement, interest rate future agreement, interest rate option agreement, interest rate swap agreement, interest rate cap agreement, interest rate collar agreement, interest rate hedge agreement, option or future contract or other similar agreement or arrangement. "Investment" means, with respect to any Person, all investments by such Person in other Persons in the form of any direct or indirect advance, loan or other extension of credit (including, without limitation, by way of Guarantee or similar arrangement; but excluding advances to customers in the ordinary course of business that are, in conformity with GAAP, recorded as accounts receivable on the balance sheet of the Corporation or its Restricted Subsidiaries and commissions, travel and similar advances to officers and employees made in the ordinary course of business) or capital contribution to (by means of any transfer of cash or other property to others or any payment for property or services for the account or use of others), or any purchase or acquisition of Capital Stock, bonds, notes, debentures or other similar instruments issued by, such other Person and shall include (i) the designation of a Restricted Subsidiary as an Unrestricted Subsidiary and (ii) the fair market value of the Capital Stock (or any other Investment), held by the Corporation or any of its Restricted Subsidiaries, of (or in) any Person that has ceased to be a Restricted Subsidiary, including, without limitation, by reason of any transaction permitted by clause (iii) of Section XI(D); provided that the fair market value of the Investment remaining in any Person that has ceased to be a Restricted Subsidiary shall not exceed the aggregate amount of Investments previously made in such Person valued at the time such Investments were made less the net reduction of such Investments. For purposes of the definition of "Unrestricted Subsidiary" and Section XI(B), (i) "Investment" shall include the fair market value of the assets (net of liabilities (other than liabilities to the Corporation or any of its Restricted Subsidiaries)) of any Restricted Subsidiary at the time that such Restricted Subsidiary is designated an Unrestricted Subsidiary, (ii) the fair market value of the assets (net of liabilities (other than liabilities to the Corporation or any of its Restricted Subsidiaries)) of any Unrestricted Subsidiary at the time that such Unrestricted Subsidiary is designated a Restricted Subsidiary shall be considered a reduction in outstanding Investments and (iii) any property transferred to or from an Unrestricted Subsidiary shall be valued at its fair market value at the time of such transfer. "Investment Grade Securities" means (i) securities issued or directly and fully guaranteed or insured by the United States government or any agency or instrumentality thereof, (ii) debt securities or debt instruments with a rating of BBB+ or higher by S&P or Baal or higher by Moody's or the equivalent of such rating by such rating organization, or, if no rating by S&P or Moody's then exists, the equivalent of such rating by any other nationally recognized securities rating agency, but excluding any debt securities or instruments constituting loans or advances among the Corporation and its Subsidiaries, and (iii) investment in any fund that invests exclusively in investments of the type described in clauses (i) and (ii) which fund may also hold cash pending investment and/or distribution. "Junior Securities" has the meaning provided in Article III hereof. "KMC Telecom" means KMC Telecom Inc, a Delaware corporation. "KMC Telecom II" means KMC Telecom II, Inc., a Delaware corporation. "KMC Telecom III" means KMC Telecom III, Inc., a Delaware corporation. "Lien" means any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including, without limitation, any conditional sale or other title retention agreement or lease in the nature thereof or any agreement to give any security interest). "Lucent" means Lucent Technologies Inc., a Delaware corporation. "Lucent Facility" means the vendor financing facility between Lucent, KMC Telecom III and KMC Telecom Leasing III LLC, providing for aggregate borrowings of up to $600 million and maturing on the eighth anniversary of the closing of such credit facility. "Mandatory Redemption Date" means February 1, 2011. "Moody's" means Moody's Investors Service, Inc. and its successors. "Nassau" means Nassau Capital Partners L.P., NAS Partners I L.L.C. or their respective successors, and their Affiliates. "Net Cash Proceeds" means (a) with respect to any Asset Sale, the proceeds of such Asset Sale in the form of cash or cash equivalents, including payments in respect of deferred payment obligations (to the extent corresponding to the principal, but not interest, component thereof) when received in the form of cash or cash equivalents (except to the extent such obligations are financed or sold with recourse to the Corporation or any Restricted Subsidiary) and proceeds from the conversion of other property received when converted to cash or cash equivalents, net of (i) brokerage commissions and other commissions, fees and expenses (including fees and expenses of counsel, accountants and investment bankers) related to such Asset Sale and any relocation expenses incurred as a result thereof, (ii) provisions for all taxes (whether or not such taxes will actually be paid or are payable) as a result of such Asset Sale without regard to the consolidated results of operations of the Corporation and its Restricted Subsidiaries, taken as a whole, (iii) payments made to repay Indebtedness or any other obligation outstanding at the time of such Asset Sale that either (A) is secured by a Lien on the property or assets sold or (B) is required to be paid as a result of such sale and (iv) appropriate amounts to be provided by the Corporation or any Restricted Subsidiary as a reserve against any liabilities associated with such Asset Sale, including, without limitation, pension and other post-employment benefit liabilities, liabilities related to environmental matters and liabilities under any indemnification obligations associated with such Asset Sale, all as determined in conformity with GAAP, and (b) with respect to any issuance or sale of Capital Stock, the proceeds of such issuance or sale in the form of cash or cash equivalents, including payments in respect of deferred payment obligations (to the extent corresponding to the principal, but not interest, component thereof) when received in the form of cash or cash equivalents (except to the extent such obligations are financed or sold with recourse to the Corporation or any Restricted Subsidiary) and proceeds from the conversion of other property received when converted to cash or cash equivalents, net of attorney's fees, accountants' fees, underwriters' or placement agents' fees, discounts or commissions and brokerage, consultant and other fees incurred in connection with such issuance or sale and net of taxes paid or payable as a result thereof. "Newcourt Facility" means the Loan and Security Agreement dated as of December 22, 1998 among KMC Telecom, KMC Telecom II, and Newcourt Finance and any other lenders or borrowers from time to time party thereto, collateral documents, instruments, and agreements executed in connection therewith and any amendments, supplements, modifications, extensions, renewals, restatements, refinancings or refundings thereof. "Newcourt Finance" means Newcourt Commercial Finance Corporation, formerly known as AT&T Commercial Finance Corporation, a Delaware corporation, and its successors. "Offer to Purchase" means an offer to purchase Series E Preferred Stock by the Corporation from the Holders commenced by mailing a notice to the Transfer Agent and each Holder stating: (i) the covenant pursuant to which the offer is being made and that all Series E Preferred Stock validly tendered will be accepted for payment on a pro rata basis, together with any other Parity Securities subject to similar offer to purchase provisions; (ii) the purchase price and the date of purchase (which shall be a Business Day no earlier than 30 days nor later than 60 days from the date such notice is mailed) (the "Payment Date"); (iii) that any Series E Preferred Stock not tendered will continue to accrue dividends pursuant to its terms; (iv) that, unless the Corporation defaults in the payment of the purchase price, any Series E Preferred Stock accepted for payment pursuant to the Offer to Purchase shall cease to accrue dividends on and after the Payment Date; (v) that each Holder electing to have Series E Preferred Stock purchased pursuant to the Offer to Purchase will be required to surrender to the Transfer Agent at the address specified in the notice prior to the close of business on the Business Day immediately preceding the payment date such holder's certificate representing such Series E Preferred Stock, together with the form entitled "Option of the Holder to Elect Purchase" appearing on the reverse side of such Series E Preferred Stock certificate completed, (vi) that Holders will be entitled to withdraw their election if the Paying Agent receives, not later than the close of business on the third Business Day immediately preceding the Payment Date, a telegram, facsimile transmission or letter setting forth the name of such Holder, the liquidation preference of Series E Preferred Stock delivered for purchase and a statement that such Holder is withdrawing its election to have such Series E Preferred Stock purchased; and (vii) that Holders whose Series E Preferred Stock is being purchased only in part will be issued new Series E Preferred Stock equal in liquidation preference to the unpurchased portion of the Series E Preferred Stock surrendered. On the Payment Date, the Corporation shall (i) accept for payment on a pro rata basis Series E Preferred Stock, together with any other Parity Securities subject to similar offer to purchase provisions, or portions thereof tendered pursuant to an Offer to Purchase; (ii) deposit with the Paying Agent money sufficient to pay the purchase price of all Series E Preferred Stock, together with any other Parity Securities subject to similar offer to purchase provisions, or portions thereof so accepted; and (iii) deliver, or cause to be delivered, to the Transfer Agent all Series E Preferred Stock or portions thereof so accepted together with an Officers' Certificate specifying shares of the Series E Preferred Stock or portions thereof accepted for payment by the Corporation. The Paying Agent shall promptly mail to the Holders of Series E Preferred Stock so accepted payment in an amount equal to the purchase price, and the Transfer Agent shall promptly authenticate and mail to such Holders new shares of Series E Preferred Stock equal in liquidation preference to any unpurchased portion of the Series E Preferred Stock surrendered. The Corporation will publicly announce the results of an Offer to Purchase as soon as practicable after the Payment Date. The Transfer Agent shall act as the Paying Agent for an Offer to Purchase. The Corporation will comply with Rule 14e-1 under the Exchange Act and any other securities laws and regulations thereunder to the extent such laws and regulations are applicable, in the event that the Corporation is required to repurchase Series E Preferred Stock pursuant to an Offer to Purchase. "Officer" means with respect to the Corporation, (i) the Chairman of the Board, the Vice Chairman of the Board, the President, the Chief Executive Officer, the Chief Financial Officer or a Vice president, and (ii) the Treasurer or any Assistant Treasurer, or the Secretary or any Assistant Secretary of the Corporation. "Officers' Certificate" means a certificate signed by one Officer listed in clause (i) of the definition thereof and one Officer listed in clause (ii) of the definition thereof; provided, however, that any such certificate may be signed by any two of the Officers listed in clause (i) of the definition thereof in lieu of being signed by one Officer listed in clause (i) of the definition thereof and one Officer listed in clause (ii) of the definition thereof. "Parity Securities" has the meaning specified in Article III hereof. "Permitted Investment" means (i) an Investment in the Corporation or a Restricted Subsidiary or a Person which will, upon the making of such Investment, become a Restricted Subsidiary or be merged or consolidated with or into or transfer or convey all or substantially all its assets to, the Corporation or a Restricted Subsidiary; provided that such person's primary business is related, ancillary or complementary to the businesses of the Corporation and its Restricted Subsidiaries on the date of such Investment; (ii) Temporary Cash Investments and Investment Grade Securities; (iii) payroll, travel and similar advances to cover matters that are expected at the time of such advances ultimately to be treated as expenses in accordance with GAAP and reasonable advances to sales representatives; (iv) any Investment acquired by the Corporation or any of its Restricted Subsidiaries (x) in exchange for any other Investment or accounts receivable held by the Corporation or any such Restricted Subsidiary in connection with or as a result of a bankruptcy, workout, reorganization or recapitalization of the issuer of such other Investment or accounts receivable or (y) as a result of a foreclosure by the Corporation or any of its Restricted Subsidiaries with respect to any secured Investment or other transfer of title with respect to any secured Investment in default; (v) any Investment acquired in consideration for the issuance of Junior Securities or the proceeds of the issuance of Junior Securities to the extent such amounts have not been previously applied to a Restricted Payment pursuant to clause (iii)(B)(2) of the first paragraph of Section XI(B) or clause (ii) of the second paragraph of Section XI(B) or used to support the Incurrence of Indebtedness pursuant to clause (viii) in accordance with Section XI(A) and Investments acquired as a capital contribution; (vi) Guarantees permitted by Section XI(A); (vii) loans or advances to employees of the Corporation or any Restricted Subsidiary that do not in the aggregate exceed at any one time outstanding $5.0 million; (viii) Currency Agreements and Interest Rate Agreements permitted under Section XI(A); (ix) Investments in prepaid expenses, negotiable instruments held for collection and lease, utility and workers' compensation, performance and other similar deposits; (x) Investments in debt securities or other evidences of Indebtedness that are issued by companies engaged in the Telecommunications Business; provided that when each Investment pursuant to this clause (x) is made, the aggregate amount of Investments outstanding under this clause (x) does not exceed $3.0 million; (xi) Strategic Investments and Investments in Permitted Joint Ventures in an amount not to exceed $20.0 million at any one time outstanding; (xii) an Investment in any Person the primary business of which is related, ancillary or complementary to the business of the Corporation and its Subsidiaries on the date of such Investment in an amount not to exceed at any time in respect of all such Investments outstanding the sum of (x) $200.0 million plus (y) 40% of the Corporation's Consolidated EBITDA, if positive, for the immediately preceding four fiscal quarters (valued in each case as provided in the definition of "Investments"); (xiii) securities received in connection with Asset Sales to the extent constituting non-cash consideration permitted under Section XI(F); and (xiv) Investments in an amount not to exceed $50.0 million at any time outstanding. "Permitted Joint Venture" means any Unrestricted Subsidiary or any other Person in which the Corporation or a Restricted Subsidiary owns, directly or indirectly, an ownership interest (other than a Restricted Subsidiary) and whose primary business is related, ancillary or complementary to the businesses of the Corporation and its Restricted Subsidiaries at the time of determination. "Person" means any individual, partnership, corporation, business trust, joint stock company, limited liability company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature. "Preferred Stock" means any and all shares, interests, participations or other equivalents of the Corporation's preferred stock, including any such security with any priority over Common Stock with respect to dividends or upon liquidation or similar events. "Public Equity Offering" means an underwritten primary public offering of Common Stock of the Corporation pursuant to an effective registration statement under the Securities Act. "Purchase Agreement" means the Securities Purchase Agreement dated as of February 4, 1999 among the Corporation, Newcourt Finance and Lucent. "Redemption Date", when used with respect to any Series E Preferred Stock to be redeemed, means the date fixed for such redemption by or pursuant to the terms of this Certificate of Designations. "Redemption Price" means, with respect to any share of Series E Preferred Stock, the price at which such share of Series E Preferred Stock is to be redeemed pursuant to the terms of this Certificate of Designations. "Restricted Subsidiary" means any Subsidiary of the Corporation other than an Unrestricted Subsidiary. "Securities Act" means the Securities Act of 1933, as amended from time to time, or any successor statute. "Senior Discount Note Indenture" means the Indenture dated as of January 29, 1998 between the Corporation and The Chase Manhattan Bank, relating to the Senior Discount Notes, as such Indenture may be amended, supplemented, extended, renewed, replaced or otherwise modified from time to time. "Senior Discount Notes" means the 12 1/2% Senior Discount Notes due 2008 issued by the Corporation under the Senior Discount Note Indenture. "Senior Securities" has the meaning provided in Article III hereof. "Significant Subsidiary" means, any Subsidiary that would be a "significant subsidiary" as defined in 17 CFR Part 210.1-01(w), promulgated pursuant to the Securities Act, as such regulation is in effect on the date hereof. "S&P" means Standard & Poor's Ratings Services, a Division of McGraw Hill, Inc., and its successors. "Stated Maturity" means (i) with respect to any debt security, the date specified in such debt security as the fixed date on which the final installment of principal of such debt security is due and payable and (ii) with respect to any scheduled installment of principal of or interest on any debt security, the date specified in such debt security as the fixed date on which such installment is due and payable. "Strategic Investments" means (a) Investments that the Board of Directors has determined in good faith will enable the Corporation or any of its Restricted Subsidiaries to obtain additional business that it might not be able to obtain without making such Investment and (b) Investments in entities the principal function of which is to perform research and development with respect to products and services that may be used or useful in the Telecommunications Business; provided that the Corporation or one of its Restricted Subsidiaries is entitled or otherwise reasonably expected to obtain rights to such products or services as a result of such Investment. "Strategic Subordinated Indebtedness" means Indebtedness of the Corporation Incurred to finance the acquisition of a Person engaged in the Telecommunications Business that by its terms, or by the terms of any agreement or instrument pursuant to which such Indebtedness is outstanding, (i) is expressly made subordinate in right of payment to the Senior Discount Notes and (ii) provides that no payment of principal, premium or interest on, or any other payment with respect to, such Indebtedness may be made prior to the payment in full of all of the Corporation's obligations under the Series E Preferred Stock and the Senior Discount Notes; provided that such Indebtedness may provide for and be repaid at any time from the proceeds of the sale of Capital Stock (other than Disqualified Stock) of the Corporation after the Incurrence of such Indebtedness. "Subsidiary" means, with respect to any Person, (i) any corporation, association, or other business entity (other than a partnership) of which more than 50% of the total voting power of shares of Capital Stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time of determination owned or controlled, directly or indirectly, by such Person or one or more of the other Subsidiaries of such Person or a combination thereof and (ii) any partnership, joint venture, limited liability company or similar entity of which (x) more than 50% of the capital accounts, distribution rights, total equity and voting interests or general or limited partnership interests, as applicable, are owned or controlled, directly or indirectly, by such Person or one or more of the other Subsidiaries of such Person or a combination thereof whether in the form of membership, general, special or limited partnership or otherwise and (y) such Person or any Wholly Owned Restricted Subsidiary of such Person is a general partner or otherwise controls such entity. "Telecommunications Business" means the development, ownership or operation of one or more telephone, telecommunications or information systems or the provision of telephony, telecommunications or information services (including, without limitation, any voice, video transmission, data or Internet services) and any related, ancillary or complementary business. "Temporary Cash Investment" means any of the following: (i) direct obligations of the United States of America or any agency thereof or obligations fully and unconditionally guaranteed by the United States of America or any agency or instrumentality thereof, (ii) time deposit accounts, certificates of deposit, eurodollar time deposits and money market deposits maturing within 180 days or less of the date of acquisition thereof issued by a bank or trust company which is organized under the laws of the United States of America, any state thereof or any foreign country recognized by the United States of America, and which bank or trust company has capital, surplus and undivided profits aggregating in excess of $50 million (or the foreign currency equivalent thereof) and has outstanding debt which is rated "A" (or such similar equivalent rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act) or any money-market fund sponsored by a registered broker dealer or mutual fund distributor, (iii) repurchase obligations with a term of not more than 30 days for underlying securities of the types described in clauses (i) and (ii) above entered into with a bank meeting the qualifications described in clause (ii) above, (iv) commercial paper, maturing not more than 90 days after the date of acquisition, issued by a corporation (other than an Affiliate of the Corporation) organized and in existence under the laws of the United States of America, any state thereof or any foreign country recognized by the United States of America with a rating at the time as of which any investment therein is made of "P-1" (or higher) according to Moody's or "A-1" (or higher) according to S&P, (v) securities with maturities of six months or less from the date of acquisition issued or fully and unconditionally guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and rated at least "A" by S&P or Moody's, and (vi) investment funds investing 95% of their assets in securities of the type described in clauses (i)-(v) above. "Trade Payables" means, with respect to any Person, any accounts payable or any other indebtedness or monetary obligation to trade creditors created, assumed or Guaranteed by such Person or any of its Subsidiaries arising in the ordinary course of business in connection with the acquisition of goods or services. "Transaction Date" means, with respect to the Incurrence of any Indebtedness by the Corporation or any of its Restricted Subsidiaries, the date such Indebtedness is to be Incurred and, with respect to any Restricted Payment, the date such Restricted Payment is to be made. "Transfer Agent" means Chase Mellon Shareholder Services, L.L.C. "Unrestricted Subsidiary" means (i) any Subsidiary of the Corporation that at the time of determination shall be designated an Unrestricted Subsidiary by the Board of Directors in the manner provided below; and (ii) any Subsidiary of an Unrestricted Subsidiary. The Board of Directors may designate any Restricted Subsidiary (including any newly acquired or newly formed Subsidiary of the Corporation) to be an Unrestricted Subsidiary unless such Subsidiary owns any Capital Stock of, or owns or holds any Lien on any property of, the Corporation or any Restricted Subsidiary; provided that (A) any Guarantee by the Corporation or any Restricted Subsidiary of any Indebtedness of the Subsidiary being so designated shall be deemed an "Incurrence" of such Indebtedness and an "Investment" by the Corporation or such Restricted Subsidiary (or both, if applicable) at the time of such designation; (B) either (I) the Subsidiary to be so designated has total assets of $1,000 or less or (II) if such Subsidiary has assets greater than $1,000, such designation would be permitted in accordance with Section XI(B); and (C) if applicable, the Incurrence of Indebtedness and the Investment referred to in clause (A) of this proviso would be permitted in accordance with Section XI(A) and Section XI(B). The Board of Directors may designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided that all Indebtedness of such Unrestricted Subsidiary outstanding immediately after such designation would, if Incurred at such time, have been permitted to be Incurred (and shall be deemed to have been Incurred) for all purposes of this Certificate of Designations. Any such designation by the Board of Directors shall be evidenced to the Transfer Agent by promptly filing with the Transfer Agent a copy of the Board Resolution giving effect to such designation and an Officers' Certificate certifying that such designation complied with the foregoing provisions. "Voting Stock" means, with respect to any Person, Capital Stock of any class or kind ordinarily having the power to vote for the election of directors, managers or other voting members of the governing body of such Person. "Warrant Agreement" means the warrant agreement, dated the Closing Date, among the Corporation, Newcourt Finance, Lucent and any Additional Purchaser (as described therein) and The Chase Manhattan Bank, as warrant agent. "Warrants" means any warrants that may be issued under the Warrant Agreement. "Wholly Owned" means, with respect to any Subsidiary of any Person, the ownership of 95% or more of the outstanding Capital Stock of such Subsidiary (other than any director's qualifying shares or Investments by foreign nationals mandated by applicable law) by such Person or one or more Wholly Owned Subsidiaries of such Person. II. Designation. The series of Preferred Stock authorized hereunder shall be designated as the "Series E Senior Redeemable, Exchangeable, PIK Preferred Stock" and is referred to herein as the "Series E Preferred Stock." The number of shares constituting such series shall be 175,000. The par value of the Series E Preferred Stock shall be $.01 per share of Series E Preferred Stock. Each share of Series E Preferred Stock purchased from the Corporation shall have a liquidation preference of $1,000. The Corporation may from time to time in its discretion issue fractional shares of Series E Preferred Stock. III. Ranking. The Series E Preferred Stock shall, with respect to dividend distributions and distributions upon the liquidation, winding-up and dissolution of the Corporation, rank (i) senior to all classes of Common Stock of the Corporation, (ii) senior to each other class of capital stock or series of Preferred Stock the terms of which do not expressly provide that it ranks senior to or on a parity with the Series E Preferred Stock as to dividend distributions and distributions upon the liquidation, winding-up and dissolution of the Corporation (collectively referred to, together with all classes of Common Stock of the Corporation, as the "Junior Securities"); (iii) on a parity with (A) any class of Capital Stock or series of Preferred Stock the terms of which expressly provide that such class or series will rank on a parity with the Series E Preferred Stock as to dividend distributions and distributions upon the liquidation, winding-up and dissolution of the Corporation and (B) the Corporation's Series A Cumulative Convertible Preferred Stock, Series C Cumulative Convertible Preferred Stock, Series D Cumulative Convertible Preferred Stock and Series F Preferred Stock (collectively referred to as "Parity Securities"); and (iv) junior to each class of Capital Stock or series of Preferred Stock issued by the Corporation the terms of which expressly provide that such class or series will rank senior to the Series E Preferred Stock as to dividend distributions and distributions upon liquidation, winding-up and dissolution of the Corporation (collectively referred to as "Senior Securities"). The Series E Preferred Stock will be subject to the issuance of series of Junior Securities, Parity Securities and Senior Securities, provided that the Corporation may not authorize, create or issue, or increase the authorized amount of, any new class of Senior Securities (or any class of any security convertible into shares of any Senior Security) without the approval of the holders of at least a majority of the shares of Series E Preferred Stock then outstanding, voting or consenting, as the case may be, separately as one class, except that, without the approval of holders of the Series E Preferred Stock, the Corporation may issue shares of Senior Securities (or any class of any security convertible into shares of any Senior Security) in exchange for, or the proceeds of which are used to redeem or repurchase, (1) all (but not less than all) shares of Series E Preferred Stock and Series F Preferred Stock then outstanding, (2) any Senior Securities or (3) Indebtedness of the Corporation. IV. Dividends. (A) Holders of Series E Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors, out of funds legally available therefor, dividends on the Series E Preferred Stock at a rate per annum equal to 14.5% of the liquidation preference per share, payable quarterly. All dividends will be cumulative, whether or not earned or declared, accruing on a daily basis, whether or not there are profits, surplus or other funds legally available for the payment of such dividends, from the date of issuance of the Series E Preferred Stock and will be payable quarterly in arrears on each Dividend Payment Date, commencing on April 15, 1999. On and before January 15, 2004, the Corporation may pay dividends, at its option, in cash or in additional fully paid and nonassessable shares of Series E Preferred Stock having an aggregate liquidation preference equal to the amount of such dividends rounded to the nearest $1.00. After January 15, 2004, dividends must be paid in cash, unless the Corporation's debt securities prohibit such payment or there are no funds legally available therefor, in which case dividends may be paid in additional fully paid and nonassessable shares of Series E Preferred Stock having an aggregate liquidation preference equal to the amount to such dividends rounded to the nearest $1.00. If any dividend (or portion thereof) payable on any Dividend Payment Date is not declared or paid in full on such Dividend Payment Date, the amount of accrued and unpaid dividends will accrue at the dividend rate on the Series E Preferred Stock, compounding quarterly, until declared and paid in full. (B) No full dividends may be declared or paid or funds set apart for the payment of dividends on any Parity Securities for any period unless full cumulative dividends shall have been or contemporaneously shall be declared and paid in full on the Series E Preferred Stock. If full dividends are not so paid, the Series E Preferred Stock shall share dividends pro rata with the Parity Securities. No dividends may be paid or set apart for such payment on Junior Securities (except dividends on Junior Securities in additional shares of Junior Securities) and no Junior Securities or Parity Securities may be repurchased, redeemed or otherwise retired nor may funds be set apart for payment with respect thereto if full cumulative dividends shall not have been paid on the Series E Preferred Stock. (C) Each dividend paid on the Series E Preferred Stock shall be payable to Holders of record as their names shall appear in the stock ledger of the Corporation on the Dividend Record Date for such dividend, except that dividends in arrears for any past Dividend Payment Date may be declared and paid at any time without reference to such regular Dividend Payment Date to Holders of record on a later dividend record date determined by the Board of Directors. V. Liquidation Preference. (A) Upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, holders of Series E Preferred Stock will be entitled to be paid, out of the assets of the Corporation available for distribution, $1,000 per share, plus an amount in cash equal to accrued and unpaid dividends thereon to the date fixed for liquidation, dissolution or winding-up (including an amount equal to a prorated dividend for the period from the last Dividend Payment Date to the date fixed for liquidation, dissolution or winding-up), before any distribution is made on any Junior Securities. If, upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, the amounts payable with respect to the Series E Preferred Stock and all other Parity Securities are not paid in full, the holders of the Series E Preferred Stock and the Parity Securities will share equally and ratably in any distribution of assets of the Corporation in proportion to the full liquidation preference and accrued and unpaid dividends to which each is entitled. After payment of the full amount of the liquidation preferences and accrued and unpaid dividends to which they are entitled, the holders of Series E Preferred Stock will not be entitled to any further participation in any distribution of assets of the Corporation. (B) For the purposes of this Article V only, neither the sale, lease, conveyance, exchange or transfer (for cash, shares of stock, securities or other consideration) of all or substantially all of the property or assets of the Corporation nor the consolidation or merger of the Corporation with or into one or more corporations shall be deemed to be a liquidation, dissolution or winding-up of the Corporation. VI. Redemption. (A) Mandatory Redemption. The Series E Preferred Stock shall be subject to mandatory redemption (subject to the legal availability of funds therefor and any contractual or other restrictions with respect thereto) in whole on the Mandatory Redemption Date at a Redemption Price, payable in cash, equal to the liquidation preference thereof on the Redemption Date plus all accrued and unpaid dividends thereon to the Redemption Date. (B) Optional Redemption. The Series E Preferred Stock may be redeemed at any time on or after April 15, 2004, at the Corporation's option, in whole or in part, at the Redemption Prices (expressed as a percentage of the liquidation preference thereof on the Redemption Date) set forth below, plus an amount in cash equal to all accrued and unpaid dividends thereon to the Redemption Date, if redeemed during the period beginning April 15 of each of the years set forth below: YEAR PERCENTAGE 2004 ...............................110.000% 2005 ...............................106.667% 2006 ...............................103.333% 2007 and thereafter.................... 100.000% In addition, at any time or from time to time, on or prior to April 15, 2002, the Corporation may, at its option, redeem shares of Series E Preferred Stock with the proceeds of one or more sales of the Corporation's Capital Stock at a Redemption Price, payable in cash, equal to 110% of the liquidation preference thereof on the Redemption Date, plus an amount in cash equal to all accrued and unpaid dividends thereon to the Redemption Date, provided that as of the date of any such redemption, the cumulative aggregate liquidation preference of all shares of Series E Preferred Stock redeemed pursuant to this provision on or prior to such date shall not exceed 35% of the aggregate liquidation preference of shares of Series E Preferred Stock issued on or prior to such date whether or not still outstanding on such date. No optional redemption may be authorized or made unless prior thereto full unpaid cumulative dividends shall have been paid or a sum set apart for such payment on the Series E Preferred Stock. (C) Procedure for Redemption. (i) Not more than sixty (60) and not less than thirty (30) days prior to the Redemption Date, written notice (the "Redemption Notice") shall be given by the Corporation by first-class mail to each Holder at such Holder's address as the same appears on the stock ledger of the Corporation; provided, however, that no failure to give such notice nor any deficiency therein shall affect the validity of the procedure for the redemption of any shares of Series E Preferred Stock to be redeemed, except as to the Holders to whom the Corporation has failed to give such notice or except as to the Holders whose notice was defective. The Redemption Notice shall state: (a) the Redemption Price; (b) the Redemption Date; (c) that the Holder is to surrender to the Corporation, at the place or places designated in such Redemption Notice, its certificates representing the shares of Series E Preferred Stock to be redeemed; and (d) the name of any bank or trust company performing the duties referred to in Section VI(C)(iv) below. (ii) On or before the Redemption Date, each Holder of Series E Preferred Stock to be redeemed shall surrender the certificate or certificates representing such shares of Series E Preferred Stock to the Corporation, in the manner and at the place designated in the Redemption Notice, and on the Redemption Date the full Redemption Price for such shares shall be payable in cash to the Holder whose name appears in the stock ledger of the Corporation as the owner thereof, and each surrendered certificate shall be returned to authorized but unissued shares of Preferred Stock of the Corporation. (iii) Unless the Corporation defaults in the payment in full of the applicable Redemption Price, dividends on the Series E Preferred Stock called for redemption shall cease to accrue on the Redemption Date, and the Holders of such shares shall cease to have any further rights with respect thereto on the Redemption Date, other than the right to receive the Redemption Price. (iv) If a Redemption Notice shall have been duly given or if the Corporation shall have given to the bank or trust company hereinafter referred to irrevocable authorization promptly to give such notice, and if on or before the Redemption Date specified therein the funds necessary for such redemption shall have been irrevocably and indefeasibly deposited by the Corporation with such bank or trust company in trust for the pro rata benefit of the Holders of the Series E Preferred Stock called for redemption, then, notwithstanding that any certificate for shares so called for redemption shall not have been surrendered for cancellation, from and after the time of such deposit, all shares so called, or to be so called pursuant to such irrevocable authorization, for redemption shall be deemed no longer to be outstanding and all rights with respect to such shares shall forthwith cease and terminate, excepting only the right of the Holders thereof to receive from such bank or trust company at any time after the time of such deposit the funds so deposited, without interest. Any interest accrued on such funds shall be paid to the Corporation from time to time. Any funds so set aside or deposited, as the case may be, and unclaimed at the end of three years from such Redemption Date shall, to the extent permitted by law, be released or repaid to the Corporation, after which repayment the Holders of the shares to be redeemed shall look only to the Corporation for payment thereof. (v) In the event of partial redemptions of Series E Preferred Stock, the shares to be redeemed will be determined pro rata or by lot, as determined by the Corporation, except that the Corporation may redeem such shares held by any holder of fewer than 100 shares without regard to such pro rata redemption requirement. If any Series E Preferred Stock is to be redeemed in part, the Redemption Notice that relates to such Series E Preferred Stock shall state the portion of the liquidation preference to be redeemed. New shares of Series E Preferred Stock having an aggregate liquidation preference equal to the unredeemed portion shall be issued in the name of the Holder thereof upon cancellation of the original Series E Preferred Stock. (vi) Notwithstanding anything herein to the contrary, a Redemption Notice will be revocable if (i) it states that it is revocable and provides that a notice of revocation may be given not less than five days prior to the Redemption Date by the Corporation in accordance with Article XVII hereof and (ii) the Board of Directors determines that the availability of funds to pay the Redemption Price is subject to the closing of a financing and, at the time such Redemption Notice is given, such closing is subject to uncertainty. VII. Voting Rights. (A) The Holders of Series E Preferred Stock shall have no voting rights except as set forth below and as otherwise provided by law. (B)(i) If and whenever (1) dividends on the Series E Preferred Stock are in arrears and remain unpaid with respect to four quarterly periods (whether or not consecutive), (2) the Corporation fails to discharge any redemption obligation with respect to the Series E Preferred Stock, (3) a breach or violation by the Corporation of the provisions of Article X occurs, or the Corporation fails to exchange Exchange Debentures for the Series E Preferred Stock tendered for exchange on the exchange date, whether or not the Corporation satisfies the conditions to permit such exchange, (4) the Corporation fails to make a Change of Control Offer or cash payment with respect thereto if required by the provisions of Article VIII or (5) a breach or violation of any provision of Article IX or Article XI occurs and is not remedied within 30 days after notice thereof to the Corporation by Holders of 25% or more of the liquidation preference of the Series E Preferred Stock then outstanding (each such event referred to as a "Voting Rights Triggering Event"), then the number of directors then constituting the Board of Directors of the Corporation shall be increased by one director and the Holders of a majority of the then outstanding shares of Series E Preferred Stock, voting as a single class, shall be entitled to elect one additional director at any annual meeting of shareholders or special meeting held in place thereof, or at a special meeting of the Holders of Series E Preferred Stock called as hereinafter provided. (ii) Whenever a Voting Rights Triggering Event shall have occurred, voting rights of the Holders of Series E Preferred Stock may be exercised initially either at a special meeting of the Holders of Series E Preferred Stock called as hereinafter provided, or at any annual meeting of shareholders held for the purpose of electing directors, and thereafter at each such annual meeting or by the written consent of the Holders of Series E Preferred Stock, voting as a single class, pursuant to the Delaware General Corporation Law. The term of office of any such elected director shall expire at the next annual meeting of shareholders held for the purpose of electing directors, subject to a new election of a director by the Holders of Series E Preferred Stock, voting as a single class, at each successive annual meeting, but such voting rights and the term of office of any such elected director shall expire at such time as (A) all dividends accrued on Series E Preferred Stock shall have been paid in full and (B) each failure, breach or default referred to in paragraph VII(B) (i)(A)(2), (3), (4) and (5) above is remedied. (iii) At any time after a Voting Rights Triggering Event shall have occurred and such voting rights shall not already have been initially exercised, a proper officer of the Corporation may, and upon the written request of any Holder of Series E Preferred Stock (addressed to the Secretary at the principal office of the Corporation) shall, call a special meeting of the Holders of Series E Preferred Stock for the election of a director to be elected by them, voting as a single class, as herein provided, such call to be made by notice similar to that provided in the Bylaws for a special meeting of the shareholders or as required by law. (iv) Such meeting shall be held at the earliest practicable date upon the notice required for annual meetings of shareholders at the place for holding annual meetings of shareholders of the Corporation or, if none, at a place designated by the Secretary of the Corporation. If such meeting shall not be called by a proper officer of the Corporation within 30 days after the personal service of such written request upon the Secretary of the Corporation, or within 30 days after mailing the same within the United States, by registered mail, addressed to the Secretary of the Corporation at its principal office (such mailing to be evidenced by the registry receipt issued by the postal authorities), then the holders of record of 10% of the shares of Series E Preferred Stock then outstanding, may designate in writing a Holder of Series E Preferred Stock to call such meeting at the expense of the Corporation, and such meeting may be called by such person so designated upon the notice required for annual meetings of shareholders and shall be held at the same place as is elsewhere provided in this paragraph VII(B)(iv) or at such other place as is selected by such person so designated. Any Holder of Series E Preferred Stock that would be entitled to vote at any such meeting shall have access to the stock books of the Corporation for the purpose of causing a meeting of shareholders to be called pursuant to the provisions of this paragraph. Notwithstanding the provisions of this paragraph, however, no such special meeting shall be called during a period within 90 days immediately preceding the date fixed for the next annual meeting of shareholders. (v) At any meeting held for the purpose of electing directors at which the Holders of Series E Preferred Stock, voting as a single class, shall have the right to elect a director as provided herein, the presence in person or by proxy of the Holders of a majority of the then outstanding shares of Series E Preferred Stock shall be required and be sufficient to constitute a quorum of such class for the election of a director by such class. At any such meeting or adjournment thereof, (x) the absence of a quorum of the Holders of Series E Preferred Stock shall not prevent the election of directors other than the director to be elected by such Holders and the absence of a quorum or quorums of the holders of Capital Stock entitled to elect such other directors shall not prevent the election of a director to be elected by the Holders of Series E Preferred Stock, voting as a single class, and (y) in the absence of a quorum of the holders of any class of stock entitled to vote for the election of directors, a majority of the holders present in person or by proxy of such class shall have the power to adjourn the meeting for the election of directors which the holders of such class are entitled to elect, from time to time, without notice (except as required by law) other than announcement at the meeting, until a quorum shall be present. (vi) The term of office of the director elected by the Holders of Series E Preferred Stock, pursuant to paragraph VII(B)(i) in office at any time when the aforesaid voting rights are vested in the Holders of Series E Preferred Stock, shall terminate upon the election of his/her successor by the Holders of the Series E Preferred Stock at any meeting of shareholders for the purpose of electing directors. Upon any termination of the aforesaid voting rights in accordance with paragraph VII(B)(ii), the term of office of the director elected pursuant to paragraph VII(B)(i) then in office shall thereupon terminate and upon such termination the number of directors constituting the Board of Directors shall, without further action, be reduced by one, subject always to the increase of the number of directors pursuant to paragraph VII(B)(i) in case of the future right of the Holders of Series E Preferred Stock to elect a director as provided herein. (vii) If the director elected pursuant to paragraph VII(B)(ii) shall cease to serve as director before his/her term shall expire, the Holders of Series E Preferred Stock then outstanding, voting as a single class, at a special meeting called as provided above, may elect a successor to hold office for the unexpired terms of the director whose place shall be vacant. VIII. Change of Control. Upon the occurrence of a Change of Control, the Corporation shall be required (subject to any contractual and other restrictions with respect thereto and the legal availability of funds therefor) to make an Offer to Purchase (the "Change of Control Offer") to each Holder of Series E Preferred Stock to repurchase all or any part, at the Holder's option, of such Holder's Series E Preferred Stock at a cash purchase price equal to 101% of the liquidation preference thereof, plus an amount in cash equal to all accrued and unpaid dividends (including an amount in cash equal to a prorated dividend for the period from the immediately preceding Dividend Payment Date to the date of purchase) (the "Change of Control Payment"). The Change of Control Offer must be made within 30 days following the conclusion of all change of control offers for the Corporation's debt securities, must remain open for at least 30 and not more than 60 days and must comply with the requirements of Rule 14e-1 under the Exchange Act and any other securities laws and regulations thereunder to the extent such laws and regulations are applicable. Prior to commencing any Change of Control Offer, the Corporation shall first consummate any change of control offer to purchase required to be made to any holder of its Indebtedness. The Corporation shall make the Change of Control Offer within 30 days following the consummation of any mandatory offers to purchase and any other required repayments of the Corporation's Indebtedness resulting from a change of control. IX. Consolidation, Merger and Sale of Assets. The Corporation shall not consolidate with, merge with or into, or sell, convey, transfer, lease or otherwise dispose of all or substantially all of its property and assets (as an entirety or substantially an entirety in one transaction or a series of related transactions) to, any Person or permit any Person to merge with or into the Corporation unless: (i) the Corporation shall be the continuing Person, or the Person (if other than the Corporation) formed by such consolidation or into which the Corporation is merged or that acquired or leased such property and assets of the Corporation shall be a corporation organized and validly existing under the laws of the United States of America or any jurisdiction thereof and the Series E Preferred Stock shall be converted into or exchanged for and shall become shares of such successor company, having in respect of such successor company or resulting company substantially the same powers, preferences and relative participating, optional or other special rights and the qualifications, limitations or restrictions thereon that the Series E Preferred Stock had immediately prior to such transaction in respect of the Corporation; (ii) immediately after giving effect to such transaction on a pro forma basis, (A) the Corporation or any Person becoming the successor or resulting company, as the case may be, shall have a Consolidated Net Worth equal to or greater than the Consolidated Net Worth of the Corporation immediately prior to such transaction or (B) the Corporation or any Person becoming the successor or resulting company, as the case may be, shall have a Consolidated Leverage Ratio no more than the greater of (I) 6:1 and (II) the Consolidated Leverage Ratio of the Corporation immediately prior to such transaction; provided that this clause (ii) shall not apply to a consolidation or merger with or into a Wholly Owned Restricted Subsidiary with a positive net worth; provided that, in connection with any such merger or consolidation, no consideration (other than Capital Stock (other than Disqualified Stock) in the surviving Person or the Corporation) shall be issued or distributed to the stockholders of the Corporation; and (iii) the Corporation delivers to the Transfer Agent an Officers' Certificate (attaching the arithmetic computations to demonstrate compliance with clause (ii)) and Opinion of Counsel, in each case stating that such consolidation, merger or transfer complies with this provision and that all conditions precedent provided for herein relating to such transaction have been complied with; provided, however, that clause (ii) above does not apply if, in the good faith determination of the Board of Directors of the Corporation, whose determination shall be evidenced by a Board Resolution, the principal purpose of such transaction is to change the state of incorporation of the Corporation and any such transaction shall not have as one of its purposes the evasion of the foregoing limitations. X. Exchange. (A) The Corporation may, at the sole option of the Board of Directors (subject to the legal availability of funds therefor), exchange all, but not less than all, of the shares of Series E Preferred Stock then outstanding, including any shares of Series E Preferred Stock issued as payment for dividends, for a new series of senior subordinated debentures of the Corporation (the "Exchange Debentures") to be issued pursuant to an indenture (the "Indenture") qualified under the Trust Indenture Act of 1939, as amended, substantially in the form attached as an exhibit to the Purchase Agreement (a copy of which shall be provided to any Holder upon written request to the Secretary of the Corporation), at any time following the date on which such exchange is permitted by the terms of the then-existing Indebtedness of the Corporation and subject to the conditions contained in paragraph X(B) below. The Exchange Debentures will be issued in registered form, without coupons, be duly executed, authenticated as of the date on which the exchange is effective and dated the date of exchange. In the event of an exchange, Holders of Series E Preferred shall be entitled to receive on the date of exchange Exchange Debentures having an aggregate principal amount equal to (i) the total of the liquidation preference for each share of Series E Preferred exchanged, plus (ii) an amount equal to all accrued but unpaid dividends payable on such share (including a prorated dividend for the period from the immediately preceding Dividend Payment Date to the date of exchange). In the event such exchange would result in the issuance of Exchange Debentures in a principal amount which is less than $1,000 or which is not an integral multiple of $1,000 (such principal amount less than $1,000 or the difference between such principal amount and the highest integral of $1,000 which is less than such principal amount, as the case may be, is hereinafter referred to as the "Fractional Principal Amount"), the Corporation may, subject to any restrictions in the terms of the then-existing Indebtedness of the Corporation, at the option of the Board of Directors, pay cash to each Holder of Series E Preferred in lieu of Fractional Principal Amounts of Exchange Debentures otherwise issuable upon exchange of the Series E Preferred Stock. The Person entitled to receive the Exchange Debentures issuable upon exchange shall be treated for all purposes as the registered holder of such Exchange Debentures as of the date of exchange. The Corporation will mail to each Holder of Series E Preferred Stock written notice of its intention to exchange no less than 20 nor more than 60 days prior to the date of exchange. (B) As a condition of the right of the Corporation to issue Exchange Debentures in exchange for the Series E Preferred Stock under paragraph (A) above, on the date of exchange, (A) there shall be legally available funds sufficient therefor; (B) a registration statement relating to the Exchange Debentures shall have been declared effective under the Securities Act prior to such exchange and shall continue to be effective on the date of exchange, or the Corporation shall have obtained a written opinion of its outside counsel reasonably acceptable to Holders of a majority of the shares of Series E Preferred Stock that an exemption from the registration requirements of the Securities Act is available for such exchange and that upon receipt of such Exchange Debentures pursuant to such an exchange made in accordance with such exemption, each holder of an Exchange Debenture that is not an Affiliate of the Corporation will not be subject to any restrictions imposed by the Securities Act upon the resale of such Exchange Debenture, and such exemption is relied upon by the Corporation for such exchange, (C) the Indenture and the trustee thereunder shall have been qualified under the Trust Indenture Act of 1939, as amended; (D) immediately after giving effect to such exchange, no default or event of default would exist under any of the Corporation's existing Indebtedness; and (E) the Corporation shall have delivered to the Trustee under the Indenture a written opinion of counsel, dated the date of exchange, regarding the satisfaction of the conditions set forth in clauses (A), (B) and (C). XI. Covenants. (A) Limitation on Indebtedness (a) The Corporation shall not, and will not permit any of its Restricted Subsidiaries to, Incur any Indebtedness (other than Indebtedness existing on the Closing Date); provided that the Corporation may Incur Indebtedness if, after giving effect to the Incurrence of such Indebtedness and the receipt and application of the proceeds therefrom, the Consolidated Leverage Ratio would be greater than zero and less than 6:1. Notwithstanding the foregoing, the Corporation and any Restricted Subsidiary (except as specified below) may Incur each and all of the following: (i) Indebtedness outstanding at any time in an aggregate principal amount not to exceed $400 million; (ii) Indebtedness in existence on the Closing Date; (iii) Indebtedness of the Corporation to a Restricted Subsidiary and Indebtedness of a Restricted Subsidiary to the Corporation or another Restricted Subsidiary; provided that such Indebtedness is made pursuant to an intercompany note and any event which results in any such Restricted Subsidiary ceasing to be a Restricted Subsidiary or any subsequent transfer of such Indebtedness (other than to the Corporation or another Restricted Subsidiary) shall be deemed, in each case, to constitute an Incurrence of such Indebtedness not permitted by this clause (iii); (iv) Indebtedness issued in exchange for, or the net proceeds of which are used to refinance or refund, then outstanding Indebtedness (other than Indebtedness Incurred under clause (i), (iii), (v) or (ix) of this paragraph) and any refinancings thereof in an amount not to exceed the amount so refinanced or refunded (plus premiums, accrued interest, fees and expenses); provided that such new Indebtedness, determined as of the date of Incurrence of such new Indebtedness, does not mature or have a mandatory redemption or repurchase date prior to the Stated Maturity of the Indebtedness to be refinanced or refunded, and the Average Life of such new Indebtedness is at least equal to the remaining Average Life of the Indebtedness to be refinanced or refunded; (v) Indebtedness (A) in respect of performance, surety, appeal bonds and completion guarantees provided in the ordinary course of business; (B) under Currency Agreements and Interest Rate Agreements; provided that such agreements (a) are designed solely to protect the Corporation or its Restricted Subsidiaries against fluctuations in foreign currency exchange rates or interest rates and (b) do not increase the Indebtedness of the obligor outstanding at any time (except to the extent Incurred under another clause hereof) other than as a result of fluctuations in foreign currency exchange rates or interest rates or by reason of fees, indemnities and compensation payable thereunder; and (C) arising from agreements providing for indemnification, adjustment of purchase price or similar obligations, or from Guarantees or letters of credit, surety bonds or performance bonds securing any obligations of the Corporation or any of its Restricted Subsidiaries pursuant to such agreements, in each case Incurred in connection with the disposition of any business, assets or Restricted Subsidiary (other than Guarantees of Indebtedness Incurred by any Person acquiring all or any portion of such business, assets or Restricted Subsidiary for the purpose of financing such acquisition), in a principal amount not to exceed the gross proceeds actually received by the Corporation or any Restricted Subsidiary in connection with such disposition; (vi) Indebtedness of the Corporation, to the extent the net proceeds thereof are promptly (A) used to purchase the Series E Preferred Stock and/or Series F Preferred Stock tendered in an Offer to Purchase made as a result of a Change in Control or (B) deposited to defease the Senior Discount Notes or used to redeem all the Series E Preferred Stock or Series F Preferred Stock; (vii) Indebtedness Incurred to finance the cost (including the cost of design, development, acquisition, construction, installation, improvement, transportation or integration) to acquire equipment, inventory or network assets (including acquisitions by way of acquisitions of real property, leasehold improvements, Capitalized Leases and acquisitions of the Capital Stock of a Person that becomes a Restricted Subsidiary to the extent of the fair market value of the equipment, inventory or network assets so acquired) by the Corporation or a Restricted Subsidiary after the Closing Date; (viii) Indebtedness of the Corporation not to exceed, at any one time outstanding, two times the sum of (A) the Net Cash Proceeds received by the Corporation on or after the Closing Date from the issuance and sale of its Capital Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of the Corporation, to the extent such Net Cash Proceeds have not been used pursuant to clause (iii)(B)(2) of the first paragraph or clause (ii) of the second paragraph of Section XI(B) or clause (v) of the definition of "Permitted Investments" to make a Restricted Payment and (B) 80% of the fair market value of property (other than cash and cash equivalents) received by the Corporation after the Closing Date from the sale of its Capital Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of the Corporation, to the extent such sale of Capital Stock has not been used pursuant to clause (iii) of the second paragraph of Section XI(B) to make a Restricted Payment; provided that such Indebtedness does not mature prior to the Mandatory Redemption Date; (ix) Indebtedness Incurred by the Corporation or any of its Restricted Subsidiaries constituting reimbursement obligations with respect to letters of credit in the ordinary course of business, including, without limitation, letters of credit in respect of workers' compensation claims or self insurance, or other Indebtedness with respect to reimbursement type obligations regarding workers' compensation claims; provided, however, that upon the drawing of such letters of credit or the Incurrence of such Indebtedness, such obligations are reimbursed within 30 days following such drawing or Incurrence; (x) Indebtedness of Persons that are acquired by the Corporation or any of its Restricted Subsidiaries or merged into a Restricted Subsidiary in accordance with the terms of this Certificate of Designations; provided that such Indebtedness is not incurred in contemplation of such acquisition or merger; and provided further that after giving effect to such acquisition or merger, either (x) the Corporation would be permitted to incur at least $1.00 of additional Indebtedness pursuant to the Consolidated Leverage Ratio test set forth in the first sentence of this covenant or (y) the Consolidated Leverage Ratio is lower (if greater than zero) or higher (if less than zero) than immediately prior to such acquisition; (xi) Strategic Subordinated Indebtedness; and (xii) Indebtedness under the Lucent Facility. (b) Notwithstanding any other provision of this Section XI(A), the maximum amount of Indebtedness that the Corporation or a Restricted Subsidiary may Incur pursuant to this Section XI(A) shall not be deemed to be exceeded, with respect to any outstanding Indebtedness due solely to the result of fluctuations in the exchange rates of currencies. Accretion on an instrument issued at a discount will not be deemed to constitute an Incurrence of Indebtedness. (c) For purposes of determining any particular amount of Indebtedness pursuant to this Section XI(A), Guarantees, Liens or obligations with respect to letters of credit supporting Indebtedness otherwise included in the determination of such particular amount shall not be treated as Indebtedness. For purposes of determining compliance with this Section XI(A), in the event that an item of Indebtedness meets the criteria of more than one of the types of Indebtedness described in the above clauses, the Corporation, in its sole discretion, shall classify such item of Indebtedness and only be required to include the amount and type of such Indebtedness in one of such clauses. (B) Limitation on Restricted Payments The Corporation shall not, and shall not permit any Restricted Subsidiary to, directly or indirectly, (i) declare or pay any dividend or make any distribution on or with respect to its Junior Securities (other than (x) dividends or distributions payable solely in shares of its Junior Securities (other than Disqualified Stock) or in options, warrants or other rights to acquire shares of such Junior Securities and (y) pro rata dividends or distributions on Common Stock of Restricted Subsidiaries held by minority stockholders) held by Persons other than the Corporation or any of its Restricted Subsidiaries, (ii) purchase, redeem, retire or otherwise acquire for value any shares of Junior Securities of (A) the Corporation or an Unrestricted Subsidiary (including options, warrants or other rights to acquire such shares of Junior Securities) held by any Person or (B) a Restricted Subsidiary other than a Wholly Owned Restricted Subsidiary (including options, warrants or other rights to acquire such shares of Junior Securities) held by any Affiliate of the Corporation (other than a Wholly Owned Restricted Subsidiary), or (iii) make any Investment, other than a Permitted Investment, in any Person (such payments or any other actions described in clauses (i) through (iii) above being collectively "Restricted Payments") if, at the time of, and after giving effect to, the proposed Restricted Payment: (A) the Corporation could not Incur at least $1.00 of Indebtedness under the first paragraph of Section XI(A), or (B) the aggregate amount of all Restricted Payments (the amount, if other than in cash, to be determined in good faith by the Board of Directors whose determination shall be conclusive and evidenced by a Board Resolution) made after the Closing Date shall exceed the sum of (1) 50% of the aggregate amount of the Adjusted Consolidated Net Income (or, if the Adjusted Consolidated Net Income is a loss, minus 100% of the amount of such loss) (determined by excluding income resulting from transfers of assets by the Corporation or a Restricted Subsidiary to an Unrestricted Subsidiary) accrued on a cumulative basis during the period (taken as one accounting period) beginning on the first day of the fiscal quarter immediately following the Closing Date and ending on the last day of the last fiscal quarter preceding the Transaction Date for which reports have been provided to the Transfer Agent plus (2) 100% of the aggregate Net Cash Proceeds and the actual market value of marketable securities (on the date the calculation hereunder is made) received by the Corporation after the Closing Date from the issuance and sale permitted by this Certificate of Designations of its Capital Stock (other than Disqualified Stock) to a Person who is not a Subsidiary of the Corporation, including an issuance or sale permitted by this Certificate of Designations of Indebtedness of the Corporation for cash subsequent to the Closing Date upon the conversion of such Indebtedness into Capital Stock (other than Disqualified Stock) of the Corporation, or from the issuance to a Person who is not a Subsidiary of the Corporation of any options, warrants or other rights to acquire Capital Stock of the Corporation (in each case, exclusive of any Disqualified Stock or any options, warrants or other rights that are redeemable at the option of the holder, or are required to be redeemed, prior to the Mandatory Redemption Date), and the Net Cash Proceeds from any capital contributions to the Corporation after the Closing Date from Persons other than Subsidiaries of the Corporation, in each case excluding such Net Cash Proceeds to the extent used to Incur Indebtedness pursuant to clause (viii) of the second paragraph of Section XI(A) and excluding Net Cash Proceeds from the issuance of Capital Stock to the extent used to make a Permitted Investment in accordance with clause (v) of such defined term, plus (3) amounts received from Investments (other than Permitted Investments) in any Person resulting from payments of interest on Indebtedness, dividends, repayments of loans or advances, or other transfers of assets, in each case to the Corporation or any Restricted Subsidiary or from the Net Cash Proceeds from the sale of any such Investment (except, in each case, to the extent any such payment or proceeds are included in the calculation of Adjusted Consolidated Net Income), or from redesignations of Unrestricted Subsidiaries as Restricted Subsidiaries (valued in each case as provided in the definition of "Investments"), not to exceed, in each case, the amount of Investments previously made by the Corporation or any Restricted Subsidiary in such Person or Unrestricted Subsidiary or (C) dividends on Series E Preferred Stock shall not have been paid in full as provided in this Certificate of Designations. The foregoing provision shall not be violated by reason of: (i) the payment of any dividend within 60 days after the date of declaration thereof if, at said date of declaration, such payment would comply with the foregoing paragraph; (ii) the redemption, repurchase or other acquisition of Junior Securities of the Corporation including premium, if any, and accrued and unpaid dividends, with the proceeds of, or in exchange for, Junior Securities (other than Disqualified Stock) of the Corporation; (iii) payments or distributions, to dissenting stockholders pursuant to applicable law, pursuant to or in connection with a consolidation, merger or transfer of assets that complies with Article IX; (iv) the declaration or payment of dividends on the Common Stock of the Corporation following a Public Equity Offering of such Common Stock, of up to 6% per annum of the Net Cash Proceeds received by the Corporation in such Public Equity Offering; (v) the repurchase, retirement or other acquisition or retirement for value of any shares of Junior Securities of the Corporation that are not registered under the Exchange Act and are held by any current or former employee, director or consultant (or their estates or the beneficiaries of such estates) of the Corporation or any Subsidiary, not to exceed (A) in any calendar year $2.0 million or (B) $5.0 million in the aggregate; (vi) repurchases of Junior Securities deemed to occur upon exercise of stock options if such Capital Stock represents a portion of the exercise price of such options; (vii) repurchases of fractional shares of Junior Securities in connection with the exercise of Warrants in accordance with the Warrant Agreement or other warrants to purchase the Corporation's Common Stock; and (viii) other Restricted Payments in an aggregate amount not to exceed $2.0 million. Each Restricted Payment permitted pursuant to the preceding paragraph (other than the Restricted Payment referred to in clauses (ii) or (vi) thereof, an exchange of Junior Securities for Junior Securities and an Investment referred to in clause (iv) thereof) shall be included in calculating whether the conditions of clause (iii)(B) of the first paragraph of this Section XI(B) have been met with respect to any subsequent Restricted Payments. In the event the proceeds of an issuance of Capital Stock of the Corporation are used for the redemption, repurchase or other acquisition of Parity Securities, then the Net Cash Proceeds of such issuance shall be included in clause (iii)(B) of the first paragraph of this Section XI(B) only to the extent such proceeds are not used for such redemption, repurchase or other acquisition of securities. Any Restricted Payments made other than in cash shall be valued at fair market value. The amount of any Investment "outstanding" at any time shall be deemed to be equal to the amount of such Investment on the date made, less the return of capital to the Corporation and its Restricted Subsidiaries with respect to such Investment by distribution, sale or otherwise (up to the amount of such Investment on the date made). (C) Limitation on Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries The Corporation shall not, and shall not permit any Restricted Subsidiary to, create or otherwise cause or suffer to exist or become effective any consensual encumbrance or restriction of any kind on the ability of any Restricted Subsidiary to (i) pay dividends or make any other distributions permitted by applicable law on any Capital Stock of such Restricted Subsidiary owned by the Corporation or any other Restricted Subsidiary, (ii) pay any Indebtedness owed to the Corporation or any other Restricted Subsidiary, (iii) make loans or advances to the Corporation or any other Restricted Subsidiary or (iv) transfer any of its property or assets to the Corporation or any other Restricted Subsidiary. The foregoing provisions shall not restrict any encumbrances or restrictions: (i) existing on the Closing Date, in the Newcourt Facility, the Lucent Facility, this Certificate of Designations or any other agreements in effect on the Closing Date, and any extensions, refinancings, renewals or replacements of such agreements; provided that the encumbrances and restrictions in any such extensions, refinancings, renewals or replacements are no less favorable in any material respect to the Holders than those encumbrances or restrictions that are then in effect and that are being extended, refinanced, renewed or replaced; (ii) existing under or by reason of applicable law, rule, regulation or order; (iii) existing with respect to any Person or the property or assets of such Person acquired by the Corporation or any Restricted Subsidiary, existing at the time of such acquisition and not incurred in contemplation thereof, which encumbrances or restrictions are not applicable to any Person or the property or assets of any Person other than such Person or the property or assets of such Person so acquired; (iv) in the case of clause (iv) of the first paragraph of this Section XI(C), (A) that restrict in a customary manner the subletting, assignment or transfer of any property or asset that is a lease, license, conveyance or contract or similar property or asset, (B) existing by virtue of any transfer of, agreement to transfer, option or right with respect to, or Lien on, any property or assets of the Corporation or any Restricted Subsidiary not otherwise prohibited by this Certificate of Designations, (C) arising or agreed to in the ordinary course of business, not relating to any Indebtedness, and that do not, individually or in the aggregate, detract from the value of property or assets of the Corporation or any Restricted Subsidiary in any manner material to the Corporation or any Restricted Subsidiary or (D) purchase money obligations for property acquired in the ordinary course of business that impose restrictions of the nature discussed in clause (iv) above on the property so acquired; (v) with respect to the Corporation or a Restricted Subsidiary and imposed pursuant to an agreement that has been entered into for the sale of assets, including, without limitation, customary restrictions on the disposition of all or substantially all of the Capital Stock of, or property and assets of, such Restricted Subsidiary or the Corporation; (vi) contained in the terms of any Indebtedness or any agreement pursuant to which such Indebtedness was issued (in each case other than Indebtedness incurred under the Newcourt Facility) if (A) the encumbrance or restriction applies only in the event of a payment default or a default with respect to a financial covenant contained in such Indebtedness or agreement, (B) the encumbrance or restriction is not materially more disadvantageous to the Holders of the Series E Preferred Stock than is customary in comparable financings (as determined by the Corporation) and (C) the Corporation determines that any such encumbrance or restriction will not materially affect the Corporation's ability to make dividend and mandatory redemption payments on the Series E Preferred Stock; (vii) restrictions on cash or other deposits or net worth imposed by customers under contracts entered into in the ordinary course of business; (viii) customary provisions in joint venture agreements and other similar agreements entered into in the ordinary course of business; and (ix) any encumbrances or restrictions of the type referred to in clauses (i)-(iv) of the first paragraph of this covenant imposed by any amendments, modifications, renewals, restatements, increases, supplements, refundings, replacements or refinancings of the contracts referred to in clauses (i) through (viii) above; provided that such amendments, modifications, restatements, renewals, increases, supplements, refundings, replacements or refinancings are, in the good faith judgment of the Corporation, not materially more disadvantageous to the Holders than those contained in the restriction prior to such amendment, modification, restatement, renewal, increase, supplement, refunding, replacement or refinancing. Nothing contained in this Section XI(C) shall prevent the Corporation or any Restricted Subsidiary from restricting the sale or other disposition of property or assets of the Corporation or any of its Restricted Subsidiaries that secure Indebtedness of the Corporation or any of its Restricted Subsidiaries. (D) Limitation on the Issuance and Sale of Capital Stock of Restricted Subsidiaries The Corporation shall not sell, and shall not permit any Restricted Subsidiary, directly or indirectly, to issue or sell, any shares of Capital Stock of a Restricted Subsidiary (including options, warrants or other rights to purchase shares of such Capital Stock) except (i) to the Corporation or a Wholly Owned Restricted Subsidiary; (ii) issuances of director's qualifying shares or sales to foreign nationals of shares of Capital Stock of foreign Restricted Subsidiaries, to the extent required by applicable law; (iii) if, immediately after giving effect to such issuance or sale, such Restricted Subsidiary would no longer constitute a Restricted Subsidiary and any Investment in such Person remaining after giving effect to such issuance or sale would have been permitted to be made in accordance with Section XI(B) if made on the date of such issuance or sale; or (iv) issuances or sales of common stock of a Restricted Subsidiary, provided that the Corporation or any Restricted Subsidiary applies an amount equal to the Net Cash Proceeds thereof in accordance with Section XI(F). (E) Limitation on Transactions with Shareholders and Affiliates The Corporation shall not, and shall not permit any Restricted Subsidiary to, directly or indirectly, enter into, renew or extend any transaction (including, without limitation, the purchase, sale, lease or exchange of property or assets, or the rendering of any service) with any Affiliate of the Corporation or any Restricted Subsidiary, except upon fair and reasonable terms no less favorable to the Corporation or such Restricted Subsidiary than could be obtained, at the time of such transaction or, if such transaction is pursuant to a written agreement, at the time of the execution of the agreement providing therefor, in a comparable arm's-length transaction with a Person that is not an Affiliate. The foregoing limitation does not limit, and shall not apply to (i) transactions (A) approved by a majority of the disinterested members of the Board of Directors or (B) for which the Corporation or a Restricted Subsidiary delivers to the Transfer Agent a written opinion of a nationally recognized investment banking firm or a nationally recognized firm having expertise in the specific area which is the subject of such determination stating that the transaction is fair to the Corporation or such Restricted Subsidiary from a financial point of view; (ii) any transaction solely between the Corporation and any of its Restricted Subsidiaries or solely between Restricted Subsidiaries; (iii) the payment of reasonable and customary regular fees to, and indemnity provided on behalf of, officers, directors, employees or consultants of the Corporation or its Restricted Subsidiaries; (iv) any payments or other transactions pursuant to any tax-sharing agreement between the Corporation and any other Person with which the Corporation files a consolidated tax return or with which the Corporation is part of a consolidated group for tax purposes; (v) any agreement as in effect as of the Closing Date or any amendment thereto (so long as any such amendment is not disadvantageous to the Holders in any material respect); (vi) the existence of, or the performance by the Corporation or any of its Restricted Subsidiaries of its obligations under the terms of, any stockholders agreement (including any registration rights agreement or purchase agreement related thereto) to which it is a party as of the Closing Date and any similar agreements which it may enter into thereafter (so long as any such amendment is not disadvantageous to the Holders in any material respect); or (vii) any Permitted Investments and Restricted Payments not prohibited by Section XI(B). Notwithstanding the foregoing, any transaction or series of related transactions covered by the first paragraph of this Section XI(E) and not covered by clauses (ii) through (vii) of this paragraph the aggregate amount of which exceeds $3.0 million in value, must be approved or determined to be fair in the manner provided for in clause (i)(A) or (B) above. (F) Limitation on Asset Sales The Corporation shall not, and shall not permit any Restricted Subsidiary to, consummate any Asset Sale, unless (i) the consideration received by the Corporation or such Restricted Subsidiary is at least equal to the fair market value of the assets sold or disposed of and (ii) at least 75% of the consideration received consists of cash or Temporary Cash Investments. For purposes of this covenant, the following are deemed to be cash: (x) the principal amount or accreted value (whichever is larger) of Indebtedness of the Corporation or any Restricted Subsidiary with respect to which the Corporation or such Restricted Subsidiary has either (A) received a written release or (B) been released by operation of law, in either case, from all liability on such Indebtedness in connection with such Asset Sale and (y) securities received by the Corporation or any Restricted Subsidiary from the transferee that are promptly converted by the Corporation or such Restricted Subsidiary into cash. In the event and to the extent that the Net Cash Proceeds received by the Corporation or any of its Restricted Subsidiaries from one or more Asset Sales occurring on or after the Closing Date in any period of 12 consecutive months exceed 10% of Adjusted Consolidated Net Tangible Assets (determined as of the date closest to the commencement of such 12-month period for which a consolidated balance sheet of the Corporation and its Subsidiaries has been provided to the Transfer Agent), then the Corporation shall or shall cause the relevant Restricted Subsidiary to (i) within 12 months after the date Net Cash Proceeds so received exceed 10% of Adjusted Consolidated Net Tangible Assets (A) apply an amount equal to such excess Net Cash Proceeds to permanently repay Indebtedness of the Corporation, repay Indebtedness of any Restricted Subsidiary or redeem any Senior Securities, in each case owing to, or held by, a Person other than the Corporation or any of its Restricted Subsidiaries or (B) invest an equal amount, or the amount not so applied pursuant to clause (A) (or enter into a definitive agreement committing to so invest within 12 months after the date of such agreement), in property or assets (other than current assets) of a nature or type or that are used in a business (or in a Person (other than a natural person) having property and assets of a nature or type, or engaged in a business) similar or related to the nature or type of the property and assets of, or the business of, the Corporation and its Restricted Subsidiaries existing on the date of such investment (as determined in good faith by the Board of Directors whose determination shall be conclusive and evidenced by a Board Resolution) and (ii) apply (no later than the end of the 12-month period referred to in clause (i)) such excess Net Cash Proceeds (to the extent not applied pursuant to clause (i)) as provided in the following paragraph of this Section XI(F). The amount of such excess Net Cash Proceeds required to be applied (or to be committed to be applied) during such 12-month period as set forth in clause (i) of the preceding sentence and not applied as so required by the end of such period shall constitute "Excess Proceeds." If, as of the first day of any calendar month, the aggregate amount of Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to this Section XI(F) totals at least $5 million, the Corporation must commence, not later than the fifteenth Business Day of such month, and consummate an Offer to Purchase from the Holders on a pro rata basis, and an offer to purchase any outstanding Parity Securities with similar provisions requiring the Corporation to make an offer to purchase such securities, in an aggregate liquidation preference of Series E Preferred Stock and such Parity Securities equal to (A) with respect to the Series E Preferred Stock, the product of such Excess Proceeds multiplied by a fraction, the numerator of which is the liquidation preference of the outstanding shares of the Series E Preferred Stock and the denominator of which is the sum of the outstanding liquidation preference of the Series E Preferred Stock and such Parity Securities (the product hereinafter referred to as the "Series E Preferred Stock Amount"), and (B) with respect to the Parity Securities, the excess of the Excess Proceeds over the Series E Preferred Stock Amount, at a purchase price equal to 100% of the liquidation preference of the Series E Preferred Stock or such Parity Securities, as the case may be, on the relevant Payment Date or such other date set forth in the documentation governing the Parity Securities, plus, in each case, accrued dividends (if any) to the Payment Date or such other date set forth in the documentation governing the Parity Securities. If the aggregate purchase price of the Preferred Stock tendered pursuant to the Offer to Purchase is less than the Excess Proceeds, the remaining will be available for use by the Corporation for general corporate purposes. Upon the consummation of any Offer to Purchase in accordance with the terms of this Certificate of Designations, the amount of Net Cash Proceeds from Asset Sales subject to any future Offer to Purchase shall be deemed to be zero. Prior to commencing any Offer to Purchase, the Corporation shall first consummate any offer to purchase required to be made to any Holder of its Indebtedness. (G) Commission Reports and Reports to Holders. While the Series E Preferred Stock is outstanding, whether or not the Corporation is then required to file reports with the Commission, the Corporation shall deliver for filing with the Commission all such reports and other information as it would be required to file with the Commission by Sections 13(a) or 15(d) under the Exchange Act if it were subject thereto. All references herein to reports "filed" with the Commission shall be deemed to refer to the reports then most recently delivered for filing, whether or not accepted by the Commission. XII. Mutilated or Missing Series E Preferred Stock Certificates. If any of the Series E Preferred Stock certificates shall be mutilated, lost, stolen or destroyed, the Corporation shall issue, in exchange and in substitution for and upon cancellation of the mutilated Series E Preferred Stock certificate, or in lieu of and substitution for the Series E Preferred Stock certificate lost, stolen or destroyed, a new Series E Preferred Stock certificate of like tenor and representing an equivalent amount of shares of Series E Preferred Stock, but only upon receipt of evidence of such loss, theft or destruction of such Series E Preferred Stock certificate and indemnity, if requested, satisfactory to the Corporation. XIII. Reissuance; Preemptive Rights (i) Shares of Series E Preferred Stock that have been issued and reacquired in any manner, including shares purchased or redeemed, shall (upon compliance with any applicable provisions of the laws of the State of Delaware) have the status of authorized and unissued shares of Preferred Stock undesignated as to series and may be redesignated and reissued as part of any series of Preferred Stock. (ii) No shares of Series E Preferred Stock shall have any rights of preemption whatsoever as to any securities of the Corporation, or any warrants, rights or options issued or granted with respect thereto, regardless of how such securities or such warrants, rights or options may be designated, issued or granted. XIV. Business Day. If any payment or redemption shall be required by the terms hereof to be made on a day that is not a Business Day, such payment or redemption shall be made on the immediately succeeding Business Day and no further dividends shall accrued after the day payment was required. XV. Headings of Subdivisions. The headings of various subdivisions hereof are for convenience of reference only and shall not affect the interpretation of any of the provisions hereof. XVI. Severability of Provisions. If any right, preference or limitation of the Series E Preferred Stock set forth in this Certificate of Designations (as may be amended from time to time) is invalid, unlawful or incapable of being enforced by reason of any rule or law or public policy, all other rights, preferences and limitations set forth in this Certificate of Designations, as amended, which can be given effect without the invalid, unlawful or unenforceable right, preference or limitation shall, nevertheless remain in full force and effect, and no right, preference or limitation herein set forth shall be deemed dependent upon any other such right, preference or limitation unless so expressed herein. XVII. Notice. All notices, requests, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered by hand or when sent by telex or telecopier (with receipt confirmed), provided a copy is also sent by express (overnight, if possible) courier, addressed (i) in the case of a Holder of the Series E Preferred Stock, to such holder's address of record shown on the records of the Corporation, and (ii) in the case of the Corporation, to the Corporation's principal executive offices (currently located on the date of the adoption of these resolutions at the following address: KMC Telecom Holdings, Inc., 1545 Route 206, Suite 300, Bedminster, New Jersey 07921) to the attention of the Corporation's Chief Financial Officer. XVIII. Limitations. Except as may otherwise be required by law, the shares of Series E Preferred Stock shall not have any powers, preferences or relative, participating, optional or other special rights other than those specifically set forth in this Certificate of Designations (as may be amended from time to time) or otherwise in the Certificate of Incorporation of the Corporation. XIX. Transfer and Legending of Shares. No transfer of shares of the Series E Preferred Stock shall be effective until such transfer is registered on the books of the Corporation. Any shares of the Series E Preferred Stock so transferred must bear the following legend: THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), NOR HAS IT BEEN REGISTERED UNDER THE SECURITIES OR BLUE SKY LAWS OF ANY STATE. THIS SECURITY MAY NOT BE OFFERED, SOLD, PLEDGED OR IN ANY OTHER MANNER TRANSFERRED OR DISPOSED OF UNLESS (I) SUCH TRANSFER IS IN COMPLIANCE WITH THE SECURITIES ACT AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER AND APPLICABLE STATE SECURITIES LAWS OR BLUE SKY LAWS AND (II) PRIOR TO ANY SUCH TRANSFER, THE TRANSFEROR OR THE TRANSFEREE DELIVERS AN OPINION OF COUNSEL (REASONABLY ACCEPTABLE TO THE CORPORATION) TO THE TRANSFER AGENT AND THE CORPORATION, THAT SUCH TRANSFER IS IN COMPLIANCE WITH THE SECURITIES ACT AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. The Corporation shall refuse to register any attempted transfer of shares of Series E Preferred Stock not in compliance with this Article XIX. In the event the shares of Series E Preferred Stock are issued as part of a unit together with Warrants, the shares of Series E Preferred Stock and the Warrants shall not be separately transferable from each other until the next Business Day after the issuance of such shares of Series E Preferred Stock or until such other date as may be specified in a legend to the shares of Series E Preferred Stock. XX. Amendments and Waivers (A) Except as provided in this Article XX, any right, preference, privilege or power of, or restriction provided for the benefit of, the Series E Preferred Stock set forth herein may be amended and the observance thereof may be waived (either generally or in a particular instance and either retroactively or prospectively) only with the written consent of the Corporation and the affirmative vote or written consent of the Holders of at least a majority of the shares of Series E Preferred Stock then outstanding (excluding any shares held by Affiliates of the Corporation, any Existing Stockholders or any of their Affiliates), and any amendment or waiver so effected shall be binding upon the Corporation and all Holders of the Series E Preferred Stock. (B) Notwithstanding the foregoing, if any amendment is made to the covenants of the Senior Discount Note Indenture, in accordance with the provisions therein, then a conforming amendment may be made to the covenants set forth in Article XI of this Certificate of Designations by the Corporation, without the consent of any Holder, and any amendment so effected shall be binding upon the Corporation and all Holders of the Series E Preferred Stock; provided however, that if in connection with making any such amendment to the Senior Discount Note Indenture, the Corporation has paid consideration to the holders of the Senior Discount Notes to obtain their consent to make such amendment, then the Corporation shall pay each Holder consideration per $1,000 liquidation preference of Series E Preferred Stock equal to the consideration per $1,000 Accreted Value (as defined in the Senior Discount Note Indenture) of Senior Discount Notes paid to the holders of the Senior Discount Notes. In connection with any such amendment, the Corporation shall deliver to the Transfer Agent an Opinion of Counsel, reasonably acceptable to it, that such amendment complies with the terms hereof. The Corporation shall provide notice in accordance with Article XVII of this Certificate of Designations of any amendment effected pursuant to this Section XX(B) to the Holders of the Series E Preferred Stock. XXI. Increase of Authorized Amount of Shares. Notwithstanding any other provision herein, the Board of Directors may, from time to time, in its sole discretion, increase the number of shares of Preferred Stock designated as Series E Preferred Stock under Article II of this Certificate of Designations, up to the maximum amount of shares of Preferred Stock authorized to be issued, without the consent of the holders of any shares of its Capital Stock. XXII. Issuance of Additional Shares of Series E Preferred Stock. Except with respect to the issuance of shares of Series E Preferred Stock to pay dividends on the Series E Preferred Stock or upon conversion of the Series F Preferred Stock, the Corporation may not issue additional shares of the Series E Preferred Stock to any purchaser unless (A) it has obtained the consent of the Holders of a majority of the shares of Series E Preferred Stock then outstanding and the holders of a majority of the shares of Series F Preferred Stock then outstanding or (B)(i) the per share price paid for such additional shares is at least equal to the per share price paid to the Corporation for the shares of Series E Preferred Stock issued on the Closing Date, (ii) the Corporation does not issue to such purchaser more than 1,363.64 Warrants per $1,000,000 of liquidation preference of Series E Preferred Stock, (iii) (a) the Holders of Series E Preferred Stock issued on the Closing Date retain their right to receive at least 227.273 Warrants, pursuant to Section 2.4 of the Warrant Agreement, per $100,000 of liquidation preference of Series E Preferred Stock issued on the Closing Date and (b) the holders of Series F Preferred Stock issued on the Closing Date retain their right to receive at least 227.273 Warrants, pursuant to Section 2.4 of the Warrant Agreement, per $100,000 of liquidation preference of Series F Preferred Stock issued on the Closing Date and (iv) the aggregate amount of shares of Series E Preferred Stock and Series F Preferred Stock issued (other than shares of Series E Preferred Stock and Series F Preferred Stock issued to pay dividends thereon or shares of Series E Preferred Stock issued upon conversion of the Series F Preferred Stock) shall not exceed 150,000 shares. Except with respect to the issuance of shares of Series F Preferred Stock to pay dividends on the Series F Preferred Stock, the Corporation shall not issue in excess of 40,000 shares of Series F Preferred Stock, unless it has obtained the consent of the Holders of a majority of the shares of Series E Preferred Stock then outstanding and the holders of a majority of the shares of Series F Preferred Stock then outstanding. IN WITNESS WHEREOF, this Certificate has been signed on this 4th day of February, 1999. KMC TELECOM HOLDINGS, INC. By:/s/ CYNTHIA WORTHMAN --------------------------- Name: Cynthia Worthman Title: Chief Financial Officer Attested by: EX-3.8 7 CERTIFICATE OF CORRECTION 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. -------------------------- Pursuant to Section 151 of the General Corporation Law of the State of Delaware -------------------------- I, Cynthia Worthman, Corporate Secretary of KMC Telecom Holdings, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, in accordance with the provisions of Section 151 of the General Corporation Law of the State of Delaware, DO HEREBY CERTIFY: That, pursuant to authority conferred upon the Board of Directors by the Certificate of Incorporation, as amended, of said Corporation (the "Certificate of Incorporation"), said Board of Directors, at a meeting duly called and held on February 1, 1999, adopted a resolution providing for the issuance of 55,000 authorized shares of Series F Senior Redeemable, Exchangeable, PIK Preferred Stock (the "Series F Preferred Stock"), which resolution is as follows: WHEREAS, the Board of Directors is authorized, within the limitations and restrictions stated in the Certificate of Incorporation, as amended, to fix by resolution or resolutions the designation of each series of preferred stock and the powers, designations, preferences and relative participating, optional or other rights, if any, or the qualifications, limitations or restrictions thereof, including, without limiting the generality of the foregoing, such provisions as may be desired concerning voting, redemption, dividends, dissolution or the distribution of assets, conversion or exchange, and such other subjects or matters as may be fixed by resolution or resolutions of the Board of Directors under the General Corporation Law of Delaware; and WHEREAS, it is the desire of the Board of Directors, pursuant to its authority as aforesaid, to authorize and fix the terms of a series of preferred stock and the number of shares constituting such series; NOW, THEREFORE, BE IT RESOLVED, that there is hereby authorized such series of preferred stock on the terms and with the provisions herein set forth: I. Certain Definitions. As used herein, the following terms shall have the following meanings (with terms defined in the singular having comparable meanings when used in the plural and vice versa), unless the context otherwise requires: "Acquired Indebtedness" means Indebtedness of a Person existing at the time such Person becomes a Restricted Subsidiary or assumed in connection with an Asset Acquisition by the Corporation or a Restricted Subsidiary and not Incurred in connection with, or in anticipation of, such Person becoming a Restricted Subsidiary or such Asset Acquisition; provided that Indebtedness of such Person which is redeemed, defeased, retired or otherwise repaid at the time of or immediately upon consummation of the transactions by which such Person becomes a Restricted Subsidiary or upon consummation of such Asset Acquisition shall not be Acquired Indebtedness. "Adjusted Consolidated Net Income" means, for any period, the aggregate net income (or loss) of the Corporation and its Restricted Subsidiaries for such period determined in conformity with GAAP; provided that the following items shall be excluded in computing Adjusted Consolidated Net Income (without duplication): (i) the net income (or loss) of any Person that is not a Restricted Subsidiary (or is an Unrestricted Subsidiary), except to the extent of the amount of dividends or other distributions actually paid to the Corporation or any of its Restricted Subsidiaries by such Person or an Unrestricted Subsidiary during such period; (ii) solely for the purposes of calculating the amount of Restricted Payments that may be made pursuant to clause (iii)(B) of the first paragraph of Section XI(B) (and in such case, except to the extent includable pursuant to clause (i) above), the net income (or loss) of any Person accrued prior to the date it becomes a Restricted Subsidiary or is merged into or consolidated with the Corporation or any of its Restricted Subsidiaries or all or substantially all of the property and assets of such Person are acquired by the Corporation or any of its Restricted Subsidiaries; (iii) the net income of any Restricted Subsidiary to the extent that the declaration or payment of dividends or similar distributions by such Restricted Subsidiary of such net income is not at the time permitted by the operation of the terms of its charter or any agreement, instrument, judgment, decree, order, statute, rule or governmental regulation applicable to such Restricted Subsidiary (except to the extent such restriction has been legally waived); (iv) any gains or losses (on an after-tax basis) attributable to Asset Sales including for purposes hereof the items referred to in clauses (b), (c) and (e) of the definition of "Asset Sale" or the termination of discontinued operations; (v) except for purposes of calculating the amount of Restricted Payments that may be made pursuant to clause (iii)(B) of the first paragraph of Section XI(B), any amount paid or accrued as dividends on Preferred Stock (including the Series F Preferred Stock) of the Corporation or any Restricted Subsidiary owned by Persons other than the Corporation and any of its Restricted Subsidiaries; (vi) all extraordinary gains and extraordinary losses; (vii) the cumulative effect of a change in accounting principles since the High Yield Closing Date; and (viii) at the irrevocable election of the Corporation for each occurrence, any net after-tax income (loss) from discontinued operations; provided that for purposes of any subsequent Investment in the entity conducting such discontinued operations pursuant to Section XI(B), such entity shall be treated as an Unrestricted Subsidiary until such discontinued operations have actually been disposed of. "Adjusted Consolidated Net Tangible Assets" means the total amount of assets of the Corporation and its Restricted Subsidiaries (less applicable depreciation, amortization and other valuation reserves), except to the extent resulting from write-ups of capital assets (excluding write-ups in connection with accounting for acquisitions in conformity with GAAP), after deducting therefrom (i) all current liabilities of the Corporation and its Restricted Subsidiaries (excluding intercompany items) and (ii) all goodwill, trade names, trademarks, patents, unamortized debt discount and expense and other like intangibles, all as set forth on the most recent quarterly or annual consolidated balance sheet of the Corporation and its Restricted Subsidiaries, prepared in conformity with GAAP. "Affiliate" means, as applied to any Person, any other Person directly or indirectly controlling, controlled by, or under direct or indirect common control with, such Person. For purposes of this definition, "control" (including, with correlative meanings, the terms "controlling," "controlled by" and "under common control with"), as applied to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. "Asset Acquisition" means (i) an investment by the Corporation or any of its Restricted Subsidiaries in any other Person pursuant to which such Person shall become a Restricted Subsidiary or shall be merged into or consolidated with the Corporation or any of its Restricted Subsidiaries or (ii) an acquisition by the Corporation or any of its Restricted Subsidiaries of the property and assets of any Person other than the Corporation or any of its Restricted Subsidiaries that constitute substantially all of a division or line of business of such Person. "Asset Sale" means any sale, transfer or other disposition (including by way of merger, consolidation or sale-leaseback transaction) in one transaction or a series of related transactions by the Corporation or any of its Restricted Subsidiaries to any Person other than the Corporation or any of its Restricted Subsidiaries of (i) all or any of the Capital Stock of any Restricted Subsidiary, (ii) all or substantially all of the property and assets of an operating unit or business of the Corporation or any of its Restricted Subsidiaries or (iii) any other property and assets (other than the Capital Stock or other Investment in an Unrestricted Subsidiary) of the Corporation or any of its Restricted Subsidiaries outside the ordinary course of business of the Corporation or such Restricted Subsidiary and, in each case, that is not governed by Section IX; provided that "Asset Sale" shall not include (a) sales or other dispositions of inventory, receivables and other current assets, (b) sales or other dispositions of assets for consideration at least equal to the fair market value of the assets sold or disposed of, to the extent that the consideration received would constitute property or assets of the kind described in clause (i)(B) of Section XI(F), (c) a disposition of cash or Temporary Cash Investments, (d) any Restricted Payment that is permitted to be made, and is made, in accordance with Section XI(B), (e) sales or other dispositions of assets with a fair market value (as certified in an Officers' Certificate) not in excess of $2 million (provided that any series of related sales or dispositions in excess of $2 million shall be considered "Asset Sales"), (f) the lease, assignment of a lease or sub-lease of any real or personal property in the ordinary course of business, (g) foreclosures on assets, (h) pledges of assets or stock by the Corporation or any of its Restricted Subsidiaries otherwise permitted under this Certificate of Designations, including such pledges securing Indebtedness under the Newcourt Facility or under the Lucent Facility, (i) the issuance of the Warrants to Newcourt Finance and Lucent by the Corporation and (j) the exercise of the Warrants by Newcourt Finance and Lucent and the exercise of common stock warrants by Newcourt Finance in respect of KMC Telecom. "Average Life" means, at any date of determination with respect to any debt security, the quotient obtained by dividing (i) the sum of the products of (a) the number of years from such date of determination to the dates of each successive scheduled principal payment of such debt security and (b) the amount of such principal payment by (ii) the sum of all such principal payments. "Board of Directors" means the Board of Directors of the Corporation. "Board Resolution" means a copy of a resolution, certified by the Secretary or Assistant Secretary of the Corporation as required by the context to have been duly adopted by the Board of Directors and to be in full force and effect on the date of such certification, and delivered to the Transfer Agent. "Business Day" means a day other than a Saturday, Sunday or other day on which commercial banks in New York City are authorized or required by law to close. "Capital Stock" means, with respect to any Person, any and all shares, interests, participations or other equivalents (however designated, whether voting or non-voting) in equity of such Person, whether outstanding on the Closing Date or issued thereafter, including, without limitation, all Common Stock, Preferred Stock (including the Series F Preferred Stock), partnership or membership interests and any other right to receive a share of the profits and losses of, or distributions of assets of, the issuing Person. "Capitalized Lease" means, as applied to any Person, any lease of any property (whether real, personal or mixed) of which the discounted present value of the rental obligations of such Person as lessee, in conformity with GAAP, is required to be capitalized on the balance sheet of such Person. "Capitalized Lease Obligations" means the amount of the liability in respect of a Capitalized Lease that would at such time be required to be capitalized and reflected as a liability on a balance sheet prepared in accordance with GAAP. "Change of Control" means such time as (i) a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) becomes the ultimate "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) of more than 50% of the total voting power of the Voting Stock of the Corporation on a fully diluted basis and such ownership represents a greater percentage of the total voting power of the Voting Stock of the Corporation, on a fully diluted basis, than is held by the Existing Stockholders on such date; or (ii) individuals who on the Closing Date constitute the Board of Directors (together with any new directors whose election by the Board of Directors or whose nomination by the Board of Directors for election by the Corporation's stockholders was approved by a vote of at least a majority of the members of the Board of Directors then in office who either were members of the Board of Directors on the Closing Date or whose election or nomination for election was so previously approved) cease for any reason to constitute a majority of the members of the Board of Directors then in office. "Closing Date" means February 4, 1999. "Commission" means the Securities and Exchange Commission and any successor agency having similar powers. "Common Stock" means the Common Stock, par value $.01 per share, of the Corporation and any other class of common stock hereafter authorized by the Corporation from time to time. "Consolidated EBITDA" means, for any period, Adjusted Consolidated Net Income for such period plus, to the extent such amount was deducted in calculating such Adjusted Consolidated Net Income, (i) Consolidated Interest Expense, (ii) income taxes (other than income taxes (either positive or negative) attributable to extraordinary and non-recurring gains or losses or sales of assets), (iii) depreciation expense, (iv) amortization expense and (v) all other non-cash items reducing Adjusted Consolidated Net Income (other than items that will require cash payments and for which an accrual or reserve is, or is required by GAAP to be, made), less all non-cash items increasing (or, in the case of a loss, decreasing) Adjusted Consolidated Net Income, determined, with respect to clauses (ii), (iii) and (iv), on a consolidated basis for the Corporation and its Restricted Subsidiaries in conformity with GAAP; provided that, if any Restricted Subsidiary is not a Wholly Owned Restricted Subsidiary, Consolidated EBITDA shall be reduced (to the extent not otherwise reduced in accordance with GAAP) by an amount equal to (A) the amount of the Adjusted Consolidated Net Income attributable to such Restricted Subsidiary multiplied by (B) the percentage ownership interest in the income of such Restricted Subsidiary not owned on the last day of such period by the Corporation or any of its Restricted Subsidiaries. "Consolidated Interest Expense" means, for any period, the aggregate amount (without duplication) of interest in respect of Indebtedness (including, without limitation, amortization of original issue discount on any Indebtedness and the interest portion of any deferred payment obligation, calculated in accordance with the effective interest method of accounting; all commissions, discounts and other fees and charges owed with respect to letters of credit and bankers' acceptance financing; the net costs associated with Interest Rate Agreements; and Indebtedness that is Guaranteed or secured by the Corporation or any of its Restricted Subsidiaries) and the interest component of Capitalized Lease Obligations paid, accrued or scheduled to be paid or to be accrued by the Corporation and its Restricted Subsidiaries during such period; excluding, however, (i) any amount of such interest of any Restricted Subsidiary if the net income of such Restricted Subsidiary is excluded in the calculation of Adjusted Consolidated Net Income pursuant to clause (iii) of the definition thereof (but only in the same proportion as the net income of such Restricted Subsidiary is excluded from the calculation of Adjusted Consolidated Net Income pursuant to clause (iii) of the definition thereof) and (ii) any premiums, fees and expenses (and any amortization thereof) payable in connection with the Lucent Facility, the Newcourt Facility and the offering of the Series E Preferred Stock, the Series F Preferred Stock and the Senior Discount Notes, all as determined on a consolidated basis (without taking into account Unrestricted Subsidiaries) in conformity with GAAP. "Consolidated Leverage Ratio" means, on any Transaction Date, the ratio of (i) the aggregate amount of Indebtedness of the Corporation and its Restricted Subsidiaries on a consolidated basis outstanding on such Transaction Date to (ii) the aggregate amount of Consolidated EBITDA for the then most recent four fiscal quarters for which financial statements of the Corporation have been provided to the Transfer Agent (such four fiscal quarter period being the "Four Quarter Period"); provided that, in making the foregoing calculation, pro forma effect shall be given to the following events which occur from the beginning of the Four Quarter Period through the Transaction Date (the "Reference Period"): (i) the Incurrence of the Indebtedness with respect to which the computation is being made and (if applicable) the application of the net proceeds therefrom, including to refinance other Indebtedness, as if such Indebtedness was incurred, and the application of such proceeds occurred, at the beginning of the Four Quarter Period; (ii) the Incurrence, repayment or retirement of any other Indebtedness by the Corporation and its Restricted Subsidiaries since the first day of the Four Quarter Period as if such Indebtedness was incurred, repaid or retired at the beginning of the Four Quarter Period; (iii) in the case of Acquired Indebtedness, the related acquisition, as if such acquisition occurred at the beginning of the Four Quarter Period; (iv) any acquisition or disposition by the Corporation and its Restricted Subsidiaries of any corporation or any business or any assets out of the ordinary course of business, whether by merger, stock purchase or sale or asset purchase or sale or any related repayment of Indebtedness, in each case since the first day of the Four Quarter Period, assuming such acquisition or disposition had been consummated on the first day of the Four Quarter Period and after giving pro forma effect to net cost savings that the Corporation reasonably believes in good faith could have been achieved during the Four Quarter Period as a result of such acquisition or disposition (provided that both (A) such cost savings were identified and quantified in an Officers' Certificate delivered to the Transfer Agent at the time of the consummation of the acquisition or disposition and (B) with respect to each acquisition or disposition completed prior to the 90th day preceding such date of determination, actions were commenced or initiated by the Corporation within 90 days of such acquisition or disposition to effect such cost savings identified in such Officers' Certificate and with respect to any other acquisition or disposition, such Officers' Certificate sets forth the specific steps to be taken within the 90 days after such acquisition or disposition to accomplish such cost savings); and provided further that (x) in making such computation, the Consolidated Interest Expense attributable to interest on any Indebtedness computed on a pro forma basis and (A) bearing a floating interest rate shall be computed as if the rate in effect on the date of computation had been the applicable rate for the entire period and (B) which was not outstanding during the period for which the computation is being made but which bears, at the option of the Corporation, a fixed or floating rate of interest shall be computed by applying, at the option of the Corporation, either the fixed or floating rate, and (y) in making such computation, the Consolidated Interest Expense of the Corporation attributable to interest on any Indebtedness under a revolving credit facility computed on a pro forma basis shall be computed based upon the pro forma average daily balance of such Indebtedness during the applicable period; and (v) the occurrence of any of the events described in clauses (i)-(iv) above by any Person that has become a Restricted Subsidiary or has been merged with or into the Corporation or any Restricted Subsidiary during such Reference Period. "Consolidated Net Worth" means, at any date of determination, stockholders' equity as set forth on the most recently available quarterly or annual consolidated balance sheet of the Corporation and its Restricted Subsidiaries (which shall be as of a date not more than 90 days prior to the date of such computation, and which shall not take into account Unrestricted Subsidiaries), less any amounts attributable to Disqualified Stock or any equity security convertible into or exchangeable for Indebtedness, the cost of treasury stock and the principal amount of any promissory notes receivable from the sale of the Capital Stock of the Corporation or any of its Restricted Subsidiaries, each item to be determined in conformity with GAAP (excluding the effects of foreign currency exchange adjustments under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 52). "Corporation" means KMC Telecom Holdings, Inc., a Delaware corporation. "Currency Agreement" means any foreign exchange contract, currency swap agreement or other similar agreement or arrangement. "Disqualified Stock" means any class or series of Capital Stock of any Person that by its terms or otherwise is (i) required to be redeemed prior to the Mandatory Redemption Date, (ii) redeemable at the option of the holder of such class or series of Capital Stock at any time prior to the Mandatory Redemption Date or (iii) convertible into or exchangeable for Capital Stock referred to in clause (i) or (ii) above or Indebtedness having a scheduled maturity prior to the Mandatory Redemption Date; provided that any Capital Stock that would not constitute Disqualified Stock but for provisions thereof giving holders thereof the right to require such Person to repurchase or redeem such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) upon the occurrence of an "asset sale" or "change of control" occurring prior to the Mandatory Redemption Date shall not constitute Disqualified Stock if the "asset sale" or "change of control" provisions applicable to such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) are no more favorable to the holders of such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) than the provisions contained in Section XI(F) and Article VIII below and such Capital Stock (or the security for which such Capital Stock is convertible into or exchangeable for) specifically provides that such Person will not repurchase or redeem any such stock pursuant to such provision prior to the Corporation's repurchase of such Series F Preferred Stock as are required to be repurchased pursuant to Section XI(F) and Article VIII below. "Dividend Payment Date" means any Redemption Date, January 15, April 15, July 15 and October 15 and any other date on which dividends are payable or may be paid, as determined by the Board of Directors. "Dividend Record Date" means, with respect to each Dividend Payment Date, the close of business on the date set forth next to such Dividend Payment Date below: DIVIDEND PAYMENT DATE DIVIDEND RECORD DATE January 15 January 1 April 15 April 1 July 15 July 1 October 15 October 1 or such other record date as may be designated by the Board of Directors with respect to dividends payable on such other Dividend Payment Date; provided, however, that such record date may not be more than 60 days or less than ten days prior to such Dividend Payment Date. If any scheduled Dividend Record Date is not a Business Day, then such Dividend Record Date shall be the Business Day immediately preceding such scheduled Dividend Record Date. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Existing Stockholders" means Harold N. Kamine, his Affiliates and Nassau. "fair market value" means the price that would be paid in an arm's-length transaction between an informed and willing seller under no compulsion to sell and an informed and willing buyer under no compulsion to buy, as determined in good faith by the Board of Directors, whose determination shall be conclusive if evidenced by a Board Resolution; provided that for purposes of clause (vii) of the second paragraph of Section XI(A), (x) the fair market value of any security registered under the Exchange Act shall be the average of the closing prices, regular way, of such security for the 20 consecutive trading days immediately preceding the sale of Capital Stock and (y) in the event the aggregate fair market value of any other property (other than cash or cash equivalents) received by the Corporation exceeds $100 million, the fair market value of such property shall be determined by a nationally recognized investment banking firm or a nationally recognized firm having expertise in the specific area which is the subject of such determination and set forth in their written opinion which shall be delivered to the Transfer Agent. "GAAP" means generally accepted accounting principles in the United States of America as in effect as of the High Yield Closing Date, including, without limitation, those set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as approved by a significant segment of the accounting profession. All ratios and computations contained or referred to in this Certificate of Designations shall be computed in conformity with GAAP applied on a consistent basis, except that calculations made for purposes of determining compliance with the terms of the covenants and with other provisions of this Certificate of Designations shall be made without giving effect to (i) the amortization of any expenses incurred in connection with the Lucent Facility, the Newcourt Facility, the offering of the Senior Discount Notes, the Series E Preferred Stock and the Series F Preferred Stock and (ii) except as otherwise provided, the amortization of any amounts required or permitted by Accounting Principles Board Opinion Nos. 16 and 17. "Guarantee" means any obligation, contingent or otherwise, of any Person directly or indirectly guaranteeing any Indebtedness of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness of such other Person (whether arising by virtue of partnership arrangements, or by agreements to keep-well, to purchase assets, goods, securities or services (unless such purchase arrangements are on arm's-length terms and are entered into in the ordinary course of business), to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for purposes of assuring in any other manner the obligee of such Indebtedness of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part); provided that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. "High Yield Closing Date" means January 29, 1998. "Holder" means a registered holder of shares of Series F Preferred Stock. "Incur" means, with respect to any Indebtedness, to incur, create, issue, assume, Guarantee or otherwise become liable for or with respect to, or become responsible for, the payment of, contingently or otherwise, such Indebtedness, including an "Incurrence" of Acquired Indebtedness; provided that neither the accrual of interest nor the accretion of original issue discount shall be considered an Incurrence of Indebtedness. "Indebtedness" means, with respect to any Person at any date of determination (without duplication), (i) all indebtedness of such Person for borrowed money, (ii) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (iii) all obligations of such Person in respect of letters of credit or other similar instruments (including reimbursement obligations with respect thereto, but excluding trade letters of credit), (iv) all obligations of such Person to pay the deferred and unpaid purchase price of property or services, which purchase price is due more than six months after the date of placing such property in service or taking delivery and title thereto or the completion of such services, except Trade Payables and accrued current liabilities arising in the ordinary course of business, (v) all Capitalized Lease Obligations of such Person, (vi) all Indebtedness referred to in clauses (i) through (v) hereof of other Persons secured by a Lien on any asset of such Person, whether or not such Indebtedness is assumed by such Person; provided that the amount of such Indebtedness shall be the lesser of (A) the fair market value of such asset at such date of determination and (B) the amount of such Indebtedness, (vii) all Indebtedness of other Persons Guaranteed by such Person to the extent such Indebtedness is Guaranteed by such Person and (viii) to the extent not otherwise included in this definition, obligations under Currency Agreements and Interest Rate Agreements. The amount of Indebtedness of any Person at any date shall be the outstanding balance at such date (or, in the case of a revolving credit or other similar facility, the total amount of funds outstanding on the date of determination) of all unconditional obligations as described above and, with respect to contingent obligations, the maximum liability upon the occurrence of the contingency giving rise to the obligation of the types described above, provided (A) that the amount outstanding at any time of any Indebtedness issued with original issue discount is the original issue price of such Indebtedness, (B) that money borrowed and set aside at the time of the Incurrence of any Indebtedness in order to prefund the payment of the interest on such Indebtedness shall not be deemed to be "Indebtedness" and (C) that Indebtedness shall not include any liability for federal, state, local or other taxes. "Interest Rate Agreement" means any interest rate protection agreement, interest rate future agreement, interest rate option agreement, interest rate swap agreement, interest rate cap agreement, interest rate collar agreement, interest rate hedge agreement, option or future contract or other similar agreement or arrangement. "Investment" means, with respect to any Person, all investments by such Person in other Persons in the form of any direct or indirect advance, loan or other extension of credit (including, without limitation, by way of Guarantee or similar arrangement; but excluding advances to customers in the ordinary course of business that are, in conformity with GAAP, recorded as accounts receivable on the balance sheet of the Corporation or its Restricted Subsidiaries and commissions, travel and similar advances to officers and employees made in the ordinary course of business) or capital contribution to (by means of any transfer of cash or other property to others or any payment for property or services for the account or use of others), or any purchase or acquisition of Capital Stock, bonds, notes, debentures or other similar instruments issued by, such other Person and shall include (i) the designation of a Restricted Subsidiary as an Unrestricted Subsidiary and (ii) the fair market value of the Capital Stock (or any other Investment), held by the Corporation or any of its Restricted Subsidiaries, of (or in) any Person that has ceased to be a Restricted Subsidiary, including, without limitation, by reason of any transaction permitted by clause (iii) of Section XI(D); provided that the fair market value of the Investment remaining in any Person that has ceased to be a Restricted Subsidiary shall not exceed the aggregate amount of Investments previously made in such Person valued at the time such Investments were made less the net reduction of such Investments. For purposes of the definition of "Unrestricted Subsidiary" and Section XI(B), (i) "Investment" shall include the fair market value of the assets (net of liabilities (other than liabilities to the Corporation or any of its Restricted Subsidiaries)) of any Restricted Subsidiary at the time that such Restricted Subsidiary is designated an Unrestricted Subsidiary, (ii) the fair market value of the assets (net of liabilities (other than liabilities to the Corporation or any of its Restricted Subsidiaries)) of any Unrestricted Subsidiary at the time that such Unrestricted Subsidiary is designated a Restricted Subsidiary shall be considered a reduction in outstanding Investments and (iii) any property transferred to or from an Unrestricted Subsidiary shall be valued at its fair market value at the time of such transfer. "Investment Grade Securities" means (i) securities issued or directly and fully guaranteed or insured by the United States government or any agency or instrumentality thereof, (ii) debt securities or debt instruments with a rating of BBB+ or higher by S&P or Baal or higher by Moody's or the equivalent of such rating by such rating organization, or, if no rating by S&P or Moody's then exists, the equivalent of such rating by any other nationally recognized securities rating agency, but excluding any debt securities or instruments constituting loans or advances among the Corporation and its Subsidiaries, and (iii) investment in any fund that invests exclusively in investments of the type described in clauses (i) and (ii) which fund may also hold cash pending investment and/or distribution. "Junior Securities" has the meaning provided in Article III hereof. "KMC Telecom" means KMC Telecom Inc, a Delaware corporation. "KMC Telecom II" means KMC Telecom II, Inc., a Delaware corporation. "KMC Telecom III" means KMC Telecom III, Inc., a Delaware corporation. "Lien" means any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including, without limitation, any conditional sale or other title retention agreement or lease in the nature thereof or any agreement to give any security interest). "Lucent" means Lucent Technologies Inc., a Delaware corporation. "Lucent Facility" means the vendor financing facility between Lucent and KMC Telecom III and KMC Telecom Leasing III LLC, providing for aggregate borrowings of up to $600 million and maturing on the eighth anniversary of the closing of such credit facility. "Mandatory Redemption Date" means February 1, 2011. "Moody's" means Moody's Investors Service, Inc. and its successors. "Nassau" means Nassau Capital Partners L.P., NAS Partners I L.L.C. or their respective successors, and their Affiliates. "Net Cash Proceeds" means (a) with respect to any Asset Sale, the proceeds of such Asset Sale in the form of cash or cash equivalents, including payments in respect of deferred payment obligations (to the extent corresponding to the principal, but not interest, component thereof) when received in the form of cash or cash equivalents (except to the extent such obligations are financed or sold with recourse to the Corporation or any Restricted Subsidiary) and proceeds from the conversion of other property received when converted to cash or cash equivalents, net of (i) brokerage commissions and other commissions, fees and expenses (including fees and expenses of counsel, accountants and investment bankers) related to such Asset Sale and any relocation expenses incurred as a result thereof, (ii) provisions for all taxes (whether or not such taxes will actually be paid or are payable) as a result of such Asset Sale without regard to the consolidated results of operations of the Corporation and its Restricted Subsidiaries, taken as a whole, (iii) payments made to repay Indebtedness or any other obligation outstanding at the time of such Asset Sale that either (A) is secured by a Lien on the property or assets sold or (B) is required to be paid as a result of such sale and (iv) appropriate amounts to be provided by the Corporation or any Restricted Subsidiary as a reserve against any liabilities associated with such Asset Sale, including, without limitation, pension and other post-employment benefit liabilities, liabilities related to environmental matters and liabilities under any indemnification obligations associated with such Asset Sale, all as determined in conformity with GAAP, and (b) with respect to any issuance or sale of Capital Stock, the proceeds of such issuance or sale in the form of cash or cash equivalents, including payments in respect of deferred payment obligations (to the extent corresponding to the principal, but not interest, component thereof) when received in the form of cash or cash equivalents (except to the extent such obligations are financed or sold with recourse to the Corporation or any Restricted Subsidiary) and proceeds from the conversion of other property received when converted to cash or cash equivalents, net of attorney's fees, accountants' fees, underwriters' or placement agents' fees, discounts or commissions and brokerage, consultant and other fees incurred in connection with such issuance or sale and net of taxes paid or payable as a result thereof. "Newcourt Capital" means Newcourt Capital USA, Inc., a Delaware corporation. "Newcourt Facility" means the Loan and Security Agreement dated as of December 22, 1998 among KMC Telecom, KMC Telecom II, and Newcourt Finance and any other lenders or borrowers from time to time party thereto, collateral documents, instruments, and agreements executed in connection therewith and any amendments, supplements, modifications, extensions, renewals, restatements, refinancings or refundings thereof. "Newcourt Finance" means Newcourt Commercial Finance Corporation, formerly known as AT&T Commercial Finance Corporation, a Delaware corporation, and its successors. "Offer to Purchase" means an offer to purchase Series F Preferred Stock by the Corporation from the Holders commenced by mailing a notice to the Transfer Agent and each Holder stating: (i) the covenant pursuant to which the offer is being made and that all Series F Preferred Stock validly tendered will be accepted for payment on a pro rata basis, together with any other Parity Securities subject to similar offer to purchase provisions; (ii) the purchase price and the date of purchase (which shall be a Business Day no earlier than 30 days nor later than 60 days from the date such notice is mailed) (the "Payment Date"); (iii) that any Series F Preferred Stock not tendered will continue to accrue dividends pursuant to its terms; (iv) that, unless the Corporation defaults in the payment of the purchase price, any Series F Preferred Stock accepted for payment pursuant to the Offer to Purchase shall cease to accrue dividends on and after the Payment Date; (v) that each Holder electing to have Series F Preferred Stock purchased pursuant to the Offer to Purchase will be required to surrender to the Transfer Agent at the address specified in the notice prior to the close of business on the Business Day immediately preceding the payment date such holder's certificate representing such Series F Preferred Stock, together with the form entitled "Option of the Holder to Elect Purchase" appearing on the reverse side of such Series F Preferred Stock certificate completed, (vi) that Holders will be entitled to withdraw their election if the Paying Agent receives, not later than the close of business on the third Business Day immediately preceding the Payment Date, a telegram, facsimile transmission or letter setting forth the name of such Holder, the liquidation preference of Series F Preferred Stock delivered for purchase and a statement that such Holder is withdrawing its election to have such Series F Preferred Stock purchased; and (vii) that Holders whose Series F Preferred Stock is being purchased only in part will be issued new Series F Preferred Stock equal in liquidation preference to the unpurchased portion of the Series F Preferred Stock surrendered. On the Payment Date, the Corporation shall (i) accept for payment on a pro rata basis Series F Preferred Stock, together with any other Parity Securities subject to similar offer to purchase provisions, or portions thereof tendered pursuant to an Offer to Purchase; (ii) deposit with the Paying Agent money sufficient to pay the purchase price of all Series F Preferred Stock, together with any other Parity Securities subject to similar offer to purchase provisions, or portions thereof so accepted; and (iii) deliver, or cause to be delivered, to the Transfer Agent all Series F Preferred Stock or portions thereof so accepted together with an Officers' Certificate specifying shares of the Series F Preferred Stock or portions thereof accepted for payment by the Corporation. The Paying Agent shall promptly mail to the Holders of Series F Preferred Stock so accepted payment in an amount equal to the purchase price, and the Transfer Agent shall promptly authenticate and mail to such Holders new shares of Series F Preferred Stock equal in liquidation preference to any unpurchased portion of the Series F Preferred Stock surrendered. The Corporation will publicly announce the results of an Offer to Purchase as soon as practicable after the Payment Date. The Transfer Agent shall act as the Paying Agent for an Offer to Purchase. The Corporation will comply with Rule 14e-1 under the Exchange Act and any other securities laws and regulations thereunder to the extent such laws and regulations are applicable, in the event that the Corporation is required to repurchase Series F Preferred Stock pursuant to an Offer to Purchase. "Officer" means with respect to the Corporation, (i) the Chairman of the Board, the Vice Chairman of the Board, the President, the Chief Executive Officer, the Chief Financial Officer or a Vice president, and (ii) the Treasurer or any Assistant Treasurer, or the Secretary or any Assistant Secretary of the Corporation. "Officers' Certificate" means a certificate signed by one Officer listed in clause (i) of the definition thereof and one Officer listed in clause (ii) of the definition thereof; provided, however, that any such certificate may be signed by any two of the Officers listed in clause (i) of the definition thereof in lieu of being signed by one Officer listed in clause (i) of the definition thereof and one Officer listed in clause (ii) of the definition thereof. "Parity Securities" has the meaning specified in Article III hereof. "Permitted Investment" means (i) an Investment in the Corporation or a Restricted Subsidiary or a Person which will, upon the making of such Investment, become a Restricted Subsidiary or be merged or consolidated with or into or transfer or convey all or substantially all its assets to, the Corporation or a Restricted Subsidiary; provided that such person's primary business is related, ancillary or complementary to the businesses of the Corporation and its Restricted Subsidiaries on the date of such Investment; (ii) Temporary Cash Investments and Investment Grade Securities; (iii) payroll, travel and similar advances to cover matters that are expected at the time of such advances ultimately to be treated as expenses in accordance with GAAP and reasonable advances to sales representatives; (iv) any Investment acquired by the Corporation or any of its Restricted Subsidiaries (x) in exchange for any other Investment or accounts receivable held by the Corporation or any such Restricted Subsidiary in connection with or as a result of a bankruptcy, workout, reorganization or recapitalization of the issuer of such other Investment or accounts receivable or (y) as a result of a foreclosure by the Corporation or any of its Restricted Subsidiaries with respect to any secured Investment or other transfer of title with respect to any secured Investment in default; (v) any Investment acquired in consideration for the issuance of Junior Securities or the proceeds of the issuance of Junior Securities to the extent such amounts have not been previously applied to a Restricted Payment pursuant to clause (iii)(B)(2) of the first paragraph of Section XI(B) or clause (ii) of the second paragraph of Section XI(B) or used to support the Incurrence of Indebtedness pursuant to clause (viii) in accordance with Section XI(A) and Investments acquired as a capital contribution; (vi) Guarantees permitted by Section XI(A); (vii) loans or advances to employees of the Corporation or any Restricted Subsidiary that do not in the aggregate exceed at any one time outstanding $5.0 million; (viii) Currency Agreements and Interest Rate Agreements permitted under Section XI(A); (ix) Investments in prepaid expenses, negotiable instruments held for collection and lease, utility and workers' compensation, performance and other similar deposits; (x) Investments in debt securities or other evidences of Indebtedness that are issued by companies engaged in the Telecommunications Business; provided that when each Investment pursuant to this clause (x) is made, the aggregate amount of Investments outstanding under this clause (x) does not exceed $3.0 million; (xi) Strategic Investments and Investments in Permitted Joint Ventures in an amount not to exceed $20.0 million at any one time outstanding; (xii) an Investment in any Person the primary business of which is related, ancillary or complementary to the business of the Corporation and its Subsidiaries on the date of such Investment in an amount not to exceed at any time in respect of all such Investments outstanding the sum of (x) $200.0 million plus (y) 40% of the Corporation's Consolidated EBITDA, if positive, for the immediately preceding four fiscal quarters (valued in each case as provided in the definition of "Investments"); (xiii) securities received in connection with Asset Sales to the extent constituting non-cash consideration permitted under Section XI(F); and (xiv) Investments in an amount not to exceed $50.0 million at any time outstanding. "Permitted Joint Venture" means any Unrestricted Subsidiary or any other Person in which the Corporation or a Restricted Subsidiary owns, directly or indirectly, an ownership interest (other than a Restricted Subsidiary) and whose primary business is related, ancillary or complementary to the businesses of the Corporation and its Restricted Subsidiaries at the time of determination. "Person" means any individual, partnership, corporation, business trust, joint stock company, limited liability company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature. "Preferred Stock" means any and all shares, interests, participations or other equivalents of the Corporation's preferred stock, including any such security with any priority over Common Stock with respect to dividends or upon liquidation or similar events. "Public Equity Offering" means an underwritten primary public offering of Common Stock of the Corporation pursuant to an effective registration statement under the Securities Act. "Purchase Agreement" means the Securities Purchase Agreement dated as of February 4, 1999 among the Corporation, Newcourt Finance and Lucent. "Redemption Date", when used with respect to any Series F Preferred Stock to be redeemed, means the date fixed for such redemption by or pursuant to the terms of this Certificate of Designations. "Redemption Price" means, with respect to any share of Series F Preferred Stock, the price at which such share of Series F Preferred Stock is to be redeemed pursuant to the terms of this Certificate of Designations. "Restricted Subsidiary" means any Subsidiary of the Corporation other than an Unrestricted Subsidiary. "Securities Act" means the Securities Act of 1933, as amended from time to time, or any successor statute. "Senior Discount Note Indenture" means the Indenture dated as of January 29, 1998 between the Corporation and The Chase Manhattan Bank, relating to the Senior Discount Notes, as such Indenture may be amended, supplemented, extended, renewed, replaced or otherwise modified from time to time. "Senior Discount Notes" means the 12 1/2% Senior Discount Notes due 2008 issued by the Corporation under the Senior Discount Note Indenture. "Senior Securities" has the meaning provided in Article III hereof. "Significant Subsidiary" means, any Subsidiary that would be a "significant subsidiary" as defined in 17 CFR Part 210.1-01(w), promulgated pursuant to the Securities Act, as such regulation is in effect on the date hereof. "S&P" means Standard & Poor's Ratings Services, a Division of McGraw Hill, Inc., and its successors. "Stated Maturity" means (i) with respect to any debt security, the date specified in such debt security as the fixed date on which the final installment of principal of such debt security is due and payable and (ii) with respect to any scheduled installment of principal of or interest on any debt security, the date specified in such debt security as the fixed date on which such installment is due and payable. "Strategic Investments" means (a) Investments that the Board of Directors has determined in good faith will enable the Corporation or any of its Restricted Subsidiaries to obtain additional business that it might not be able to obtain without making such Investment and (b) Investments in entities the principal function of which is to perform research and development with respect to products and services that may be used or useful in the Telecommunications Business; provided that the Corporation or one of its Restricted Subsidiaries is entitled or otherwise reasonably expected to obtain rights to such products or services as a result of such Investment. "Strategic Subordinated Indebtedness" means Indebtedness of the Corporation Incurred to finance the acquisition of a Person engaged in the Telecommunications Business that by its terms, or by the terms of any agreement or instrument pursuant to which such Indebtedness is outstanding, (i) is expressly made subordinate in right of payment to the Senior Discount Notes and (ii) provides that no payment of principal, premium or interest on, or any other payment with respect to, such Indebtedness may be made prior to the payment in full of all of the Corporation's obligations under the Series F Preferred Stock and the Senior Discount Notes; provided that such Indebtedness may provide for and be repaid at any time from the proceeds of the sale of Capital Stock (other than Disqualified Stock) of the Corporation after the Incurrence of such Indebtedness. "Subsidiary" means, with respect to any Person, (i) any corporation, association, or other business entity (other than a partnership) of which more than 50% of the total voting power of shares of Capital Stock entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time of determination owned or controlled, directly or indirectly, by such Person or one or more of the other Subsidiaries of such Person or a combination thereof and (ii) any partnership, joint venture, limited liability company or similar entity of which (x) more than 50% of the capital accounts, distribution rights, total equity and voting interests or general or limited partnership interests, as applicable, are owned or controlled, directly or indirectly, by such Person or one or more of the other Subsidiaries of such Person or a combination thereof whether in the form of membership, general, special or limited partnership or otherwise and (y) such Person or any Wholly Owned Restricted Subsidiary of such Person is a general partner or otherwise controls such entity. "Telecommunications Business" means the development, ownership or operation of one or more telephone, telecommunications or information systems or the provision of telephony, telecommunications or information services (including, without limitation, any voice, video transmission, data or Internet services) and any related, ancillary or complementary business. "Temporary Cash Investment" means any of the following: (i) direct obligations of the United States of America or any agency thereof or obligations fully and unconditionally guaranteed by the United States of America or any agency or instrumentality thereof, (ii) time deposit accounts, certificates of deposit, eurodollar time deposits and money market deposits maturing within 180 days or less of the date of acquisition thereof issued by a bank or trust company which is organized under the laws of the United States of America, any state thereof or any foreign country recognized by the United States of America, and which bank or trust company has capital, surplus and undivided profits aggregating in excess of $50 million (or the foreign currency equivalent thereof) and has outstanding debt which is rated "A" (or such similar equivalent rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act) or any money-market fund sponsored by a registered broker dealer or mutual fund distributor, (iii) repurchase obligations with a term of not more than 30 days for underlying securities of the types described in clauses (i) and (ii) above entered into with a bank meeting the qualifications described in clause (ii) above, (iv) commercial paper, maturing not more than 90 days after the date of acquisition, issued by a corporation (other than an Affiliate of the Corporation) organized and in existence under the laws of the United States of America, any state thereof or any foreign country recognized by the United States of America with a rating at the time as of which any investment therein is made of "P-1" (or higher) according to Moody's or "A-1" (or higher) according to S&P, (v) securities with maturities of six months or less from the date of acquisition issued or fully and unconditionally guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and rated at least "A" by S&P or Moody's, and (vi) investment funds investing 95% of their assets in securities of the type described in clauses (i)-(v) above. "Trade Payables" means, with respect to any Person, any accounts payable or any other indebtedness or monetary obligation to trade creditors created, assumed or Guaranteed by such Person or any of its Subsidiaries arising in the ordinary course of business in connection with the acquisition of goods or services. "Transaction Date" means, with respect to the Incurrence of any Indebtedness by the Corporation or any of its Restricted Subsidiaries, the date such Indebtedness is to be Incurred and, with respect to any Restricted Payment, the date such Restricted Payment is to be made. "Transfer Agent" means Chase Mellon Shareholder Services, L.L.C. "Unrestricted Subsidiary" means (i) any Subsidiary of the Corporation that at the time of determination shall be designated an Unrestricted Subsidiary by the Board of Directors in the manner provided below; and (ii) any Subsidiary of an Unrestricted Subsidiary. The Board of Directors may designate any Restricted Subsidiary (including any newly acquired or newly formed Subsidiary of the Corporation) to be an Unrestricted Subsidiary unless such Subsidiary owns any Capital Stock of, or owns or holds any Lien on any property of, the Corporation or any Restricted Subsidiary; provided that (A) any Guarantee by the Corporation or any Restricted Subsidiary of any Indebtedness of the Subsidiary being so designated shall be deemed an "Incurrence" of such Indebtedness and an "Investment" by the Corporation or such Restricted Subsidiary (or both, if applicable) at the time of such designation; (B) either (I) the Subsidiary to be so designated has total assets of $1,000 or less or (II) if such Subsidiary has assets greater than $1,000, such designation would be permitted in accordance with Section XI(B); and (C) if applicable, the Incurrence of Indebtedness and the Investment referred to in clause (A) of this proviso would be permitted in accordance with Section XI(A) and Section XI(B). The Board of Directors may designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided that all Indebtedness of such Unrestricted Subsidiary outstanding immediately after such designation would, if Incurred at such time, have been permitted to be Incurred (and shall be deemed to have been Incurred) for all purposes of this Certificate of Designations. Any such designation by the Board of Directors shall be evidenced to the Transfer Agent by promptly filing with the Transfer Agent a copy of the Board Resolution giving effect to such designation and an Officers' Certificate certifying that such designation complied with the foregoing provisions. "Voting Stock" means, with respect to any Person, Capital Stock of any class or kind ordinarily having the power to vote for the election of directors, managers or other voting members of the governing body of such Person. "Warrant Agreement" means the warrant agreement, dated the Closing Date, among the Corporation, Newcourt Finance, Lucent and any Additional Purchaser (as described therein) and The Chase Manhattan Bank, as warrant agent. "Warrants" means any warrants that may be issued under the Warrant Agreement. "Wholly Owned" means, with respect to any Subsidiary of any Person, the ownership of 95% or more of the outstanding Capital Stock of such Subsidiary (other than any director's qualifying shares or Investments by foreign nationals mandated by applicable law) by such Person or one or more Wholly Owned Subsidiaries of such Person. II. Designation. The series of Preferred Stock authorized hereunder shall be designated as the "Series F Senior Redeemable, Exchangeable, PIK Preferred Stock" and is referred to herein as the "Series F Preferred Stock." The number of shares constituting such series shall be 55,000. The par value of the Series F Preferred Stock shall be $.01 per share of Series F Preferred Stock. Each share of Series F Preferred Stock purchased from the Corporation shall have a liquidation preference of $1,000. The Corporation may from time to time in its discretion issue fractional shares of Series F Preferred Stock. III. Ranking. The Series F Preferred Stock shall, with respect to dividend distributions and distributions upon the liquidation, winding-up and dissolution of the Corporation, rank (i) senior to all classes of Common Stock of the Corporation, (ii) senior to each other class of capital stock or series of Preferred Stock the terms of which do not expressly provide that it ranks senior to or on a parity with the Series F Preferred Stock as to dividend distributions and distributions upon the liquidation, winding-up and dissolution of the Corporation (collectively referred to, together with all classes of Common Stock of the Corporation, as the "Junior Securities"); (iii) on a parity with (A) any class of Capital Stock or series of Preferred Stock the terms of which expressly provide that such class or series will rank on a parity with the Series F Preferred Stock as to dividend distributions and distributions upon the liquidation, winding-up and dissolution of the Corporation and (B) the Corporation's Series A Cumulative Convertible Preferred Stock, Series C Cumulative Convertible Preferred Stock, Series D Cumulative Convertible Preferred Stock and Series E Preferred Stock (collectively referred to as "Parity Securities"); and (iv) junior to each class of Capital Stock or series of Preferred Stock issued by the Corporation the terms of which expressly provide that such class or series will rank senior to the Series F Preferred Stock as to dividend distributions and distributions upon liquidation, winding-up and dissolution of the Corporation (collectively referred to as "Senior Securities"). The Series F Preferred Stock will be subject to the issuance of series of Junior Securities, Parity Securities and Senior Securities, provided that the Corporation may not authorize, create or issue, or increase the authorized amount of, any new class of Senior Securities (or any class of any security convertible into shares of any Senior Security) without the approval of the holders of at least a majority of the shares of Series F Preferred Stock then outstanding, voting or consenting, as the case may be, separately as one class, except that, without the approval of holders of the Series F Preferred Stock, the Corporation may issue shares of Senior Securities (or any class of any security convertible into shares of any Senior Security) in exchange for, or the proceeds of which are used to redeem or repurchase, (1) all (but not less than all) shares of Series E Preferred Stock and Series F Preferred Stock then outstanding, (2) any Senior Securities or (3) Indebtedness of the Corporation. IV. Dividends. (A) Holders of Series F Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors, out of funds legally available therefor, dividends on the Series F Preferred Stock at a rate per annum equal to 14.5% of the liquidation preference per share, payable quarterly. All dividends will be cumulative, whether or not earned or declared, accruing on a daily basis, whether or not there are profits, surplus or other funds legally available for the payment of such dividends, from the date of issuance of the Series F Preferred Stock and will be payable quarterly in arrears on each Dividend Payment Date, commencing on April 15, 1999. On and before January 15, 2004, the Corporation may pay dividends, at its option, in cash or in additional fully paid and nonassessable shares of Series F Preferred Stock having an aggregate liquidation preference equal to the amount of such dividends rounded to the nearest $1.00. After January 15, 2004, dividends must be paid in cash, unless the Corporation's debt securities prohibit such payment or there are no funds legally available therefor, in which case dividends may be paid in additional fully paid and nonassessable shares of Series F Preferred Stock having an aggregate liquidation preference equal to the amount of such dividends rounded to the nearest $1.00. If any dividend (or portion thereof) payable on any Dividend Payment Date is not declared or paid in full on such Dividend Payment Date, the amount of accrued and unpaid dividends will accrue at the dividend rate on the Series F Preferred Stock, compounding quarterly, until declared and paid in full. (B) No full dividends may be declared or paid or funds set apart for the payment of dividends on any Parity Securities for any period unless full cumulative dividends shall have been or contemporaneously shall be declared and paid in full on the Series F Preferred Stock. If full dividends are not so paid, the Series F Preferred Stock shall share dividends pro rata with the Parity Securities. No dividends may be paid or set apart for such payment on Junior Securities (except dividends on Junior Securities in additional shares of Junior Securities) and no Junior Securities or Parity Securities may be repurchased, redeemed or otherwise retired nor may funds be set apart for payment with respect thereto if full cumulative dividends shall not have been paid on the Series F Preferred Stock. (C) Each dividend paid on the Series F Preferred Stock shall be payable to Holders of record as their names shall appear in the stock ledger of the Corporation on the Dividend Record Date for such dividend, except that dividends in arrears for any past Dividend Payment Date may be declared and paid at any time without reference to such regular Dividend Payment Date to Holders of record on a later dividend record date determined by the Board of Directors. V. Liquidation Preference. (A) Upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, holders of Series F Preferred Stock will be entitled to be paid, out of the assets of the Corporation available for distribution, $1,000 per share, plus an amount in cash equal to accrued and unpaid dividends thereon to the date fixed for liquidation, dissolution or winding-up (including an amount equal to a prorated dividend for the period from the last Dividend Payment Date to the date fixed for liquidation, dissolution or winding-up), before any distribution is made on any Junior Securities. If, upon any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, the amounts payable with respect to the Series F Preferred Stock and all other Parity Securities are not paid in full, the holders of the Series F Preferred Stock and the Parity Securities will share equally and ratably in any distribution of assets of the Corporation in proportion to the full liquidation preference and accrued and unpaid dividends to which each is entitled. After payment of the full amount of the liquidation preferences and accrued and unpaid dividends to which they are entitled, the holders of Series F Preferred Stock will not be entitled to any further participation in any distribution of assets of the Corporation. (B) For the purposes of this Article V only, neither the sale, lease, conveyance, exchange or transfer (for cash, shares of stock, securities or other consideration) of all or substantially all of the property or assets of the Corporation nor the consolidation or merger of the Corporation with or into one or more corporations shall be deemed to be a liquidation, dissolution or winding-up of the Corporation. VI. Redemption. (A) Mandatory Redemption. The Series F Preferred Stock shall be subject to mandatory redemption (subject to the legal availability of funds therefor and any contractual or other restrictions with respect thereto) in whole on the Mandatory Redemption Date at a Redemption Price, payable in cash, equal to the liquidation preference thereof on the Redemption Date plus all accrued and unpaid dividends thereon to the Redemption Date. (B) Optional Redemption. The Series F Preferred Stock may be redeemed at any time, at the Corporation's option, in whole or in part, at a Redemption Price, payable in cash, equal to 110% of the liquidation preference thereof on the Redemption Date, plus an amount in cash equal to all accrued and unpaid dividends thereon to the Redemption Date. No optional redemption may be authorized or made unless prior thereto full unpaid cumulative dividends shall have been paid or a sum set apart for such payment on the Series F Preferred Stock. (C) Procedure for Redemption. (i) Not more than sixty (60) and not less than thirty (30) days prior to the Redemption Date, written notice (the "Redemption Notice") shall be given by the Corporation by first-class mail to each Holder at such Holder's address as the same appears on the stock ledger of the Corporation; provided, however, that no failure to give such notice nor any deficiency therein shall affect the validity of the procedure for the redemption of any shares of Series F Preferred Stock to be redeemed, except as to the Holders to whom the Corporation has failed to give such notice or except as to the Holders whose notice was defective. The Redemption Notice shall state: (a) the Redemption Price; (b) the Redemption Date; (c) that the Holder is to surrender to the Corporation, at the place or places designated in such Redemption Notice, its certificates representing the shares of Series F Preferred Stock to be redeemed; and (d) the name of any bank or trust company performing the duties referred to in Section VI(C)(iv) below. (ii) On or before the Redemption Date, each Holder of Series F Preferred Stock to be redeemed shall surrender the certificate or certificates representing such shares of Series F Preferred Stock to the Corporation, in the manner and at the place designated in the Redemption Notice, and on the Redemption Date the full Redemption Price for such shares shall be payable in cash to the Holder whose name appears in the stock ledger of the Corporation as the owner thereof, and each surrendered certificate shall be returned to authorized but unissued shares of Preferred Stock of the Corporation. (iii) Unless the Corporation defaults in the payment in full of the applicable Redemption Price, dividends on the Series F Preferred Stock called for redemption shall cease to accrue on the Redemption Date, and the Holders of such shares shall cease to have any further rights with respect thereto on the Redemption Date, other than the right to receive the Redemption Price. (iv) If a Redemption Notice shall have been duly given or if the Corporation shall have given to the bank or trust company hereinafter referred to irrevocable authorization promptly to give such notice, and if on or before the Redemption Date specified therein the funds necessary for such redemption shall have been irrevocably and indefeasibly deposited by the Corporation with such bank or trust company in trust for the pro rata benefit of the Holders of the Series F Preferred Stock called for redemption, then, notwithstanding that any certificate for shares so called for redemption shall not have been surrendered for cancellation, from and after the time of such deposit, all shares so called, or to be so called pursuant to such irrevocable authorization, for redemption shall be deemed no longer to be outstanding and all rights with respect to such shares shall forthwith cease and terminate, excepting only the right of the Holders thereof to receive from such bank or trust company at any time after the time of such deposit the funds so deposited, without interest. Any interest accrued on such funds shall be paid to the Corporation from time to time. Any funds so set aside or deposited, as the case may be, and unclaimed at the end of three years from such Redemption Date shall, to the extent permitted by law, be released or repaid to the Corporation, after which repayment the Holders of the shares to be redeemed shall look only to the Corporation for payment thereof. (v) In the event of partial redemptions of Series F Preferred Stock, the shares to be redeemed will be determined pro rata or by lot, as determined by the Corporation, except that the Corporation may redeem such shares held by any holder of fewer than 100 shares without regard to such pro rata redemption requirement. If any Series F Preferred Stock is to be redeemed in part, the Redemption Notice that relates to such Series F Preferred Stock shall state the portion of the liquidation preference to be redeemed. New shares of Series F Preferred Stock having an aggregate liquidation preference equal to the unredeemed portion shall be issued in the name of the Holder thereof upon cancellation of the original Series F Preferred Stock. (vi) Notwithstanding anything herein to the contrary, a Redemption Notice will be revocable if (i) it states that it is revocable and provides that a notice of revocation may be given not less than five days prior to the Redemption Date by the Corporation in accordance with Article XVII hereof and (ii) the Board of Directors determines that the availability of funds to pay the Redemption Price is subject to the closing of a financing and, at the time such Redemption Notice is given, such closing is subject to uncertainty. VII. Voting Rights. (A) The Holders of Series F Preferred Stock shall have no voting rights except as set forth below and as otherwise provided by law. (B)(i)If and whenever (1) dividends on the Series F Preferred Stock are in arrears and remain unpaid with respect to four quarterly periods (whether or not consecutive), (2) the Corporation fails to discharge any redemption obligation with respect to the Series F Preferred Stock, (3) a breach or violation by the Corporation of the provisions of Article X occurs, or the Corporation fails to exchange Exchange Debentures for the Series F Preferred Stock tendered for exchange on the exchange date, whether or not the Corporation satisfies the conditions to permit such exchange, (4) the Corporation fails to make a Change of Control Offer or cash payment with respect thereto if required by the provisions of Article VIII or (5) a breach or violation of any provision of Article IX or Article XI occurs and is not remedied within 30 days after notice thereof to the Corporation by Holders of 25% or more of the liquidation preference of the Series F Preferred Stock then outstanding (each such event referred to as a "Voting Rights Triggering Event"), then the number of directors then constituting the Board of Directors of the Corporation shall be increased by one director and the Holders of a majority of the then outstanding shares of Series F Preferred Stock, voting as a single class, shall be entitled to elect one additional director at any annual meeting of shareholders or special meeting held in place thereof, or at a special meeting of the Holders of Series F Preferred Stock called as hereinafter provided. (ii) Whenever a Voting Rights Triggering Event shall have occurred, voting rights of the Holders of Series F Preferred Stock may be exercised initially either at a special meeting of the Holders of Series F Preferred Stock called as hereinafter provided, or at any annual meeting of shareholders held for the purpose of electing directors, and thereafter at each such annual meeting or by the written consent of the Holders of Series F Preferred Stock, voting as a single class, pursuant to the Delaware General Corporation Law. The term of office of any such elected director shall expire at the next annual meeting of shareholders held for the purpose of electing directors, subject to a new election of a director by the Holders of Series F Preferred Stock, voting as a single class, at each successive annual meeting, but such voting rights and the term of office of any such elected director shall expire at such time as (A) all dividends accrued on Series F Preferred Stock shall have been paid in full and (B) each failure, breach or default referred to in paragraph VII(B) (i)(A)(2), (3), (4) and (5) above is remedied. (iii) At any time after a Voting Rights Triggering Event shall have occurred and such voting rights shall not already have been initially exercised, a proper officer of the Corporation may, and upon the written request of any Holder of Series F Preferred Stock (addressed to the Secretary at the principal office of the Corporation) shall, call a special meeting of the Holders of Series F Preferred Stock for the election of a director to be elected by them, voting as a single class, as herein provided, such call to be made by notice similar to that provided in the Bylaws for a special meeting of the shareholders or as required by law. (iv) Such meeting shall be held at the earliest practicable date upon the notice required for annual meetings of shareholders at the place for holding annual meetings of shareholders of the Corporation or, if none, at a place designated by the Secretary of the Corporation. If such meeting shall not be called by a proper officer of the Corporation within 30 days after the personal service of such written request upon the Secretary of the Corporation, or within 30 days after mailing the same within the United States, by registered mail, addressed to the Secretary of the Corporation at its principal office (such mailing to be evidenced by the registry receipt issued by the postal authorities), then the holders of record of 10% of the shares of Series F Preferred Stock then outstanding, may designate in writing a Holder of Series F Preferred Stock to call such meeting at the expense of the Corporation, and such meeting may be called by such person so designated upon the notice required for annual meetings of shareholders and shall be held at the same place as is elsewhere provided in this paragraph VII(B)(iv) or at such other place as is selected by such person so designated. Any Holder of Series F Preferred Stock that would be entitled to vote at any such meeting shall have access to the stock books of the Corporation for the purpose of causing a meeting of shareholders to be called pursuant to the provisions of this paragraph. Notwithstanding the provisions of this paragraph, however, no such special meeting shall be called during a period within 90 days immediately preceding the date fixed for the next annual meeting of shareholders. (v) At any meeting held for the purpose of electing directors at which the Holders of Series F Preferred Stock, voting as a single class, shall have the right to elect a director as provided herein, the presence in person or by proxy of the Holders of a majority of the then outstanding shares of Series F Preferred Stock shall be required and be sufficient to constitute a quorum of such class for the election of a director by such class. At any such meeting or adjournment thereof, (x) the absence of a quorum of the Holders of Series F Preferred Stock shall not prevent the election of directors other than the director to be elected by such Holders and the absence of a quorum or quorums of the holders of Capital Stock entitled to elect such other directors shall not prevent the election of a director to be elected by the Holders of Series F Preferred Stock, voting as a single class, and (y) in the absence of a quorum of the holders of any class of stock entitled to vote for the election of directors, a majority of the holders present in person or by proxy of such class shall have the power to adjourn the meeting for the election of directors which the holders of such class are entitled to elect, from time to time, without notice (except as required by law) other than announcement at the meeting, until a quorum shall be present. (vi) The term of office of the director elected by the Holders of Series F Preferred Stock, pursuant to paragraph VII(B)(i) in office at any time when the aforesaid voting rights are vested in the Holders of Series F Preferred Stock, shall terminate upon the election of his/her successor by the Holders of the Series F Preferred Stock at any meeting of shareholders for the purpose of electing directors. Upon any termination of the aforesaid voting rights in accordance with paragraph VII(B)(ii), the term of office of the director elected pursuant to paragraph VII(B)(i) then in office shall thereupon terminate and upon such termination the number of directors constituting the Board of Directors shall, without further action, be reduced by one, subject always to the increase of the number of directors pursuant to paragraph VII(B)(i) in case of the future right of the Holders of Series F Preferred Stock to elect a director as provided herein. (vii) If the director elected pursuant to paragraph VII(B)(ii) shall cease to serve as director before his/her term shall expire, the Holders of Series F Preferred Stock then outstanding, voting as a single class, at a special meeting called as provided above, may elect a successor to hold office for the unexpired terms of the director whose place shall be vacant. VIII. Change of Control. Upon the occurrence of a Change of Control, the Corporation shall be required (subject to any contractual and other restrictions with respect thereto and the legal availability of funds therefor) to make an Offer to Purchase (the "Change of Control Offer") to each Holder of Series F Preferred Stock to repurchase all or any part, at the Holder's option, of such Holder's Series F Preferred Stock at a cash purchase price equal to 101% of the liquidation preference thereof, plus an amount in cash equal to all accrued and unpaid dividends (including an amount in cash equal to a prorated dividend for the period from the immediately preceding Dividend Payment Date to the date of purchase) (the "Change of Control Payment"). The Change of Control Offer must be made within 30 days following the conclusion of all change of control offers for the Corporation's debt securities, must remain open for at least 30 and not more than 60 days and must comply with the requirements of Rule 14e-1 under the Exchange Act and any other securities laws and regulations thereunder to the extent such laws and regulations are applicable. Prior to commencing any Change of Control Offer, the Corporation shall first consummate any change of control offer to purchase required to be made to any holder of its Indebtedness. The Corporation shall make the Change of Control Offer within 30 days following the consummation of any mandatory offers to purchase and any other required repayments of the Corporation's Indebtedness resulting from a change of control. IX. Consolidation, Merger and Sale of Assets. The Corporation shall not consolidate with, merge with or into, or sell, convey, transfer, lease or otherwise dispose of all or substantially all of its property and assets (as an entirety or substantially an entirety in one transaction or a series of related transactions) to, any Person or permit any Person to merge with or into the Corporation unless: (i) the Corporation shall be the continuing Person, or the Person (if other than the Corporation) formed by such consolidation or into which the Corporation is merged or that acquired or leased such property and assets of the Corporation shall be a corporation organized and validly existing under the laws of the United States of America or any jurisdiction thereof and the Series F Preferred Stock shall be converted into or exchanged for and shall become shares of such successor company, having in respect of such successor company or resulting company substantially the same powers, preferences and relative participating, optional or other special rights and the qualifications, limitations or restrictions thereon that the Series F Preferred Stock had immediately prior to such transaction in respect of the Corporation; (ii) immediately after giving effect to such transaction on a pro forma basis, (A) the Corporation or any Person becoming the successor or resulting company, as the case may be, shall have a Consolidated Net Worth equal to or greater than the Consolidated Net Worth of the Corporation immediately prior to such transaction or (B) the Corporation or any Person becoming the successor or resulting company, as the case may be, shall have a Consolidated Leverage Ratio no more than the greater of (I) 6:1 and (II) the Consolidated Leverage Ratio of the Corporation immediately prior to such transaction; provided that this clause (ii) shall not apply to a consolidation or merger with or into a Wholly Owned Restricted Subsidiary with a positive net worth; provided that, in connection with any such merger or consolidation, no consideration (other than Capital Stock (other than Disqualified Stock) in the surviving Person or the Corporation) shall be issued or distributed to the stockholders of the Corporation; and (iii) the Corporation delivers to the Transfer Agent an Officers' Certificate (attaching the arithmetic computations to demonstrate compliance with clause (ii)) and Opinion of Counsel, in each case stating that such consolidation, merger or transfer complies with this provision and that all conditions precedent provided for herein relating to such transaction have been complied with; provided, however, that clause (ii) above does not apply if, in the good faith determination of the Board of Directors of the Corporation, whose determination shall be evidenced by a Board Resolution, the principal purpose of such transaction is to change the state of incorporation of the Corporation and any such transaction shall not have as one of its purposes the evasion of the foregoing limitations. X. Exchange. (A) The Corporation may, at the sole option of the Board of Directors (subject to the legal availability of funds therefor), exchange all, but not less than all, of the shares of Series F Preferred Stock then outstanding, including any shares of Series F Preferred Stock issued as payment for dividends, for a new series of senior subordinated debentures of the Corporation (the "Exchange Debentures") to be issued pursuant to an indenture (the "Indenture") qualified under the Trust Indenture Act of 1939, as amended, substantially in the form attached as an exhibit to the Purchase Agreement (a copy of which shall be provided to any Holder upon written request to the Secretary of the Corporation), at any time following the date on which such exchange is permitted by the terms of the then-existing Indebtedness of the Corporation and subject to the conditions contained in paragraph X(B) below. The Exchange Debentures will be issued in registered form, without coupons, be duly executed, authenticated as of the date on which the exchange is effective and dated the date of exchange. In the event of an exchange, Holders of Series F Preferred shall be entitled to receive on the date of exchange Exchange Debentures having an aggregate principal amount equal to (i) the total of the liquidation preference for each share of Series F Preferred exchanged, plus (ii) an amount equal to all accrued but unpaid dividends payable on such share (including a prorated dividend for the period from the immediately preceding Dividend Payment Date to the date of exchange). In the event such exchange would result in the issuance of Exchange Debentures in a principal amount which is less than $1,000 or which is not an integral multiple of $1,000 (such principal amount less than $1,000 or the difference between such principal amount and the highest integral of $1,000 which is less than such principal amount, as the case may be, is hereinafter referred to as the "Fractional Principal Amount"), the Corporation may, subject to any restrictions in the terms of the then-existing Indebtedness of the Corporation, at the option of the Board of Directors, pay cash to each Holder of Series F Preferred in lieu of Fractional Principal Amounts of Exchange Debentures otherwise issuable upon exchange of the Series F Preferred Stock. The Person entitled to receive the Exchange Debentures issuable upon exchange shall be treated for all purposes as the registered holder of such Exchange Debentures as of the date of exchange. The Corporation will mail to each Holder of Series F Preferred Stock written notice of its intention to exchange no less than 20 nor more than 60 days prior to the date of exchange. (B) As a condition of the right of the Corporation to issue Exchange Debentures in exchange for the Series F Preferred Stock under paragraph (A) above, on the date of exchange, (A) there shall be legally available funds sufficient therefor; (B) a registration statement relating to the Exchange Debentures shall have been declared effective under the Securities Act prior to such exchange and shall continue to be effective on the date of exchange, or the Corporation shall have obtained a written opinion of its outside counsel reasonably acceptable to Holders of a majority of the shares of Series F Preferred Stock that an exemption from the registration requirements of the Securities Act is available for such exchange and that upon receipt of such Exchange Debentures pursuant to such an exchange made in accordance with such exemption, each holder of an Exchange Debenture that is not an Affiliate of the Corporation will not be subject to any restrictions imposed by the Securities Act upon the resale of such Exchange Debenture, and such exemption is relied upon by the Corporation for such exchange, (C) the Indenture and the trustee thereunder shall have been qualified under the Trust Indenture Act of 1939, as amended; (D) immediately after giving effect to such exchange, no default or event of default would exist under any of the Corporation's existing Indebtedness; and (E) the Corporation shall have delivered to the Trustee under the Indenture a written opinion of counsel, dated the date of exchange, regarding the satisfaction of the conditions set forth in clauses (A), (B) and (C). XI. Covenants. (A) Limitation on Indebtedness (a) The Corporation shall not, and will not permit any of its Restricted Subsidiaries to, Incur any Indebtedness (other than Indebtedness existing on the Closing Date); provided that the Corporation may Incur Indebtedness if, after giving effect to the Incurrence of such Indebtedness and the receipt and application of the proceeds therefrom, the Consolidated Leverage Ratio would be greater than zero and less than 6:1. Notwithstanding the foregoing, the Corporation and any Restricted Subsidiary (except as specified below) may Incur each and all of the following: (i) Indebtedness outstanding at any time in an aggregate principal amount not to exceed $400 million; (ii) Indebtedness in existence on the Closing Date; (iii) Indebtedness of the Corporation to a Restricted Subsidiary and Indebtedness of a Restricted Subsidiary to the Corporation or another Restricted Subsidiary; provided that such Indebtedness is made pursuant to an intercompany note and any event which results in any such Restricted Subsidiary ceasing to be a Restricted Subsidiary or any subsequent transfer of such Indebtedness (other than to the Corporation or another Restricted Subsidiary) shall be deemed, in each case, to constitute an Incurrence of such Indebtedness not permitted by this clause (iii); (iv) Indebtedness issued in exchange for, or the net proceeds of which are used to refinance or refund, then outstanding Indebtedness (other than Indebtedness Incurred under clause (i), (iii), (v) or (ix) of this paragraph) and any refinancings thereof in an amount not to exceed the amount so refinanced or refunded (plus premiums, accrued interest, fees and expenses); provided that such new Indebtedness, determined as of the date of Incurrence of such new Indebtedness, does not mature or have a mandatory redemption or repurchase date prior to the Stated Maturity of the Indebtedness to be refinanced or refunded, and the Average Life of such new Indebtedness is at least equal to the remaining Average Life of the Indebtedness to be refinanced or refunded; (v) Indebtedness (A) in respect of performance, surety, appeal bonds and completion guarantees provided in the ordinary course of business; (B) under Currency Agreements and Interest Rate Agreements; provided that such agreements (a) are designed solely to protect the Corporation or its Restricted Subsidiaries against fluctuations in foreign currency exchange rates or interest rates and (b) do not increase the Indebtedness of the obligor outstanding at any time (except to the extent Incurred under another clause hereof) other than as a result of fluctuations in foreign currency exchange rates or interest rates or by reason of fees, indemnities and compensation payable thereunder; and (C) arising from agreements providing for indemnification, adjustment of purchase price or similar obligations, or from Guarantees or letters of credit, surety bonds or performance bonds securing any obligations of the Corporation or any of its Restricted Subsidiaries pursuant to such agreements, in each case Incurred in connection with the disposition of any business, assets or Restricted Subsidiary (other than Guarantees of Indebtedness Incurred by any Person acquiring all or any portion of such business, assets or Restricted Subsidiary for the purpose of financing such acquisition), in a principal amount not to exceed the gross proceeds actually received by the Corporation or any Restricted Subsidiary in connection with such disposition; (vi) Indebtedness of the Corporation, to the extent the net proceeds thereof are promptly (A) used to purchase the Series E Preferred Stock and/or Series F Preferred Stock tendered in an Offer to Purchase made as a result of a Change in Control or (B) deposited to defease the Senior Discount Notes or used to redeem all the Series E Preferred Stock or Series F Preferred Stock; (vii) Indebtedness Incurred to finance the cost (including the cost of design, development, acquisition, construction, installation, improvement, transportation or integration) to acquire equipment, inventory or network assets (including acquisitions by way of acquisitions of real property, leasehold improvements, Capitalized Leases and acquisitions of the Capital Stock of a Person that becomes a Restricted Subsidiary to the extent of the fair market value of the equipment, inventory or network assets so acquired) by the Corporation or a Restricted Subsidiary after the Closing Date; (viii) Indebtedness of the Corporation not to exceed, at any one time outstanding, two times the sum of (A) the Net Cash Proceeds received by the Corporation on or after the Closing Date from the issuance and sale of its Capital Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of the Corporation, to the extent such Net Cash Proceeds have not been used pursuant to clause (iii)(B)(2) of the first paragraph or clause (ii) of the second paragraph of Section XI(B) or clause (v) of the definition of "Permitted Investments" to make a Restricted Payment and (B) 80% of the fair market value of property (other than cash and cash equivalents) received by the Corporation after the Closing Date from the sale of its Capital Stock (other than Disqualified Stock) to a Person that is not a Subsidiary of the Corporation, to the extent such sale of Capital Stock has not been used pursuant to clause (iii) of the second paragraph of Section XI(B) to make a Restricted Payment; provided that such Indebtedness does not mature prior to the Mandatory Redemption Date; (ix) Indebtedness Incurred by the Corporation or any of its Restricted Subsidiaries constituting reimbursement obligations with respect to letters of credit in the ordinary course of business, including, without limitation, letters of credit in respect of workers' compensation claims or self insurance, or other Indebtedness with respect to reimbursement type obligations regarding workers' compensation claims; provided, however, that upon the drawing of such letters of credit or the Incurrence of such Indebtedness, such obligations are reimbursed within 30 days following such drawing or Incurrence; (x) Indebtedness of Persons that are acquired by the Corporation or any of its Restricted Subsidiaries or merged into a Restricted Subsidiary in accordance with the terms of this Certificate of Designations; provided that such Indebtedness is not incurred in contemplation of such acquisition or merger; and provided further that after giving effect to such acquisition or merger, either (x) the Corporation would be permitted to incur at least $1.00 of additional Indebtedness pursuant to the Consolidated Leverage Ratio test set forth in the first sentence of this covenant or (y) the Consolidated Leverage Ratio is lower (if greater than zero) or higher (if less than zero) than immediately prior to such acquisition; (xi) Strategic Subordinated Indebtedness; and (xii) Indebtedness under the Lucent Facility. (b) Notwithstanding any other provision of this Section XI(A), the maximum amount of Indebtedness that the Corporation or a Restricted Subsidiary may Incur pursuant to this Section XI(A) shall not be deemed to be exceeded, with respect to any outstanding Indebtedness due solely to the result of fluctuations in the exchange rates of currencies. Accretion on an instrument issued at a discount will not be deemed to constitute an Incurrence of Indebtedness. (c) For purposes of determining any particular amount of Indebtedness pursuant to this Section XI(A), Guarantees, Liens or obligations with respect to letters of credit supporting Indebtedness otherwise included in the determination of such particular amount shall not be treated as Indebtedness. For purposes of determining compliance with this Section XI(A), in the event that an item of Indebtedness meets the criteria of more than one of the types of Indebtedness described in the above clauses, the Corporation, in its sole discretion, shall classify such item of Indebtedness and only be required to include the amount and type of such Indebtedness in one of such clauses. (B) Limitation on Restricted Payments The Corporation shall not, and shall not permit any Restricted Subsidiary to, directly or indirectly, (i) declare or pay any dividend or make any distribution on or with respect to its Junior Securities (other than (x) dividends or distributions payable solely in shares of its Junior Securities (other than Disqualified Stock) or in options, warrants or other rights to acquire shares of such Junior Securities and (y) pro rata dividends or distributions on Common Stock of Restricted Subsidiaries held by minority stockholders) held by Persons other than the Corporation or any of its Restricted Subsidiaries, (ii) purchase, redeem, retire or otherwise acquire for value any shares of Junior Securities of (A) the Corporation or an Unrestricted Subsidiary (including options, warrants or other rights to acquire such shares of Junior Securities) held by any Person or (B) a Restricted Subsidiary other than a Wholly Owned Restricted Subsidiary (including options, warrants or other rights to acquire such shares of Junior Securities) held by any Affiliate of the Corporation (other than a Wholly Owned Restricted Subsidiary), or (iii) make any Investment, other than a Permitted Investment, in any Person (such payments or any other actions described in clauses (i) through (iii) above being collectively "Restricted Payments") if, at the time of, and after giving effect to, the proposed Restricted Payment: (A) the Corporation could not Incur at least $1.00 of Indebtedness under the first paragraph of Section XI(A), or (B) the aggregate amount of all Restricted Payments (the amount, if other than in cash, to be determined in good faith by the Board of Directors whose determination shall be conclusive and evidenced by a Board Resolution) made after the Closing Date shall exceed the sum of (1) 50% of the aggregate amount of the Adjusted Consolidated Net Income (or, if the Adjusted Consolidated Net Income is a loss, minus 100% of the amount of such loss) (determined by excluding income resulting from transfers of assets by the Corporation or a Restricted Subsidiary to an Unrestricted Subsidiary) accrued on a cumulative basis during the period (taken as one accounting period) beginning on the first day of the fiscal quarter immediately following the Closing Date and ending on the last day of the last fiscal quarter preceding the Transaction Date for which reports have been provided to the Transfer Agent plus (2) 100% of the aggregate Net Cash Proceeds and the actual market value of marketable securities (on the date the calculation hereunder is made) received by the Corporation after the Closing Date from the issuance and sale permitted by this Certificate of Designations of its Capital Stock (other than Disqualified Stock) to a Person who is not a Subsidiary of the Corporation, including an issuance or sale permitted by this Certificate of Designations of Indebtedness of the Corporation for cash subsequent to the Closing Date upon the conversion of such Indebtedness into Capital Stock (other than Disqualified Stock) of the Corporation, or from the issuance to a Person who is not a Subsidiary of the Corporation of any options, warrants or other rights to acquire Capital Stock of the Corporation (in each case, exclusive of any Disqualified Stock or any options, warrants or other rights that are redeemable at the option of the holder, or are required to be redeemed, prior to the Mandatory Redemption Date), and the Net Cash Proceeds from any capital contributions to the Corporation after the Closing Date from Persons other than Subsidiaries of the Corporation, in each case excluding such Net Cash Proceeds to the extent used to Incur Indebtedness pursuant to clause (viii) of the second paragraph of Section XI(A) and excluding Net Cash Proceeds from the issuance of Capital Stock to the extent used to make a Permitted Investment in accordance with clause (v) of such defined term, plus (3) amounts received from Investments (other than Permitted Investments) in any Person resulting from payments of interest on Indebtedness, dividends, repayments of loans or advances, or other transfers of assets, in each case to the Corporation or any Restricted Subsidiary or from the Net Cash Proceeds from the sale of any such Investment (except, in each case, to the extent any such payment or proceeds are included in the calculation of Adjusted Consolidated Net Income), or from redesignations of Unrestricted Subsidiaries as Restricted Subsidiaries (valued in each case as provided in the definition of "Investments"), not to exceed, in each case, the amount of Investments previously made by the Corporation or any Restricted Subsidiary in such Person or Unrestricted Subsidiary or (C) dividends on Series F Preferred Stock shall not have been paid in full as provided in this Certificate of Designations. The foregoing provision shall not be violated by reason of: (i) the payment of any dividend within 60 days after the date of declaration thereof if, at said date of declaration, such payment would comply with the foregoing paragraph; (ii) the redemption, repurchase or other acquisition of Junior Securities of the Corporation including premium, if any, and accrued and unpaid dividends, with the proceeds of, or in exchange for, Junior Securities (other than Disqualified Stock) of the Corporation; (iii) payments or distributions, to dissenting stockholders pursuant to applicable law, pursuant to or in connection with a consolidation, merger or transfer of assets that complies with Article IX; (iv) the declaration or payment of dividends on the Common Stock of the Corporation following a Public Equity Offering of such Common Stock, of up to 6% per annum of the Net Cash Proceeds received by the Corporation in such Public Equity Offering; (v) the repurchase, retirement or other acquisition or retirement for value of any shares of Junior Securities of the Corporation that are not registered under the Exchange Act and are held by any current or former employee, director or consultant (or their estates or the beneficiaries of such estates) of the Corporation or any Subsidiary, not to exceed (A) in any calendar year $2.0 million or (B) $5.0 million in the aggregate; (vi) repurchases of Junior Securities deemed to occur upon exercise of stock options if such Capital Stock represents a portion of the exercise price of such options; (vii) repurchases of fractional shares of Junior Securities in connection with the exercise of Warrants in accordance with the Warrant Agreement or other warrants to purchase the Corporation's Common Stock; and (viii) other Restricted Payments in an aggregate amount not to exceed $2.0 million. Each Restricted Payment permitted pursuant to the preceding paragraph (other than the Restricted Payment referred to in clauses (ii) or (vi) thereof, an exchange of Junior Securities for Junior Securities and an Investment referred to in clause (iv) thereof) shall be included in calculating whether the conditions of clause (iii)(B) of the first paragraph of this Section XI(B) have been met with respect to any subsequent Restricted Payments. In the event the proceeds of an issuance of Capital Stock of the Corporation are used for the redemption, repurchase or other acquisition of Parity Securities, then the Net Cash Proceeds of such issuance shall be included in clause (iii)(B) of the first paragraph of this Section XI(B) only to the extent such proceeds are not used for such redemption, repurchase or other acquisition of securities. Any Restricted Payments made other than in cash shall be valued at fair market value. The amount of any Investment "outstanding" at any time shall be deemed to be equal to the amount of such Investment on the date made, less the return of capital to the Corporation and its Restricted Subsidiaries with respect to such Investment by distribution, sale or otherwise (up to the amount of such Investment on the date made). (C) Limitation on Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries The Corporation shall not, and shall not permit any Restricted Subsidiary to, create or otherwise cause or suffer to exist or become effective any consensual encumbrance or restriction of any kind on the ability of any Restricted Subsidiary to (i) pay dividends or make any other distributions permitted by applicable law on any Capital Stock of such Restricted Subsidiary owned by the Corporation or any other Restricted Subsidiary, (ii) pay any Indebtedness owed to the Corporation or any other Restricted Subsidiary, (iii) make loans or advances to the Corporation or any other Restricted Subsidiary or (iv) transfer any of its property or assets to the Corporation or any other Restricted Subsidiary. The foregoing provisions shall not restrict any encumbrances or restrictions: (i) existing on the Closing Date, in the Newcourt Facility, the Lucent Facility, this Certificate of Designations or any other agreements in effect on the Closing Date, and any extensions, refinancings, renewals or replacements of such agreements; provided that the encumbrances and restrictions in any such extensions, refinancings, renewals or replacements are no less favorable in any material respect to the Holders than those encumbrances or restrictions that are then in effect and that are being extended, refinanced, renewed or replaced; (ii) existing under or by reason of applicable law, rule, regulation or order; (iii) existing with respect to any Person or the property or assets of such Person acquired by the Corporation or any Restricted Subsidiary, existing at the time of such acquisition and not incurred in contemplation thereof, which encumbrances or restrictions are not applicable to any Person or the property or assets of any Person other than such Person or the property or assets of such Person so acquired; (iv) in the case of clause (iv) of the first paragraph of this Section XI(C), (A) that restrict in a customary manner the subletting, assignment or transfer of any property or asset that is a lease, license, conveyance or contract or similar property or asset, (B) existing by virtue of any transfer of, agreement to transfer, option or right with respect to, or Lien on, any property or assets of the Corporation or any Restricted Subsidiary not otherwise prohibited by this Certificate of Designations, (C) arising or agreed to in the ordinary course of business, not relating to any Indebtedness, and that do not, individually or in the aggregate, detract from the value of property or assets of the Corporation or any Restricted Subsidiary in any manner material to the Corporation or any Restricted Subsidiary or (D) purchase money obligations for property acquired in the ordinary course of business that impose restrictions of the nature discussed in clause (iv) above on the property so acquired; (v) with respect to the Corporation or a Restricted Subsidiary and imposed pursuant to an agreement that has been entered into for the sale of assets, including, without limitation, customary restrictions on the disposition of all or substantially all of the Capital Stock of, or property and assets of, such Restricted Subsidiary or the Corporation; (vi) contained in the terms of any Indebtedness or any agreement pursuant to which such Indebtedness was issued (in each case other than Indebtedness incurred under the Newcourt Facility) if (A) the encumbrance or restriction applies only in the event of a payment default or a default with respect to a financial covenant contained in such Indebtedness or agreement, (B) the encumbrance or restriction is not materially more disadvantageous to the Holders of the Series F Preferred Stock than is customary in comparable financings (as determined by the Corporation) and (C) the Corporation determines that any such encumbrance or restriction will not materially affect the Corporation's ability to make dividend and mandatory redemption payments on the Series F Preferred Stock; (vii) restrictions on cash or other deposits or net worth imposed by customers under contracts entered into in the ordinary course of business; (viii) customary provisions in joint venture agreements and other similar agreements entered into in the ordinary course of business; and (ix) any encumbrances or restrictions of the type referred to in clauses (i)-(iv) of the first paragraph of this covenant imposed by any amendments, modifications, renewals, restatements, increases, supplements, refundings, replacements or refinancings of the contracts referred to in clauses (i) through (viii) above; provided that such amendments, modifications, restatements, renewals, increases, supplements, refundings, replacements or refinancings are, in the good faith judgment of the Corporation, not materially more disadvantageous to the Holders than those contained in the restriction prior to such amendment, modification, restatement, renewal, increase, supplement, refunding, replacement or refinancing. Nothing contained in this Section XI(C) shall prevent the Corporation or any Restricted Subsidiary from restricting the sale or other disposition of property or assets of the Corporation or any of its Restricted Subsidiaries that secure Indebtedness of the Corporation or any of its Restricted Subsidiaries. (D) Limitation on the Issuance and Sale of Capital Stock of Restricted Subsidiaries The Corporation shall not sell, and shall not permit any Restricted Subsidiary, directly or indirectly, to issue or sell, any shares of Capital Stock of a Restricted Subsidiary (including options, warrants or other rights to purchase shares of such Capital Stock) except (i) to the Corporation or a Wholly Owned Restricted Subsidiary; (ii) issuances of director's qualifying shares or sales to foreign nationals of shares of Capital Stock of foreign Restricted Subsidiaries, to the extent required by applicable law; (iii) if, immediately after giving effect to such issuance or sale, such Restricted Subsidiary would no longer constitute a Restricted Subsidiary and any Investment in such Person remaining after giving effect to such issuance or sale would have been permitted to be made in accordance with Section XI(B) if made on the date of such issuance or sale; or (iv) issuances or sales of common stock of a Restricted Subsidiary, provided that the Corporation or any Restricted Subsidiary applies an amount equal to the Net Cash Proceeds thereof in accordance with Section XI(F). (E) Limitation on Transactions with Shareholders and Affiliates The Corporation shall not, and shall not permit any Restricted Subsidiary to, directly or indirectly, enter into, renew or extend any transaction (including, without limitation, the purchase, sale, lease or exchange of property or assets, or the rendering of any service) with any Affiliate of the Corporation or any Restricted Subsidiary, except upon fair and reasonable terms no less favorable to the Corporation or such Restricted Subsidiary than could be obtained, at the time of such transaction or, if such transaction is pursuant to a written agreement, at the time of the execution of the agreement providing therefor, in a comparable arm's-length transaction with a Person that is not an Affiliate. The foregoing limitation does not limit, and shall not apply to (i) transactions (A) approved by a majority of the disinterested members of the Board of Directors or (B) for which the Corporation or a Restricted Subsidiary delivers to the Transfer Agent a written opinion of a nationally recognized investment banking firm or a nationally recognized firm having expertise in the specific area which is the subject of such determination stating that the transaction is fair to the Corporation or such Restricted Subsidiary from a financial point of view; (ii) any transaction solely between the Corporation and any of its Restricted Subsidiaries or solely between Restricted Subsidiaries; (iii) the payment of reasonable and customary regular fees to, and indemnity provided on behalf of, officers, directors, employees or consultants of the Corporation or its Restricted Subsidiaries; (iv) any payments or other transactions pursuant to any tax-sharing agreement between the Corporation and any other Person with which the Corporation files a consolidated tax return or with which the Corporation is part of a consolidated group for tax purposes; (v) any agreement as in effect as of the Closing Date or any amendment thereto (so long as any such amendment is not disadvantageous to the Holders in any material respect); (vi) the existence of, or the performance by the Corporation or any of its Restricted Subsidiaries of its obligations under the terms of, any stockholders agreement (including any registration rights agreement or purchase agreement related thereto) to which it is a party as of the Closing Date and any similar agreements which it may enter into thereafter (so long as any such amendment is not disadvantageous to the Holders in any material respect); or (vii) any Permitted Investments and Restricted Payments not prohibited by Section XI(B). Notwithstanding the foregoing, any transaction or series of related transactions covered by the first paragraph of this Section XI(E) and not covered by clauses (ii) through (vii) of this paragraph the aggregate amount of which exceeds $3.0 million in value, must be approved or determined to be fair in the manner provided for in clause (i)(A) or (B) above. (F) Limitation on Asset Sales The Corporation shall not, and shall not permit any Restricted Subsidiary to, consummate any Asset Sale, unless (i) the consideration received by the Corporation or such Restricted Subsidiary is at least equal to the fair market value of the assets sold or disposed of and (ii) at least 75% of the consideration received consists of cash or Temporary Cash Investments. For purposes of this covenant, the following are deemed to be cash: (x) the principal amount or accreted value (whichever is larger) of Indebtedness of the Corporation or any Restricted Subsidiary with respect to which the Corporation or such Restricted Subsidiary has either (A) received a written release or (B) been released by operation of law, in either case, from all liability on such Indebtedness in connection with such Asset Sale and (y) securities received by the Corporation or any Restricted Subsidiary from the transferee that are promptly converted by the Corporation or such Restricted Subsidiary into cash. In the event and to the extent that the Net Cash Proceeds received by the Corporation or any of its Restricted Subsidiaries from one or more Asset Sales occurring on or after the Closing Date in any period of 12 consecutive months exceed 10% of Adjusted Consolidated Net Tangible Assets (determined as of the date closest to the commencement of such 12-month period for which a consolidated balance sheet of the Corporation and its Subsidiaries has been provided to the Transfer Agent), then the Corporation shall or shall cause the relevant Restricted Subsidiary to (i) within 12 months after the date Net Cash Proceeds so received exceed 10% of Adjusted Consolidated Net Tangible Assets (A) apply an amount equal to such excess Net Cash Proceeds to permanently repay Indebtedness of the Corporation, repay Indebtedness of any Restricted Subsidiary or redeem any Senior Securities, in each case owing to, or held by, a Person other than the Corporation or any of its Restricted Subsidiaries or (B) invest an equal amount, or the amount not so applied pursuant to clause (A) (or enter into a definitive agreement committing to so invest within 12 months after the date of such agreement), in property or assets (other than current assets) of a nature or type or that are used in a business (or in a Person (other than a natural person) having property and assets of a nature or type, or engaged in a business) similar or related to the nature or type of the property and assets of, or the business of, the Corporation and its Restricted Subsidiaries existing on the date of such investment (as determined in good faith by the Board of Directors whose determination shall be conclusive and evidenced by a Board Resolution) and (ii) apply (no later than the end of the 12-month period referred to in clause (i)) such excess Net Cash Proceeds (to the extent not applied pursuant to clause (i)) as provided in the following paragraph of this Section XI(F). The amount of such excess Net Cash Proceeds required to be applied (or to be committed to be applied) during such 12-month period as set forth in clause (i) of the preceding sentence and not applied as so required by the end of such period shall constitute "Excess Proceeds." If, as of the first day of any calendar month, the aggregate amount of Excess Proceeds not theretofore subject to an Offer to Purchase pursuant to this Section XI(F) totals at least $5 million, the Corporation must commence, not later than the fifteenth Business Day of such month, and consummate an Offer to Purchase from the Holders on a pro rata basis, and an offer to purchase any outstanding Parity Securities with similar provisions requiring the Corporation to make an offer to purchase such securities, in an aggregate liquidation preference of Series F Preferred Stock and such Parity Securities equal to (A) with respect to the Series F Preferred Stock, the product of such Excess Proceeds multiplied by a fraction, the numerator of which is the liquidation preference of the outstanding shares of the Series F Preferred Stock and the denominator of which is the sum of the outstanding liquidation preference of the Series F Preferred Stock and such Parity Securities (the product hereinafter referred to as the "Series F Preferred Stock Amount"), and (B) with respect to the Parity Securities, the excess of the Excess Proceeds over the Series F Preferred Stock Amount, at a purchase price equal to 100% of the liquidation preference of the Series F Preferred Stock or such Parity Securities, as the case may be, on the relevant Payment Date or such other date set forth in the documentation governing the Parity Securities, plus, in each case, accrued dividends (if any) to the Payment Date or such other date set forth in the documentation governing the Parity Securities. If the aggregate purchase price of the Preferred Stock tendered pursuant to the Offer to Purchase is less than the Excess Proceeds, the remaining will be available for use by the Corporation for general corporate purposes. Upon the consummation of any Offer to Purchase in accordance with the terms of this Certificate of Designations, the amount of Net Cash Proceeds from Asset Sales subject to any future Offer to Purchase shall be deemed to be zero. Prior to commencing any Offer to Purchase, the Corporation shall first consummate any offer to purchase required to be made to any Holder of its Indebtedness. (G) Commission Reports and Reports to Holders. While the Series F Preferred Stock is outstanding, whether or not the Corporation is then required to file reports with the Commission, the Corporation shall deliver for filing with the Commission all such reports and other information as it would be required to file with the Commission by Sections 13(a) or 15(d) under the Exchange Act if it were subject thereto. All references herein to reports "filed" with the Commission shall be deemed to refer to the reports then most recently delivered for filing, whether or not accepted by the Commission. XII. Mutilated or Missing Series F Preferred Stock Certificates. If any of the Series F Preferred Stock certificates shall be mutilated, lost, stolen or destroyed, the Corporation shall issue, in exchange and in substitution for and upon cancellation of the mutilated Series F Preferred Stock certificate, or in lieu of and substitution for the Series F Preferred Stock certificate lost, stolen or destroyed, a new Series F Preferred Stock certificate of like tenor and representing an equivalent amount of shares of Series F Preferred Stock, but only upon receipt of evidence of such loss, theft or destruction of such Series F Preferred Stock certificate and indemnity, if requested, satisfactory to the Corporation. XIII. Reissuance; Preemptive Rights (i) Shares of Series F Preferred Stock that have been issued and reacquired in any manner, including shares purchased or redeemed, shall (upon compliance with any applicable provisions of the laws of the State of Delaware) have the status of authorized and unissued shares of Preferred Stock undesignated as to series and may be redesignated and reissued as part of any series of Preferred Stock. (ii) No shares of Series F Preferred Stock shall have any rights of preemption whatsoever as to any securities of the Corporation, or any warrants, rights or options issued or granted with respect thereto, regardless of how such securities or such warrants, rights or options may be designated, issued or granted. XIV. Business Day. If any payment or redemption shall be required by the terms hereof to be made on a day that is not a Business Day, such payment or redemption shall be made on the immediately succeeding Business Day and no further dividends shall accrued after the day payment was required. XV. Headings of Subdivisions. The headings of various subdivisions hereof are for convenience of reference only and shall not affect the interpretation of any of the provisions hereof. XVI. Severability of Provisions. If any right, preference or limitation of the Series F Preferred Stock set forth in this Certificate of Designations (as may be amended from time to time) is invalid, unlawful or incapable of being enforced by reason of any rule or law or public policy, all other rights, preferences and limitations set forth in this Certificate of Designations, as amended, which can be given effect without the invalid, unlawful or unenforceable right, preference or limitation shall, nevertheless remain in full force and effect, and no right, preference or limitation herein set forth shall be deemed dependent upon any other such right, preference or limitation unless so expressed herein. XVII. Notice. All notices, requests, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered by hand or when sent by telex or telecopier (with receipt confirmed), provided a copy is also sent by express (overnight, if possible) courier, addressed (i) in the case of a Holder of the Series F Preferred Stock, to such holder's address of record shown on the records of the Corporation, and (ii) in the case of the Corporation, to the Corporation's principal executive offices (currently located on the date of the adoption of these resolutions at the following address: KMC Telecom Holdings, Inc., 1545 Route 206, Suite 300, Bedminster, New Jersey 07921) to the attention of the Corporation's Chief Financial Officer. XVIII. Limitations. Except as may otherwise be required by law, the shares of Series F Preferred Stock shall not have any powers, preferences or relative, participating, optional or other special rights other than those specifically set forth in this Certificate of Designations (as may be amended from time to time) or otherwise in the Certificate of Incorporation of the Corporation. XIX. Transfer and Legending of Shares. No transfer of shares of the Series F Preferred Stock shall be effective until such transfer is registered on the books of the Corporation. Any shares of the Series F Preferred Stock so transferred must bear the following legend: THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), NOR HAS IT BEEN REGISTERED UNDER THE SECURITIES OR BLUE SKY LAWS OF ANY STATE. THIS SECURITY MAY NOT BE OFFERED, SOLD, PLEDGED OR IN ANY OTHER MANNER TRANSFERRED OR DISPOSED OF UNLESS (I) SUCH TRANSFER IS IN COMPLIANCE WITH THE SECURITIES ACT AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER AND APPLICABLE STATE SECURITIES LAWS OR BLUE SKY LAWS AND (II) PRIOR TO ANY SUCH TRANSFER, THE TRANSFEROR OR THE TRANSFEREE DELIVERS AN OPINION OF COUNSEL (REASONABLY ACCEPTABLE TO THE CORPORATION) TO THE TRANSFER AGENT AND THE CORPORATION, THAT SUCH TRANSFER IS IN COMPLIANCE WITH THE SECURITIES ACT AND THE APPLICABLE RULES AND REGULATIONS THEREUNDER. THE SHARES OF SERIES F PREFERRED STOCK REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO A COVENANT OF LUCENT TECHNOLOGIES, INC. ("LUCENT") IN A SECURITIES PURCHASE AGREEMENT DATED AS OF FEBRUARY 4, 1999 WHICH PROHIBITS LUCENT FROM TRANSFERRING THIS SERIES OF PREFERRED STOCK PRIOR TO THE EARLIER OF (i) AUGUST 4, 2000 OR (ii) ONE YEAR AFTER A HIGH YIELD OFFERING BY KMC TELECOM HOLDINGS, INC. YIELDING GROSS PROCEEDS OF AT LEAST $50 MILLION. The Corporation shall refuse to register any attempted transfer of shares of Series F Preferred Stock not in compliance with this Article XIX. In the event the shares of Series F Preferred Stock are issued as part of a unit together with Warrants, the shares of Series F Preferred Stock and the Warrants shall not be separately transferable from each other until the next Business Day after the issuance of such shares of Series F Preferred Stock or until such other date as may be specified in a legend to the shares of Series F Preferred Stock. XX. Amendments and Waivers (A) Except as provided in this Article XX, any right, preference, privilege or power of, or restriction provided for the benefit of, the Series F Preferred Stock set forth herein may be amended and the observance thereof may be waived (either generally or in a particular instance and either retroactively or prospectively) only with the written consent of the Corporation and the affirmative vote or written consent of the Holders of at least a majority of the shares of Series F Preferred Stock then outstanding (excluding any shares held by Affiliates of the Corporation, any Existing Stockholders or any of their Affiliates), and any amendment or waiver so effected shall be binding upon the Corporation and all Holders of the Series F Preferred Stock. (B) Notwithstanding the foregoing, if any amendment is made to the covenants of the Senior Discount Note Indenture, in accordance with the provisions therein, then a conforming amendment may be made to the covenants set forth in Article XI of this Certificate of Designations by the Corporation, without the consent of any Holder; and any amendment so effected shall be binding upon the Corporation and all Holders of the Series F Preferred Stock, provided however, that if in connection with making any such amendment to the Senior Discount Note Indenture, the Corporation has paid consideration to the holders of the Senior Discount Notes to obtain their consent to make such amendment, then the Corporation shall pay each Holder consideration per $1,000 liquidation preference of Series F Preferred Stock equal to the consideration per $1,000 Accreted Value (as defined in the Senior Discount Note Indenture) of Senior Discount Notes paid to the holders of the Senior Discount Notes. In connection with any such amendment, the Corporation shall deliver to the Transfer Agent an Opinion of Counsel, reasonably acceptable to it, that such amendment complies with the terms hereof. The Corporation shall provide notice in accordance with Article XVII of this Certificate of Designations of any amendment effected pursuant to this Section XX(B) to the Holders of the Series F Preferred Stock. XXI. Conversion. Upon the Business Day after the earlier of (i) the date that is sixty days after the date on which the Corporation 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 (such Business Day hereinafter referred to as, the "Conversion Date"), the Series F Preferred Stock will automatically convert into the right to receive Series E Preferred Stock having a liquidation preference equal to the liquidation preference of the Series F Preferred Stock). Each such share of Series E Preferred Stock issued upon conversion of the Series F Preferred Stock and surrender of the certificates representing the Series F Preferred Stock shall accrue dividends as provided in the Series E Certificate of Designations from the last date on which dividends were paid on the Series F Preferred Stock. On or after the Conversion Date, each Holder shall surrender the certificate(s) representing its shares of Series F Preferred Stock, accompanied by transfer instrument(s) satisfactory to the Corporation and sufficient to transfer the Series F Preferred Stock being so converted to the Corporation free of any lien or other adverse interest, at any of the offices or agencies maintained for such purpose by the conversion agent designated by the Corporation (the "Conversion Agent") and shall give written notice to the Corporation that the Holder is surrendering its certificates of Series F Preferred Stock for conversion into shares of Series E Preferred Stock pursuant to this Article XXI of this Certificate of Designations. The initial Conversion Agent shall be the Transfer Agent. Such notice shall also state the name(s), together with address(es), in which the certificate(s) for shares of Series E Preferred Stock shall be issued. As promptly as practicable after the surrender of such shares of Series F Preferred Stock as aforesaid, the Corporation shall issue and deliver at the office of such Conversion Agent to such Holder, or on such Holder's written order, certificate(s) representing the number of full shares of Series E Preferred Stock issuable upon the conversion of such shares in accordance with the provisions hereof. Each conversion shall be deemed to have been effected immediately prior to the close of business on the date on which shares of Series F Preferred Stock shall have been surrendered as aforesaid, and the Person(s) in whose name(s) any certificate(s) for shares of Series E Preferred Stock shall be issuable upon such conversion shall be deemed to have become the holder(s) of record of the Series E Preferred Stock represented thereby at such time, unless the stock transfer books of the Corporation shall be closed on the date on which shares of Series F Preferred Stock are so surrendered for conversion, in which event such conversion shall be deemed to have been effected immediately prior to the close of business on the next succeeding day on which such stock transfer books are open, and such person(s) shall be deemed to have become such holder(s) of record of the Series E Preferred Stock at the close of business on such later day. The Corporation shall at all times reserve a sufficient number of shares of Series E Preferred Stock to be issued upon conversion of the Series F Preferred Stock pursuant to this Article XXI. XXII. Increase of Authorized Amount of Shares. Notwithstanding any other provision herein, the Board of Directors may, from time to time, in its sole discretion, increase the number of shares of Preferred Stock designated as Series F Preferred Stock under Article II of this Certificate of Designations, up to the maximum amount of shares of Preferred Stock authorized to be issued, without the consent of the holders of any shares of its Capital Stock. The Corporation shall at all times reserve a sufficient number of authorized but unissued shares of Series F Preferred Stock to provide for the payment of all dividends that may accrue on the shares of Series F Preferred Stock then outstanding in additional shares of Series F Preferred Stock. XXIII. Issuance of Additional Shares of Series F Preferred Stock. Except with respect to the issuance of shares of Series E Preferred Stock to pay dividends on the Series E Preferred Stock or upon conversion of the Series F Preferred Stock, the Corporation may not issue additional shares of the Series E Preferred Stock to any purchaser unless (A) it has obtained the consent of the Holders of a majority of the shares of Series F Preferred Stock then outstanding and the holders of a majority of the shares of Series E Preferred Stock then outstanding or (B)(i) the per share price paid for such additional shares is at least equal to the per share price paid to the Corporation for the shares of Series E Preferred Stock issued on the Closing Date, (ii) the Corporation does not issue to such purchaser more than 1,363.64 Warrants per $1,000,000 of liquidation preference of Series E Preferred Stock, (iii) (a) the holders of Series E Preferred Stock issued on the Closing Date retain their right to receive at least 227.273 Warrants, pursuant to Section 2.4 of the Warrant Agreement, per $100,000 of liquidation preference of Series E Preferred Stock issued on the Closing Date and (b) the Holders of Series F Preferred Stock issued on the Closing Date retain their right to receive at least 227.273 Warrants, pursuant to Section 2.4 of the Warrant Agreement, per $100,000 of liquidation preference of Series F Preferred Stock issued on the Closing Date and (iv) the aggregate amount of all shares of Series E Preferred Stock and Series F Preferred Stock issued (other than shares of Series E Preferred Stock and Series F Preferred Stock issued to pay dividends thereon or shares of Series E Preferred Stock issued upon conversion of the Series F Preferred Stock) shall not exceed 150,000 shares. Except with respect to the issuance of shares of Series F Preferred Stock to pay dividends on the Series F Preferred Stock, the Corporation shall not issue in excess of 40,000 shares of Series F Preferred Stock, unless it has obtained the consent of the Holders of a majority of the shares of Series F Preferred Stock then outstanding and the Holders of a majority of the shares of Series E Preferred Stock then outstanding. IN WITNESS WHEREOF, this Certificate has been signed on this 4th day of February, 1999. KMC TELECOM HOLDINGS, INC. By:/s/CYNTHIA WORTHMAN ----------------------------- Name: Cynthia Worthman Title: Chief Financial Officer Attested by: EX-4.5 8 AMENDMENT NO. 4 AMENDED AND RESTATED STOCKHOLDER AMENDMENT NO. 4 TO THE AMENDED AND RESTATED STOCKHOLDERS AGREEMENT AMENDMENT NO. 4 dated as of February 4, 1999 to the Amended and Restated Stockholders Agreement, dated as of October 31, 1997 (as heretofore amended, the "Stockholders Agreement") among KMC Telecom Holdings, Inc., Nassau Capital Partners L.P., NAS Partners I L.L.C., Harold N. Kamine, AT&T Credit Corporation, General Electric Capital Corporation, CoreStates Bank, N.A., and CoreStates Holdings, Inc. W I T N E S S E T H WHEREAS, the parties hereto desire to make certain amendments to the Stockholders Agreement; NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. DEFINED TERMS. Unless otherwise defined herein, all capitalized terms defined in the Stockholders Agreement and used herein are so used as so defined. In addition, the following terms shall have the meanings set forth below: "1999 PURCHASE AGREEMENT" means the Securities Purchase Agreement dated as of February 4, 1999 among the Company, Lucent Technologies Inc. and Newcourt Capital USA, Inc. "1999 WARRANT REGISTRATION RIGHTS AGREEMENT" means the Warrant Registration Rights Agreement dated as of February 4, 1999 among the Company, Newcourt Capital USA, Inc., Lucent Technologies Inc. and any Additional Purchasers (as defined therein), , which Warrant Registration Rights Agreement is being entered into in connection with the execution and delivery of the Preferred Stock Warrant Agreement. "PREFERRED STOCK WARRANT AGREEMENT" means the Warrant Agreement dated as of February 4, 1999 among the Company, The Chase Manhattan Bank, as Warrant Agent, Newcourt Capital USA, Inc., Lucent Technologies Inc. and any Additional Purchasers (as defined therein), which Preferred Stock Warrant Agreement is being entered into in connection with the execution and delivery of the 1999 Purchase Agreement. "PREFERRED STOCK WARRANT SHARES" means shares of Common Stock issuable upon exercise of Preferred Stock Warrants, such other securities as shall be issuable upon the exercise of Preferred Stock Warrants, or shares of Common Stock or other securities received upon the exercise of Preferred Stock Warrants "PREFERRED STOCK WARRANTS" means Warrants issued to holders of Series E Preferred Stock and Series F Preferred Stock pursuant to the Preferred Stock Warrant Agreement, each such Warrant initially entitling the holder thereof to purchase 0.42887 shares of Common Stock at an exercise price of $.01 per share. "SERIES E PREFERRED STOCK" means the Company's Series E Senior, Redeemable, Exchangeable PIK Preferred Stock, par value $.01 per share. "SERIES F PREFERRED STOCK" means the Company's Series F Senior, Redeemable, Exchangeable PIK Preferred Stock, par value $.01 per share. 2. AMENDMENTS TO SECTIONS 6.1 AND 6.2 OF THE STOCKHOLDERS AGREEMENT. Paragraphs (d) and (g) of Section 6.1 and paragraphs (c) and (d) of Section 6.2 of the Stockholders Agreement are amended to read as follows: 6.1 DEMAND REGISTRATIONS. (d) PRIORITY ON DEMAND REGISTRATIONS. The Company will not include in any Demand Registration any securities which are not Registrable Securities without the prior written consent of the Demand Holder; provided, however, that no such consent shall be required in connection with the inclusion in any Demand Registration of the Senior Discount Notes, Warrant Shares and Preferred Stock Warrant Shares as and to the extent provided below. If a Demand Registration is an underwritten offering and the managing underwriters advise the Company in writing that in their opinion the number of Registrable Securities and, if permitted hereunder, other securities requested to be included in such offering exceeds the number of Registrable Securities and other securities, if any, which can be sold therein without adversely affecting the price, timing or distribution of the offering, the Company will include in such registration, (i) first, the Registrable Securities requested to be included in such registration, pro rata among the holders of such Registrable Securities, on the basis of the number of shares of Registrable Securities owned by each such holder and requested to be included therein and (ii) second, other securities, if any, requested to be included in such registration (in such relative order of priority among such securities as may be specified with respect thereto). Any Persons other than holders of Registrable Securities who participate in Demand Registrations must pay their proportionate share of the Registration Expenses as provided in Section 6.5 hereof that are not borne by the Company. (g) OTHER REGISTRATION RIGHTS. (i) Within the limitations prescribed by this paragraph (i), but not otherwise, the Company may grant to subsequent investors in the Company rights of incidental registration (such as those provided in Section 6.2). Such rights may only pertain to the Senior Discount Notes and Warrant Shares, in the case of the HYDEO, Preferred Stock Warrant Shares, in the case of the Preferred Stock Warrant Agreement, and, otherwise, shares of Common Stock, including shares of Common Stock into which any other securities may be converted. Such rights may be granted with respect to (a) registrations actually requested by a Demand Holder pursuant to Section 6.1, but only in respect of that portion of any such registration as remains after inclusion of all Registrable Securities requested by the Demand Holder and (b) registrations initiated by the Company, but only in respect of that portion of such registration as is available under the limitations set forth in Section 6.2(c) (which limitations shall apply pro rata to all holders of Registrable Securities) and such rights shall be limited in all cases to sharing in the available portion of the registration in question with holders of Registrable Securities and other investors as provided in Section 6.2(c), such sharing to be based on the number of shares of Common Stock held by the respective holders of Registrable Securities and held by such other investors, plus the number of shares of Common Stock into which other securities held by the holders of Registrable Securities and such other investors are convertible, which are entitled to registration rights. With respect to registrations which are for underwritten public offerings, "available portion" as used above shall mean the portion of the underwritten shares which is available as specified in clauses (a) and (b) of the third sentence of this paragraph (i). Shares not included in such underwriting shall not be registered. (ii) The Company may not grant to subsequent investors in the Company rights of registration upon request (such as those provided in Section 6.1) unless (a) such rights are limited to shares of Common Stock; (b) the Demand Holders are given enforceable contractual rights to participate in registrations requested by such subsequent investors (but subject to the right of priority of registration in the following order: such subsequent investors and the holders of Registrable Securities on a pro rata basis), such participation to be on the pro rata basis and subject to the limitations described in the final three sentences of paragraph (i) of this Section 6.1(g); (c) such rights shall not become effective prior to 90 days after the effective date of the first registration pursuant to Section 6.1; and (d) such rights shall not be more favorable than those granted to the Demand Holders. Notwithstanding the foregoing or anything to the contrary contained in this Agreement, the Company may file shelf registrations under the Securities Act (x) as required by Section 3 of the Warrant Registration Rights Agreement, substantially upon the terms and subject to the conditions contained therein, (y) as required by Section 2(b) of the Registration Rights Agreement, substantially upon the terms and subject to the conditions contained therein and (z) as required by Section 3 of the 1999 Warrant Registration Rights Agreement, substantially upon the terms and subject to the conditions contained therein. 6.2 PIGGYBACK REGISTRATIONS. (c) PRIORITY ON PRIMARY REGISTRATIONS. If a Piggyback Registration is an underwritten primary registration on behalf of the Company, the Company will include in such registration all securities requested to be included in such registration; PROVIDED, that if the managing underwriters advise the Company in writing that in their opinion the number of securities requested to be included in such registration exceeds the number which can be sold in such offering without adversely affecting the price, timing or distribution of the offering, the Company will include in such registration (i) first, the securities the Company proposes to sell, (ii) second, the Registrable Securities requested to be included in such registration, pro rata among the holders of such Registrable Securities on the basis of the number of Registrable Securities owned by each such holder and requested to be included therein, and (iii) third, other securities (including Warrant Shares and Preferred Stock Warrant Shares), if any, requested to be included in such registration (in such relative order of priority among such securities as may be specified with respect thereto). (d) PRIORITY ON SECONDARY REGISTRATIONS. If a Piggyback Registration is an underwritten secondary registration on behalf of holders of the Company's securities, and the managing underwriters advise the Company in writing that in their opinion the number of securities requested to be included in such registration exceeds the number which can be sold in such offering without adversely affecting the price, timing or distribution of the offering, the Company will include in such registration (i) first, the Registrable Securities requested to be included in such registration, pro rata among the holders of such Registrable Securities on the basis of the number of Registrable Securities owned by each such holder and requested to be included therein, and (ii) second, other securities requested to be included in such registration (in such relative order of priority among such securities as may be specified with respect thereto). 3. Except as expressly amended hereby, all of the provisions of the Stockholders Agreement are hereby affirmed and shall continue in full force and effect in accordance with their terms. 4. This Amendment shall be governed and construed in accordance with the laws of the state of Delaware applicable to agreements made and to be performed entirely within such state, without regard to the principles of conflicts of laws thereof. 5. This Amendment may be executed in one or more counterparts, each of which shall be deemed an original and all of which, taken together, shall constitute one and the same instrument. IN WITNESS WHEREOF, the undersigned have executed, or caused to be executed, this Agreement as of the date first above written. KMC TELECOM HOLDINGS, INC. By: /S/ CYNTHIA WORTHMAN ------------------------- Name: Title: NASSAU CAPITAL PARTNERS L.P. By: Nassau Capital L.L.C., its General Partner By: /S/ RANDALL A. HACK ------------------------- Name: Title: NAS PARTNERS I L.L.C. By: /S/ RANDALL A. HACK ------------------------- Name: Title: HAROLD N. KAMINE /S/ HAROLD N. KAMINE ----------------------------- AT&T CREDIT CORPORATION By:__________________________ Name: Title: First Union National Bank as Successor to CORESTATES BANK, N.A. By: /S/ MARK M. HARDEN ------------------------- Name: Title: CORESTATES HOLDINGS, INC. By: /S/ JAMES C. COOK ------------------------- Name: Title: GENERAL ELECTRIC CAPITAL CORPORATION By: /S/ MARK F. MYLON ------------------------- Name: Title: KMC TELECOMMUNICATIONS L.P. By:__________________________ Name: Title: EX-10.2 9 LOAN AND SECURITY AGREEMENT - - ----------------------------------------------------------------------------- LOAN AND SECURITY AGREEMENT DATED AS OF DECEMBER 22, 1998 AMONG KMC TELECOM INC., KMC TELECOM II, INC., KMC TELECOM OF VIRGINIA, INC., KMC TELECOM LEASING I LLC, AND KMC TELECOM LEASING II LLC AS BORROWERS, THE FINANCIAL INSTITUTIONS FROM TIME TO TIME PARTIES HERETO, AS LENDERS, AND FIRST UNION NATIONAL BANK AS ADMINISTRATIVE AGENT FOR THE LENDERS AND AT&T COMMERCIAL FINANCE CORPORATION AS COLLATERAL AGENT FOR THE LENDERS - - ----------------------------------------------------------------------------- TABLE OF CONTENTS ARTICLE I DEFINITIONS...........................................................1 SECTION 1.01. Definitions............................................1 SECTION 1.02. Accounting Terms......................................21 SECTION 1.03. Others Defined in New York Uniform Commercial Code....21 ARTICLE II LOANS AND LETTERS OF CREDIT..........................................22 SECTION 2.01. Agreement to Lend.....................................22 SECTION 2.02. Loans.................................................22 SECTION 2.03. Procedure for Loan Request and Borrowing Commitment...23 SECTION 2.04. The Notes.............................................24 SECTION 2.05. Interest on Loans.....................................25 SECTION 2.06. Conversion or Continuation.............................25 SECTION 2.07. Special Provisions Governing LIBOR Loans..............26 SECTION 2.08. Payments..............................................29 SECTION 2.09. Optional and Mandatory Prepayment of Loans; Optional and Mandatory Reduction of Revolving Loan Commitment Amount................................30 SECTION 2.10. Letters of Credit....................................32 SECTION 2.11. Fees..................................................37 SECTION 2.12. Manner of Payment; Special Tax Considerations.........38 SECTION 2.13. Maximum Lawful Interest Rate..........................41 SECTION 2.14. Funding Issues........................................42 SECTION 2.15. Joint and Several Liability; Contribution.............43 ARTICLE III REPRESENTATIONS AND WARRANTIES.......................................44 SECTION 3.01. Organization; Powers..................................44 SECTION 3.02. Corporate Authorization...............................44 SECTION 3.03. Financial Statements..................................45 SECTION 3.04. No Material Adverse Change............................45 SECTION 3.05. Litigation............................................45 SECTION 3.06. Tax Returns...........................................45 SECTION 3.07. No Defaults...........................................45 SECTION 3.08. Properties............................................45 SECTION 3.09. Licenses, Material Agreements, Intellectual Property..............................................45 SECTION 3.10. Compliance With Laws..................................46 SECTION 3.11. ERISA.................................................46 SECTION 3.12. Investment Company Act; Public Utility Holding Company Act...................................47 SECTION 3.13. Federal Reserve Regulations...........................47 SECTION 3.14. Collateral............................................47 SECTION 3.15. Chief Place of Business...............................48 SECTION 3.16. Other Corporate Names.................................48 i SECTION 3.17. Insurance.............................................48 SECTION 3.18. Milestone Plan........................................48 SECTION 3.19. Capitalization and Subsidiaries.......................48 SECTION 3.20. Real Property, Leases and Easements...................49 SECTION 3.21. Solvency..............................................49 SECTION 3.22. Brokers, etc..........................................49 SECTION 3.23. No Material Misstatements.............................49 SECTION 3.24. Year 2000 Problems....................................49 ARTICLE IV CONDITIONS FOR LOANS.................................................49 SECTION 4.01. Conditions Precedent to Initial Loan on or after the Closing Date................................50 SECTION 4.02. Conditions Precedent to All Loans.....................54 ARTICLE V AFFIRMATIVE COVENANTS................................................56 SECTION 5.01. Corporate and Franchise Existence.....................56 SECTION 5.02. Compliance with Laws, Etc.............................56 SECTION 5.03. Maintenance of Properties.............................56 SECTION 5.04. Insurance.............................................56 SECTION 5.05. Obligations and Taxes.................................62 SECTION 5.06. Financial Statements, Reports, etc....................62 SECTION 5.07. Litigation and Other Notices..........................64 SECTION 5.08. Mortgages; Landlord Consents; Licenses and Other Agreements..................................64 SECTION 5.09. ERISA.................................................65 SECTION 5.10. Access to Premises and Records........................65 SECTION 5.11. Design and Construction...............................66 SECTION 5.12. Environmental Notices.................................66 SECTION 5.13. Amendment of Organizational Documents.................66 SECTION 5.14. Third Party Agreements and Delivery and Acceptance Certificates............................66 SECTION 5.15. Accounts Payable......................................67 SECTION 5.16. Intellectual Property.................................67 SECTION 5.17. Fiscal Year...........................................67 SECTION 5.18. Completed Systems.....................................67 SECTION 5.19. Year 2000 Problems.....................................67 SECTION 5.20. Subsidiary Guarantees and Pledges.....................67 SECTION 5.21. Accounting............................................67 SECTION 5.22. Further Assurances....................................67 ARTICLE VI NEGATIVE COVENANTS...................................................68 SECTION 6.01. Liens, etc............................................68 SECTION 6.02. Use of Proceeds.......................................69 SECTION 6.03. Sale of Assets, Consolidation, Merger, etc............69 SECTION 6.04. Dividends and Distributions; Sale of Equity Interests......................................69 ii SECTION 6.05. Management Fees and Permitted Corporate Overhead......69 SECTION 6.06. Guarantees; Third Party Sales and Leases..............70 SECTION 6.07. Investments...........................................70 SECTION 6.08. Subsidiaries..........................................70 SECTION 6.09. Permitted Activities..................................70 SECTION 6.10. Disposition of Licenses, etc..........................70 SECTION 6.11. Transactions with Affiliates..........................70 SECTION 6.12. ERISA.................................................71 SECTION 6.13. Indebtedness..........................................71 SECTION 6.14. Prepayment and Debt Documents.........................72 SECTION 6.15. Sale and Leaseback Transactions.......................72 SECTION 6.16. Margin Regulation.....................................72 SECTION 6.17. Management and Tax Sharing Agreements.................72 ARTICLE VII FINANCIAL COVENANTS..................................................73 SECTION 7.01. Financial Covenants Prior to Achieving Positive EBITDA.......................................73 SECTION 7.02. Financial Covenants After Achieving Positive EBITDA.......................................74 ARTICLE VIII COLLATERAL SECURITY..................................................75 SECTION 8.01. Collateral Security...................................75 SECTION 8.02. Preservation of Collateral and Perfection of Security Interests Therein.........................76 SECTION 8.03. Appointment of the Collateral Agent as the Borrowers' Attorney-in-Fact...........................76 SECTION 8.04. Collection of Accounts and Restricted Account Arrangements..................................77 SECTION 8.05. Cure Rights...........................................78 ARTICLE IX EVENTS OF DEFAULT; REMEDIES..........................................78 SECTION 9.01. Events of Default.....................................78 SECTION 9.02. Termination of Commitment; Acceleration...............81 SECTION 9.03. Waivers...............................................81 SECTION 9.04. Rights and Remedies Generally.........................81 SECTION 9.05. Entry Upon Premises and Access to Information.........82 SECTION 9.06. Sale or Other Disposition of Collateral by the Agent.................................................82 SECTION 9.07. Governmental Approvals................................82 SECTION 9.08. Appointment of Receiver or Trustee....................83 SECTION 9.09. Right of Setoff.......................................83 ARTICLE X THE AGENT AND THE COLLATERAL AGENT...................................84 SECTION 10.01. Appointment of Agent..................................84 731574 iii SECTION 10.02. Agent's Reliance, Etc................................85 SECTION 10.03. FUNB and Affiliates..................................86 SECTION 10.04. Lender Credit Decision...............................86 SECTION 10.05. Indemnification......................................86 SECTION 10.06. Successor Agent......................................87 SECTION 10.07. Payments; Non-Funding Lenders; Information; Actions in Concert...................................87 SECTION 10.08. Collateral Matters...................................89 SECTION 10.09. Agency for Perfection................................90 SECTION 10.10. Concerning the Collateral and the Related Loan Documents and the Collateral Agent...................90 ARTICLE XI MISCELLANEOUS ......................................................90 SECTION 11.01. Notices; Action on Notices, etc......................90 SECTION 11.02. No Waivers; Amendments...............................91 SECTION 11.03. Governing Law and Jurisdiction.......................92 SECTION 11.04. Expenses.............................................92 SECTION 11.05. Equitable Relief.....................................92 SECTION 11.06. Indemnification; Limitation of Liability.............93 SECTION 11.07. Survival of Representations and Warranties, etc......93 SECTION 11.08. Successors and Assigns; Assignments; Participations..94 SECTION 11.09. Severability.........................................96 SECTION 11.10. Cover Page, Table of Contents and Section Headings...96 SECTION 11.11. Counterparts.........................................96 SECTION 11.12. Application of Payments..............................97 SECTION 11.13. Marshalling; Payments Set Aside......................97 SECTION 11.14. SERVICE OF PROCESS...................................97 SECTION 11.15. WAIVER OF JURY TRIAL, ETC............................97 SECTION 11.16. Confidentiality......................................98 SECTION 11.17. Entire Agreement, etc................................98 SECTION 11.18. No Strict Construction...............................98 iv EXHIBITS EXHIBIT A Milestone Plan EXHIBIT B Form of Collateral Assignment of Leases EXHIBIT C Form of Collateral Assignment of Licenses EXHIBIT D Form of Landlord Waiver EXHIBIT E-1 Form of Revolving Loan Note EXHIBIT E-2 Form of Term Loan Note EXHIBIT F Form of Periodic Reporting Certificate EXHIBIT G Form of Guaranty EXHIBIT H-1 Form of Notice of Borrowing EXHIBIT H-2 Form of Notice of Continuation/Conversion EXHIBIT I Financials EXHIBIT J-1 Form of Secretary's Certificate of Borrower EXHIBIT J-2 Form of Secretary's Certificate of KMC Holdings EXHIBIT K-1 Form of Opinion of Borrowers' Special Counsel EXHIBIT K-2 Form of Opinion of Borrowers' Regulatory Counsel EXHIBIT K-3 Form of Opinion of Borrowers' Local Counsel EXHIBIT L Form of Pledge Agreement EXHIBIT M Form of Loss Payable Endorsement EXHIBIT N Form of Restricted Account Agreement EXHIBIT O Form of Assignment Agreement EXHIBIT P Form of Accession Agreement EXHIBIT Q Form of Contribution Agreement EXHIBIT R Form of Delivery and Acceptance Certificate EXHIBIT S Form of Trademark Security Agreement v SCHEDULES SCHEDULE 1.01(a) Applicable Margin SCHEDULE 3.02 Consents SCHEDULE 3.05 Litigation SCHEDULE 3.09(a) Governmental Authorizations and Approvals SCHEDULE 3.09(b) Material Agreements SCHEDULE 3.09(c) Intellectual Property SCHEDULE 3.10 Environmental Matters SCHEDULE 3.11 Plans SCHEDULE 3.14 Filing Offices SCHEDULE 3.16 Corporate and Fictitious Names SCHEDULE 3.17 Insurance SCHEDULE 3.19 Capitalization and Subsidiaries SCHEDULE 3.20 Real Property, Leased Real Property and Easements SCHEDULE 6.11 Transactions With Affiliates SCHEDULE 8.04 Collection Accounts ANNEXES ANNEX A - Commitment Amounts ANNEX B - Financial Covenant Information ANNEX C - Revolving Loan Commitment Reductions vi LOAN AND SECURITY AGREEMENT ("Agreement") dated as of December 22, 1998 among KMC TELECOM INC., a Delaware corporation ("KMC"), KMC TELECOM II, INC., a Delaware corporation ("KMC II"), KMC TELECOM OF VIRGINIA, INC., a Virginia public service company ("KMC Virginia"), KMC TELECOM LEASING I LLC, a Delaware limited liability company ("Leasing I"), KMC TELECOM LEASING II, LLC, a Delaware limited liability company ("Leasing II"), the Additional Borrowers from time to time parties hereto (KMC, KMC II, KMC Virginia, Leasing I, Leasing II and any Additional Borrowers being collectively referred to hereinafter as the "Borrowers" and sometimes individually as a "Borrower"), the financial institutions signatory hereto from time to time, as "Lenders", FIRST UNION NATIONAL BANK, as administrative agent for the Lenders (in such capacity, the "Agent") and AT&T COMMERCIAL FINANCIAL CORPORATION, as collateral agent for the Lenders (in such capacity, the "Collateral Agent"). WHEREAS, the Borrowers have requested the Lenders to extend credit to the Borrowers; WHEREAS, the Lenders are willing to extend such credit to the Borrowers subject to, and on the terms and conditions of, this Agreement; and WHEREAS, the initial extension of credit hereunder will, inter alia, refinance and refund the loans made to KMC and Leasing I pursuant to that Amended and Restated Loan and Security Agreement dated as of September 22, 1997 among KMC, Leasing I and AT&T Commercial Finance Corporation; Accordingly, in consideration of the mutual promises contained herein, the Borrowers, the Agent, the Collateral Agent and the Lenders agree as follows: ARTICLE I DEFINITIONS SECTION 1.01. Definitions. As used in this Agreement, the following words and terms shall have the meanings specified below: "Access Lines" shall mean the total number of installed business lines that provide service to a business customer of a Borrower including "resale", "on-net" and "unbundled network element"; provided, that resale shall constitute no more than twenty-five percent (25%) of the total Access Lines. "Accounts" shall mean all present and future rights of any Borrower to payment for goods sold or leased or for services rendered which are not evidenced by instruments or chattel paper, and whether or not they have been earned by performance. 1 "Additional Borrower" shall mean any Subsidiary of KMC Holdings, KMC, KMC II, KMC Virginia, Leasing I or Leasing II that enters into an accession agreement substantially in the form of Exhibit P hereto, is acceptable to the Requisite Lenders, and the outstanding Equity Interests of which are pledged to the Agent pursuant to a pledge agreement substantially in the form of Exhibit L attached hereto. "Additional Purchase Agreement" shall mean a purchase agreement between any Borrower and an Additional Vendor relating to the purchase of Telecommunications Equipment on terms and conditions reasonably satisfactory to the Agents, if such purchase agreement contemplates Telecommunications Equipment purchases in excess of $5,000,000 in any one year or $15,000,000 in the aggregate, otherwise on the terms and conditions reasonably satisfactory to the Collateral Agent. "Additional Vendor" shall mean a vendor of Telecommunications Equipment other than Lucent, which Additional Vendor shall be reasonably satisfactory to the Agents if the Additional Purchase Agreement the Additional Vendor is a party to contemplates Telecommunications Equipment purchases in excess of $5,000,000 in any one year or $15,000,000 in the aggregate, otherwise on the terms and conditions reasonably satisfactory to the Collateral Agent. "Affiliate" shall mean any Person other than any Lender directly or indirectly controlling, controlled by or under common control with any Borrower and any officer or shareholder of such Person or any Borrower, which shareholder beneficially owns at least ten percent (10%) of the Equity Interests of such Person or any Borrower. For the purposes of this definition, "control" (including, with correlative meanings, the terms "controlling," "controlled by", and "under common control with"), as used with respect to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of such Person, whether through the ownership of voting securities, by agreement or otherwise; provided, however, that beneficial ownership of at least 10% of the Equity Interests of a Person shall be deemed to constitute control. "Aged Equipment" shall mean Telecommunications Equipment, which has been in commercial operation for more than twelve months. "Agents" shall mean collectively, the Agent, the Collateral Agent, the Documentation Agent and the Syndication Agent. "Applicable Margin" shall mean with respect to (i) each Loan bearing interest based upon the Base Rate, the margin determined in accordance with the criteria set forth on Schedule 1.01(a) hereto, and (ii) each Loan bearing interest based upon the LIBO Rate, the margin determined in accordance with the criteria set forth on Schedule 1.01(a) hereto, which margins shall be calculated based upon the financial statements provided pursuant to Section 5.06, with any readjustments being effective five Business Days following the Agent's receipt thereof. 2 "Assignment Agreement" shall mean an assignment agreement entered into in connection with an assignment pursuant to Section 11.08 hereof substantially in the form of Exhibit O hereof. "Base LIBO Rate" shall mean, during any Interest Period, the rate of interest per annum (rounded upward to the nearest whole multiple of 1/16 of 1.0%, if such rate is not such a multiple) equal to the rate of interest notified to the Agent by the Reference Bank at which Dollar deposits in the approximate amount of the Loans to be made or continued as, or converted into, LIBOR Loans for such Interest Period and having a maturity comparable to such Interest Period would be offered by the London lending office of the Reference Bank in the London interbank market at approximately 11:00 a.m. (London time) two (2) Business Days prior to the commencement of such Interest Period. "Base Rate" shall mean the higher of (i) a rate per annum equal to the corporate base rate, prime rate or base rate of interest, as applicable, announced by the Reference Bank from time to time, changing when and as such rate changes, it being understood that such rate of interest is not necessarily the lowest or best rate charged by the Reference Bank to its customers, and (ii) the sum of the Federal Funds Effective Rate plus one-half percent (0.50%) per annum. "Base Rate Loan" shall mean a Loan, or portion thereof, during any period in which it bears interest at a rate based upon the Base Rate. "Base Rate Revolving Loan" shall mean a Revolving Loan during any period for which it is a Base Rate Loan. "Base Rate Term Loan" shall mean any portion of the Term Loans during any period for which such portion is a Base Rate Loan. "Benefit Plan" shall mean a defined benefit plan as defined in Section 3(35) of ERISA (other than a Multiemployer Plan) in respect of which any Borrower or any ERISA Affiliate is, or within the immediately preceding six (6) years was, an "employer" as defined in Section 3(5) of ERISA. "Borrower" shall mean any of KMC, KMC II, KMC Virginia, Leasing I, Leasing II and any Additional Borrower. "Borrowing Base" shall mean at any time the aggregate cost of Telecommunications Equipment financed under this Agreement, minus any reserves established by the Collateral Agent with respect to Aged Equipment. "Business" shall mean with respect to (i) each of KMC, KMC II and KMC Virginia, the business of constructing, operating and maintaining the Systems owned by them and all operations related thereto or in support thereof, and (ii) each of Leasing I and Leasing II, the business of owning and leasing Switch Equipment. 3 "Business Day" shall mean (a) any day not a Saturday, Sunday or legal holiday in the State of New York or New Jersey, on which banks are open for business in New York and New Jersey and (b) with respect to all notices, determinations, fundings and payments in connection with the LIBO Rate or LIBOR Loans, any day that is a Business Day pursuant to clause (a) above and that is also a day on which trading is carried on by and between banks in the London interbank market. "Capitalization" shall mean funded equity capitalization of KMC Holdings. "Capitalized Lease Obligations" shall mean Debt represented by obligations under a lease that is required to be capitalized for financial reporting purposes in accordance with GAAP, and the amount of such Debt shall be the capitalized amount of such obligations determined in accordance with GAAP. "Change of Control" shall mean (A) Harold N. Kamine ceases to have senior management responsibilities with respect to the Borrowers or KMC Holdings, (B) KMC Holdings no longer beneficially owns all of the outstanding Equity Interests of each Borrower, (C) a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) becomes the ultimate "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) of more than 35% of the total voting power of the Voting Stock of KMC Holdings on a fully diluted basis and such ownership represents a greater percentage of the total voting power of the Voting Stock of KMC Holdings, on a fully diluted basis, than is held by the Existing Stockholders on such date, or (D) individuals who on the Closing Date constitute the Board of Directors (together with any new directors whose election by the Board of Directors or whose nomination by the Board of Directors for election by KMC Holdings' stockholders was approved by a vote of at least a majority of the members of the Board of Directors then in office who either were members of the Board of Directors on the Closing Date or whose election or nomination for election was previously so approved) cease for any reason to constitute a majority of the members of the Board of Directors then in office. "Closing Date" shall mean the date on which this Agreement is executed and delivered by the parties hereto. "Collateral" shall mean, all property and interests in property now owned or hereafter acquired by any Borrower in or upon which a security interest, lien or mortgage is granted to the Collateral Agent by any Borrower, whether under this Agreement or the other Loan Documents. "Collateral Assignment of Leases" shall mean the Collateral Assignment of Leases in the form of Exhibit B attached hereto, to be executed and delivered pursuant to Section 4.01 hereof. 4 "Collateral Assignment of Licenses" shall mean the Collateral Assignment of Licenses in the form of Exhibit C attached hereto, to be executed and delivered pursuant to Section 4.01 hereof. "Collection Accounts" and "Collection Agent" shall have the meanings given to such terms in Section 8.04 hereof. "Commitment" shall mean Lenders' commitment to lend as set forth in Section 2.01 hereof. "Commitment Amount" shall mean (a) as to any Lender, the aggregate of such Lender's Revolving Loan Commitment Amount and Term Loan Commitment Amount as set forth opposite such Lender's name on Annex A to this Agreement or in the most recent Assignment Agreement executed by such Lender and (b) as to all Lenders, the aggregate of all Lenders' Revolving Loan Commitment Amounts and Term Loan Commitment Amounts, which aggregate commitment shall be Two Hundred Fifty Million Dollars ($250,000,000) on the Closing Date, as such amount may be adjusted from time to time in accordance with this Agreement "Common Stock" shall mean with respect to any Person, all Equity Interests of such Person that are generally entitled to (i) vote in the election of directors of such Person or (ii) if such Person is not a corporation, vote or otherwise participate in the selection of the governing body, partners, managers or others that will control the management and policies of such Person. "Completed System" shall mean any System which is fully operational, which if contemplated by the Milestone Plan, shall have a Lucent 5-ESS Switch Equipment or other comparable Switch Equipment deployed, which shall be switching paid traffic on its owned Telecommunications Equipment, and which shall have sales, customer service and billing systems operational to the satisfaction of the Collateral Agent and consistent with the then current operating Systems of any Borrower, with switching capabilities, encompasses at least twenty route miles, and with respect to which all Governmental Approvals have been obtained and connectivity to at least one major interexchange carrier point-of-presence has been achieved. "Consolidated" or "consolidated" refers, with respect to any Person, to the consolidation of the accounts of such Person and its Subsidiaries, if any, in accordance with GAAP; provided, that with respect to KMC Holdings, unless otherwise indicated, its Subsidiaries shall not include any Excluded Subsidiaries. "Consolidated Debt" shall mean, with respect to KMC Holdings on a consolidated basis, at any date, the sum of the following determined on a consolidated basis, without duplication, in accordance with GAAP: (a) all liabilities, obligations and indebtedness for borrowed money, including, but not limited to, obligations evidenced by bonds, debentures, notes or other similar instruments of any Borrower or KMC Holdings, (b) all obligations to pay the deferred purchase price of property or services of any Borrower or KMC Holdings 5 (exclusive of rent for real property under leases that would not be capitalized in accordance with GAAP), including, but not limited to, all obligations under noncompetition agreements, except trade payables arising in the ordinary course of business not more than ninety (90) days past due, (c) all obligations of any Borrower or KMC Holdings as lessee under capital leases (exclusive of the interest component thereof), (d) all Debt of any other Person secured by a Lien on any asset of any such Borrower or KMC Holdings, (e) all guaranty obligations of any Borrower or KMC Holdings, (f) all obligations, contingent or otherwise, of any Borrower or KMC Holdings relative to the face amount of letters of credit, whether or not drawn, and banker's acceptances issued for the account of any Borrower or KMC Holdings, (g) all obligations to redeem, repurchase, exchange, defease or otherwise make payments in respect of capital stock or other securities of any Borrower or KMC Holdings at any time prior to the third annual anniversary of the Term Loan Termination Date, and (h) all termination payments which would be due and payable by any Borrower or KMC Holdings pursuant to any hedging agreement. "Consolidated Debt" shall not include any intercompany Debt between the Borrowers or between any Borrower and KMC Holdings. "Contaminant" shall mean any pollutant, hazardous substance, toxic substance, hazardous waste, special waste, petroleum or petroleum derived substance or waste, or any constituent of any such substance or waste. "Contributed Capital" shall mean, with respect to the Borrowers, at any date of determination, all contributed capital to such Borrowers including all funded equity and all Qualified Intercompany Loans. "Contribution Agreement" shall mean the Contribution Agreement among the Borrowers of even date herewith substantially in the form of Exhibit Q. "Counsel" shall mean Sidley & Austin or such successor counsel selected by the Collateral Agent. "Credit Support" shall have the meaning given to such term in Section 2.10. "Debt" shall mean, with respect to any Person, (i) indebtedness for borrowed money, (ii) obligations evidenced by bonds, debentures, notes or other similar instruments, (iii) obligations which have been incurred in connection with the acquisition of property or services (including, without limitation, obligations to pay the deferred purchase price of property or services), excluding trade payables and accrued expenses incurred in the ordinary course of business, (iv) obligations as lessee under leases which shall have been or should be, in accordance with GAAP, recorded as capital or operating leases, (v) all Guarantees of such Person, including without limitation, all debt of any other Person secured by a Lien on property of such Person, (vi) all reimbursement obligations, contingent or otherwise, with respect to letters of credit or banker's acceptances issued for the account of any Borrower, and (vii) all indebtedness, obligations or other liabilities in respect of any Interest Rate Agreement, provided that Debt shall not include any liability for Federal, state, local or other taxes, and provided, further, that the amount outstanding at any time of any Debt issued with original issue discount is the principal amount of such Debt less the remaining unamortized portion of the original issue discount of such Debt at such time as determined in conformity with GAAP, and that with respect to any high-yield Debt, the amount thereof shall not include fees incurred in raising such Debt or overfunded amounts set aside solely to pay interest.. Notwithstanding any other provision of the foregoing definition, any trade payable arising from the purchase of goods or materials or for services obtained in the ordinary course of business shall not be deemed to be "Debt" of any Borrower for purposes of this definition. Furthermore, guarantees of (or obligations with respect to letters of credit supporting) Debt otherwise included in the determination of such amount shall not be included. 6 "Default" shall mean any event which but for the passage of time or giving of notice would constitute an Event of Default. "Documentation Agent" shall mean General Electric Capital Corporation. "Dollars" or "$" shall mean lawful money of the United States of America. "Easements" shall have the meaning given to such term in Section 3.20 hereof. "EBITDA" shall mean, with respect to any Person, for any period, an amount equal to (i) Net Income plus (ii) the sum of the following, to the extent deducted in determining Net Income: (A) income and franchise taxes, (B) interest expense, (C) amortization, depreciation and other non-cash charges, minus (iii) the sum of interest income plus extraordinary gains, as determined in accordance with GAAP as calculated at the end of such period. "Environmental Laws" shall mean all federal, state and local laws, rules, regulations, ordinances, programs, permits, guidance, orders and consent decrees or other binding determination of any Governmental Authority relating to protection of the environment, the handling, disposal or Release of Contaminants and occupational safety and health. Such laws and regulations include but are not limited to the Resource Conservation and Recovery Act, 33 U.S.C. ss. 6901 et seq., as amended; the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. ss. 9601 et seq., as amended; the Toxic Substances Control Act, 15 U.S.C. ss. 2601 et seq., as amended; the Clean Water Act, 33 U.S.C. ss. 1251 et seq., as amended; the Clean Air Act, 42 U.S.C. ss. 7401 et seq., as amended; state and federal environmental lien and environmental cleanup programs; the Occupational Safety and Health Act, 29 U.S.C. ss. 651 et seq.; and U.S. Department of Transportation regulations related to the transportation of hazardous materials, each as from time to time hereafter in effect. "Equity Affiliate" shall mean, as applied to any Person, any other Person directly or indirectly controlling, controlled by, or under direct or indirect common control with, such Person. For purposes of this definition, "control" (including, with correlative meanings, the terms "controlling", "controlled by" and "under common control with"), as applied to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. "Equity Interest" shall mean, with respect to any Person, any and all shares or other equivalents (however designated) of capital stock, membership units, partnership interests or any other participation right or other interest in the nature of an equity interest in such Person or any option, warrant or other security convertible into any of the foregoing. 7 "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" shall mean (i) any corporation which is a member of the same controlled group of corporations (within the meaning of Section 414(b) of the IRC) as any Borrower, (ii) any partnership or other trade or business (whether or not incorporated) under common control (within the meaning of Section 414(c) of the IRC) with any Borrower and (iii) any member of the same affiliated service group (within the meaning of Section 414(m) of the IRC) as any Borrower, any corporation described in clause (i) above or any partnership or trade or business described in clause (ii) above. "Eurocurrency Liabilities" shall have the meaning assigned to that term in Regulation D of the Federal Reserve Board, as in effect from time to time. "Event of Default" shall have the meaning given to such term in Article IX hereof. "Event of Loss" shall mean, with respect to any item of Collateral, the actual or constructive loss of such item of Collateral or the use thereof, due to theft, destruction, damage beyond repair or damage from any reason whatsoever which is not reimbursable by insurance, to an extent which makes repair uneconomical, or rendition thereof unfit for normal use, or the condemnation, confiscation or seizure of, or requisition of title to or use of, such item of Collateral by any Governmental Authority or any other Person, acting under or deemed to be acting under color of any Governmental Authority. "Excess Operating Cash Flow" shall mean for any fiscal quarter, Net Income of the Borrowers plus non-cash interest expense, depreciation and amortization and any other non-cash items of the Borrowers, minus scheduled principal payments of the Borrowers to Lenders, lease payments and capital expenditures of the Borrowers, plus or minus changes in working capital of the Borrowers, as appropriate. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended from time to time. "Excluded Letters of Credit" shall have the meaning ascribed to such term in Section 6.13(viii). "Excluded Subsidiary" shall mean (a) any Subsidiary of KMC Holdings which is neither a Borrower under this Agreement nor a Person which directly or indirectly beneficially owns Equity Interests in any Borrower, provided that (i) at the time such other Subsidiary was created or acquired, no Default or Event of Default shall have occurred and be continuing before or after giving effect to the creation or acquisition of such Subsidiary, and (ii) no portion of the Required Contributions or the Revolving Loan Commitment Amount shall have been or shall be used to fund the acquisition or operations of such Subsidiary, and the Guarantor has external sources of funding (other than the Required Contributions and the Revolving Loan Commitment Amount) to finance the acquisition and operations of such Subsidiary, (b) KMC International, and KMC Telecom III, Inc., a Delaware corporation or (c) any other Subsidiary of the 8 Guarantor which the Guarantor or any Borrower requests the Lenders to designate as such, and which designation is agreed to by the Required Lenders. "Existing Stockholders" shall mean Harold N. Kamine, his Equity Affiliates, Nassau Capital Partners L.P., NAS Partners I L.L.C. or their respective successors, and their Equity Affiliates. "FCC" shall mean the Federal Communications Commission or any successor commission or agency of the United States of America having jurisdiction over any Borrower or any System. "Federal Funds Effective Rate" shall mean, for any period, a fluctuating interest rate per annum equal for each day during such period to (a) the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, as published for such day (or if such day is not a Business Day, for the preceding Business Day) by the Federal Reserve Bank of New York in the Composite Closing Quotations for U.S. Government Securities; or (b) if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 10:30 a.m. (New York time) for such day on such transactions received by the Reference Bank from three federal funds brokers of recognized standing selected by it. "Federal Reserve Board" shall mean the Board of Governors of the Federal Reserve System or any successor thereto. "Fee Letters" shall mean (i) that certain letter agreement dated September 25, 1998 among the Borrowers, KMC Holdings, the Collateral Agent, Capital Syndications Corporation ("CSC"), General Electric Capital Corporation ("GECC"), GECC Capital Market Groups, Inc. ("GECG"), the Agent, First Union Capital Markets, a Division of Wheat First Securities, Inc. ("FUCM") and Canadian Imperial Bank of Commerce ("CIBC"), (ii) that certain letter agreement dated September 25, 1998 among the Borrowers, KMC Holdings, the Collateral Agent, CSC, GECC, GECG, the Agent and FUCM, and (iii) that certain letter agreement dated December 22, 1998 among the Borrowers, KMC Holdings, the Collateral Agent, CSC, GECC, GECG, the Agent, FUCM and CIBC. "Financials" shall have the meaning given to such term in Section 3.03. "First Eight Cities" shall mean the following eight cities where Systems have been or will be constructed in accordance with the Milestone Plan: Huntsville, Alabama; Melbourne, Florida (including the actual switch site located in Palm Bay, Florida); Augusta, Georgia; Savannah, Georgia; Baton Rouge, Louisiana; Shreveport, Louisiana; Corpus Christi, Texas; and Madison, Wisconsin. 9 "Fixed Charges" shall mean with respect to any period for the Borrowers on a combined basis, the sum of the following amounts calculated at the end of such period with respect to such period without duplication and in accordance with GAAP: (i) the product of two multiplied by scheduled principal and interest payments with respect to Debt for the six month period then ending, (ii) capital expenditures for the four quarter period then ending, (iii) the product of two multiplied by income tax payments for the six month period then ending, and (iv) the product of two multiplied by cash dividend payments for the six month period then ending. "Fixed Charge Coverage Ratio" shall have the meaning assigned to such term in Section 7.02(c). "FUNB" shall mean First Union National Bank, a national banking association. "Governmental Approval" shall mean, with respect to any Borrower, any license, permit, franchise or certificate of public convenience and necessity issued to any Borrower by the FCC, any PUC or any other Governmental Authority in connection with any System. "Governmental Authority" shall mean any federal, state, local or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Guarantee" shall mean any obligation, contingent or otherwise, of any Person guaranteeing any indebtedness of any other Person (the "Primary Obligor") in any manner, whether directly or indirectly, and including any obligation of such Person, direct or indirect, (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such indebtedness or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such indebtedness; (ii) to purchase property, securities or services for the purpose of assuring the owner of such indebtedness of the payment of such indebtedness; or (iii) to maintain working capital, equity capital or other financial statement condition of the Primary Obligor so as to enable the Primary Obligor to pay such indebtedness. "Indenture" shall mean that certain Indenture dated as of January 29, 1998 between KMC Holdings, as Issuer and The Chase Manhattan Bank, as Trustee, relating to KMC Holdings' 12 1/2 percent Senior Discount Notes due 2008. "Initial Funding Date" shall mean the date upon which, subject to the satisfaction of all conditions precedent contained in Sections 4.01 and 4.02, or the waiver thereof by the Agent and the Requisite Lenders, the initial Loans are made on or after the Closing Date. "Intellectual Property Documents" shall mean (i) the Trademark Security Agreement of even date herewith, in the form of Exhibit S attached hereto, executed by the Borrowers in favor of the Collateral Agent for the benefit of the Agents and the Lenders, as amended, restated or otherwise modified from time to time and (ii) any other trademark, patent or copyright security agreement executed pursuant to Section 5.16 by any Borrower. 10 "Interest Expense" shall mean for any period, the total interest expense (including, without limitation, interest expense attributable to capital leases) determined on a combined basis, without duplication, for the Borrowers in accordance with GAAP. "Interest Period" shall mean, with respect to each LIBOR Loan, the interest period applicable to such LIBOR Loan as set forth in the applicable Notice of Borrowing or Notice of Conversion or Continuation. "Interest Rate Agreement" shall mean for any Person, any interest rate swap agreement, interest rate cap agreement, interest rate collar agreement or other similar agreement designed to protect the party indicated therein against fluctuations in interest rates. "Investment" shall mean, as applied to any Person, any direct or indirect purchase or other acquisition by that Person of securities, or of a beneficial interest in securities, of any other Person, and any direct or indirect loan, advance (other than deposits with financial institutions available for withdrawal on demand, prepaid expenses, advances to employees, officers and directors and similar items, each made or incurred in the ordinary course of business), or capital contribution by that Person to any other Person, including all Debt of such other Person to that Person, but excluding accounts owed by that other Person in the ordinary course of business. Investments shall exclude (i) extensions of trade credit on commercially reasonable terms in accordance with normal trade practices and (ii) the repurchase of securities of any Person by such Person. The amount of any Investment shall be determined in conformity with GAAP. "IRC" shall mean the Internal Revenue Code of 1986, as amended from time to time, and the rules and regulations promulgated thereunder, and any successor statutes or rules and regulations. "IRS" shall mean the Internal Revenue Service or any successor agency. "KMC Holdings" shall mean KMC Telecom Holdings, Inc., a Delaware corporation. "KMC Holdings Guaranty" shall mean that certain unlimited guaranty of KMC Holdings in the form of Exhibit G hereto. "KMC International" shall mean KMC Telecom International, Inc., a corporation to be formed under the laws of Delaware. "Lending Office" shall mean, with respect to a Lender or Agent, any office, branch, subsidiary or affiliate of such Lender or the Agent. 11 "Letter of Credit" shall mean a letter of credit issued or caused to be issued for the account of a Borrower or with respect to which Credit Support is provided, in any case pursuant to Section 2.10. "Letter of Credit Obligations" shall mean without duplication, the sum of the aggregate maximum undrawn face amount of all outstanding Letters of Credit and unpaid reimbursement obligations with respect to all Letters of Credit. "LIBO Rate" shall mean, for any Interest Period with respect to LIBOR Loans comprising part of the same borrowing, the rate of interest per annum equal to the per annum rate of interest displayed on the Dow Jones Market Screen Page 3750, as being the one-month, two-month, three-month or six-month, as applicable, reserve adjusted "London Interbank Offered Rate", provided, however, that if such rate is not displayed or published, then the rate of interest per annum (rounded upward to the nearest whole multiple of 1/16 of 1.0%, if such rate is not such a multiple) determined by the Agent as follows: LIBO Rate = Base LIBO Rate ------------------------------- 1.00 - LIBOR Reserve Percentage "LIBOR Interest Payment Date" shall mean, with respect to a LIBOR Loan, the last day of each Interest Period applicable to such Loan, and, if such Interest Period has a duration of more than three months, on each day which occurs during such Interest Period every three months from the first day of such Interest Period. "LIBOR Interest Rate Determination Date" shall mean each date of calculating the LIBO Rate for purposes of determining the interest rate with respect to an Interest Period. The LIBOR Interest Rate Determination Date for any LIBOR Loan shall be the second Business Day prior to the first day of the related Interest Period for such LIBOR Loan. "LIBOR Loan" shall mean a Loan, or portion thereof, during any period in which it bears interest at a rate based upon the LIBO Rate. "LIBOR Reserve Percentage" shall mean for any day for any Interest Period the maximum reserve percentage (expressed as a decimal, rounded upward to the next 1/100th of 1.0%) in effect on such day (whether or not applicable to any Lender) for United States domestic banks under regulations issued from time to time by the Federal Reserve Board for determining the maximum reserve requirement (including any emergency, supplemental or other marginal reserve requirement) with respect to Eurocurrency Liabilities having a term comparable to such Interest Period. "LIBOR Revolving Loan" shall mean a Revolving Loan during any period for which it is a LIBOR Loan. "LIBOR Term Loan" shall mean any portion of the Term Loans during any period for which such portion is a LIBOR Loan. 12 "Lien" shall mean any mortgage, pledge, deed of trust, assignment, lien, charge, encumbrance or security interest of any kind, or the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement, but excluding easements, rights of way or similar encumbrances on real property which are in the ordinary course and which do not materially affect the value, use and insurability of title of such real property. "Loan" shall mean a Revolving Loan or a Term Loan. "Loan Documents" shall mean all agreements, instruments and documents, including, without limitation, security agreements, loan agreements, notes, guarantees, mortgages, deeds of trust, subordination agreements, pledges, powers of attorney, consents, assignments, contracts, notices, leases, financing statements, Interest Rate Agreements between any Borrower and the Agent, the Collateral Agent, or the Lenders and all other written matter whether heretofore, now, or hereafter executed by or on behalf of any Borrower or any other Person in connection with the transactions contemplated hereby and delivered to the Agent, the Collateral Agent or the Lenders, together with all agreements and documents referred to therein or contemplated thereby; provided, however, that the documents executed in connection with the purchase by Newcourt Communications Finance Corporation (formerly known as AT&T Credit Corporation) or any Lender of Equity Interests in KMC or KMC Holdings shall not constitute Loan Documents. "Lucent" shall mean Lucent Technologies Inc. "Lucent Purchase Agreement" shall mean an agreement between any Borrower and Lucent for the purchase of Telecommunications Equipment, on terms and conditions satisfactory to the Agents. "Management Agreement" shall mean that certain Management Agreement dated as of December 18, 1998 among KMC Holdings, the Borrowers, KMC International and KMC Telecom III, Inc. "Material Adverse Effect" shall mean, with respect to any Person, a material adverse effect upon the condition (financial or otherwise), operations or properties of such Person, or upon the ability of such Person to perform under the Loan Documents. "Maximum Rate" shall have the meaning given to such term in Section 2.13 hereof. "Milestone Plan" shall mean the Milestone Plan of the Borrowers attached as Exhibit A hereto, as such Milestone Plan may be amended from time to time with the prior written consent of the Requisite Lenders. "Mortgages" shall mean mortgages or deeds of trust in favor of the Collateral Agent, with respect to any Borrower's (i) owned Real Property and (ii) other interests in those items of real property and Easements, as specified by the Collateral Agent, which mortgages and deeds of trust shall be in form and substance satisfactory to the Collateral Agent. 13 "Multiemployer Plan" shall mean a "multiemployer plan" as defined in Section 4001(a)(3) of ERISA which is, or within the immediately preceding six (6) years was, contributed to by any Borrower or an ERISA Affiliate. "Net Income" shall mean, with respect to any Person for any period, the net income (loss) of such Person determined in accordance with GAAP. "Note" shall mean any Revolving Loan Note or any Term Loan Note. "Notice of Borrowing" shall mean a notice substantially in the form of Exhibit H-1 attached hereto. "Notice of Conversion/Continuation" shall have the meaning given to such term in Section 2.06(b). "Obligations" shall mean all the obligations of any Borrower now or hereafter existing under this Agreement or any other Loan Document to which any Borrower is a party, whether for principal, interest, fees, expenses, reimbursement, indemnification or otherwise. Obligations shall include, without limitation, all interest, charges, expenses, fees, attorneys' fees and disbursements, and paralegals' fees which accrue after the commencement of any case or proceeding in bankruptcy after the insolvency of, or for the reorganization of any Borrower, whether or not allowed in such proceeding, and Obligations shall not include any reimbursement obligations with respect to Excluded Letters of Credit. "Payment Account" shall mean the Agent's account at First Union National Bank, ABA No. 053000219, Account # 5000000016905, KMC reference: Payment Account. "Payment Date" shall mean the first day of January, April, July and October in each calendar year, but if any such date is not a Business Day, the next succeeding Business Day, commencing January 4, 1999. "PBGC" shall mean the Pension Benefit Guaranty Corporation referred to and defined in ERISA. "Periodic Reporting Certificate" shall mean a periodic reporting certificate in the form of Exhibit F attached hereto. "Permitted Liens" shall have the meaning set forth in Section 6.01 hereof. "Person" shall mean any natural person, corporation, division of a corporation, business trust, joint venture, association, company, partnership, unincorporated organization or other legal entity, or a government or any agency or political subdivision thereof. 14 "Plan" shall mean any employee benefit plan as defined in Section 3(3) of ERISA (other than a Multiemployer Plan) in respect of which any Borrower or any ERISA Affiliate is, or within the immediately preceding six (6) years was, an "employer" as defined in Section 3(5) of ERISA. "Pledge Agreement" shall mean a pledge agreement substantially in the form of Exhibit L attached hereto. "Prepayment Premium" shall mean (A) for the Revolving Loans, (i) with respect to the period commencing on the Closing Date and ending on the first annual anniversary thereof, two and one-half percent (2.5%) of the amount prepaid, (ii) with respect to the period commencing thereafter and ending on the second annual anniversary of the Closing Date, one and one-half percent (1.5%) of the amount prepaid, (iii) with respect to the period commencing thereafter and ending on the third anniversary of the Closing Date, one-half percent (0.5%) of the amount prepaid, and (iv) at all times thereafter, $0, and (B) for the Term Loans, (i) with respect to the period commencing on the Closing Date and ending on the first annual anniversary thereof, three percent (3.0%) of the amount prepaid, (ii) with respect to the period commencing thereafter and ending on the second annual anniversary of the Closing Date, two percent (2.0%) of the amount prepaid, (iii) with respect to the period commencing thereafter and ending on the third annual anniversary of the Closing Date, one percent (1.0%) of the amount prepaid, and (iv) at all times thereafter, $0. "Principal Payments" shall mean, for any period, total required Debt amortization (including, without limitation, the principal payments attributable to capital leases) determined on a combined basis, without duplication, for the Borrowers in accordance with GAAP. "Pro Rata Share" shall mean with respect to all matters relating to any Lender (a) with respect to the Revolving Loans and the Letters of Credit, the percentage obtained by dividing (1) at any time prior to the Revolving Credit Commitment Termination Date, the Revolving Loan Commitment Amount of such Lender by the aggregate Revolving Loan Commitment Amount of all Lenders, and (2) at any time after the Revolving Credit Commitment Termination Date, the aggregate outstanding principal balance of the sum of the Revolving Loans held by that Lender plus the Letters of Credit Obligations incurred by such Lender by the sum of the aggregate outstanding principal balance of the Revolving Loans held by all Lenders plus the aggregate Letter of Credit Obligations incurred by all the Lenders, and (b) with respect to the Term Loans, the percentage obtained by dividing (1) at any time prior to the date on which the Term Loans are funded, the Term Loan Commitment Amount of that Lender by the Term Loan Commitment Amount of all Lenders, and (2) on and after the date on which the Term Loans are funded, the aggregate outstanding principal balance of the Term Loans held by that Lender, by the aggregate outstanding principal balance of the Term Loans held by all Lenders. "PUC" shall mean any state Governmental Authority having utility or telecommunications regulatory authority over any Borrower or any System. "Purchase Debt" shall have the meaning given to such term in Section 6.13(iv). 15 "Qualified Intercompany Loan" shall mean a loan to a Borrower from KMC Holdings, which loan is expressly subordinated to the Obligations on terms and conditions satisfactory to the Agents, has a maturity date occurring on or after the third annual anniversary of the Term Loan Termination Date, and requires no cash payment of principal or interest prior to the scheduled maturity date of such loan. "Real Property" shall have the meaning given to such term in Section 3.20 hereof. "Reference Bank" shall mean First Union National Bank. "Register" shall have the meaning given to such term in Section 11.08(c)(iii). "Release" shall mean any release, spill, emission, leaking, pumping, injection, deposit, disposal, discharge, dispersal, leaching or migration into the environment or into or out of any property, including the movement of Contaminants through or in the air, soil, surface water, groundwater or property. "Remedial Action" shall mean actions required to (1) clean up, remove, treat or in any other way address Contaminants in the environment; (2) prevent the Release or threat of Release or prevent or minimize the further Release of Contaminants so they do not migrate or endanger or threaten to endanger public health or welfare or the environment; or (3) perform preremedial studies and investigations and postremedial monitoring and care. "Reportable Event" shall mean any reportable event as defined in Section 4043 of ERISA unless the reporting requirement with respect to such reportable event has been waived by the PBGC or other appropriate Governmental Authority. "Required Contribution" shall have the meaning assigned to such term in the KMC Holdings Guaranty. "Requisite Lenders" shall mean (a) prior to the date on which the Term Loans are made, Lenders having at least sixty-six and two-thirds percent (66 2/3%) of the aggregate Commitment Amount of all Lenders, (b) on and after the date on which the Term Loans are made and prior to the date on which all Lenders' Commitment to make Revolving Loans has been terminated, Lenders holding at least sixty-six and two-thirds percent (66 2/3%) of the sum of (i) the aggregate outstanding amount of the Term Loans and (ii) the Revolving Loan Commitment Amount of all the Lenders, or (c) on and after the date on which all Lenders' Commitment to make Revolving Loans has been terminated, at least sixty-six and two-thirds percent (66 2/3%) of the aggregate outstanding amount of the sum of all Loans plus Letter of Credit Obligations incurred by all the Lenders. "Requisite Revolving Lenders" shall mean (a) Lenders having at least sixty-six and two-thirds percent (66 2/3%) of the aggregate Revolving Loan Commitment Amount of all Lenders, or (b) if the Revolving Loan Commitment has been terminated, at least sixty-six and two-thirds percent (66 2/3%) of the aggregate outstanding amount of the sum of all Revolving Loans plus Letter of Credit Obligations incurred by all the Lenders. 16 "Revolving Credit Commitment Termination Date" shall mean the eighth annual anniversary of the Closing Date. "Revolving Lenders" shall mean, as of any date of determination on or prior to the Revolving Credit Commitment Termination Date, Lenders having a Revolving Loan Commitment Amount, and thereafter Lenders having outstanding Revolving Loans or Letter of Credit Obligations. "Revolving Loan" shall mean any loan made to the Borrower pursuant to the provisions of Section 2.01(b) below. "Revolving Loan Commitment Amount" shall mean (a) as to any Revolving Lender, the aggregate commitment of such Revolving Lender to make Revolving Loans and/or incur Letter of Credit Obligations as set forth opposite such Revolving Lender's name on Annex A to this Agreement or in the most recent Assignment Agreement executed by such Revolving Lender and (b) as to all Revolving Lenders, the aggregate commitment of all Revolving Lenders to make Revolving Loans and/or incur Letter of Credit Obligations, which aggregate commitment shall be One Hundred Seventy-Five Million Dollars ($175,000,000) on the Closing Date, as such amount may be adjusted from time to time in accordance with this Agreement. "Revolving Loan Note" shall mean a promissory note of the Borrower substantially in the form of Exhibit E-1 attached hereto. "Solvent" shall mean, at any time of determination, with respect to any Person: (i) the assets of such Person, at a fair valuation, are in excess of the total amount of its debts (including, without limitation, contingent liabilities); and (ii) the present fair saleable value of its assets is greater than its probable liability on its existing debts as such debts become absolute and matured; and (iii) it is then able and expects to be able to pay its debts (including, without limitation, contingent debts and other commitments) as they mature; and (iv) it has capital sufficient to carry on its business as conducted. For purposes of determining whether a Person is Solvent, the amount of any contingent liability shall be computed as the amount that, in light of all the facts and circumstances existing at such time, represents the amount that can reasonably be expected to become an actual or mature liability. 17 "Subsidiary" shall mean, with respect to any Person, any corporation, partnership, joint venture, association or other business entity, whether now existing or hereafter organized or acquired, (i) in the case of a corporation, of which more than 50% of the total voting power of the Equity Interests entitled (without regard to the occurrence of any contingency) to vote in the election of directors, officers or trustees thereof is held by such Person or any of its Subsidiaries; or (ii) in the case of a partnership, joint venture, association or other business entity, with respect to which such Person or any of its Subsidiaries has the power to direct or cause the direction of the management and policies of such entity by contract or otherwise or if in accordance with GAAP such entity is consolidated with the such Person for financial statement purposes. "Supporting Letter of Credit" shall have the meaning given to such in Section 2.10(j). "Switch Equipment" shall mean telecommunications switches and associated electronics. "Syndication Agent" shall mean Canadian Imperial Bank of Commerce. "System" shall mean each telephone, telecommunications or information system (including, without limitation, any voice, video transmission, data or Internet services) and any related, ancillary or complementary services, as described in the Milestone Plan, and all replacements, enhancements or additions thereto. "Tax Sharing Agreement" shall mean that certain Tax Allocation Agreement dated as of December 18, 1998 among KMC Holdings, the Borrowers, KMC International and KMC Telecom III, Inc. "Taxes" shall mean any and all license, documentation, recording and registration fees, and all taxes, including, without limitation, income (other than net income taxes, franchise taxes and capital taxes imposed on the Lenders, the Agent or the Collateral Agent other than by withholding), gross receipts, sales, value-added, use, excise, personal property (tangible and intangible), real estate and stamp, documentary, transfer or recording taxes, levies, imposts, deductions, duties, assessments, fees, charges, and withholdings of any nature whatsoever, whether or not presently in existence, together with any penalties, fines, additions to tax, or interest thereon, imposed by any taxing authority or other Governmental Authority. "Telecommunications Equipment" shall mean fiber optic cable, Lucent 5-ESS Switch Equipment or other comparable Switch Equipment, transmission equipment and other ancillary equipment necessary for the installation and operation of a switch room or central office and co-location with other telecommunications providers that will enable a Borrower to offer telephony services, as well as all software and hardware associated with the network operating center and back office systems (including operations support systems, billing systems and data services), together with all related support, construction and installation costs associated with an operational system, provided that such costs are capitalized in accordance with GAAP. 18 "Temporary Cash Investments" shall mean (i) Investments in marketable, direct obligations issued or guaranteed by the United States of America, or of any governmental agency or political subdivision thereof, maturing within 365 days of the date of purchase; (ii) Investments in certificates of deposit issued by a bank organized under the laws of the United States of America or any state thereof or the District of Columbia, in each case having capital, surplus and undivided profits totaling more than $500,000,000 and rated at least A by Standard & Poor's Ratings Service and A-2 by Moody's Investors Service, Inc. maturing within 365 days of purchase; or (iii) Investments not exceeding 365 days in duration in money market funds that invest substantially all of such funds' assets in the Investments described in the preceding clauses (i) and (ii). "Term Lenders" shall mean those Lenders having Term Loan Commitment Amounts or who have made Term Loans. "Term Loan" shall mean any loan made to the Borrower pursuant to Section 2.01(a) below. "Term Loan Commitment Amount" shall mean (a) as to any Lender, the commitment of such Lender to make a Term Loan as set forth opposite such Lender's name on Annex A to this Agreement and (b) as to all Lenders, the aggregate commitment of all Lenders to make Term Loans, which aggregate commitment shall be Seventy-Five Million Dollars ($75,000,000) on the Closing Date. "Term Loan Funding Date", shall mean the date upon which, subject to the satisfaction of all conditions precedent contained in Section 4.02, the Term Loans are made, which date shall be the earlier of (i) January 30, 1999 and (ii) the date on which the general syndication of the Loans is completed. "Term Loan Note" shall mean a promissory note of a Borrower substantially in the form of Exhibit E-2 attached hereto. "Term Loan Termination Date" shall mean July 1, 2007. "Termination Event" shall mean (i) a Reportable Event with respect to a Benefit Plan; (ii) the withdrawal of any Borrower or any ERISA Affiliate from a Benefit Plan during a plan year in which any Borrower or such ERISA Affiliate was a "substantial employer" as defined in Section 4001(a)(2) of ERISA; (iii) the imposition of an obligation on any Borrower or any ERISA Affiliate under Section 4041 of ERISA to provide affected parties written notice of intent to terminate a Benefit Plan in a distress termination described in Section 4041(c) of ERISA; (iv) the institution by the PBGC of proceedings to terminate a Benefit Plan; (v) any event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Benefit Plan; or (vi) the partial or complete withdrawal of any Borrower or any ERISA Affiliate from a Multiemployer Plan. 19 "Third Party Interactives" shall mean all Persons with whom any Borrower exchanges data electronically in the ordinary course of business, including without limitation, customers, suppliers, third-party vendors, subcontractors, processors-converters, shippers and warehousemen. "Total Debt" shall mean, with respect to the Borrowers, at any date, the sum of the following determined on a combined basis, without duplication: (a) all liabilities, obligations and indebtedness for borrowed money, including, but not limited to, obligations evidenced by bonds, debentures, notes or other similar instruments, (b) all obligations to pay the deferred purchase price of property or services (exclusive of any rent for real property pursuant to a lease that would not be capitalized in accordance with GAAP), including, but not limited to, all obligations under non-competition agreements, except trade payables arising in the ordinary course of business not more than ninety (90) days past due, (c) all obligations as lessee under capital leases (exclusive of the interest component thereof), (d) all Debt of any other Person secured by a Lien on any asset of any Borrower, (e) all guaranty obligations, (f) all obligations, contingent or otherwise, relative to the face amount of letters of credit, whether or not drawn and banker's acceptances issued for the account of any Borrower, (g) all obligations to redeem, repurchase, exchange, defease or otherwise make payments in respect of capital stock or other securities at any time prior to the third annual anniversary of the Term Loan Termination Date, and (h) all termination payments which would be due and payable by any Borrower thereof pursuant to any Interest Rate Agreement or hedging agreement. "Total Debt" shall not include any intercompany Debt between the Borrowers or between any Borrower and KMC Holdings. "Total Leverage Ratio" shall mean the ratio of (i) Total Debt as of the last day of any fiscal quarter, to (ii) the product of (A) two multiplied by (B) EBITDA of the Borrowers on a combined basis, for the most recently ended six month period. "Trigger Date" shall mean the date on which KMC, KMC II and KMC Virginia shall have sixteen Completed Systems. "Unused Letter of Credit Subfacility" shall mean an amount equal to the lesser of (i) $5,000,000 minus the Letter of Credit Obligations, and (ii) the undrawn portion of the Revolving Loan Commitment Amount of all Lenders. "Voting Stock" shall mean securities of any class or classes of a corporation, the holders of which are ordinarily, in the absence of contingencies, entitled to elect a majority of the corporate directors (or Persons performing similar functions). "Year 2000 Corrective Actions" shall mean, as to each Borrower, all actions necessary to eliminate such Person's Year 2000 Problems, including, without limitation, computer code enhancements and revisions, upgrades and replacements of Year 2000 Date-Sensitive Systems/Components, and coordination of such enhancements, revisions, upgrades and replacements with Third Party Interactives. 20 "Year 2000 Corrective Plan" shall mean, with respect to each Borrower, a comprehensive plan to eliminate all of its Year 2000 Problems on or before September 30, 1999, including without limitations (i) computer code enhancements or revisions, (ii) upgrades or replacements of Year 2000 Date-Sensitive Systems/Components, (iii) test and validation procedures, (iv) an implementation time line and budget and (v) designation of specific employees who will be responsible for planning, coordinating and implementing each phase or subpart of the Year 2000 Corrective Plan. "Year 2000 Date-Sensitive System/Component" shall mean, as to any Person, any system software, network software, applications software, database, computer file, embedded microchip, firmware or hardware that accepts, creates, manipulates, sorts, sequences, calculates, compares or outputs calendar-related data accurately; such systems and components shall include, without limitation, mainframe computers, file server/client system, computer workstations, routers, hubs, other network-related hardware, and other computer-related software, firmware or hardware and information processing and delivery systems of any kind and telecommunications systems and other communications processors, security systems, alarms, elevators and HVAC systems. "Year 2000 Implementation Testing" shall mean, as to each Borrower, (i) the performance of test and validation procedures regarding Year 2000 Corrective Actions on a unit basis and a system wide basis, (ii) the performance of test and validation procedures regarding data exchanges among the Borrowers' Year 2000 Date-Sensitive Systems/Components and data exchanges with Third Party Interactives, and (iii) the design and implementation of additional Corrective Actions, the need for which has been demonstrated by test and validation procedures. "Year 2000 Problems" shall mean, with respect to each Borrower, limitations on the capacity or readiness of any such Borrower's Year 2000 Date-Sensitive Systems/Components to accurately accept, create, manipulate, sort, sequence, calculate, compare or output calendar date information with respect to calendar year 1999 or any subsequent calendar year beginning on or after January 1, 2000 (including leap year computations), including, without limitation, exchanges of information among Year 2000 Date-Sensitive Systems/Components of the Borrowers and exchanges of information among the Borrowers and Year 2000 Date-Sensitive Systems/Components of Third Party Interactives and functionality of peripheral interfaces, firmware and embedded microchips. SECTION 1.02. Accounting Terms. Except as otherwise herein specifically provided, each accounting term used herein shall have the meaning given to it under generally accepted accounting principles ("GAAP") applied on a consistent basis. SECTION 1.03. Others Defined in New York Uniform Commercial Code. All other terms contained in this Agreement (and which are not otherwise specifically defined herein) shall have the meanings provided by the Uniform Commercial Code of the State of New York (the "Code") to the extent the same are used or defined therein. 21 ARTICLE II LOANS AND LETTERS OF CREDIT SECTION 2.01. Agreement to Lend. (a) Each Term Lender severally agrees, on the terms and conditions hereinafter set forth, to make on the Term Loan Funding Date a Term Loan in the amount of such Lender's Term Loan Commitment Amount. (b) Each Revolving Lender severally agrees, on the terms and conditions hereinafter set forth, to make on and after the Initial Funding Date and until but not including the Revolving Credit Commitment Termination Date, one or more Revolving Loans to the Borrowers in an amount not to exceed the Revolving Loan Commitment Amount of such Revolving Lender less such Lender's Pro Rata Share of the Letter of Credit Obligations. (c) At any time that the Total Leverage Ratio is greater than 6:1 as determined by reference to the financial statements delivered pursuant to Section 5.06, the maximum amount of Revolving Loans that may be borrowed from all Revolving Lenders shall not exceed the Borrowing Base and transaction costs incurred in connection with the execution and delivery of the Loan Documents, minus, if the Term Loans have not yet been made, the Term Loan Commitment Amounts of all Term Lenders, and otherwise, the outstanding principal balance of the Term Loans. (d) Term Loans which are repaid or prepaid may not be reborrowed. Revolving Loans which are repaid or prepaid may be reborrowed. SECTION 2.02. Loans. (a) The proceeds of the Loans shall be used by the Borrowers to purchase Telecommunications Equipment, to pay transaction costs incurred in connection with the execution, delivery and performance of the Loan Documents, and for working capital and other general corporate purposes, all as specified in the Notice of Borrowing and in accordance with the Milestone Plan; provided, however, that at any time that the Total Leverage Ratio is greater than 6:1 as determined by reference to the financial statements delivered pursuant to Section 5.06, proceeds of Loans may be used only to pay transaction costs incurred in connection with the execution and delivery of the Loan Documents and to purchase Telecommunications Equipment. Loans with respect to Telecommunications Equipment purchases may not be made to finance (i) soft costs (including installation, delivery and engineering costs) in excess of fifteen percent (15%) of the invoiced price for the related Switch Equipment or (ii) any support or installation costs associated with an operational system that would not be capitalized in accordance with GAAP. (b) Each Base Rate Loan shall be in a minimum principal amount of $1,000,000 and increments of $250,000 in excess thereof. Each LIBOR Loan shall be in a minimum principal amount of $5,000,000 and increments of $1,000,000 in excess thereof. (c) In any calendar month not more than six (6) Revolving Loans may be requested. 22 SECTION 2.03. Procedure for Loan Request and Borrowing Commitment. (a) A Borrower requesting a Loan shall deliver to the Agent a Notice of Borrowing substantially in the form of Exhibit H-1 attached hereto on or before 11:00 a.m. (New York time) at least five (5) Business Days prior to the date on which such Loan is requested to be made if such Loan is requested to be a LIBOR Loan and at least two (2) Business Days prior to the date on which such Loan is requested to be made if such Loan is requested to be a Base Rate Loan, which notice, once given, shall be irrevocable. The Revolving Loans made on the Initial Funding Date shall be Base Rate Loans and thereafter may be continued as Base Rate Loans or converted into LIBOR Loans in the manner provided in Section 2.06 and subject to the other conditions and limitations therein set forth and set forth in this Article II. In the case of a Loan the proceeds of which will be used to purchase or reimburse any Borrower for Telecommunications Equipment (including any Telecommunications Equipment being purchased or reimbursed under the Lucent Purchase Agreement), the Notice of Borrowing will include a schedule supporting one hundred percent (100%) of Telecommunications Equipment requested to be funded. Such schedule will detail all invoices for equipment, third party labor, permits, other third party costs and all capitalized internal costs of the Borrowers with respect to such Telecommunications Equipment permitted under GAAP. All invoices over $25,000 will be attached to such schedule and when combined with the above described capitalized internal costs will support at least seventy percent (70%) of the total requested funding. In addition, if the Telecommunications Equipment is being purchased or reimbursed under the Lucent Purchase Agreement, a certificate of delivery and acceptance in the form of Exhibit R shall be attached to the Notice of Borrowing. In the case of a Loan the proceeds of which will be used to pay or reimburse any Borrower for transaction costs, the Notice of Borrowing will include a copy of the invoice from the provider of the service or other appropriate supporting documentation. In the case of a Loan, the proceeds of which will be used for working capital or other general corporate purposes, the Notice of Borrowing will contain a certification that the making of such Loan does not violate any provision of the Indenture. The Notice of Borrowing shall, with respect to any Loans requested, specify whether such requested Loans are to be Base Rate Loans or LIBOR Loans, and if such requested Loans are to be LIBOR Loans, the requested Interest Period for such Loans. (b) The Agent agrees, promptly upon receipt of a Notice of Borrowing, to notify each Revolving or Term Lender of the date and amount of the Loan proposed thereunder and the amount of such Lender's Pro Rata Share therein. So long as no Event of Default has occurred and is continuing and upon fulfillment of the applicable conditions set forth in Article IV, each such Lender severally agrees, on or before 12:00 P.M. (New York time) on the date of each proposed Loan, to pay into the Payment Account, an amount equal to such Lender's Pro Rata Share of such Loan in dollars and in same day funds. After the Agent's receipt of such Lender's Loan proceeds, the Agent shall make available such proceeds to the Borrower requesting the Loan or the Person entitled to payment thereof at the bank account(s) specified in the Notice of Borrowing on the date specified in such Notice of Borrowing in Dollars in immediately available funds. (c) Unless the Agent has received written notice from a Lender prior to the date of any proposed Loan that such Lender will not make available to the Agent such Lender's Pro Rata Share of such Loan, the Agent may, but is not obligated to, assume that such Lender has made its Pro Rata Share of such Loan available to the Agent on the date of such Loan in accordance with paragraph (b) above, and the Lenders may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If such Pro Rata Share is not, 23 in fact, paid to Agent by such Lender when due, the Agent will be entitled to recover such amount on demand from such Lender or the Borrower which received the proceeds of such Loan without set-off, counterclaim or deduction of any kind, together with interest thereon, for each day from the date such amount is made available to such Borrower until the date such amount is repaid to the Agent either by such Borrower or such Lender, at, (1) in the case of such Borrower, the interest rate applicable to such Loan, and (2) in the case of such Lender, the Federal Funds Effective Rate. Nothing in this Section 2.03(c) or elsewhere in this Agreement or the other Loan Documents shall be deemed to require Agent to advance funds on behalf of any Lender or to relieve any Lender from its obligation to fulfill its Commitment hereunder or to prejudice any rights that the Borrower may have against any Lender as a result of any default by such Lender hereunder. Without limiting the foregoing, with respect to any Lender which for any reason fails to make timely payment to the Agent of its Pro Rata Share of any Loan, the Agent, in addition to other rights and remedies which it may have, shall be entitled to withhold or set off from any payments due to such Lender hereunder, an amount equal to the Pro Rata Share required to have been paid by such Lender plus interest as described above, and to withhold from such Lender any right of consent provided to such Lender by Article V or VI of this Agreement and to bring an action or suit against such Lender in a court of competent jurisdiction to recover such Pro Rata Share thereof and any related interest thereon. If such Lender shall repay to the Agent such corresponding amount, such amount so repaid shall constitute such Lender's applicable Pro Rata Share of such Loan for purposes of this Agreement. If both such Lender and such Borrower shall have repaid the corresponding amount, the Agent shall promptly return to such Borrower its corresponding amount. (d) The Borrowers commit to the Lenders to request Loans to be made (1) on a date not later than the Term Loan Funding Date, of at least $75,000,000 in the aggregate, the initial $75,000,000 of which shall constitute Term Loans; provided, that the Borrowers shall not be permitted to request Loans in excess of $75,000,000 until they have provided each item required to be delivered with respect to Systems located outside of the First Eight Cities, including, without limitation, the mortgages and third party agreements required pursuant to Section 4.02(k), as further described in Section 5.08, (2) during calendar year 1999 in an aggregate amount of at least $80,000,000, (3) during calendar year 2000 in an aggregate amount of at least $80,000,000, and (4) during calendar year 2001 in an aggregate amount equal to the undrawn portion of the Revolving Loan Commitment Amount. SECTION 2.04. The Notes. Each Borrower shall execute and deliver to each Revolving Lender a Revolving Loan Note and to each Term Lender a Term Loan Note to evidence the Commitment of that Lender. Each Revolving Loan Note shall be in the principal amount of the Revolving Loan Commitment Amount of the applicable Lender, dated the Initial Funding Date, stated to mature on the Revolving Credit Commitment Termination Date and substantially in the form of Exhibit E-1. Each Term Loan Note shall be in the principal amount of the Term Loan Commitment Amount of the applicable Term Lender, dated the Initial Funding Date, stated to mature on the Term Loan Termination Date and substantially in 24 the form of Exhibit E-2. The Notes payable to a Lender shall represent the obligation of such Borrower to pay the amount of each Lender's Revolving Loan Commitment Amount or Term Loan Commitment Amount or, if less, the applicable Lender's Pro Rata Share of the aggregate unpaid principal amount of all Loans to such Borrower and Letter of Credit Obligations incurred by such Lender together with interest thereon as prescribed in Section 2.05. The aggregate principal amount of all the Notes shall not exceed the aggregate Commitments of all the Lenders. The Agent is hereby authorized by such Borrower to record in the Register the date and amount of each Revolving Loan or Term Loan made to such Borrower, as applicable, and to record therein the date and amount of each payment on each Loan made to such Borrower, and such recordations shall be conclusive evidence against such Borrower of the amounts owing to the Lenders with respect to the Loans in the absence of manifest error; provided, however, that the failure of the Agent to register any such information on such schedule shall not in any manner affect the obligation of such Borrower to repay the Loans made to such Borrower in accordance with the terms of this Agreement. SECTION 2.05. Interest on Loans. (a) General. Subject to the provisions of Sections 2.05(b), 2.06 and 2.07, each Loan shall bear interest at the rate per annum equal to (i) the Base Rate plus the Applicable Margin, computed on the basis of a 365 or 366 day year, as applicable, or (ii) the LIBO Rate plus the Applicable Margin, computed on the basis of a 360 day year, as selected by the Borrowers in the Notices of Borrowing and the Notices of Continuation/Conversion. (b) Default Interest. If any Borrower shall default in the payment of the principal of or interest on any Loan or any other amount becoming due hereunder on its due date and such default shall continue uncured for three days, then the Borrowers shall, on demand, from the Agent, thereafter pay interest on all Loans at a rate that is four percent (4.00%) per annum above the rates of interest otherwise payable on all the Loans from the date such payment is due to the date such payment default is either cured or waived in writing by the Requisite Lenders. If any other Event of Default shall occur and be continuing and shall be declared by the Agent upon the direction of the Requisite Lenders, then the Borrowers shall, on demand, thereafter pay interest on all the Loans at a rate that is two percent (2.00%) per annum above the rates of interest otherwise payable on the Loans from the date of the occurrence of such Event of Default until the date such Event of Default has been cured or waived in writing by the Requisite Lenders; provided, that if an Event of Default described in the first sentence of this clause (b) shall occur at any time that an Event of Default described in this second sentence has occurred and is continuing, then the rate of interest described in the first sentence of this clause (b) shall apply. After the occurrence and during the continuance of any Event of Default, the Borrowers shall be subject to the limitations on borrowings of, conversions into and continuations as LIBOR Loans set forth in Section 2.07(g). SECTION 2.06. Conversion or Continuation. (a) Subject to the provisions of Section 2.07, each Borrower shall have the option (i) to convert (A) all or any part of its outstanding Term Loans or (B) all or any part of its outstanding Revolving Loans, in a minimum amount of $5,000,000 and integral multiples of $1,000,000 in excess of that amount, from a Term Loan or Revolving Loans that are Base Rate Loans to LIBOR Term Loans or LIBOR Revolving Loans, as 25 the case may be; (ii) to convert (A) all or any part of its outstanding Term Loan or (B) all or any part of its outstanding Revolving Loans from LIBOR Loans to Base Rate Loans on the expiration of the Interest Period applicable thereto; and (iii) upon the expiration of any Interest Period applicable to its outstanding LIBOR Term Loan or any outstanding LIBOR Revolving Loan, to continue (A) all of such LIBOR Term Loan or (B) all or any portion of such LIBOR Revolving Loan equal to $5,000,000 and integral multiples of $1,000,000 in excess of that amount as a LIBOR Term Loan or LIBOR Revolving Loan, as applicable; provided, however, that no outstanding Loans may be converted into, or continued as, LIBOR Loans when any Default or Event of Default has occurred and is continuing. Any conversion or continuation made with respect to less than the entire outstanding balance of a Borrower's Revolving Loans or Term Loans must be applied pro rata to such Borrower's Revolving Loans or Term Loans, as applicable, according to the outstanding principal balance of such Revolving Loans or Term Loans. (b) Whenever a Borrower elects to convert or continue Loans under this Section 2.06, such Borrower shall deliver to the Agent a written notice substantially in the form of that attached hereto as Exhibit H-2 (a "Notice of Conversion/ Continuation"), signed by an authorized officer of such Borrower (i) no later than 10:00 a.m. (New York time) two (2) Business Days in advance of the requested conversion date, in the case of a conversion into Base Rate Loans, and (ii) no later than 10:00 a.m (New York time) three (3) Business Days in advance of the requested conversion or continuation date, in the case of a conversion into, or continuation of, LIBOR Loans. The Notice of Conversion/Continuation shall specify (1) the conversion or continuation date (which shall be a Business Day), (2) the amount and type of the Loans to be converted or continued, (3) the nature of the requested conversion or continuation, and (4) in the case of a conversion into, or continuation of, LIBOR Loans, the requested Interest Period. Promptly after receipt of a Notice of Conversion/Continuation pursuant to this Section 2.06(b), the Agent shall notify the Revolving Lenders or the Term Lenders, as applicable, by telecopy, telephone or other similar form of transmission, of the requested conversion or continuation. In the event that a Borrower should fail to provide a Notice of Conversion/Continuation with respect to any LIBOR Loans as provided above, such Loans shall, on the last day of the Interest Period with respect to such Loans, convert to Base Rate Loans. (c) Any Notice of Conversion/Continuation for conversion to, or continuation of, Loans made pursuant to this Section 2.06 shall be irrevocable and the applicable Borrower shall be bound to convert or continue in accordance therewith. SECTION 2.07. Special Provisions Governing LIBOR Loans. Notwithstanding any other provisions to the contrary contained in this Agreement, the following provisions shall govern with respect to LIBOR Loans as to the matters covered: (a) Amount of LIBOR Loans. Each continuation of or conversion to LIBOR Term Loans, and each election of, continuation of or conversion to LIBOR Revolving Loans, shall be in a minimum amount of $5,000,000 and in integral multiples of $1,000,000 in excess of that amount. 26 (b) Determination of Interest Period. By giving notice as set forth in Section 2.06(b), a Borrower shall have the option, subject to the other provisions of this Section 2.07, to specify whether the Interest Period for such LIBOR Loan shall be a one, two, three or six month period. The determination of Interest Periods shall be subject to the following provisions: (i) In the case of immediately successive Interest Periods, each successive Interest Period shall commence on the day on which the preceding Interest Period expires. (ii) If any Interest Period would otherwise expire on a day which is not a Business Day, the Interest Period shall be extended to expire on the next succeeding Business Day; provided, however, that if the next succeeding Business Day occurs in the following calendar month, then such Interest Period shall expire on the immediately preceding Business Day. (iii) A Borrower may not select an Interest Period for any LIBOR Loan, which Interest Period expires later than the maturity date of such Loan. (iv) A Borrower may not select an Interest Period with respect to any portion of such Borrower's Term Loans which extends beyond an installment payment date for such Term Loans unless, after giving effect to such selection, the portion of such Term Loans not subject to Interest Periods ending after such installment payment date is equal to or greater than the principal due on such installment payment date. (v) A Borrower may not select an Interest Period with respect to any portion of such Borrower's Revolving Loans which extends beyond any date on which the Revolving Loan Commitment Amounts are scheduled to be reduced unless, after giving effect to such selection, the portion of the Revolving Loans not subject to Interest Periods ending after any such date is equal to or greater than any amount of the Revolving Loans required to be prepaid as a result of any such reduction. (vi) There shall be no more than eight (8) Interest Periods in effect at any one time. 27 (c) Determination of Interest Rate. As soon as practicable after 10:00 a.m. (New York time) on the LIBOR Interest Rate Determination Date, the Agent shall determine (which determination shall, absent manifest error, be presumptively correct) the interest rate for the LIBOR Loans for which an interest rate is then being determined and shall promptly give notice thereof (in writing or by telephone confirmed in writing) to the applicable Borrower. In the event that on any LIBOR Interest Rate Determination Date the Agent shall have determined (which determination shall, absent manifest error, be presumptively correct and binding upon all parties) that: (i) adequate and fair means do not exist for ascertaining the applicable interest rates by reference to which the LIBO Rate then being determined is to be fixed; or (ii) the LIBO Rate plus the Applicable Margin for any Interest Period for such Loans will not adequately reflect the cost to any Lender of making, funding or maintaining its LIBOR Loan for such Interest Period, the Agent shall forthwith so notify the applicable Borrower and the Lender, whereupon: (A) each LIBOR Loan will automatically, on the last day of the then existing Interest Period therefor, convert into a Base Rate Loan; and (B) the obligation of the Lenders to make, or to convert Loans into, LIBOR Loans shall be suspended until the Agent shall notify the applicable Borrower and the Lenders that the circumstances causing such suspension no longer exist. (d) Illegality. Notwithstanding any other provision of this Agreement, if any Lender shall notify the Agent that the introduction of or any change in or in the interpretation of any law or regulation makes it unlawful, or any central bank or other Governmental Authority asserts that it is unlawful, for any Lender to perform its obligations hereunder to make LIBOR Loans or to fund or maintain LIBOR Loans hereunder, (i) the obligation of the Lenders to make, or to convert Loans into or to continue Loans as, LIBOR Loans shall be suspended until the Agent shall notify the Borrowers and the Lenders that the circumstances causing such suspension no longer exist and (ii) the Borrowers shall on the termination of the Interest Period then applicable thereto, or on such earlier date required by law, prepay in full all LIBOR Loans then outstanding together with accrued interest thereon, or convert all such LIBOR Loans into Base Rate Loans in accordance with Section 2.06. (e) Compensation. In addition to such amounts as are required to be paid by the Borrowers pursuant to the other Sections of this Article II, the Borrowers agree to compensate any Lender for all losses, expenses and liabilities, including, without limitation, any loss or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund or maintain such Lender's LIBOR Loans (including the Applicable Margin component thereof) to the Borrowers, which such Lender may sustain (i) if for any reason a funding of any LIBOR Loans does not occur on a date specified therefor in a Notice of Borrowing or Notice of Conversion/Continuation, or a successive Interest Period does not commence after notice therefor is given pursuant to Section 2.06 as a result of any act or omission of any Borrower, (ii) if any voluntary or mandatory prepayment of any LIBOR Loans occurs for any reason on a date which is not the last scheduled day of an Interest Period, (iii) as a consequence of any required conversion of LIBOR Loans to Base Rate Loans as a result of any of the events indicated in Section 2.07(d), or (iv) as a consequence of any other failure by a Borrower to repay LIBOR Loans when required by the terms of this Agreement. 28 (f) Booking of LIBOR Loans. The Lenders may make, carry or transfer LIBOR Loans at, to, or for the account of, any of their respective branch offices or the office of any of their respective affiliates. (g) LIBOR Loans After Event of Default. Unless the Requisite Lenders shall otherwise agree, after the occurrence of and during the continuance of any Event of Default, the Borrowers may not borrow Revolving Loans as LIBOR Loans or elect to have any Loans continued as, or converted to, LIBOR Loans after the expiration of any Interest Period then in effect for such Loans. SECTION 2.08. Payments. (a) Interest on each LIBOR Loan shall be payable in arrears on each LIBOR Interest Payment Date and, if such LIBOR Loan is paid in full other than on such LIBOR Interest Payment date, on such other date. Interest on each Base Rate Loan will be payable in arrears on each Payment Date and, if such Base Rate Loan is paid in full other than on such Payment Date, on such other date. (b) Subject to the provisions of Sections 2.09 and 9.02, the outstanding principal balance of the Term Loans made to the Borrowers shall be payable in twenty consecutive quarterly installments of $187,500 each beginning on the fourteenth Payment Date (i.e. the Payment Date occurring on April 1, 2002) and continuing on each Payment Date thereafter through and including the thirty-third Payment Date (i.e. the Payment Date occurring on January 1, 2007) and two final installments of $35,625,000 on April 1, 2007 and on the Term Loan Termination Date. Subject to the provisions of Sections 2.09 and 9.02, the outstanding principal balance of the Revolving Loans made to the Borrowers shall be payable on the Revolving Credit Commitment Termination Date. (c) Payments made with respect to the Loans by each Borrower shall be applied by the Agent first to unpaid and accrued fees and interest and then to the outstanding unpaid principal balance of the Loans of such Borrower; provided, however, that upon the occurrence and during the continuance of an Event of Default, all payments and prepayments with respect to the Obligations and all proceeds of Collateral shall be applied in the following order by the Agent; provided, further, that the order of priority set forth in the following clauses may be altered upon direction from the Requisite Lenders to the Agent: (1) first, to pay Obligations in respect of any expenses then due and payable by the Borrowers to the Agents, the Lenders or any Person which is not a Lender that has issued a Letter of Credit; (2) second, to pay Obligations in respect of any reimbursement or indemnities then due and payable to the Agents, the Lenders or any Person which is not a Lender that has issued a Letter of Credit (excluding any reimbursement obligations with respect to any Letters of Credit); 29 (3) third, to pay Obligations in respect of any fees due and owing to the Agent, the Collateral Agent or any Person which is not a Lender that has issued a Letter of Credit; (4) fourth, to pay Obligations in respect of the commitment fee and any other fees and commissions then due and owing to the Agents, the Lenders or any Person which is not a Lender that has issued a Letter of Credit; (5) fifth, to pay Obligations in respect of any accrued and unpaid interest due in respect of Loans and Letter of Credit Obligations; (6) sixth, to pay termination payments due and payable pursuant to any Interest Rate Agreement or hedging agreement; (7) to the ratable payment or prepayment of principal of any outstanding Loans and reimbursement obligations with respect to Letters of Credit; (8) to provide required cash collateral, if required pursuant to Section 2.10(j); and (9) to the ratable payment of all other Obligations. SECTION 2.09. Optional and Mandatory Prepayment of Loans; Optional and Mandatory Reduction of Revolving Loan Commitment Amount. (a) Provided that no Event of Default has occurred and is continuing, the Borrowers shall have the right upon the provision of sixty (60) days' prior written notice to the Agent, which notice, once given, shall be irrevocable, on any Payment Date with respect to any Base Rate Term Loans and on the last day of the applicable Interest Period with respect to any LIBOR Term Loans, to prepay the outstanding principal of the Base Rate Term Loans in a minimum principal amount of $1,000,000 and increments of $250,000 in excess thereof, or the outstanding principal of the LIBOR Term Loans in a minimum principal amount of $5,000,000 and increments of $1,000,000 in excess thereof, multiple thereof, together in each case with accrued interest thereon and the aggregate Prepayment Premium applicable thereto. The amount of principal so prepaid shall be applied to the remaining principal payments of the type of Loans prepaid (i.e. Base Rate Term Loans or LIBOR Term Loans) in the inverse order of maturity. (b) Upon the occurrence of any Event of Loss in excess of $1,000,000 with respect to any item of Collateral that is not repaired or replaced, or any Events of Loss which, in the aggregate, exceed $5,000,000 with respect to any item or items of Collateral that are not repaired or replaced (in each case, other than an item of Collateral no longer used or useful in the Business) such that after such repair or replacement it has a value at least equal to its value prior to the occurrence of such Event of Loss, the Borrower which suffered such Event of Loss shall make a principal prepayment within thirty (30) days of such Event of Loss in an amount equal to the replacement value of the item of Collateral which suffered such Event of Loss, together with accrued interest thereon (but without the Prepayment Premium) with such principal payment to be applied, pro rata, to outstanding principal balance of the Revolving Loans and the Term Loans. 30 (c) In the event that any Borrower finances any Telecommunications Equipment (exclusive of soft costs that exceed fifteen percent (15%) of the invoiced price of the related Telecommunications Equipment) with a financing source other than a Loan pursuant to this Agreement, then thirty (30) days following such financing the Revolving Loan Commitment Amounts of all the Revolving Lenders shall be reduced by the actual or imputed principal amount of any such financing, and any prepayments of the Revolving Loans required by the provisions of clause (h) below shall be accompanied by any applicable Prepayment Premium thereon. (d) The Borrowers shall prepay the Revolving Loans and the Term Loans on a pro rata basis in a principal amount equal to (i) all of the net proceeds of any sales of assets of any Borrower other than sales in the ordinary course of business, which proceeds are not reinvested within 270 days after receipt thereof in replacement assets, plus the applicable Prepayment Premium, and (ii) the proceeds of insurance policies paid to any Borrower and not applied within 270 days after any such payment to replacing, rebuilding or restoring the Collateral which was the subject of insurance loss, without any Prepayment Premium, in each case, within five (5) days after the expiration of the applicable 270 day period. (e) On the first Payment Date of each year, commencing in 2002, the Revolving Loan Commitment Amounts of all the Lenders shall be reduced by an amount equal to fifty percent (50%) of Excess Operating Cash Flow for the preceding fiscal year until the Borrowers have achieved and maintained for at least two consecutive fiscal quarters, a Total Leverage Ratio of less than 5:1, as determined by reference to the financial statements delivered pursuant to Section 5.06. (f) Provided that no Event of Default has occurred and is continuing, commencing January 1, 2002, the Borrowers shall have the right upon the provision of thirty days' prior written notice to the Agent, which notice, once given, shall be irrevocable, on any Payment Date, to reduce the Revolving Loan Commitment Amount of all the Lenders. Each such reduction shall be in a minimum principal amount of $1,000,000 and increments of $250,000 in excess thereof. Any Revolving Loans that must be prepaid in connection with such reduction in the Revolving Loan Commitment Amount pursuant to clause (h) below, shall be accompanied by any applicable Prepayment Premium thereon. (g) The Revolving Loan Commitment Amount of all the Lenders shall be reduced on each Payment Date beginning April 1, 2002 as set forth on Annex C hereto. In addition, in the event that at any time more than fifteen percent (15.0%) of the average outstanding principal balance of Revolving Loans during the immediately preceding 90-day period is repaid and is not reborrowed within 120 days after such repayment, then on such date, the Revolving Loan Commitment Amount of all the Lenders shall be reduced by an amount equal to such amount that was not reborrowed. Any Revolving Loans that must be prepaid in connection with such reduction in the Revolving Loan Commitment Amount pursuant to Section 2.09(h) below, shall be accompanied by any applicable Prepayment Premium. (h) On each date that the Revolving Loan Commitment Amount is reduced, the Borrowers shall prepay first, the Revolving Loans, and second, provide to the Agent cash collateral with respect to the Letter of Credit Obligations in such amounts such that the sum of the outstanding principal balance of the 31 Revolving Loans plus the Letter of Credit Obligations does not exceed the Revolving Loan Commitment Amount of all the Revolving Lenders after giving effect to the reduction thereof effective on such date, together with any applicable Prepayment Premium thereon. Any reduction in the Revolving Loan Commitment Amount of all the Lenders shall be allocated to each Revolving Lender based on its Pro Rata Share. All prepayments of principal shall be applied to the remaining principal payments of the type of Loans prepaid in the inverse order of maturity. The Letter of Credit Obligations shall be reduced on a dollar-for-dollar basis by the cash collateral. SECTION 2.10. Letters of Credit. (a) Agreement to Cause Issuance. Subject to the terms and conditions of this Agreement, and in reliance upon the representations and warranties of the Borrowers herein set forth, the Agent agrees to (1) cause Letters of Credit to be issued by Lenders who are willing to do so or (2) provide credit support or enhancement or otherwise confirm payment (any such credit support, enhancement or payment confirmation being referred to as "Credit Support") to banks other than Lenders, which banks are acceptable to the Agent, which issue Letters of Credit for the respective accounts of the Borrowers in accordance with this Section 2.10 from time to time during the term of this Agreement. (b) Amounts; Outside Expiration Date. The Agent shall not have any obligation to cause any Letter of Credit to be issued by a Lender or to provide Credit Support for any Letter of Credit at any time if: (1) the maximum undrawn face amount of the Letter of Credit is greater than the Unused Letter of Credit Subfacility; or (2) such Letter of Credit has an expiration date later than thirty (30) days prior to the Revolving Credit Commitment Termination Date, or more than one (1) year from the date of issuance. (c) Other Conditions. In addition to being subject to the satisfaction of the applicable conditions precedent contained in Article IV, the obligation of the Agent to cause any Letter of Credit to be issued by a Lender or to provide Credit Support for any Letter of Credit is subject to the following conditions precedent having been satisfied in a manner satisfactory to the Agent: (1) the applicable Borrower shall have delivered to the proposed issuer of such Letter of Credit, at such times and in such manner as such proposed issuer may prescribe, an application in form and substance satisfactory to such proposed issuer for the issuance of the Letter of Credit and such other documents as may be required pursuant to the terms thereof, and the form and terms of the proposed Letter of Credit shall be satisfactory to the Agent and such proposed issuer; and (2) as of the date of issuance, no order of any court, arbitrator or Governmental Authority shall purport by its terms to enjoin or restrain money center banks generally from issuing letters of credit of the type and in the amount of the proposed Letter of Credit, and no 32 law, rule or regulation applicable to money center banks generally and no request or directive (whether or not having the force of law) from any Governmental Authority with jurisdiction over money center banks generally shall prohibit, or request that the proposed issuer of such Letter of Credit refrain from, the issuance of letters of credit generally or the issuance of such Letters of Credit. (d) Issuance of Letters of Credit. (1) Request for Letter of Credit. The applicable Borrower shall give the Agent five (5) Business Days' prior written notice, containing the original signature of an authorized officer of such Borrower, of such Borrower's request for the issuance of a Letter of Credit or the provision of Credit Support for a Letter of Credit. Such notice shall be irrevocable and shall specify the original face amount of the Letter of Credit, the effective date (which date shall be a Business Day) of issuance of such proposed Letter of Credit, whether such Letter of Credit may be drawn in a single or in partial draws, the date on which such proposed Letter of Credit is to expire (which date shall be a Business Day), the purpose for which such Letter of Credit is to be issued, and the beneficiary of such Letter of Credit. The applicable Borrower shall attach to such notice the form of the proposed Letter of Credit. (2) Responsibilities of the Agent; Issuance. The Agent shall determine, as of the Business Day immediately preceding the requested effective date of issuance of the Letter of Credit set forth in the notice from the applicable Borrower pursuant to Section 2.10(d)(1), the amount of the applicable Unused Letter of Credit Subfacility. If (A) the undrawn face amount of the proposed Letter of Credit is not greater than the applicable Unused Letter of Credit Subfacility, and (B) the Agent has received a certificate from such Borrower stating that the applicable conditions set forth in Article IV have been satisfied, the Agent shall cause such Letter of Credit to be issued on such proposed effective date of issuance. (3) Notice of Issuance. The Agent shall promptly give each Lender written notice of the issuance of each Letter of Credit. (4) No Extensions or Amendment. No Letter of Credit shall be extended or amended unless the requirements of this Section 2.10(d) are met as though a new Letter of Credit were being requested and issued. (e) Payments Pursuant to Letters of Credit. (1) Payment of Letter of Credit Obligations. The Borrowers agree to reimburse the issuer for any draw under any Letter of Credit, and the Agent, for the account of the Lenders, upon any payment pursuant to any Credit Support, immediately upon demand, and to pay the issuer of the Letter of Credit the amount of all other Obligations and other amounts payable to such issuer under or in connection with any Letter of Credit immediately when due, irrespective of any claim, set-off, defense or other right which a Borrower may have at any time against such issuer or any other Person. 33 (2) Revolving Loans to Satisfy Reimbursement Obligations. In the event that the issuer of any Letter of Credit honors a draw under such Letter of Credit, or the Agent shall have made any payment pursuant to any Credit Support, and the Borrowers shall not have repaid such amount to the issuer of such Letter of Credit or the Agent, as applicable, pursuant to Section 2.10(e)(1), the Agent shall, upon receiving notice of such failure, notify each Revolving Lender of such failure, and each Revolving Lender shall unconditionally pay to the Agent, for the account of such issuer or the Agent, as applicable, as and when provided hereinbelow, an amount equal to such Revolving Lender's Pro Rata Share of the amount of such payment in Dollars and in same day funds. If the Agent so notifies the Revolving Lenders prior to 12:00 p.m. (New York time) on any Business Day, each Revolving Lender shall make available to the Agent the amount of such payment, as provided in the immediately preceding sentence, on such Business Day. Such amounts paid by the Revolving Lenders to the Agent shall constitute Revolving Loans which shall be deemed to have been requested by the applicable Borrower pursuant to Section 2.03. (f) Participations. (1) Purchase of Participations. Immediately upon issuance of any Letter of Credit in accordance with Section 2.10(d), each Revolving Lender shall be deemed to have irrevocably and unconditionally purchased and received without recourse or warranty, an undivided interest and participation in such Letter of Credit (if issued by a Revolving Lender) or the Credit Support provided through the Agent to such issuer in connection with the issuance of such Letter of Credit, as applicable, equal to such Revolving Lender's Pro Rata Share of the face amount of such Letter of Credit or the amount of such Credit Support (including, without limitation, all obligations of the Borrowers with respect thereto, and any security therefor or guaranty pertaining thereto). (2) Sharing of Reimbursement Obligation Payments. Whenever the Agent receives a payment from a Borrower on account of reimbursement obligations in respect of a Letter of Credit or Credit Support as to which the Agent has previously received for the account of the issuer thereof payment from a Revolving Lender pursuant to this Section 2.10(f)(2), the Agent shall promptly pay to such Lender such Revolving Lender's Pro Rata Share of such payment from such Borrower in Dollars. Each such payment shall be made by the Agent on the Business Day on which the Agent receives immediately available funds paid to such Person pursuant to the immediately preceding sentence, if received prior to 11:00 a.m. (New York time) on such Business Day and otherwise on the next succeeding Business Day. (3) Documentation. Upon the request of any Revolving Lender, the Agent shall furnish to such Revolving Lender copies of any Letter of Credit, reimbursement agreement executed in connection therewith, application for any Letter of Credit and Credit Support provided through the Agent in connection with the issuance of any Letter of Credit, and such other documentation as may reasonably be requested by such Revolving Lender. 34 (4) Obligations Irrevocable. The obligations of each Revolving Lender to make payments to the Agent with respect to any Letter of Credit or with respect to any Credit Support provided through the Agent with respect to a Letter of Credit, and the obligations of the Borrowers to make payments to the Agent, for the account of the Revolving Lenders, shall be irrevocable, not subject to any qualification or exception whatsoever and shall be made in accordance with the terms and conditions of this Agreement (assuming, in the case of the obligations of the Revolving Lenders to make such payments, that the Agent has provided Credit Support for such Letter of Credit in accordance with the terms of Section 2.10(d)), including, without limitation, any of the following circumstances: (i) any lack of validity or enforceability of this Agreement or any of the other Loan Documents; (ii) the existence of any claim, set-off, defense or other right which a Borrower may have at any time against a beneficiary named in a Letter of Credit or any transferee of any Letter of Credit (or any Person for whom any such transferee may be acting), any Lender, the Agent, the Collateral Agent, the issuer of such Letter of Credit, or any other Person, whether in connection with this Agreement, any Letter of Credit, the transactions contemplated herein or any unrelated transactions (including any underlying transactions between a Borrower or any other Person and the beneficiary named in any Letter of Credit); (iii) any draft, certificate or any other document presented under the Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (iv) the surrender or impairment of any security for the performance or observance of any of the terms of any of the Loan Documents; or (v) the occurrence of any Default or Event of Default. (g) Recovery or Avoidance of Payments. In the event any payment by or on behalf of a Borrower received by the Agent with respect to a Letter of Credit or Credit Support provided for any Letter of Credit (or any guaranty by a Borrower or reimbursement obligation of a Borrower relating thereto) and distributed by the Agent to the Revolving Lenders on account of their respective participations therein, is thereafter set aside, avoided or recovered from the Agent in connection with any receivership, liquidation or bankruptcy proceeding, the Revolving Lenders shall, upon demand by the Agent, pay to the Agent their respective Pro Rata Shares of such amount set aside, avoided or recovered, together with interest at the rate required to be paid by the Agent upon the amount required to be repaid by it. (h) Compensation for Letters of Credit. The Borrowers agree to pay the fees set forth in Section 2.11 with respect to any Letters of Credit. 35 (i) Indemnification; Exoneration. (1) Indemnification. In addition to amounts payable as elsewhere provided in this Section 2.10, the Borrowers hereby agree to protect, indemnify, pay and save the Lenders and the Agent harmless from and against any and all claims, demands, liabilities, damages, losses, costs, charges and expenses (including reasonable attorneys' fees) which any Lender or the Agent may incur or be subject to as a consequence, direct or indirect, of the issuance of any Letter of Credit or the provision of any Credit Support in connection therewith. The agreements contained in this Section 2.10(i)(1) shall survive the payment in full of the Obligations. (2) Assumption of Risk by the Borrowers. As among the Borrowers, the Lenders and the Agent, each Borrower assumes all risks of the acts and omissions of, or misuse of any of the Letters of Credit by, the respective beneficiaries of such Letters of Credit. In furtherance and not in limitation of the foregoing, the Lenders and the Agent shall not be responsible for: (A) the form, validity, sufficiency, accuracy, genuineness or legal effect of any document submitted by any Person in connection with the application for and issuance of and presentation of drafts with respect to any of the Letters of Credit, even if it should prove to be in any or all respects invalid, insufficient, inaccurate, fraudulent or forged; (B) the validity or sufficiency of any instrument transferring or assigning or purporting to transfer or assign any Letter of Credit or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason; (C) the failure of the beneficiary of any Letter of Credit to comply duly with conditions required in order to draw upon such Letter of Credit; (D) errors, omissions, interruptions or delays in transmission or delivery of any messages, by mail, cable, telegraph, telex or otherwise, whether or not they be in cipher; (E) errors in interpretation of technical terms; (F) any loss or delay in the transmission or otherwise of any document required in order make a drawing under any Letter of Credit or of the proceeds thereof; (G) the misapplication by the beneficiary of any Letter of Credit of the proceeds of any drawing under such Letter of Credit; or (H) any consequences arising from causes beyond the control of the Lenders or the Agent, including, without limitation, any act or omission, whether rightful or wrongful, of any present or future de jure or de facto Governmental Authority. None of the foregoing shall affect, impair or prevent the vesting of any rights or powers of the Agent or any Lender under this Section 2.10(i). (3) Exoneration. In furtherance and extension, and not in limitation, of the specific provisions set forth above, any action taken or omitted by the Agent or any Lender under or in connection with any of the Letters of Credit or any related certificates, if taken or omitted in good faith, shall not put the Agent or any Lender under any resulting liability to any Borrower or relieve any Borrower of any of its obligations hereunder to any such Person. 36 (j) Supporting Letter of Credit; Cash Collateral. If, notwithstanding the provisions of Section 2.10(b), any Letter of Credit is outstanding upon the termination of this Agreement, then upon such termination the Borrowers shall cause the termination of such Letter of Credit. If, at the Agent's election, any such Letter of Credit remains outstanding, then the Borrowers shall deposit with the Agent, for the ratable benefit of the Agent and the Revolving Lenders, with respect to each Letter of Credit then outstanding, as the Agent shall specify, either (A) a standby letter of credit (a "Supporting Letter of Credit") in form and substance satisfactory to the Required Revolving Lenders, issued by an issuer satisfactory to the Agent in an amount equal to the greatest amount for which such Letter of Credit may be drawn, plus any fees and expenses associated with such Letter of Credit, under which Supporting Letter of Credit the Agent is entitled to draw amounts necessary to reimburse the Agent and the Revolving Lenders for payments made by the Agent and the Revolving Lenders under such Letter of Credit or under any Credit Support provided through the Agent with respect thereto and any fees and expenses associated with such Letter of Credit, or (B) cash in amounts necessary to reimburse the Agent and the Revolving Lenders for payments made by the Agent or the Revolving Lenders under such Letter of Credit or under any Credit Support provided through the Agent with respect thereto, and any fees and expenses associated with such Letter of Credit. Such Supporting Letter of Credit or deposit of cash shall be held by the Agent, for the ratable benefit of the Agent and the Revolving Lenders, as security for, and to provide for the payment of, the aggregate undrawn face amount of such Letters of Credit remaining outstanding. SECTION 2.11. Fees. (a) The Borrowers shall pay and the Borrowers shall be jointly and severally liable to the Agent for the account of the Revolving Lenders for payment of a nonutilization fee calculated on a per annum basis and equal to the percentage corresponding to the criteria set forth below of the average of the unused Revolving Loan Commitment Amount for the quarterly period preceding a Payment Date, which fee shall be payable on each Payment Date following such last day of a quarter beginning on the Payment Date following the Initial Funding Date until and including the Payment Date following the Revolving Credit Commitment Termination Date: Drawn Portion of Revolving Loan Commitment Amount as of the Last Day of each Quarter Preceding a Payment Date Percentage ---------------------------------- ---------- Less than or equal to $58,333,333 1.25% Greater than $58,333,333 and less than or equal to $116,666,666 1.00% Greater than $116,666,666 and less than or equal to $175,000,000 0.75% 37 In the event that at any time the Borrowers fail to comply with the requirements of Section 2.03(d) for any calendar year, each of the above described nonutilization fees shall be increased by 100 basis points for the entire such calender year with payment of such increment in the nonutilization fee being due and payable not later than the last Business Day of such calendar year. (b) The Borrowers shall pay the Agent and the Collateral Agent and shall be jointly and severally liable to the Agent and the Collateral Agent, respectively, for payment of an annual administration fee and a collateral monitoring fee at the times and in the amounts set forth in the Fee Letters. (c) The Borrowers shall on the Closing Date pay the Agent the underwriting fee and the structuring fee referred to in the Fee Letters. (d) The Borrowers shall pay and the Borrowers shall be jointly and severally liable to the Agent (i) for the account of the Revolving Lenders for payment in arrears on each Payment Date of a fee equal to equal to the product of the Applicable Margin in effect with respect to LIBOR Loans for the preceding calendar quarter on an annualized basis, multiplied by the average Letter of Credit Obligations outstanding during such calendar quarter, and (ii) for the account of any Person which issues any Letter of Credit, for payment in arrears on each Payment Date of a fee equal to (A) the product of one-eighth percent (0.125%) per annum multiplied by the average face amount of Letters of Credit issued by such Person and outstanding during the preceding calendar quarter, and (B) if such Person is not a Lender, any additional fees as may be charged by such Person in connection with the issuance or maintenance of such Letter of Credit. (e) All fees once paid shall be nonrefundable. SECTION 2.12. Manner of Payment; Special Tax Considerations. (a) All payments by the Borrowers hereunder and under the Notes shall be made to the Agent by wire transfer or other electronic payment method to the Payment Account or to such bank account as the Agent may designate, for the account of the Lenders in Dollars in immediately available funds by 11:00 a.m., New York time, on the date on which such payment shall be due. The Agent will promptly thereafter cause to be distributed like funds relating to the payment of principal or interest or other fees ratably (other than amounts payable pursuant to Section 2.14) to each Lender in accordance with Section 10.07 hereof. Interest in respect of any Loan hereunder shall accrue from the day such Loan is made up to and including the day prior to the date on which such Loan is paid in full. Payments received after 12:00 p.m. shall not be given credit until the next Business Day, and the Borrowers shall be liable for interest, if any, accruing on such payment until the next Business Day. (b) (1) Any and all payments by each Borrower hereunder shall be made free and clear of and without deduction for any and all Taxes. If any Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder or under the other Loan Documents to any Lender or Agent, (A) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable 38 under this Section 2.12) such Lender or Agent receives an amount equal to the sum it would have received had no such deductions been made, (B) such Borrower shall make such deductions, and (C) such Borrower shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law. If a withholding tax of the United States of America or any other Governmental Authority shall be or become applicable (y) after the date of this Agreement, to the payments by any Borrower made to the Lending Office or any other office that a Lender may claim as its Lending Office, or (z) after such Lender's selection and designation of any other Lending Office, to such payments made to such other Lending Office, such Lender shall use reasonable efforts to make, fund and maintain its Loans through another Lending Office of such Lender in another jurisdiction so as to reduce, but not increase, the applicable Borrower's liability hereunder, if the making, funding or maintenance of such Loans through such other Lending Office of such Lender does not, in the judgment of such Lender, otherwise materially adversely affect such Loans, such Lender's obligations under its Commitment or such Lender. Notwithstanding anything to the contrary hereunder, if a Person becomes a Lender under this Agreement pursuant to Section 11.08 hereof, the Borrowers shall in no event be required to increase any payment pursuant to paragraph (b) of this Section 2.12 by an amount that would exceed the amount of any increase that would be required to be made under paragraph (b) of this Section 2.12 to the assigning Lender. (2) The Borrowers will jointly and severally indemnify each Lender and the Agents and hold them harmless for the full amount of Taxes (including, without limitation, any Taxes imposed by any Governmental Authority on amounts payable under this Section 2.12 or any other documentary taxes, assessments or charges made by any Governmental Authority by reason of the execution and delivery of this Agreement or any other Loan Document) paid by such Lender or the Agent (as the case may be) and any liability (including penalties, interest, and expenses) arising therefrom or with respect thereto. This indemnification shall be made within thirty (30) days after the date such Lender or the Agent (as the case may be) makes written demand therefor. A certificate as to any additional amount payable to any Lender or the Agent under this Section 2.12 submitted to the Borrowers and the Agent (if a Lender is so submitting) by such Lender or the Agent shall show in reasonable detail the amount payable and the calculations used to determine such amount. With respect to such deduction or withholding for or on account of any Taxes and to confirm that all such Taxes have been paid to the appropriate Governmental Authorities, the applicable Borrower shall promptly (and in any event not later than thirty (30) days after receipt) furnish to each Lender and the Agent such certificates, receipts and other documents as may be required (in the judgment of such Lender or the Agent) to establish any tax credit to which such Lender or the Agent may be entitled. (3) Within thirty (30) days after the date of any payment of Taxes on amounts payable hereunder by any Borrower, such Borrower will furnish to the Agent, at its address referred to in Section 11.01, the original or a certified copy of a receipt evidencing payment thereof. (4) Without prejudice to the survival of any other agreement of any Borrower hereunder, the agreements and obligations of such Borrower contained in this Section 2.12 shall survive the payment in full of principal and interest hereunder and the termination of this Agreement. 39 (5) Without limiting the obligations of the Borrowers under this Section 2.12, each Lender that is not created or organized under the laws of the United States of America or a political subdivision thereof shall deliver to the Borrowers and the Agent on or before the effective date hereof, or, if later, the date on which such Lender becomes a Lender pursuant to Section 11.08 hereof, a true and accurate certificate executed in duplicate by a duly authorized officer of such Lender, in a form satisfactory to the Borrowers and the Agent, to the effect that such Lender is capable under the provisions of an applicable tax treaty concluded by the United States of America (in which case the certificate shall be accompanied by two original, executed copies of Form 1001 of the IRS) or under Section 1442 of the IRC (in which case the certificate shall be accompanied by two original, executed copies of Form 4224 of the IRS) of receiving payments of interest hereunder exempt from or at a reduced deduction or withholding of United States federal income tax or that such Lender is not a bank described in Section 881(c)(3)(A) of the IRC (in which case the certificate should be accompanied by two original, executed copies of Form W-8 or W-9 of the IRC). Each such Lender further agrees to deliver to the Borrowers and the Agent from time to time a true and accurate certificate executed in duplicate by a duly authorized officer of such Lender substantially in a form satisfactory to the Borrowers and the Agent, before or promptly upon the occurrence of any event requiring a change in the most recent certificate previously delivered by it to the Borrowers and the Agent pursuant to this Section 2.12(b)(5). Further, each Lender which delivers a certificate accompanied by Form 1001 of the IRS covenants and agrees to deliver to the Borrowers and the Agent within fifteen (15) days prior to January 1, 1999, and every third anniversary of such date thereafter, on which this Agreement is still in effect, another such certificate and two accurate and complete original signed copies of Form 1001 (or any successor form or forms required under the IRC or the applicable regulations promulgated thereunder), and each Lender that delivers a certificate accompanied by Form 4224 of the IRS covenants and agrees to deliver to the Borrowers and the Agent within fifteen (15) days prior to the beginning of each subsequent taxable year of such Lender during which this Agreement is still in effect, another such certificate and two accurate and complete original signed copies of IRS Form 4224 (or any successor form or forms required under the IRC or the applicable regulations promulgated thereunder). Each such certificate shall certify as to one of the following: (a) that such Lender is capable of receiving payments of interest hereunder exempt from or at a reduced deduction or withholding of United States of America federal income tax; (b) that such Lender is not capable of receiving payments of interest hereunder exempt from or at a reduced deduction or withholding of United States of America federal income tax as specified therein but is capable of recovering the full amount of any such deduction or withholding from a source other than the Borrowers and will not seek any such recovery from the Borrowers; or 40 (c) that, as a result of the adoption of or any change in any law, treaty, rule, regulation, guideline or determination of a Governmental Authority or any change in the interpretation or application thereof by a Governmental Authority after the date such Lender became a party hereto, such Lender is not capable of receiving payments of interest hereunder without deduction or withholding of United States of America federal income tax as specified therein and that it is not capable of recovering the full amount of the same from a source other than the Borrowers. Each Lender shall promptly furnish to the Borrowers and the Agent such additional documents as may be reasonably required by the Borrowers or the Agent to establish any exemption from or reduction of any Taxes required to be deducted or withheld and which may be obtained without undue expense to such Lender (6) For a period with respect to which a Lender has failed to provide the Agent and the Borrowers with the appropriate form described in this Section 2.12(b)(5) (other than if such failure is due to a change in law occurring subsequent to the date on which a form originally was required to be provided), such Lender shall not be entitled to indemnification under this Section 2.12 with respect to Taxes imposed by the United States by reason of such failure; provided, however, that should a Lender become subject to Taxes because of its failure to deliver a form required hereunder, the Borrowers shall take such steps as such Lender shall reasonably request to assist such Lender to recover such Taxes. (c)(1) If a Borrower pays any additional amount under this Section 2.12 and, as a result, any Lender, together with the Agent, subsequently, in their sole discretion and based on their own interpretation of any relevant laws (but acting in good faith) receive or are granted a final and non-appealable credit against or deduction from or in respect of any tax payable by such Lender, or obtain any other final and non-appealable relief in respect of any tax, which in the opinion of such Lender and the Agent, acting in good faith, is both reasonably identifiable and quantifiable by them without requiring any Lender, the Agent or their professional advisers to expend a material amount of time or incur a material cost in so identifying or quantifying (any of the foregoing, to the extent so reasonably identifiable and quantifiable, being referred to as a "Saving"), such Lender shall, to the extent that it can do so without prejudice to the retention of the Saving, reimburse such Borrower promptly after such identification and quantification with the amount of such Saving; provided, however, that any such Saving shall be reduced by any costs incurred by such Lender or the Agent in obtaining such Saving. (2) Nothing in this Section 2.12(c) shall require any Lender to disclose to any Person any information regarding its tax affairs or to arrange its tax and other affairs in any particular manner. SECTION 2.13. Maximum Lawful Interest Rate. Notwithstanding any provision contained herein, the total liability of the Borrowers for payment of interest pursuant hereto and the Notes, including any other charges or other amounts, to the extent such charges and other amounts are deemed to be interest, shall not exceed the maximum amount of such interest permitted by law to be charged, collected, or received from the Borrowers (the "Maximum Rate"). If any payments by any Borrower for the account of any Lender include interest in excess of the Maximum Rate, such Lender shall apply such excess to the reduction of the unpaid principal amount owing by such Borrower, or if none is due, such excess shall be returned to such Borrower. 41 SECTION 2.14. Funding Issues. (a) Increased Costs. If, due to either (i) the introduction after the date hereof of, or any change after the date hereof in or in the interpretation of, any applicable law, rule or regulation by any Governmental Authority, central bank or comparable agency charged with the interpretation or administration thereof or (ii) compliance by any Lender after the date hereof with any final request or final directive issued after the date hereof (whether or not having the force of law) by any such Governmental Authority, central bank or comparable agency, and, as a result of any of the events set forth in the above clauses (i) and (ii), (x) there shall be any increase in the cost to such Lender in maintaining its Commitment under this Agreement or funding or maintaining its Pro Rata Share of the Loans under this Agreement, or (y) any Lender is subjected to any charge or withholding on its obligations hereunder, or changes in the basis of taxation of payments to any Lender in connection with any of the foregoing (except for changes in the rate of tax on overall net income of any Lender) (collectively, "Increased Costs"), then the Borrowers shall, from time to time, pay, to the Agent for the benefit of such Lender within 15 days after such Lender shall have provided notice to the Agent (and the Agent shall have provided notice to the Borrowers) of such Increased Cost, an amount sufficient to compensate such Lender for such Increased Cost, as provided herein. A certificate setting forth in reasonable detail the computation of the amount of such Increased Cost (which increase in cost shall be determined by such Lender's reasonable allocation of the aggregate of such cost increases resulting from such event), submitted to the Borrowers by such Lender, shall be conclusive and binding for all purposes, absent manifest error. (b) Increased Capital. If any Lender which is subject to minimum capital requirements determines that compliance by such Lender, with any guideline or request from any central bank or other Governmental Authority (whether or not having the force of law) affects or would affect the amount of capital required or expected to be maintained by such Lender, or any corporation controlling such Lender, and such Lender reasonably determines that the amount of such capital is increased by or based upon any commitment to lend hereunder or making or maintaining Loans, its commitment to participate (as provided for in Section 2.10(f)) in any Letter of Credit or any Credit Support provided through the Agent in connection with the issuance of any Letter of Credit, or other commitments of this type, then, upon demand by such Person, the Borrowers agree to, within five (5) days of such demand, pay to such Person, from time to time as specified by such Person, additional amounts sufficient to compensate such Person in the light of such circumstances, to the extent that such Person reasonably determines such increase in capital to be allocable to such Person's commitment or maintenance of Loans hereunder or such Person's commitment to participate in any Letter of Credit or Credit Support. A certificate as to the amount of such increased cost, submitted to the Borrowers by the applicable Person shall, absent manifest error, be conclusive and binding on the Borrowers for all purposes. 42 (c) Replacement of Lender. If any Borrower, as a result of the requirements of either Section 2.14(a) or Section 2.14(b), shall be required to pay any particular Lender (an "Affected Lender") the additional amounts referred to in such Section, which costs are not imposed by the other Lenders, and such additional amounts are material, then such Borrower shall be entitled to find a replacement Lender, reasonably acceptable to the Agents (the Agents' consent to such replacement Lender not to be unreasonably withheld), to replace the Affected Lender. The Affected Lender and the replacement Lender shall execute an Assignment Agreement with respect to all of the Affected Lender's Commitments and all Loans owing to the Affected Lender and comply with the other provisions of Section 11.08(c). Upon the payment by the replacement Lender to the Affected Lender of the then outstanding principal amount of Loans owing to the Affected Lender, together with accrued interest thereon, and the payment by the Borrower to the Affected Lender of any compensation required with respect to LIBOR Loans pursuant to Section 2.07(e), the replacement Lender shall succeed to all of the Affected Lender's rights and obligations under this Agreement and the other Loan Documents. SECTION 2.15. Joint and Several Liability; Contribution. (a) Notwithstanding anything to the contrary in this Agreement or the other Loan Documents, all payment and performance Obligations arising under this Agreement and the other Loan Documents shall be joint and several obligations of each Borrower secured by all the Borrowers' Collateral. The Agent and the Collateral Agent may apply any portion of any Borrower's Collateral to satisfy any of the Obligations of any other Borrower. (b) Contribution and Indemnification between the Borrowers. To the extent that any Borrower shall, as a result of the operation of Section 2.15, pay any Obligation of any other Borrower under the Loan Documents (such payment being referred to as an "Accommodation Payment"), then such Borrower shall be entitled to contribution and indemnification from, and be reimbursed by such other Borrower, as set forth in the Contribution Agreement. Each Borrower agrees that any extension, forbearance or amendment, or any acceptance, release or substitution of security, or any impairment or suspension of Lender's remedies or rights against any other Borrower or the cessation of the liability of any other Borrower for any reason other than full and indefeasible satisfaction of all Obligations shall not in any way affect the liability of such Borrower. Each Borrower has provided itself of the means of remaining informed of the financial condition of each other Borrower, and waives any right to require Lender to keep it informed of the financial condition of any other Borrower. The provisions of this section shall, to the extent expressly inconsistent with any provision in any Loan Document, supersede such inconsistent provision. 43 ARTICLE III REPRESENTATIONS AND WARRANTIES Each Borrower represents and warrants to the Agent, the Collateral Agent and the Lenders that: SECTION 3.01. Organization; Powers. (a) Such Borrower (i) is a corporation or limited liability company duly organized, validly existing and in good standing under the laws of its jurisdiction of organization and (ii) is qualified to do business in the jurisdiction in which its principal place of business is located and in every other jurisdiction where such qualification is necessary; (b) such Borrower has the power and authority to own its properties, to carry on its business as now conducted; and (c) such Borrower has the power and authority to execute and deliver and perform this Agreement and the other Loan Documents to which it is a party, to borrow hereunder, and will have the power to execute and deliver any Mortgages and Collateral Assignments of Leases or other instruments to be delivered by it subsequent to the date hereof. SECTION 3.02. Corporate Authorization. The execution, delivery and performance of this Agreement and the other Loan Documents to which such Borrower is a party, and the Loans hereunder: (a) have been duly authorized by such Borrower's Board of Directors or managers and, if necessary, such Borrower's stockholders or members; (b) (1) do not violate (i) any existing provision of law applicable to such Borrower and not immaterial to its business, (ii) such Borrower's Certificate or Articles of Incorporation or other organizational documents, as the case may be, or (iii) any applicable order of any court or other governmental agency, and (2) do not conflict with, result in a breach of or constitute (with due notice or lapse of time or both) a default under any indenture, agreement for borrowed money, bond, note or other similar instrument or any other material agreement to which such Borrower is a party or by which such Borrower or any of such Borrower's property is bound; (c) do not result in the creation or imposition of any Lien of any nature whatsoever upon any property or assets of such Borrower other than the Liens granted pursuant to this Loan Agreement or the other Loan Documents; (d) constitute legal, valid and binding obligations of such Borrower, enforceable against such Borrower in accordance with their respective terms; and (e) do not, as of the date of execution hereof, require any governmental consent, filing, registration or approval except as set forth on Schedule 3.02. 44 SECTION 3.03. Financial Statements. The Borrowers have furnished to the Agent and the Lenders the audited consolidated financial statements of KMC Holdings dated as of December 31, 1997, and the unaudited consolidated financial statements for the fiscal quarter ended September 30, 1998 and for the period ended October 31, 1998, which statements are attached hereto as Exhibit I (collectively, the "Financials"). The Financials have been prepared in accordance with GAAP applied on a basis consistent with that of preceding periods and are complete and correct in all material respects. As of the date of the Financials, (a) the Financials fairly represent KMC Holdings' financial position and results of operations; and (b) there are no omissions from the Financials or any other facts or circumstances not reflected in the Financials which are or may be material according to GAAP. SECTION 3.04. No Material Adverse Change. There has been no material adverse change in the condition (financial or otherwise), operations or properties of such Borrower since the date of the Financials. SECTION 3.05. Litigation. Except as set forth on Schedule 3.05, there are no actions, suits or proceedings at law or in equity or by or before any Governmental Authority now pending or, to the knowledge of such Borrower against or affecting such Borrower or any property or rights of such Borrower as to which there is a reasonable possibility of an adverse determination and which, if adversely determined, would individually or in the aggregate materially impair the right of any Borrower to carry on business substantially as now being conducted or as presently contemplated or would result in any Material Adverse Effect. SECTION 3.06. Tax Returns. Such Borrower has filed or caused to be filed all Federal, state and local tax returns which are required to be filed and has paid or caused to be paid all taxes as shown on such returns or on any assessment received by it to the extent that such taxes have become due, except such taxes the amount, applicability or validity of which are being contested in good faith by appropriate proceedings and with respect to which such Borrower shall have set aside on its books adequate reserves with respect to such taxes as are required by GAAP. SECTION 3.07. No Defaults. Such Borrower is not in default (i) with respect to any judgment, writ, injunction, decree, rule or regulation of any Governmental Authority which is likely to have a Material Adverse Effect, or (ii) in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any material agreement or instrument to which such Borrower is a party or by which any of its assets are bound, which is likely to have a Material Adverse Effect. SECTION 3.08. Properties. Such Borrower has good and marketable title to all its material properties and assets and all Collateral of such Borrower is free and clear of all Liens of any nature whatsoever, except Permitted Liens. SECTION 3.09. Licenses, Material Agreements, Intellectual Property. (a) Such Borrower has obtained all Governmental Approvals and approvals of any Governmental Authority having jurisdiction over such Borrower, which Governmental Approvals and approvals are necessary or appropriate for the construction and operation of the Systems as are presently operating, as contemplated in the Milestone Plan, other than immaterial municipal business 45 permits. Such Governmental Approvals and approvals are correctly listed on Schedule 3.09(a) and constitute the only material licenses, permits or franchises or other Governmental Approvals of any Governmental Authority required in connection with the Systems as are presently operating. All Governmental Approvals of such Borrower are in full force and effect, are duly issued in the name of, or validly assigned to, such Borrower and such Borrower has the power and authority to operate thereunder. (b) Schedule 3.09(b) accurately and completely lists all material agreements to which such Borrower is a party, including, without limitation, all purchase agreements, construction contracts, right of way or right of occupancy agreements, lease agreements, consulting, employment, management and related agreements. All of the foregoing agreements are valid, subsisting and in full force and effect and none of such Borrower, or, to the best of such Borrower's knowledge and belief, any other parties, are in material default thereunder. Such Borrower has given true and complete copies of all such agreements to the Agent and the Lenders. (c) Such Borrower owns or possesses all the patents, trademarks, service marks, trade names, copyrights and licenses, and all rights with respect to the foregoing (the "Intellectual Property"), necessary for the conduct of its business as presently conducted without any known conflict with the rights of others. Schedule 3.09(c) accurately and completely lists all Intellectual Property owned or possessed by or licensed to such Borrower. Such Borrower has entered into Intellectual Property Documents with respect to its Intellectual Property, as requested by the Collateral Agent. SECTION 3.10. Compliance With Laws. Except as disclosed on Schedule 3.10, the operations of such Borrower comply in all material respects with all applicable federal, state or local laws and regulations, including Environmental Laws. Except as disclosed on Schedule 3.10, none of the operations of such Borrower is subject to any judicial or administrative proceeding alleging the violation of any Environmental Laws. Except as disclosed on Schedule 3.10, such Borrower neither knows nor reasonably should know that any of the operations of such Borrower is the subject of federal or state investigation evaluating whether any Remedial Action is needed to respond to a Release. Except as disclosed on Schedule 3.10, such Borrower has not filed any notice under any federal or state law indicating past or present treatment, storage or disposal of a hazardous waste or reporting a Release. Except as disclosed on Schedule 3.10, such Borrower has no contingent liability of which such Borrower has knowledge or reasonably should have knowledge in connection with any Release. SECTION 3.11. ERISA. None of such Borrower or any ERISA Affiliate of such Borrower maintains or contributes to any Plan other than a Plan listed on Schedule 3.11 hereto. Each Plan which is intended to be qualified under Section 401(a) of the IRC has been determined by the IRS to be so qualified, and each trust related to any such Plan has been determined to be exempt from federal income tax under Section 501(a) of the IRC. Except as disclosed on Schedule 3.11, none of such Borrower or any ERISA Affiliate maintains or contributes to any employee welfare benefit plan within the meaning of Section 3(1) of ERISA 46 which provides benefits to employees after termination of employment other than as required by Section 601 of ERISA. None of such Borrower or any ERISA Affiliate has breached any of the responsibilities, obligations or duties imposed on it by ERISA or regulations promulgated thereunder with respect to any Plan which breach could result in a Material Adverse Effect. No Plan has incurred any accumulated funding deficiency (as defined in Section 302(a)(2) of ERISA and Section 412(a) of the IRC), whether waived or not waived. None of such Borrower or any ERISA Affiliate nor any fiduciary of any Plan which is not a Multiemployer Plan (i) has engaged in a nonexempt "prohibited transaction" described in Section 406 of ERISA or Section 4975 of the IRC or (ii) has taken or failed to take any action which would constitute or result in a Termination Event. None of such Borrower or any ERISA Affiliate has incurred any liability to the PBGC which remains outstanding and which could result in a Material Adverse Effect, other than the payment of premiums, and there are no premium payments which have become due which are unpaid. Schedule B to the most recent annual report filed with the IRS with respect to each Plan is complete and accurate. Since the date of each such Schedule B, there has been no adverse change in the funding status or financial condition of the Plan relating to such Schedule B. None of such Borrower or any ERISA Affiliate has (i) failed to make a required contribution or payment to a Multiemployer Plan or (ii) made a complete or partial withdrawal under Sections 4203 or 4205 of ERISA from a Multiemployer Plan. None of such Borrower or any ERISA Affiliate has failed to make a required installment or any other required payment under Section 412 of the IRC on or before the due date for such installment or other payment. None of such Borrower or any ERISA Affiliate is required to provide security to a Plan under Section 401(a)(29) of the IRC due to a Plan amendment that results in an increase in current liability for the plan year. SECTION 3.12. Investment Company Act; Public Utility Holding Company Act. Such Borrower is not an "investment company" as that term is defined in, and is not otherwise subject to regulation under, the Investment Company Act of 1940. Such Borrower is not a "holding company" as that term is defined in, and is not otherwise subject to regulation under, the Public Utility Holding Company Act of 1935. SECTION 3.13. Federal Reserve Regulations. Such Borrower is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying any margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System of the United States), and no part of the proceeds of the Loans made to such Borrower will be used to purchase or carry any such margin stock or to extend credit to others for the purpose of purchasing or carrying any such margin stock or for any purpose that violates, or is inconsistent with, the provisions of Regulation T, U or X of said Board of Governors. SECTION 3.14. Collateral. The security interests granted by Article VIII hereof, and accompanying financing statements, when duly filed in the offices and jurisdictions set forth on Schedule 3.14 hereof, create valid and perfected first priority Liens in and to the Collateral of such Borrower, enforceable against other Persons in all jurisdictions securing the payment, as applicable, of the Obligations hereunder. Upon filing such financing statements, to the extent that the filing of a financing statement is sufficient to perfect 47 a security interest, no further action is required to perfect the Liens of the Collateral Agent in favor of the Lenders in the Collateral of such Borrower described in Section 8.01. SECTION 3.15. Chief Place of Business. As of the Closing Date, the chief executive office and principal place of business address of such Borrower is 1545 Route 206, Bedminster, New Jersey 07921. If any change in any such location occurs, such Borrower shall notify the Agent and the Collateral Agent thereof not later than ten days after the occurrence thereof. As of the date of execution hereof, the books and records of such Borrower and all chattel paper and all records of account are located at the principal place of business or chief executive office of such Borrower and if any change in such location occurs, such Borrower shall notify the Agent and the Collateral Agent thereof not later than ten days after the occurrence thereof. SECTION 3.16. Other Corporate Names. Except as set forth on Schedule 3.16, such Borrower has not used and does not now use and will not use any corporate or fictitious name. SECTION 3.17. Insurance. Schedule 3.17 contains a description of all insurance which such Borrower maintains or has maintained on its behalf. All of such insurance is in full force and effect. SECTION 3.18. Milestone Plan. The Milestone Plan represents good faith projections of future financial performance of the Borrowers for the periods set forth therein. Such document has been prepared on the basis of the assumptions set forth therein, which the Borrowers believe are reasonable in light of current and reasonably foreseeable business conditions. SECTION 3.19. Capitalization and Subsidiaries. The classes of Equity Interests, number of authorized shares, number of outstanding shares and par values or other designations of the Equity Interests or other equity securities or beneficial interests of such Borrower are correctly set forth on Schedule 3.19. All the outstanding shares of Equity Interests or other equity securities or beneficial interests of such Borrower are duly and validly issued, fully paid and nonassessable, and none of such issued and outstanding shares, equity securities or beneficial interests has been issued in violation of, or is subject to, any preemptive or subscription rights. Except as set forth on Schedule 3.19, there are no: (A) outstanding shares of Equity Interests or other equity securities or beneficial interests or other securities convertible into or exchangeable for shares of Equity Interests or other equity securities or other beneficial interests of such Borrower, (B) outstanding rights of subscription, warrants, calls, options, contracts or other agreements of any kind, issued, made or granted to or with any Person under which such Borrower may be obligated to issue, sell, purchase, retire or redeem or otherwise acquire or dispose of any shares of Equity Interests or other equity securities or beneficial interests of such Borrower, or (C) Subsidiaries of such Borrower. KMC Holdings beneficially owns, directly or indirectly, all of the Equity Interests of such Borrower. 48 SECTION 3.20. Real Property, Leases and Easements. Such Borrower leases or owns the real property described on Schedule 3.20. Set forth on Schedule 3.20 is a list of (i) all real property leased or owned by such Borrower (the "Real Property") and (ii) all easements, rights of way, rights of occupancy, licenses and similar rights with respect to real property granted to such Borrower not otherwise disclosed to the Collateral Agent and the Lenders on a title report delivered to the Collateral Agent and the Lenders pursuant to the terms hereof (together with all easements, rights of way, rights of occupancy, licenses and similar rights with respect to real property granted to such Borrower which are so disclosed, collectively, the "Easements"). Also set forth on Schedule 3.20 is a street address of the Real Property locations described above, including a description of such properties' current use. Except as set forth in Schedule 3.20, such Borrower's interests in the Real Property and the Easements are sufficient in order for such Borrower to conduct its business and operations as presently conducted. SECTION 3.21. Solvency. After giving effect to any Loans made to such Borrower hereunder, the disbursement of the proceeds of such Loans pursuant to such Borrower's instructions and the execution, delivery and performance of each of the Loan Documents and transactions contemplated thereby, such Borrower is Solvent and is not contemplating either the filing of a petition by it under any state or federal bankruptcy or insolvency laws or the liquidation of all or a substantial portion of its property, and has no knowledge of any Person contemplating the filing of any such petition against such Borrower. SECTION 3.22. Brokers, etc. Such Borrower has not dealt with any broker, finder, commission agent or other similar Person in connection with the Loans or the transactions being effected contemporaneously with this Agreement, and such Borrower covenants and agrees to indemnify and hold harmless the Agent, the Collateral Agent and the Lenders from and against, any broker's fee, finder's fee or commission in connection with such transactions. SECTION 3.23. No Material Misstatements. Neither any report, financial statement, exhibit or schedule furnished by or on behalf of such Borrower to the Agent, the Collateral Agent or any Lender in connection with the negotiation of this Agreement and the other Loan Documents or included herein or therein, nor any other information required to be furnished pursuant to the provisions of Article V hereof, contains any material misstatement of fact or omits to state any material fact necessary to make the statements therein not materially misleading. SECTION 3.24. Year 2000 Problems. Each Borrower has made a full and complete assessment of the Year 2000 Problems and has a realistic and achievable program for remediating the Year 2000 Problems on a timely basis. Based on such assessment and program, such Borrower does not reasonably anticipate that Year 2000 Problems will have a Material Adverse Effect. 49 ARTICLE IV CONDITIONS FOR LOANS The obligations of each Lender to make Loans hereunder are subject to the accuracy, as of the Initial Funding Date and as of the date of making of each of the Loans after the Initial Funding Date, of the representations and warranties contained in Article III (except that any representations or warranties that relate to a specified date shall only be reaffirmed as of such date) and the other Loan Documents, to the performance by each Borrower of its obligations to be performed hereunder on or before the date of such Loan and to the satisfaction of the following further conditions: SECTION 4.01. Conditions Precedent to Initial Loan on or after the Closing Date. In the case of the Loans to be made on the Initial Funding Date and Letters of Credit to be issued or Credit Support for any Letters of Credit to be incurred on the Initial Funding Date: (a) All then applicable legal matters incident to this Agreement and the other Loan Documents shall be reasonably satisfactory to Counsel. (b) The Agent and the Collateral Agent , as applicable, shall have received payment in full of the fees set forth in the Fee Letters, and all the other documented out-of-pocket costs and expenses of the Agent and the Lenders incurred on or prior to the Initial Funding Date, including, without limitation, reasonable attorneys' and paralegals' fees and expenses and the fees and expenses incurred in connection with preparation of any environmental audits; provided, however, that any such attorneys' and paralegals' fees shall be limited to those of Counsel and to those permitted in those certain letter agreements dated September 25, 1998 between KMC Holdings and the Agent, and KMC Holdings and the Documentation Agent with respect to the fees and expenses of counsel for the Agent and the Documentation Agent. (c) (1) The Agent and the Collateral Agent shall have received the following items, in each case in form and substance satisfactory to the Agent and the Collateral Agent: (i) the Financials; (ii) the Milestone Plan showing in reasonable detail and specifying any material underlying assumptions, for the subsequent nine (9) year period, the Borrower's anticipated revenues and expenses and projected statements of cash flow and information with respect to projected capital expenditures and changes in working capital over such period, and a detailed Systems construction and buildout schedule; (iii)certificates substantially in the form of Exhibits J-1 and J-2 hereto, dated the Initial Funding Date or dated the Closing Date and a reaffirmation of such certificate dated the Initial Funding Date, of the secretaries or assistant secretaries of each of the Borrowers or the sole members of the Borrowers, as applicable, and KMC Holdings, certifying (1) the names and true signatures of the officers authorized to sign each Loan Document to which any Borrower or KMC 50 Holdings is a party, (2) the resolutions of the Board of Directors of any Borrower or KMC Holdings approving the transactions contemplated by the Loan Documents to which each is a party, (3) each Borrower's or KMC Holdings' bylaws, and only with respect to the certificate of KMC Holdings, (4) a true and correct copy of the Indenture, (5) true and correct copies of the Management Agreement and the Tax Sharing Agreement and (5) that KMC Holdings has made the Required Contributions to the Borrowers; (iv) the written opinions of special, regulatory and local counsel for the Borrowers and KMC Holdings, dated the Initial Funding Date, addressed to the Agent, the Collateral Agent and the Lenders satisfactory to (and containing only such qualifications and limitations as are satisfactory to) Counsel, which opinions shall be substantially in the forms set forth in Exhibits K-1, K-2 and K-3, respectively, attached hereto; (v) certificates of appropriate public officials dated not more than 30 days prior to the Initial Funding Date, as to the legal existence or qualification, and good standing of each Borrower and KMC Holdings from such Person's jurisdiction of organization and from the jurisdiction in which such Person has its principal place of business; (vi) each Borrower's and KMC Holdings' Certificate or Articles of Incorporation, as amended, modified or supplemented on or prior to the Initial Funding Date, each certified to be true, correct and complete by the Secretary of State of the state in which such Person is organized; (vii)completed Year 2000 questionnaires executed by each Borrower; (viii) the Notes duly executed and delivered by the Borrowers; and (ix) this Agreement duly executed and delivered by the Borrowers. (2) The Collateral Agent shall have received the following items in each case in form and substance satisfactory to the Collateral Agent: (i) Pledge Agreements duly executed by (A) KMC Holdings with respect to the Equity Interests of KMC and KMC II, (B) KMC with respect to the Equity Interests of KMC Virginia and Leasing I, and (C) KMC II with respect to the Equity Interests of Leasing II, together with, in each case, for 51 all such Equity Interests which are certificated, stock certificates and undated stock powers executed in blank in form and substance satisfactory to the Collateral Agent and for all such Equity Interests which are limited liability company interests, pledge instructions and initial transaction statements in form and substance satisfactory to the Collateral Agent; (ii) the KMC Holdings Guaranty, duly executed by KMC Holdings; (iii)loss payable endorsements substantially in the form of Exhibit M attached hereto with respect to each Borrower's insurance policies relating to the Collateral, and insurance certificates required by Section 5.04(g) from nationally recognized insurance brokers with respect to each Borrower's insurance policies; (iv) with respect to each Borrower's then existing Collection Accounts, Restricted Account Agreements substantially in the form of Exhibit N attached hereto, duly executed by the applicable Borrower and the financial institutions maintaining the Collection Accounts; (v) a duly executed Collateral Assignment of Licenses by each Borrower, together with consents to assignment of licenses and rights from Persons designated by the Collateral Agent duly executed by such Persons, including agreements as to default notices, cure rights, waiver of lien rights, conveyance of nondisturbance rights and other terms satisfactory to the Collateral Agent (provided the Borrowers shall have the post-closing period provided for in Section 5.08 with respect to obtaining the consents to Collateral Assignment of Licenses required pursuant to such Section); (vi) a duly executed Collateral Assignment of Leases by each Borrower, together with consents to assignment, duly executed by the appropriate Persons, including agreements as to default notices, cure rights, waiver of lien rights, conveyance of nondisturbance rights and other terms satisfactory to the Collateral Agent with respect to those leased properties specified by the Collateral Agent, together with landlord waivers in the form of Exhibit D hereto executed by the appropriate landlord with respect to those leased properties specified by the Collateral Agent; (vii)completed environmental questionnaires and indemnity agreement executed by each Borrower and Phase I Environmental Reports with respect to premises described on Schedule 3.10 (if any); 52 (viii) an Access Agreement executed and delivered by Cogeneration Services, Inc. with respect to each Borrower's premises located at 1545 Route 206, Suite 300, Bedminster, New Jersey in form and substance satisfactory to the Collateral Agent; (ix) the Contribution Agreement duly executed and delivered by the Borrowers; and (x) a Trademark Security Agreement in the form of Exhibit S hereto, executed and delivered by the Borrowers. (d) The Agents or the Collateral Agent, as applicable, shall have satisfactorily completed their review of any Lucent Purchase Agreement, any Additional Purchase Agreements, construction and maintenance contracts, right of way agreements and interconnection agreements related to the Systems being financed with the Loans made on the Initial Funding Date. (e) The Collateral Agent shall have received evidence satisfactory to the Collateral Agent that the Collateral Agent's security interests in the Collateral have been properly perfected and constitute first and prior security interests subject only to Permitted Liens, including by (i) filing Mortgages, the Collateral Assignment of Licenses, the Collateral Assignment of Leases, leasehold mortgages and UCC-1 financing statements in certain filing and recording offices, (ii) filing the Trademark Security Agreement in the United States Patent and Trademark Office, (iii) obtaining consents to the Collateral Assignments of Licenses and the Collateral Assignments of Leases (provided the Borrowers shall have the post-closing period provided for in Section 5.08 with respect to obtaining the consents to certain Collateral Assignments of Licenses required pursuant to such Section) and (iv) taking possession of stock certificates and other instruments, in each case, as requested by the Collateral Agent. (f) The Collateral Agent shall have received evidence satisfactory to the Collateral Agent, including the results of searches conducted in the mortgage recording, UCC, tax Lien and judgment filing records in each appropriate filing office or jurisdiction, that there are no Liens against the Collateral except Permitted Liens. (g) The Agent shall have received evidence satisfactory to the Agent that no Borrower has any Debt other than as described in Section 6.13 and that the holders of any such Debt described in clauses (v) and (vii) of Section 6.13 have executed subordination and standstill agreements satisfactory to the Agent. (h) The Collateral Agent, as it may require, shall have obtained or waived in writing with respect to each real estate and material equipment lease and each mortgage of any Borrower relating to the Systems being financed with the initial Loan made after the Closing Date (i) the right from the applicable lessors and mortgagees to cure all payment defaults under such leases and mortgages by making payment directly to the applicable lessors and mortgagees and (ii) landlord waivers and consents, as the Collateral Agent may require, with respect to each leased facility. 53 (i) The Agents shall have satisfactorily completed their due diligence investigation of the Borrowers and the Systems and the Borrowers' other assets, and their respective officers and directors including, without limitation, environmental reviews, engineering reviews, review of material agreements of the Borrowers and review of easement matters. (j) All right of way agreements with respect to each System under construction shall be sufficient to allow full operation of such System and shall, upon request of the Collateral Agent, be assignable to the Collateral Agent or its designee. (k) Lucent shall have executed and delivered to the Collateral Agent, in form and substance satisfactory to the Agents, a consent to collateral assignment of the Lucent Purchase Agreement. (l) KMC Holdings shall have, by either the making of capital contributions or Qualified Intercompany Loans, contributed or loaned cash to the Borrowers in an aggregate amount equal to at least $260,000,000. SECTION 4.02. Conditions Precedent to All Loans. In the case of each Loan hereunder, including, without limitation, the Loans made on the Term Loan Funding Date, and the obligation to issue Letters of Credit or provide Credit Support therefor: (a) The representations and warranties of each Borrower set forth in Article III or in any other Loan Document shall be true and correct in all material respects on and as of the date of such Loan with the same effect as though such representations and warranties had been made on and as of such date, except that any representations or warranties that relate to a specified date shall only be reaffirmed as of such date. (b) At the time of each such Loan, and after giving effect to such Loan, each Borrower shall be in compliance with all the terms and provisions set forth herein on its part to be observed or performed, and no Event of Default or Default shall have occurred and be continuing. (c) At the time of each such Loan and after giving effect to each such Loan, there shall have been no material adverse change in the condition (financial or otherwise), operations, properties or prospects of any Borrower since the date of the Financials. (d) Such Loan, when combined with Loans previously made to the Borrowers, shall not exceed the Commitment Amount. (e) All legal matters incident to such Loan and the Loan Documents shall be satisfactory to Counsel. (f) The Agent shall have received a Notice of Borrowing for the Loan and acceptance certificate and invoices required by Section 2.03. 54 (g) The Collateral Agent shall have first priority Liens on all personal and real property assets that comprise or relate to each System to be funded by such Loan, shall have received collateral assignments of all material third party agreements relating to such Systems, consented to by the applicable third parties, as requested by the Collateral Agent, and shall have received evidence that all necessary Governmental Approvals for such System have been obtained. (h) The Collateral Agent shall have received copies of such lien waivers and other acknowledgments from Persons constructing the Systems, any subcontractors or vendors (including Lucent or each Additional Vendor) with respect to the construction of the Systems as the Collateral Agent may reasonably request. (i) All fees and expenses which are due and payable to the Agent on or prior to the date of the advance of such Loan shall have been paid. (j) The Agents or the Collateral Agent, as applicable, shall have satisfactorily completed their review of any Additional Purchase Agreements, construction and maintenance contracts related to the Systems being financed with such Loan and the interconnection agreements for each System being financed with such Loan. (k) The Collateral Agent shall have obtained or waived in writing with respect to each real estate and material equipment lease, each mortgage, and each material third party agreement relating to the Systems being financed with such Loan (i) the right from the applicable lessors and mortgagees to cure all payment defaults under such leases and mortgages by making payments directly to the applicable lessors and mortgagees, as the Collateral Agent may request, (ii) landlord waivers and consents, as the Collateral Agent may require, with respect to each leased facility, and (iii) consents to collateral assignment, as the Collateral Agent may require, with respect to each such material third party agreement. (l) There shall not have occurred in the opinion of the Agents, any material adverse change in any two of the three members of Borrower's or KMC Holdings' senior management team, which shall comprise its Chief Executive Officer, Chief Financial Officer and Executive Vice President - Field Sales and Operations. (m) If a Loan is requested to finance Aged Equipment, the Collateral Agent, if it so elects, shall have obtained an appraisal of such Aged Equipment from an appraiser selected by the Collateral Agent, which appraisal shall be satisfactory to the Collateral Agent and the cost of which shall be borne by such Borrower. 55 ARTICLE V AFFIRMATIVE COVENANTS Each Borrower covenants and agrees that so long as this Agreement shall remain in effect, any Commitment hereunder shall be outstanding or any Obligations hereunder or under any of the other Loan Documents are unpaid, unless the Requisite Lenders shall have otherwise given prior written consent: SECTION 5.01. Corporate and Franchise Existence. Such Borrower shall preserve and maintain its corporate existence, rights, franchises, licenses and privileges in its jurisdiction of its organization, and in all other jurisdictions in which such qualification is necessary in view of its business and operations and property and preserve, protect and keep in full force and effect its material rights and its Governmental Approvals. SECTION 5.02. Compliance with Laws, Etc. Such Borrower shall comply in all material respects with all laws and regulations applicable to it, including, without limitation, Environmental Laws, regulations promulgated by the FCC and any PUC, and other telecommunications laws and regulations, and all material contractual obligations applicable to it. SECTION 5.03. Maintenance of Properties. Such Borrower shall at all times maintain in good repair, working order and condition, excepting ordinary wear and tear, all of its properties material to its operations and make all appropriate repairs, replacements and renewals thereof, in each case consistent with prudent industry practices and sound business judgment and with respect to the maintenance of machinery and equipment, in compliance with applicable government regulations, manufacturers' warranty requests and any licensing requirements. SECTION 5.04. Insurance. (a) Coverage. Without limiting any of the other obligations or liabilities of such Borrower under this Agreement, such Borrower shall carry and maintain, and require each contractor retained in connection with the construction of any System to carry and maintain, each at its own expense, at least the minimum insurance coverage set forth in this Section 5.04. Such Borrower shall also carry and maintain any other insurance that the Collateral Agent may reasonably require from time to time. All insurance carried pursuant to this Section 5.04 shall be placed with such insurers that have an A.M. Best rating of A:X or better, or as may be acceptable to the Collateral Agent. Such coverage shall be in such form, with terms, conditions, limits and deductibles as shall be acceptable to the Collateral Agent. (b) Construction Period. During the period from, and including the commencement of construction of any System, to and including the completion of construction of any System, such Borrower shall maintain in full force and effect, pay all premiums when due in respect of, and comply with all terms and conditions of the following coverages: (i) All Risk Builder's Risk. Such Borrower shall maintain all risk builder's risk insurance covering physical loss or damage to such System including, but not limited to, fire and extended coverage, collapse, flood, earth movement, and comprehensive boiler and machinery coverage (including electrical malfunction and mechanical breakdown). Such insurance shall cover all property during 56 construction and testing, as well as any and all materials, equipment and machinery intended for such System during off-site storage and inland transit and, if necessary, during ocean and air transit. All transit coverage shall be on a "warehouse to warehouse" basis. The all risk builder's risk policy shall be written on a replacement cost basis for the full construction cost of such System or in an amount acceptable to the Collateral Agent and shall contain an agreed amount endorsement waiving any coinsurance penalty. Coverage shall not exclude resultant damage caused by faulty workmanship, design or materials nor shall it exclude machinery and equipment under guarantee or warranty; and (ii) Delay in Start-Up. As an extension of the coverage required under subsection (b)(i) or as a separate policy, such Borrower shall maintain delay in start-up insurance covering net profits (if any), continuing expenses and debt service payments resulting from delays in achieving the completion date for the construction of any System caused by (i) physical loss or damage to such System during construction or testing, (ii) loss or damage to equipment while in ocean, air or inland transit or (iii) loss or damage to equipment while in storage away from the site. Contingent delay in start-up coverage shall also be included to cover delay caused by damage to critical path items while under manufacture or at the supplier's premise. Such extension or separate policy shall have a period of indemnity of not less than twelve (12) months with an agreed amount limit not less than $1,400,000 per System and shall contain an agreed amount endorsement waiving any coinsurance penalty. Such extension or separate policy shall also cover expediting expenses in an amount not less than $1,000,000. Deductibles may not exceed thirty (30) days; and (iii) Comprehensive or Commercial General Liability. Such Borrower shall maintain comprehensive general liability insurance written on an occurrence basis with a limit of liability not less than $1,000,000. Coverage shall include, but not be limited to, premises/operations, explosion, collapse, and underground hazards, broad form contractual, independent contractors products/completed operations, broad form property damage, and personal injury liability. Such insurance shall not exclude coverage for punitive or exemplary damages where insurable by law; and (iv) Workers' Compensation/Employer's Liability. Such Borrower shall maintain workers' compensation insurance in accordance with statutory provisions covering accidental injury, illness or death of an employee of such Borrower while at work or in the scope of his or her employment with such Borrower and employer's liability insurance in an amount not less than $1,000,000. Such coverage shall not contain any occupational disease exclusions; and (v) Automobile Liability. Such Borrower shall maintain automobile liability insurance covering owned, non-owned, leased, hired or borrowed vehicles against bodily injury or property damage. Such coverage shall have a limit of not less than $1,000,000; and 57 (vi) Excess/Umbrella Liability. Such Borrower shall maintain excess or umbrella liability insurance in an amount not less than $25,000,000 written on an occurrence basis providing coverage limits in excess of the insurance limits required under Section 5.04(b)(iii), (b)(iv) (employer's liability only), and (b)(v). Such insurance shall follow from the primary insurances and drop down in case of exhaustion of underlying limits and/or aggregates. Such insurance shall not exclude coverage for punitive or exemplary damages where insurable by law. (c) Contractor Insurance Coverage. Such Borrower shall cause each contractor retained in connection with the construction of any System to carry and maintain, in full force and effect, such insurance and such bonds as such contractor is required to maintain pursuant to the following: (i) Bond. Such Contractor shall maintain performance and payment bonds written in a form and by a surety acceptable to the Collateral Agent. Such bonds shall cover all payments, performance, material and other obligations of such contractor and all subcontractors. The applicable performance and payment bonds shall, at all times, be in an amount equal to the full value of the construction contracts. Each bond shall cover the faithful performance of the construction contract. Such Borrower and the Collateral Agent shall be named as obligees under each bond; and (ii) Comprehensive or Commercial General Liability. Such contractor shall maintain comprehensive general liability insurance covering the construction of such System written on an occurrence basis with a limit of liability not less than $25,000,000. Coverage shall include, but not be limited to, premises/operations, explosion, collapse, and underground hazards, sudden and accidental pollution, broad form contractual, independent contractors, products/completed operations, broad form property damage, and personal injury liability. Such insurance may be written in any combination of primary and excess/umbrella forms. The products completed operations coverage shall be extended to cover such System for two years after completion of such System. Such insurance shall not exclude coverage for punitive or exemplary damages where insurable by law; and (iii) Workers' Compensation/Employer's Liability. Such contractor shall maintain workers' compensation insurance in accordance with statutory provisions covering accidental injury, illness or death of an employee of such contractor while at work or in the scope of his or her employment with such contractor and employer's liability insurance in an amount not less than $25,000,000 written in any combination of primary and excess/umbrella policies, and 58 (iv) Automobile Liability. Such contractor shall maintain automobile liability insurance covering owned, non-owned, leased, hired or borrowed vehicles against bodily injury or property damage. Such coverage shall have a limit of not less than $25,000,000 written in any combination of primary and excess/umbrella policies. (d) Operations Period. Beginning on the completion date of each System, such Borrower shall maintain in full force and effect, pay all premiums when due in respect of, and comply with all terms and conditions of the following insurance coverages for each System. (i) All Risk Property Insurance. Such Borrower shall maintain all risk property insurance covering such System against physical loss or damage, including but not limited to fire and extended coverage, collapse, flood, earth movement and comprehensive boiler and machinery coverage (including electrical malfunction and mechanical breakdown). Such insurance shall cover each and every component of such System and shall not contain any exclusion for resultant damage caused by faulty workmanship, design or materials. Coverage shall be written on a replacement cost basis in an amount acceptable to the Collateral Agent. Such insurance policy shall contain an agreed amount endorsement waiving any coinsurance penalty; and (ii) Business Interruption. As an extension of the coverage required under Section 5.04(d)(i), such Borrower shall maintain business interruption insurance in an agreed amount equal to twelve (12) months projected loss of net profits, continuing expenses and debt service payments of such System and shall contain an agreed amount endorsement waiving any coinsurance penalty. Contingent business interruption insurance shall also be included to cover the major suppliers and customers of the Borrowers. Coverage shall be included for expediting expenses in an amount not less than $1,000,000. Such insurance shall also cover service interruption. Deductibles shall not exceed thirty (30) days; and (iii) Comprehensive or Commercial General Liability Insurance. Such Borrower shall maintain comprehensive general liability insurance written on an occurrence basis with a limit of not less than $1,000,000. Such coverage shall include, but not be limited to, premises/operations, explosion, collapse, underground hazards, contractual liability, independent contractors, products, completed operations, property damage and personal injury liability. Such insurance shall not exclude coverage for punitive or exemplary damages where insurable by law; and (iv) Workers' Compensation/Employer's Liability. Such Borrower shall maintain workers' compensation insurance in accordance with statutory provisions covering accidental injury, illness or death of an employee of such Borrower while at work or in the scope of his or her employment with such Borrower and employer's liability insurance in an amount not less than $1,000,000. Such coverage shall not contain any occupational disease exclusions; and (v) Automobile Liability. Such Borrower shall maintain automobile liability insurance covering owned, non-owned, leased, hired or borrowed vehicles against bodily injury or property damage. Such coverage shall have a limit of not less than $1,000,000; and 59 (vi) Excess/Umbrella Liability. Such Borrower shall maintain excess or umbrella liability insurance in an amount not less than $25,000,000 written on an occurrence basis providing coverage limits in excess of the insurance limits required under Sections 5.04(d)(iii), (d)(iv) (employer's liability only), and (d)(v). Such insurance shall follow from the primary insurances and drop down in case of exhaustion of underlying limits and/or aggregates. Such insurance shall not exclude coverage for punitive or exemplary damages where insurable by law. (e) Endorsements. Such Borrower shall cause all insurance carried and maintained in accordance with this Section 5.04 to be endorsed as follows: (i) Such Borrower shall be the named insured and the Collateral Agent shall be an additional named insured and loss payee with respect to policies described in Section 5.04(b)(i), (b)(ii), (d)(i) and (d)(ii). Such Borrower shall be the named insured and the Collateral Agent shall be an additional insured with respect to policies described in Section 5.04(b)(iii), (b)(iv) (to the extent allowed by law), (b)(v), (b)(vi), (d)(iii), (d)(iv) (to the extent allowed by law), (d)(v) and (d)(vi). Such Borrower and the Collateral Agent shall be additional insureds under all insurances carried by contractors under Section 5.04(c) to the extent allowed by law. All policies shall provide that any obligation imposed upon such Borrower and/or any contractor, including but not limited to the obligation to pay premiums, shall be the sole obligation of such Borrower and/or the contractor and not that of the Agent, the Collateral Agent or any Lender; and (ii) with respect to policies described in Section 5.04(b)(i) and (b)(ii), and (d)(i) and (d)(ii), the interests of the Collateral Agent shall not be invalidated by any action or inaction of such Borrower, or any other Person, and shall insure the Collateral Agent regardless of any breach or violation by such Borrower, any contractor or any other Person, of any warranties, declarations or conditions of such policies, and (iii) inasmuch as the liability policies are written to cover more than one insured, all terms, conditions, insuring agreements and endorsements, with the exception of the limits of liability, shall operate in the same manner as if there were a separate policy covering such insured; and (iv) the insurers thereunder shall waive all rights of subrogation against the Agent, the Collateral Agent or the Lenders, any right of setoff or counterclaim and any other right to deduction, whether by attachment or otherwise; and (v) such insurance shall be primary without right of contribution of any other insurance carried by or on behalf of the Agent, the Collateral Agent or the Lenders with respect to their interests as such in such System; and 60 (vi) if such insurance is canceled for any reason whatsoever, including nonpayment of premium, or any changes are initiated by such Borrower or carrier which affect the interests of the Collateral Agent, such cancellation or change shall not be effective as to the Collateral Agent until thirty (30) days, except in the case of non-payment of premium which shall be ten (10) days, after receipt by the Collateral Agent of written notice sent by registered mail from such insurer. (f) Certifications. On the Initial Funding Date, and at each policy renewal, but not less than annually, such Borrower shall provide to the Collateral Agent approved certification from each insurer or by an authorized representative of each insurer. Such certification shall identify the underwriters, the type of insurance, the limits, deductibles, and term thereof and shall specifically list the special provisions delineated for such insurance required for this Section 5.04. (g) Insurance Report. Concurrently with the furnishing of all certificates referred to in this Section 5.04, such Borrower shall furnish the Collateral Agent with an opinion from an independent insurance broker, acceptable to the Collateral Agent, stating that all premiums then due have been paid and that, in the opinion of such broker, the insurance then maintained by such Borrower is in accordance with this section. Furthermore, upon its first knowledge, such broker shall advise the Collateral Agent promptly in writing of any default in the payment of any premiums or any other act or omission, on the part of any Person, which might invalidate or render unenforceable, in whole or in part, any insurance provided by such Borrower hereunder. (h) Application of Payments. All payments received by such Borrower from any insurance referred in Section 5.04(b)(i), (b)(ii), (d)(i) and (d)(ii) shall be promptly delivered directly to the Collateral Agent, which amounts shall be applied by the Collateral Agent, upon request by such Borrower and provision to the Collateral Agent of detailed information, including a construction schedule and cost estimates, which establish to the reasonable satisfaction of the Collateral Agent that the amounts available and the proposed schedule are adequate to restore, replace or rebuild the property subject to insurance payments in a timely manner, to such restoration, replacement or rebuilding unless an Event of Default or Default shall have occurred and be continuing or such Borrower shall have failed to make such request within thirty (30) days after receipt of such amounts by Collateral Agent, in which case such amounts shall be applied in the Requisite Lenders' sole discretion to the repayment of the Obligations or such restoration, replacement or rebuilding. (i) General. The Collateral Agent shall be entitled, upon reasonable advance notice, to review and/or receive copies of such Borrower's (or other appropriate party's) books and records regarding all insurance policies carried and maintained with respect to each System and such Borrower's obligations under this Section 5.04. Notwithstanding anything to the contrary herein, no provision of this Agreement or any other Loan Document shall impose on the Collateral Agent, the Agent or any Lender any duty or obligation to verify the existence or adequacy of the insurance coverage maintained by such Borrower, nor shall the Collateral Agent, the Agent or any Lender be responsible for any representations or warranties made by or on behalf of such Borrower to any insurance broker, company or underwriter. The Collateral Agent or the Agent, at its sole option, 61 may obtain such insurance if not provided by such Borrower; in such event, such Borrower shall reimburse the Collateral Agent or the Agent upon demand for the cost thereof together with interest, and such costs shall constitute Obligations secured by the Collateral. SECTION 5.05. Obligations and Taxes. Such Borrower shall pay all of its indebtedness and obligations promptly and in accordance with their terms and pay and discharge promptly all taxes, assessments and governmental charges or levies imposed upon it or upon its income or profits or in respect of its property, before the same shall become in default, as well as all lawful claims for labor, materials and supplies or otherwise which, if unpaid, might become a Lien upon such properties or any part thereof; provided, however, that such Borrower shall not be required to pay and discharge or to cause to be paid and discharged any such tax, assessment, charge, levy or claim so long as the validity or amount thereof shall be contested in good faith by appropriate proceedings diligently pursued, and such Borrower shall set aside on its books such reserves as are required by GAAP with respect to any such tax, assessment, charge, levy or claim so contested. SECTION 5.06. Financial Statements, Reports, etc. Such Borrower shall furnish to the Agent and the Lenders (except as otherwise provided herein): (a) within one hundred twenty (120) days after the end of each fiscal year of such Borrower, two sets of annual consolidated and consolidating financial statements for KMC Holdings (one excluding Excluded Subsidiaries and one including Excluded Subsidiaries), and combined financial statements for the Borrowers, including the balance sheets and statements of operations, income, stockholders' equity and cash flows, for such fiscal year, prepared in accordance with GAAP, which consolidated financial statements and other above described financial information shall have been audited by a nationally recognized independent certified public accounting firm satisfactory to the Agent, and accompanied by such independent certified public accounting firm's unqualified opinion; (b) within forty-five (45) days after the end of each month and each fiscal quarter during each fiscal year of such Borrower, consolidated and consolidating unaudited balance sheets and statements of operations for KMC Holdings, and combined unaudited balance sheets and statements of operations for the Borrowers and consolidated and consolidating statements of stockholders' equity and cash flows of KMC Holdings, and combined consolidated statements of stockholders' equity and cash flows of the Borrowers as of the end of each such month or fiscal quarter, as applicable, and for the then elapsed portion of the fiscal year; provided, that with respect to the consolidated and consolidating unaudited balance sheets and statements of operations for KMC Holdings and statements of stockholders' equity and cash flows of KMC Holdings delivered as of the end of each fiscal quarter, such Borrower shall provide two sets of such statements (one excluding Excluded Subsidiaries and one including Excluded Subsidiaries); provided, further, that such Borrower shall not be required to deliver the items described in this Section 5.06(b) on a monthly basis at any time that, and only for so long as, the Borrowers have achieved positive EBITDA; 62 (c) concurrently with provision of the financial statements referred to in clauses (a) and (b) above, a certificate of KMC Holdings' independent certified public accountant or KMC Holdings' chief financial officer, as applicable, to the effect that the financial statements referred to in clause (a) or (b) above, present fairly the financial position and results of operations of KMC Holdings, and the Borrowers and as having been prepared in accordance with GAAP consistently applied, in each case subject to normal year end audit adjustments except for the statements referred to in clause (a) above; (d) concurrently with (a) above, and any statements delivered pursuant to (b) above in respect of the month of March and the period ending March 31, the month of June and the period ending June 30 or the month of September and the period ending September 30, a Periodic Reporting Certificate of the chief financial officer of KMC Holdings setting forth the calculations contemplated in Article VII hereof, the number of Completed Systems and certifying as to the fact that such Person has examined the provisions of this Agreement and that no Event of Default or any Default, shall have occurred and be continuing or if such an event has occurred, a statement explaining its nature and extent and setting forth the steps the Borrowers propose to take to cure such Event of Default; (e) (i) not later than December 1 of each calendar year, consolidating and consolidated projected and annual revenue and income statements, including detailed revenue and expense statements, balance sheets and cash flow statements for KMC Holdings for the succeeding fiscal year, such statements to be reasonably acceptable to the Agents, and (ii) not later than January 15, 1999, an annual operating budget on a monthly basis for such calendar year and not later than January 15 of each calendar year beginning January 15, 2000, an annual operating budget on a quarterly basis for such calendar year, with each such budget to be in compliance with the Milestone Plan; (f) to the Collateral Agent, all material agreements or licenses affecting the Governmental Approvals of any Borrower or any System promptly after any execution, or material amendment thereto; (g) to the Collateral Agent, promptly upon their becoming available, copies of any material periodic or special documents, statements or other information filed by any Borrower with the FCC, PUC or other Governmental Authority in connection with the construction and/or operation of any System or with respect to the transactions contemplated by any of the Loan Documents, and copies of any material notices and other material communications from the FCC, PUC or from any other Governmental Authority; (h) immediately upon any officer of any Borrower obtaining knowledge of any condition or event (i) which either constitutes an Event of Default or a Default, (ii) which renders any representation or warranty contained herein materially false or misleading, or when made, renders any document materially false or misleading, or (iii) which would result in any financial results for any fiscal year to materially deviate from the financial results projected for such fiscal year in the Milestone Plan or the financial projections described in clause (e) above, a certificate signed by an authorized officer of such Borrower specifying in reasonable detail the nature and period of existence thereof and what corrective action such Borrower has taken or proposes to take with respect thereto; 63 (i) within thirty (30) days after the end of each fiscal year of such Borrower, a certificate signed by an authorized officer of such Borrower (x) setting forth all the Real Property, Easements, licenses, rights of way and other similar interests in real property acquired by such Borrower in the preceding year and (y) confirming that no Default or Event of Default has occurred and is continuing; (j) evidence in the manner set forth in Section 5.04(e) of insurance complying with Section 5.04; (k) following the written request of the Agent, not later than forty-five (45) days after the end of each fiscal month, reports on accounts receivable and accounts payable of such Borrower in such detail and format as may be reasonably requested by the Agent; (l) promptly upon the filing thereof, copies of all registration statements and annual, quarterly, monthly or other regular reports which such Borrower or KMC Holdings files with the Securities and Exchange Commission; and (m) promptly from time to time such other information regarding the operations (including, without limitation, construction budgeting and System completion), business affairs and condition (financial or otherwise) of such Borrower or KMC Holdings as the Agent may reasonably request. SECTION 5.07. Litigation and Other Notices. Such Borrower shall give the Agent prompt written notice upon obtaining knowledge of the following: (a) all Events of Default or Defaults and all events of default or any event that would become an event of default upon notice or lapse of time or both under any of the terms or provisions of any note, or of any other evidence of indebtedness or agreement or contract governing the borrowing of money in excess of $250,000 in the aggregate, of such Borrower; (b) any levy, attachment, execution or other process against any of the property or assets, real or personal, of such Borrower in an amount in excess of $250,000; (c) the filing or commencement of any action, suit or proceeding by or before any court or any Governmental Authority which, if adversely determined against such Borrower, would result in a Material Adverse Effect; (d) any material adverse notice, letter or other correspondence of any kind from the FCC or the PUC relating to the Governmental Approvals or any System; (e) any default under any other material license, agreement or contract to which such Borrower is a party; and (f) any matter which has resulted in, or which such Borrower reasonably believes will result in, a Material Adverse Effect on such Borrower. SECTION 5.08. Mortgages; Landlord Consents; Licenses and Other Agreements. As security for the Obligations, such Borrower shall with respect to each Completed System, and each System which is not a Completed System but which is requested to be financed with the proceeds of Loans (a) promptly execute and deliver to the Collateral Agent (1) Mortgages in favor of and satisfactory to the Collateral Agent with respect to any real property purchased by such Borrower on which a switch or network operating center is located, and at the request of the Collateral Agent, with respect to any other real property purchased by such Borrower, together with lender's title policies for any such real property satisfactory to the Collateral Agent, if requested by the Collateral Agent, (2) leasehold mortgages or collateral assignments of leases, landlord waivers or consents, and appropriate Uniform Commercial Code fixture financing statements, in each case satisfactory to the Collateral Agent with respect to any real property leased by such Borrower and on which Switch Equipment or a network operating center is located, and at the request of the Collateral Agent, with respect to any other leased real property of such Borrower, (3) Mortgages or collateral assignments and consents satisfactory to the Collateral Agent with respect to such Borrower's Easements and rights of way, as requested by the Collateral Agent, (4) collateral assignments of leases and lessor consents, satisfactory to and as requested by the Collateral Agent, with respect to any long-haul fiber leased by such Borrower and (5) with respect to the First Eight Cities, on or before the Closing Date, and with respect to each other Completed System or System, at all times from and after the earlier of (i) the date on which any Borrower requests funding for such other Completed System or System and (ii) the date that is forty-five (45) days after the Closing Date, collateral assignments and consents to such assignments from the applicable third Persons, for each other material lease, license, contract or other agreement or instrument entered into by such Borrower after the date hereof, as required by the Collateral Agent and (b) (1) update Schedule 1 to the Collateral Assignment of Licenses to cover all Governmental Approvals obtained by such Borrower after the Closing Date and agreements entered into by such Borrower after the Closing Date with third Persons, (2) obtain consents to collateral assignments from the licensors granting the Governmental Approvals referred to in clause (b)(1) above and from those third Persons referred to in clause (b)(1) above that are specified by the Collateral Agent, such consents to collateral assignment to be in form and substance satisfactory to the Collateral Agent and (3) update Schedule 1 to the Collateral Assignment of Leases to cover all leases referred to in clause (a)(2) above. SECTION 5.09. ERISA. Such Borrower shall comply in all material respects with the applicable provisions of ERISA and furnish to the Agent, (i) as soon as possible, and in any event within thirty (30) days after such Borrower or any officer of such Borrower knows or has reason to know that any Reportable Event with respect to any Plan has occurred or any Termination Event has occurred, a statement of an officer of such Borrower setting forth details as to such Reportable Event or Termination Event and the corrective action that such Borrower proposes to take with respect thereto, together with a copy of the notice of any such Reportable Event given to the PBGC, and (ii) promptly after receipt thereof, a copy of any notice such Borrower may receive from the PBGC relating to the intention of the PBGC to terminate any Plan or to appoint a trustee to administer any such Plan. SECTION 5.10. Access to Premises and Records. Such Borrower shall permit representatives of the Agents to have access to such Borrower's books and records and to the Collateral and the premises of such Borrower at reasonable times upon reasonable notice and to make such excerpts from such records as such representatives deem necessary and to inspect the Collateral. 64 SECTION 5.11. Design and Construction. Such Borrower shall design, construct, equip and operate its Systems substantially as previously disclosed to Lenders in the Milestone Plan and in accordance with prudent industry standards. SECTION 5.12. Environmental Notices. If such Borrower shall (a) receive written notice that any violation of any Environmental Law may have been committed or is about to be committed by such Borrower, (b) receive written notice that any administrative or judicial complaint or order has been filed or is about to be filed against such Borrower alleging violations of any Environmental Law or requiring such Borrower to take any action in connection with any Release of any Contaminant into the environment, or (c) receive any written notice from a Governmental Authority or private party alleging that such Borrower may be liable or responsible for costs associated with a response to or cleanup of a Release or any damages caused thereby, such Borrower shall provide the Agent with a copy of such notice within twenty (20) Business Days of such Borrower's receipt thereof. SECTION 5.13. Amendment of Organizational Documents. Such Borrower shall notify the Agent and the Collateral Agent of any amendment to its Certificate or Articles of Incorporation or other organizational documents within ten (10) days of the occurrence of any such event, and provide the Agent with copies of any amendments certified by the secretary of such Borrower and of all other relevant documentation. Such Borrower shall promptly deliver to the Collateral Agent such financing statements executed by such Borrower which the Collateral Agent may request as a result of any such event. SECTION 5.14. Third Party Agreements and Delivery and Acceptance Certificates. Such Borrower shall provide the Collateral Agent with (i) copies of all interconnection agreements, right of way agreements, easement agreements, real property leases, construction agreements, equipment purchase agreements, fiber leases, telephone line leases, state and local franchise agreements and other agreements with municipalities, that in each case relate to each System of such Borrower, promptly after execution of each such agreement; provided, however, that with respect to certain of the foregoing categories of agreements specified by the Collateral Agent, such Borrower shall be permitted to provide the Collateral Agent with inventories of the particular types of agreements in lieu of delivering copies of the agreements, which inventories shall be (x) in form and substance satisfactory to the Collateral Agent and (y) updated by the applicable Borrower promptly following the execution of any additional agreement of the type inventoried; provided, further, however, that nothing in the foregoing proviso shall limit the Collateral Agent's ability to, at any time, request and receive a copy of any third party agreement from the applicable Borrower, and (ii) (A) if the Lenders are funding a Completed System, a delivery and acceptance certificate substantially in the form of Exhibit R hereto with respect to such Completed System and (B) otherwise, copies of delivery and acceptance certificates substantially in the form of Exhibit R hereto with respect to each item of Telecommunications Equipment with an invoiced purchase price in excess of $250,000, in each case, where such certificates are not required to be delivered to the Agent pursuant to Section 2.03(a), promptly after completion of such System or acceptance of such item of Equipment, as applicable. 65 SECTION 5.15. Accounts Payable. Such Borrower shall pay each of its accounts payable in accordance with its practices as of the Closing Date but in any event no later than sixty (60) days after the due date, provided, however, that such Borrower shall not be required to pay any account payable as long as the validity thereof shall be contested in good faith by appropriate protest or proceedings and such Borrower shall have set aside adequate reserves with respect thereto in accordance with GAAP. SECTION 5.16. Intellectual Property. Such Borrower shall enter into Intellectual Property Documents, in form and substance satisfactory to the Collateral Agent, with respect to all of the Intellectual Property owned by such Borrower. SECTION 5.17. Fiscal Year. Such Borrower shall maintain a fiscal year ending on December 31. SECTION 5.18. Completed Systems. On or prior to June 30, 1999, the Borrowers shall have, on a combined basis, Completed Systems in twenty-one (21) cities. On or prior to September 30, 1999, the Borrowers shall have, on a combined basis, Completed Systems in twenty-three (23) cities. SECTION 5.19. Year 2000 Problems. On or prior to March 31, 1999, each Borrower shall complete and deliver to the Agent a Year 2000 Corrective Plan. On or prior to April 30, 1999, each Borrower shall implement Year 2000 Corrective Actions. On or prior to June 30, 1999, each Borrower shall complete Year 2000 Corrective Actions and Year 2000 Implementation Testing. On or prior to September 30, 1999, each Borrower shall eliminate all Year 2000 Problems, except where the failure to correct the same could not reasonably be expected to have a Material Adverse Effect, individually or in the aggregate. SECTION 5.20. Subsidiary Guarantees and Pledges. Such Borrower shall (i) cause each Person which becomes a Subsidiary of such Borrower and does not become a Borrower under this Agreement to execute a guaranty of the Obligations substantially in the form of Exhibit G hereto, but exclusive of any financial covenants, and (ii) execute a Pledge Agreement pursuant to which all of the Equity Interests in such Person will be pledged to the Collateral Agent, provided, that in the event such Person is an indirect Subsidiary of such Borrower, such Borrower shall cause each applicable Subsidiary of such Borrower to pledge all of the Equity Interests in such Person to the Collateral Agent. SECTION 5.21. Accounting; Maintenance of Records. Such Borrower shall maintain a system of accounting established and administered in accordance with GAAP. Such Borrower shall keep and maintain, and cause each of its Subsidiaries to keep and maintain, in all material respects, proper books of record and account in which entries in conformity with GAAP shall be made of all dealings and transactions in relation to their respective businesses and activities. SECTION 5.22. Further Assurances. Such Borrower agrees to do such further acts and things and to execute and deliver to the Agent or the Collateral Agent such additional assignments, agreements, powers and instruments, at such Borrower's expense, as the Agent or the Collateral Agent may reasonably require or deem advisable to carry into effect the purposes of this Agreement and the other Loan Documents or to better assure and confirm unto the Agent or the Collateral Agent its rights, powers and remedies hereunder and thereunder. 66 ARTICLE VI NEGATIVE COVENANTS Each Borrower covenants and agrees with the Agent, the Collateral Agent and the Lenders that as long as this Agreement shall remain in effect, any Commitment hereunder shall be outstanding or any Obligations hereunder or under any of the Loan Documents shall be unpaid, unless the Requisite Lenders shall have otherwise given prior written consent: SECTION 6.01. Liens, etc. Such Borrower shall not create, incur, assume or suffer to exist, directly or indirectly, any Lien upon or with respect to any of its properties or the Collateral, now owned or hereafter acquired, or upon any proceeds, products, issues, income or profits therefrom except for the following ("Permitted Liens"): (i) Liens granted pursuant to the Loan Documents; (ii) Liens securing any Purchase Debt to the extent that the Liens cover only the subject assets purchased with such Purchase Debt; 67 (iii) Liens for taxes, assessments or governmental charges or levies on such Borrower's property if the same shall not at the time be delinquent or thereafter can be paid without penalty, or are being diligently contested in good faith and by appropriate proceedings and for which such Borrower shall have set aside reserves on its books as required by GAAP; (iv) Liens imposed by law, such as landlord's, carrier's, warehousemen's and mechanic's liens, which liens shall be waived in writing to the extent waivable, and with respect to obligations not yet due or being contested in good faith by appropriate proceedings and in either case for which such Borrower shall have set aside reserves on its books as required by GAAP; (v) Liens arising out of pledges or deposits under workmen's compensation laws, unemployment insurance, old age pensions, or other social security benefits other than any Lien imposed by ERISA; (vi) Liens incurred or deposits made in the ordinary course of business to secure surety bonds provided that such Liens shall extend only to cash collateral for such surety bonds; or 68 (vii) Liens on cash securing the reimbursement obligations under the Excluded Letters of Credit. SECTION 6.02. Use of Proceeds. Such Borrower shall not use the proceeds of any Loan for any purpose other than as provided in Section 2.02 hereof. SECTION 6.03. Sale of Assets, Consolidation, Merger, etc. Such Borrower shall not consolidate with or merge into any other Person, or without the prior written consent of the Requisite Lenders, sell, lease, transfer or otherwise dispose of any Collateral, except for (a) sales of inventory in the ordinary course of business, and (b) any sale, lease, transfer or other disposition of assets no longer used or useful in the conduct of the Business for the fair market value thereof not to exceed $250,000 in the aggregate; provided, however, that if no Event of Default has then occurred or is continuing or would result therefrom, any Borrower, upon provision of thirty days prior written notice to the Agent and upon compliance with Section 8.02, may merge with another Borrower. SECTION 6.04. Dividends and Distributions; Sale of Equity Interests. (a) Such Borrower shall not purchase, redeem or otherwise acquire any interest of such Borrower, declare or make or pay any dividends in any fiscal year of such Borrower on any class or classes of stock, return capital of such Borrower to its shareholders, make any other distribution on or in respect of any shares of any class of capital stock of such Borrower or make other payments to any shareholder of such Borrower (including in the form of compensation, loan, expense reimbursement or management fee); provided, however, that provided no Event of Default or Default has occurred and is continuing or would result therefrom, (i) such Borrower may make payments of fees or compensation for services which are in the nature of management, corporate overhead or administrative services to the extent permitted by Section 6.05 hereof, (ii) provided further, that (A) during the previous four fiscal quarters of the Borrowers, EBITDA equaled at least eighty-five percent (85%) of "Estimated EBITDA" (as defined below) and such Estimated EBITDA is a positive number, (B) during the previous four fiscal quarters of the Borrowers, the Borrowers maintained a Fixed Charge Coverage Ratio of at least 1.10 to 1.00, (C) with respect to the next four fiscal quarters of the Borrowers, EBITDA for the Borrowers, as projected in the most recent financial information furnished pursuant to Section 5.06(e), is projected to equal at least eighty-five percent (85%) of Estimated EBITDA for such fiscal quarters and such Estimated EBITDA is a positive number, and (D) with respect to the next four fiscal quarters of the Borrowers, the Fixed Charge Coverage Ratio as projected in the most recent financial information submitted to the Agent and the Lenders pursuant to Section 5.06(e), is projected to equal at least 1.10 to 1.00, the Borrowers may pay to KMC Holdings dividends in the amount necessary to make scheduled principal and interest payments under the Indenture, and any other amounts due under the Indenture (including Sections 4.14 and 7.07 thereunder). Estimated EBITDA shall mean "EBITDA" as calculated in the Milestone Plan. 69 (b) Such Borrower shall not sell or issue any additional Equity Interests. SECTION 6.05. Management Fees and Permitted Corporate Overhead. Such Borrower shall not pay or enter into any arrangement to pay any fee or compensation, or reimburse expenses of, an Affiliate or any other Person for services which are in the nature of management, corporate overhead or administrative services except to the extent provided for in the Milestone Plan, the Management Agreement or as described on Schedule 6.11 attached hereto. SECTION 6.06. Guarantees; Third Party Sales and Leases. Such Borrower shall not directly or indirectly, (i) assume any obligation or indebtedness of another Person, (ii) make or assume any Guarantee, or (iii) finance any third party sales or leases, other than its obligations under Section 2.15. SECTION 6.07. Investments. Such Borrower shall not, directly or indirectly, make any Investments except: (i) Temporary Cash Investments; (ii) Investments in certificates of deposit, repurchase agreements, money market or other cash management accounts, bankers acceptances and short term Eurodollar time deposits with financial institutions having a long term deposit rating of at least A+ from Moody's Investors Service, Inc. or Standard & Poor's Ratings Group, respectively; (iii) Investments in commercial paper rated P1 or A1 by Moody's Investors Service, Inc. or Standard & Poor's Ratings Group respectively; and (iv) until March 15, 1999 an Investment in a corporate bond of Associates Corporation North America in the principal amount of $3,650,000 and maturing March 15, 1999. SECTION 6.08. Subsidiaries. Such Borrower shall not create or acquire any Subsidiary other than with the prior written consent of the Requisite Lenders. SECTION 6.09. Permitted Activities. Such Borrower shall not engage in any business or activity other than the operation of its Business in accordance with the Milestone Plan without the prior written consent of the Requisite Lenders. SECTION 6.10. Disposition of Licenses, etc. Such Borrower shall not sell, assign, transfer or otherwise dispose or attempt to dispose of in any way any Governmental Approval or any other licenses, permits or approvals (i) prior to the Trigger Date, material, in each case, to the operation of any System in accordance with the Milestone Plan and (ii) on or after the Trigger Date, the assignment, transfer or disposal of which would result in a Material Adverse Effect, without the prior written consent of the Requisite Lenders. 70 SECTION 6.11. Transactions with Affiliates. Except for the Management Agreement, the Tax Sharing Agreement, or as set forth on Schedule 6.11, such Borrower shall not directly or indirectly, enter into any transaction, including, without limitation, leases or other agreements for the purchase or use of any goods or services, with any Affiliate, except in the ordinary course of and pursuant to reasonable requirements of such Borrower's business upon fair and reasonable terms no less favorable to such Borrower than it would obtain in a comparable arm's length transaction with an unaffiliated Person. SECTION 6.12. ERISA. Such Borrower shall not: (A) engage, or permit any ERISA Affiliate to engage, in any prohibited transaction described in Section 406 of ERISA or 4975 of the IRC for which a statutory or class exemption is not available or a private exemption has not been previously obtained from the United States Department of Labor; (B) permit to exist any accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the IRC), whether or not waived; (C) fail, or permit any ERISA Affiliate to fail, to pay timely required contributions or annual installments due with respect to any waived funding deficiency to any Benefit Plan; (D) terminate, or permit any ERISA Affiliate to terminate, any Benefit Plan which would result in any material liability of such Borrower under Title IV of ERISA; (E) fail to make any contribution or payment to any Multiemployer Plan which such Borrower or any ERISA Affiliate may be required to make under any agreement relating to such Multiemployer Plan, or any law pertaining thereto; (F) amend, or permit any ERISA Affiliate to amend, a Plan resulting in an increase in current liability for the plan year such that such Borrower is required to provide security to such Plan under Section 401(a)(29) of the IRC; or (G) fail, or permit any ERISA Affiliate to fail, to pay any required installment under Section 412 of the IRC on or before the due date for such installment or other payment. SECTION 6.13. Indebtedness. Such Borrower shall not create or suffer to exist any Debt or any other obligations for the deferred purchase price of property or services except: (i) the Obligations; (ii) the obligations arising under any Loan Document; (iii) obligations under leases contemplated in the Milestone Plan and the Schedules to this Agreement; 71 (iv) obligations under Capitalized Leases, financing leases or loan agreements or similar debt documents with respect to the financing and contemplated purchase of office equipment, vehicles and non-essential telecommunications equipment, not to exceed an aggregate amount for the Borrowers of $5,000,000 at any time ("Purchase Debt"); (v) additional unsecured Debt subordinate to the payment of the Obligations on terms and conditions approved by the Agents but in no event to exceed an aggregate amount for the Borrowers of $1,000,000 in principal amount outstanding at any time; (vi) performance bonds executed solely in connection with the construction of Systems in the ordinary course of business; (vii) Qualified Intercompany Loans; and (viii) Debt to the Agent consisting of reimbursement obligations for letters of credit in an aggregate outstanding amount not to exceed $250,000 at any one time for the account of the Borrower and not issued pursuant to Section 2.10 (the "Excluded Letters of Credit"). SECTION 6.14. Prepayment and Debt Documents. (a) Such Borrower shall not voluntarily prepay any Debt, except the Obligations in accordance with the terms hereof. (b) Such Borrower shall not amend any agreement relating to Debt other than the Obligations in any manner which would increase the amount of principal, interest or fees on such debt, or accelerate any payments of such Debt. SECTION 6.15. Sale and Leaseback Transactions. Such Borrower shall not, directly or indirectly, enter into any arrangement with any Person providing for such Borrower to lease or rent property that any Borrower or KMC Holdings has sold or will sell or otherwise transfer to such Person. SECTION 6.16. Margin Regulation. Such Borrower shall not use or permit any other Person to use any portion of the proceeds of any credit extended under this Agreement in any manner which might cause the extension of credit made by any Lender or the application of such proceeds to violate the Securities Act of 1933 or Securities Exchange Act of 1934 (each as amended from time to time, and any successor statute) or to violate Regulation G, Regulation U, or Regulation X, or any other regulation of the Federal Reserve Board, in each case as in effect on the date or dates of such extension of credit and such use of proceeds. SECTION 6.17. Management and Tax Sharing Agreements. Such Borrower shall not amend the Management Agreement or the Tax Sharing Agreement in any manner that would have a material adverse effect on the Lenders, the Borrowers or the transactions contemplated hereby. 72 ARTICLE VII FINANCIAL COVENANTS Each Borrower covenants and agrees with the Agent and the Lenders that as long as this Agreement shall remain in effect, any Commitment hereunder shall be outstanding or the Obligations hereunder or under any of the Loan Documents shall be unpaid, unless the Requisite Lenders shall have otherwise given prior written consent: SECTION 7.01. Financial Covenants Prior to Achieving Positive EBITDA. Until the earlier to occur of (i) June 29, 2001 and (ii) the date on which the Borrowers shall have achieved positive EBITDA for all the Borrowers on a combined basis for two consecutive fiscal quarters as determined by reference to the financial statements submitted pursuant to Section 5.06: (a) Total Debt to Contributed Capital. The Borrowers shall not at any time permit the ratio of the Total Debt to Contributed Capital to exceed 1.00 to 1.00. (b) Minimum Revenues. As of the last day of each fiscal quarter, the Borrowers shall on a combined basis have revenues at least equal to 85% of the amount projected for such date in the Milestone Plan, which amount is set forth in item 1 on Annex B attached hereto. (c) EBITDA. (i) As of the last day of each fiscal quarter occurring on or after the Closing Date and on or prior to September 30, 2000, the Borrowers shall not permit the EBITDA losses for all the Borrowers on a combined basis for the two fiscal quarters then ending to exceed the greater of (A) 115% of such losses projected for each such date in the Milestone Plan, which amount is set forth in item 2 on Annex B attached hereto and (B) $5,000,000 less than the aggregate amount of EBITDA projected for each such date in the Milestone Plan, which amount is set forth in item 2 on Annex B attached hereto. (ii) As of the last day of each fiscal quarter thereafter, the Borrowers shall not permit EBITDA for all the Borrowers on a combined basis for the two fiscal quarters then ending to be less than the greater of (A) 85% of the amount of EBITDA projected for each such date in the Milestone Plan, which amount is set forth in item 3 on Annex B attached hereto and (B) $5,000,000 less than the aggregate amount of EBITDA projected for each such date in the Milestone Plan, which amount is set forth as item 3 on Annex B attached hereto. (d) Capital Expenditures. As of the last day of each fiscal quarter, the Borrowers shall not permit capital expenditures on a combined, cumulative basis beginning on the Closing Date to exceed the amounts set forth in item 4 on Annex B attached hereto. 73 (e) Minimum Access Lines. As of the last day of each fiscal quarter beginning March 31, 2000, the Borrowers shall have in place at least seventy-five percent (75%) of the Access Lines projected for each such date in the Milestone Plan, which amounts are set forth in item 6 on Annex B attached hereto. SECTION 7.02. Financial Covenants After Achieving Positive EBITDA. On and after the earlier of (i) June 30, 2001, and (ii) the date on which the Borrowers have achieved positive EBITDA on a combined basis for two consecutive fiscal quarters as determined by reference to the financial statements submitted pursuant to Section 5.06: (a) Maximum Total Leverage Ratio. As of the last day of each fiscal quarter, the Borrowers shall not permit the Total Leverage Ratio to be greater than the following: Maximum Total Fiscal Quarter Ending Leverage Ratio - - --------------------- -------------- On or Prior to June 30, 2001 8.0 to 1.0 September 30, 2001 6.0 to 1.0 December 31, 2001 4.0 to 1.0 March 30, 2002 3.0 to 1.0 June 30, 2002 3.0 to 1.0 September 30, 2002 3.0 to 1.0 December 31, 2002 3.0 to 1.0 Last Day of each 2.0 to 1.0 Fiscal Quarter Thereafter (b) Minimum Debt Service Coverage Ratio. As of the last day of each fiscal quarter, the Borrowers shall not permit the ratio of (1) EBITDA for the Borrowers on a combined basis for the most recently ended six month period, to (2) Interest Expense for the most recently ended six month period plus Principal Payments required during the most recently ended six month period to be less than the following: Minimum Debt Service Fiscal Quarter Ending Coverage Ratio - - --------------------- -------------- On or prior to December 31, 2001 1.5 to 1.0 Last Day of each Fiscal 2.0 to 1.0 Quarter Thereafter (c) Minimum Fixed Charge Coverage Ratio. As of the last day of any fiscal quarter, the Borrowers shall not permit the ratio of (1) the product of two times the EBITDA for the Borrowers on a combined basis for the most recently ended six month period to (2) Fixed Charges for the Borrowers (such ratio being referred to as the "Fixed Charge Coverage Ratio") to be less than the following: 74 Minimum Fixed Charge Fiscal Quarter Ending Coverage Ratio - - --------------------- -------------- On or prior to June 30, 2001 0.5 to 1.0 September 30, 2001 1.0 to 1.0 December 31, 2001 1.0 to 1.0 Last Day of each Fiscal 1.1 to 1.0 Quarter Thereafter (d) Maximum Consolidated Leverage Ratio. As of the last day of any fiscal quarter, the Borrowers shall not permit the ratio of (1) Consolidated Debt to (2) the product of two times the sum of EBITDA for KMC Holdings and its Subsidiaries (excluding its Excluded Subsidiaries) on a consolidated basis for the most recently ended six month period to be greater than the following: Maximum Total Fiscal Quarter Ending Leverage Ratio - - --------------------- -------------- On or Prior to June 30, 2001 20.0 to 1.0 September 30, 2001 15.0 to 1.0 December 31, 2001 11.0 to 1.0 March 31, 2002 10.0 to 1.0 June 30, 2002 10.0 to 1.0 September 30, 2002 10.0 to 1.0 December 31, 2002 10.0 to 1.0 March 31, 2003 8.0 to 1.0 June 30, 2003 8.0 to 1.0 September 30, 2003 8.0 to 1.0 December 31, 2003 8.0 to 1.0 Last Day of Each Fiscal 6.0 to 1.0 Quarter Thereafter ARTICLE VIII COLLATERAL SECURITY SECTION 8.01. Collateral Security. (a) To secure payment and performance of all of the Obligations, each of the Borrowers hereby grants to the Collateral Agent for the benefit of the Collateral Agent, the Agent and the Lenders, to the extent permitted by law, a right of setoff against and a continuing security interest in and to all of such Borrower's tangible and intangible personal property, fixtures and real property leasehold and easement interests, whether now owned or existing, or hereafter acquired or arising, wheresoever located, including, without limitation, all of the following property, or interests in property: (a) all machinery, equipment, Telecommunications Equipment and fixtures, including without limitation, fiber optic and other cables, transmission and switching equipment, transmission facilities, connection equipment, conduit, carrier pipes, junctions, 75 regenerators, power sources, alarm systems, electronics, structures and shelters and cable laying equipment; (b) all Accounts, accounts receivable, other receivables, contract rights, leases, chattel paper, investment property, and general intangibles of such Borrower (including, without limitation, goodwill, going concern value, patents, trademarks, trade names, service marks, blueprints, designs, product lines and research and development), including, without limitation, all of such Borrower's rights under all present and future Governmental Approvals, permits, licenses and franchises heretofore or hereafter granted to such Borrower for the operation and ownership of its Systems (excluding licenses and permits issued by the FCC, any PUC or any other Governmental Authority to the extent, and only to the extent, it is unlawful to grant a security interest in such licenses and permits, but including, to the maximum extent permitted by law, all rights incident or appurtenant to such licenses and permits, including, without limitation, the right to receive all proceeds derived from or in connection with the sale, assignment or transfer of such licenses and permits), whether now owned or hereafter acquired by such Borrower, or in which such Borrower may now have or hereafter acquire an interest; (c) all instruments, letters of credit, documents of title, policies and certificates of insurance, securities, bank deposits, deposit accounts (including such Borrower's Collection Accounts), checking accounts and cash now or hereafter owned by such Borrower, or in which such Borrower may now have or hereafter acquire an interest; (d) all inventory, including all merchandise, raw materials, work in process, finished goods and supplies, now or hereafter owned by such Borrower or in which such Borrower may now have or hereafter acquire an interest; (e) all of such Borrower's leasehold interest in any real property, all of such Borrower's licenses, easements and rights of way with respect to real property; (f) all accessions, additions or improvements to, substitutions for and all proceeds and products of, all of the foregoing, including proceeds of insurance; and (g) all books, records, documents, computer tapes and discs relating to all of the foregoing. SECTION 8.02. Preservation of Collateral and Perfection of Security Interests Therein. Such Borrower shall execute and deliver to the Collateral Agent for the benefit of the Collateral Agent, the Agent and the Lenders, prior to the Initial Funding Date, and at any time or times thereafter at the request of the Collateral Agent, all financing statements or other documents (and pay the cost of filing or recording the same in all public offices deemed necessary by the Collateral Agent), as the Collateral Agent may request, in a form satisfactory to the Collateral Agent, to perfect and keep perfected the security interest in the Collateral granted by such Borrower to the Collateral Agent or to otherwise protect and preserve the Collateral and the Collateral Agent's security interest therein or to enforce the Collateral Agent's security interest in the Collateral. Should such Borrower fail to do so, the Collateral Agent is authorized to sign any such financing statements as such Borrower's agent. Such Borrower further agrees that a carbon, photographic or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement. SECTION 8.03. Appointment of the Collateral Agent as the Borrowers' Attorney-in-Fact. Such Borrower hereby irrevocably designates, makes, constitutes and appoints the Collateral Agent (and all persons designated by the Collateral Agent) as such Borrower's true and lawful attorney-in-fact, and authorizes the Collateral Agent, in such Borrower's or the Collateral Agent's name, to, following the occurrence and during the continuance of an Event of Default: (i) demand payment of such Borrower's Accounts; (ii) enforce payment of 76 such Borrower's Accounts by legal proceedings or otherwise; (iii) exercise all of such Borrower's rights and remedies with respect to proceedings brought to collect an Account; (iv) sell or assign any Account upon such terms, for such amount and at such time or times as the Collateral Agent deems advisable; (v) settle, adjust, compromise, extend or renew an Account; (vi) discharge and release any Account; (vii) prepare, file and sign such Borrower's name on any proof of claim in bankruptcy or other similar document against an account debtor of such Borrower; (viii) notify the post office authorities to change the address for delivery of such Borrower's mail to an address designated by the Collateral Agent, and open and deal with all mail addressed to such Borrower; (ix) do all acts and things which are necessary, in the Collateral Agent's sole discretion, to fulfill such Borrower's obligations under this Agreement; (x) take control in any manner of any item of payment or proceeds thereof; (xi) have access to any lockbox or postal box into which such Borrower's mail is deposited; (xii) endorse such Borrower's name upon any items of payment or proceeds thereof and deposit the same in the Collateral Agent's account on account of the Obligations; (xiii) endorse such Borrower's name upon any chattel paper, document, instrument, invoice, or similar document or agreement relating to any Account or any goods pertaining thereto; and (xiv) sign such Borrower's name on any verification of Accounts and notices thereof to account debtors. SECTION 8.04. Collection of Accounts and Restricted Account Arrangements. Such Borrower hereby represents and warrants that each depository account ("Collection Account") now maintained by such Borrower at any bank ("Collection Agent") for the collection of checks and cash constituting proceeds of Accounts and sales of other personal property which are part of the Collateral is identified on Schedule 8.04 attached hereto and made a part hereof. With respect to each Collection Account, such Borrower shall, no later than the Initial Funding Date, deliver to the Collateral Agent, a "Restricted Account Agreement" substantially in the form of Exhibit N attached hereto and made a part hereof, duly executed and delivered by such Borrower and the applicable Collection Agent, authorizing and directing such Collection Agent, upon receipt of written notice from the Collateral Agent that an Event of Default has occurred and is continuing, to deposit all checks and cash received into a restricted account (a "Restricted Account") and remit all amounts deposited in such Restricted Account to the Collateral Agent's account specified in such Restricted Account Agreement until such time as the Collection Agent receives written notice from the Collateral Agent rescinding such instruction. Such Borrower shall, following the occurrence and during the continuance of an Event of Default and any subsequent request by the Collateral Agent therefor, take such further action as the Collateral Agent may reasonably deem desirable to effect the transfer of exclusive ownership and control of the Restricted Accounts and all Collection Accounts to the Collateral Agent. Until all of the Obligations have been indefeasibly paid in full, such Borrower agrees not to enter into any agreement or execute and deliver any direction which would modify, impair or adversely affect the rights and benefits of the Collateral Agent under any Restricted Account Agreement. Such Borrower shall not open, establish or maintain any Collection Account (other than those identified on Schedule 8.04 hereto) without first having delivered to the Collateral Agent a duly executed and delivered Restricted Account Agreement with respect to such Collection Account. Such Borrower shall notify the Collateral Agent in writing not less than five (5) days prior to the date it shall open or establish any Collection Account other than an account described on Schedule 8.04 hereto. 77 SECTION 8.05. Cure Rights. Such Borrower expressly authorizes the Collateral Agent, and the Collateral Agent may, but shall not be required to, at any time and from time to time, to take any and all action that it reasonably determines to be necessary or desirable to cure any default or violation (including a payment default) of such Borrower in connection with any real estate lease, license agreement, Governmental Approval or any other material lease, agreement or contract entered into with respect to the Systems. ARTICLE IX EVENTS OF DEFAULT; REMEDIES SECTION 9.01. Events of Default. The following events shall each constitute an "Event of Default": (a) Any Borrower shall fail to pay the principal of or interest on its Notes or any other amounts payable hereunder or under any of the other Loan Documents when due, whether as scheduled, at a date fixed for prepayment, by acceleration or otherwise, and five (5) Business Days shall have elapsed; or (b) Any Borrower shall fail to observe or perform any other covenant, condition or agreement to be observed or performed by such Borrower in any of the Loan Documents, and such Borrower fails to cure such breach within ten (10) Business Days after written notice thereof unless the breach relates to a covenant contained in Sections 5.04, or Article VI (other than Section 6.05 or Section 6.07) or VII, in which case no notice or grace period shall apply, or unless the breach relates to Section 5.06, in which case an Event of Default shall occur on the thirtieth day following the breach without any notice requirement, unless the breach shall have been cured before such date; or (c) Any representation or warranty made by any Borrower or KMC Holdings in connection with this Agreement or any other Loan Document, or the Loans or any statement or representation made in any report, certificate, financial statement or other instrument furnished by or on behalf of such Borrower or KMC Holdings pursuant to this Agreement or any other Loan Document, shall prove to have been false or misleading in any material respect when made or delivered or when deemed made in accordance with the terms hereof or thereof; or (d) Any Borrower or KMC Holdings shall fail to make any payment due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) on any other obligation for borrowed money in excess of $250,000 with respect to any Borrower or in excess of $1,000,000 with respect to KMC Holdings, and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such indebtedness; or any other default or event under any agreement or instrument relating to any indebtedness for borrowed money in excess of $250,000 with respect to any Borrower or in excess of $1,000,000 with respect to KMC Holdings, or any other event, shall occur and shall continue after the applicable grace period, if any, specified in such agreement or instrument if the effect of such default or event is to accelerate, or to permit the acceleration of, the maturity of such 78 indebtedness in excess of $250,000 with respect to any Borrower or in excess of $1,000,000 with respect to KMC Holdings; or any such indebtedness in excess of $250,000 with respect to any Borrower or in excess of $1,000,000 with respect to KMC Holdings shall be declared to be due and payable or required to be prepaid (other than by a regularly scheduled required prepayment) prior to the stated maturity thereof; or (e) Any Borrower or KMC Holdings shall (i) apply for or consent to the appointment of a receiver, trustee, custodian, sequestrator or similar official for such Borrower or KMC Holdings or for a substantial part of its property, (ii) make a general assignment for the benefit of creditors, (iii) become unable, or admit in writing its inability, to pay its debts as they become due, (iv) voluntarily or involuntarily dissolve, liquidate or wind up its affairs, or (v) take action for the purpose of effecting any of the foregoing; or (f) a proceeding under any bankruptcy, reorganization, arrangement of debts, insolvency or receivership law is filed by or against any Borrower or KMC Holdings, or any Borrower or KMC Holdings takes any action to authorize any of the foregoing matters, and in the case of any such proceeding instituted against any Borrower or KMC Holdings (but not instituted by any Borrower or KMC Holdings), either such proceeding shall remain undismissed or unstayed for a period of 60 days or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against, or the appointment of a receiver, trustee or other similar official for any Borrower or KMC Holdings or any substantial part of its property) shall be granted or shall occur; or (g) a Termination Event occurs which the Requisite Lenders in good faith believe would subject any Borrower to a material liability; or (h) the plan administrator of any Plan applies under Section 412(d) of the IRC for a waiver of the minimum funding standards of Section 412(a) of the IRC and the Requisite Lenders in good faith believe that the approval of such waiver could subject any Borrower or any ERISA Affiliate to material liability; or (i) any of the Governmental Approvals or any other license, Governmental Approval or other governmental consent or approval necessary for the continuing operation of any Borrower or any System or any other material Governmental Approval or approval of or material filing with the FCC, any PUC or any other Governmental Authority with respect to the conduct by any Borrower of its business and operations, including its Business, shall not be obtained or shall cease to be in full force and effect, which in respect of any of the Governmental Approvals shall, in the case of an order of the FCC, any PUC or other Governmental Authority having jurisdiction with respect thereto, revoking, or deciding not to renew, any such Governmental Approval, occur upon the issuance of such order, and, in the case of any other order revoking or terminating any of the Governmental Approvals or deciding not to renew such Governmental Approvals prior to the termination thereof, occur when such order becomes final, and in each case, with respect to any such event occurring on or after the Trigger Date, such event is also reasonably likely to result in a Material Adverse Effect; or 79 (j) the FCC, any PUC or any other Governmental Authority, by final order, determines that the existence or performance of this Agreement or any other Loan Document will result in a revocation, suspension or material adverse modification of any of the Governmental Approvals for any System, and with respect to any such event occurring on and after the Trigger Date, such determination is reasonably likely to result in a Material Adverse Effect; or (k) for any reason any Loan Document shall not be in full force and effect or shall not be enforceable in accordance with its terms, or any security interest or lien granted pursuant thereto with respect to Collateral having an aggregate value of $500,000 or greater shall fail to be perfected or to have its intended priority, or any Borrower or any Affiliate thereof shall contest the validity of any Lien granted under, or shall disaffirm its obligations under any Loan Document; or (l) any Borrower shall default under any Lucent Purchase Agreement or Additional Purchase Agreement, which default shall not have been cured or waived within the applicable grace period thereunder unless such Borrower is contesting such default in good faith by appropriate protest or proceedings and shall have set aside adequate reserves in accordance with GAAP; or (m) for any reason, any Borrower ceases to operate any System or ceases to own any of its Governmental Approvals necessary for the continuing operation of any System, and with respect to any such event occurring on or after the Trigger Date, such cessation is reasonably likely to result in a Material Adverse Effect; or (n) a judgment or judgments for the payment of money in excess of $250,000 individually or $500,000 in the aggregate at any one time shall have been rendered against any Borrower and the same shall have remained unsatisfied and in effect for any period of sixty (60) days during which no stay of execution shall have been obtained; or (o) any Borrower is enjoined, restrained or in any way prevented by the order of any court or administrative or regulatory agency from conducting its business in any material respect with respect to any one or more of its Systems and with respect to any such event occurring on or after the Trigger Date, such event is reasonably likely to result in a Material Adverse Effect; or (p) any Borrower becomes subject to any liabilities, costs, expenses, damages, fines or penalties which could reasonably be expected to have a Material Adverse Effect arising out of or related to (i) any Remedial Action in response to a Release or threatened Release at any location of any Contaminant into the indoor or outdoor environment or (ii) any material violation of any Environmental Law; or (q) a Change of Control shall occur; or (r) KMC Holdings shall fail to observe or perform any covenant, condition or agreement to be observed or performed by KMC Holdings in the KMC Holdings Guaranty; or 80 (s) any Borrower shall fail to observe or perform any covenant, condition or agreement to be observed or performed by such Borrower in any material agreement (other than a Loan Document or an agreement referred to in Section 9.01(d)), such Borrower fails to cure such breach within ten (10) Business Days after written notice thereof, and with respect to any such failure occurring on or after the Trigger Date, such failure is reasonably likely to result in a Material Adverse Effect, unless such Borrower is contesting such covenant, condition or agreement by appropriate protest or proceedings and shall have set aside adequate reserves in accordance with GAAP. SECTION 9.02. Termination of Commitment; Acceleration. Upon the occurrence and at any time during the continuance of any Event of Default, the Agent shall upon direction from the Requisite Lenders: (a) by notice to the Borrowers, terminate Lenders' Commitment to make Loans hereunder; or (b) by notice to the Borrowers, declare the Obligations to be immediately due and payable, whereupon all the Obligations shall be immediately due and payable without further notice of any kind, provided, however, that if an Event of Default described in Section 9.01(f) shall exist or occur, all of the Obligations shall automatically, without declaration or notice of any kind, be immediately due and payable and the Commitment shall be automatically terminated. SECTION 9.03. Waivers. Demand, presentment, protest and notices of nonpayment, protest, dishonor and acceptance are hereby waived by each Borrower. Each Borrower also waives the benefit of all valuation, appraisal and exemption laws and the posting of any bond required of the Collateral Agent, the Agent or any Lender in connection with any judicial process to realize on the Collateral, to enforce any judgment or other court order entered in favor of the Collateral Agent, the Agent or any Lender or to enforce by specific performance, temporary restraining order, or preliminary or permanent injunction, this Agreement or any other Loan Documents. Each Borrower waives the right, if any, to the benefit of, or to direct the application of, any Collateral. Each Borrower hereby acknowledges that none of the Collateral Agent, the Agent or any Lender has any obligation to resort to any Collateral or make claim against any other Person before seeking payment or performance from any Borrower. SECTION 9.04. Rights and Remedies Generally. If an Event of Default occurs and is continuing, the Agent and the Collateral Agent shall have, in addition to any other rights and remedies contained in this Agreement or in any of the other Loan Documents, all of the rights and remedies of a secured party under the Code or other applicable laws, all of which rights and remedies shall be cumulative, and none exclusive, to the extent permitted by law. In addition to all such rights and remedies, the sale, lease or other disposition of the Collateral, or any part thereof, by the Collateral Agent or the Agent after the occurrence of an Event of Default may be for cash, credit or any combination thereof, and the Collateral Agent or the Agent may purchase all or any part of the Collateral at public or, if permitted by law, private sale, and in lieu of actual payment of such purchase price, may set off the amount of such purchase price against the Obligations then owing. Any sales of the Collateral may be adjourned from time to time with or without notice. The Agent or the Collateral 81 Agent, may, in its sole discretion, cause the Collateral to remain on the premises of any Borrower, at the expense of the Borrowers, pending sale or other disposition of the Collateral. The Agent or the Collateral Agent shall have the right to conduct such sales on the premises of any Borrower, at the expense of the Borrowers, or elsewhere, on such occasion or occasions as it may see fit. SECTION 9.05. Entry Upon Premises and Access to Information. If an Event of Default occurs and is continuing, the Agent and the Collateral Agent shall have the right to enter upon the premises of any Borrower where any Collateral is located (or is believed to be located) without any obligation to pay rent to such Borrower, or any other place or places where the Collateral is believed to be located and kept, and render the Collateral unusable or remove the Collateral therefrom to the premises of the Agent or the Collateral Agent or any agent of the Agent or the Collateral Agent, for such time as the Agent or the Collateral Agent may desire, in order effectively to collect or liquidate the Collateral, and/or the Agent or the Collateral Agent may require any Borrower to assemble the Collateral and make it available to the Agent or the Collateral Agent at a place or places to be designated by the Agent or the Collateral Agent. If an Event of Default occurs and is continuing, the Agent or the Collateral Agent shall have the right to obtain access to any Borrower's data processing equipment, computer hardware and software relating to the Collateral and to use all of the foregoing and the information contained therein in any manner the Agent or the Collateral Agent deems appropriate. SECTION 9.06. Sale or Other Disposition of Collateral by the Agent. Any notice required to be given by the Agent or the Collateral Agent of a sale, lease or other disposition or other intended action by the Agent or the Collateral Agent with respect to any of the Collateral which is deposited in the United States mails, registered or certified, postage prepaid and duly addressed to the Borrowers at the address specified in Section 11.01 below, at least ten days prior to such proposed action shall constitute fair and reasonable notice to the Borrowers of any such action. The net proceeds realized by the Agent or the Collateral Agent upon any such sale or other disposition, after deduction for the expense of retaking, holding, preparing for sale, selling or the like and the reasonable attorneys' fees and legal expenses incurred by the Agent or the Collateral Agent in connection therewith, shall be applied as provided herein toward satisfaction of the Obligations. The Agent or the Collateral Agent, as applicable, shall account to the Borrowers for any surplus realized upon such sale or other disposition, and the Borrowers shall remain liable for any deficiency. The commencement of any action, legal or equitable, or the rendering of any judgment or decree for any deficiency shall not affect the Collateral Agent's security interest in the Collateral. The Borrowers agree that the Collateral Agent has no obligation to preserve rights to the Collateral against any other parties. The Agent and the Collateral Agent are hereby granted a license or other right to use, without charge, the Borrowers' labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks and advertising matter, or any property of a similar nature, as it pertains to the Collateral, and the Borrowers' rights under all licenses and all franchise agreements shall inure to the Agent's and the Collateral Agent's benefit until the Obligations are paid in full. SECTION 9.07. Governmental Approvals. In connection with the enforcement by the Agent or the Collateral Agent of any remedies available to it as a result of any Event of Default, each Borrower agrees that it shall join and 82 cooperate fully with, at the request of the Agent or the Collateral Agent, any receiver referred to below and/or the successful bidder or bidders at any foreclosure sale in a filing of an application (and furnishing any additional information that may be required in connection with such application or which the Agent or the Collateral Agent may believe relevant to such application) with the FCC, any PUC and all other applicable Governmental Authorities, requesting their prior approval of (i) the operation or abandonment of all or the portion of any System and/or (ii) the transfer of control of such Borrower or assignment of all licenses, certificates, Governmental Approvals, approvals and permits, issued to such Borrower by the FCC, any PUC or any such Governmental Authorities with respect to any System and the operation thereof, to the Agent or the Collateral Agent, the receiver or to the successful bidder or bidders. In connection with the foregoing, each Borrower shall take such further actions, and execute all such instruments, as the Agent or the Collateral Agent reasonably deems necessary or desirable. Each Borrower agrees that the Agent or the Collateral Agent may enforce any obligation of such Borrower as set forth in this section by an action for specific performance. In addition, each Borrower hereby irrevocably constitutes and appoints the Agent and the Collateral Agent and any agent or officer thereof (which appointment is coupled with an interest) as its true and lawful attorney-in-fact with full irrevocable power and authority and in the place and stead of such Borrower and in the name of such Borrower or in its own name, from time to time in its discretion after the occurrence and during the continuance of an Event of Default and in connection with the foregoing, for the purpose of executing on behalf and in the name of such Borrower any and all of the above-referenced instruments and to take any and all appropriate action in furtherance of the foregoing. THE EXERCISE OF ANY RIGHTS OR REMEDIES HEREUNDER OR UNDER ANY OTHER LOAN DOCUMENT BY ANY LENDER, THE AGENT OR THE COLLATERAL AGENT THAT MAY REQUIRE FCC, ANY PUC OR ANY OTHER GOVERNMENTAL AUTHORITY APPROVAL SHALL BE SUBJECT TO OBTAINING SUCH APPROVAL. PENDING THE RECEIPT OF ANY FCC, ANY PUC OR ANY OTHER GOVERNMENTAL AUTHORITY APPROVAL, NO BORROWER SHALL DO ANYTHING TO DELAY, HINDER, INTERFERE OR OBSTRUCT THE EXERCISE OF THE AGENT'S OR THE COLLATERAL AGENT'S RIGHTS OR REMEDIES HEREUNDER IN OBTAINING SUCH APPROVALS. SECTION 9.08. Appointment of Receiver or Trustee. In connection with the exercise of its remedies under this Agreement, the Agent or the Collateral Agent may, upon the occurrence of an Event of Default, obtain the appointment of a receiver or trustee to assume, upon receipt of all necessary judicial, FCC, any PUC or other Governmental Authority consents or approvals, control of or ownership of any of the Governmental Approvals. Such receiver or trustee shall have all rights and powers provided to it by law or by court order or provided to the Agent or the Collateral Agent under this Agreement. Upon the appointment of such trustee or receiver, the Borrowers agree to cooperate, to the extent necessary or appropriate, in the expeditious preparation, execution and filing of an application to the FCC, any PUC or any other Governmental Authority or for consent to the transfer of control or assignment of any Borrower's Governmental Approvals to the receiver or trustee. SECTION 9.09. Right of Setoff. In addition to any rights now or hereafter granted under applicable law and not by way of limitation of any such rights, upon the occurrence and during the continuance of any Event of Default, each Lender and each holder of any Note is hereby authorized at any time or from time to time, without notice to any Borrower or to any other Person, any such 83 notice being hereby expressly waived, to set off and to appropriate and to apply any and all balances held by it at any of its offices for the account of any Borrower (regardless of whether such balances are then due to such Borrower) and any other properties or assets any time held or owing by that Lender or that holder to or for the credit or for the account of any Borrower against and on account of any of the Obligations which are not paid when due. Any Lender or holder of any Note exercising a right to set off or otherwise receiving any payment on account of the Obligations in excess of its Pro Rata Share thereof shall purchase for cash (and the other Lenders or holders shall sell) such participation in each such other Lender's or holder's Pro Rata Share of the Obligations as would be necessary to cause such Lender to share the amount so set off or otherwise received with each other Lender or holder in accordance with their respective Pro Rata Shares. Each Borrower agrees, to the fullest extent permitted by law, that (a) any Lender or holder may exercise its right to set off with respect to amounts in excess of its Pro Rata Share of the Obligations and may sell participations in such amount so set off to other Lenders and holders and (b) any Lender or holder so purchasing a participation in the Loans made or other Obligations held by other Lenders or holders may exercise all rights of set-off, bankers' lien, counterclaim or similar rights with respect to such participation as fully as if such Lender or holder were a direct holder of the Loans and the other Obligations in the amount of such participation. Notwithstanding the foregoing, if all or any portion of the set-off amount or payment otherwise received is thereafter recovered from the Lender that has exercised the right of set-off, the purchase of participations by that Lender shall be rescinded and the purchase price restored without interest. Each Borrower hereby agrees that the foregoing provisions are intended to be construed so as to satisfy the requirements of Section 553 of the Federal Bankruptcy Code or amendments thereto (including any requirement of mutuality of obligations therein). ARTICLE X THE AGENT AND THE COLLATERAL AGENT SECTION 10.01. Appointment of Agent. (a) First Union National Bank is hereby appointed to act as contractual representative on behalf of all Lenders under this Agreement and the other Loan Documents. The Agent agrees to act as such contractual representative upon the express conditions contained in this Article X. The provisions of this Section 10.01 are solely for the benefit of the Agent and the Lenders and no Borrower or any other Person shall have any rights as a third party beneficiary of any of the provisions hereof. In performing its functions and duties under this Agreement and the other Loan Documents, the Agent shall act solely as an agent of the Lenders and does not assume and shall not be deemed to have assumed any obligation toward or relationship of agency or trust with or for any Borrower or any other Person. The Agent shall have no duties or responsibilities except for those expressly set forth in this Agreement and the other Loan Documents. Notwithstanding the use of the defined term "Agent", it is expressly understood and agreed that the Agent shall not have any fiduciary responsibilities to any Lender by reason of this Agreement and that the Agent is merely acting as the representative of the Lenders with only those duties as are expressly set forth in this Agreement and the other Loan Documents. In its capacity as the Lenders' contractual representative, the Agent (i) does not assume any fiduciary duties to any of the Lenders, (ii) is a "representative" of the Lenders within the meaning of Section 84 9-105 of the UCC and (iii) is acting as an independent contractor, the rights and duties of which are limited to those expressly set forth in this Agreement and the other Loan Documents. Each of the Lenders agrees to assert no claim against the Agent on any agency theory or any other theory of liability for breach of fiduciary duty, all of which claims each Lender waives. Neither the Agent nor any of its Affiliates nor any of their respective officers, directors, employees, agents or representatives shall be liable to any Lender for any action taken or omitted to be taken by it hereunder or under any other Loan Document, or in connection herewith or therewith, except for damages caused by its or their own gross negligence or willful misconduct. (b) If the Agent shall request instructions from all Lenders, Requisite Lenders, Requisite Revolving Lenders or all affected Lenders with respect to any act or action (including failure to act) in connection with this Agreement or any other Loan Document, then the Agent shall be entitled to refrain from such act or taking such action unless and until the Agent shall have received instructions from all Lenders, Requisite Lenders, Requisite Revolving Lenders or all affected Lenders, as the case may be, and the Agent shall not incur liability to any Person by reason of so refraining. The Agent shall be fully justified in failing or refusing to take any action hereunder or under any other Loan Document (a) if such action would, in the opinion of the Agent, be contrary to law or the terms of this Agreement or any other Loan Document, (b) if such action would, in the opinion of the Agent, expose the Agent to liabilities beyond the limits of this Agreement or (c) if the Agent shall not first be indemnified to its satisfaction against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. Without limiting the foregoing, no Lender shall have any right of action whatsoever against the Agent as a result of the Agent acting or refraining from acting hereunder or under any other Loan Document in accordance with the instructions of all Lenders, Requisite Lenders, Requisite Revolving Lenders or all affected Lenders, as applicable. SECTION 10.02. Agent's Reliance, Etc. Neither the Agent nor any of its Affiliates nor any of their respective directors, officers, agents or employees shall be liable for any action taken or omitted to be taken by it or them under or in connection with this Agreement or the other Loan Documents, except for damages caused by its or their own gross negligence or willful misconduct. Without limitation of the generality of the foregoing, the Agent: (a) may treat the payee of any Note as the holder thereof until the Agent receives written notice of the assignment or transfer thereof signed by such payee and in form satisfactory to the Agent; (b) may consult with legal counsel, independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such counsel, accountants or experts; (c) makes no warranty or representation to any Lender and shall not be responsible to any Lender for any statements, warranties or representations made in or in connection with this Agreement or the other Loan Documents; (d) shall not have any duty to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions of this Agreement or the other Loan Documents on the part of any Borrower or to inspect the Collateral (including the books and records); (e) shall not be responsible to any Lender for the due execution, legality, validity, enforceability, genuineness, sufficiency or value of this Agreement or the other Loan Documents or any other instrument or document furnished pursuant hereto or thereto; and (f) shall incur no liability under or in respect of this 85 Agreement or the other Loan Documents by acting upon any notice, consent, certificate or other instrument or writing (which may be by telecopy, telegram, cable or telex) believed by it to be genuine and signed or sent by the proper party or parties. SECTION 10.03. FUNB and Affiliates. With respect to its Commitments hereunder, FUNB shall have the same rights and powers under this Agreement and the other Loan Documents as any other Lender and may exercise the same as though it were not the Agent; and the term "Lender" or "Lenders" shall, unless otherwise expressly indicated, include FUNB in its individual capacity. FUNB and its Affiliates may lend money to, invest in, and generally engage in any kind of business with, any Borrower, any of its Affiliates and any Person who may do business with or own securities of any Borrower or any such Affiliate, all as if FUNB were not the Agent and without any duty to account therefor to Lenders. FUNB and its Affiliates may accept fees and other consideration from any Borrower for services in connection with this Agreement or otherwise without having to account for the same to Lenders. FUNB may also purchase or hold Equity Interests or warrants in KMC Holdings or any Borrower and make subordinated loans to any Borrower. Each Lender acknowledges the potential conflict of interest between FUNB as a Lender holding disproportionate interests in the Loans, FUNB as a member or subordinated debt holder, of the Borrower and FUNB as Agent. SECTION 10.04. Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon the Agent or any other Lender and based on the financial information given it by the Borrowers and such other documents and information as it has deemed appropriate, made its own credit and financial analysis of the Borrowers and its own decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Agent or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. Each Lender acknowledges the potential conflict of interest of each other Lender as a result of Lenders holding disproportionate interests in the Loans, and expressly consents to, and waives any claim based upon, such conflict of interest. SECTION 10.05. Indemnification. Each of the Lenders agrees to indemnify the Agent (to the extent not reimbursed by the Borrowers and without limiting the obligations of Borrowers hereunder), ratably according to their respective Pro Rata Shares, from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by, or asserted against the Agent in any way relating to or arising out of this Agreement or any other Loan Document or any action taken or omitted by the Agent in connection therewith; provided, however, that no Lender shall be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from the Agent's gross negligence or willful misconduct. Without limiting the foregoing, each Lender agrees to reimburse the Agent promptly upon demand for its ratable share of any out-of-pocket expenses (including counsel fees) incurred by the Agent in connection with the preparation, execution, delivery, administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise) of, or legal advice in respect of 86 rights or responsibilities under, this Agreement and each other Loan Document, to the extent that the Agent is not reimbursed for such expenses by the Borrowers. SECTION 10.06. Successor Agent. The Agent may resign at any time by giving not less than thirty (30) days' prior written notice thereof to Lenders and the Borrowers. Upon any such resignation, the Requisite Lenders shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Requisite Lenders and shall have accepted such appointment within 30 days after the resigning Agent's giving notice of resignation, then the resigning Agent may, on behalf of Lenders, appoint a successor Agent, which shall be a Lender, if a Lender is willing to accept such appointment, or otherwise shall be a commercial bank or financial institution or a subsidiary of a commercial bank or financial institution if such commercial bank or financial institution is organized under the laws of the United States of America or of any State thereof and has a combined capital and surplus of at least $300,000,000. If no successor Agent has been appointed pursuant to the foregoing, by the 30th day after the date such notice of resignation was given by the resigning Agent, such resignation shall become effective and the Requisite Lenders shall thereafter perform all the duties of Agent hereunder until such time, if any, as the Requisite Lenders appoint a successor Agent as provided above. Any successor Agent appointed by the Requisite Lenders hereunder shall be subject to the approval of Borrowers, such approval not to be unreasonably withheld or delayed; provided that such approval shall not be required if a Default or an Event of Default shall have occurred and be continuing. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall succeed to and become vested with all the rights, powers, privileges and duties of the resigning Agent. Upon the earlier of the acceptance of any appointment as Agent hereunder by a successor Agent or the effective date of the resigning Agent's resignation, the resigning Agent shall be discharged from its duties and obligations under this Agreement and the other Loan Documents, except that any indemnity rights or other rights in favor of such resigning Agent shall continue. After any resigning Agent's resignation hereunder, the provisions of this Section 10.06 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent under this Agreement and the other Loan Documents. SECTION 10.07. Payments; Non-Funding Lenders; Information; Actions in Concert. (a) Loans; Payments. Whenever the Agent receives a payment of principal, interest, fee or premium (if any) or other payment, or whenever the Agent makes an application of funds, in connection with the Loans or the Notes (including, without limitation, any payment or application from any Collateral), the Agent will on the date such payment is received or applied, if on or prior to 11:00 a.m. (Eastern time) on such date, or otherwise on the next Business Day, pay over to each Lender as instructed by such Lender in writing, an amount equal to such Lender's Pro Rata Share of such payment provided that such Lender has funded all Loans required to be made by it and has purchased all participation required to be purchased by it under this Agreement and the other Loan Documents as of such date. To the extent that any Lender (a "Non-Funding Lender") has failed to fund all such payments and Loans or failed to fund the purchase of all such participation, the Agent shall be entitled to set off the funding short-fall against that Non-Funding Lender's Pro Rata Share of all payments received from the Borrowers. All payments by Agent shall be made by wire transfer to such Lender's account (as specified by such Lender) not later than 2:00 p.m. (Eastern time) on the applicable Business Day. 87 (b) Return of Payments. (i) If Agent pays an amount to a Lender under this Agreement in the belief or expectation that a related payment has been or will be received by the Agent from the Borrowers and such related payment is not received by Agent, then the Agent will be entitled to recover such amount from such Lender on demand without set-off, counterclaim or deduction of any kind. (ii) If the Agent determines at any time that any amount received by the Agent under this Agreement must be returned to any Borrower or paid to any other Person pursuant to any insolvency law or otherwise, then, notwithstanding any other term or condition of this Agreement or any other Loan Document, the Agent will not be required to distribute any portion thereof to any Lender. In addition, each Lender will repay to Agent on demand any portion of such amount that the Agent has distributed to such Lender, together with interest at such rate, if any, as the Agent is required to pay to any Borrower or such other Person, without set-off, counterclaim or deduction of any kind. (c) Non-Funding Lenders. The failure of any Non-Funding Lender to make any portion of its Loans or any payment required by it hereunder on the date specified therefor shall not relieve any other Lender (each such other Lender, an "Other Lender") of its obligations to make any such Loan on such date, but neither any Other Lender nor the Agent shall be responsible for the failure of any Non-Funding Lender to make any Loan. Notwithstanding anything set forth herein to the contrary, a Non-Funding Lender shall not have any voting or consent rights under or with respect to any Loan Document or constitute a "Lender" (or be included in the calculation of "Requisite Lenders" or "Requisite Revolving Lenders" hereunder) for any voting or consent rights under or with respect to any Loan Document. (d) Dissemination of Information. The Agent will use reasonable efforts to provide Lenders with any notice of Default or Event of Default received by the Agent from, or delivered by the Agent to, the Borrowers, with notice of any Event of Default of which the Agent has actually become aware and with notice of any action taken by the Agent following any Event of Default; provided, however, that the Agent shall not be liable to any Lender for any failure to do so, except to the extent that such failure is attributable to the Agent's gross negligence or willful misconduct. Lenders acknowledge that the Borrowers are required to provide financial statements and other documents to Lenders pursuant to this Agreement and agree that the Agent shall have no duty to provide the same to Lenders. (e) Actions in Concert. Anything in this Agreement to the contrary notwithstanding, each Lender hereby agrees with each other Lender that no Lender shall take any action to protect or enforce its rights arising out of this Agreement or the Notes (including exercising any rights of set-off) without first obtaining the prior written consent of the Agent and Requisite Lenders, it being the intent of Lenders that any such action to protect or enforce rights under this Agreement and the Notes shall be taken in concert and at the direction or with the consent of Agent. 88 SECTION 10.08. Collateral Matters. (a) The Lenders hereby irrevocably authorize the Collateral Agent, at its option and in its reasonable business judgment, to release any Lien upon any Collateral (i) upon the termination of the Commitments and payment and satisfaction of all Loans and all other Obligations and which the Collateral Agent has been notified in writing are then due and payable; (ii) constituting property being sold or disposed of if the applicable Borrower certifies to the Collateral Agent that the sale or disposition is made in compliance with Section 6.03 (and the Collateral Agent may rely conclusively on any such certificate, without further inquiry); or (iii) constituting property leased to the applicable Borrower under a lease which has expired or been terminated in a transaction permitted under this Agreement or which will expire imminently and which has not been, and is not intended by such Borrower to be, renewed or extended and with respect to which such Borrower has not exercised any purchase option. Except as provided above, the Collateral Agent will not release any of the Liens without the prior written authorization of the Requisite Lenders; provided that the Collateral Agent may not release the Liens on Collateral valued in the aggregate in excess of $500,000 without the prior written authorization of the Requisite Lenders and may not release all or substantially all of the Collateral without the consent of the Lenders. Upon request by the Collateral Agent or the Borrowers at any time, the Lenders will confirm in writing the Collateral Agent's authority to release any Liens upon particular types or items of Collateral pursuant to this Section 10.08(a). (b) Upon receipt by the Collateral Agent of any authorization required pursuant to Section 10.08(a) from the Requisite Lenders or Lenders, as applicable, of the Collateral Agent's authority to release any Liens upon particular types or items of Collateral, and upon at least five (5) Business Days' prior written request by the applicable Borrower, and provided that no Event of Default has occurred and is then continuing, the Collateral Agent shall (and is hereby irre vocably authorized by the Lenders to) execute such documents as may be necessary to evidence the release of the Liens upon such Collateral; provided, however, that (i) the Collateral Agent shall not be required to execute any such document on terms which, in the Collateral Agent's opinion, would expose the Collateral Agent to liability or create any obligation or entail any consequence other than the release of such Liens without recourse or warranty, and (ii) such release shall not in any manner discharge, affect or impair the Obligations or any Liens (other than those expressly being released) upon (or obligations of the applicable Borrower in respect of) all interests retained by the applicable Borrower, including (without limitation) the proceeds of any sale, all of which shall continue to constitute part of the Collateral. (c) The Collateral Agent shall have no obligation whatsoever to any of the Lenders to assure that the Collateral exists or is owned by any Borrower or is cared for, protected or insured or has been encumbered, or, other than a duty to act without recklessness, willful misconduct or gross (but not mere) negligence, that the Liens have been properly or sufficiently or lawfully created, perfected, protected or enforced or are entitled to any particular priority, or to exercise at all or in any particular manner or under any duty of care, disclosure or fidelity, or to continue exercising, any of the rights, authorities and powers granted or available to the pursuant to this Section 10.08 or pursuant to any of the Loan Documents, it being understood and agreed that in respect of the Collateral, or any act, omission or event related thereto, the Collateral Agent may act in any manner it may deem appropriate, in 89 its reasonable business judgment, given the Collateral Agent's own interest in the Collateral in its capacity as one of the Lenders and that the Collateral Agent shall have no other duty or liability whatsoever to any Lender as to any of the foregoing. SECTION 10.09. Agency for Perfection. Each Lender hereby appoints each other Lender as agent for the purpose of perfecting the Lenders' security interest in assets which, in accordance with Article 9 of the UCC can be perfected only by possession. Should any Lender (other than the Collateral Agent) obtain possession of any such Collateral, such Lender shall notify the Collateral Agent thereof, and, promptly upon the Collateral Agent's request therefor shall deliver such Collateral to the Collateral Agent. SECTION 10.10. Concerning the Collateral and the Related Loan Documents and the Collateral Agent. (a) Each Lender authorizes and directs the Collateral Agent to enter into this Agreement and the other Loan Documents relating to the Collateral, for the ratable benefit of the Lenders. Each Lender agrees that any action taken by the Collateral Agent or Requisite Lenders in accordance with the terms of this Agreement or the other Loan Documents relating to the Collateral, and the exercise by the Collateral Agent or the Requisite Lenders of their respective powers set forth therein or herein, together with such other powers that are reasonably incidental thereto, shall be binding upon all of the Lenders. (b) The Collateral Agent with respect to the administration of the Collateral shall have the same rights, obligations and status as the Agent as are set forth in Section 10.01, 10.02, 10.03, 10.04, 10.05, and 10.06 above. ARTICLE XI MISCELLANEOUS SECTION 11.01. Notices; Action on Notices, etc. (a) Notices and other communications provided for herein shall be in writing and shall be delivered by a courier service of recognized standing (specifying one (1) day delivery), or by registered or certified mail, postage prepaid, return receipt requested (or, if by telecopy communications equipment of the sending party, delivered by such equipment) addressed, if to the Borrowers, at KMC Telecom Inc., 1545 Route 206, Suite 300, Bedminster, NJ 07921; Attention: President; (telecopy no. (908) 719-8775, confirmation no. (908) 470-2200) with a copy to Alan M. Epstein Esq., Kelley Drye & Warren LLP, 101 Park Avenue, New York, NY 10178; (telecopy no. (212) 808-7897, confirmation no. (212) 808-7800), if to the Agent, at First Union National Bank, Communications/Media Finance-PA4829, 1339 Chestnut Street, Philadelphia, PA 19107, Attention: Elizabeth Elmore (telecopy no. (215) 786-7721, confirmation no. (215) 786-4321), and if to the Collateral Agent, at AT&T Commercial Finance, Two Gatehall Drive, Parsippany, NJ 07054, Attention: Media and Communications, (telecopy no. (973) 355-7644, confirmation no. (973) 355-7630). All notices and other communications given to any party hereto in accordance with the provisions of this Agreement shall be deemed to have been given (a) five Business Days after mailing when sent by registered or certified mail, postage prepaid, return receipt requested, or (b) upon receipt, if by 90 courier service or any telecopy communications equipment of the sender, in each case addressed to such party as provided in this Section or in accordance with the latest unrevoked direction from such party. (b) Each Borrower agrees that the Agent or the Collateral Agent may act upon any notice, consent, certificate, cable, telex or other instrument or writing believed by the Agent or the Collateral Agent to be genuine, that the Agent or the Collateral Agent may consult with legal counsel, selected by the Agent or the Collateral Agent and shall not be liable to any Borrower for any action taken or omitted to be taken in good faith by Lender in accordance with the advice of such counsel. SECTION 11.02. No Waivers; Amendments. (a) No failure or delay of the Agent, the Collateral Agent or any Lender to exercise any right hereunder or under any other Loan Document shall operate as a waiver thereof, nor shall any single or partial exercise of any such right, preclude any other or further exercise thereof or the exercise of any other right. No waiver of any provision of this Agreement or any other Loan Document nor consent to any departure by any Borrower therefrom shall in any event be effective unless the same shall be in writing and signed by the Agent and the Requisite Lenders, and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. No notice or demand on any Borrower in any case shall entitle any Borrower to any other or further notice or demand in similar or other circumstances. (b) Subject to the provisions of this Section 11.02(b), the Requisite Lenders (or the Agent with the consent in writing of the Requisite Lenders) and the Borrowers may enter into agreements supplemental hereto for the purpose of adding or modifying any provisions to the Loan Documents or changing in any manner the rights of the Lenders or the Borrowers hereunder or waiving any Event of Default or Default hereunder; provided, however, that no such supplemental agreement shall, without the consent of each Lender affected thereby: (i) Postpone or extend the Revolving Credit Commitment Termination Date, the maturity date for the loans or any other date fixed for any payment of principal of, or interest on, the Loans or any fees or other amounts payable to such Lender except with respect to (A) any modifications of the provisions relating to prepayments of Loans and other Obligations and (B) a waiver of the application of the default rate of interest pursuant to Section 2.05(b) hereof. (ii) Reduce the principal amount of any Loans, or reduce the rate or extend the time of payment of interest or fees thereon. (iii) Reduce the percentage specified in the definition of Requisite Lenders or Requisite Revolving Lenders or any other percentage of Lenders specified to be the applicable percentage in this Agreement to act on specified matters or amend the definition of "Pro Rata Share". 91 (iv) Increase the amount of any Commitment of any Lender hereunder or increase any Lender's Pro Rata Share. (v) Permit any Borrower to assign its rights under this Agreement. (vi) Release all or substantially all of the Collateral. (vii) Amend this Section 11.02(b). No amendment of any provision of this Agreement relating to the Agent or the Collateral Agent shall be effective without the written consent of the Agent or the Collateral Agent, as applicable. SECTION 11.03. GOVERNING LAW AND JURISDICTION. THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF NEW YORK WITHOUT GIVING EFFECT TO ANY CONFLICTS OF LAWS PRINCIPLES. THE BORROWERS, THE AGENT, THE COLLATERAL AGENT AND THE LENDERS CONSENT TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURT LOCATED IN THE CITY AND STATE OF NEW YORK AND WAIVE ANY OBJECTION RELATING TO IMPROPER VENUE OR FORUM NON CONVENIENCE TO THE CONDUCT OF ANY PROCEEDING BY SUCH COURT. SECTION 11.04. Expenses. The Borrowers will pay, and have joint and several liability for, all documented out-of-pocket third-party expenses (including in each case all reasonable attorneys' and paralegals' fees and related expenses and costs), (i) incurred by the Agent, the Collateral Agent and the Documentation Agent in connection with the negotiation, preparation and execution of the Loan Documents (whether or not the transactions contemplated hereby shall be consummated), subject, however, to the limitations set in those certain letters dated September 25, 1998 between KMC Holdings and the Agent, and KMC Holdings and the Documentation Agent, with respect to the fees and expenses of counsel for the Agent and the Documentation Agent, (ii) incurred by the Agents, in connection with the administration of the Loan Documents, and the creation, perfection, priority and protection of the Liens in the Collateral, and (iii) incurred by any Agent or any Lender in connection with the enforcement of the rights of any Agent or any Lender in connection with this Agreement, any other Loan Documents or the Collateral, or any restructuring or workout of this Agreement or the other Loan Documents. SECTION 11.05. Equitable Relief. Each Borrower recognizes that, in the event such Borrower fails to perform, observe or discharge any of its obligations or liabilities under this Agreement, or any other Loan Document, any remedy at law may prove to be inadequate relief to the Agent, the Collateral Agent and the Lenders; therefore, such Borrower agrees that the Agent or the Collateral Agent, if it so requests, shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages. 92 SECTION 11.06. Indemnification; Limitation of Liability. (a) The Borrowers jointly and severally agree to protect, indemnify and hold harmless the Agent, the Collateral Agent each Lender and each of their respective officers, affiliates, directors, employees, attorneys, accountants, consultants, representatives and agents (collectively called the "Indemnitees") from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements (including, without limitation, payment by the Agent, the Collateral Agent or any Lender of any obligations due or past due under any contract or agreement to which any Borrower is or becomes a party) of any kind or nature whatsoever (including, without limitation, the fees and disbursements of counsel for and consultants of such Indemnitees in connection with any investigative, administrative or judicial proceeding, whether or not such Indemnitees shall be designated a party thereto), which may be imposed on, incurred by, or asserted against such Indemnitees (whether direct, indirect, or consequential and whether based on any federal or state laws or other statutory regulations, including, without limitation, securities, environmental and commercial laws and regulations, under common law or at equitable cause or on contract or otherwise) in any manner relating to or arising out of this Agreement or any of the other Loan Documents, or any act, event or transaction related or attendant thereto, the agreements of the Agent, the Collateral Agent or the Lenders contained herein, the making of Loans, the management of such Loans or the Collateral (including any liability under Environmental Laws) or the use or intended use of the proceeds of such Loans hereunder (collectively, the "Indemnified Matters"); provided that the Borrowers shall not have any obligation to any Indemnitee hereunder with respect to Indemnified Matters caused by or resulting from the willful misconduct or gross negligence of such Indemnitee; provided, further that no Borrower shall have any obligation to any Indemnitee hereunder with respect to taxes that are imposed on the net income of any Indemnitee or any franchise or doing business taxes imposed on any Indemnitee. To the extent that the undertaking to indemnify, pay and hold harmless set forth in the preceding sentence may be unenforceable because it is violative of any law or public policy, the Borrowers shall contribute the maximum portion which they are permitted to pay and satisfy under applicable law, to the payment and satisfaction of all Indemnified Matters incurred by the Indemnitees. (b) To the extent permitted by applicable law, no claim may be made by the Borrowers or any other Person against the Agent, the Collateral Agent, any Lender or any of their respective affiliates, directors, officers, employees, agents, attorneys, accountants, representatives or consultants for any special, indirect, consequential or punitive damages in respect of any claim for breach of contract or any other theory of liability arising out of or related to the transactions contemplated by any of the Loan Documents or any act, omission or event occurring in connection therewith; and the Borrowers hereby waive, release and agree not to sue upon any claim for any such damages, whether or not accrued and whether or not known or suspected to exist in its favor. SECTION 11.07. Survival of Representations and Warranties, etc. All warranties and representations made by any Borrower in any Loan Document shall survive the execution and delivery of this Agreement and the other Loan Documents and the making and repayment of the Obligations. The confidentiality obligations of each Borrower in Section 11.16, the indemnification obligations of each Borrower in Section 11.06, and to the extent the second sentence of Section 11.13 is applicable, all covenants of each Borrower, survive the repayment of the Obligations. 93 SECTION 11.08. Successors and Assigns; Assignments; Participations. (a) General. The terms and provisions of the Loan Documents shall be binding upon and inure to the benefit of the Borrowers, the Agent, the Collateral Agent and the Lenders and their respective successors and assigns, except that (i) no Borrower shall have any right to assign its rights or obligations under the Loan Documents and (ii) any assignment by any Lender must be made in compliance with subsection (c) below. With respect to any Borrower, successors and assigns shall include, without limitation, any receiver, trustee or debtor-in-possession of or for such Borrower. Notwithstanding the foregoing, any Lender may at any time, without the consent of the Borrowers or the Agent, assign all or any portion of its rights under this Agreement and its Notes to a Federal Reserve Bank or to an affiliate of such Lender; provided, however, that no such assignment shall release the transferor Lender from its obligations hereunder. The Agent shall be entitled to utilize its Register to determine the payee of any Note for all purposes hereof. Any request, authority or consent of any Person, who at the time of making such request or giving such authority or consent is the holder of any Note, shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note or Notes issued in exchange therefor. (b) Participations. (i) Subject to the terms set forth in this Section 11.08(b), any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time sell to one or more banks or other entities ("Participants") participating interests in any Loan owing to such Lender, any Note held by such Lender, any Commitment of such Lender or any other interest of such Lender under the Loan Documents on a pro rata or non-pro rata basis in an aggregate principal amount of at least $5,000,000. Notice of such participation to the Agent shall be required prior to any participation becoming effective with respect to a Participant which is not a Lender or an Affiliate thereof. In the event of any such sale by a Lender of participating interests to a Participant, such Lender's obligations under the Loan Documents shall remain unchanged, such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, such Lender shall remain the holder of any such Note for all purposes under the Loan Documents, such Lender shall be solely responsible for any withholding taxes or any filing or reporting requirements in connection therewith relating to such Participant, all amounts payable by the Borrowers under this Agreement shall be determined as if such Lender had not sold such participating interests, and the Borrowers and the Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under the Loan Documents except that, for purposes of Section 2.13 hereof, the Participants shall be entitled to the same rights as if they were Lenders, provided that no Participant shall be entitled to receive any greater amount pursuant to Section 2.13 than such Lender would have been entitled to receive in respect of the amount of the participation transferred to such Participant had no transfer occurred. 94 (ii) Each Lender shall retain the sole right to approve, without the consent of any Participant, any amendment, modification or waiver of any provision of the Loan Documents other than any amendment, modification or waiver with respect to any Loan or Commitment in which such Participant has an interest which forgives principal, interest or fees or reduces the interest rate or fees payable pursuant to the terms of this Agreement with respect to any such Loan or Commitment, postpones any date fixed for any regularly-scheduled payment of principal of, or interest or fees on, any such Loan or Commitment, or releases all or substantially all of the Collateral, if any, securing any such Loan. (iii) The Borrowers agree that each Participant shall be deemed to have the right of setoff provided in Section 9.09 hereof in respect to its participating interest in amounts owing under the Loan Documents to the same extent as if the amount of its participating interest were owing directly to it as a Lender under the Loan Documents, provided that each Lender shall retain the right of setoff provided in Section 9.09 hereof with respect to the amount of participating interests sold to each Participant except to the extent such Participant exercises its right of setoff. The Lenders agree to share with each Participant, and each Participant, by exercising the right of setoff provided in Section 9.09 hereof, agrees to share with each Lender, any amount received pursuant to the exercise of its right of setoff, such amounts to be shared in accordance with Section 9.09 as if each Participant were a Lender. (c) Assignments. (i) Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time assign to one or more banks or other entities ("Purchasers") all or a portion of its rights and obligations under this Agreement (including, without limitation, its Commitment and the Loans owing to it hereunder) in accordance with the provisions of this Section 11.08(c). Each assignment shall be of a constant, and not a varying, ratable percentage of all of the assigning Lender's rights and obligations under this Agreement. Such assignment shall be evidenced by an Assignment Agreement in form and substance reasonably satisfactory to the Agent and shall not be permitted hereunder unless such assignment is either for all of such Lender's rights and obligations under the Loan Documents or, for Loans and Commitments in an aggregate principal amount equal to the lesser of $5,000,000 (which minimum amount may be waived by the Requisite Lenders after the occurrence of a Default) and such Lender's Commitment Amount. (ii) Upon (i) delivery to the Agent of a notice of assignment (a "Notice of Assignment"), together with any consent required hereunder, and (ii) payment of a $3,500 processing fee to the Agent for processing such assignment if such assignment is to a Person which is not an affiliate of the assigning Lender, such assignment shall become effective on the effective date specified in such Notice of Assignment. The assigning Lender shall be obligated to reimburse the 95 Agent for all other costs and expenses associated with the preparation and execution of such assignment (including reasonable attorneys' fees arising out of such preparation and execution of such assignment). The Notice of Assignment shall contain a representation by the Purchaser to the effect that none of the consideration used to make the purchase of the Commitment and Loans under the applicable assignment agreement are "plan assets" as defined under ERISA and that the rights and interests of the Purchaser in and under the Loan Documents will not be "plan assets" under ERISA. On and after the effective date of such assignment, such Purchaser, if not already a Lender, shall for all purposes be a Lender party to this Agreement and any other Loan Documents executed by the Lenders and shall have all the rights and obligations of a Lender under the Loan Documents, to the same extent as if it were an original party hereto, and no further consent or action by the Borrowers, the Lenders or the Agent shall be required to release the transferor Lender with respect to the percentage of the aggregate Commitment and Loans assigned to such Purchaser. Upon the consummation of any assignment to a Purchaser pursuant to this Section 11.08(c)(ii), the transferor Lender, the Agent and the Borrowers shall make appropriate arrangements so that replacement Notes are issued to such transferor Lender and new Notes or, as appropriate, replacement Notes, are issued to such Purchaser, in each case in principal amounts reflecting their Commitment and their Loans, as adjusted pursuant to such assignment. (iii) The Agent shall maintain at its address referred to in Section 11.01 a copy of each assignment delivered to and accepted by it pursuant to this Section 11.08 and a register (the "Register") for the recordation of the names and addresses of the Lenders and the Commitment of and principal amount of the Loans owing to, each Lender from time to time and whether such Lender is an original Lender or the assignee of another Lender pursuant to an assignment under this Section 11.08. The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and the Borrowers, the Agent and the Lenders may treat each Person whose name is recorded in the Register as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrowers or any Lender at any reasonable time and from time to time upon reasonable prior notice. SECTION 11.09. Severability. In case any one or more of the provisions contained in this Agreement or any other Loan Document shall be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein and therein shall not in any way be affected or impaired thereby. SECTION 11.10. Cover Page, Table of Contents and Section Headings. The cover page, Table of Contents and section headings used herein are for convenience of reference only, are not part of this Agreement and are not to affect the construction of or be taken into consideration in interpreting this Agreement. SECTION 11.11. Counterparts. This Agreement may be signed in counterparts with the same effect as if the signatures thereof and hereto were upon the same instrument. 96 SECTION 11.12. Application of Payments. Notwithstanding any contrary provision contained in this Agreement or in any of the other Loan Documents, upon the occurrence and during the continuance of any Event of Default, each Borrower irrevocably waives the right to direct the application of any and all payments at any time or times hereafter received by the Agent or any Lender from such Borrower or with respect to any of the Collateral, and such Borrower does hereby irrevocably agree that the Agent or any Lender shall have the continuing exclusive right to apply and reapply any and all payments received at any time or times hereafter, whether with respect to the Collateral or otherwise, against the Obligations in such manner as the Agent or any Lender may deem advisable, notwithstanding any entry by the Agent or any Lender upon any of its books and records, subject, however, to the provisions of Section 2.08(c). SECTION 11.13. Marshalling; Payments Set Aside. Neither the Agent nor the Collateral Agent shall be under any obligation to marshall any assets in favor of any Borrower or any other party or against or in payment of any or all of the Obligations. To the extent that any Borrower makes a payment or payments to any Agent or any Lender or the Agent, the Collateral Agent or any Lender enforces its security interests or exercises its rights of setoff, and such payment or payments or the proceeds of such enforcement or setoff or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside and/or required to be repaid to a trustee, receiver or any other party under any bankruptcy law, state or federal law, common law or equitable cause, then to the extent of such recovery, the obligation or part thereof originally intended to be satisfied shall be revived and continued in full force and effect as if such payment had not been made or such enforcement or setoff had not occurred. SECTION 11.14. SERVICE OF PROCESS. EACH BORROWER WAIVES PERSONAL SERVICE OF ANY PROCESS UPON IT AND, CONSENTS THAT ALL SERVICE OF PROCESS SHALL BE MADE BY REGISTERED MAIL, RETURN RECEIPT REQUESTED, DIRECTED TO SUCH BORROWER AT THE ADDRESS INDICATED IN SECTION 11.01 AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED FIVE (5) BUSINESS DAYS AFTER SAME SHALL HAVE BEEN POSTED AS AFORESAID. SECTION 11.15. WAIVER OF JURY TRIAL, ETC. EACH OF THE BORROWERS, THE AGENT, THE COLLATERAL AGENT AND THE LENDERS WAIVES ANY RIGHT TO HAVE A JURY PARTICIPATE IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE, BETWEEN THE AGENT, THE COLLATERAL AGENT OR ANY LENDER AND ANY BORROWER ARISING OUT OF, CONNECTED WITH, RELATED TO OR INCIDENTAL TO THE RELATIONSHIP ESTABLISHED BETWEEN THEM IN CONNECTION WITH THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT OR ANY OTHER INSTRUMENT, DOCUMENT OR AGREEMENT EXECUTED OR DELIVERED IN CONNECTION THEREWITH OR THE TRANSACTIONS RELATED THERETO. EACH OF THE BORROWERS, THE AGENT, THE COLLATERAL AGENT AND THE LENDERS HEREBY AGREES AND CONSENTS THAT ANY SUCH CLAIM, DEMAND, ACTION OR CAUSE OF ACTION SHALL BE DECIDED BY COURT TRIAL WITHOUT A JURY AND THAT ANY OF THEM MAY FILE AS AN ORIGINAL COUNTERPART OR A COPY OF THIS AGREEMENT WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF THE PARTIES HERETO TO THE WAIVER OF THEIR RIGHT TO TRIAL BY JURY. 97 SECTION 11.16. Confidentiality. No Borrower shall at any time before or after payment in full and satisfaction of all of the Obligations, reveal, divulge or make known, or knowingly permit to be so revealed, divulged or made known, to any Person (including Persons within its own organization who do not have a definite need to know for the purpose of performance of this Agreement), the terms or conditions of the Fee Letters; provided that the foregoing shall not apply to information required to be disclosed by order of a court of competent jurisdiction or in connection with any governmental investigation (in each case to the extent disclosure is required, but no further) so long as such Borrower notifies the Agent in writing of any circumstances of which such Borrower is aware that may lead to such a requirement or order, so as to allow the Agent to take steps to contest such order or investigation; provided, further, that the foregoing shall not apply to information which is required to be disclosed by such Borrower or information which in the reasonable determination of such Borrower is desirable for such Borrower to disclose, pursuant to federal or state securities laws, pursuant to the rules or regulations of the FCC, any PUC or other applicable Governmental Authority, or to Persons who are consultants, advisors (including but not limited to attorneys and auditors), officers, directors or employees of such Borrower, provided that each such Person is required by such Borrower to keep such information confidential. SECTION 11.17. Entire Agreement, etc. This Agreement (including all schedules and exhibits referred to herein), the Notes, the Fee Letters and all other Loan Documents constitute the entire contract between the parties hereto with respect to the subject matter hereof and thereof and shall supersede and take the place of any other instrument purporting to be an agreement of the parties hereto relating to such subject matter. SECTION 11.18. No Strict Construction. The parties hereto have participated, jointly in the negotiation and drafting of this Agreement. In the event of any ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the parties hereto and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of authorship of any provisions of this Agreement. 98 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their duly authorized officers as of the day and year first above written. KMC TELECOM INC., as a Borrower By:/S/CYNTHIA WORTHMAN ------------------------------------- Name: Cynthia Worthman Title: Vice President & Chief Financial Officer KMC TELECOM II, INC., as a Borrower By:/S/CYNTHIA WORTHMAN ------------------------------------- Name: Cynthia Worthman Title: Vice President & Chief Financial Officer KMC TELECOM OF VIRGINIA, INC., as a Borrower By:/S/CYNTHIA WORTHMAN ------------------------------------- Name: Cynthia Worthman Title: Vice President & Chief Financial Officer KMC TELECOM LEASING I LLC, as a Borrower BY: KMC TELECOM INC., as Sole Member By:/S/CYNTHIA WORTHMAN ------------------------------------- Name: Cynthia Worthman Title: Vice President & Chief Financial Officer KMC TELECOM LEASING II LLC, as a Borrower BY: KMC TELECOM II, INC., as Sole Member By:/S/CYNTHIA WORTHMAN ------------------------------------- Name: Cynthia Worthman Title: Vice President & Chief Financial Officer AT&T COMMERCIAL FINANCE CORPORATION, as a Lender and as Collateral Agent By:/S/MICHAEL V. MONAHAN ------------------------------------- Name: Michael V. Monahan Title: Vice President FIRST UNION NATIONAL BANK, as a Lender and as Administrative Agent By:/S/MARK M. HARDEN ------------------------------------- Name: Mark M. Harden Title: Senior Vice President GENERAL ELECTRIC CAPITAL CORPORATION, as a Lender By:/S/MOLLY S. FERGUSON ------------------------------------- Name: Molly S. Ferguson Title: Manager - Operations CANADIAN IMPERIAL BANK OF COMMERCE, as a Lender By:/S/ELLEN E. MARSHALL ------------------------------------- Name: Ellen B. Marshall Title: Managing Director ANNEX A COMMITMENT AMOUNTS REVOLVING LOANS Revolving Loan Lender Commitment Amount - - ------ ----------------- AT&T Commercial Finance $43,750,000 Canadian Imperial Bank of Commerce $43,750,000 First Union National Bank $43,750,000 General Electric Capital Corporation $43,750,000 ------------ TOTAL $175,000,000 TERM LOANS Term Loan Lender Commitment Amount - - ------ ----------------- AT&T Commercial Finance $18,750,000 Canadian Imperial Bank of Commerce $18,750,000 First Union National Bank $18,750,000 General Electric Capital Corporation $18,750,000 ----------- TOTAL $75,000,000 ------------ TOTAL COMMITMENTS $250,000,000 ------------ ANNEX B FINANCIAL COVENANT INFORMATION ANNEX C REVOLVING LOAN COMMITMENT REDUCTIONS Payment Date Percentage Reduction April 1, 2002 2.5% July 1, 2002 2.5% October 1, 2002 2.5% January 1, 2003 2.5% July 1, 200 April 1, 2003 5.0% July 1, 2003 5.0% October 1, 2003 5.0% January 1, 2004 5.0% July 1, 200 April 1, 2004 5.0% July 1, 2004 5.0% October 1, 2004 5.0% January 1, 2005 5.0% July 1, 200 April 1, 2005 5.0% July 1, 2005 5.0% October 1, 2005 5.0% January 1, 2006 5.0% July 1, 200 April 1, 2006 7.5% July 1, 2006 7.5% October 1, 2006 7.5% Revolving Loan Termination Date 7.5% SCHEDULE 1.01(A) APPLICABLE MARGIN FOR REVOLVING LOANS
Applicable Applicable Margin for Margin for Base Rate LIBOR Loans Loans ----- ----- The Borrowers have fewer than 12 Completed Cities 3.00% 4.00% The Borrowers have 12 or more Completed Cities and the 2.75% 3.75% Total Leverage Ratio > = 12.0x The Total Leverage Ratio > = 10.0x and < 12.0x 2.50% 3.50% The Total Leverage Ratio > = 8.0x and < 10.0x 2.25% 3.25% The Total Leverage Ratio > = 6.0x and < 8.0x 2.00% 3.00% The Total Leverage Ratio < 6.0x 1.75% 2.75%
APPLICABLE MARGIN FOR TERM LOANS
Applicable Applicable Margin for Margin for Base Rate LIBOR Loans Loans ----- ----- The Borrowers have fewer than 12 Completed Cities 3.25% 4.25% The Borrowers have 12 or more Completed Cities and the 3.00% 4.00% Total Leverage Ratio > = 12.0x The Total Leverage Ratio > = 10.0x and < 12.0x 2.75% 3.75% The Total Leverage Ratio > = 8.0x and < 10.0x 2.50% 3.50% The Total Leverage Ratio > = 6.0x and < 8.0x 2.25% 3.25% The Total Leverage Ratio < 6.0x 2.00% 3.00%
EX-10.3 10 AMENDMENT NO. 1 TO LOAN AND SECURITY AGMT. AMENDMENT NO. 1 TO LOAN AND SECURITY AGREEMENT AMENDMENT NO. 1 TO LOAN AND SECURITY AGREEMENT ("AMENDMENT") dated as of March 3, 1999, among KMC TELECOM INC., a Delaware corporation ("KMC"), KMC Telecom II, Inc., a Delaware corporation ("KMC II"), KMC Telecom of Virginia, Inc., a Virginia public service company ("KMC VIRGINIA"), KMC Telecom Leasing I LLC, a Delaware limited liability company ("LEASING I"), KMC Telecom Leasing II LLC, a Delaware limited liability company ("LEASING II"; KMC, KMC II, KMC Virginia, Leasing I and Leasing II being hereinafter collectively referred to hereinafter as the "BORROWERS" ), the financial institutions from time to time parties thereto (the "LENDERS"), FIRST UNION NATIONAL BANK, as administrative agent for the Lenders (the "AGENT") and NEWCOURT COMMERCIAL FINANCE CORPORATION (f/k/a AT&T COMMERCIAL FINANCE CORPORATION), as collateral agent for the Lenders (the "COLLATERAL AGENT"; the Agent together with the Collateral Agent being referred to as the "AGENTS"). WHEREAS, the Borrowers, the Agents and the Lenders are parties to that certain Loan and Security Agreement (the "LOAN AGREEMENT"; undefined capitalized terms used herein shall have the meanings assigned thereto in the Loan Agreement) dated as of December 22, 1998, pursuant to which the Lenders have agreed to make certain "Loans" and other financial accommodations to the Borrowers; and WHEREAS, the Borrowers have requested that the Agents and the Lenders amend the Loan Agreement in the manner set forth herein, and the Agents and the Lenders have agreed to such request; NOW, THEREFORE, in consideration of the premises set forth above, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrowers, the Agents and the Lenders agree as follows: 1. AMENDMENT TO THE LOAN AGREEMENT. Effective as of the date first above written and subject to the execution of this Amendment by the parties hereto, the Loan Agreement shall be and hereby is amended as follows: 1.1 SECTIONS 2.03(A) and (B) of the Loan Agreement are hereby deleted in their entirety and the following language is substituted therefor: SECTION 2.03. PROCEDURE FOR LOAN REQUEST AND BORROWING COMMITMENT. (a) A Borrower requesting a Loan shall deliver to each of the Agent and the Collateral Agent a Notice of Borrowing substantially in the form of EXHIBIT H-1 attached hereto on or before 11:00 a.m. (New York time) at least five (5) Business Days prior to the date on which such Loan is requested to be made if such Loan is requested to be a LIBOR Loan and at least two (2) Business Days prior to the date on which such Loan is requested to be made if such Loan is requested to be a Base Rate Loan, which notice, once given, shall be irrevocable; provided, however, that only the Collateral Agent shall receive the attachments to the Notice of Borrowing, as outlined below. The Revolving Loans made on the Initial Funding Date shall be Base Rate Loans and thereafter may be continued as Base Rate Loans or converted into LIBOR Loans in the manner provided in SECTION 2.06 and subject to the other conditions and limitations therein set forth and set forth in this ARTICLE II. In the case of a Loan the proceeds of which will be used to purchase or reimburse any Borrower for Telecommunications Equipment (including any Telecommunications Equipment being purchased or reimbursed under the Lucent Purchase Agreement), the Notice of Borrowing delivered to the Collateral Agent will include a schedule supporting one hundred percent (100%) of Telecommunications Equipment requested to be funded. Such schedule will detail all invoices for equipment, third party labor, permits, other third party costs and all capitalized internal costs of the Borrowers with respect to such Telecommunications Equipment permitted under GAAP. All invoices over $25,000 will be attached to such schedule delivered to the Collateral Agent who shall review such invoices and verify that, when combined with the above described capitalized internal costs, such invoices will support at least seventy percent (70%) of the total requested funding. In addition, if the Telecommunications Equipment is being purchased or reimbursed under the Lucent Purchase Agreement, a certificate of delivery and acceptance in the form of EXHIBIT R shall be attached to the Notice of Borrowing delivered to the Collateral Agent. In the case of a Loan the proceeds of which will be used to pay or reimburse any Borrower for transaction costs, the Notice of Borrowing delivered to the Collateral Agent will include a copy of the invoice from the provider of the service or other appropriate supporting documentation. In the case of a Loan, the proceeds of which will be used for working capital or other general corporate purposes, the Notice of Borrowing delivered to the Collateral Agent will contain a certification that the making of such Loan does not violate any provision of the Indenture. The Notice of Borrowing shall, with respect to any Loans requested, specify whether such requested Loans are to be Base Rate Loans or LIBOR Loans, and if such requested Loans are to be LIBOR Loans, the requested Interest Period for such Loans. (b) The Agent agrees, promptly upon (i) receipt of a Notice of Borrowing and (ii) acknowledgment by the Collateral Agent that the Borrowers have delivered and the Collateral Agent has reviewed to its satisfaction (x) each of the invoices or certificates required to be provided to the Collateral Agent pursuant to SECTION 2.03(A) above and (y) each of the collateral documents, including, without limitation, all third party agreements and the related consents to collateral assignments required pursuant to SECTION 5.08 of the Loan Agreement, as requested by the Collateral Agent, to notify each Revolving or Term Lender of the date and amount of the Loan proposed thereunder and the amount of such Lender's Pro Rata Share therein. So long as no Event of Default has occurred and is continuing and upon fulfillment of the applicable conditions set forth in ARTICLE IV and the 2 requirements set forth in SECTION 2.03(A) above and in the applicable Notice of Borrowing, each such Lender severally agrees, on or before 12:00 P.M. (New York time) on the date of each proposed Loan, to pay into the Payment Account, an amount equal to such Lender's Pro Rata Share of such Loan in dollars and in same day funds. After the Agent's receipt of such Lender's Loan proceeds, the Agent shall make available such proceeds to the Borrower requesting the Loan or the Person entitled to payment thereof at the bank account(s) specified in the Notice of Borrowing on the date specified in such Notice of Borrowing in Dollars in immediately available funds. 1.2 EXHIBIT H-1 to the Loan Agreement is hereby deleted in its entirety and the Form of Notice of Borrowing attached hereto as EXHIBIT H-1 is substituted therefor. 2. CONDITIONS PRECEDENT. This Amendment shall become effective as of the date above written, if, and only if, the Agents have received duly executed originals of this Amendment from the Borrowers, the Lenders and the Agents. 3. REPRESENTATIONS AND WARRANTIES OF THE BORROWERS. The Borrowers hereby represent and warrant as follows: (a) This Amendment and the Loan Agreement, as amended hereby, constitute legal, valid and binding obligations of the Borrowers and are enforceable against the Borrowers in accordance with their terms. (b) Upon the effectiveness of this Amendment, the Borrowers hereby reaffirm all representations and warranties made in the Loan Agreement, and to the extent the same are not amended hereby, agree that all such representations and warranties shall be deemed to have been remade as of the date of delivery of this Amendment, unless and to the extent that any such representation and warranty is stated to relate solely to an earlier date, in which case such representation and warranty shall be true and correct as of such earlier date. 4. REFERENCE TO AND EFFECT ON THE LOAN AGREEMENT. (a) Upon the effectiveness of SECTION 1 hereof, on and after the date hereof, each reference in the Loan Agreement to "this Loan Agreement," "hereunder," "hereof," "herein" or words of like import shall mean and be a reference to the Loan Agreement as amended hereby, and each reference to the Loan Agreement in any other document, instrument or agreement shall mean and be a reference to the Loan Agreement as modified hereby. (b) The Loan Agreement, as amended hereby, and all other documents, instruments and agreements executed and/or delivered in connection therewith, shall remain in full force and effect, and are hereby ratified and confirmed. 3 (c) Except as expressly provided herein, the execution, delivery and effectiveness of this Amendment shall not operate as a waiver of any right, power or remedy of the Agents or the Lenders, nor constitute a waiver of any provision of the Loan Agreement or any other documents, instruments and agreements executed and/or delivered in connection therewith. 5. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE OTHER REMAINING TERMS OF THE LOAN AGREEMENT AND THE INTERNAL LAWS (AS OPPOSED TO CONFLICT OF LAW PROVISIONS) OF THE STATE OF NEW YORK. 6. PARAGRAPH HEADINGS. The paragraph headings contained in this Amendment are and shall be without substance, meaning or content of any kind whatsoever and are not a part of the agreement among the parties hereto. 7. COUNTERPARTS. This Amendment may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. [Signature Page Follows] 4 IN WITNESS WHEREOF, this Amendment has been duly executed as of the day and year first above written. THE BORROWERS: KMC TELECOM INC. KMC TELECOM II, INC. KMC TELECOM OF VIRGINIA, INC. In each case: By:/s/ CYNTHIA WORTHMAN ---------------------------------- Name: Cynthia Worthman Title: Vice President and CFO KMC TELECOM LEASING I LLC By: KMC TELECOM INC., as its Sole Member By:/s/ CYNTHIA WORTHMAN ---------------------------------- Name: Cynthia Worthman Title: Vice President and CFO KMC TELECOM LEASING II LLC By: KMC TELECOM II, INC., as its Sole Member By:/s/ CYNTHIA WORTHMAN ---------------------------------- Name: Cynthia Worthman Title: Vice President and CFO Signature Page-1 Amendment No. 1 to Loan Agreement FIRST UNION NATIONAL BANK, as the Agent and as a Lender By:/s/ MARK M. HARDEN ---------------------------------- Name: Mark M. Harden Title: Senior Vice President NEWCOURT COMMERCIAL FINANCE CORPORATION (f/k/a AT&T COMMERCIAL FINANCE CORPORATION), as the Collateral Agent and as a Lender By:/s/ MICHAEL V. MONIHAN ---------------------------------- Name: Michael V. Monihan Title: Vice President CANADIAN IMPERIAL BANK OF COMMERCE, as a Lender By:/s/ ELLEN MARSHALL ---------------------------------- Name: Ellen Marshall Title: Managing Director GENERAL ELECTRIC CAPITAL CORPORATION, as a Lender By:/s/ MARK F. MYLON ---------------------------------- Name: Mark F. Mylon Title: Manager - Operations Signature Page-2 Amendment No. 1 to Loan Agreement BANKBOSTON, N.A., as a Lender By:/s/ ILLEGIBLE ---------------------------------- Name: Title: Vice President CREDIT SUISSE FIRST BOSTON, as a Lender By:/s/ KRISTEN LEPRI ---------------------------------- Name: Kristin Lepri Title: Associate DRESDNER BANK AG NEW YORK AND GRAND CAYMAN BRANCHES, as a Lender By:/s/ CONSTANCE ROOSMORE ---------------------------------- Name: Constance Roosmore Title: Assistant Vice President By:/s/ LAURA FAZIO ---------------------------------- Name: Laura Fazio Title: Assistant Vice President MORGAN STANLEY SENIOR FUNDING, INC., as a Lender By: ---------------------------------- Name: Title: By: ---------------------------------- Name: Title: Signature Page-3 Amendment No. 1 to Loan Agreement SUMMIT BANK, as a Lender By: ---------------------------------- Name: Title: MORGAN STANLEY DEAN WITTER PRIME INCOME TRUST, as a Lender By:/s/ ILLEGIBLE ---------------------------------- Name: ILLEGIBLE Title: AUTHORIZED SIGNATORY UNION BANK OF CALIFORNIA, as a Lender By:/s/ RYAN D. FLANAGAN ---------------------------------- Name: Ryan D. Flanagan Title: Assistant Vice President Signature Page-4 Amendment No. 1 to Loan Agreement EXHIBIT H-1 NOTICE OF BORROWING To: First Union National Bank, as Agent Agency Services-PA4830 1339 Chestnut Street Philadelphia, Pennsylvania 19107 Facsimile no. (215) 973-1887 Newcourt Commercial Finance Corporation (f/k/a AT&T Commercial Finance Corporation), as Collateral Agent 2 Gatehall Drive Parsippany, New Jersey 07054 Attention: Vice President-Operations/Media & Communication Dated:______________________ Ladies and Gentlemen: The undersigned, KMC Telecom Inc., a Delaware corporation, KMC Telecom II, Inc., a Delaware corporation, KMC Telecom of Virginia, Inc., a Virginia public service company, KMC Telecom Leasing I LLC, a Delaware limited liability company, KMC Telecom Leasing II LLC, a Delaware limited liability company, the "Additional Borrowers" signatory thereto from time to time (collectively, the "BORROWERS"), refer to that certain Loan and Security Agreement dated as of December 22, 1998 among the Borrowers, the financial institutions signatory thereto from time to time (the "LENDERS"), First Union National Bank, as administrative agent for the Lenders (the "AGENT") and AT&T Commercial Finance Corporation, as collateral agent for the Lenders (the "COLLATERAL AGENT"; together with the Agent, the "AGENTS") (as amended, restated, supplemented or otherwise modified from time to time, the "LOAN AGREEMENT"; undefined, capitalized terms used herein shall have the meanings assigned thereto in the Loan Agreement) and hereby give the Agent notice, irrevocably, pursuant to SECTION 2.03 of the Loan Agreement that [KMC Telecom Inc.] [KMC Telecom II, Inc.] [KMC Telecom of Virginia, Inc.] [KMC Telecom Leasing I LLC] [KMC Telecom Leasing II LLC] [Additional Borrower] hereby requests a Loan under the Loan Agreement, and in that connection sets forth below the information relating to such Loan (the "PROPOSED LOAN") as required by SECTION 2.03 of the Loan Agreement: (i) The Business Day of the Proposed Loan is _________ __, ____; H-1 (ii) The proceeds of the Proposed Loan are to be used for the purposes as specified on SCHEDULE A attached hereto; (iii) The bank account into which the proceeds of the Proposed Loan are to be [credited]1[transferred]2 is account no. [___________________]3 maintained at [___________]4; (iv) If the bank referenced in (iii) above is not the Agent, the ABA number of the above-referenced bank is [___________], and the name and address, phone and fax numbers of the contact person at such bank, are as follows: ________________________________________ ________________________________________ ________________________________________ Telephone Number:_______________________ Fax Number: ______________________; (v) The aggregate amount of the Proposed Loan is $[_____________]; (vi) Such Loan, if the initial Loan is to bear interest at the Base Rate; (vii) Such Loan, if after the initial Loan, is to bear interest at the [Base Rate] [LIBO Rate, with an applicable Interest Period of [one month] [two months] [three months] [six months]]; (viii) The Borrowing Base at such time is $[________________]. The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the Business Day of the Proposed Loan: (A) The representations and warranties contained in ARTICLE III of the Loan Agreement and contained in the other Loan Documents are correct in all respects, before and after giving effect to the Proposed Loan and to the application of the proceeds therefrom, as though made on as of such date; (B) No event has occurred and is continuing, or would result from such Proposed Loan or from the application of the proceeds therefrom, which constitutes either an Event of Default or an event which but for the requirement - - ----------------------- 1 Select if the Agent is the depository bank. 2 Select if the depository bank is not the Agent. 3 Insert specific account number. 4 Insert name of financial institution. H-2 that notice be given and/or the elapse of time, would constitute an Event of Default; and (C) All agreements and all conditions to the Proposed Loan, contained in the Loan Agreement or any other of the Loan Documents which are required to be performed or satisfied by the Borrower on the date hereof or by the Business Day of the Proposed Loan have been and will be performed and satisfied. (D) [To be included in the Notice of Borrowing at any time that the Total Leverage Ratio is greater than 6:1 as determined by reference to the financial statements delivered pursuant to SECTION 5.06 of the Loan Agreement] The sum of the Proposed Loans and all other Revolving Loans outstanding at the time of such Proposed Loan do not exceed the Borrowing Base and transaction costs incurred in connection with the execution and delivery of the Loan Documents, MINUS, if the Term Loans have not yet been made, the Term Loan Commitment Amounts of all Term Lenders, and otherwise, the outstanding principal balance of the Term Loans. (E) In addition, by its acknowledgment signature below, the Collateral Agent hereby confirms that the Borrowers have delivered and the Collateral Agent has reviewed to its satisfaction (i) each of the invoices or certificates required to be provided to the Collateral Agent pursuant to SECTION 2.03(A) of the Loan Agreement and (ii) each of the collateral documents, including, without limitation, all third party agreements and the related consents to collateral assignments required pursuant to SECTION 5.08 of the Loan Agreement, as requested by the Collateral Agent. H-3 The undersigned hereby further certifies that in accordance with SECTION 6.02 of the Loan Agreement the proceeds of the Proposed Loan shall be used only for the purposes permitted in accordance with SECTION 2.02 of the Loan Agreement. Very truly yours, KMC TELECOM INC. KMC TELECOM II, INC. KMC TELECOM OF VIRGINIA, INC. In each case: --------------------------- By: Its: KMC TELECOM LEASING I LLC By: KMC TELECOM INC., as Sole Member --------------------------- By: Its: KMC TELECOM LEASING II LLC By: KMC TELECOM II, INC., as Sole Member --------------------------- By: Its: H-4 Acknowledged and agreed solely with respect to the assertions set forth in section (E) above this [____] day of [______________]: NEWCOURT COMMERCIAL FINANCE CORPORATION (f/k/a AT&T COMMERCIAL FINANCE CORPORATION), as Collateral Agent - - ------------------------------ By: Its: H-5 SCHEDULE A TO NOTICE OF BORROWING DESCRIPTION OF THE PURPOSES FOR WHICH THE PROCEEDS OF THE PROPOSED LOAN WILL BE USED [If the proceeds of the Proposed Loan will be used to fund the costs and expenses of a System, copies of lien waivers and other acknowledgments from Persons constructing such System and any subcontractors or vendors with respect to such construction, will be required to be delivered to the Collateral Agent, together with all applicable consents to collateral assignments of any licenses or leases with respect to such System. Additionally, any schedules to the Loan Agreement which, as of the date of such proposed Loan, require modification, shall be appropriately supplemented and delivered to the Agent. Exceptions to such requirements should be set forth and attached to the Notice of Borrowing.] [If the proceeds of the Proposed Loan will be used to purchase or reimburse any Borrower for Telecommunications Equipment, a schedule supporting one hundred percent (100%) of Telecommunications Equipment requested to be funded shall be delivered to the Collateral Agent. Such schedule will detail all invoices for equipment, third party labor, permits, other third party costs and all capitalized internal costs of the Borrowers with respect to such Telecommunications Equipment permitted under GAAP. All invoices over $25,000 will be attached to such schedule delivered to the Collateral Agent, who shall review such invoices and verify that, when combined with the above described capitalized internal costs, such invoices will support at least seventy percent (70%) of the total requested funding. Additionally, any schedules to the Loan Agreement which, as of the date of such Proposed Loan, require modification, shall be supplemented and delivered to the Agent. In addition, if the Telecommunications Equipment is being purchased or reimbursed under the Lucent Purchase Agreement, a certificate of delivery and acceptance in the form of EXHIBIT R shall be attached to the Notice of Borrowing delivered to the Collateral Agent.] [If the proceeds of the Proposed Loan will be used to pay or reimburse for transaction costs, a copy of the invoice from the provider of the service or other appropriate supporting documentation must be included for the Collateral Agent.] [If the proceeds of the Proposed Loan will be used for working capital or other general corporate purposes, a certificate will be required to be delivered to the Collateral Agent verifying that the making of the Proposed Loan does not violate any provision of the Indenture.] H-6 EX-10.6 11 MEMORANDUM OF AGREEMENT MEMORANDUM OF AGREEMENT [object omitted] EFTIA OSS SOLUTION [object omitted] KMC Telecom Holdings, Inc. CLEC Solution ------------------------- Prepared by: Gupta & Somji Revision: 3.1 October 26th, 98 ------------------------- EFTIA OSS SOLUTION INC. RESTRICTIONS This document contains information intended for KMC Telecom Holdings, Inc. and Eftia OSS Solutions Inc. The information herein is restricted to Eftia and KMC personnel and any organizations authorized by Eftia. i TABLE OF CONTENTS 1. PROJECT...................................................................1 2. DELIVERABLES..............................................................3 3. PRICING...................................................................4 4. PROJECT MILESTONES........................................................4 5. PAYMENT TERMS.............................................................6 6. CHANGE REQUEST............................................................9 7. LICENSE AGREEMENT.........................................................9 8. SOFTWARE SUPPORT AGREEMENT................................................9 9. ATTACHMENTS...............................................................9 10. ACCEPTANCE...............................................................10 ii MEMORANDUM OF AGREEMENT Between KMC TELECOM HOLDINGS, INC. And EFTIA OSS SOLUTIONS INC. This Memorandum of Agreement, dated as of October 26th, 1998 ("Effective Date") sets forth the mutual agreement of KMC TELECOM HOLDINGS, INC. ("KMC") and EFTIA OSS SOLUTIONS INC. ("Eftia") with regard to the following: 1. PROJECT Implementation of the Master.Scribe CLEC package with associated software packages as listed in the attached quotation identified as Appendix A. Eftia will provide all the required customizations to the Enhanced Data Services and Long Distance Service Order options as agreed to in writing during the assessment process. The customizations will not include any interfaces. All the required customizations and implementation services including data migration required for the Maintenance, Number Tracking and Circuit Inventory applications will be billable at a daily rate of $1,250. 2. DELIVERABLES The deliverables consist of Eftia's Master.Scribe CLEC package and associated software packages as listed in the attached quotation identified as Appendix A. All the software packages will include complete set of documentation and media. 3. PRICING All prices are in US Dollars. THE FOLLOWING PRICE PROPOSAL IS ONLY VALID UP TO OCTOBER 30TH, 1998. New product prices will apply for orders received after October 30th 1998.
PHASE I PHASE 11 PHASE III PHASE IV PHASE V ------------ ------------ ----------- ---------- ------------- SOFTWARE $1,493,128 $1,176,200 $710,000 $213,000 $1,000,000 SUPPORT $286,380 $245,700 $127,800 $38,340 $180,000 TRAINING $103,000 $25,000 $0 $0 $0 ------------ ------------ ----------- ---------- ------------- TOTAL COST $1,882,508 $1,446,900 $837,800 $251,340 $1,180,000
The prices quoted above do not include any additional customizations, implementation or data migration services that may be required by KMC. Eftia will provide these services at a per them rate of $1,250. All travel expenses will be reasonable, itemized and subject to prior written approval by KMC. All applicable taxes are extra. NOTE: 1. EFTIA WILL OFFER KMC SUBSIDIARY A 25% DISCOUNT ON CLEC MASTER.SCRIBE PACKAGE IF THIS PACKAGE WAS TO BE PURCHASED AS PART OF THIS MOA. 2. THE PRICES QUOTED FOR PHASES II TO V ARE VALID FOR ONE YEAR FROM THE DATE OF QUOTATION, BUT ARE SUBJECT TO RE-NEGOTIATION SHOULD KMC'S BUSINESS REQUIREMENTS CHANGE. ALL SUPPORT PRICES ARE SUBJECT TO CHANGE AND WILL BE BASED ON THEN CURRENT LIST PRICE OF SUPPORT. 4. PROJECT MILESTONES The project milestones will be agreed to, in writing, by KMC and Eftia after project kickoff meeting. Proposed milestones are as follows: 2 PHASE I CLEC Master.Scribe Service Order for Long Distance Service Order for Enhanced Data Services Form Generation System - Two forms (ASR, LSR) Additional Forms for Service Order - Seven Forms (E911, LIDB, CNAM, MCI LD, Calling Card, Toll-Free, Lucent Service Order Form) Integrated Fax Server Basic Network Management Interface Interface to Billing System Service Bureau - Note 2 AR System Software Licenses - As per quotation in Appendix A All Required Training (as per quotation in Appendix A) PHASE II Integrated Paging and IVR System Workforce Management ASR Order Gateway with single set of transactions LSR Order Gateway with single set of transactions Interface to LNP Service Bureau (Illuminet) All Required Training (as per quotation in Appendix A) PHASE III Integrated Basic Network Management Interface Service Impact Module E911 and Directory Assistance Interfaces Interface to LIDB / CNAM Service Bureau (Illuminet) 3 PHASE IV WEB Interface for Order Submission and Query Real Time Business Process Metrics for Service Order WEB Interface for Ticket Submission and Query Real Time NOC Metrics ARSystem Software Licenses - As per quotation in Appendix A PHASE V Trouble Administration Gateway - Client Trouble Administration Gateway - Manager NOTE: 1. ALL PHASES ARE SUCCESSIVE. IMPLEMENTATION OF PHASES II TO V IS DEPENDENT UPON THE SUCCESSFUL IMPLEMENTATION OF EACH PREVIOUS PHASE. KMC WILL INFORM EFTIA OF PHASE CONTENTS AND START DATES WHICH ARE SUBJECT TO CHANGE SHOULD KMC'S BUSINESS REQUIREMENTS CHANGE. 2. INTERFACE TO BILLING SYSTEM MILESTONE IS BASED UPON THE IMPLEMENTATION OF AN INDUSTRY STANDARD BILLING PLATFORM. AN INTERFACE TO ANY OTHER BILLING SYSTEM REQUIRES EFTIA'S APPROVAL AND COULD CHANGE THE COST AND THE PHASE IN WHICH THE INTERFACE TO THE BILLING SYSTEM WOULD OCCUR. 5. PAYMENT TERMS All payments are due net 30 days from receipt of invoice. Interest rate of 2% per month will apply on any late payment. Training and additional Customizations will be billed at the end of the month they are delivered. All travel expenses will be billed on a monthly basis and are due on receipt of detailed invoice. Actual expense bills will be provided with each invoice. 4 DESCRIPTION AMOUNT ----------- ------ PHASE I On completion of JAD (Joint $342,726 Application Design ) With KMC And KMC's selected billing vendor. Upon implementation of CLEC $685,454 Master.Scribe System This includes cost for CLEC package, ARSystem licenses and one-year support on AR System licenses only. Upon implementation of Service $103,000 Order for Long Distance Upon implementation of Service $103,000 Order for Enhanced Data Services Upon completion of above items - $180,000 Support for CLEC package Upon implementation and $35,400 Integration of Form Generation System - Two forms Upon implementation and $23,600 Integration of each additional forms for Service Order Total $165,200 Upon implementation of Integrated $35,400 Fax Server Upon implementation of Inter-face $82,128 to Billing System Service Bureau (Note 2) Upon implementation of Backup $47,200 Software PHASE II Upon implementation of Integrated $35,400 Paging and IVR System Upon integration of Workforce $118,000 Management Upon Implementation of Interface $177,000 to LNP Service Bureau (Illuminet) - APPROXIMATE COST Upon Implementation of ASR Order $619,500 Gateway with single set of transactions 5 Upon Implementation of LSR Order $472,000 Gateway with single set of transactions PHASE III Upon Integration of Basic Network $70,800 Management Interface Upon Implementation and $236,000 Integration of Service Impact Module Upon implementation of E911 and $354,000 Directory Assistance Interfaces Upon Implementation of Interface $177,000 to LIDB/CNAM Service Bureau (Illuminet) - APPROXIMATE COST PHASE IV Upon implementation of WEB $59,000 Interface for Order Submission and Query Upon implementation of Real Time $41,300 Business Process Metrics for Service Order Upon implementation of WEB $59,000 Interface for Ticket Submission and Query Upon implementation of Real Time $39,530 NOC Metrics AR System Licenses and Support $52,510 PHASE V Upon implementation of Trouble $590,000 Administration Gateway - Client Upon implementation of Trouble $590,000 Administration Gateway - Manager NOTES: 1. EACH TIME EFTIA SELLS AND COLLECTS FROM SALE OF TA GATEWAY, A ROYALTY OF 20% OF THE NET SALE PROCEEDS COLLECTED BY EFTIA FROM SUCH SALE WILL BE PAID TO KMC. THIS PAYMENT, BY EFTIA TO KMC, IN AGGREGATE, WILL NOT EXCEED 50% OF THE TA GATEWAY COST PAID BY KMC TO EFTIA. 2. INTERFACE TO BILLING SYSTEM MILESTONE IS BASED UPON THE IMPLEMENTATION OF AN INDUSTRY STANDARD BILLING PLATFORM. AN INTERFACE TO ANY OTHER BILLING SYSTEM REQUIRES EFTIA'S APPROVAL AND COULD CHANGE THE COST AND THE PHASE IN WHICH THE INTERFACE TO THE BILLING SYSTEM WOULD OCCUR. 6 6. CHANGE REQUEST Any change request is required in writing. Upon receipt of a change request, system development timelines and associated costs will be provided to KMC for approval. 7. LICENSE AGREEMENT The attached License Agreement identified as Appendix B needs to be read and initialized for acceptance of the terms. 8. SOFTWARE SUPPORT AGREEMENT The attached Software Support Agreement identified as Appendix C needs to be read and initialized for acceptance of the terms. 9. ATTACHMENTS Appendix A - Quotations dated October 26th, 1998 Appendix B - Software License Agreement Appendix C - Software Support Agreement 7 10. ACCEPTANCE IN WITNESS WHEREOF, the parties have caused this Memorandum of Agreement to be executed by their duly authorized representatives. KCM Telecom Holdings, INC EFTIA OSS SOLUTIONS INC By: /S/ By: /S/ ---------------------- ---------------------- Title: CIO Title: CFO ------------------- ------------------- Date: 10 NOV. 1998 Date: NOV. 17, 1998 -------------------- -------------------- 8 EFTIA OSS SOLUTIONS, INC. APPENDIX "B" - LICENSE AGREEMENT This is a legal and binding agreement between you "End User" and Eftia OSS Solutions Inc ("Eftia"). By accepting the delivery of the software, the End User agrees to and accept all terms of this license agreement. If the End User does not agree to all terms, do not accept the application software and return the product(s), all manuals and documentation within 30 days of first acquiring this product. 1. DEFINITION As used herein, the term "Software" means the EFTIA Application Module Software provided with this License, including all associated schema definitions, filters, escalations, active links and menus and all supporting documentation ("`Documentation") for which the End User has purchased licenses. Software, as used herein, does not refer to source code and no license is granted with respect to source code software. No license is granted with respect to EFTIA Application Module Software for which the End User has not paid the applicable license fee. Evaluation Licenses for the Software are provided for a limited term as described in Paragraph 2 below. 2. LIMITED USE LICENSE In consideration of the End User's license fee, EFTIA hereby grants to the End User and the End User's affiliates, a non-exclusive, nontransferable License to install and use the programs(s) on a server directly connected to a local area network, object code form only, upon the terms and conditions of this License Agreement. The total number of users that may access the server on which the Software is installed is limited to the number of designated users for which Remedy client licenses have been purchased. THE SOFTWARE MAY ONLY BE USED FOR THE PROCESSING OF THE END USER'S OWN INFORMATION AND DATA. If the Software has been provided to the End User for evaluation, the license grant above shall be limited to a 30-calendar day term after which the license shall automatically terminate. Eftia and its licensors retain all rights not expressly granted herein. With the exception of evaluation Software, the End User may assign the End User's rights under this License Agreement to a third party who agrees in writing to be bound by this License Agreement prior to the assignment and provided that the End User transfer all copies of the Software and related documentation to the third party and destroy any copies not transferred. Except as set forth above, the End User may not assign the End User's rights under this License Agreement. The End User agrees that EFTIA may cause an audit and/or inspection to be made of the End User's applicable records and facilities in order to verify compliance with the terms and conditions of this License Agreement. 3. OWNERSHIP OF SOFTWARE This license is not a sale of the Software or any copy thereof. All worldwide ownership of and rights, title and interest in and to the Software, and all copies and portions thereof, including without limitation, all copyrights, patent rights, trademark rights, trade secret rights, inventions and other proprietary rights therein and thereto, are and shall remain exclusively in EFTIA and its Licensors. 4. COPY RESTRICTIONS The Software and the accompanying written materials ("the Documentation") are protected by federal copyright law and international treaties. The End User may not prepare derivative works of the Software but may combine the Software with other software and customize the Software in accordance with the supporting Documentation. The End User may create a reasonable number of backup or archive copies of the Software. In addition, the End User may copy the Software, provided that the End User has purchased a license for each copy of the Software that the End User makes. The End User agrees that: (a) the End User shall not, (b) the End User shall not permit a third party to and (c) if the End User is a corporation, the End User shall use reasonable efforts to prevent the End User's employees and contractors from attempting to (i) decompile, disassemble, reverse engineer or otherwise attempt to reconstruct or discover the source code of any Software, or to (ii) remove any product identification, copyright or other notice from the Software or the Documentation. The End User shall not release the results of any benchmark of the Software to any third party. without the written prior consent of EFTIA. 5. TERMINATION The license granted herein is effective until terminated, except for evaluation copies of the Software which have a 30 calendar day license term. This license will terminate immediately without prior additional notice if the End User fails to comply with any material provisions of this License Agreement and fail to correct such default within 30 days after notice thereof. Upon termination or expiration of the evaluation term, the End User shall remove all copies of the Software or any part thereof from the server and any and all of the End User's systems and storage devices, and destroy the same and destroy all Documentation. Upon EFTIA'S written request the End User shall certify to EFTIA in writing that all complete and Partial copies of the Software and the Documentation have been destroyed and that none remain in the End User's possession or under the End User's control. The provisions of this License Agreement other then the license grant contained in Section 2 ("Limited Use License") hereof, shall survive termination. 2 6. LIMITED WARRANTY AND DISCLAIMERS EFTIA warrants to the End User, for the period of thirty (30) days from the date of delivery to the End User, that the software will be free from defects in media, and, if not modified and if properly installed and used, will substantially conform to the material specifications set forth in the documentation ("limited warranty"). Such warranties are for the End User's benefit and the benefit of the End User's affiliates only and are non-transferable. EFTIA does not warrant that the software will operate error free, or uninterrupted, or will meet the End User's requirements. Except for the express warranties stated in this section 6 ("Limited Warranty and Disclaimers"), the software and documentation are each licensed "as is" and EFTIA hereby specifically excludes and disclaims all warranties, whether express, implied or statutory, including, without limitation, the implied warranties of merchantability and of fitness for a particular purpose. 7. EXCLUSIVE REMEDY The End User's sole and exclusive remedy, and EFTIA'S sole and exclusive obligation and liability, with respect to Software which does not conform to an express warranty set forth above, or with respect to Software or the quality or performance thereof under any warranty, negligence, strict liability or other theory, shall be (a) in the case of a defect, to provide non-defective replacement of the Software, or (b) in case of a material non-conformance with specifications to use commercially reasonable efforts to correct such material non-conformance or, if such is not reasonably feasible, in EFTIA'S opinion, to refund the Software license fee upon return of the Software and destruction of all remaining copies. The End User understands that EFTIA does not guarantee that any error or other non-conformance can and will be corrected. This limited Warranty is void if failure of the Software has resulted from the End User's negligence or misapplication. The End User agrees to report any material non-conformance in the Software to EFTIA and provide EFTIA with all available information in written or electronic form so as to enable EFTIA to reproduce the non-conformance. 3 8. LIMITED LIABILITY Neither EFTIA or the End User will be liable for any special, indirect, incidental or consequential damages of any kind or nature whatsoever, arising out of or in any way related to this agreement, the software or the use of or inability to use the software, including, without limitation, lost goodwill, lost profits, loss of data or software, work stoppage or impairment of other goods, and whether arising out of breach of warranty, breach of contract, tort (including negligence), strict liability or otherwise, even if advised of the possibility of such damage or if such damage could have been reasonably foreseen, and notwithstanding any failure of essential purpose of any exclusive remedy provided herein, in addition, except for Section 11 ("Patent and Copyright Indemnity") in no event shall EFTIA'S total liability relating to or in connection with this agreement or any software, whether based on contract, warranty, tort (including negligence), strict liability or otherwise, exceed the actual amount paid to EFTIA for software giving rise to the liability. In no event shall EFTIA be liable for the costs of procurement of substitute software or services. 9. U.S. GOVERNMENT RESTRICTED RIGHTS If this Software is being acquires by the U.S. Government, the Software and related documentation is commercial computer software and documentation developed exclusively at private expense, and (a) if acquired by or on behalf of a civilian agency, shall be subject to the terms to this computer software License as specified in 48 C.F.R. 12.212 of the Federal Acquisition Regulations and its successors; and (b) if acquired by or on behalf of units of the Department of Defense ("DoD") shall be subject to the terms of this commercial computer software license as specified in 48 C.F.R. 227.720202, DoD FAR Supplement and its successors. 10. EXPORT The Software is subject to the export control laws and regulations of the United States, and the End User agrees to fully comply with all U.S. export control laws and regulations 11. PATENT AND COPYRIGHT INDEMNITY EFTIA will defend, at its own expense, any legal action brought against the End User to the extent that it is based on a claim that the Software used within the scope of this Agreement infringes a patent, copyright or other intellectual property right of third party, and EFTIA will pay any costs and damages finally awarded against the End User in any such action that are 4 attributable to any such claim or incurred by the End User through settlement thereof. However, such defense and payments are subject to the condition that the End User must: (i) notify EFTIA promptly in writing of such claim, (ii) permit EFTIA to have sole control of the defence, compromise or settlement of such claim, including, any appeals, provided that EFTIA will not settle any claims against the End User without the End User's prior written consent, which will not be unreasonably withheld, and (iii) reasonably cooperate with EFTIA in the defence or settlement of such claim at no charge to EFTIA. Except as described above, EFTIA shall not be liable for any other costs, damages or fees incurred by the End User in connection with such action or claim unless authorized in writing by EFTIA. Should the Software become, or in EFTIA'S opinion be likely to become, the subject of any such claim, the End User shall permit EFTIA, at EFTIA'S option and expense, to (a) procure for the End User the right to continue using the Software, (b) replace or modify the Software so that it becomes non-infringing, or (c) if the foregoing, is nor practicable, terminate the right to use the Software and remove the Software, upon which termination the End User agrees to promptly return and/or destroy all copies of the Software and certify the same to EFTIA, whereupon EFTIA will refund the End User license fees for the Software as depreciated on a straightens three (3) year basis. EFTIA shall have no liability, for any claim of patent or copyright infringement which is based on (a) the use of other than the then latest version the Software, if such infringement could have been avoided by the use of the latest version so long as the latest version is available to the End User at no charge, (b) the use or combination of the Software with software, hardware or other materials not provided or approved by EFTIA, provided such infringement would not have arisen but for such use or combination, (c) use of the Software in a manner other than for which it was designed or contemplated as evidenced by EFTIA'S published specification, (d) any modification by the End User or a third party of the Software that is not approved by EFTIA, or (e) any compliance with specific, detailed written designs, plans or specifications furnished by the End User or on the End User's behalf. This section 11 ("Patent and Copyright Indemnity") states the entire liability of EFTIA, and the End User's sole and exclusive remedy, with respect to infringement of any patents, copyrights, or other intellectual property rights, and EFTIA shall have no additional liability with respect to any alleged or proved infringement. 5 12. GOVERNING LAW This Agreement is governed by the laws of the State of New Jersey without regard to conflict of laws, rules and principles. The United Nations Convention on Contracts for the International Sale of Goods is specifically disclaimed. 13. MISCELLANEOUS If any provision hereof shall be held illegal, invalid or unenforceable, in whole or in part, such provision shall be modified to the minimum extent necessary to make it legal, valid and enforceable, and the legality, validity and enforceability of all other provisions of this Agreement shall not be affected thereby. No delay or failure by either party to exercise or enforce at any time any right or provision hereof shall be considered a waiver thereof, or of such party's right thereafter to exercise or enforce each and every right and provision of this Agreement. A waiver or amendment hereto shall be effective only if it is in writing (by non-preprinted agreement or terms and conditions) and signed by an authorized representative of the End User and EFTIA. No single waiver shall constitute a continuing or subsequent waiver. The prevailing party in any action to enforce this Agreement shall be entitled to recover costs and expenses, including reasonable attorneys' fees. The price terms of this Agreement are confidential and no press release or any other written or oral disclosure of any price terms may be made by either party without the other party's prior written consent. This Agreement is the complete and exclusive statement of the End User and EFTIA relating to the subject matter hereof and supersedes all prior oral and written and all contemporaneous oral negations, commitments and understandings of the parties. EFTIA OSS SOLUTIONS INC. KMC TELECOM HOLDINGS INC. Signature: /S/ Signature: /S/ ------------------------- ------------------------- Name/Title: CFO Name/Title: CIO ------------------------ ------------------------ Date: NOV. 17, 1998 Date: 10 NOV. 1998 ------------------------------ ------------------------------ 6 APPENDIX C [object omitted] Eftia OSS Solutions Inc. CUSTOMER SUPPORT SERVICES AGREEMENT This Customer Support Services Agreement (the "Agreement") is effective as of 1 December 1998 ("Effective Date") by and between Eftia OSS Solutions, Inc. ("'EFTIA"), with its principal place of business at 1600 Scott Street, 3rd Floor, Ottawa, Ontario KlY 4N7 and KMC TELECOM HOLDINGS INC. ("Licensee"), with its principal place of business at 1545 ROUTE 206, SUITE 300, BEDMINSTER, NJ 07921. The following are included herein by reference as integral parts of this Agreement: EXHIBIT A: Licensed Software Products Covered by this Agreement EXHIBIT B: Explanation of Escalation Procedures 1. DEFINITIONS 1.1 "Documentation" shall mean any user manuals, release notes, installation notes, and other materials in any form provided in conjunction with the Licensed Software Products. 1.2 "Error" means a problem which causes the Licensed Software Products not to perform substantially in accordance with the specifications set forth in applicable Licensed Software Products Documentation. 1.3 "Licensee" shall mean that End User which acquires the Licensed Software Product for its own use and which has no right to sublicense or transfer the Licensed Software Product to any third party, and its subsidiaries and affiliates. 1.4 "Licensed Software Product(s)" shall mean the software in object code specified on a purchase order referencing this agreement, together with the Documentation, licensed to the Licensee by way of a separate license agreement. 7 1.5 "Release" shall mean any update, enhancement, or bug-fix of a Licensed Software Product which is substantially similar to and is marketed under the same product number and nomenclature. A Release is designated by a number to the right of the decimal point (such as Vx.1 or Vx.2 or Vx.2.2). 1.6 "Site" shall mean a single corporate or business entity, located within an area having a radius of less than 25 miles (40 kilometers) for which a single Customer Support Services Agreement exists to cover support of all Licensed Software Products. 1.7 "Software Maintenance" shall mean the issuance of new Releases of Licensed Software Products on an as-needed basis in order to correct "bugs" or to add functional enhancements. 1.8 "Software Support" shall mean providing commercially reasonable responses to a reasonable amount of technical questions posed via telephone, facsimile or electronic mail during Eftia's normal business hours - 8.00 a.m. to 5.00 p.m. EST. 1.9 "Update" shall mean at Release of the Licensed Software Product or new Documentation designated to correct any Errors or to improve performance or functionality. 1.10 "Version" shall mean specific edition of the Licensed Software Products and is designated by a number located to the left of the decimal point (such as Vl.x or V2.x). Each new Version of the Licensed Software Products contains significant functionality changes or improvements. 2. PURPOSE AND SUPPORT PLANS AVAILABLE 2.1 Purpose: Eftia offers optional support and maintenance plans for the Licensed Software Products detailed in Exhibit A on an annual subscription basis. Licensee desires to subscribe to one of these support plans as indicated on Exhibit A. 2.2 Support Plans: Licensee may obtain services under this Agreement by issuing a purchase order to Eftia. No purchase order is binding on Eftia unless and until accepted by Eftia and nothing contained in any purchase order, P.O. Acknowledgment, or invoice shall in any way modify the terms of this Agreement or add any additional terms or conditions. The Basic Plan: Eftia will provide diagnostic assistance through telephone, facsimile or electronic mail to assist Licensee in isolating and resolving Errors and other problems during normal 8 business hours. Response time is two (2) hours or less. The Basic Plan also includes updates to Licensed Software Product and Documentation or delivery of software patches and workarounds. Support Coverage: Monday to Friday 8:00 to 17:00 EST, excluding Eftia Holidays Telephone Number: 1-888-423-3842 (1 888 42EFTIA) E-mail Address: support@eftia.com B. Consulting Services: Licensee questions concerning the adaptation or modification of the supported Software Licensed Products are not covered by this Customer Support Agreement. Eftia does offer optional Consulting Services for areas beyond the scope of this Agreement for additional fees. 3. EFTIA RESPONSIBILITIES 3.1 Eftia will provide the standard Software Support services on weekdays from 8:00 AM to 5:00 PM, Eastern Standard Time, excluding Eftia holidays. 3.2 Eftia shall investigate Errors in the Licensed Software Product reported by the Licensee. If Eftia's investigation reveals an Error or malfunction in the supported Licensed Software Products, Eftia will use commercially reasonable efforts to either provide a correction to the Error or to provide a suitable workaround solution. 9 3.3 Eftia shall have no obligation to support: A. Altered or Licensee/Third Party-modified Licensed Software Products that have not been approved by Eftia; B. Derivative works; C. Any combination of the supported Licensed Software Product with other software not covered by this Agreement that has not been approved by Eftia; D. Software Errors created through Licensee's negligence or misapplication of the Licensed Software Products for purposes other than those specified in the Documentation; E. Software Errors resulting from hardware malfunction or Licensee's failure to backup data; F. Licensed Software Product used on non-qualified computer systems or hardware. Eftia will provide to the Licensee a list of qualified hardware and software upon releasing any enhancements to the product as part of the support agreement. 3.4: Eftia will provide support services for the most recent Release of the Licensed Software Product. Eftia will also support the preceding release ("Previous Sequential Release") until the most recent Release has been generally commercially available for one (1) year. 3.5 Product Updates: The Licensee will be provided software upgrades from Eftia, if annual maintenance fees are current. 3.6 Eftia will provide temporary re-host of the Licensed Software Product at extra cost to a substantially similar back-up system when the primary designated system is inoperable. 4. LICENSEE RESPONSIBILITIES 4.1 Licensee shall appoint a Technical Representative, and an Alternate if the system size warrants i, who will be trained and qualified to maintain the integrity of the Licensed Software Products on Licensee's system. The Technical Representative or Alternate shall make all technical communications by Licensee to Eftia. All technical information and materials provided to Eftia pursuant to this Agreement will be routed to the Technical Representative. 10 4.2 Licensee end users shall use reasonable efforts to read, comprehend and follow operating instructions and procedures specified in Documentation. 4.3 Licensee will use reasonable efforts to notify Eftia if problems or Errors with the Licensed Software Product are encountered. Licensee shall provide descriptions of the Error to Eftia. Licensee will answer questions and use reasonable efforts to assist Eftia's efforts to duplicate any Licensed Software Product Errors or problems. Subject to Licensee's security and confidentiality requirements, Licensee will provide Eftia with access to and use of information and system facilities reasonably determined necessary by Eftia to provide timely support. 4.4 Licensee will provide reasonable remedial corrective action, if necessary, under the direction of Eftia support personnel. 4.5 For customers on the Eftia Support Plan, at least two named technical contacts must have received training on all of the Licensed Software Products in use at Licensee's site. 5. TERM 5.1 Term: Unless terminated earlier as provided herein, this Agreement is effective for one (1) year from the Effective Date of this Agreement. 5.2 Renewal: This Agreement will be automatically renewed for additional one year terms unless Licensee notifies Eftia in writing that support is not being renewed. Licensee agrees to provide at least thirty (30) days written notice that support is not being renewed. Eftia has the right not to renew this Agreement with respect to the Licensed Software Products by providing written notice of such election at least ninety (90) days prior to the anniversary date, if and only if Eftia no longer generally provides support for such Licensed Software Products, or no longer provides the specific services previously offered. 6. PAYMENT TERMS 6.1 Payment Terms: Payment terms are net 30 days from receipt of Eftia invoice. 6.2 Payment will be made in U.S. dollars to Eftia's Corporate Address. 6.3 All prices are F.O.B. at Ottawa, ONTARIO, Canada. 11 6.4 In addition to any other sums payable hereunder, Licensee shall pay all reasonable transportation charges, shipping insurance or duties, and shall be responsible for any and all taxes, import or export fees, excise taxes, and withholding taxes arising from use of the licensed Software Products (excluding taxes based upon Eftia's income). 7. CONFIDENTIALITY 7.1 Both parties understand and acknowledge that by reason of their relationship with each other, they will have access to certain information and materials concerning the other party's business, plans, customers, and technology, that are confidential and of substantial value, which value would be impaired if such information were disclosed to third parties. Both parties agree that they shall not use in any way for its own account or the account of any third party, nor disclose to any third party, any such confidential information revealed to it by the other party other than to fulfill its express obligations under this Agreement except as otherwise required by applicable law or legal process. Each party will take every reasonable precaution to protect the confidentiality of such information. 7.2 All customer lists, potential customer lists, marketing and financial information, business plans, and technical information, whether written or verbal, shall be deemed confidential information. 7.3 Licensed Software Products and all code, inventions, algorithms, know how and ideas obtained from Eftia shall be deemed confidential information. 7.4 This Agreement is confidential and neither party shall make any public announcement of this Agreement or the relationship between the parties without the advance, written consent of the other party. 8. TERMINATION 8.1 Termination for Cause: Upon default in the performance of any provision of this Agreement, the non-defaulting party will issue a written notice to the defaulting party and if the default is not cured, or the defaulting party does not submit a Plan for Cure acceptable to the non-defaulting party, within 30 days then the non-defaulting party shall have the right to terminate the agreement immediately. A. Eftia may suspend or terminate services under this Agreement if Licensee fails to timely pay support fees. 12 B. In the event Licensee terminates this Agreement, Eftia will refund any unused support fees that have already been paid by the Licensee to Eftia. 8.2 Termination for Insolvency: Either party may terminate this Agreement immediately upon written notice in the event the other party shall (a) become insolvent or files or have filed against it a petition for bankruptcy (which is not dismissed within 90 days after it is filed), or (b) make an assignment for the benefit of creditors, or (c) dissolve or cease to do business in the ordinary course. 8.3 Services under this Agreement shall automatically terminate upon termination of the License Agreement. 9. LIMITED LIABILITY 9.1 EFTIA'S SOLE LIABILITY AND LICENSEE'S EXCLUSIVE REMEDY FOR DAMAGES WITH RESPECT TO SERVICES UNDER THIS AGREEMENT, TORT (INCLUDING NEGLIGENCE), STRICT LIABILITY OR OTHER THEORY, SHALL BE LIMITED TO THE AMOUNT PAID ANNUALLY BY LICENSEE FOR THESE SERVICES. 9.2 UNDER NO CIRCUMSTANCES, INCLUDING NEGLIGENCE, SHALL EFTIA OR LICENSEE BE LIABLE FOR ANY SPECIAL, INCIDENTAL OR CONSEQUENTIAL DAMAGES INCLUDING, WITHOUT LIMITATION, DAMAGES FOR LOST PROFITS, LOSS OF DATA, OR COSTS OF PROCUREMENT OF SUBSTITUTE GOODS OR SERVICES, ARISING IN ANY WAY OUT OF THIS AGREEMENT OR THE USE OF THE LICENSED SOFTWARE PRODUCT OR DOCUMENTATION. 10. ASSIGNMENT 10.1 This Agreement and the rights hereunder are not transferable or assignable without the prior written consent of the parties hereto, except for rights to payment and except to a person or entity who acquires all or substantially all of the assets or business of a party, whether by sale, merger or otherwise. 11. GENERAL 11.1 Headings: Headings and captions are for convenience only and are not to be used in the interpretation of this Agreement. 13 11.2 Governing Law: This agreement shall be governed by and construed under the laws of the State of New Jersey. In any action or proceeding to enforce rights under this Agreement, the prevailing party shall be entitled to recover reasonable costs and attorneys' fees. 11.3 No Waiver: Failure by either party to enforce any provision of this Agreement will not be deemed a waiver of future enforcement of that or any other provision. 11.4 Partial Invalidity: If any portion of this Agreement is held to be invalid by a court of competent jurisdiction, then the remaining provisions shall nevertheless remain in full force and effect. 11.5 Notices: Notices under this Agreement shall be sufficient only if personally delivered, delivered by a major commercial rapid delivery courier service or mailed by certified or registered mail, return receipt requested to a party at its addresses first set forth herein or as amended by notice pursuant to this subsection. If not received sooner, notice by mail shall be deemed received 5 days after deposit in Canada or international mails. 11.6 Entire Agreement: This Agreement sets forth the entire agreement and understanding of the parties relating to the subject matter and supersedes all prior agreements or representations, oral or written, regarding such subject matter. No modification of or amendment to this Agreement, nor any waiver of rights under this Agreement, shall be effective unless in writing signed by authorized representatives of both parties. 14 EXHIBIT A SOFTWARE COVERED BY THIS AGREEMENT |X| Licensee elects to subscribe to the Basic Support Plan. EFTIA OSS MODULES: Master.Scribe CLEC Licensee /S/ Date 10 NOV. 1998 --------------------------- ----------------------------- Eftia /S/ Date NOV. 17, 1998 ------------------------------ ----------------------------- 15 EXHIBIT B ESCALATION PROCEDURES Eftia shall investigate Errors in the Licensed Software Product reported by the Licensee. If Eftia's investigation reveals an Error or malfunction in the supported Licensed Software Products, Eftia will use commercially reasonable efforts to either provide a correction to the Error or to provide a suitable workaround solution. Eftia classifies Errors as follows: A. CRITICAL: Licensee is unable to use the Licensed Software Product because specified functions are consistently failing, resulting in critical impact to operations; with no known workaround. Eftia will use commercially diligent efforts to have a two hour acknowledgment, and same day response, and a one-day resolution/work around/patch. B. MAJOR: Licensee is able to use the Licensed Software Product but is severely restricted because specified functions are failing, resulting in impaired productivity. There is a workaround but it is awkward. Eftia will use commercially diligent efforts to have a two hour acknowledgment, one day response, and two-day resolution/work around/patch. C. MODERATE: Licensee Nvork is impeded but progress is not seriously impacted. Eftia will use commercially diligent efforts to have a one day acknowledgment and a four day response. D. MINOR: Licensee has discovered Licensed Software Product behavior that is different from specifications in Documentation, but operations are not impacted. There may be a known workaround. Eftia will acknowledge problem and will endeavor to resolve the problem in a future bug-fix or minor release. If Licensee does not receive the level of attention that Licensee feels is necessary to resolve the Error or problem, or Licensee feels the problem should be reclassified, the Licensee should contact the manager of the Eftia Customer Care (Telephone Number: 1 613 722 4407). Eftia encourages Licensee to use this option any time that Licensee would like to speak with an Eftia manager about concerns with the level of support. Eftia's modules are supported by the developers that engineered them. Our software developers are on a support rotation specifically to focus on customer concerns or troubles. The support line takes the initial call and then passes on the trouble to the appropriate developer for resolution. Eftia 's staff wear pagers to ensure prompt response to any troubles during the support hours. 16 KMC Telecom Holdings, Inc. /S/ Date 10 NOV. 1998 ---------------------- -------------------------- Eftia /S/ Date NOV 17, 1998 ---------------------- -------------------------- QUOTATION FROM: QUOTATION TO: AllKarim Somji (graphic Daphne Howard Eftia OSS Solutions, Inc. omitted) KMC Telecom 1600 Scott St., 3rd Floor Suite 245, 3005 Breckenridge Blvd. P.O. Box 165 Duluth, Georgia Ottawa, Ontario K1Y 4S1 30096 EFTIA OSS SOLUTIONS INC. Tel: (613) 722-4407 Tel: (770) 935-2592 Fax: (613) 722-4430 Fax: (770) 935-2500 PHASE I KMC REVISED APPENDIX: A Quotation Number: 102698.1 Quotation Expiry: October 30th, 1998 Quotation Date: October 26th, 1998 Currency: US $$'s
ITEM PART NO. DESCRIPTION QTY UNIT PRICE EXT. PRICE COMMENTS 01A Eftia's CLEC Package. Includes: 1.00 $1,000,000 $1,000,000 Service Order Circuit Inventory and Asset Telephone Number Administration Maintenance System Includes CLR and DLR forms Notes: 1) All the required customizations for Service Order are included - up to 20 days. This does not include any work on the interfaces. One Year Support Cost 1.00 $180,000 $180,000 Discount - 15% ($150,000) 01B Service Order for Long Distance 1.00 $100,000 $100,000 Process ASRs from AT&T - Required customizations included One Year Support Cost 1.00 $18,000 $18,000 Discount - 15% ($15,000) 01C Service Order for Enhanced Data 1.00 $100,000 $100,000 Process orders for Services ATM, Frame Relay, etc. - Required customizations included One Year Support Cost 1.00 $18,000 $18,000 Discount - 15% ($15,000) 02 Fax Integration Option Form Generation System. Includes: 1.00 $30,000 $30,000 - Software and implementation of two forms - ASR & LSR - Integration to the fax server One Year Support Cost 1.00 $5,400 $5,400 Additional Forms for Service Order 7.00 $20,000 $140,000 - E911, LIDB, CNAM, MCI LD, Calling Card, Toll-Free and Lucent Service Order Form One Year Support Cost 1.00 $25,200 Integrated Fax Software Option. 1.00 $30,000 $30,000 Includes - Server based software with integration to Service Order One Year Support Cost 1.00 $5,400 $5,400 03 Training - All training is offered at customer site - Maximum number of ten (10) students per class - Training costs provided are per class costs Service Order Training Four days of application and 2.00 $12,000 $24,000 "process" training Two days of administration training 1.00 $7,000 $7,000 Circuit Inventory and Asset Training Four days of user training 2.00 $12,000 $24,000 Two days of administration training 1.00 $7,000 $7,000 Telephone Number Administration Training Three days of user training 1.00 $9,000 $9,000 Two days of administration training 1.00 $7,000 $7,000 Maintenance Training Three days of user training 2.00 $9,500 $19,000 Two days of administration training 1.00 $7,000 $7,000 04 Required Software Licenses AR System Server with multiple 2.00 $9,500 $19,000 server option. Includes three fixed write licenses AR System Floating Write licenses - 10.00 $10,000 $100,000 In packs of five (5) AR System Fixed Write licenses - In 8.00 $4,000 $32,000 packs of five (5) One Year Support Cost 1.00 $27,180 05 Backup Solution Backup Software, Installation and 1.00 $40,000 $40,000 Customization Services for CLEC Master.Scribe Package One Year Support Cost 1.00 $7,200 06 Required Interfaces Interface to Billing System Service 1.00 $160,000 $160,000 Bureau - Includes ORB Software One Year Support Cost 1.00 $28,800 Development Discount ($106,672) NOTES: - Cost for distributed application and disaster recovery environments would be provided after detailed discussions with KMC. - No costing has been provided for setting up test and development environments. - Customization and Integration assistance (including development of interfaces) will be provided at a per diem rate of $1,250 or on a fixed price based on an assessment. ASSUMPTIONS: - KMC would be providing the appropriate hardware and software to run the Eftia OSS applications including the selected database software. Subtotal $1,882,508
GENERAL NOTES: [1] All Taxes are extra [2] Travel Expenses are extra [3] Payment terms are net 30 days; 2% per month charged on all overdue accounts [4] FOB Ottawa QUOTATION FROM: QUOTATION TO: AllKarim Somji Daphne Howard Eftia OSS Solutions, Inc. (graphic omitted) KMC Telecom 1600 Scott St., 3rd Floor Suite 245, 3005 Breckenridge Blvd. P.O. Box 165 Duluth, Georgia Ottawa, Ontario K1Y 4S1 30096 EFTIA OSS SOLUTIONS INC. Tel: (613) 722-4407 Tel: (770) 935-2592 Fax: (613) 722-4430 Fax: (770) 935-2500 PHASE II KMC REVISED APPENDIX: A Quotation Number: 102698.2 Quotation Expiry: October 30th, 1998 Quotation Date: October 26th, 1998 Currency: US $$'s
ITEM PART NO. DESCRIPTION QTY UNIT PRICE EXT. PRICE COMMENTS 01 Trouble Notification Integrated Paging and Basic IVR 1.00 $30,000 $30,000 System - Integrated and automated notification from Maintenance - Paging and Basic IVR hardware and software One Year Support Cost 1.00 $5,400 $5,400 02 Workforce Management Workforce Management integrated to 1.00 $100,000 $100,000 Service Order and Maintenance - For up to 100 scheduled users One Year Support Cost 1.00 $18,000 $18,000 Workforce Management Training Three days of user training 2.00 $9,000 $18,000 Two days of administration training 1.00 $7,000 $7,000 03 Required Interfaces Interface to LNP Service Bureau 1.00 $150,000 $150,000 Approximate Cost (Illuminet) One Year Support Cost 1.00 $27,000 ASR Order Gateway with single set $525,000 of transactions. Customization required for individual interfaces - at extra cost One Year Support Cost 1.00 $94,500 LSR Order Gateway with single set $400,000 of transactions. Customization required for individual interfaces - at extra cost One Year Support Cost 1.00 $72,000 NOTES: - Cost for distributed application and disaster recovery environments would be provided after detailed discussions with KMC. - No costing has been provided for setting up test and development environments. - Customization and Integration assistance (including development of interfaces) will be provided at a per diem rate of $1,250 or on a fixed price based on an assessment. ASSUMPTIONS: - KMC would be providing the appropriate hardware and software to run the Eftia OSS applications including the selected database software. Subtotal $1,446,900
GENERAL NOTES: [1] All Taxes are extra [2] Travel Expenses are extra [3] Payment terms are net 30 days; 2% per month charged on all overdue accounts [4] FOB Ottawa QUOTATION FROM: QUOTATION TO: AllKarim Somji (graphic Daphne Howard Eftia OSS Solutions, Inc. omitted) KMC Telecom 1600 Scott St., 3rd Floor Suite 245, 3005 Breckenridge Blvd. P.O. Box 165 Duluth, Georgia Ottawa, Ontario K1Y 4S1 30096 EFTIA OSS SOLUTIONS INC. Tel: (613) 722-4407 Tel: (770) 935-2592 Fax: (613) 722-4430 Fax: (770) 935-2500 PHASE II KMC REVISED APPENDIX: Quotation Number: 102698.3 Quotation Expiry: October 30th, 1998 Quotation Date: October 26th, 1998 Currency: US $$'s
ITEM PART NO. DESCRIPTION QTY UNIT PRICE EXT. PRICE COMMENTS 01 Options for Maintenance Integrated Basic Network Management 1.00 $60,000 $60,000 Interface. Includes: - Customization of rules (maximum of eight) - Following Reports: Event History, Category and Trend - Event Archival One Year Support Cost 1.00 $10,800 $10,800 Service Impact Module - Integrated 1.00 $200,000 $200,000 to Maintenance and Circuit Inventory to provide circuit trace and customer impact One Year Support Cost 1.00 $36,000 $36,000 02 Required Interfaces Interface to E911 and Directory 1.00 $300,000 $300,000 Assistance Service Bureau One Year Support Cost 1.00 $54,000 Interface to LIDB/CNAM Service 1.00 $150,000 $150,000 Approximate Cost Bureau (Illuminet) One Year Support Cost 1.00 $27,000 NOTES: - Cost for distributed application and disaster recovery environments would be provided after detailed discussions with KMC. - No costing has been provided for setting up test and development environments. - Customization and Integration assistance (including development of interfaces) will be provided at a per diem rate of $1,250 or on a fixed price based on an assessment. ASSUMPTIONS: - KMC would be providing the appropriate hardware and software to run the Eftia OSS applications including the selected database software. Subtotal $837,800
GENERAL NOTES: [1] All Taxes are extra [2] Travel Expenses are extra [3] Payment terms are net 30 days; 2% per month charged on all overdue accounts [4] FOB Ottawa QUOTATION FROM: QUOTATION TO: AllKarim Somji (graphic Daphne Howard Eftia OSS Solutions, Inc. omitted) KMC Telecom 1600 Scott St., 3rd Floor Suite 245, 3005 Breckenridge Blvd. P.O. Box 165 Duluth, Georgia Ottawa, Ontario K1Y 4S1 30096 EFTIA OSS SOLUTIONS INC. Tel: (613) 722-4407 Tel: (770) 935-2592 Fax: (613) 722-4430 Fax: (770) 935-2500 PHASE IV KMC REVISED APPENDIX: A Quotation Number: 102698.4 Quotation Expiry: October 30th, 1998 Quotation Date: October 26th, 1998 Currency: US $$'s
ITEM PART NO. DESCRIPTION QTY UNIT PRICE EXT. PRICE COMMENTS 01A WEB Interface for Order Submission 1.00 $50,000 $50,000 Requires ARWeb Server and Query product One Year Support Cost 1.00 $9,000 $9,000 01B "Real Time" Business Process 1.00 $35,000 $35,000 Requires Flashboards Metrics for Service Order Server product One Year Support Cost 1.00 $6,300 $6,300 02A WEB Interface for Ticket Submission 1.00 $50,000 $50,000 Requires ARWeb Server and Query Product One Year Support Cost 1.00 $9,000 $9,000 02B "Real Time" NOC Metrics 1.00 $33,500 $33,500 Requires Flashboards Server Product One Year Support Cost 1.00 $6,030 $6,030 03 Action Request System - ARWeb 2.00 $12,000 $24,000 Action Request System - Flashboards 2.00 $8,500 $17,000 with one five pack fixed licenses Additional five pack fixed licenses 1.00 $3,500 $3,500 for Flashboards One Year Support 1.00 $8,010 NOTES: - Cost for distributed application and disaster recovery environments would be provided after detailed discussions with KMC. - No costing has been provided for setting up test and development environments. - Customization and Integration assistance (including development of interfaces) will be provided at a per diem rate of $1,250 or on a fixed price based on an assessment. ASSUMPTIONS: - KMC wold be providing the appropriate hardware and software to run the Eftia OSS applications including the selected database software. Subtotal $251,340
GENERAL NOTES: [1] All Taxes are extra [2] Travel Expenses are extra [3] Payment terms are net 30 days; 2% per month charged on all overdue accounts [4] FOB Ottawa QUOTATION FROM: QUOTATION TO: AllKarim Somji (graphic Daphne Howard Eftia OSS Solutions, Inc. omitted) KMC Telecom 1600 Scott St., 3rd Floor Suite 245, 3005 Breckenridge Blvd. P.O. Box 165 Duluth, Georgia Ottawa, Ontario K1Y 4S1 30096 EFTIA OSS SOLUTIONS INC. Tel: (613) 722-4407 Tel: (770) 935-2592 Fax: (613) 722-4430 Fax: (770) 935-2500 PHASE IV KMC REVISED APPENDIX: A Quotation Number: 102698.4 Quotation Expiry: October 30th, 1998 Quotation Date: October 26th, 1998 Currency: US $$'s
ITEM PART NO. DESCRIPTION QTY UNIT PRICE EXT. PRICE COMMENTS 01 Trouble Administration Gateway Trouble Administration Gateway - 1.00 $500,000 $500,000 Electronically receive Client Integrated to Maintenance trouble admin. data from Module trading partners One Year Support Cost 1.00 $90,000 with electronic bonding TA capability Trouble Administration Gateway - 1.00 $500,000 $500,000 Electronically receive Manager Integrated to Maintenance trouble admin. data from Module trading partners One Year Support Cost 1.00 $90,000 with electronic bonding TA capability 50% of the TA Gateway will be refunded to KMC as part of royalty NOTES: - Cost for distributed application and disaster recovery environments would be provided after detailed discussions with KMC. - No costing has been provided for setting up test and development environments. - Customization and Integration assistance (including development of interfaces) will be provided at a per diem rate of $1,250 or on a fixed price based on an assessment. ASSUMPTIONS: - KMC wold be providing the appropriate hardware and software to run the Eftia OSS applications including the selected database software. Subtotal $1,180,000
GENERAL NOTES: [1] All Taxes are extra [2] Travel Expenses are extra [3] Payment terms are net 30 days; 2% per month charged on all overdue accounts [4] FOB Ottawa EX-10.7 12 MASTER LICENSE AGREEMENT BILLING CONCEPTS SYSTEMS, INC. MASTER LICENSE AGREEMENT Customer Effective Date: KMC TELECOM HOLDINGS, INC. _____________________________________ Agreement Number: _____________________________________ BILLING CONCEPTS SYSTEMS, INC. MASTER LICENSE AGREEMENT This Master License Agreement (this "License") is made and entered into this 31st day of December, 1998 (the "Effective Date"), by and between Billing Concepts Systems, Inc., a Delaware corporation ("BCS"), and KMC Telecom Holdings, Inc., a Delaware corporation ("Customer"). WHEREAS, Customer desires to license from BCS the proprietary software system known as the Modular Business Application System (the "MBA System"); and WHEREAS, BCS has agreed to license the MBA System to Customer, subject to the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the mutual promises contained herein, BCS and Customer agree as follows: ARTICLE I DEFINITIONS 1.1 CURRENT RELEASE shall mean, at any time, the MBA System as described in the MBA System Specifications in effect on the date of the most recent major, formal software release (e.g., Version 3.0). Current Release does not include modifications made by BCS pursuant to an agreement between BCS and Customer, modifications made by Customer to the MBA System, or Optional Applications Software as defined herein. 1.2 MBA BASE SYSTEM shall mean Version 3.0 of the MBA System and related documentation as described in Exhibit A of this License. 1.3 MBA SYSTEM shall mean the MBA Base System, together with any and all future System Releases, PTFs and modifications that may be acquired in the future by Customer through a product support agreement or other agreement between BCS and Customer. 1.4 MBA SYSTEM SPECIFICATIONS shall mean the documentation of the MBA System on file at BCS' offices in San Antonio, Texas, and which is delivered to Customer in Exhibit A. The MBA System Specifications also include the minimum hardware and software configuration recommended by BCS for the operation of the MBA System. 1.5 PROGRAM TEMPORARY FIX (PTF) shall mean the program and/or documentation changes and associated installation instructions which at Customer's request are made available to Customer at no charge in advance of the next System Release to correct a specific problem reported by Customer during the term of this License. 1.6 SYSTEM RELEASE shall mean a collection of program and documentation changes (revisions, deletions and/or additions) and associated installation instruction which are periodically made available to Customer at a price determined by BCS for the purpose of updating a Current Release to produce a new Current Release. 2 1.7 CUSTOMER as used herein shall mean both KMC Telecom Holdings, Inc. and any of its Affiliates. An Affiliate of Customer shall mean any entity that directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with Customer. For purposes of this Section, "control" means the ownership of over 50% of the voting capital securities of an entity. ARTICLE II MBA SYSTEM LICENSE 2.1 TERM. The license granted herein shall be for a perpetual term commencing as of the Effective Date, and continuing until terminated as provided herein. 2.2 GRANT OF LICENSE. Subject to all of the terms and conditions of this License, BCS hereby grants to Customer, and Customer hereby accepts, a nonexclusive, non-transferable and perpetual license to use the software listed in Exhibit A of this License (the "Licensed Software"). This License authorizes the use of the Licensed Software solely for the purpose of processing its internal business data and/or external data as required to perform normal operations for Customer's business. Customer may not use the Licensed Software for any purpose other than those expressly authorized hereunder. Customer shall not: (i) use the Licensed Software to act as a service bureau or provide data processing services to any third persons; (ii) make copies of the Licensed Software for distribution to third parties; (iii) reverse-engineer or decompile the Licensed Software for the purpose of designing, or developing for distribution, license or sale to third parties a software system competitive with the Licensed Software; and/or (iv) sublicense or resell the Licensed Software or any license rights granted hereunder. No transfer of title to the Licensed Software is effected by this License, and BCS shall retain sole and exclusive title to the Licensed Software and all modifications thereto and all intellectual property rights associated therewith. This License is limited to use of the Licensed Software by Customer for processing of Customer's own internal data (and/or external data as required to perform normal operations for Customer's business) and files at a data processing facility owned and controlled by Customer or BCS. Customer may make copies of the Licensed Software only for Customer's internal use in training, testing, development, backup and disaster recovery purposes. 2.3 SUBLICENSING AND ASSIGNMENT. This License may not be sublicensed by Customer to any other person, firm or organization without the prior written consent of BCS. This License shall be binding on the parties hereto and their respective successors and assigns. Neither party may assign or transfer its rights or obligations under this License without the prior written consent of the other party, except that a party may assign this License without the prior written consent of the other party if such assignment is made to a person or entity acquiring substantially all of the assets of such assigning party. Notwithstanding the foregoing, however, Customer shall have the right, without the consent of BCS, to collaterally assign this License to any lender providing financing to Customer; provided, however, that any such assignment shall expressly provide that: (i) Customer shall remain jointly and severally liable 3 with the assignee for all obligations arising under this License unless expressly released therefrom by BCS; (ii) the assignee shall have no right to further assign this License to any person or entity without the prior written consent of BCS, which shall not be unreasonably withheld; and (iii) any breach by the assignee or Customer of any of the terms of this License shall constitute a breach entitling BCS to terminate this License as to both Customer and the assignee (subject to the conditions set forth in Article III hereof. Any collateral assignment by Customer to a lender which does not comply with the conditions of the preceding sentence shall be null and void. Within a reasonable time after receiving a written request from Customer, BCS will issue a consent to a collateral assignment of this License to a lender of Customer without any further consideration so long as such collateral assignment complies with the conditions provided herein. 2.4 LICENSE. Upon the Effective Date, Customer shall pay to BCS the initial license fee referenced on Exhibit B for the Licensed Software. The initial license fee shall entitle Customer to use the licensed software components up to the capacities referenced in Exhibit B. If any of the licensed software components are used by Customer in excess of the capacities referenced in Exhibit B, then Customer shall pay to BCS additional license fees as set forth in Exhibit B. 2.5 MODIFICATION OF THE LICENSED SOFTWARE. BCS shall have the sole and exclusive right to design and develop any derivative works from or modifications to the Licensed Software. Any and all modifications and/or derivative works made from the Licensed Software, including any and all intellectual property rights associated therewith, shall be the sole and exclusive property of BCS regardless of whether those modifications or derivative works are prepared at the request of Customer. 2.6 USE OF PROPRIETARY MATERIALS BY CUSTOMER. Following execution of this License by BCS and Customer, BCS shall deliver to Customer certain confidential and proprietary documentation of BCS concerning the Licensed Software (collectively, the "Confidential Materials"). Customer shall be permitted to use the Confidential Materials in order to operate the Licensed Software, or for any other purpose for which Customer has been licensed to use the Licensed Software. Customer shall not be permitted to use the Confidential Materials for any purpose for which Customer is not licensed to use the Licensed Software. Customer represents and warrants to BCS that it will establish and maintain reasonable procedures to protect the Confidential Materials from unauthorized disclosure or use. Customer shall not disclose the Confidential Materials to any third persons without the advance written consent of BCS. 2.7 BCS INSPECTION OF LICENSED SOFTWARE. In order to assure compliance with the provisions of this License, BCS and its representatives, employees and agents will have the right to inspect, at BCS' expense, the use of the Licensed Software at Customer's site (and at any backup or disaster recovery sites) from time to time during normal business hours. Customer will assist BCS in making such inspections in such manner as BCS may reasonably request. Such inspections shall be conducted with at least twenty four (24) hours prior notice and shall not unduly disrupt the conduct of Customer's business. 2.8 INFRINGEMENT. BCS represents and warrants that BCS is the sole owner of the MBA System. BCS also represents and warrants that BCS has the right to 4 license the MBA System and that this License does not and will not infringe upon any United States copyrights, United States patent or other proprietary interest of any person, firm or organization. 2.8.1 NOTICE OF CLAIM. If any action, claim or suit is threatened, brought or made against Customer based upon infringement of a United States copyright, United States patent, or other proprietary right under the laws of the United States, in connection with the use of the MBA System by Customer, Customer will promptly notify BCS in writing of such action, claim or suit of which it has actual knowledge and the failure to so notify shall relieve BCS of its obligations hereunder. 2.8.2 DEFENSE. BCS shall at BCS' expense take charge of the defense of any infringement action through attorneys of BCS' selection. If any infringement action is instituted against BCS and Customer jointly, BCS will at BCS' expense defend such action on behalf of both parties. Customer will cooperate at its own expense in such defense as reasonably requested by BCS. Customer will have the right to participate in the defense of such action, at Customer's expense, and/or take its own position in any litigation. If BCS appeals an adverse decision it will obtain judicial relief for Customer or post a bond protecting Customer from liability for judgment on the adverse decision pending the final determination of the appeal. BCS will pay in full any settlement negotiated by BCS relating to a claim under this Section 2.8, which settlement shall provide a full release of Customer from all claims. BCS will indemnify and hold harmless Customer of and from all costs and expenses of litigation hereunder, as well as the amount of any adverse judgment rendered against Customer as a result of a finding of infringement in favor of any third party as a result of Customer's use of the Licensed Software. 2.8.3 REMEDIAL ACTION. If BCS anticipates an action, claim or suit for such infringement, or if such an action, claim or suit has been made and the MBA System, or any part of thereof, has been held to constitute an infringement and the use of the MBA System or any part of it is enjoined, BCS will, at its expense, either: (i) obtain for the Customer the right to continue to use the MBA System, or (ii) replace the MBA System, or part of the MBA System, with a noninfringing functionally equivalent substitute reasonably acceptable to Customer, or (iii) modify the MBA System so as to be non-infringing, functionally equivalent and reasonably acceptable to Customer. A replacement or partial replacement of, or a modification to, the MBA System shall be acceptable to Customer if Customer remains able to process its business in substantially the same manner as before such replacement, partial replacement or modification, and the effect of such replacement, partial replacement or modification is not to require the expenditure of substantial additional effort by Customer in the day to day conduct of Customer's business. If, however, BCS is unable, despite diligent efforts, to effect any of these options, Customer may then terminate the License granted herein by notifying BCS in writing thereof. In the event of such termination, Customer shall: i. return the MBA System and all Confidential Materials to BCS; and ii. be relieved of any further obligation to pay license fees to BCS hereunder. 5 In any event, BCS agrees to provide Customer with reasonable transition assistance should the License be terminated for patent or copyright infringement. 2.8.4 LIMITATION OF LIABILITY FOR INFRINGEMENT. BCS will have no liability for any claim of infringement of copyright, patent or proprietary interest to the extent such claim is based on either (i) use of any version other than the unmodified version of the MBA System, except as modified by enhancements and pre-release enhancements provided by BCS which become part of the MBA Base System at a later date if infringement could have been avoided by use of such unmodified version; or (ii) use or combination of the MBA System with other than BCS provided or approved programs, if infringement could have been avoided by not using the MBA System in combination with other than such programs. 2.9 CUSTOMER'S OBLIGATIONS UPON TERMINATION. Upon termination of this License for any reason whatsoever, Customer agrees to return to BCS the Licensed Software and all Confidential Materials, including all copies of object code, documentation, programs and other materials delivered by BCS under this License, and to certify to BCS in writing within thirty (30) days after termination that Customer has not retained any copies of those items. Following any such termination, Customer agrees to cease and permanently refrain from any and all use whatsoever of the Licensed Software, and all Confidential Materials and any other information supplied by BCS pursuant to this License. 2.10 SPECIAL WARRANTY AND LIMITATION OF LIABILITY. 2.10.1 SPECIAL WARRANTY. BCS warrants that for 90 days following installation of the MBA Base System: (i) the MBA Base System will conform in all material respects to the MBA System Specifications; and (ii) the media in which the Licensed Software is contained shall be free of material defects in materials and workmanship. During the 90 day warranty period, Customer may request the services of BCS to analyze any apparent failure of the MBA Base System to conform to the MBA System Specifications. Any failure to conform must be reported to BCS on a System Problem Report in the format specified by BCS. On or before July 31, 1999: (a) BCS shall install upgrades to the MBA System licensed by Customer (including any enhancements) which will render the MBA System Year 2000 Compliant, as defined below; and (b) BCS will provide Customer, at BCS' expense, an independent certification certifying to such compliance. Year 2000 Compliant means that: (1) date data from at least 1900 through 2100 will process without error or interruption in the MBA System, including leap year calculations; and (2) there will be no loss of any functionality of the MBA System with respect to the introduction, processing or output of records containing dates falling on or after January 1, 2000. Year 2000 Compliance does not include any processing failure resulting from or related to any operating system software, hardware, microcode, firmware, system interface not developed by BCS, or failure of any hardware, software, firmware or other program used in combination with the MBA System to properly exchange date data with it. 6 The Year 2000 Compliance Systems(s) shall be provided to Licensee as part of BCS's regular maintenance and support services, subject to Licensee's timely payment of maintenance and support fees, except as otherwise provided in Section 5.4 of the Product Support Agreement. Customer's sole and exclusive remedy for any breach of these warranties shall be to require BCS to cause the MBA Base System to conform to the applicable System Specifications; provided, however, that in the event that BCS cannot remedy such breach and such failure to so remedy such breach materially impacts Customer's ability to use the Licensed Software, then BCS shall refund to Customer all license fees paid for the Licensed Software on a pro-rata basis based on a straight line basis over a sixty (60) month period. BCS' LIABILITY FOR BREACH OF THE WARRANTIES PROVIDED IN THIS SECTION IS LIMITED TO THE REMEDIES SET FORTH HEREIN. THE WARRANTIES PROVIDED HEREIN ARE IN LIEU OF ANY AND ALL WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. BCS EXPRESSLY DISCLAIMS ANY IMPLIED WARRANTIES OF MERCHANTABILITY OR OF FITNESS FOR A PARTICULAR PURPOSE. THERE ARE NO WARRANTIES WHICH EXTEND BEYOND THE DESCRIPTION HEREIN. 2.10.2 LIMITATION OF LIABILITY. BCS' LIABILITY TO CUSTOMER UNDER THIS LICENSE, SHALL NOT EXCEED, AND SHALL BE LIMITED TO, ALL PAYMENTS MADE BY CUSTOMER UNDER THIS LICENSE. BCS WILL NOT BE LIABLE FOR ANY OTHER DAMAGES HEREUNDER, INCLUDING, BUT NOT LIMITED TO, INCIDENTAL DAMAGES, LOSS OF PROFITS AND OTHER CONSEQUENTIAL DAMAGES AND ANY CLAIMS OR DEMANDS AGAINST CUSTOMER BY ANY OTHER PARTY, EVEN IF BCS HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGE. ARTICLE III TERMINATION 3.1 TERMINATION FOR CAUSE. In the event that Customer breaches the terms of this License by making any unauthorized use of the Licensed Software or engaging in any other conduct which could impair BCS' copyrights and intellectual property rights in the Licensed Software, then following five (5) days' notice of such breach by BCS and failure of Customer to cure such breach within such five (5) day period, BCS shall have the right to terminate this License without notice immediately and require Customer to return to BCS the Licensed Software, all Confidential Materials, and all object code and documentation. In the event of any other kind of material breach of this License by either party hereto (except for nonpayment by Customer which is controlled by Section 3.2 of this License), and the breaching party fails to cure such breach within sixty (60) days after its receipt of a written notice specifying the details of the breach or, with respect to any material breach which cannot reasonably be cured within sixty days, should the breaching party fail to proceed within sixty days to commence curing the breach and thereafter to proceed with all due diligence to cure the breach, the party not in breach of this License may terminate this License by giving prompt written notice of termination. 7 3.2 TERMINATION FOR NONPAYMENT. In the event that Customer fails to pay all amounts due BCS in accordance with the terms of this License, then following ten (10) days' notice of such breach by BCS and failure to remedy such breach within such ten (10) day period, BCS may terminate this License upon written notice to Customer. 3.3 TERMINATION DUE TO INSOLVENCY. In the event either party to this License becomes or is declared insolvent, becomes subject to a voluntary or involuntary bankruptcy or similar proceeding, or makes an assignment for the benefit of all or substantially all of its creditors, then in such event the other party to this License may terminate this License by giving written notice thereof to such party which notice shall specify the date of termination. 3.4 BANKRUPTCY OF BCS. In the event that BCS becomes subject to bankruptcy proceedings, this License shall continue in full force and effect, and Customer shall continue to enjoy all License rights granted herein subject to Customer's continued compliance with all of the terms and conditions of this License. BCS acknowledges that if BCS as a debtor-in-possession (or a trustee in bankruptcy in a case under the United States bankruptcy code) rejects this License or any agreement supplementary hereto, Customer may elect to retain its rights under this License or any agreement supplementary hereto as provided in Section 365(n) of the bankruptcy code. Upon written request of the Customer to BCS or the bankruptcy trustee, BCS or such bankruptcy trustee shall not interfere with the rights of Customer as provided in this License or any agreement supplementary hereto to obtain the Confidential Materials from BCS or the bankruptcy trustee and shall, if requested, cause a copy of the Confidential Materials to be made available to Customer at no additional charge. ARTICLE IV OWNERSHIP OF PROGRAMS, CONFIDENTIALITY AND AUDIT RIGHTS 4.1 ACKNOWLEDGMENT OF INTELLECTUAL PROPERTY RIGHTS AND TRADE SECRETS. Customer acknowledges that the Licensed Software (including, without limitation, the database, data model and any modifications to the MBA System and any work product of BCS which is related to the MBA System) is a commercially valuable proprietary product of BCS, the design and development of which has involved the expenditure of substantial amounts of money and the use of skilled development experts over a long period of time and which affords BCS a commercial advantage over its competitors, and that loss of this competitive advantage due to unauthorized disclosure or use of such proprietary information would cause great injury and harm to BCS. Customer acknowledges that the Licensed Software (specifically including, but not limited to, the documentation thereof) constitute intellectual property and TRADE SECRETS, disclosed to Customer on the basis of the confidential relationship between Customer and BCS under this License, to be used only as may be expressly permitted by the terms and conditions of this License, and that the restrictions imposed upon Customer by this Section 4.1 are necessary to protect the secrecy of such proprietary information and prevent the occurrence of such injury and harm to BCS. 8 Customer covenants that it will not, without the prior written consent of BCS, disclose, divulge, publish to others or employ to its own advantage, other than as herein provided, the Licensed Software or any proprietary information of BCS relating thereto and that it will reveal the same only to those of its employees, employees of Customer's affiliates, attorneys or auditors who require it for the purpose of Customer's use of the Licensed Software hereunder and only if such employees, attorneys or auditors are subject to use and disclosure restrictions as complete as those assumed by Customer hereunder. The obligations of Customer in this Section 4.1 shall survive any termination of this License. 4.2 CONFIDENTIALITY. BCS and Customer agree that all proprietary information in whatever form delivered by one party to the other shall be deemed of proprietary and trade secret status and shall be held in strict confidence and shall be used only for purposes of this License. Each party agrees to exercise at least the same standard of care to protect the other party's proprietary information as is used to protect its own such proprietary information from unauthorized disclosures (but no less than a reasonable standard of care). No such information shall be disclosed by the recipient party, its agents or employees without the prior written consent of the other party, except as may be necessary to enforce this License or by reason of legal, accounting or regulatory requirements beyond the reasonable control of the recipient party. Notwithstanding the foregoing, proprietary information shall not include such information that: (a) is or becomes generally available to the public other than as a result of a disclosure by the receiving party; (b) is or becomes available to the receiving party on a non-confidential basis from a source (other than the disclosing party or one if its agents, representatives or employees) that is not prohibited from disclosing such information by a legal, contractual or fiduciary obligation; or (c) was known to the receiving party on a non-confidential basis prior to its disclosure to the receiving party by the disclosing party. The provisions of this Section shall survive termination of this License for any reason. ARTICLE V MISCELLANEOUS 5.1 TAXES. Customer shall be solely responsible for all state, local or federal taxes, however designated, levied or based on any fees payable hereunder (excluding those taxes based on net income derived from BCS), including but not limited to state and local privilege and excise taxes based on gross revenue, and any sales taxes or amounts in lieu thereof, paid or payable by BCS in respect of the foregoing. Customer shall pay any such taxes to BCS no later than thirty (30) days after Customer's receipt of invoice from BCS. Customer hereby indemnifies and holds BCS harmless from and against any losses caused by Customer's failure to pay any such taxes, including any penalties or interest thereon incurred with respect to such taxes. BCS will inform Customer of any audit by any governmental authority regarding such taxes, will allow Customer to control any challenge to, settlement of or payment of any amounts deemed payable by such government authority as a result of such audit or inquiry, and will cooperate with all reasonable requests by Customer for BCS to assist in challenging, settling and paying such amounts. Customer's obligations pursuant to this Section 5.1 shall survive any termination or expiration of this License. 9 5.2 EXCUSED PERFORMANCE. Except for Customer's obligation to pay BCS hereunder, Customer and BCS shall be excused from performance, and shall have no liability, for any period and to the extent that either of them is prevented, hindered or delayed from performing any services or other obligations under this License, in whole or in part, as a result of acts, omissions or events beyond the reasonable control of such party, including by way of illustration and not limitation, acts or omissions of Customer; failure or malfunction of computer or telecommunications hardware, equipment or software, beyond the reasonable control of such party (other than the telecommunications hardware, equipment or software that is the subject of this License); breach or other nonperformance by BCS' or Customer's vendors and suppliers; strikes or labor disputes; riots; war; fire; acts of God or governmental regulations (excluding any problems due to the Licensed Software's failure to be Year 2000 Compliant as required under the License). 5.3 EMPLOYEES. Customer and BCS acknowledge that their success in their respective industries is largely dependent on the performance of their personnel and that, therefore, Customer and BCS expend substantial resources in connection with employment and training. Accordingly, neither Customer nor BCS shall hire or retain, either as an employee or independent contractor, any person who was a Restricted Employee of the other party at any time during the twelve (12) months preceding such hiring or retention, without obtaining the advance written consent of such other party. A Restricted Employee of Customer or BCS is any employee or third party independent contractor of Customer or BCS, except a member of the clerical staff. This undertaking by Customer and BCS shall be deemed an essential element of this License and shall survive its termination. 5.4 NO WAIVER. No failure of either party to exercise any power or right given either party hereunder or to insist upon strict compliance by either party with its obligations hereunder, and no custom or practice of the parties at variance with the terms hereof shall constitute a waiver of either party's right to demand exact compliance with the terms hereof. 5.5 RIGHTS CUMULATIVE. All rights, powers, and privileges conferred hereunder upon the parties shall be cumulative and shall not restrict those given by law. 5.6 SINGULAR INCLUDES PLURAL. The singular of any word in this License includes the plural. 5.7 NOTICES. Whenever under this License one party is required or permitted to give notice to the other, such notice shall be deemed given when delivered in hand or three (3) business days after the date mailed by United States mail, certified mail, return receipt requested, postage prepaid, or one business day after deposit with Federal Express where the notice has been designated for next day priority delivery, and addressed as follows: 10 In the case of BCS: Billing Concepts Systems, Inc. 7411 John Smith Drive San Antonio, Texas 78229 Attention: Mike Hancock cc: General Counsel Facsimile: (210) 949-4375 In the case of Customer: KMC Telecom Holdings, Inc. 1545 Route 206, Suite 300 Bedminster, New Jersey 07921 Attention: Paul DiMarco Facsimile: (908) 719-8775 Either party may change its address for notification purposes by giving the other three (3) days prior written notice of the new address and the date upon which it will become effective. 5.8 DISPUTE RESOLUTION. This Section 5.8 governs any dispute, disagreement, claim or controversy between Customer and BCS arising from or related to this License (a "Disputed Matter"). All Disputed Matters shall be submitted to the following dispute resolution process: (a) INTERNAL ESCALATION. First, the Disputed Matter shall be referred jointly to senior executives of each of the parties. If such executives do not agree upon a resolution within ten (10) business days after referral of the matter to them, the complaining party shall proceed to the next stage of this dispute resolution procedure. (b) MEDIATION. The complaining party shall, upon written notice and within ten (10) business days after the conclusion of the internal escalation procedure, elect to have the Disputed Matter referred to non-binding mediation before a single impartial mediator to be jointly agreed upon by the parties. The mediation hearing shall be attended by executives of both parties possessing authority to resolve the Dispute Matter, and shall be conducted no more than thirty (30) business days after a party serves a written notice of an intention to mediate. Customer and BCS shall share equally all costs of such mediation. If the Disputed Matter cannot be resolved at mediation, the complaining party shall proceed to the next stage of this dispute resolution procedure. (c) ARBITRATION. In the event that a Disputed Matter has not been resolved through mediation, the complaining party shall submit the Disputed Matter to binding arbitration pursuant to the Commercial Arbitration Rules of the American Arbitration Association (the "AAA"). The arbitration panel shall have the authority to render any award or remedy allowed by law. The arbitration panel shall consist of three neutral arbitrators selected from the AAA's Panel of Arbitrators, and 11 the arbitration hearing shall be conducted in Dallas, Texas. Within ten (15) days after receipt of notice by a party of submission to arbitration, each party shall designate in writing one (1) neutral arbitrator from the AAA's Panel of Arbitrators, and the two (2) arbitrators named by the parties shall select the third arbitrator from the AAA's Panel of Arbitrators. If the two arbitrators selected cannot agree upon a third arbitrator, the third arbitrator will be selected by the AAA in accordance with the AAA Rules. Each party shall be entitled to conduct not more than three (3) depositions, not to exceed 8 hours each, within thirty (30) days after the third arbitrator has been selected. The parties shall diligently attempt to schedule the arbitration hearing for a time within one hundred and twenty (120) days after the demand for arbitration hereunder has been issued. Following the hearing, the arbitrators shall issue a written decision specifying the basis of their decision, and the award made, if any. The cost of the arbitration proceeding shall be shared equally by the parties, but the prevailing party in any arbitration proceeding shall be entitled to recover its reasonable and necessary attorneys' fees and expenses incurred in connection with the arbitration. Provided that Customer continues to timely pay BCS for services rendered under this License, BCS shall continue to provide such services during the pendency of any Disputed Matter before arbitration. The arbitrators shall have no authority to award punitive or exemplary damages or to award damages in excess or in contravention of this License. (d) INJUNCTIVE RELIEF PENDING ARBITRATION. NOTWITHSTANDING THE FOREGOING, HOWEVER, IT IS AGREED THAT ANY BREACH OF THIS LICENSE BY CUSTOMER MAKING ANY UNAUTHORIZED USE OF THE LICENSED SOFTWARE OR ENGAGING IN ANY OTHER CONDUCT WHICH COULD IMPAIR BCS' COPYRIGHTS OR INTELLECTUAL PROPERTY RIGHTS IN THE LICENSED SOFTWARE WILL CAUSE IMMEDIATE AND IRREPARABLE HARM TO BCS. IN THE EVENT OF ANY SUCH BREACH BY CUSTOMER, BCS SHALL BE ENTITLED TO PURSUE IMMEDIATE AND INTERIM INJUNCTIVE RELIEF FROM ANY COURT OF COMPETENT JURISDICTION TO RESTRAIN SUCH UNAUTHORIZED USE OR CONDUCT, AND OBTAIN OTHER INJUNCTIVE RELIEF AS MAY BE NECESSARY TO PROTECT BCS' COPYRIGHTS AND INTELLECTUAL PROPERTY RIGHTS. 5.9 RELATIONSHIP OF PARTIES. In licensing the Licensed Software to Customer, BCS is acting only as an independent software licensor. Except as expressly set forth in this License, BCS does not undertake by this License or otherwise to perform any obligation of Customer, whether regulatory or contractual, or to assume any responsibility for Customer's business or operations. This License shall not be deemed to create a partnership, joint venture or fiduciary relationship between the parties. 5.10 CONSEQUENTIAL DAMAGES OF BCS. Customer shall not be liable to BCS for any loss of profits, any incidental, special, exemplary, or consequential damages of any kind in connection with this License. 12 5.11 SEVERABILITY. In the event any provision of this License is held to be unenforceable or invalid by any court of competent jurisdiction, the validity and enforceability of the remaining provisions of this License shall not be affected and, in lieu of such invalid or unenforceable provision, there shall be added automatically as part of this License one or more provisions as similar in terms as may be valid and enforceable under applicable law. 5.12 ENTIRE AGREEMENT. This License and all Exhibits and attachments hereto, together with the Hardware and Software Procurement Agreement, Product Support Agreement, Outsourcing Agreement and the Consulting Services Agreement, all dated as of the date hereof, between BCS and Customer (collectively the "Other Agreements"), constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior and contemporaneous representations, understandings or agreements, whether oral or written, relating to the subject matter hereof. All prior or contemporaneous representations, understandings or agreements, whether oral or written, that are not expressly set forth within the four corners of this License or the Other Agreements are hereby deemed waived, superseded and abandoned. 5.13 AMENDMENTS. No amendment or modification of this License will be binding on either of the parties to this License unless such Amendment is contained in a written document which expresses an intention to amend this License and is executed by both the parties. 5.14 COUNTERPARTS. This License may be executed in several counterparts all of which taken together shall constitute one single agreement between the parties. 5.15 HEADINGS. The article and section headings included in this License are for reference and convenience only and shall not enter into the interpretation of this License. 5.16 GOVERNING LAW AND VENUE. This License shall be governed and construed in accordance with the laws of the State of Texas, without regard to the choice of law rules of Texas. All suits concerning any and all matters related to or arising under or by virtue of this License shall be commenced exclusively in either the State Courts located in Dallas, Texas or the federal courts located in Dallas, Texas, and venue of any such action shall rest exclusively in Dallas, Texas. 5.17 CURRENCY. All monetary amounts stated in this License are stated in United States Dollars, and all amounts due hereunder shall be paid by Customer in United States Dollars. 5.18 TERMS CONFIDENTIAL. The terms and conditions of this License are confidential and shall be treated as such by Customer and BCS. Neither Customer nor BCS will disclose the terms of this License to third parties, including the amount of fees to be paid hereunder, except as may be required for the filing of reports and forms with governmental agencies under applicable statutes and regulations. Notwithstanding the foregoing, however, BCS may disclose that it has entered into this License in a press release (previously approved by Customer, such approval not to be unreasonably withheld) and in sales presentations to third parties, and BCS may generally describe the services provided to Customer without disclosing the pricing terms contained herein. 13 IN WITNESS WHEREOF, the parties hereto, each acting under due and proper authority, have executed this License on the dates indicated below. BILLING CONCEPTS SYSTEMS, INC. KMC TELECOM HOLDINGS, INC By: /S/ MICHAEL A. HARRELSON By: /S/ MICHAEL STERNBERG (Signature-Authorized Officer) (Signature-Authorized Officer) Name: Michael A. Harrelson Name: Michael Sternberg Title: President/COO Title: President Date: 12/31/98 Date: December 31, 1998 14 EXHIBIT A MBA SYSTEM LICENSE SCHEDULE Customer is licensing the BCS system known as the MBA Base System, Release No. 3.0, which includes the following Standard Modules: Customer Acquisition, Customer Care, Product and Rate Definition, Invoice Preparation, Accounts Receivable and Payments Processing. Customer is also licensing the following MBA Base Options: Travel Card Processing Switch Interface Customer is also licensing the following MBA Item Rating Modules: Local Data Private Line Internet Customer is also licensing the following Usage Rating Modules: Usage Carrier Access Billing Customer is also licensing the following Non-MBA Software: Seagull (GUI), at the license fees reflected in Exhibit B. In addition to the above-listed software, BCS grants to Customer a non-exclusive, nontransferable and perpetual license to use: (i) any System Releases or PTFs for the above-listed software obtained by Customer from BCS pursuant to a product support or other agreement entered into by BCS and Customer; and (ii) any modifications made by BCS for Customer to the above-listed software. Customer shall be entitled to use such additional software items at no additional license fee. Customer acknowledges that it will be necessary for Customer to enter into separate licensing arrangements at Customer's expense with Vertex and Bellcore to license related software necessary to process Customer's data using the MBA System. 15 EXHIBIT B THE LICENSE FEES Customer shall pay to BCS an initial license fee of $1,749,166 which shall entitle Customer to use the licensed software components up to the maximum usage levels indicated below: MBA LICENSED SOFTWARE COMPONENT MAXIMUM USAGE LEVEL LICENSE FEE MBA Base System 125,000 Accounts $250,000 Travel Card Processing 125,000 Accounts $12,500 Switch Interface 125,000 Accounts $25,000 Local Item Rating Module 125,000 Billed Items Per $375,000 Month Data Item Rating Module 50,000 Billed Items Per Month $50,000 Private Line Item Rating Module 50,000 Billed Items Per Month $35,000 Internet Item Rating Module 25,000 Billed Items Per Month $35,000 Usage Rating Module 50,000,000 Billed Records $933,333 Per Month] CABS Usage Rating Module 2,500,000 Billed Records Per $33,333 Month] ================================================================================ GRAND TOTAL OF MBA LICENSE FEE $1,749,166 NON-MBA LICENSED SOFTWARE MAXIMUM USAGE LEVEL LICENSE FEE Seagull GUII Software Copies 150 Seats $37,750 ================================================================================ GRAND TOTAL OF NON-MBA LICENSE FEE $37,750 In the event that Customer's usage of any of the licensed software components exceeds the maximum usage levels indicated above for any three (3) consecutive calendar monthly periods, then Customer shall pay to BCS an additional license fee for the licensed software component(s) involved at the prices set forth below, and for the maximum usage levels set forth below: A. MBA BASE SYSTEM MAXIMUM USAGE LEVEL (TOTAL NUMBER OF ACCOUNTS) LICENSE FEE 250,000 $500,000 350,000 $700,000 500,000 $1,000,000 650,000 $1,300,000 800,000 $1,600,000 1,000,000 $2,000,000 16 B. MBA BASE OPTIONS 1. TRAVEL CARD PROCESSING 5% of the applicable license fee set forth in subsection A above. 2. SWITCH INTERFACE 10% of the applicable license fee set forth in subsection A above. C. MBA ITEM RATING MODULES 1. LOCAL BILLED ITEMS PER MONTH LICENSE FEE 250,000 $750,000 350,000 $1,050,000 500,000 $1,500,000 650,000 $1,950,000 800,000 $2,400,000 1,000,000 $3,000,000 2. DATA BILLED ITEMS PER MONTH LICENSE FEE 125,000 $125,000 250,000 $250,000 350,000 $350,000 500,000 $500,000 650,000 $650,000 800,000 $800,000 1,000,000 $1,000,000 3. PRIVATE LINE BILLED ITEMS PER MONTH LICENSE FEE 125,000 $93,750 250,000 $187,500 350,000 $262,500 500,000 $375,000 650,000 $487,500 800,000 $600,000 1,000,000 $750,000 17 4. INTERNET BILLED ITEMS PER MONTH LICENSE FEE 50,000 $50,000 125,000 $125,000 250,000 $250,000 350,000 $350,000 500,000 $500,000 650,000 $650,000 800,000 $800,000 1,000,000 $1,000,000 D. USAGE RATING MODULES 1. USAGE BILLED RECORDS PER MONTH LICENSE FEE 75,000,000 $2,000,000 2. CABS BILLED RECORDS PER MONTH LICENSE FEE 5,000,000 $66,667 10,000,000 $133,333 20,000,000 $266,667 35,000,000 $466,667 50,000,000 $666,667 75,000,000 $1,000,000 E. CALCULATION OF SEAGULL NON-MBA LICENSE FEES BCS will procure for Customer the Seagull GUI software at a rate of $225 per seat. INITIAL SEATS ORDERED LICENSE FEE 150 $33,750 F. CALCULATION OF ADDITIONAL LICENSE FEES. When Customer exceeds the appreciable maximum usage level for any of the software components for three (3) consecutive calendar months, Customer shall be required to pay the difference between its currently licensed maximum usage 18 level and the new maximum usage level license fee. For example, if Customer's total number of accounts increases to 175,000, then Customer shall be required to pay an additional license fees calculated as follows: MBA Base System Additional License Fee = $250,000 ($500,000 - $250,000) Travel Card Processing Additional License Fee = $12,500 ([$500,000 - $250,000] * .05) Switch Interface Additional License Fee = $25,000 ([$500,000 - $250,000] * . 10) Similarly, if Billed Internet Items Per Month increases from 25,000 to 130,000, then the additional license fee would be $220,000 ($250,000 - $35,000). Payment by Customer of any additional license fees due to BCS shall be made within thirty (30) days after the end of the third consecutive calendar monthly period in which usage has exceeded the capacity for which the software has been licensed. Thereafter, further increases in usage of the licensed software components by Customer over any three (3) consecutive calendar monthly periods shall require Customer to pay further additional license fees as set forth in Exhibit B. Customer shall in no event be entitled to receive any refunds or credits for license fees in the event that Customer's maximum usage levels decrease for any period of time. 19 EX-10.8 13 LEASE AGREEMENT The Lease Summary attached hereto is a part of this Lease Agreement and is incorporated by reference as if fully set forth herein. Capitalized terms not otherwise defined herein shall have the meanings as set forth in the Lease Summary. LEASE AGREEMENT THIS LEASE AGREEMENT, made on the Date of This Lease Agreement, between Landlord and Tenant; 1. LEASED PREMISES: The Landlord does hereby lease to the Tenant and the Tenant does hereby rent from the Landlord the Gross Rentable Square Feet in the building (the "Building") which space is more particularly shown on Exhibit A, (Site Plan), and Exhibit B. (Demised Premises), attached hereto. 2. TERM OF LEASE: Notwithstanding anything contained in this Lease Agreement to the contrary: (a) The Term of this Lease shall be as defined in the Lease Summary. (b) If the Term of the Lease shall commence on a date other than the first day of the calendar month, the monthly installment of the annual rent for the calendar month shall be prorated accordingly. The Term of the Lease shall end after the Commencement Date plus such number of years and days, if any as will cause this Lease to expire on the last day of the month. 3. BASE RENT: Tenant shall pay to Landlord the base rent (Base Rent) at the respective rates set forth on Schedule 'C' hereof, in twelve (12) equal installments, payable monthly in advance, due on the first (lst) of the month. The Tenant shall pay to the Landlord one month of Base Rent and Additional Rent at the time of the complete execution of this Lease Agreement. Said amount shall be credited to the first partial month or first full month (as the case may be) that Tenant is to pay Base Rent and Additional Rent. In the event Tenant is delinquent more the number of days as noted on the Lease Summary, after the first day of the month, in the payment of any Base Rent or Additional Rent (as hereafter defined) due under this Lease, Tenant shall pay to Landlord the Late Charge as noted in the Lease Summary. The Gross Rentable Square Feet shall for the purposes of determining the rental payment include the space occupied by Tenant; (outside dimensions) and a prorata share of any common area of the Building as verified by Landlord's Architect. 4. RIGHTS IN COMMON: Tenant shall have the right in common with other tenants and occupants of the Building to use the access driveways to public streets and to park in the parking area. Tenant will not permit or cause access to said areas to be blocked, restricted or otherwise hindered. 5. ADDITIONAL RENT: A. In addition to the annual Base Rent payable by Tenant under this Lease, from the date of Tenant's occupancy of the Leased Premises, Tenant shall pay as additional rent any and all other charges required to be paid in connection with this Lease at the times herein provided for the payment thereof ("Additional Rent"). B. Tenant shall pay monthly as Additional Rent, Tenant's Proportionate Share of all real estate taxes including municipal sewer and water rents and charges, if any, and extraordinary expenses and assessments, if any, assessed against the entire parcel of which the Demised Premises forms a part for the lease year. In addition to the obligation to pay taxes, Tenant shall pay Tenant's Proportionate Share of any levy for the installation of local improvements affecting the real estate of which the Demised Premises are a part which may be assessed by applicable governmental entities for all purposes of this Lease. In the event that Landlord obtains a reduction in real estate taxes, as established during the Term of this Lease Agreement, Landlord shall pass on to Tenant Tenant's C. Tenant shall pay to Landlord as Additional Rent Tenant's Proportionate Share of all maintenance and management costs for the exterior areas of the Building and the common areas of the Building, including, but not limited to, items noted on Exhibit D. Landlord shall, at its own expense maintain the foundations and the steel structure of the Building; provided that Tenant shall be solely responsible for damage to any of these areas occasioned by the fault or negligence of Tenant, its employees, agents, contractors and/or invitees. D. The Tenant shall pay to the Landlord utility meter installation and maintenance charges and such gas, electric, water and sewer service and usage charges or rentals as may, during the Term of this Lease, be assessed or imposed for the utilities used or consumed in or on the Demised Premises, whether determined by meter or otherwise, as soon as the same may be payable. If such charges or rentals are not so paid, the same shall be added as Additional Rent. E. Tenant shall, at Tenant's expense, maintain Service Contracts with reliable contractors to perform regular, monthly or other required services and maintenance to the heating, plumbing, electrical, fire safety and mechanical systems in the Demised Premises. Tenant shall pay for either directly to the appropriate utility company or as Additional Rent all gas, electricity, water, sewer and/or other utilities consumed or used in the Demised Premises and the proportionate share of common area utilities during the Term of the Lease. F. If Landlord shall incur any charge or expense on behalf of the Tenant under the terms of this Lease, such charge or expense shall be considered Additional Rent (including construction costs and expenses for the fit up of the Demised Premises) hereunder; in addition to and not in limitation of any other rights and remedies which Landlord may have in case of the failure by Tenant to pay such sums when due, such non-payment shall entitle Landlord to the remedies available to it hereunder for non-payment of rent. All such charges or expenses shall be paid to Landlord at its office or its successor assignee or nominee, in Gladstone, New Jersey or at such other place and to such other person as Landlord may from time to time designate in writing. Any unpaid rent or additional rent shall accrue interest thereon at the rate of fifteen percent (15%) per annum, commencing thirty (30) days after the date it is due. G. Tenant shall pay the cost of insurance, as defined in Paragraph 14, as Additional Rent. H. With respect to Tenants' obligations under this Paragraph 6 and Paragraphs 7 and 14 hereafter, Landlord shall estimate and bill Tenant monthly for Tenant's Proportionate Share of the costs thereof, which sums Tenant shall pay as Additional Rent together with the monthly Base Rent due hereunder. Said estimates may be revised upward or downward from time to time to reflect increased or decreased costs. Sometime after the end of each calendar year, (or at the end of the Term of the Lease, if other than December 31), Landlord shall determine the actual costs incurred and bill Tenant for any balance due or pay Tenant any monies due it. In the event Tenant does not question Landlord's estimate, in writing, within 2 months of Tenant's receipt of said estimate, said estimate shall be considered non-negotiable and a valid claim. 6. NET RENT LEASE: It is the purpose and intent of the Landlord and the Tenant that the adjusted annual rental shall be absolutely net to the Landlord, so that this Lease shall yield, net to the Landlord, the net Base Rent specified in the Lease Summary in each year during the Term of this Lease, and that all costs, fees, interest, charges, expenses, reimbursements and obligations of every kind and nature whatsoever relating to the Demised Premises which may arise or become due during or out of the Term of the Lease shall be paid or discharged by the Tenant as Additional Rent, and the Tenant hereby agrees to indemnify and to save the Landlord harmless from and against such costs, fees, interests, charges, expenses, reimbursements and obligations and any interest thereon. 2 7. USE: Tenant covenants to use and occupy the Demised Premises for the Use of the Demised Premises, which use by Tenant, however, is and shall be expressly subject to all applicable zoning ordinances and regulations of any governmental institutional instrumentality's, board, or bureaus having jurisdiction thereof. Tenant may not use the Demised Premises for any other use whatsoever without Landlord's prior written consent. Tenant shall not allow the Demised Premises to be vacant for more than thirty (30) consecutive days. If Tenant violates this provision, Landlord may, at Landlord's option upon ten (10) days' notice to Tenant, terminate this Lease. 8. COMPLIANCE WITH LAWS AND INSURANCE: A. Tenant will not do or permit to be done in the Demised Premises, or the Building of which they form a part, or bring or keep anything therein, which shall in any way increase the rate of fire or other insurance in said Building or on the property kept therein, or obstruct, or interfere with the rights of the other tenants, or in any way injure or annoy them or those having business with them, or conflict with the fire laws or regulations or with any insurance policy upon said Building or any part thereof, or with any statutes, rules or regulations enacted or established by the Federal Government or by the State Municipality or County in which the subject property is located. Any increase in fire insurance premiums caused by Tenant's activities will be paid by Tenant as Additional Rent. B. The Tenant shall promptly comply at its own expense with all laws, ordinances, rules, regulations, requirements and directives of the Federal, State and Municipal Governments or Public Authorities and of all their departments, bureaus and subdivisions, applicable to and affecting the Demised Premises, their use and occupancy. Tenant shall take all steps necessary for the correction, prevention and abatement of nuisances, violations or other grievances in, upon or connected with the Demised Premises. During the term thereof, Tenant shall promptly comply with all orders, regulations, requirements and directives of the Board of Fire Underwriters or similar authority and of any insurance companies which have issued or are about to issue policies of insurance covering the Demised Premises and its contents, for the prevention of fire or other casualty, damage or injury, at the Tenant's own cost and expense. 9. ALTERATIONS: A. Tenant will not make any alterations, installations, changes, replacements, additions, or improvements, structural or otherwise, in or to the Demised Premises or any part thereof, without the prior written consent of the Landlord. All alterations, etc., shall be made at the sole expense of the Tenant and shall be in compliance with all applicable governmental and insurance requirements and shall not interfere with the occupancy by any other tenant in the Building. Landlord's consent will not be unreasonably withheld. B. No alterations, additions or improvements shall be made, and no climate regulating, air conditioning, cooling, heating or sprinkler systems, television or radio antennas, heavy equipment, apparatus and fixtures, shall be installed in or attached to the Demised Premises without the written consent of the Landlord. Unless otherwise provided herein, all such alterations, additions or improvements and systems, when made, installed in or attached to the Demised Premises, shall belong to and become the property of the Landlord and shall be surrendered with the Demised Premises and as part thereof upon the expiration or sooner termination of the Lease, without hindrance, molestation or injury. 3 10. COVENANT AGAINST LIENS: Unless otherwise provided by law, any contract(s) executed by Tenant for alterations, additions or improvements to the Demised Premises which Landlord permits Tenant to do pursuant to Paragraph 10, whether in the nature of erection, construction, alteration or repair, shall not be deemed to have been authorized by Landlord merely by reason of any consent given by Landlord to Tenant to improve the Demised Premises unless Landlord specifically reviews such contract(s) and consents in writing to such contract(s). Landlord, in granting its consent to Tenant for any such alterations, additions or improvements to the Demised Premises, shall have no obligation to authorize in writing any contract(s) executed by Tenant for such work, it being the intention of the parties that to the extent permitted by the New Jersey Construction Lien Law, N.J.S.A. 2A:44A-1 ET SEQ. (the "Construction Lien Law") any liens by any contractor, subcontractor or supplier who provides work, services, material or equipment to Tenant pursuant to such contract(s) shall attach only to the leasehold interest of Tenant. Tenant shall pay promptly all persons furnishing work, equipment, services or materials with respect to any work performed by Tenant or its contractor on or about the Demised Premises. In the event any construction or other liens or any other notices of claim, including, without limitation any Notice of Unpaid Balance and Right to File Lien ("lien"), shall at any time be filed pursuant to the Construction Lien Law by reason of work, services, equipment or materials performed or furnished to Tenant or to anyone holding the Demised Premises through or under Tenant, Tenant shall immediately notify Landlord of the same and shall forthwith cause the same to be discharged by paying the claimant and obtaining a discharge or by filing a surety bond or making a deposit of funds with the Clerk of the Superior Court of New Jersey as provided in N.J.S.A. 2A:44A-31. If Tenant shall fail to cause such lien forthwith to be so discharged in compliance with all the provisions of the Construction Lien Law within ten (10) business days after being notified of the filing thereof, then, in addition to any other right or remedy of Landlord, Landlord may discharge the same by paying the amount claimed to be due and the amount so paid by Landlord together with interest thereon at three (3%) percent over the prime rate of the First Fidelity Bank and all costs and expenses, including reasonable attorneys' fees incurred by Landlord in procuring the discharge of such lien, shall be due and payable by Tenant to the Landlord as Additional Rent on the first day of the next following month, or may, at the Landlord's election, be subtracted from any sums owing to Tenant. Tenant shall provide Landlord with copies of any contracts, subcontracts, supply contracts, equipment leases, consulting agreements or similar documents and any amendments thereto with respect to any work performed by Tenant or its contractor(s) on or about the Demised Premises within ten (10) days of execution of same. Tenant, without further request, written or oral, is hereby required and agrees to provide Landlord each month during any period work is performed by Tenant or its contractor(s) on or about the Demised Premises with an accurate and full list, verified under oath, of the names and addresses of each contractor, subcontractor, construction manager, design professional, supplier or other persons or entities providing work, services, materials or equipment who may have a right to file a lien pursuant to the Construction Lien Law. Said list shall be in compliance with all provisions of the Construction Lien Law. 11. SURRENDER OF PREMISES: A. It is distinctly understood that all alterations, installations, changes, replacements, additions to or improvements upon the Demised Premises (whether with or without Landlord's consent) shall at the election of Landlord remain upon the Demised Premises and be surrendered with the Demised Premises at the expiration of this Lease without disturbance, molestation or injury. Should Landlord elect that alterations, installations, changes, replacements, additions to or improvements upon the Demised Premises be removed, upon termination of this Lease or upon termination of any renewal period hereof, Tenant hereby agrees to cause same to be removed at Tenant's sole cost and expense, and should Tenant fail to remove the same, then and in such event, Landlord shall cause same to be removed at Tenant's expense and Tenant hereby agrees to reimburse Landlord for the cost of such removal, together with any and all damages which Landlord may suffer and sustain by reason of failure of Tenant to remove the same. 4 B. The Tenant covenants, at the expiration or other termination of this Lease, to remove all goods and effects from the Demised Premises not the property of the Landlord, and to yield up to the Landlord the Demised Premises and all keys, locks and other fixtures connected therewith (except trade fixtures and other fixtures belonging to the Tenant), in good repair, order and condition in all respects, reasonable wear and use thereof and damage by fire or other casualty and damage from risk with respect to which Tenant is not herein expressly made liable excepted. In the event Tenant does not surrender the Demised Premises as herein required, Tenant shall indemnify Landlord against loss or liability resulting from delay by Tenant in surrendering possession. Unless Landlord agrees in writing to Tenant's holding over after the Lease is terminated, Tenant's continued occupancy will be as a month-to-month tenant upon all the same terms and conditions set forth in this Lease except that the annual base rent shall be two (2) times the fixed annual rent payable during the month the Lease terminated. 12. TENANT'S INSURANCE: It is expressly agreed by the parties that Tenant shall assume all risk of damage to its property, equipment and trade fixtures occurring in or about the Demised Premises whatever the cause of such damage or casualty. Landlord assumes no liability or responsibility whatever with respect to the conduct and operation of the business to be conducted in the Demised Premises nor for any loss or damage of whatsoever kind or nature or by whomsoever caused, to personal property, documents, records, monies, or goods of Tenant or to anyone in or about the Demised Premises, however caused, and Tenant agrees to hold Landlord harmless against all such claims. Tenant will, at its own cost and expense maintain all risk insurance coverage on its trade fixtures, and other personal property located in the Demised Premises in an amount equal to full replacement cost thereof. The Tenant, at Tenant's own cost and expense, shall obtain or provide and keep in full force for the benefit of the Landlord, during the term hereof, general public liability insurance, insuring the Landlord against any and all liability or claims of liability arising out of, occasioned by or resulting from any accident or otherwise in or about the Demised Premises, for injuries to any person or persons, for limits of not less than the Limit of Liability Insurance To Be Maintained by Tenant as set forth in the Lease Summary. The policy or policies of insurance shall be of a company or companies authorized to do business in the State of New Jersey and shall be delivered to the Landlord, together with evidence of the payment of the premiums therefor, not less than fifteen days prior to the commencement of the term hereof or of the date when the Tenant shall enter into possession, whichever occurs sooner. At least thirty (30) days prior to the expiration or termination date of any policy, the Tenant shall deliver a renewal or replacement policy with proof of the payment of the premium therefor. 13. LANDLORD'S INSURANCE: Tenant shall pay to Landlord as Additional Rent Tenant's Proportionate Share of the premium cost for comprehensive insurance, including liability insurance, fire insurance with loss of rent and customary all risk conditions, insuring the Building and improvements of which the Demised Premises are a part in an amount equal to the full replacement value of said Building and insurable improvements, exclusive or footings and foundations, which insurance shall include, at Landlord's election, any customary extensions or Overages or additional policy Overages, including but not limited to, vandalism, malicious mischief, sprinkler damage, flood insurance, broad form boiler and machinery coverage (inclusive of air conditioning system, if any), glass insurance, and rent/business interruption insurance (inclusive of real estate taxes and maintenance items and applicable insurance premiums). 5 14. HOLD HARMLESS: A. The Tenant also agrees to and shall save, hold and keep harmless and indemnify the Landlord from and for any and all payments, expenses, costs, attorney fees and from and for any and all claims and liability for losses or damage to property or injuries to persons occasioned wholly or in part by or resulting from any acts or omissions by the Tenant or the Tenant's agents, employees, guests, licensees, invitees, subtenants, assignees or successors, or for any cause or reason whatsoever arising out of or by reason of the occupancy by the Tenant and the conduct of the Tenant's business. B. Tenant shall indemnify and hold the Landlord harmless from and against all suits, actions, damages, losses, penalties, liabilities, claims, costs and expenses including, without limitation, reasonable attorney's fees, which the Landlord may suffer or incur in connection with (i) any matter, cause or thing arising out of Tenant's use, occupancy, control or management of the Demised Premises; (ii) any negligence, or acts of omission or commission on the part of Tenant or any of its agents, contractors, servants, employees or invitees; (iii) any failure on the part of Tenant to perform or comply with any of the covenants, agreements, terms or conditions contained in this Lease on its part to be performed or complied with; (iv) any loss of life, bodily or personal injury or property damage which is not due to the fault of the Landlord, its employees, contractors or agents. Landlord shall promptly notify Tenant of any such claim asserted against it and shall promptly send to Tenant copies of all papers or legal process served upon it in connection with an action or proceeding brought against Landlord by reason of any such claim. Nothing herein shall impose on Tenant any obligation to indemnify Landlord for Landlord's negligence. 15. TENANT'S DEMISED PREMISES: The Tenant shall take good care of the Demised Premises and at the Tenant's own cost and expense, make all repairs, including painting and decorating, and shall maintain the Demised Premises in good condition and state of repair, and at the end or other expiration of the term thereof, shall deliver up the Demised Premises in good order and condition, wear and tear from a reasonable use thereof, and damage by the elements not resulting from the neglect or fault of the Tenant, excepted. 16. SUBLEASING: Tenant shall not assign, transfer, or encumber this Lease or any interest therein, or sublet the Premises or any part thereof, or acquiesce in any such assignment, transfer, or encumbrance, without in each case obtaining the prior written consent of Landlord. Landlord may withhold this consent for any reason in its sole discretion. Any transfer or assignment of any controlling interest in Tenant, whether voluntarily or by operation of law, shall constitute an assignment for purposes of this Section of the Lease. In the event Landlord shall consent to an assignment or sublease, the obligations of this Lease shall bind and benefit the assignees and transferees of Tenant with the same effect as if they were mentioned in each instance where Tenant herein is named or referred to. No such assignment or transfer shall relieve Tenant of any obligations hereunder and Tenant shall remain primarily liable for such obligations. Tenant shall deliver to Landlord a true and complete copy of every assignment and sublease relating to the Premises promptly after execution thereof. Every sublease relating to the Premises shall contain the agreement of the sub-tenant thereunder to attorn to Landlord in the event of termination by Landlord of this Lease. Tenant shall pay to Landlord the reasonable cost, if any, of Landlord's professional review of the transaction. 17. FIRE DAMAGE: A. In the event the Building or the Demised Premises shall be destroyed or rendered untenantable either in whole or in part by fire or other casualty, Landlord may at its option restore the Building or Demised Premises to as near their previous conditions as is reasonably possible. In the meantime, unless the damage was caused by acts, omissions, or negligence of Tenant, its agents, employees, contractors, or invitees, the rent shall be abated in the same proportion as the untenantable portion of the Demised Premises bears to the whole thereof. But, unless Landlord within twenty-one (21) days after the happening of any such casualty shall notify Tenant of its election not to restore the damage within nine (9) months from date of casualty, this Lease shall continue and Landlord shall commence the necessary restoration. 6 Such restoration by Landlord shall not include replacement of Tenant's trade fixtures, furniture, equipment, or other items that do not become part of the Building or any improvements to the Premises in excess of those provided for in the allowance for building standard items as of the Commencement Date of this Lease. Restoration of the premises required beyond Landlords obligation shall be performed by the Tenant at no cost to the Landlord. If Landlord shall elect to notify Tenant that Landlord shall not restore, this Lease shall terminate as of the date of the occurrence and Tenant shall promptly vacate the Premise. B. No penalty shall accrue to landlord to delay in commencing or completing repairs caused by adjustment of insurance claims, government requirements, or any cause beyond Landlord's reasonable control. C. No damages, compensation, or claim shall be payable by Landlord except as such is provided for in Landlord's standard insurance policy if any, for inconvenience, loss of business, or annoyance arising from any repair or restoration of any portion of the Premises or of the Building. Landlord shall use commercially reasonable efforts to effect such repairs promptly and in such manner as not to unreasonably interfere with Tenant's occupancy. D. Landlord will not carry insurance of any kind on any improvements, additions, or alterations made and paid for by Tenant or Tenant's furniture or furnishings or on any fixtures, equipment, improvements, or appurtenances of Tenant under this lease, and Landlord (except as provided by law by reason of its negligence) shall not be obligated to repair any damage thereto or replace the same. E. In case the Building shall be substantially destroyed by fire or other causes at any time during the last year of the term of this Lease, either Landlord or Tenant may terminate this Lease upon written notice to the other party hereto given within twenty-one (21) days of the date of such destruction. F. Upon any termination of this Lease as a result of damage or destruction of the Building or Premises as provided herein, the parties shall be released thereby without further obligation to the other from the date possession of the Premises is surrendered to Landlord, except for rent and any other monies which have accrued and are then unpaid, and further, except for any prepaid rent due to tenant. 18. LANDLORD'S RIGHT OF ENTRY: The Tenant agrees that the Landlord and the Landlord's agents, employees or other representatives, shall have the right to enter into and upon the Demised Premises or any part thereof. at all reasonable hours (or at any hour in the event of an emergency) for the purpose of examining the same or making such repairs or alterations therein as may be necessary for the safety and preservation thereof or for the purpose of showing same to prospective purchasers or mortgagees or placing a suitable "For Sale" or "To Let" sign therein. This clause shall not be deemed to be a covenant by the Landlord nor be construed to create an obligation on the part of the Landlord to make such inspection or repairs. 19. GLASS: Tenant agrees to replace, at its cost and expense, any broken glass in the windows or apertures of the Demised Premises which may be damaged or destroyed. If Landlord does not obtain plate glass insurance coverage, Tenant will either carry plate glass insurance or in lieu thereof, will self-insure and replace said plate glass. In case of the destruction of or any damage to the glass in the Demised Premises, or the destruction of or damage of any kind whatsoever to the said Demised Premises, caused by the carelessness, negligence or improper conduct on the part of the Tenant or the Tenant's agents, employees, guests, licensees, invitees, subtenants, assignees or successors, the Tenant shall repair the said damage or replace or restore any destroyed parts of the Demised Premises, as speedily as possible, at the Tenant's own cost and expense. 7 20. TENANT'S SIGNS: The Tenant shall not place nor allow to be placed any signs of any kind whatsoever, upon, in or about the said Demised Premises or any part thereof, except of a design and structure and in or at such places as may be indicated and consented to by the Landlord in writing. Tenant shall, at its expense, apply for any such sign approval as is required from any applicable governing body and shall maintain the sign(s) in good condition and repair. In case the Landlord or the Landlord's agents, employees or representatives shall deem it necessary to remove any such signs in order to paint or make any repairs, alterations or improvements in or upon the Demised Premises or any part thereof, they may be so removed, but shall be replaced at the Landlord's expense when the said repairs, alterations or improvements shall have been completed. Any signs permitted by the Landlord shall at all times conform with all municipal ordinances or other laws and regulations applicable thereto. 21. LANDLORD'S NON-LIABILITY: The Landlord shall not be liable to Tenant for, nor shall Base Rent or Additional Rent be abated or diminished because of any damage or injury which may be sustained by the Tenant or any other person, as a consequence of the failure, breakage, leakage or obstruction of the water, plumbing, steam sewer, waste or soil pipes, roof, drains, leaders, gutters, valleys, down spouts or the like or of the electrical, gas, power, conveyor, refrigeration, sprinkler, air conditioning or heating systems, elevators or hoisting equipment; or by reason of the elements; or resulting from the carelessness, negligence or improper conduct on part of any other tenant or of the Landlord or the Landlord's or this Tenant's or any other tenant's agents, employees, guests, licensees, invitees, subtenants, assignees or successors; or attributable to any inconvenience, interference with, interruption of or failure, beyond the control of the Landlord, of any services to be furnished or supplied by the Landlord or repairs to be made, materials to be stored or work to be performed and the same shall not constitute an eviction. 22. SUBORDINATION: This Lease is and shall always be subject and subordinate at all times to the lien of any mortgages or ground leases or other encumbrances now existing or hereafter placed upon the Demised Premises and to all renewals, modifications, consolidations, replacements and extensions thereof. The recording of such mortgage or mortgages shall have preference and precedence and be superior and prior in lien to this Lease, irrespective of the date of recording and the Tenant agrees to execute any instruments, without cost, which may be deemed necessary or desirable, to further effect the subordination of this Lease to any such mortgage or mortgages. A refusal by the Tenant to execute such instruments shall entitle the Landlord to the option of canceling this Lease, and the term hereof expressly limited accordingly. 23. CONDEMNATION: If the land and/or Building herein, or of which the Demised Premises are a part, or any portion thereof, shall be taken under eminent domain or condemnation proceedings, or if suit or other action shall be instituted for the taking or condemnation thereof, or if in lieu of any formal condemnation proceedings or actions, the Landlord shall grant an option to purchase and/or shall sell and convey the land and/or Building of which the Demised Premises are a part or any portion thereof, to the governmental or other public authority, agency, body or public utility, seeking to take said land and/or Building or any portion thereof, then this Lease, at the option of the Landlord, shall terminate, and the term hereof shall end as of such date as the Landlord shall fix by notice in writing; and the Tenant shall have no claim or right to claim or be entitled to any portion of any amount which may be awarded as damages or paid as the result of such condemnation proceedings or paid as the purchase price for such option, sale or conveyance in lieu of formal condemnation proceedings; and all rights of the Tenant's to damages, if any, are hereby assigned to the Landlord. Tenant shall have the right to make a claim against the condemning authority for such independent claim which it may have as may be allocated by law, for costs and damages due to relocating, moving and other similar costs and charges directly incurred by Tenant and resulting from such condemnation provided the same does not in any way diminish the Landlord's award. The Tenant agrees to execute and deliver any instruments, at the expense of the Landlord, as may be deemed necessary or required to expedite any condemnation proceedings or to effectuate a proper transfer of title to such governmental or other public authority, agency, body or public utility seeking to take or acquire the said lands and/or Building or any portion thereof. The Tenant covenants and agrees to vacate the Demised Premises, remove all the Tenant's personal property therefrom and deliver up peaceable possession thereof to the Landlord or to such other party designated by the Landlord in the aforementioned notice. Failure by the Tenant to comply with any provisions in this clause shall subject the Tenant to such costs, expenses, damages and losses as the Landlord may incur by reason of the Tenant's breach hereof. 8 24. DEFAULT OF TENANT: A. If there should occur any default on the part of the Tenant in the due and punctual payment of any Base Rent or Additional Rent when due or in the performance of any conditions and covenants herein contained, or if during the term hereof the Demised Premises or any part thereof shall be or become abandoned or deserted, vacated or vacant, or should the Tenant be evicted by summary proceedings or otherwise, the Landlord, in addition to any other remedies herein contained or as may be permitted by law, may either by force or otherwise, without being liable for prosecution therefor, or for damages, re-enter the Demised Premises and the same have again possess and enjoy; and as agent for the Tenant or otherwise, re-let the Demised Premises and receive the rents therefor and apply the same, first to the payment of such expenses, reasonable attorney fees and costs, as the Landlord may have been put to in re-entering and repossessing the same and in making such repairs and alterations as may be necessary; and second to the payment of the rents due hereunder. The Tenant shall remain liable for such rents as may be in arrears and also the rents as may accrue subsequent to the re-entry by the Landlord, to the extent of the difference between the rents reserved hereunder and the rents, if any, received by the Landlord during the remainder of the unexpired term hereof, after deducting the aforementioned expenses, fees and costs; the same to be paid as such deficiencies arise and are ascertained each month. Tenant expressly waivers any and all rights of redemption granted by or under any present or future law in the event it is evicted or dispossessed for any cause or if Landlord obtains possession of the Demised Premises by reason of violation or any terms, covenants and conditions of the Lease. B. Upon the occurrence of any of the contingencies set forth in the proceeding clause, or should the Tenant be adjudicated bankrupt, insolvent or placed in receivership, or should proceedings be instituted by or against the Tenant for bankruptcy, insolvency, receivership, agreement of composition or assignment for the benefit of creditors, or should Tenant be dissolved or liquidated or possession of the property of Tenant be taken by any governmental officer or agency pursuant to statutory authority for dissolution rehabilitation, reorganization or liquidation, or if this Lease or the estate of the Tenant hereunder shall pass to another by virtue of any court proceedings, writ of execution, levy, sale, or by operation of law, the Landlord may, in addition to any other remedies Landlord may have, if the Landlord so elects, at any time thereafter, terminate this Lease and the term hereof, upon giving to the Tenant or to any trustee, receiver, assignee or other person in charge of or acting as custodian of the assets or property of the Tenant, five days notice in writing, of the Landlord's intention so to do. Upon the giving of such notice, this Lease and the term hereof shall end on the date fixed in such notice as if the said date was the date originally fixed in this Lease for the expiration hereof; and the Landlord shall have the right to remove all persons, goods, fixtures and chattels therefrom, by force or otherwise, without liability for damages. C. The parties hereby shall and they hereby do waive trial by jury in any action or proceeding brought by either of the parties hereto against the other on any matters whatsoever arising out of or in any way connected with this Lease, the relationship of Landlord and Tenant, Tenant's use or occupancy of the Demised Premises any claim of injury or damage. In the event Landlord commences any proceedings for non-payment of Base Rent and/or Additional Rent, Tenant waives its right to file a counterclaim or remove such action to the Superior Court from Special Civil Part. This shall not, however, be construed as a waiver of Tenant's rights to assert such claims in any special action or actions. D. If the Tenant shall fail or refuse to comply with and perform any conditions and covenants of the within Lease, the Landlord may (but shall not be obligated to) if the Landlord so elects, carry out and perform such conditions and covenants, at the cost and expense of the Tenant, and the said cost and expense shall be payable on demand, or at the option of the Landlord shall be added to the installment of rent due immediately thereafter but in no case later than one month after such demand, whichever occurs sooner, and shall be due and payable as such. This remedy shall be in addition to such other remedies as the Landlord may have hereunder by reason for the breach by the Tenant of any of the covenants and conditions in this Lease contained. Landlords delay or failure to insist upon strict performance of any of the covenants and conditions of this Lease or to exercise any other available right or remedy shall not impair any such right or remedy, nor shall it be construed to be a forbearance or waiver. 9 25. FORCE MAJEURE: This Lease and the obligation of the Tenant to pay rent hereunder and to comply with the covenants and conditions hereof, shall not be affected, curtailed, impaired or excused because of the Landlord's inability to obtain or supply any service, labor or material called for herein, by reason of any rule, order, regulation or preemption or embargo by any governmental entity, authority, department, agency or subdivision or for any delay which may arise by reason of negotiations for the adjustment of any fire, catastrophe or other loss or because of strikes, lockouts or other labor trouble, civil commotion, acts of God or of the public enemy, the act or default of the other party, holding over by any existing tenant of the Demised Premises or for any cause or effect beyond the control of the Landlord (collectively "Force Majeure"). The period of time during which Landlord is prevented from performing any act required to be performed under this Lease due to Force Majeure shall be added to the time for performance of such act. 26. SEVERABILITY: The terms, conditions, covenants and provisions of this Lease shall be deemed to be severable. If any clause or provision herein contained shall be adjudged to be invalid or unenforceable by a court of competent jurisdiction or by operation of any applicable law, it shall not affect the validity of any other clause or provision herein, but such other clauses or provisions shall remain in full force and effect. 27. CUMULATION RIGHTS: The various rights, remedies, options and elections of the Landlord, expressed herein, are distinct, separate and cumulative. In addition, to other legal remedies for violation or breach by Tenant or anyone holding or claiming under Tenant of the restrictions, agreements or covenants of this Lease on Tenant's part to be performed or fulfilled, such violation or breach shall be restrainable by injunction of the suit of Landlord. No receipt of money by Landlord from any receiver, trustee or custodian or debtor in possession shall reinstate, continue or extend the term of this Lease or affect any notice continue or theretofore given to Tenant or to any such reseller, trustee, custodian or debtor in possession or operate as a waiver or estoppel of the right of Landlord to recover possession of the Demised Premises for any of the caused therein enumerated by any lawful remedy. The failure of the Landlord to enforce strict performance by the Tenant of the conditions and covenants of this Lease or to exercise any election or option or to resort or have recourse to any remedy herein conferred or the acceptance by the Landlord of any installment of rent after any breach by the Tenant, in any one or more instances, shall not be construed or deemed to be a waiver or a relinquishment for the future by the Landlord of any such conditions and covenants, options, elections or remedies, but the same shall continue in full force and effect. 28. NOTICES: All notices required under the terms of this Lease shall be given and shall be complete by mailing such notices by certified or registered mail, return receipt requested, to the address of the parties as shown at the head of this Lease, or to such other address as may be designated in writing, which notice of change of address shall be given in the same manner. 29. ENTIRE CONTRACT: This Lease contains the entire contract between the parties. No representative, agent or employee of the Landlord has been authorized to make any representations or promises with reference to the within letting or to vary, after or modify the terms hereof. No additions, changes or modifications, renewals or extensions hereof, shall be binding unless reduced to writing and signed by the Landlord and the Tenant. 10 30. ISRA: Tenant represents that its Standard Industrial Classification ("SIC") number is the number set forth in the Lease Summary. Tenant shall, with respect to its use and occupancy of the Demised Premises, or its SIC classification, at Tenant's own expense, comply with the Industrial Site Recovery Act, N.J.S.A. 13:1 K-6 ET SEQ. ("ISRA"), the Resource Conservation and Recovery Act, 42 U.S.C. 6901 ET SEQ. ("RCRA"), the Comprehensive Environmental Response, Compensation & Liability Act, 42 U.S.C. 9601 ET SEQ. ("CERCLA"), the Spill Compensation and Control Act, N.J.S.A. 58:10-23.11 ET SEQ. ("Spill Act"), the Clean Water Act, 33 U.S.C. 1241 ET SEQ., the New Jersey Water Pollution Control Act, N.J.S.A. 58:10A-1 ET SEQ., the Worker and Community Right-To-Know Act, N.J.S.A.34:5A-1 ET SEQ., the occupational Safety and Health Act of 1979, 29 U.S.C. 651 ET SEQ. and such other environmental statutes as may now or hereafter be enacted and are applicable to the Demised Premises, land or Building (the above acts and any future environmental enactment's are hereinafter collectively referred to as "Environmental Laws") and any and all amendments, orders and regulations promulgated pursuant to the Environmental Laws. Tenant shall, at Tenant's own expense, provide all information within Tenant's control requested by Landlord or the Bureau of Industrial Site Evaluation (or such other entity authorized to administer and/or enforce the Environmental Laws) for the preparation of submissions, declarations, reports and plans pursuant to the Environmental Laws. If the New Jersey Department of Environmental Protection and Energy (DEPE) (or such other entity authorized to administer and/or enforce the Environmental Laws) shall determine that a clean-up plan be prepared and that a clean-up or any other required action be undertaken because of any spills or discharges of hazardous substances or wastes at the Demised Premises which occur during the term of this Lease or that any other action be taken in order to comply with the Environmental Laws, then Tenant shall, at Tenant's own expense, prepare and submit the required plans and carry out the approved plans and/or perform such other required actions. Tenant shall indemnify, defend and save harmless Landlord from all fines, suits, procedures, claims and actions of any kind arising out of or in any way connected with any spills or discharges of hazardous substances or wastes at the Demised Premises which occur during the term of this Lease and/or other required compliance with Environmental Laws. Tenant's obligations and liability under this paragraph shall survive the term of this Lease and shall continue so long as Landlord remains subject to the Environmental Laws or is held responsible for any spills or discharges of hazardous substances or wastes at the Demised Premises which occur during the term of this Lease and/or other required compliance with Environmental Laws. 31. BROKER: Tenant and Landlord represent and warrant to each other that there are no claims or brokerage commissions or finder's fees in connection with the execution of the Lease, except for the Real Estate Broker as noted in the Lease Summary. Each party agrees to indemnify the other against, and hold it harmless from, all liabilities arising from claims of any entity other than the Real Estate Broker (including, without limitation, the cost of counsel fees in connection therewith) arising out of acts by the warranting party in violation of its covenant herein. 32. SHORT FORM LEASE: It is understood between the parties hereto that this Lease will not be recorded but that a short form lease, describing the Demised Premises, giving the term and making particular mention of any special clauses as herein contained, may only at Landlord's option, be recorded in accordance with the laws governing and regulating the recording of such documents in the State of New Jersey. 11 33. ARBITRATION: Except with respect to any summary dispossess proceedings for non-payment of rent, in the event of any controversy between Landlord and Tenant hereafter arising out of any of the provisions of this Lease or out of the refusal of Landlord or Tenant to observe or perform any of the provisions hereof, then, if the parties hereto have not agreed to settle such controversy within thirty (30) days after the same shall have arisen, either party may submit such matter to a binding arbitration in New Jersey before three (3) arbitrators of the American Arbitration Association (or any successor thereto) in accordance with its commercial Rules then obtaining. In the event of the failure, refusal or inability of the American Arbitration Association (or any successor thereto) to act, application may be made for such appointment to a court of competent jurisdiction. The determination made by the arbitrators so appointed shall be conclusive upon the parties and judgment may be entered on the award of the arbitrators in any court of competent jurisdiction. The request for formal arbitration may be made by either party upon written notice to the other party which notice shall include an express statement of the matter in dispute. The arbitrators may only interpret and apply the terms of the Lease and may neither change such terms nor deprive either party to the Lease of any rights hereunder. The expenses of arbitration shall be borne equally by Landlord and Tenant, except that each party shall pay its own counsel fees. The existence of any dispute or the submission thereof to arbitration shall not affect or delay the performance by Tenant of its obligations under the Lease. Tenant shall continue to pay all rent and other sums owing under the Lease and shall make any required deposits (as reasonably determined by Landlord, if necessary) without prejudice to Tenant's rights; and, if required by reason of the determination of the arbitrators, Landlord shall make any appropriate refund to Tenant. 34. ESTOPPEL: The Tenant shall deliver to the Landlord's mortgage lender or Landlord within ten (10) days of a request, from time to time, a statement in writing certifying (a) that this Lease is unmodified and is in full force and effect (or if there have been modifications, that the same is in full force and effect as modified and stating the modifications), (b) that there exists no default or if a default is claimed, stating the exact nature of the default) (c) the dates to which Base Rent and Additional Rent have been paid in advance, if any (d) whether any security has been deposited by Tenant with Landlord and if so the amount thereof; it being intended that any such statement delivered pursuant to this paragraph may be relied upon as to the facts contained therein. Tenant shall from the date hereof send to any Landlord's mortgage lender, upon written request, a copy of any notice or statement required to be sent under the Lease to the Landlord, at the same time such notice is sent to the Landlord. If Landlord's mortgage lender requests reasonable modifications to this Lease, Tenant will not unreasonably withhold or delay its consent thereto, provided such modifications do not increase Tenant's obligations hereunder or materially adversely affect the leasehold interest hereby created or Tenant's use and enjoyment of the Demised Premises. 35. MISCELLANEOUS: A. The Landlord may pursue the relief or remedy sought in any invalid clause, by conforming the said clause with the provisions of the statutes or the regulations of any governmental agency in such case made and provided as if the particular provisions of the applicable statutes or regulations were set forth herein at length. B. Tenant agrees not to encumber or suffer or permit to be encumbered, the Demised Premises or the fee thereof by any lien, charge, or encumbrance, and Tenant shall have no authority to mortgage or hypothecate this Lease in any way whatsoever. 12 C. Notwithstanding anything set forth in this Lease to the contrary, neither Landlord nor any partner of Landlord shall have any personal liability in connection with its obligations under this Lease, and Tenant agrees to look solely to the property described on Exhibit A hereof to enforce any claim it may have against Landlord. When the term "Landlord" is used in this Lease it shall be construed to mean and include only the owner of the fee title, to the Demised Premises. Upon transfer by Landlord of the fee title, Landlord shall notify Tenant of Landlord's transferee. In such event, Landlord shall be automatically freed and relieved from and after the date of such transfer of title of all liability with respect to the performance of any covenants on and obligations on Landlord's part to be performed after the date of transfer provided that any such transfer and conveyance by Landlord is expressly subject to the assumption by the grantee or transferee of the obligations of Landlord to be performed pursuant to the terms and conditions of this Lease. D. In all references herein to any parties, persons, entities or corporations the use of any particular gender of the plural or singular number is intended to include the appropriate gender or number as the text of the within instrument may require. All the terms, covenants, and conditions herein contained shall be for and shall inure to the benefit of and shall bind the respective parties hereto and their heirs, executors, administrators, personal or legal representatives, successors and assigns. E. This Lease is to be construed pursuant to laws of state of New Jersey. F. Tenant represents that: (a) it is a corporation, partnership or limited liability company as defined in the Lease Summary, validly existing and in good standing under the laws of the State as defined in the Lease Summary; (b) that the officer, partner or member executing and delivering this Lease has been duly authorized to enter into this Lease; (c) that the execution and delivery of this Lease does not and shall not violate any provision of any by-law, partnership agreement, operating agreement, order, judgment, governmental regulation or any other obligation to which Tenant is a party or to which it is subject. 36. APPLICATION OF UNDERLYING LEASE: Except as set forth in this Lease and to the extent not otherwise inconsistent with the agreements and understandings expressed in this Lease, the terms, provisions, covenants and conditions of the Underlying Lease are hereby incorporated herein by reference upon the understanding that the term "Landlord" as used in the Underlying Lease shall refer to Landlord hereunder and the term "Tenant" as used in the Underlying Lease shall refer to Tenant hereunder. Landlord and Tenant hereunder each agree to perform and comply with the terms, provisions, covenants, and conditions of the Underlying Lease and not to do or cause the Underlying Lease to be terminated except where the Underlying Lease or this Lease specifically provide for termination upon the happening of certain events. 37. LANDLORD AS OWNER: The Landlord covenants and represents that the Landlord is not the owner of the Demised Premises but is the tenant under the Underlying Lease and has the right and authority to enter into, execute and deliver this Lease; and does further covenant that the Tenant on paying the rent and performing the conditions and covenants herein contained, shall and subject to the provisions of this Lease and the Underlying Lease, peaceably and quietly have, hold and enjoy the Demised Premises for the term aforementioned. 13 THE LANDLORD HEREBY LEASES THE DEMISED PREMISES TO THE TENANT, AND THE TENANT HEREBY LEASES THE PREMISES FROM THE LANDLORD, IN ACCORDANCE WITH THE TERMS OF THIS LEASE AGREEMENT. LANDLORD: COGENERATION SERVICES INC. /S/ Harold N. Kamine By: --------------------------(Signature) Hal Kamine --------------------------(Name) President --------------------------(Title) TENANT: KMC TELECOM INC. /S/ Harold N. Kamine By: --------------------------(Signature) Hal Kamine --------------------------(Name) President --------------------------(Title) 14 EXHIBIT A [GRAPHIC OMITTED] EX-10.10 14 FORM OF NON-QUALIFIED STOCK OPTION AGREEMENTS FORM OF NON-QUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT, dated as of ___________ ___, 199__, is made by and between KMC Telecom Holdings, Inc., a Delaware corporation hereinafter referred to as the "Corporation", and ____________________, an employee of the Corporation or a Subsidiary (as defined below) or Affiliate (as defined below) of the Corporation, hereinafter referred to as "Optionee". WHEREAS, the Corporation wishes to afford the Optionee the opportunity to purchase shares of its Common Stock, par value $.01 per share (the "Common Stock"); WHEREAS, the Corporation wishes to carry out the Plan (as hereinafter defined), the terms of which are hereby incorporated by reference and made a part of this Agreement; and WHEREAS, the Committee (as hereinafter defined), appointed to administer the Plan, has determined that it would be to the advantage and best interest of the Corporation and its stockholders to grant the Non-Qualified Options provided for herein to the Optionee as an incentive for increased efforts during his term of office with the Corporation or its Subsidiaries or Affiliates, and has advised the Corporation thereof and instructed the undersigned officers to issue said Options; NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto do hereby agree as follows: Article I DEFINITIONS Whenever the following terms are used in this Agreement, they shall have the meaning specified in the Plan or below unless the context clearly indicates to the contrary. SECTION 1.1 - AFFILIATE "Affiliate" shall mean, with respect to the Corporation, any corporation directly or indirectly controlling, controlled by, or under common control with, the Corporation or any other entity designated by the Board of Directors of the Corporation in which the Corporation or an Affiliate has an interest. 2 SECTION 1.2 - CAUSE "Cause" shall mean, except if such term or similar term is defined in an employment agreement between the Corporation and the Optionee, in which case the employment agreement definition shall apply in lieu of this Section 1.2, (a) the commission of an act of fraud or embezzlement (including the unauthorized disclosure of confidential or proprietary information of the Corporation or any of its subsidiaries which results in financial loss to the Corporation or any of its Affiliates), (b) the conviction of a felony, (c) willful misconduct as an employee of the Corporation or any of its Affiliates which is reasonably likely to result in material injury or financial loss to the Corporation or any of its Affiliates or (d) the willful failure to render services to the Corporation or any of its Affiliates in accordance with his employment which failure amounts to a material neglect of duties to the Corporation or any of its subsidiaries that is not corrected by the Optionee, to the satisfaction of the Corporation, in its sole discretion, within 30 days after the Corporation provides Optionee with written notice of its intention to terminate his employment for Cause by virtue of this section (d). Any voluntary termination of employment by the Optionee (i) within 40 days after having received the written notice provided in section (d) or (ii) after the Corporation first has reason to believe that the Optionee has committed a felony and before any final judicial determination regarding such felony, shall be deemed to be a termination of Optionee's employment by the Corporation for Cause. SECTION 1.3 - CODE "Code" shall mean the Internal Revenue Code of 1986, as amended. SECTION 1.4 - COMMITTEE "Committee" shall mean the Compensation Committee of the Corporation. SECTION 1.5 - COMMON STOCK "Common Stock" shall mean the Corporation's common stock, par value $.0l per share. SECTION 1.6 - COST "Cost" shall mean the exercise price per share paid to exercise the option, as adjusted for stock splits, subdivisions, combinations, Common Stock dividends and similar transactions. SECTION 1.7 - GRANT DATE "Grant Date" shall mean the date on which the Options provided for in this Agreement were granted or, if earlier, the date the Optionee's employment with the Company or any Affiliate began, but in no event earlier than January 1, 1995. 3 SECTION 1.8 - MANAGER STOCKHOLDER'S AGREEMENT "Manager Stockholder's Agreement" shall mean a Manager Stockholder's Agreement substantially in the form annexed hereto as Exhibit A. SECTION 1.9 - OPTIONS "Options" shall mean the non-qualified options to purchase Common Stock granted under this Agreement. SECTION 1.10 - OPTION SHARES "Option Shares" shall mean any Common Stock issuable or issued by the Company upon exercise of any Option, as adjusted as a result of any stock dividend, stock split, merger, consolidation, reorganization or other recapitalization. SECTION 1.11 - PERMANENT DISABILITY The Optionee shall be deemed to have a "Permanent Disability" if the Optionee is unable to engage in the activities required by the Optionee's job by reason of any medically determined physical or mental impairment which has lasted for a continuous period of not less than 12 months. SECTION 1.12 - PLAN "Plan" shall mean the 1998 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates, as amended from time to time. SECTION 1.13 - PRONOUNS The masculine pronoun shall include the feminine and neuter, and the singular the plural, where the context so indicates. SECTION 1.14 - PUBLIC OFFERING "Public Offering" shall mean a sale of shares of the Corporation's common stock to the public pursuant to a registration statement under the Securities Act of 1933, as amended, that has been declared effective by the Securities and Exchange Commission (other than a registration statement on Form S-4 or Form S-8, or any successor or other forms promulgated for similar purposes, or a registration statement in connection with an offering to employees of the Corporation and its Affiliates). SECTION 1.15 - QUALIFIED PUBLIC OFFERING "Qualified Public Offering" shall mean the first offer for sale of Common Stock, in any single transaction or series of related transactions, pursuant to an effective registration statement filed by the Company under the Securities Act of 1933, as amended, in which the Company receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000, provided that, the price per share at which such shares are sold in the offering (before deduction of underwriting discounts and expenses of sale) is at least four (4) times the Conversion Price of the Company's Series A Convertible Preferred Stock (it being acknowledged that, as of May 31, 1998, such Conversion Price was $20.63 per share) which would then be in effect if determined pursuant to the terms of the Series A Convertible Preferred Stock in effect (whether or not any shares of such stock are then outstanding). 4 SECTION 1.16 - RETIREMENT "Retirement" shall mean the voluntary termination of employment by the Optionee after the later of (i) having been employed by the Corporation for a period of 5 years following the Grant Date or by an Affiliate for a period of 5 years from the later of (a) January 1, 1995 or (b) the date Optionee first rendered service to the Affiliate and (ii) the date on which the sum of (a) the Optionee's years of service (calculated as in (i) above) and (b) the Optionee's age, equals or exceeds 65, unless the Committee shall have provided, prior to the Grant Date or thereafter, that some other lesser age, period of service, combination thereof or other terms or conditions shall constitute "Retirement". SECTION 1.17 - SECRETARY "Secretary" shall mean the Secretary of the Corporation. SECTION 1.18 - SUBSIDIARY "Subsidiary" shall mean any corporation in an unbroken chain of corporations beginning with the Corporation if each of the corporations, or group of commonly controlled corporations (other than the last corporation in the unbroken chain), then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. ARTICLE II GRANT OF OPTIONS SECTION 2.1 - GRANT OF OPTIONS For good and valuable consideration, on and as of the date hereof the Corporation irrevocably grants to the Optionee an Option to purchase any part or all of an aggregate of the number of shares set forth with respect to each such Option on the signature page hereof of its $.0l par value Common Stock upon the terms and conditions set forth in this Agreement. SECTION 2.2 - EXERCISE PRICE Subject to Section 2.4, the exercise price of the shares of stock covered by the Options shall be at the price per share, without commission or other charge, as follows: - shares (representing 60 percent of the shares hereunder) shall be at $20 - shares (representing 20 percent of the shares hereunder) shall be at $30 - shares (representing 20 percent of the shares hereunder) shall be at $40 5 SECTION 2.3 - CONSIDERATION TO THE CORPORATION In consideration of the granting of these Options by the Corporation, the Optionee agrees to render faithful and efficient services to the Corporation or a Subsidiary or Affiliate, with such duties and responsibilities as the Corporation shall from time to time prescribe but subject to the employment agreement, if any, between the Company and the Optionee. Nothing in this Agreement or in the Plan shall confer upon the Optionee any right to continue in the employ of the Corporation or any Subsidiary or Affiliate or shall interfere with or restrict in any way the rights of the Corporation and its Subsidiaries or Affiliates, which are hereby expressly reserved, to terminate the employment of the Optionee at any time for any reason whatsoever, with or without cause. Notwithstanding the foregoing, any termination shall be subject to the employment agreement, if any, between the Company and the Optionee. SECTION 2.4 - ADJUSTMENTS IN OPTIONS PURSUANT TO MERGER, CONSOLIDATION, ETC. Subject to Section 9 of the Plan, in the event that the outstanding shares of the stock subject to an Option are, from time to time, changed into or exchanged for a different number or kind of shares of the Corporation or other securities of the Corporation by reason of a merger, consolidation, recapitalization, Change of Control, reclassification, stock split, stock dividend, combination of shares, or otherwise, the Committee shall make an appropriate and equitable adjustment in the number and kind of shares and/or the amount of consideration as to which or for which, as the case may be, such Option, or portions thereof then unexercised, shall be exercisable. Any such adjustment made by the Committee shall be final and binding upon the Optionee, the Corporation and all other interested persons. Article III PERIOD OF EXERCISABILITY SECTION 3.1 - COMMENCEMENT OF EXERCISABILITY (a) The Option shall become exercisable as to 10% of the shares subject to the Option on the sixth month anniversary of the Grant Date and shall become exercisable as to an additional 10% of the shares upon each six month anniversary thereafter; provided, however, that subject to the foregoing schedule, the portion of the Option which shall first become exercisable shall be those shares exercisable at $20 per share; thereafter, commencing in the fourth year after grant, the shares with an exercise price of $30 per share shall become exercisable and, commencing in the fifth year after grant, the shares with an exercise price of $40 per share shall become exercisable. (b) Notwithstanding any other provision of this Agreement, no Option shall become exercisable as to any additional shares of Common Stock following the termination of employment of the Optionee for any reason and any Option or portion thereof which is not exercisable as of the Optionee's termination of employment shall be immediately cancelled. 6 SECTION 3.2 - ACCELERATION OF EXERCISABILITY The exercisability of the Option shall be accelerated as follows: (a) In the event of a Qualified Public Offering, the 10% of the shares subject to the Option which would have become exercisable at the next six month anniversary of the Grant Date shall become immediately exercisable. The remaining portion of the shares subject to the Option shall continue to become exercisable as to each 10% of the shares subject to the Option, following the Qualified Public Offering, upon each six month anniversary of the Grant Date so that the final unvested 10% of the shares subject to the Option shall become exercisable six months earlier than originally scheduled. (b) The Option shall become exercisable immediately following a Change of Control as to the greater of (i) 25% of the shares subject to the Option as of the Grant Date or (ii) 50% of the unvested shares subject to the Option, but only to the extent such Option has not otherwise terminated (75% of the unvested shares if the sale price per share is between $60 - $79.99 and 100% of the unvested shares if the sale price per share is $80 or greater) (in either (i) or (ii), starting with the shares with the lowest exercise price). The remaining Options shall continue to vest in accordance with the terms of this Agreement and the Plan. SECTION 3.3 - EXPIRATION OF OPTIONS The Options may not be exercised to any extent by the Optionee after the first to occur of the following events: (a) The tenth anniversary of the Grant Date; or (b) The first anniversary of the date of the Optionee's termination of employment by reason of death, Permanent Disability or Retirement; or (c) The first business day which is fifteen calendar days after the earlier of (i) 75 days after termination of employment of the Optionee for any reason other than for death, Permanent Disability, Retirement or Cause or (ii) the delivery of notice by the Corporation, after termination of Optionee's employment, that it does not intend to exercise its call right pursuant to Section 5.3; or (d) The date the Option is terminated pursuant to the Manager Stockholder's Agreement; (e) The date of an Optionee's termination of employment by the Corporation for Cause; or (f) If the Committee so determines pursuant to Section 9 of the Plan, the effective date of either the merger or consolidation of the Corporation into another Person, a Change of Control, or the recapitalization, reclassification, liquidation or dissolution of the Corporation. At least ten (10) days prior to the effective date of such merger, consolidation, exchange, acquisition, recapitalization, reclassification, liquidation or dissolution, the Committee shall give the Optionee notice, in writing, of such event if the Option has then neither been fully exercised nor become unexercisable under this Section 3.2. 7 ARTICLE IV EXERCISE OF OPTIONS SECTION 4.1 - PERSON ELIGIBLE TO EXERCISE During the lifetime of the Optionee, only he may exercise an Option or any portion thereof. After the death of the Optionee, any exercisable portion of an Option may, prior to the time when an Option becomes unexercisable under Section 3.3, be exercised by his personal representative or by any person empowered to do so under the Optionee's will or under the then applicable laws of descent and distribution. SECTION 4.2 - PARTIAL EXERCISE AND PERIODS OF UNEXERCISABILITY Any exercisable portion of an Option or the entire Option, if then wholly exercisable, may be exercised in whole or in part at any time, or from time to time, prior to the time when the Option or portion thereof becomes unexercisable under Section 3.3; provided, however, that any partial exercise shall be for whole shares of Common Stock only; provided, further, that notwithstanding any other provision of this Agreement, no Option shall be exercisable during: a) the 40 day period commencing on the date the Corporation provides written notice to the Optionee that it intends to terminate Optionee's employment pursuant to provision (d) of the definition of Cause if the Optionee does not cure; or b) the period between the time the Corporation first has reasonable cause to believe that Optionee has committed a felony and any final judicial determination regarding such felony. SECTION 4.3 - MANNER OF EXERCISE An Option, or any exercisable portion thereof, may be exercised solely by delivering to the Secretary or his office all of the following prior to the time when the Option or such portion becomes unexercisable under Section 3.3: (a) Notice in writing signed by the Optionee or the other person then entitled to exercise the Option or portion thereof, stating that the Option or portion thereof is thereby exercised, such notice complying with all applicable administrative rules established by the Committee. In the event such rules are materially modified by the Committee such Optionee shall be notified in writing; (b) Full payment (in cash, by check, unrestricted shares of the Company held for at least six months (but only following a Public Offering) or by a combination thereof) for the shares with respect to which such Option or portion thereof is exercised; (c) A bona fide written representation and agreement, in a form satisfactory to the Committee, signed by the Optionee or other person then entitled to exercise such Option or portion thereof, stating that the shares of stock are being acquired for his own account, for investment and without any present intention of distributing or reselling said shares or any of them except as may be permitted under the Securities Act of 1933, as amended (the "Act"), and then applicable rules and regulations thereunder, and that the Optionee or other person then entitled to exercise such Option or portion thereof will indemnify the Corporation against and hold it free and harmless from any loss, damage, expense or liability resulting to the Corporation if any sale or distribution of the shares by such person is contrary to the representation and agreement referred to above; provided, however, that the Committee may, in its discretion, take whatever additional actions it deems appropriate to ensure the observance and performance of such representation and agreement and to effect compliance with the Act and any other federal or state securities laws or regulations; 8 (d) Full payment to the Corporation of all amounts which, under federal, state or local law, it is required to withhold upon exercise of the Option; (e) An executed Manager Stockholder's Agreement, or appropriate proof that a Manager Stockholder's Agreement has been previously executed by the Optionee; and (f) In the event the Option or portion thereof shall be exercised pursuant to Section 4.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the option. Without limiting the generality of the foregoing, the Committee may require an opinion of counsel reasonably acceptable to it to the effect that any subsequent transfer of shares acquired on exercise of an Option does not violate the Act, and. may issue stop-transfer orders covering such shares, provided such stop-transfer orders remain in effect only so long as is required to Permit the Company to remain in compliance with the Act. Share certificates evidencing stock issued on exercise of this Option shall bear an appropriate legend referring to the provisions of subsection (c) above and the agreements herein. The written representation and agreement referred to in subsection (c) above shall, however, not be required if the shares to be issued pursuant to such exercise have been registered under the Act, and such registration is then effective in respect of such shares. In addition, after the occurrence of a Public Offering, the Corporation shall pay the interest expenses incurred by the Optionee in connection with any loan from a broker incurred by the Optionee in order to exercise his Option; provided, however, that the Corporation shall only reimburse the interest relating to such loan outstanding for a period not to exceed 5 business days. SECTION 4.4 - CONDITIONS TO ISSUANCE OF STOCK CERTIFICATES The shares of stock deliverable upon the exercise of an Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Corporation. Such shares shall be fully paid and nonassessable. The Corporation shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of an Option or portion thereof prior to fulfillment of all of the following conditions: (a) The obtaining of approval or other clearance from any state or federal governmental agency which the Committee shall, in its absolute discretion, determine to be necessary or advisable; and (b) The lapse of such reasonable period of time following the exercise of the Option as the Committee may from time to time establish for reasons of administrative convenience. SECTION 4.5 - RIGHTS AS STOCKHOLDER The holder of an Option shall not be, nor have any of the rights or privileges of, a stockholder of the Corporation in respect of any shares purchasable upon the exercise of the Option or any portion thereof unless and until certificates representing such shares shall have been issued or, upon the determination of a court of competent jurisdiction, should have been issued by the Corporation to such holder. 9 ARTICLE V MISCELLANEOUS SECTION 5.1 - ADMINISTRATION The Committee shall have the power, such power to be exercised reasonably, to interpret the Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan as are consistent therewith and herewith and to interpret or revoke any such rules. All such actions taken and all interpretations and determinations made by the Committee shall be final and binding upon the Optionee, the Corporation and all other interested persons. No member of the Committee shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or the Options. In its absolute discretion, the Board of Directors may at any time and from time to time exercise any and all rights and duties of the Committee under the Plan and this Agreement. SECTION 5.2 - OPTIONS NOT TRANSFERABLE Except as provided in the Manager Stockholder's Agreement, neither the Options nor any interest or right therein or part thereof shall be liable for the debts, contracts or engagements of the Optionee or his successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted disposition thereof shall be null and void and of no effect; provided, however, that this Section 5.2 shall not prevent transfers by will or by the applicable laws of descent and distribution. SECTION 5.3 - CORPORATION'S OPTION TO PURCHASE UPON TERMINATION OF EMPLOYMENT (a) Upon any termination of Optionee's employment, the Corporation shall have the right for 75 days following the date of such termination to give notice to the Optionee and the Optionee shall be required to sell, on one occasion, within 60 days of the receipt of such notice, a specified portion of the Option and Option Shares then held by the Optionee at a specified price as follows: (i) If the Optionee is terminated without Cause or due to death, Permanent Disability or Retirement, the Optionee shall be required to sell to the Company 50% of the Option and Option Shares then held by the Optionee at a price equal to: (A) with respect to Option being sold to the Company, the excess of (a) the Fair Market Value, at the time of the termination of Optionee's employment, of the shares to be received upon exercise of the Option (not including any shares as to which the Option was not exercisable) over (b) the aggregate exercise price for those shares; and (B) with respect to the Option Shares being sold to the Company, the Fair Market Value of the shares, at the time of the termination of Optionee's employment; (ii) If the Optionee voluntarily terminates employment, the Optionee shall be required to sell to the Company all the Option and Option Shares then held by the Optionee at a price equal to: (A) with respect to Option being sold to the Company, the excess of (a) the Fair Market Value, at the time of the termination of Optionee's employment, of the shares to be received upon exercise of the Option (not including any shares as to which the Option was not exercisable) over (b) the aggregate exercise price for those shares; and 10 (B) with respect to the Option Shares being sold to the Company, the Fair Market Value of the shares, at the time of the termination of Optionee's employment; (iii) If the Optionee is terminated by the Company for Cause, the Optionee shall be required to sell to the Company all or any portion of the Option Shares then held by the Optionee at a price equal to the lesser of Cost or Fair Market Value. (b) If the Company exercises its right under (a) above, the Optionee shall receive payments for such Option and/or Option Shares as follows: (i) If the Optionee is terminated without Cause or due to death, Permanent Disability or Retirement, the Optionee shall receive payment in cash; provided, however' that if the Company cannot make such payment in cash, the Company's shareholders shall have the ability to exercise the rights specified in (a) above. (ii) If the Optionee is terminated for Cause, the Optionee shall receive, at the Company's discretion, payment in the form of cash or Company notes; any such Company notes will bear interest, payable semi-annually, at a rate of prime plus 1% per annum and shall mature on the later of (A) the fifth anniversary of the issuance thereof and (B) the earliest date permitted under the terms of any indebtedness of the Company or its subsidiaries outstanding at the time of such issuance. (iii) If the Optionee voluntarily terminates employment, the Optionee shall receive, at the Company's discretion, payment in the form of cash or 50% in the form of cash and 50% in the form of Company notes; any such Company notes will bear interest, payable semi-annually, at a rate of prime plus 1% per annum and shall mature on the later of (A) the fifth anniversary thereof and (B) the earliest date permitted under the terms of any indebtedness of the Company or its subsidiaries outstanding at the time of such issuance; i) PROVIDED, HOWEVER, that if the Optionee does not violate the noncompete provisions of the Manager Stockholder's Agreement, the note shall be paid, if earlier than the date specified in the immediately preceding clause of this paragraph (iii), at the conclusion of the Noncompete Period (including extensions) (as defined in the Manager Stockholder's Agreement). SECTION 5.4 - SHARES TO BE RESERVED The Corporation shall at all times during the term of the Options reserve and keep available such number of shares of stock as will be sufficient to satisfy the requirements of this Agreement. SECTION 5.5 - NOTICES Any notice to be given under the terms of this Agreement to the Corporation shall be addressed to the Corporation in care of its Secretary, and any notice to be given to the Optionee shall be addressed to him at the address given beneath his signature hereto. By a notice given pursuant to this Section 5.5, either party may hereafter designate a different address for notices to be given to him. Any notice which is required to be given to the Optionee shall, if the Optionee is then deceased, be given to the Optionee's personal representative if such representative has previously informed the Corporation of his status and address by written notice under this Section 5.5. Any notice shall have been deemed duly given three days after the date when enclosed in a properly seated envelope or wrapper addressed as aforesaid and sent via certified or registered mail, return receipt requested. SECTION 5.6 - TITLES Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of this Agreement. 11 SECTION 5.7 - APPLICABILITY OF PLAN AND MANAGER STOCKHOLDER'S AGREEMENT The Option and the shares of Common Stock issued to the Optionee upon exercise of the Options shall be subject to all of the terms and provisions of the Plan and the Manager Stockholder's Agreement, to the extent applicable to the Options and such shares. In the event of any conflict between this Agreement and the Plan, the terms of the Plan shall control. In the event of any conflict between this Agreement and the employment agreement, if any, between the Company and the Optionee, the terms of the employment agreement shall control; provided, that such employment agreement, and any amendments thereto, has been approved by the Committee. In the event of any conflict between this Agreement or the Plan and the Manager Stockholder's Agreement, the terms of the Manager Stockholder's Agreement shall control. SECTION 5.8 - AMENDMENT This Agreement may be amended only by a writing executed by the parties hereto which specifically states that it is amending this Agreement. SECTION 5.9 - GOVERNING LAW The laws of the State of New York shall govern the interpretation, validity and performance of the terms of this Agreement regardless of the law that might be applied under principles of conflicts of laws. SECTION 5.10 - JURISDICTION Any suit, action or proceeding against the Optionee with respect to this Agreement, or any judgment entered by any court in respect of any thereof, may be brought in any court of competent jurisdiction in the State of New York, and the Optionee hereby submits to the non-exclusive jurisdiction of such courts for the purpose of any such suit, action, proceeding or judgment. The Optionee hereby irrevocably waives any objections which he may now or hereafter have to the laying of the venue of any suit, action or proceeding arising out of or relating to this Agreement brought in any court of competent jurisdiction in the State of New York, and hereby further irrevocably waives any claim that any such suit, action or proceeding brought in any such court has been brought in any inconvenient forum. No suit, action or proceeding against the Corporation with respect to this Agreement may be brought in any court, domestic or foreign, or before any similar domestic or foreign authority other than in a court of competent jurisdiction in the State of New York, and the Optionee hereby irrevocably waives any right which he may otherwise have had to bring such an action in any other court, domestic or foreign, or before any similar domestic or foreign authority. The Corporation hereby submits to the jurisdiction of such courts for the purpose of any such suit, action or proceeding. SECTION 5.11 - CANCELLATION OF KMC TELECOM, INC. OPTIONS The Optionee hereby agrees, that in consideration of the Options granted hereunder, that any and all options granted to the Optionee pursuant to the 1996 Stock Purchase and Option Plan for Key Employees of KMC Telecom, Inc. and Affiliates shall become null and void and of no force or effect upon approval of the Plan by the stockholders of the Company. IN WITNESS WHEREOF, this Agreement has been executed and delivered by the parties hereto. KMC TELECOM HOLDINGS, INC. By ______________________________ Name: Title: 12 Aggregate number of shares of Common Stock for which the Option granted - - --------------------------------- hereunder is exercisable: Optionee - - --------------------------------- ------------------ - - --------------------------------- Address Optionee's Taxpayer Identification Number: - - -------------------- EXHIBIT A --------- MANAGER STOCKHOLDER'S AGREEMENT This Manager Stockholder's Agreement (this "Agreement") is entered into as of ____________ __, 199_ between KMC Telecom Holdings, Inc., a Delaware corporation (the "COMPANY") , (the "Manager"), Nassau Capital Partners L.P. ("Nassau Capital"), NAS Partners I L.L.C. ("NAS" and, together with Nassau Capital, "Nassau") and Harold N. Kamine ("HNK") RECITALS The Company has established the 1998 Stock Purchase and Option Plan for Key Employees of KMC Telecom Holdings, Inc. and Affiliates (the Option Plan"), providing for, among other things, the grant of options ("Options") to purchase Common Stock, par value $.01 per share, of the Company ("Common Stock"). Effective as of the date hereof, the Company is granting Options to the Manager, certain of which ("Replacement Options") are being granted in replacement of options ("Predecessor Options") to purchase Class C Common Stock, par value $.01 per share, of KMC Telecom, Inc. ("KMC"), a wholly owned subsidiary of the Company, heretofore granted to the Manager under the 1996 Stock Purchase and Option Plan of KMC Telecom, Inc. and Affiliates (the "Predecessor Plan") . The Company also is granting, or will grant, Options to certain other individuals who are or will be key employees or directors of, or persons having a unique relationship with, the Company or one of its affiliates (collectively, the "Other Managers") , each of whom is entering into, or will enter into, an agreement substantially in the form of this Agreement (the "Other Manager Agreements"). The Company is a party to an Amended and Restated Stockholders Agreement dated as of October 31, 1997 (as amended from time to time, the "Stockholders Agreement") with certain stockholders of the Company (such stockholders as are, from time to time, parties to the Stockholders Agreement being referred to collectively as the "Existing Stockholders"). The Company also is a party to a Warrant Registration Rights Agreement dated as of January 26, 1998 (as amended or supplemented from time to time, the "Registration Rights Agreement") with Morgan Stanley & Co. Incorporated, pursuant to which the Company has granted certain registration rights to the record holders of the warrants to purchase shares of Common Stock referred to therein (the "Warrants") and the holders of Stock (or other securities) received upon exercise thereof (the "Warrant Holders"). 2 The Company and the Manager wish to make provision for certain terms of ownership of Capital Stock (as herein defined) by the Manager as a result of the exercise of Options, Consistent with the Company's obligations under the Stockholders Agreement and the Registration Rights Agreement. Accordingly, the parties hereto agree as follows: 1. DEFINITIONS. As used herein, the following terms shall have the following meanings: "ACT" shall have the meaning ascribed to such term in section 2(a). "AFFILIATE" shall mean, with respect to the Company, any person or entity directly or indirectly controlling, controlled by, or under common control with, the Company, and/or any other person or entity designated by the Board of Directors of the Company in which the Company or an Affiliate has an interest. "BUYOUT NOTICE" shall have the meaning ascribed to such term in Section 5. "CAPITAL STOCK" shall mean capital stock, share capital and/or other equity participations of the Company, including, without limitation, partnership interests, and/or conversion privileges, warrants, options and/or other rights to acquire such capital stock, share capital and/or other equity participations. "CAUSE" shall mean, except if such term or a similar term is defined in an employment agreement between the Company and the Manager, in which case such employment agreement definition shall apply in lieu of this definition, (a) the commission of an act of fraud or embezzlement (including the unauthorized disclosure of confidential or proprietary information of the Company or any of its subsidiaries which results in financial loss to the Company or any of its Affiliates), (b) the conviction of a felony, (c) willful misconduct as an employee of the Company or any of its Affiliates which is reasonably likely to result in material injury or financial loss to the Company or any of its Affiliates or (d) the willful failure to render services to the Company or any of its Affiliates in accordance with the Manager's employment which failure amounts to a material neglect of duties to the Company or any of its Affiliates that is not corrected by the Manager, to the satisfaction of the Company, in its sole discretion, within 30 days after the Company provides the manager with written notice of its intention to terminate the Manager's employment for Cause by virtue of this clause (d). Any voluntary termination of employment by the Manager (i) within 40 days after having received the written notice provided in clause (d) above or (ii) after the Company first has reason to believe that the Manager has committed a felony and before any final judicial determination regarding such felony shall be deemed to be a termination of the Manager's employment by the Company for Cause. 3 "COMMON STOCK" shall have the meaning ascribed to such term in the Recitals of this Agreement. "COMMON STOCK EQUIVALENTS" means any security or obligation which is by its terms convertible into shares of Common Stock and any option, warrant or other subscription or purchase right with respect to Common Stock. "COMPANY" shall have the meaning ascribed to such term in the introductory paragraph of this Agreement. "CUSTODY AGREEMENT AND POWER OF ATTORNEY" shall have the meaning ascribed to such term in Section 9. "DEFAULT" shall mean an event of default or an event that, with notice or lapse of time or both, would become an event of default under any indebtedness for borrowed money of the Company or any of its subsidiaries. "EXCHANGE ACT" shall have the meaning ascribed to such term in Section 8 (b). "EXISTING STOCKHOLDERS" shall have the meaning ascribed to such term in the Recitals of this Agreement. "FULLY DILUTED" or "FULLY DILUTED BASIS" shall mean, at any date as of which the number of shares of Common Stock is to be determined, such number of shares determined on a basis that includes all shares of Common Stock outstanding at such date and the maximum shares of Common Stock issuable in respect of Common Stock Equivalents (giving effect to the then current respective conversion prices) and other rights to purchase (directly or indirectly) shares of Common Stock or Common Stock Equivalents, outstanding on such date, whether or not such rights to convert, exchange or exercise thereunder are presently exercisable. "GRANT DATE" shall mean the date that Options were granted to the Manager or, if earlier, the date the Manager's employment with the Company or any of its Affiliates began, but in no event earlier than January 1, 1995. "HNK" shall have the meaning ascribed to such term in the introductory paragraph of this Agreement. "KMC" shall have the meaning ascribed to such term in the Recitals of this Agreement. 4 "MANAGEMENT GROUP" shall mean the Manager and the Other Managers. "MANAGER" shall have the meaning ascribed to such term in the introductory paragraph of this Agreement. "MANAGER AGREEMENTS" shall mean this Agreement and the other Manager Agreements. "MANAGER'S ESTATE" shall have the meaning ascribed to such term in Section 2. "NAS" shall have the meaning ascribed to such term in the introductory paragraph of this Agreement. "NASSAU" shall have the meaning ascribed to such term in the introductory paragraph of this Agreement. "NASSAU CAPITAL" shall have the meaning ascribed to such term in the introductory paragraph of this Agreement. "NONCOMPETE EXTENSION PERIOD" shall have the meaning ascribed to such term in Section 23. "NONCOMPETE PERIOD" shall have the meaning ascribed to such term in Section 23. "OPTION PLAN" shall have the meaning ascribed to such term in the Recitals of this Agreement. "OPTIONS" shall have the meaning ascribed to such term in the Recitals of this Agreement. "OTHER MANAGER AGREEMENTS" shall have the meaning ascribed to such term in the Recitals of this Agreement. "OTHER MANAGERS" shall have the meaning ascribed to such term in the Recitals of this Agreement. "PREDECESSOR OPTIONS" shall have the meaning ascribed to such term in the Recitals of this Agreement. "PREDECESSOR PLAN" shall have the meaning ascribed to such term in the Recitals of this Agreement. "PRIME RATE" shall mean the prime rate of interest as indicated, from time to time, in the Money Tables section of THE WALL STREET JOURNAL. "PRINCIPAL BUSINESS ACTIVITIES" shall have the meaning ascribed to such term in Section 23. 5 "PRINCIPAL HOLDERS" shall mean, collectively, Nassau and HNK (to the extent participating in a transaction described in Section 4). "PUBLIC OFFERING" shall mean an offer for sale of Common Stock pursuant to an effective registration statement filed under the Act. "QUALIFIED PUBLIC OFFERING" shall mean the first offer for sale of Common Stock, in any single transaction or series of related transactions, pursuant to an effective registration statement filed by the Company under the 1933 Act in which the Company receives aggregate gross proceeds (before deduction of underwriting discounts and expenses of sale) of at least $40,000,000, provided that, the price per share at which such shares are sold in the offering (before deduction of underwriting discounts and expenses of sale) is at least four (4) times the Conversion Price of the Company's Series A Convertible Preferred Stock which would then be in effect if determined pursuant to the terms of the Series A Convertible Preferred Stock in effect as of October 31, 1997, whether or not any shares of such stock are then outstanding (it being acknowledged that, as of May 31., 1998, such Conversion Price was $20.63 per share). "REGISTRABLE MANAGEMENT SECURITIES" shall mean (i) Common Stock comprising any portion of the Stock; (ii) any Common Stock owned by the Other Managers; and (iii) any shares of Capital Stock of the Company issued or issuable with respect to the Common Stock referred to in clauses (i) and (ii) by way of a stock dividend or stock split or in connection with a combination of shares, recapitalization, merger, consolidation or other reorganization. As to any particular Registrable Management Securities, once issued such securities shall cease to be Registrable Management Securities when (i) such securities shall have been registered under the Act and the registration statement with respect to the sale of such securities shall have become effective under the Act and such securities sold thereunder or such securities shall have been sold under circumstances in which all applicable conditions of Rule 144 (or any similar provision then in force) under the Act are met or may be sold pursuant to Rule 144(k), (ii) such securities shall have been otherwise transferred, new certificates for them not bearing a legend restricting further transfer shall have been delivered by the Company and subsequent disposition of such securities shall not require registration or qualification of such securities under the Act or state securities or blue sky laws then in force in a preponderance of states or (iii) such securities shall cease to be outstanding. "RETIREMENT" shall mean the voluntary termination of employment by the Manager after the later of (i) having been employed by the Company for a period of 5 years following the Grant Date or by an Affiliate for a period of 5 years from the later of (a) January 1, 1995 or (b) the date the Manager first rendered service to the Affiliate and (ii) the date on which the sum of (a) the Manager's years of service (calculated as in (i) above) and (b) the Manager's age, equals or exceeds 65, unless the Compensation Committee of the Board of Directors of the Company shall have provided, prior to the Grant Date or thereafter, that some other lesser age, period of service, combination thereof or other terms or conditions shall constitute "Retirement". 6 "SEC" shall have the meaning ascribed to such term in Section 8(b). "RULE 144" shall have the meaning ascribed to such term in Section 2(c). "SERIES A CONVERTIBLE PREFERRED STOCK" shall mean the Company's Series A Cumulative Convertible Preferred Stock, par value $.01 per share. "STOCK" shall mean all Capital Stock now owned or hereafter acquired by the Manager pursuant to any Option. "STOCKHOLDERS AGREEMENT" shall have the meaning ascribed to such term in the Recitals of this Agreement. "SUBJECT MATTER" shall have the meaning ascribed to such term in Section 23. "TAG-ALONG NOTICE" shall have the meaning ascribed to such term in Section 4. "TAG-ALONG PURCHASER" shall have the meaning ascribed to such term in Section 4. "TAG-ALONG SHARES" shall have the meaning ascribed to such term in Section 4. "THIRD PARTY PURCHASER" shall have the meaning ascribed to such term in Section 5. 2. MANAGER'S REPRESENTATIONS, WARRANTIES AND AGREEMENTS. (a) Unless the shares of Common Stock to be acquired upon the exercise of the Options are then registered under the Act (as hereinafter defined): the manager hereby represents and warrants that the Manager will be acquiring, at the time of exercise (or other acquisition), the Common Stock issuable upon exercise of the Options (and any other Stock acquired from time .to time by the Manager) for investment for the Manager's own account and not with a view to, or for resale in connection with, the distribution or other disposition thereof. The Manager agrees and acknowledges that the Manager will not, directly or indirectly, offer, transfer, sell, assign, pledge, hypothecate or otherwise dispose of any shares of the Stock unless such transfer, sale, assignment, pledge, hypothecation or other disposition complies with this Agreement and all applicable provisions of state securities laws and (i) the transfer, sale, assignment, pledge, hypothecation or other disposition is pursuant to an effective registration statement under the Securities Act of 1933, as amended, and the rules and regulations in effect thereunder (the "Act") or (ii) (A) counsel for the manager (which may be the Company's counsel) shall have furnished the Company with an opinion, reasonably satisfactory in form and substance to the Company, that no such registration is required because of the availability of an exemption from registration under the Act and (B) if the Manager is a citizen or resident of any country other than the United States, or the Manager desires to effect any such transaction in any such country, counsel for the Manager (which may be the Company's counsel) shall have furnished the 7 Company with an opinion, reasonably satisfactory in form and substance to the Company, that such transaction will not violate the laws of such country. Notwithstanding the foregoing, the Company acknowledges and agrees that any of the following transfers are deemed to be in compliance with the Act and this Agreement and no opinion of counsel is required in connection therewith: (x) a transfer made pursuant to Section 4, 5 or 6 hereof; (y) a transfer upon the death of the Manager to the Manager's executors, administrators, testamentary trustees, legatees or beneficiaries (the "Manager's Estate") or a transfer to the executors, administrators, testamentary trustees, legatees or beneficiaries of a person who has become a holder of Stock in accordance with the terms of this Agreement, provided that prior to any such transfer the transferee agrees in a writing reasonably satisfactory to the Company to be bound by the provisions of this Agreement to the same extent as if such transferee were the Manager; and (z) a transfer made in compliance with the federal securities laws to a trust or custodianship the beneficiaries of which may include only the Manager, the Manager's spouse and/or the Manager's lineal descendants (a "Manager's Trust"). (b) The certificate (or certificates) representing the Stock shall bear the following legend: "THE SHARES REPRESENTED BY THIS CERTIFICATE MAY NOT BE TRANSFERRED, SOLD, ASSIGNED, PLEDGED, HYPOTHECATED OR OTHERWISE DISPOSED OF UNLESS SUCH TRANSFER, SALE, ASSIGNMENT, PLEDGE, HYPOTHECATION OR OTHER DISPOSITION COMPLIES WITH THE PROVISIONS OF THE MANAGER STOCKHOLDER'S AGREEMENT DATED AS OF _____________ ____, 199__ BETWEEN KMC TELECOM HOLDINGS, INC. ("THE COMPANY") AND __________________________ (A COPY OF WHICH IS ON FILE WITH THE SECRETARY OF THE COMPANY). EXCEPT AS OTHERWISE PROVIDED IN SUCH AGREEMENT, NO TRANSFER, SALE, ASSIGNMENT, PLEDGE, HYPOTHECATION OR OTHER DISPOSITION OF THE SHARES REPRESENTED BY THIS CERTIFICATE MAY BE MADE EXCEPT IN COMPLIANCE WITH ALL APPLICABLE PROVISIONS OF STATE SECURITIES LAWS AND (A) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND THE RULES AND REGULATIONS IN EFFECT THEREUNDER (THE "ACT") OR (B) IF (I) THE COMPANY HAS BEEN FURNISHED WITH A SATISFACTORY OPINION OF COUNSEL FOR THE HOLDER ACCEPTABLE TO THE COMPANY THAT SUCH TRANSFER, SALE, ASSIGNMENT, PLEDGE, HYPOTHECATION OR OTHER DISPOSITION IS EXEMPT FROM THE PROVISIONS OF SECTION 5 OF THE ACT AND (II) IF THE HOLDER IS A CITIZEN OR RESIDENT OF ANY COUNTRY OTHER THAN THE UNITED STATES, OR THE HOLDER DESIRES TO EFFECT ANY SUCH TRANSACTION IN ANY SUCH COUNTRY, THE COMPANY HAS BEEN FURNISHED WITH A SATISFACTORY OPINION OF COUNSEL FOR THE HOLDER ACCEPTABLE TO THE COMPANY THAT SUCH TRANSACTION WILL NOT VIOLATE THE LAWS OF SUCH COUNTRY." 8 (c) Unless the Stock is then registered under the Act, the Manager acknowledges that the Manager has been advised that (i) the Stock has not been registered under the Act, (ii) the Stock must be held indefinitely and the Manager must continue to bear the economic risk of the investment in the Stock unless the Stock is subsequently registered under the Act or an exemption from such registration is available and the Stock is disposed of in accordance with this Agreement, (iii) it is not anticipated that there will be any public market for the Stock, (iv) Rule 144 promulgated under the Act ("Rule 144") is not currently available with respect to the sales of any securities of the Company, and the Company has made no covenant to make such Rule available, (v) when and if shares of the Stock may be disposed of without registration in reliance on Rule 144, such disposition can be made only in limited amounts in accordance with the terms and conditions of such Rule, (vi) if the Rule 144 exemption is not available, public sale without registration will require compliance with Regulation A or some other exemption under the Act, (vii) a restrictive legend in the form heretofore set forth shall be placed on the certificates representing the Stock and (viii) a notation shall be made in the appropriate records of the Company indicating that the Stock is subject to restriction on transfer and, if the Company should at some time in the future engage the services of a stock transfer agent, appropriate stop transfer restrictions will be issued to such transfer agent with respect to the Stock. (d) If any shares of the Stock are to be disposed of in accordance with an exemption from registration under the Act (other than pursuant to Rule 144), the Manager shall promptly notify the Company of such intended disposition and shall deliver to the company at or prior to the time of such disposition such documentation as the Company may reasonably request in connection with such sale and, in the case of a disposition pursuant to Rule 144, shall deliver to the Company an executed copy of any notice on Form 144 required to be filed with the Securities and Exchange Commission. (e) The Manager agrees that, if any shares of Capital Stock are offered to the public pursuant to an effective registration statement under the Act, the Manager will not effect any public sale or distribution of any shares of Stock not covered by such registration statement during any period (i) required by the managing underwriter and (ii) agreed to by the Existing Stockholders with respect to their shares of Capital Stock. (f) The Manager represents and warrants that the Manager has received and reviewed a copy of the Company's Prospectus dated July 13, 1998; the Manager further represents and warrants that the Manager has been given the opportunity to obtain any information or documents and to ask questions and receive answers about such documents, the Company and the business and prospects of the Company which the Manager deems necessary to evaluate the merits and risks related to the Manager's investment in the Stock and to verify the information received as indicated in this Section 2(f), and the Manager has relied solely on such information. 9 (g) The Manager further represents and warrants that (i) the Manager's financial condition is such that the Manager can afford to bear the economic risk of holding the Stock for an indefinite period of time and has adequate means for providing for the Manager's current needs and personal contingencies, (ii) the Manager can afford to suffer a complete loss of the Manager's investment in the Stock, (iii) all information which the manager has provided to the Company concerning the Manager and the Manager's financial position is correct and complete as of the date of this Agreement, (iv) the Manager understands and has taken cognizance of all risk factors related to the purchase of the Stock, and (v) the Manager's knowledge and experience in financial and business matters are such that the Manager is capable of evaluating the merits and risks of the Manager's purchase of the Stock as contemplated by this Agreement. 3. RESTRICTION ON TRANSFER. The Manager agrees that sell, assign, pledge, hypothecate options. The Manager agrees that sell, assign, pledge, hypothecate shares of Stock at any time prior the Manager will not transfer, or otherwise dispose of any the Manager will not transfer, or otherwise dispose of any to registration of the sale of such shares of Stock, except for: (a) transfers permitted by clauses (x) , (y) and (z) of Section 2 (a); (b) a sale of shares of Capital Stock pursuant to an effective registration statement under the Act filed by the Company; and (c) a sale of shares of Stock pursuant to Rule 144 (if then available) following the lapse of the Company's right to purchase such shares of Stock under the circumstances referred to in Section 6. No transfer of any such shares in violation hereof shall be made or recorded on the books of the Company and any such transfer shall be void and of no effect. 4. TAG-ALONG RIGHT. (a) If the Principal Holders intend to transfer (in a transaction in which each of the Principal Holders that then owns Capital Stock is participating) to any third party (the "TAG-ALONG PURCHASER") , in one transaction or a series of related transactions (excluding securities offerings registered under the Act) , shares of Capital Stock constituting, in the aggregate, more than 20% of the total number of shares of Common Stock then outstanding on a Fully Diluted Basis (in the first instance of such a transfer) , then the Principal Holders shall permit each member of the Management Group, at such member's option, to transfer, for the same consideration, and on the same terms and conditions, if any, upon which the Principal Holders intend to transfer such shares, a number of shares of Common Stock (including shares subject to then exercisable Options and Options that will become exercisable as a result of such transaction or series of transactions) then owned by such member of the Management Group determined in accordance with this Section 4(a) (the "INITIAL TAG-ALONG SHARES") . Each member of the Management Group shall have the right, pursuant to this Section 4(a), to sell pursuant to the offer by the Tag-Along Purchaser, a percentage of the shares of Common Stock (including shares subject to then exercisable options) held by such member equal to the Applicable Percentage. 10 (b) For purposes hereof, the "APPLICABLE PERCENTAGE" shall be determined as follows: (i) if such transaction or series of related transactions constitutes the first instance in which the rights under Section 4(a) apply, the Applicable Percentage shall be equal to the percentage of the holdings of Capital Stock (on a Fully Diluted Basis) being transferred in such transaction or series of related transactions by the Principal Holder transferring the smaller percentage of its aggregate holdings of Capital Stock (the "APPLICABLE HOLDER"); provided that the Applicable Percentage shall be zero if the number of shares proposed to be transferred in such transaction or series of related transactions by the Principal Holders in the aggregate (when combined with all prior transactions or series of transactions of a type to which Section 4(a) applies) is not greater than 20% of the total number of shares of Common Stock outstanding on a Fully Diluted Basis; (ii) if such transaction or series of related transactions does not constitute the first instance in which the rights under Section 4(a) apply, the Applicable Percentage shall be equal to the percentage of the holdings of Capital Stock (on a Fully Diluted Basis) being transferred in such transaction or series of related transactions by the Applicable Holder; provided that the Applicable Percentage shall be zero if the percentage of the moldings of Capital Stock (on a Fully Diluted Basis) being transferred in such transaction or series of related transactions by the Applicable Holder is not greater than five percent. (c) Not less than 15 Business Days prior to any proposed transfer pursuant to this Section 4, the Principal Holders shall deliver to each member of the Management Group written notice thereof (the "TAG-ALONG NOTICE") , which notice shall set forth the consideration to be paid by the Tag-Along Purchaser and the other terms and conditions, if any, of such transaction. If any member of the Management Group elects to transfer some or all of the Tag-Along Shares pursuant to this Section 4, then such member shall so notify the Principal Holders within 10 Business Days after the date of the Tag-Along Notice, and, at the Principal Holders' request not less than two Business Days prior to the proposed transfer, such member of the Management Group shall deliver to counsel to the Principal Holders, to be held in escrow, certificates representing such Tag-Along Shares (and/or other appropriate documentation to permit the exercise of Options), duly endorsed or with duly completed and executed stock powers attached, in proper form for transfer, together with a limited power-of-attorney authorizing the Principal Holders to transfer the Tag-Along Shares to the Tag-Along Purchaser (in accordance with the terms and conditions set forth in the Tag Along Notice) and to execute all other documents required to be executed in connection with such transaction. (d) If, within 90 Business Days after delivery by a member of the Management Group to the Principal Holders of the certificates and related documents described in paragraph (c) , no transfer of shares held by the Principal Holders and Tag-Along Shares in accordance with the provisions of this Section 4 shall have been completed, or if earlier the Principal Holders shall determine not to proceed with such transfer, then the Principal Holders' counsel shall promptly return to the members of the Management Group, in proper form, all certificates representing the Tag-Along Shares and the limited power-of-attorney previously delivered by the members of the Management Group to the Principal Holders. 11 (e) Concurrently with the consummation of the transfer of the Tag-Along Shares pursuant to this Section 4, the Principal Holders shall remit or cause to be remitted to each member of the Management Group the consideration with respect to the Tag-Along Shares so transferred and shall furnish such other evidence of the completion of such transfer and the terms and conditions (if any) thereof as may reasonably be requested by such member of the Management Group. (f) The provisions of this Section 4 shall remain in effect, notwithstanding any return to any member of the Management Group of Tag-Along Shares as provided herein. 5. BRING ALONG RIGHT. If the Company or one or more of the Existing Stockholders receives a bona fide offer from a person or persons not then an Affiliate or Affiliates (a "Third Party Purchaser") to purchase Capital Stock representing more than 50% of the total number of shares of Common Stock then outstanding on a Fully Diluted Basis, then the Company shall have the right to deliver a written notice (a "Buyout Notice") to the Manager which shall state (i) that the Company or such Existing Stockholders propose to effect such transaction, (ii) the proposed purchase price per share of Capital Stock to be paid by the Third Party Purchaser, and (iii) the name or names of the Third Party Purchaser, and which attaches a copy of all writings between the Company or such Existing Stockholders and the other parties to such transaction necessary to establish the terms of such transaction. The manager agrees that, upon receipt of a Buyout Notice, the Manager shall be obligated to sell a percentage of the Manager's shares of Stock equal to the Bring Along Percentage (as defined below) upon the terms and conditions of such transaction (and otherwise take all necessary action to cause consummation of the proposed transaction); PROVIDED, HOWEVER, that the Manager shall only be obligated as provided above in this Section 5 if (i) more than 50% of the total number of shares of Common Stock then outstanding on a Fully Diluted Basis actually is sold to the Third Party Purchaser pursuant to the terms contained in the Buyout Notice, (ii) the manager receives the same per share (or per share equivalent) consideration as such Existing Stockholders receive in the transaction and (iii) the consideration received by the Manager is in the form of cash or a combination of cash and securities that will become freely tradable in the public securities markets within 180 days of receipt of such consideration by the Manager. The Bring Along Percentage shall be the percentage of the total number of shares of Common Stock outstanding on a Fully Diluted Basis that is actually sold to the Third Party Purchaser pursuant to the terms contained in the Buyout Notice; provided that if, after giving effect to such sale, the Existing Stockholders would own not more than twenty percent of the fully-diluted common equity interests in the Company, the Bring Along Percentage shall be one hundred percent. 6. THE COMPANY'S OPTION TO REPURCHASE CAPITAL STOCK AND OPTIONS OF MANAGER. If the Manager's active employment with the Company and its affiliates is terminated for any reason whatsoever, the Company shall have the right to purchase shares of Stock then held by the Manager, the manager's Estate or a Manager's Trust, and make provision with respect to the termination or cancellation of all Options and payments in respect thereof, all as provided in accordance with the terms of the Option Plan and any option agreements executed and delivered thereunder. 7. CANCELLATION OF PREDECESSOR OPTIONS. In further consideration of the transactions contemplated hereby (including, without limitation, the grant of the options) the Manager hereby agrees that all of the Manager's Predecessor options (together with any right, title or interest of the Manager in or to any other grant or award under the Predecessor Plan) shall be automatically cancelled and of no further force or effect, without further action by any party hereto, at such time as the Option Plan, the initial grant of options to the Manager and this Agreement are duly approved by the affirmative vote of holders of Capital Stock then entitled to cast a majority of the votes entitled to be cast by all holders of Capital Stock then outstanding. 12 8. THE COMPANY'S REPRESENTATIONS, WARRANTIES AND AGREEMENTS. (a) The Company represents and warrants to the Manager that this Agreement has been duly authorized, executed and delivered by the Company. (b) After the Company consummates an initial Public offering, (i) the Company shall diligently use reasonable efforts to register the options and the Common Stock to be acquired on exercise thereof on a Form S-8 Registration Statement or any successor to Form S-8 to the extent that such registration is then available with respect to such Options and Common Stock and (ii) the Company will file the reports required to be filed by it under the Act and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations adopted by the securities and Exchange Commission ("SEC") thereunder, to the extent required from time to time to enable the Manager to sell shares of Common Stock without registration under the Act within the limitations of the exemptions provided by (A) Rule 144 under the Act, as such Rule may be amended from time to time, or (B) any similar rule or regulation hereafter adopted by the SEC. Notwithstanding anything contained in this Section 9(b), the Company may deregister under Section 12 of the Exchange Act if it is then permitted to do so pursuant to the Exchange Act and the rules and regulations thereunder. Nothing in this Section 8(b) shall be deemed to limit in any manner the restrictions on sales of Stock contained in this Agreement. 9. "PIGGYBACK" REGISTRATION RIGHTS. (a) Whenever the Company proposes to register any of its equity securities (including, without limitation, the Common Stock) under the Act (other than pursuant to a registration statement on Form S-8 or S-4 or any successor forms), and the form used may be used for the registration of Registrable Management Securities (a "Piggyback Registration"), the Company will give prompt written notice to all members of the Management Group holding Registrable Management Securities of its intent to effect such registration and (subject to the further provisions of this Section 9) will include in such registration all Registrable Management Securities with respect to which the Company has received requests for inclusion therein within 20 days after receipt of the Company's notice. (b) The Registration Expenses (as defined in the Stockholders Agreement) of the holders of Registrable Management Securities will be paid by the Company in all Piggyback Registrations. (c) If a Piggyback Registration is an underwritten primary registration on behalf of the Company, the Company will include in such registration all Registrable Management Securities requested to be included in such registration; provided, that if the managing underwriters advise the Company in writing that in their opinion the number of securities requested to be included in such registration exceeds the number which can be sold in such offering without adversely affecting the marketability of the offering, the Company will include in such registration, in the following order of priority, (i) first, the securities the Company proposes to sell, (ii) second, to the extent so required by the provisions of the Stockholders Agreement, the registrable securities requested to be included in such registration by the Existing Stockholders, (iii) third, to the extent so required by the provisions of the Registration Rights Agreement, the registrable securities requested to be included in such registration by the Warrant Holders, (iv) fourth, if such Public Offering is the initial Public offering, such additional registrable securities requested to be included in such registration by any Existing Stockholder as may be required (in the reasonable estimation of the managing underwriters) to assure that the net proceeds of sale of such registrable securities (when added to the net proceeds of sale of registrable securities subject to the priority set forth in clause (ii) above) are equal to the aggregate purchase price paid for all Capital Stock then owned by such Existing Stockholder, (v) fifth, the Registrable Management Securities requested to be included in such registration, the registrable securities requested to be included in such registration by the Existing Stockholders (to the extent not then subject to the priority set forth in clause (ii) or clause (iv) above) and the registrable securities requested to be included in such registration by the Warrant Holders (to the extent not then subject to the priority set forth in clause (iii) or clause (iv) above, pro rata among the holders of such securities on the basis of the number thereof owned by each holder and requested to be included therein and (vi) sixth, other securities, if any, requested to be included in such registration. 13 (d) If a Piggyback Registration is an underwritten secondary registration on behalf of the Company, the Company will include in such registration all Registrable Management Securities requested to be included in such registration; provided, that if the managing underwriters advise the Company in writing that in their opinion the number of securities requested to be included in such registration exceeds the number which can be sold in such offering without adversely affecting the marketability of the offering, the Company will include in such registration, in the following order of priority, (i) first, to the extent so required by the provisions of the Stockholders Agreement, the registrable securities requested to be included in such registration by the Existing Stockholders, (ii) second, to the extent so required by the provisions of the Registration Rights Agreement, the registrable securities requested to be included in such registration by the Warrant Holders, (iii) third, if such Public Offering is the initial Public offering, such additional registrable securities requested to be included in such registration by any Existing Stockholder as may be required (in the reasonable estimation of the managing underwriters) to assure that the net proceeds of sale of such registrable securities (when added to the net proceeds of sale of registrable securities subject to the priority set forth in clause (i) above) are equal to the aggregate purchase price paid for all Capital Stock then owned by such Existing Stockholder, (iv) fourth, the Registrable Management Securities requested to be included in such registration, the registrable securities requested to be included in such registration by the Existing Stockholders (to the extent not then subject to the priority set forth in clause (i) or clause (iii) above) and the registrable securities requested to be included in such registration by the Warrant Holders (to the extent not then subject to the priority set forth in clause (ii) or clause (iii) above, pro rata among the holders of such securities on the basis of the number thereof owned by each holder and requested to be included therein and (v) fifth, other securities, if any, requested to be included in such registration. (e) If any Piggyback Registration is an underwritten offering, the investment banker(s), underwriters) and manager(s) for the offering or distribution will be selected by the Company. (f) The Manager hereby agrees to be, and any Manager's Trust or Manager's Estate shall be, bound by all of the obligations applicable to Existing Stockholders under Section 6 of the Stockholders Agreement. (g) In connection with the exercise of the Manager's rights under this Section 9, the Manager will, if requested by the Company, execute and deliver a reasonable custody agreement and power of attorney with respect to the shares of Stock to be registered pursuant to this Section 9 a "Custody Agreement and Power of Attorney"). The Custody Agreement and Power of Attorney will provide, among other things, that the Manager will deliver to and deposit in custody with the custodian and attorney-in-fact named therein a certificate or certificates representing such shares of Stock (duly endorsed in blank by the registered owner or owners thereof or accompanied by duly executed stock powers in blank) and irrevocably appoint said custodian and attorney-in-fact as the Manager's agent and attorney-in-fact to act under the Custody Agreement and Power of Attorney on the manager's behalf with respect to the matters specified therein. (h) The Manager agrees that he will execute such other agreements as the Company may reasonably request to further evidence and implement the provisions of this Section 9. 14 10. RIGHTS TO NEGOTIATE REPURCHASE PRICE. Nothing in this Agreement shall be deemed to restrict or prohibit the Company from purchasing shares of Capital Stock or stock options from the Manager, at any time, upon such terms and conditions, and for such price, as may be mutually agreed upon between the parties hereto, whether or not at the time of such purchase circumstances exist which specifically grant the Company the right to purchase shares of Stock or the Company has the right to pay the Option Excess Price under the terms of this Agreement. 11. BROKER LOAN PROGRAM. Following the initial Public Offering of Common Stock, the Company will use reasonable efforts to assist in the establishment of a customary broker loan program for the purpose of facilitating the exercise of Options. 12. NOTICE OF CHANGE OF BENEFICIARY. Immediately prior to any transfer of Stock to a manager's Trust, the Manager shall provide the Company with a copy of the instruments creating the Manager's Trust and with the identity of the beneficiaries of the Manager's Trust. The Manager shall notify the Company immediately prior to any change in the identity of any beneficiary of the Manager's Trust. 13. EXPIRATION OF CERTAIN PROVISIONS. The provisions contained in Sections 4, 5 and 6 of this Agreement and the portion of any other provision of this Agreement which incorporates the provisions of Sections 4, 5 and 6, shall terminate and be of no further force or effect with respect to any shares of Stock sold by the Manager, as permitted by this Agreement, either pursuant to an effective registration statement filed by the Company pursuant to Section 9 hereof or in accordance with all applicable requirements of Rule 144. The provisions contained in Sections 2(e), 3, 4, 5 and 6 of this Agreement, and the portion of any other provisions of this Agreement which incorporate the provisions of such Sections, shall terminate and be of no further force or effect upon the consummation of a Qualified Public Offering. 14. RECAPITALIZATIONS, ETC. The provisions of this Agreement shall apply, to the full extent set forth herein with respect to the Stock or the options, or any capital stock, partnership units or any other security evidencing ownership interests in any successor or assignee of the Company (whether by merger, consolidation, sale of assets or otherwise) which may be issued in respect of, in exchange for, or substitution of Stock or options, by reason of any stock dividend, split, reverse split, combination, recapitalization, liquidation, reclassification, merger, consolidation or otherwise. 15. MANAGER'S EMPLOYMENT BY THE COMPANY. Nothing contained in this Agreement or in any other agreement entered into by the Company and the Manager, contemporaneously with the execution of this Agreement (i) obligates the Company or any subsidiary or Affiliate of the Company to employ the Manager in any capacity whatsoever or (ii) prohibits or restricts the Company (or any such subsidiary or Affiliate) from terminating the employment, if any, of the Manager at any time or for any reason whatsoever, with or without cause, and the Manager hereby acknowledges and agrees that neither the Company nor any other person has made any representations or promises whatsoever to the Manager concerning the Manager's employment or continued employment by the Company. 15 16. STATE SECURITIES LAWS. The Company hereby agrees to use all reasonable efforts to comply with all state securities or "blue sky" laws which might be applicable to the issuance of the Options to the Manager. 17. BINDING EFFECT. The provisions of this Agreement shall be binding upon and accrue to the benefit of the parties hereto and their respective heirs, legal representatives, successors and assigns. In the case of a transferee permitted under Section 2(a) hereof, such transferee shall be deemed the Manager hereunder; provided, however, that no transferee (including without limitation, transferees referred to in Section 2(a) hereof) shall derive any rights under this Agreement unless and until such transferee has delivered to the Company a valid undertaking and becomes bound by the terms of this Agreement. 18. AMENDMENT. This Agreement may be-amended only by a written instrument signed by the parties hereto. 19. APPLICABLE LAW. The laws of the State of New York applicable to contracts made and to be performed therein shall govern the interpretation, validity and performance of the terms of this Agreement. Any suit, action or proceeding against the Manager, with respect to this Agreement, or any judgment entered by any court in respect of any thereof, may be brought in an court of competent jurisdiction in the State of New York, as the Company may elect in its sole discretion, and the Manager hereby submits to the non-exclusive jurisdiction of such courts for the purpose of any such suit, action, proceeding or judgment. By the execution and delivery of this Agreement, the Manager appoints The Corporation Trust Company (or such other qualified corporate agent as the Company may designate), at its office in New York, New York as the Manager's agent upon which process may be served in any such suit, action or proceeding. Service of process upon such agent, together with notice of such service given to the Manager in the manner provided in Section 22 hereof, shall be deemed in every respect effective service of process upon him in any suit, action or proceeding. Nothing herein shall in any way be deemed to limit the ability of the Company to serve any such writs, process or summonses in any other manner permitted by applicable law or to obtain jurisdiction over the Manager, in such other jurisdictions and in such manner, as may be permitted by applicable law. The Manager hereby irrevocably waives any objections which the Manager may now or hereafter have to the laying of the venue of any suit, action or proceeding arising out of or relating to this Agreement brought in any court of competent jurisdiction in the State of New York, and hereby further irrevocably waives any claim that any such suit, action or proceeding brought in any such court has been brought in any inconvenient forum. No suit, action or proceeding against the Company with respect to this Agreement may be brought in any court, domestic or foreign, or before any similar domestic or foreign authority other than in a court of competent jurisdiction in the State of New York, and the Manager hereby irrevocably waives any right which the Manager may otherwise have had to bring such an action in any other court, domestic or foreign, or before any similar domestic or foreign authority. The Company hereby submits to the jurisdiction of such courts for the purpose of any such suit, action or proceeding. 16 20. ASSIGNABILITY OF CERTAIN RIGHTS BY THE COMPANY. The Company shall have the right to assign any or all of its rights or obligations to purchase shares of Stock pursuant to the Option Plan and Section 6 hereof. 21. MISCELLANEOUS. In this Agreement all references to "dollars" or $ are to United States dollars. If any provision of this Agreement shall be declared illegal, void or unenforceable by any court of competent jurisdiction, the other provisions shall not be affected, but shall remain in full force and effect. 22. NOTICES. All notices and other communications provided for herein shall be in writing and shall be deemed to have been duly given if delivered by hand (whether by overnight courier or otherwise) or sent by registered or certified mail, return receipt requested, postage prepaid, to the Party to whom it is directed: (a) if to the Company or HNK: KMC Telecom Holdings, Inc. 1545 Route 206 Bedminster, New Jersey 07921 Attn: Chief Executive Officer Telecopier No: (908) 719-8775 with a copy to: Kelley Drye & Warren 101 Park Avenue New York, New York 10178 Attn: Alan Epstein, Esq. Telecopier No: (212) 808-7898/7899 (b) if to the Manager: with a copy to: Attn: 17 (c) if to Nassau: Nassau Capital L.L.C. 22 Chambers Street Princeton, New Jersey 08542 Attn: John Q. Quigley Telecopier No: (609) 924-8887 with a copy to: Simpson Thacher & Bartlett 425 Lexington Avenue New York, New York 10017 Attn: George R. Krouse, Jr., Esq. Telecopier No: (212) 455-2502 or at such other address as each party shall have specified by notice in writing to the other. 23. COVENANT NOT TO COMPETE; CONFIDENTIAL INFORMATION. (a) In consideration of the Company entering into this Agreement with the Manager, the Manager hereby agrees, for so long as the Manager is employed by the Company or one of its Affiliates and for a period of six (6) months after the date of termination of the Manager's employment (the "Noncompete Period"), that the Manager shall not (i) directly or indirectly, as an employee, agent, manager, director, officer, stockholder, partner or otherwise, own, manage, operate, control, be employed by, participate in or be connected in any manner whatsoever with the ownership, management, operation or control of any business in competition with the principal business activities in which the Company is engaged, or has material plans to engage in, at the time of the termination of the manager's employment, (ii) solicit from any company, or any division, department or subsidiary of any company, or any individual employed by any of the foregoing, any business relating to services similar to the services which were performed by the Company relating to the Company's principal business activities, its joint venturers or affiliates for such company during the Manager's employment by the Company or its Affiliates or (iii) request or cause any company to cancel or terminate any business relationship with the Company, its joint venturers or affiliates, or directly or indirectly solicit or otherwise cause any employee to terminate such employee's relationship with the Company, its joint venturers or affiliates. At the Company's option, the Noncompete Period may be extended for an additional three (3) month period (the "Noncompete Extension Period") if within one month of the termination of the Noncompete Period the Company gives the Manager notice of such extension and the Company pays the Manager an amount equal to one-fourth the Manager's annual base salary as of the date of termination of employment. Such amount shall be paid in installments in a manner consistent with the then current salary payment policies of the Company. At the Company's option, the Noncompete Extension Period may be extended for an additional three (3) month period pursuant to the provisions of the two preceding sentences. For purposes of this Section 23, "principal business activities" of the Company shall mean those business activities of the Company pursuant to which the Company has derived during the preceding twelve month period, or reasonably expects to derive within twelve months of the termination of the Manager's employment, ten percent (10%) or more of its consolidated revenues. 18 (b) The manager shall promptly and fully disclose to the Company, and with all Necessary detail for development, marketing; sale and installation, any and all know-how, discoveries, inventions, improvements, ideas, writings, formulae, processes and methods (whether copyrightable, patentable or otherwise) made, received, conceived, acquired or written by the Manager (whether or not at the request or upon the suggestion of the Company) during the term of the Manager's employment, solely or jointly with others, in or relating to any activities of the Company or an affiliate known to the Manager as a consequence of the Manager's employment (collectively referred to herein as the "Subject Matter"). (c) The Manager hereby assigns and transfers, and agrees to assign and transfer, to the Company, all right, title and interest in and to the Subject Matter, and the Manager further agrees' to execute, acknowledge and deliver all such further papers, including applications for copyrights and patents, as may be necessary to obtain copyrights or patents for any thereof in any and all countries and to vest title thereto to the Company. The Manager shall assist the Company in obtaining such copyrights or patents during the period of this Agreement and any time thereafter and to testify in any prosecution or litigation involving any of the Subject Matter. (d) The Manager shall not, during the period of this Agreement, or at any time thereafter, directly or indirectly, disclose or permit to be known, to any person, f inn or cooperation, any trade-secrets or confidential information acquired by him during the course of or as an incident to the employment hereunder, relating to the Company, its officers or directors, any company which the Manager has knowledge of or dealt with in the course of his employment by the Company, or any joint venture or affiliate of the Company, or in which any of the foregoing has a beneficial interest, including, but not limited to, the business affairs of each of the foregoing. Such confidential information shall include, but is not limited to, the Subject Matter as well as information relating to agreements, research, methods, writings, manuals, developments, marketing and any other document embodying such confidential information. Confidential information shall not include any information that (i) is in the public domain other than by reason of a breach hereof; or (ii) was in the possession of the Manager at the time of the disclosure; or (iii) was obtained by the Manager in good faith from a third party entitled to disclose it; or (iv) was required to be disclosed by a court of competent jurisdiction or a governmental authority with authority over the Company, in which case the Manager shall use the Manager's best efforts, prior to such disclosure, to give timely notice of such requirement to the Board of Directors of the Company which shall have the right to object to such disclosure or seek confidential treatment of the confidential information. (e) All names of actual or potential clients which have been solicited or are on any mailing lists, rolodex, files or directories in the possession or under the control of the Manager (whether in written, electronic or other formats), and all information and documents relating to the Company or its joint venturers or affiliates, shall be the-exclusive property of the Company and the Manager shall use the Manager's best efforts to prevent any publication or disclosure thereof. Upon termination of the Manager's employment with the Company, all names of actual or potential customers, documents, records, reports, writings and other similar documents containing confidential information, or trade-secrets including copies thereof, then in the Manager's possession or control shall be promptly returned to the Company. 19 (f) Notwithstanding clauses (a) and (d) above, if at any time a court holds that the restrictions stated in such clauses (a) and (d) are unreasonable or otherwise unenforceable under circumstances then existing, the parties hereto agree that the maximum period, scope or geographic area determined to be reasonable under such circumstances by such court will be substituted for the stated period, scope or area. The Manager and the Company recognize that the services to be rendered by the Manager are of a special, unique, unusual, extraordinary and intellectual character involving a high degree of skill and having a peculiar value, the loss of which may cause the Company immediate and irreparable harm which cannot be adequately compensated in damages. In the event of a breach or threatened breach by the Manager of this Agreement, the Manager consents that the Company shall be entitled to injunctive relief, both preliminary and permanent, without bond, and the Manager will not raise the defense that the Company has an adequate remedy at law. In addition, the Company shall be entitled to any other legal or equitable remedies as may be available under law. The remedies provided in this Agreement shall be deemed cumulative and the exercise of one shall not preclude the exercise of any other remedy at law or in equity for the same event or any other event. 20 IN WITNESS WHEREOF, the undersigned have executed, or caused to be executed, this Agreement as of the date first above written. KMC TELECOM HOLDINGS, INC. By:___________________________________ Name: Title: ______________________________________ Name: NASSAU CAPITAL PARTNERS L.P. By: Nassau Capital L.L.C., its General Partner By:______________________________ Name: Title: NAS PARTNERS I L.L.C. By:__________________________________ Name: Title: HAROLD N. KAMINE _____________________________________ EX-21.1 15 SUBSIDIARIES OF KMC TELECOM HOLDINGS Exhibit 21.1 Subsidiaries of KMC Telecom Holdings, Inc.
Company State of Incorporation/Organization - - ------- ----------------------------------- KMC Telecom Inc. Delaware KMC Telecom II, Inc. Delaware KMC Telecom III Holdings, Inc. Delaware KMC Telecom III, Inc. Delaware (subsidiary of KMC Telecom III Holdings, Inc.) KMC Telecom Leasing I, LLC Delaware (subsidiary of KMC Telecom Inc.) KMC Telecom Leasing II, LLC Delaware (subsidiary of KMC Telecom II, Inc.) KMC Telecom Leasing III, LLC Delaware (subsidiary of KMC Telecom III, Inc.) KMC Telecom of Virginia, Inc. Virginia (subsidiary of KMC Telecom Inc.)
EX-27 16 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the consolidated balance sheets of KMC Telecom Holdings, Inc. at December 31, 1998 and the consolidated statements of operations for the year ended December 31, 1998 and is qualified in its entirety by reference to such financial statements. 1 12-MOS Dec-31-1998 Jan-1-1998 Dec-31-1998 21,181,000 0 7,889,000 (350,000) 0 30,035,000 235,558,000 (10,668,000) 311,310,000 31,426,000 309,225,000 75,012,000 0 6,000 (104,359,000) 311,310,000 0 22,425,000 0 37,336,000 40,871,000 0 29,789,000 (76,753,000) 0 (76,753,000) 0 0 0 (76,753,000) (114.42) (114.42)
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