SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
---------------------- -----------------------
Commission File No. 333-53467
Pathnet, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-1941838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1015 31st Street, N.W.
Washington, DC 20007
(Address of principal executive offices) (Zip Code)
(202) 625-7284
(Registrant's telephone number, including area code)
Not Applicable
(Former name,former address and former fiscal year,if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ ] No [X]
As of November 7, 1998, there were 2,902,358 shares of the Issuer's common
stock, par value $.01 per share, outstanding.
<PAGE>
PATHNET, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
INDEX
<TABLE>
Page
<S> <C>
Part I. Financial Information
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 1998 (unaudited)
and December 31, 1997 3
Unaudited Consolidated Statements of Operations for the three months ended
September 30, 1998 and 1997, for the nine months ended September 30,
1998 and 1997 and for the period August 25, 1995 (date of inception) to
September 30, 1998 4
Unaudited Consolidated Statements of Comprehensive Loss for the three
months ended September 30, 1998 and 1997, for the nine months ended
September 30, 1998 and 1997 and for the period August 25, 1995
(date of inception) to September 30, 1998 5
Unaudited Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and 1997 and for the period August 25, 1995
(date of inception) to September 30, 1998 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Part II. Other Information
Item 1. Legal Proceedings 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 31
Signatures 33
Exhibits Index 34
</TABLE>
2
<PAGE>
Part I. Financial Information
Item 1. Financial Statements
PATHNET INC.
(A Development Stage Enterprise)
CONSOLIDATED BALANCE SHEETS
<TABLE>
September 30, December 31,
1998 1997
------------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 59,558,631 $ 7,831,384
Interest receivable 3,936,127 --
Marketable securities available for sale, at market 122,658,304 --
Prepaid expenses and other current assets 168,366 48,571
------------- -------------
Total current assets 186,321,428 7,879,955
Property and equipment, net 33,135,699 7,207,094
Deferred financing costs, net 10,792,256 250,428
Restricted cash 10,647,253 760,211
Marketable securities available for sale, at market 69,010,807 --
Pledged marketable securities held to maturity 83,224,243 --
------------- -------------
Total assets $ 393,131,686 $ 16,097,688
============= =============
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' DEFICIT
Accounts payable $ 14,158,634 $ 5,592,918
Accrued interest 20,484,724 --
Accrued expenses 1,906,685 --
Deferred revenue 251,863 300,000
------------- -------------
Total current liabilities 36,801,906 5,892,918
12 1/4% Senior Notes, net of unamortized bond discount of $3,890,250 346,109,750 --
------------- -------------
Total liabilities 382,911,656 5,892,918
Series A convertible preferred stock, $0.01 par value, 1,000,000 shares authorized,
issued and outstanding at September 30, 1998 and December 31, 1997, respectively
(liquidation preference $1,000,000) 1,000,000 1,000,000
Series B convertible preferred stock, $0.01 par value, 1,651,046 shares authorized,
issued and outstanding at September 30, 1998 and December 31, 1997, respectively
(liquidation preference $5,033,367) 5,008,367 5,008,367
Series C convertible preferred stock, $0.01 par value, 2,819,549 shares authorized;
2,819,549 and 939,850 shares issued and outstanding at September 30, 1998 and
December 31, 1997, respectively (liquidation preference $30,000,052) 29,961,272 9,961,274
------------- -------------
Total mandatorily redeemable preferred stock 35,969,639 15,969,641
Voting common stock, $0.01 par value, 60,000,000 and 7,500,000 shares authorized at
September 30, 1998 and December 31, 1997, respectively; 2,902,358 and 2,900,000 shares
issued and outstanding at September 30, 1998 and December 31, 1997, respectively 29,024 29,000
Common stock subscription receivable -- (9,000)
Deferred compensation (1,189,924) --
Additional paid-in capital 6,156,406 381,990
Unrealized gain on marketable securities available for sale 436,490 --
Deficit accumulated during the development stage (31,181,605) (6,166,861)
------------- -------------
Total stockholders' deficit (25,749,609) (5,764,871)
------------- -------------
Total liabilities, mandatorily redeemable preferred stock and stockholders'equity $ 393,131,686 $ 16,097,688
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
<PAGE>
PATHNET, INC.
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
For the period
August 25, 1995
For the three months ended For the nine months ended (date of inception)
September 30, September 30, to September 30,
---------------------------- ---------------------------- ----------------
1998 1997 1998 1997 1998
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenue $ 475,000 $ -- $ 1,050,000 $ 62,500 $ 1,213,500
------------ ------------ ------------ ------------ ------------
Expenses:
Cost of revenue 1,621,211 -- 5,385,718 -- 5,385,718
Selling, general and administrative 2,694,505 1,187,833 6,721,862 2,537,112 12,731,344
Depreciation expense 203,725 11,423 315,247 26,863 371,265
------------ ------------ ------------ ------------ ------------
Total expenses 4,519,441 1,199,256 12,422,827 2,563,975 18,488,327
------------ ------------ ------------ ------------ ------------
Net operating loss (4,044,441) (1,199,256) (11,372,827) (2,501,475) (17,274,827)
Interest expense (11,151,467) -- (21,862,169) -- (22,277,526)
Interest income 4,728,582 23,626 9,574,286 59,562 9,749,282
Initial public offering costs (1,354,534) -- (1,354,534) -- (1,354,534)
Other income (expense), net 1,661 -- 500 -- (5,000)
------------ ------------ ------------ ------------ ------------
Net loss $(11,820,199) $ (1,175,630) $(25,014,744) $ (2,441,913) $(31,162,605)
============ ============ ============ ============ ============
Basic and diluted loss per
common share $ (4.07) $ (0.41) $ (8.62) $ (0.84) $ (10.74)
============ ============ ============ ============ ============
Weighted average number of
common shares outstanding 2,902,358 2,900,000 2,901,917 2,900,000 2,900,462
============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
PATHNET, INC.
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(unaudited)
<TABLE>
For the period
August 25, 1995
For the three months ended For the nine months ended (date of inception)
September 30, September 30, to September 30,
---------------------------- ---------------------------- ----------------
1998 1997 1998 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net loss $ (11,820,199) $ (1,175,630) $ (25,014,744) $ (2,441,913) $ (31,162,605)
Other comprehensive income
Unrealized gain on marketable
securities available for sale 488,345 -- 436,490 -- 436,490
------------- ------------ ------------- ------------ -------------
Comprehensive loss $ (11,331,854) $ (1,175,630) $ (24,578,254) $ (2,441,913) $ (30,726,115)
============= ============ ============= ============ =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE>
PATHNET, INC.
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
For the period
August 25, 1995
For the nine months ended (date of inception)
September 30, September 30,
------------------------------ ----------------
1998 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (25,014,744) $ (2,441,913) $ (31,162,605)
Adjustment to reconcile net loss to net cash used in operating activities
Depreciation 315,247 26,863 371,265
Amortization of deferred financing costs 558,785 -- 558,785
Loss on disposal of asset -- -- 5,500
Write-off of deferred financing costs 613,910 -- 613,910
Interest expense resulting from amortization of discount on the
bonds payable 204,750 -- 204,750
Stock based compensation 489,435 -- 489,435
Interest expense for beneficial conversion feature of bridge loan -- -- 381,990
Accrued interest satisfied by conversion of bridge loan to
Series B preferred stock -- -- 33,367
Changes in assets and liabilities:
Prepaid expenses and other current assets (119,796) (39,987) (168,366)
Interest receivable (3,936,127) -- (3,936,127)
Accrued interest 20,484,724 -- 20,484,724
Deferred revenue (48,137) -- 251,863
Accounts payable 53,711 (57,608) 554,616
Accrued expenses 1,856,685 1,483 1,856,684
------------- ------------- -------------
Net cash used in operating activities (4,541,557) (2,511,162) (9,460,209)
------------- ------------- -------------
Cash flows from investing activities:
Expenditures for property and equipment (8,548,737) (148,601) (8,985,554)
Purchase of marketable securities available for sale (191,232,621) -- (191,232,621)
Purchase of marketable securities - pledged as collateral (83,224,243) -- (83,224,243)
Restricted cash (9,887,042) (750,000) (10,647,253)
Repayment of notes receivable 9,000 -- 9,000
Expenditures for network work in progress (9,183,109) -- (10,922,891)
------------- ------------- -------------
Net cash used in investing activities (302,066,752) (898,601) (305,003,562)
------------- ------------- -------------
Cash flows from financing activities:
Issuance of voting and non-voting common stock -- -- 1,000
Proceeds from sale of preferred stock 19,999,998 2,000,000 35,000,052
Proceeds from sale of Series B preferred stock representing the
conversion of committed but undrawn portion of bridge loan
to Series B preferred stock -- -- 300,000
Proceeds from bond offering 350,000,000 -- 350,000,000
Proceeds from bridge loan -- -- 700,000
Exercise of employee common stock options 81 -- 81
Payment of issuance costs -- -- (63,780)
Payment of deferred financing costs (11,664,523) -- (11,914,951)
------------- ------------- -------------
Net cash provided by financing activities 358,335,556 2,000,000 374,022,402
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 51,727,247 (1,409,763) 59,558,631
Cash and cash equivalents at the beginning of period 7,831,384 2,318,037 --
------------- ------------- -------------
Cash and cash equivalents at the end of period $ 59,558,631 $ 908,274 $ 59,558,631
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
6
<PAGE>
PATHNET, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Pathnet, Inc. (Company) is a wholesale provider of high
quality, low cost, long haul telecommunications capacity to second and
third tier U.S. markets. The Company is building its digital
telecommunications network by upgrading, integrating and leveraging
existing telecommunications assets, sites and rights of way, including
those utilized by railroads, utilities, state and local governments and
pipelines (Incumbents). In return for providing equipment, designing
systems and managing construction of the Incumbent networks, the
Company has received and expects to receive the exclusive contractual
right to market excess telecommunications capacity created and
aggregated on Incumbent networks. In addition to deploying its network
by forming long-term relationships with Incumbents, the Company may
enter into alternative markets or acquire or deploy complementary
telecommunications assets or technologies.
The Company currently has 1,200 route miles of operational
network on which telecommunication capacity is available for sale and
an additional 5,500 route miles of network under construction.
Additionally, the Company recently began providing commercial
telecommunications service to two customers with several additional
customers awaiting installation.
The Company's business has been funded primarily through
equity investments by the Company's stockholders and a private
placement in April 1998 of units consisting of senior notes and
warrants to purchase common stock (Debt Offering). On September 2,
1998, the Company commenced an offer to exchange (Exchange Offer) all
outstanding Restricted Notes for up to $350.0 million aggregate
principal amount of 12 1/4% Senior Notes due 2008 (Registered Notes)
which have been registered under the Securities Act of 1933, as
amended. The terms of the Registered Notes are identical in all
material respects to the terms of the Restricted Notes, except that the
Registered Notes have been registered under the Securities Act and are
generally freely transferable by holders thereof and are issued without
any covenant upon the Company regarding registration under the
Securities Act. The Exchange Offer expired on October 2, 1998 and all
outstanding Restricted Notes were exchanged for Registered Notes. (The
Restricted Notes and the Registered Notes are collectively referred to
herein as the "Senior Notes".)
A substantial portion of the Company's activities to date has
involved developing strategic relationships with Incumbents.
Accordingly, its revenues to date reflect only certain consulting
services in connection with the design, development and construction of
digital microwave infrastructure. The Company has also been engaged in
constructing network, developing operating systems, constructing a
network operations center, raising capital and hiring management and
other key personnel. The Company has experienced significant operating
and net losses and negative operating cash flow to date and expects to
continue to experience operating and net losses and negative operating
cash flow until such time as it is able to generate revenue sufficient
to cover its operating expenses.
7
<PAGE>
2. BASIS OF ACCOUNTING
While the Company recently commenced providing commercial
service to customers, its principal activities to date have been
securing contractual alliances with Incumbents, designing and
constructing network segments, obtaining capital and planning its
proposed service. Accordingly, the Company's consolidated financial
statements are presented as a development stage enterprise, as
prescribed by Statement of Financial Accounting Standards No. 7,
"Accounting and Reporting by Development Stage Enterprises." As a
development stage enterprise, the Company has been relying on the
issuance of equity and debt securities, rather than recurring revenues,
for its primary sources of cash since inception.
In the opinion of management, the accompanying unaudited
consolidated financial statements of the Company. and its subsidiaries
contain all adjustments (consisting only of normal recurring accruals)
necessary to present fairly the Company's consolidated financial
position as of September 30, 1998, and the results of operations and
cash flows for the periods indicated. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted. It is suggested that these consolidated financial
statements be read in conjunction with the financial statements and
notes thereto included in the Company's Registration Statement on Form
S-4 (Registration No. 333-53467). The results of operations for the
three and nine months ended September 30, 1998 are not necessarily
indicative of the operating results to be expected for the full year.
3 LOSS PER SHARE
The Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" (SFAS 128), effective December
31, 1997. Basic earnings (loss) per share is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding during the applicable period. Diluted earnings (loss) per
share is computed by dividing net income (loss) by the weighted average
common and potentially dilutive common equivalent shares outstanding
during the applicable period. For each of the periods presented, basic
and diluted loss per share are the same. The exercising of 2,541,387
employee common stock options, the exercise of warrants to purchase
1,116,500 shares of common stock, and the conversion of 5,470,595
shares of Series A, B and C convertible preferred stock into 15,864,716
shares of common stock as of September 30, 1998, which could
potentially dilute basic earnings per share in the future were not
included in the computation of diluted loss per share for the periods
presented because to do so would have been antidilutive in each case.
4. MARKETABLE SECURITIES
The Company's marketable securities are considered "available
for sale," and, as such, are stated at market value. The net unrealized
gains and losses on marketable securities are reported as a component
of stockholders' equity (deficit). Realized gains or losses from the
sale of marketable securities are based on the specific identification
method.
8
<PAGE>
The following is a summary of the investments in marketable
securities at September 30, 1998:
<TABLE>
Gross Unrealized
----------------
Cost Gains Losses Market Value
---- ----- ------ ------------
<S> <C> <C> <C> <C>
Available for sale securities:
U.S. Treasury securities and debt securities
of U.S. Government agencies $ 32,331,103 $ 79,755 $ 7,525 $ 32,403,333
Certificates of deposit and money market
funds 11,591,492 31,475 -- 11,622,967
Corporate debt securities 145,557,458 334,928 2,856 145,889,530
Debt securities issued by foreign
governments 1,752,568 713 -- 1,753,281
--------------- ---------- --------- ---------------
$ 191,232,621 $ 446,871 $ 10,381 $ 191,669,111
=============== ========== ========= ===============
</TABLE>
Proceeds from the sales of available for sale securities and gross
realized gains and gross realized losses on sales of available for sale
securities were immaterial during the nine months ended September 30, 1998.
The amortized cost and estimated fair value of available for sale
securities by contractual maturity at September 30, 1998 is as follows:
<TABLE>
Cost Market Value
<S> <C> <C>
Due in one year or less $ 122,512,247 $ 122,658,304
Due after one year through two years. 68,720,374 69,010,807
--------------- --------------
$ 191,232,621 $ 191,669,111
=============== ===============
</TABLE>
Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to prepay obligations without
prepayment penalties.
In addition to marketable securities, the Company has investments in
pledged marketable securities that are pledged as collateral for repayment of
interest on the Company's Senior Notes through April 2000 (see note 8) and are
classified as non-current assets on the consolidated balance sheet. As of
September 30, 1998 pledged marketable securities consisted of U.S. Treasury
securities classified as held to maturity with an amortized cost of
approximately $61.0 million and cash and cash equivalents of approximately $22.2
million. Approximately $40.3 million of the investments contractually mature
prior to September 30, 1999 and approximately $20.7 million contractually mature
after September 30, 1999 and prior to April 30, 2000.
9
<PAGE>
5. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, is comprised of the following
at September 30, 1998 and December 31, 1997:
<TABLE>
September 30, December 31,
1998 1997
------------ ------------
(unaudited)
<S> <C> <C>
Network work in progress $ 24,526,910 $ 6,831,795
Communications network 6,274,445 --
Office and computer equipment 1,820,335 248,880
Furniture and fixtures 740,431 120,093
Leasehold improvements 144,843 62,344
------------- ------------
33,506,964 7,263,112
Less: accumulated depreciation (371,265) (56,018)
------------- ------------
Property and equipment, net $ 33,135,699 $ 7,207,094
============= ============
</TABLE>
As of September 30, 1998 and December 31, 1997, the Company incurred
non-cash capital expenditure of approximately $13.6 million and $5.1 million,
respectively.
6. DEFERRED FINANCING COSTS
During the second quarter of 1998, the Company incurred direct issuance
costs of approximately $10.5 million in connection with the Debt Offering.
During the three and nine months ended September 30, 1998, amortization of the
costs of approximately $280,000 and $559,000, respectively, was charged to
interest expense.
As of December 31, 1997, debt financing costs comprised approximately
$250,000 related to costs incurred in obtaining debt financing arrangements.
During the period, these costs, together with additional debt financing costs
incurred during the period of approximately $364,000, were charged to interest
expense.
7. RESTRICTED CASH
Restricted cash comprises amounts held in escrow to collateralize the
Company's obligations under certain of its Fixed Point Microwave Facilities
Services Agreements. During the third quarter, the Company deposited
approximately $10.3 million in escrow.
8. LONG-TERM DEBT.
On April 8, 1998, the Company completed the Debt Offering for total
gross proceeds of $350.0 million less direct issuance costs of approximately
$10.5 million. Approximately $345.9 million of the gross proceeds were on
issuance allocated to the Restricted Notes and approximately $4.1 million were
on issuance allocated to the Warrants based upon estimated fair values. The
Warrants expire on April 15, 2008. The estimated value attributed to the
Warrants has been recorded as a discount on the face value of the Senior Notes
10
<PAGE>
and as additional paid-in capital. This discount will be amortized as an
increase to interest expense and the carrying value of the debt over the related
term using the interest method. The Company has recorded approximately $205,000
of expense for the nine months ended September 30, 1998, related to the
amortization of this discount. Interest on the Senior Notes accrues at an annual
rate of 12 1/4 %, payable semiannually, in arrears, beginning October 15, 1998,
with principal due in full on April 15, 2008. Interest expense, exclusive of the
amortization of the discount, for the nine months ended September 30, 1998 was
$20.7 million. The Company used approximately $81.1 million of the proceeds to
purchase U.S. Government debt securities, which are restricted and pledged as
collateral for repayment of all interest due on the Senior Notes through April
15, 2000. The Company made its first interest payment of approximately $22.3
million on October 15, 1998. The Senior Notes are redeemable, in whole or part,
at any time on or after April 15, 2003 at the option of the Company, at the
following redemption prices plus accrued and unpaid interest (i) on or after
April 15, 2003; 106% of the principal amount, (ii) on or after April 15, 2004;
104% of the principal amount, (iii) on or after April 15, 2005; 102% of the
principal amount and (iv) on or after April 15, 2006; 100% of the principal
amount. In addition, at any time prior to April 15, 2001, the Company may redeem
within sixty days, with the net cash proceeds of one or more public equity
offerings, up to 35% of the aggregate principal amount of the Senior Notes at a
redemption price equal to 112.25% of the principal amount plus accrued and
unpaid interest provided that at least 65% of the original principal amount of
the Senior Notes remain outstanding. Upon a change in control, as defined, each
holder of the Senior Notes may require the Company to repurchase all or a
portion of such holder's Senior Notes at a purchase price of cash equal to 101%
of the principal amount plus accrued and unpaid interest and liquidated damages
if any.
The Senior Notes contain certain covenants which restrict the
activities of the Company including limitations of indebtedness, restricted
payments, issuances and sales of capital stock, affiliate transactions, liens,
guarantees, sale of assets and dividends.
9. PREFERRED STOCK
On April 8, 1998, the Company completed the sale of 1,879,699 shares of
Series C convertible preferred stock for an aggregate purchase price of
approximately $20.0 million. There were no issuance costs associated with the
sale.
10. COMMON STOCK
On May 8, 1998, the Company filed a Registration Statement with the
Securities and Exchange Commission for an initial public offering of common
stock (Initial Public Offering). See "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" for a discussion of the Company's decision to postpone the
Offering. In relation to the postponement of the Initial Public Offering, the
Company wrote off approximately $1.4 million in expenses, consisting primarily
of legal and accounting fees, printing costs, and SEC and Nasdaq Stock Market
fees. On July 24, 1998, the Company's stockholders approved a 2.9-for-1 stock
split which was effected on August 3, 1998, the record date. All share
information has been adjusted for this stock split for all periods presented.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain statements contained in this item constitute forward-looking
statements. See Part II. Other Information, Item 5(a) "Forward-Looking
Statements."
Results of Operations
Overview
The Company is a wholesale provider of high quality, low cost, long
haul telecommunications capacity to second and third tier U.S. markets. The
Company is building its digital telecommunications network by upgrading,
integrating and leveraging existing telecommunications assets, sites and rights
of way, including those utilized by railroads, utilities, state and local
governments and pipelines (the "Incumbents").
The Company's business commenced on August 25, 1995 and has been funded
primarily through equity investments by the Company's stockholders and a private
placement (the "Debt Offering") in April 1998 of 350,000 units (the "Units"),
consisting of 12 1/4% Senior Notes (the "Restricted Notes") and warrants (the
"Warrants") to purchase shares of common stock, par value $.01 per share (the
"Common Stock"). On October 2, 1998, the Company completed an exchange (the
"Exchange Offer") of all outstanding Restricted Notes for $350,000,000 aggregate
principal amount of 12 1/4% Senior Notes due 2008 which have been registered
under the Securities Act of 1933, as amended (the "Registered Notes"). The
Restricted Notes and the Registered Notes are collectively referred to herein as
the "Senior Notes."
The Company currently has 1,200 route miles of operational network on
which telecommunication capacity is available for sale and an additional 5,500
route miles of network under construction. Additionally, the Company recently
began providing commercial telecommunications service to two customers with
several additional customers awaiting installation.
Due to Pathnet's focus on developing strategic relationships with
Incumbents, its revenues to date reflect certain consulting services in
connection with the design, development and construction of digital microwave
infrastructure. The Company has also been engaged in the acquisition of
equipment, the development of operating systems, the design and construction of
a Network Operations Center (the "NOC"), capital raising and the hiring of
management and other key personnel. The Company has experienced significant
operating and net losses and negative operating cash flow to date and expects to
continue to experience operating and net losses and negative operating cash flow
until such time as it is able to generate revenue sufficient to cover its
operating expenses. In addition to deploying its network by forming long-term
relationships with Incumbents, the Company may enter into alternative markets or
acquire or deploy complementary telecommunications assets or technologies.
Three and Nine Months Ended September 30, 1998 Compared with the Three and Nine
Months Ended September 30, 1997
During the three and nine months ended September 30, 1998, the Company
continued to develop relationships with Incumbents, buildout its network and
develop its infrastructure including the hiring of key management personnel.
12
<PAGE>
Revenue
Substantially all of the Company's revenues for the three and nine
month periods ended September 30, 1998 and 1997 consisted of fees received in
connection with services provided to Incumbents, including analysis of existing
facilities and system performance, advisory services relating to PCS relocation
matters, and turnkey network construction management services. The Company
expects substantially all future revenue to be generated from the sale of
telecommunications services. For the three months ended September 30, 1998 and
1997, the Company generated revenues of approximately $ 475,000 and $0,
respectively. The increase is attributable to fees received in connection with
the continued performance of construction management. For the nine months ended
September 30, 1998 and 1997 the Company generated revenues of approximately $1.1
million and $62,500, respectively. This increase is attributable to fees
received in connection with continued performance of construction management
services.
Operating Expenses
For the three months ended September 30, 1998 and 1997, the Company
incurred operating expenses of approximately $4.5 million and $1.2 million,
respectively. For the nine months ended September 30, 1998 and 1997 the Company
incurred operating expenses of approximately $12.4 million and $2.6 million,
respectively. In each case, the increase is primarily as a result of the
increased activity in the buildout of the Company's network and additional staff
costs incurred as part the development of the Company's infrastructure. The
Company expects selling, general and administrative expenses to continue to
increase in the remainder of 1998 as additional staff is added in all functional
areas, particularly in sales and marketing. Cost of revenue reflects direct
costs associated with performance of construction, management services and costs
incurred in connection with the provision of telecommunications services.
Interest Expense
Interest expense for the three months ended September 30, 1998 and 1997
was approximately $11.2 million and $0, respectively, and for the nine months
ended September 30, 1998 and 1997 was approximately $21.9 million and $0,
respectively. Interest expense primarily represents interest on the Senior Notes
issued in April 1998 together with financing costs associated with obtaining
debt financing arrangements and the amortization expense related to bond
issuance costs in respect of the Senior Notes.
Interest Income
Interest income for the three months ended September 30, 1998 and 1997
was approximately $4.7 million and $23,600, respectively, and for the nine
months ended September 30, 1998 and 1997 was approximately $9.6 million and
$59,600, respectively. This increase primarily represents interest earned on the
proceeds of the Senior Notes issued in April 1998.
Initial Public Offering Costs
During the three and nine months ended September 30, 1998, the Company
recorded a one-time write off of costs associated with the postponed initial
public offering of the Company's Common Stock (the "Initial Public Offering").
These costs consisted primarily of legal and accounting fees, printing costs,
and SEC and Nasdaq Stock Market fees.
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Liquidity and Capital Resources
The Company expects to continue to generate cash primarily from
external financing and, as its network matures, from operating activities. The
Company's primary uses of cash will be to fund capital expenditures, working
capital and operating losses. Deployment of the Company's digital network and
expansion of the Company's operations and services will require significant
capital expenditures. Capital expenditures will be used primarily for continued
development and construction of its network, implementing the Company's sales
and marketing strategy and constructing and improving the Company's NOC.
On April 8, 1998, the Company completed the Debt Offering resulting in
net proceeds to the Company of approximately $339.5 million, after reduction for
offering costs of approximately $10.5 million. The Company used approximately
$81.1 million of the net proceeds of the Debt Offering to purchase securities
(the "Pledged Securities") in an amount sufficient to provide for payment in
full of the interest due on the Senior Notes through April 15, 2000 and which
have been pledged as security for repayment of the Senior Notes. The Company
made its first interest payment of approximately $22.3 million on October 15,
1998. The indenture relating to the Senior Notes (the "Indenture") contains
provisions restricting, among other things, the incurrence of additional
indebtedness, the payment of dividends and the making of restricted payments,
the sale of assets and the creation of liens.
On September 2, 1998, the Company commenced the Exchange Offer to
exchange all outstanding Restricted Notes for Registered Notes. The terms of the
Registered Notes are identical in all material respects to the terms of the
Restricted Notes, except that the Registered Notes have been registered under
the Securities Act and are generally freely transferable by holders thereof and
are issued without any covenant upon the Company regarding registration under
the Securities Act. The Exchange Offer expired on October 2, 1998 and all
outstanding Restricted Notes were exchanged for Registered Notes.
Concurrently with the Debt Offering, the Company completed the issuance
and sale of 1,879,699 shares of Series C Convertible Preferred Stock at an
aggregate price of $20.0 million (the "1998 Private Equity Investment"),
bringing the total investment by the Company's private equity investors to $36.0
million.
The net proceeds from the issuance of the Units (after purchasing the
Pledged Securities) and the 1998 Private Equity Investment are being used for
capital expenditures, working capital and general corporate purposes, including
the funding of operating losses.
On May 8, 1998, the Company filed a registration statement under the
Securities Act of 1933, as amended, with the Securities and Exchange Commission,
relating to the Initial Public Offering. On August 5, 1998, pursuant to section
12(g) of the Securities and Exchange Act of 1934, the Company registered its
Common Stock under the Securities and Exchange Act of 1934. On August 13, 1998,
the Company announced that it would postpone the Initial Public Offering due to
general weakness in the capital markets. The timing and size of the Initial
Public Offering are dependent on market conditions and there can be no assurance
that the Initial Public Offering will be completed.
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As at September 30, 1998, the Company had capital commitments of
approximately $22.0 million relating to telecommunications and transmission
equipment. It is anticipated that these will be met with current resources of
the Company.
The Company believes that the modular design of its network will enable
the Company to rely on traditional sources of financing. In addition, the
Company expects to rely on other sources, including public and private debt and
equity financing and operating cash flow to fund future growth. In addition, the
Company is currently exploring several equipment financing and other financing
alternatives. The Company has not finalized commitments for any additional
financing and there can be no assurance that the Company will be able to secure
financing from these sources on terms that are favorable to the Company. In
addition, the Company may require additional capital in the future to fund
operating deficits and net losses and for potential strategic alliances, joint
ventures and acquisitions. Although there can be no assurance, if the network
roll-out were delayed from the schedule currently anticipated by the Company or
if demand for the Company's services were lower than expected, the Company
expects that it would be able to defer or reduce portions of its capital
expenditures.
Because the Company's cost of rolling out its network and operating its
business, as well as its revenues, will depend on a variety of factors
(including, among other things, the ability of the Company to meet its roll-out
schedules, its ability to negotiate favorable prices for purchases of network
equipment, the number of customers and the services they purchase, regulatory
changes and changes in technology), actual costs and revenues will vary from
expected amounts, possibly to a material degree, and such variations are likely
to affect the Company's future capital requirements. Accordingly, there can be
no assurance that the Company's actual capital requirements will not exceed the
anticipated amounts described above. Further, the exact amount of the Company's
future capital requirements will depend upon many factors, including the cost of
the development of its network, the extent of competition and pricing of
telecommunication services in its markets, the acceptance of the Company's
services and the development of new products.
Year 2000
The Year 2000 issue exists because many computer systems and software
applications use two digits rather than four digits to designate an applicable
year. As a result, the systems and applications may not properly recognize the
year 2000, or process data that includes that date, potentially causing data
miscalculations or inaccuracies or operational malfunctions or failures.
The Company has begun a corporate-wide program to ready its computer
systems and software applications for the year 2000. The Company's objective is
to target year 2000 compliance for all of its systems, including network and
customer interfacing systems, before December 31, 1999. Due to the development
stage status of the Company, few legacy systems or applications exist, however,
the Company is identifying all systems and applications that may need to be
modified or reprogrammed in order to achieve year 2000 compliance.
As part of its year 2000 plan, the Company is seeking confirmation from
major communications equipment vendors (the "Primary Vendors"), Incumbents,
suppliers, financial institutions and others that they are developing and
implementing plans to become year 2000 compliant by December 31, 1999. In
addition, the Company is developing a contingency plan to deal with potential
year 2000 related business interruptions that may occur on January 1, 2000 or
thereafter. These plans are expected to assess
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the potential for business disruption in various scenarios, and to provide for
key operational back-up, recovery and restoration alternatives.
To achieve its year 2000 compliance plan, the Company is utilizing both
internal and external resources to identify, correct or reprogram, and test its
systems for year 2000 compliance. The Company expects to incur internal labor as
well as consulting and other expenses related to infrastructure and facilities
enhancements necessary to prepare its systems for the year 2000. The Company
currently expects expenses in the last quarter of 1998 and 1999 to support its
compliance and contingency initiatives will not be material. Although the
Company intends to develop and, if necessary, implement appropriate contingency
plans to mitigate, to the extent possible, the effects of any significant Year
2000 noncompliance, such plans may not be adequate and the cost of Year 2000
compliance may be higher than expected. Further, the Company cannot predict the
outcome or the success of its year 2000 program or the year 2000 compliance
programs of the Primary Vendors, Incumbents, suppliers, financial institutions
and other third parties nor can it predict the impact on its financial condition
or results of operations, if any, in the event that such compliance objectives,
or year 2000 compliance programs of its Primary Vendors, Incumbents, suppliers,
financial institutions and other third parties, are not successful.
Risk Factors
Limited History of Operations; Operating Losses and Negative Cash Flow
The Company was formed in August 1995 to begin development of its
digital network. The Company has completed 1,200 route miles of its network,
which are commercially available, and an additional 5,500 route miles of network
are under construction. In addition, the Company is providing commercial
telecommunications service to only two customers with several additional
customers awaiting installation. There can be no assurance that the Company will
enter into any additional contracts with Incumbents for the construction of
additional network or with customers for the purchase and sale of
telecommunications capacity. Based on its experience, Pathnet expects that it
may take between six and 18 months from the initial contact with an Incumbent to
complete a long-term contract and 12 months thereafter to complete a
commercially available system. As a result of development and operating
expenses, the Company has incurred significant operating and net losses to date.
The Company's operations have resulted in cumulative net losses of $31.2 million
and cumulative net losses before interest income (expense) and income tax
benefit of $18.6 million from inception in 1995 through September 30, 1998.
The Company expects to incur significant operating losses, to generate
negative cash flows from operating activities and to invest substantial funds to
construct its digital network during the next several years. There can be no
assurance that the Company will achieve or sustain profitability or generate
sufficient positive cash flow to meet its debt service obligations, capital
expenditure requirements or working capital requirements.
Substantial Leverage; Ability to Service Debt; Restrictive Covenants
The Company is highly leveraged. As of September 30, 1998, the Company
had $346.1 million of indebtedness outstanding (approximately 97% of total
invested capital). The Company will likely incur substantial additional
indebtedness (including secured indebtedness) for the
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development of its network and other capital and operating requirements. The
level of the Company's indebtedness could adversely affect the Company in a
number of ways. For example, (i) the ability of the Company to obtain necessary
financing in the future for working capital, capital expenditures, debt service
requirements or other purposes may be limited; (ii) the Company's level of
indebtedness could limit its flexibility in planning for, or reacting to,
changes in its business; (iii) the Company will be more highly leveraged than
some of its competitors, which may place it at a competitive disadvantage; (iv)
the Company's degree of indebtedness may make it more vulnerable to a downturn
in its business or the economy generally; (v) the terms of the existing and
future indebtedness restrict, or may restrict, the payment of dividends by the
Company; and (vi) a substantial portion of the Company's cash flow from
operations must be dedicated to the payment of principal and interest on its
indebtedness and will not be available for other purposes.
The Indenture relating to the Senior Notes (the "Indenture") and
certain of the Company's agreements with Incumbents (the "FPM Agreements")
contain, or will contain, restrictions on the Company and its subsidiaries that
will affect, and in certain cases significantly limit or prohibit, among other
things, the ability of the Company and its subsidiaries to create liens, make
investments, pay dividends and make certain other restricted payments, issue
stock of subsidiaries, consolidate, merge, sell assets and incur additional
indebtedness. There can be no assurance that such covenants and restrictions
will not adversely affect the Company's ability to finance its future operations
or capital needs or to engage in other business activities that may be in the
interest of the Company.
In addition, any future indebtedness incurred by the Company or its
subsidiaries is likely to impose similar restrictions. Failure by the Company or
its subsidiaries to comply with these restrictions could lead to a default under
the terms of the Senior Notes or the Company's other indebtedness
notwithstanding the ability of the Company to meet its debt service obligations.
In the event of such a default, the holders of such indebtedness could elect to
declare all such indebtedness due and payable, together with accrued and unpaid
interest. In such event, a significant portion of the Company's indebtedness may
become immediately due and payable, and there can be no assurance that the
Company would be able to make such payments or borrow sufficient funds from
alternative sources to make any such payments. Even if additional financing
could be obtained, there can be no assurance that it would be on terms that
would be acceptable to the Company.
The successful implementation of the Company's strategy, including
expanding its digital network and obtaining and retaining a sufficient number of
customers, and significant and sustained growth in the Company's cash flow will
be necessary for the Company to meet its debt service requirements. The Company
does not currently, and there can be no assurance that the Company will be able
to, generate sufficient cash flows to meet its debt service obligations. If the
Company is unable to generate sufficient cash flows or otherwise obtain funds
necessary to make required payments, or if the Company otherwise fails to comply
with the various covenants under the terms of its existing or future
indebtedness, it could trigger a default under the terms thereof, which would
permit the holders of such indebtedness to accelerate the maturity of such
indebtedness and could cause defaults under other indebtedness of the Company.
The ability of the Company to meet its obligations will be dependent upon the
future performance of the Company, which will be subject to prevailing economic
conditions and to financial, business, regulatory and other factors.
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Significant Capital Requirements; Uncertainty of Additional Financing
Deployment of the Company's network and expansion of the Company's
operations and services will require significant capital expenditures, primarily
for continued development and construction of its network and implementation of
the Company's sales and marketing strategy. The Company intends to use capital
raised to date to meet projected capital requirements through the first quarter
of 2000. The Company will need to seek additional financing to fund capital
expenditures and working capital to expand its network further to its eventual
target of approximately 100,000 route miles. The Company estimates that this
will require substantial additional external financing but presently has no
negotiated commitments for any such additional financing. The Company may also
require additional capital for activities complementary to its currently planned
businesses, or in the event it decides to pursue network development through
acquisitions, joint ventures or strategic alliances.
The actual amount of the Company's future capital requirements will
depend upon many factors, including the costs of network deployment in each of
its markets, the speed of the development of the Company's network, the extent
of competition and pricing of telecommunications services in its markets, other
strategic opportunities pursued by the Company and the acceptance of the
Company's services. Accordingly, there can be no assurance that the actual
amount of the Company's financing needs will not exceed, perhaps significantly,
the current estimates.
There can be no assurance that the Company will be successful in
raising additional capital on terms that it will consider acceptable, that the
terms of such indebtedness or other capital will not impair the Company's
ability to develop its business or that all available capital will be sufficient
to service its indebtedness. Sources of additional capital may include equipment
financing facilities and public and private equity and debt financings. Failure
to raise sufficient funds may require the Company to modify, delay or abandon
some of its planned future expansion or expenditures, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Risks of Completing the Company's Network; Market Acceptance
The Company's ability to achieve its strategic objectives will depend
in large part upon the successful, timely and cost effective completion of its
network, as well as on selling a substantial amount of its capacity. The
successful completion of the Company's network may be affected by a variety of
factors, uncertainties and contingencies, many of which are beyond the Company's
control. Although the Company believes that its cost estimates and build-out
schedules are reasonable, only 1,200 route miles under contract have been
completed as of September 30, 1998. There can be no assurance that the Company's
network will be completed as planned at the cost and within the time frame
currently estimated, if at all. In addition, although the Company recently began
providing commercial telecommunications service to two customers with several
additional customers awaiting installation, there can be no assurances that the
Company will attract additional purchasers of capacity.
The successful and timely construction of the Company's network will
depend upon, among other things, the Company's ability to (i) obtain substantial
amounts of additional capital and financing
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at reasonable cost and on satisfactory terms and conditions, (ii) manage
effectively and efficiently the construction of its network, (iii) enter into
agreements with Incumbents and other owners of telecommunications assets that
will enable the Company to leverage the assets of Incumbents and of other owners
of telecommunications assets, (iv) access markets and enter into customer
contracts to sell capacity on its network, (v) integrate successfully such
networks and associated rights acquired in connection with the development of
the Company's network including cost effective interconnections and (vi) obtain
necessary FCC licenses and other approvals. Successful construction of the
Company's network also will depend upon the timely performance by third party
contractors of their obligations. There can be no assurance that the Company
will achieve any or all of these objectives. Any failure by the Company to
accomplish these objectives may have a material adverse affect on the Company's
business, financial condition and results of operations.
The development of the Company's network and the expansion of the
Company's business may involve acquisitions of other telecommunications
businesses and assets and implementation of other technologies (such as fiber
optic cable) either in lieu of or as a supplement to the excess capacity created
by upgrading Incumbents' networks. In addition, the Company may enter into
relationships with telecom service providers or other entities to manage
existing assets or to deploy alternative telecommunications technologies.
Furthermore, the Company may seek to serve markets which are not second or third
tier and which may present differing market risks (including as to pricing and
competition). If pursued, these opportunities could require additional
financing, impose additional risks (such as increased or different competition,
additional regulatory burdens and network economics different from those
described elsewhere herein) and could divert the resources and management time
of the Company. There can be no assurance that any such opportunity, if pursued,
could be successfully integrated into the Company's operations or that any such
opportunity would perform as expected. Furthermore, as the Company builds out
its network, there can be no assurance that the Company will enter into
agreements with the best suited Incumbents or such other owners of
telecommunications assets, as the case may be, or that the Company will continue
to pursue its core strategy of leveraging the assets of Incumbents as opposed to
other telecommunications assets, technologies or other markets. Moreover, there
can be no assurance that the resulting network will match or be responsive to
the demand for telecommunications capacity or will maximize the possible revenue
to be earned by the Company. There can be no assurance the Company will be able
to develop and expand its business and enter new markets as currently planned.
Failure of the Company to implement its expansion and growth strategy
successfully could have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Relationship with Incumbents; Rights of Incumbents to
Certain Assets
There can be no assurance that existing long-term relationships with
the Company's Incumbents will be maintained or that additional long-term
relationships will result on terms acceptable to the Company, or at all. If the
Company is not successful in negotiating such agreements, its ability to deploy
its network would be adversely affected.
The Company does not typically expect to own the underlying sites and
facilities upon which its network is deployed. Instead, the Company expects to
enter into long-term relationships with Incumbents whereby each such Incumbent
agrees to grant to the Company a leasehold interest in or
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a similar right to use such Incumbent's facilities and infrastructure as is
required for the Company to deploy its network. In some cases, system assets may
be held by subsidiaries in which both the Company and the Incumbent own an
interest. As a result, the Company will depend on the facilities and
infrastructure of its Incumbents for the operation of its business. Long-term
relationships with Incumbents may expire or terminate if the Company does not
satisfy certain performance targets with respect to sales of excess capacity or
fails to commission an initial communications system within specified time
periods. In such cases, certain equipment relating to the initial communications
system will be transferred to the Incumbent. Any such expiration of a
relationship with an Incumbent, and the resulting loss of use of the
corresponding system and opportunity to utilize such segment of its network,
could result in the Company not being able to recoup its initial capital
expenditure with respect to such segment and could have a material adverse
effect on the business and financial condition of the Company. In addition, such
a loss under certain circumstances could result in an event of default under the
Company's debt financings. There can be no assurance that the Company will
continue to have access to such Incumbent's sites and facilities after the
expiration of such agreements or in the event that an Incumbent elects to
terminate its agreement with the Company. If such an agreement were terminated
or expires and the Company were forced to remove or abandon a significant
portion of its network, such termination or expiration, as the case may be,
could have a material adverse effect on the business, financial condition and
results of operations of the Company.
The Company expects to rely significantly on its Incumbents for the
maintenance and provisioning of circuits on its network. The Company has entered
into maintenance agreements with three Incumbents and expects to enter into
agreements with additional Incumbents pursuant to which, among other things, the
Company will pay the Incumbent a monthly maintenance fee and a provisioning
services fee in exchange for such Incumbent providing maintenance and
provisioning services for that portion of the Company's network that primarily
resides along such Incumbent's system. Failure by the Company to enter
successfully into similar agreements with other Incumbents or the cancellation
or non-renewal of any of such existing agreements could have a material adverse
effect on the Company's business. To the extent the Company is unable to
establish similar arrangements in new markets with additional Incumbents or
establish replacement arrangements on systems where a maintenance agreement with
a particular Incumbent is canceled or not renewed, the Company may be required
to maintain its network and provision circuits on its network through
establishment of its own maintenance and provisioning workforce or by
outsourcing maintenance and provisioning to a third party. The Company's
operating costs under these conditions may increase.
Management of Growth
The Company's business plan may, if successfully implemented, result in
rapid expansion of its operations. Rapid expansion of the Company's operations
may place a significant strain on the Company's management, financial and other
resources. The Company's ability to manage future growth, should it occur, will
depend upon its ability to monitor operations, control costs, maintain
regulatory compliance, maintain effective quality controls and expand
significantly the Company's internal management, technical, information and
accounting systems and to attract and retain additional qualified personnel.
Furthermore, as the Company's business develops and expands, the Company will
need additional facilities for its growing workforce. There can be no assurance
that the Company will successfully implement and maintain such operational and
financial systems or successfully obtain, integrate and utilize the employees
and management, operational and financial resources necessary to manage a
developing and expanding business in an evolving and increasingly competitive
industry which is subject to regulatory change. Any failure to expand these
areas and to implement and improve such systems, procedures and controls in an
efficient manner at a pace consistent with the growth of the Company's business
could have a material adverse effect on the business, financial condition and
results of operations of the Company.
The expansion and development of the Company's business will depend on,
among other things, the Company's ability to implement successfully its sales
and marketing strategy, evaluate markets, design network path routes, secure
financing, install facilities, obtain any required government authorizations,
implement interconnection to, and co-location with, facilities owned by
Incumbents, purchasers of capacity and other owners of telecommunications
assets. The Company's ability to implement its growth strategy successfully will
require the Company to enhance its operational, management, financial and
information systems and controls and to hire and retain qualified sales,
marketing, administrative, operating and technical personnel. There can be no
assurance that
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the Company will be able to do so, and any failure to accomplish these
objectives could result in lower than expected levels of customer service, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Key Personnel; Need for Additional Personnel
The success of the Company will depend to a significant extent upon the
abilities and continued efforts of its senior management, particularly members
of its senior management team, including David Schaeffer, Chairman, Richard A.
Jalkut, President and Chief Executive Officer, Kevin J. Bennis, Executive Vice
President serving as President of the Company's Communications Services Division
and Michael L. Brooks, Vice President of Network Development. Other than its
Employment Agreement with Richard A. Jalkut, the Company does not have any
employment agreements with, nor does the Company maintain "key man" insurance
on, these employees. The loss of the services of any such individuals could have
a material adverse effect on the Company's business, financial condition and
results of operations. The success of the Company will also depend, in part,
upon the Company's ability to identify, hire and retain additional key
management personnel, including the senior management, who are also being sought
by other businesses. Competition for qualified personnel in the
telecommunications industry is intense. The inability to identify, hire and
retain such personnel could have a material adverse effect on the Company's
results of operations.
Competition; Pricing Pressures
The telecommunications industry is highly competitive. In particular,
price competition in the `carrier's carrier' market has generally been intense
and is expected to increase. The Company competes and expects to compete with
numerous competitors who have substantially greater financial and technical
resources, long-standing relationships with their customers and potential to
subsidize competitive services from less competitive service revenues and from
federal universal service subsidies. Such competitors may be operators of
existing or newly deployed wireline or wireless telecommunications networks. The
Company will also face intense competition due to an increased
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supply of telecommunications capacity, the effects of deregulation and the
development of new technologies, including technologies that will increase the
capacity of existing networks.
The Company anticipates that prices for its `carrier's carrier'
services will continue to decline over the next several years. The Company is
aware that certain long distance carriers are expanding their capacity and
believes that other long distance carriers, as well as potential new entrants to
the industry, are constructing new microwave, fiber optic and other long
distance transmission networks in the United States. If industry capacity
expansion results in capacity that exceeds overall demand along the Company's
routes, severe additional pricing pressure could develop. As a result, within a
few years, the Company could face dramatic and substantial price reductions.
Such pricing pressure could have a material adverse effect on the business,
financial condition and results of operations of the Company.
While the Company generally will not compete with telecom service
providers for end-user customers, the Company may compete, on certain routes, as
a `carrier's carrier' with long-distance carriers such as AT&T Corporation, MCI
WorldCom Inc., Sprint Corporation and operators of fiber optic systems, such as
IXC Communications, Inc., The Williams Companies, Inc., QWest Communications
International Inc. and Level 3 Communications, Inc., who would otherwise be the
Company's customers in second and third tier markets. The Company will also face
competition increasingly in the long haul market from local exchange carriers,
regional network providers, resellers and satellite carriers and may eventually
compete with public utilities and cable companies. In particular, certain ILECs
and competitive local exchange carriers ("CLECs") are allowed to provide
inter-LATA long distance services. Furthermore, Regional Bell Operating
Companies ("RBOCs") will be allowed to provide inter-LATA long distance services
within their regions after meeting certain regulatory requirements intended to
foster opportunities for local telephone competition. Certain RBOCs have
requested regulatory approval to provide inter-LATA data services within their
regions. The RBOCs already have extensive fiber optic cable, switching, and
other network facilities in their respective regions that can be used for their
long distance services after a waiting period. In addition, other new
competitors may build additional fiber capacity in the geographic areas served
and to be served by the Company.
The Company may also face competitors seeking to deploy a digital
wireless network in the same manner as the Company by leveraging the assets of
Incumbents or other owners of telecommunications assets or from Incumbents
leveraging their own assets. Although the Company believes its strategy will
provide it with a cost advantage, there can be no assurance that technological
developments will not result in competitors achieving even greater cost
efficiency and therefore a competitive advantage.
A continuing trend toward business combinations and strategic alliances
in the telecommunications industry may create stronger competitors to the
Company, as the resulting firms and alliances are likely to have significant
technological, marketing and financing resources greater than those available to
the Company.
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Reliance on Equipment Suppliers
The Company currently purchases most of its telecommunications
equipment pursuant to an agreement with NEC America, Inc. and its affiliates
("NEC") from whom the Company has agreed to purchase $200 million of equipment
by March 31, 2003 and has entered into an equipment purchase agreement with
Andrew Equipment Corporation. Any reduction or interruption in supply from
either supplier or any increase in prices for such equipment could have a
disruptive effect on the Company. Currently NEC and Northern Telecom Ltd. are
the only manufacturers of SONET radios that are compatible with the Company's
proposed system design and reliability standards, although Harris Corporation
and Alcatel Alsthom Compagnie Generale d'Electricite SA are in the process of
developing and testing similar and compatible products. Further, the Company
does not manufacture, nor does it have the capability to manufacture, any of the
telecommunications equipment used on its network. As a result, the failure of
the Company to procure sufficient equipment at reasonable prices and in a timely
manner could adversely affect the Company's successful deployment of its network
and results of operations.
Technical Limitations of the Network
The Company will not be able to offer route diversity until such time
as it has completed a substantial portion of its mature network. In addition,
the Company's network requires a direct line of sight between two antennae (each
such interval comprising a "path") which is subject to distance limitations,
freespace fade, multipath fade and rain attenuation. In order to meet industry
standards for reliability, the maximum length of a single path similar to those
being designed by the Company is generally limited to 40 miles and, as a result,
intermediate sites in the form of back-to-back terminals or repeaters are
required to permit digital wireless transmission beyond this limit based on the
climate and topographic conditions of each path. In the absence of a direct line
of sight, additional sites may be required to circumvent obstacles, such as tall
buildings in urban areas or mountains in rural areas. Topographic conditions of
a path and climate can cause reflections of signals from the ground which can
affect the transmission quality of digital wireless services. In addition, in
areas of heavy rainfall, the intensity of rainfall and the size of the raindrops
can affect the transmission quality of digital wireless services. Paths in these
areas are engineered for shorter distances to maintain transmission quality and
use space diversity, frequency diversity, adaptive power control and forward
error correction to minimize transmission errors. The use of additional sites
and shorter paths to overcome obstructions, multipath fade or rain attenuation
will increase the Company's capital costs. While these increased costs may not
be significant in all cases, such costs may render digital wireless services
uneconomical in certain circumstances.
Due to line of sight limitations, the Company currently installs its
antennae on towers, the rooftops of buildings or other tall structures. Line of
sight and distance limitations generally do not present problems because
Incumbents have already selected, developed and constructed unobstructed
transmission sites. In certain instances, however, the additional frequencies
required for the excess capacity to be installed by the Company may not be
available from Incumbents' existing sites. In these instances, the Company
generally expects to use other developed sites already owned or leased by such
Incumbent. In some instances, however, the Company has encountered, and may in
the future encounter, line of sight, frequency blockage and distance limitations
that cannot be solved
23
<PAGE>
economically. While the effect on the financial condition and results of
operations of the Company resulting from such cases has been minimal to date,
there can be no assurance that such limitations will not be encountered more
frequently as the Company expands its network. Such limitations may have a
material adverse effect on the Company's future development costs and results of
operations. In addition, the current lack of compression applications for
wireless technology limits the Company's ability to increase capacity without
significant capital expenditures for additional equipment.
In order to obtain the necessary access to install its radios, antennae
and other equipment required for interconnection to the PSTN or to points of
presence ("POP") of the Company's capacity purchasers, the Company must acquire
the necessary rights and enter into the arrangements to deploy and operate such
interconnection equipment. There can be no assurance that the Company will
succeed in obtaining the rights necessary to deploy its interconnection
equipment in its market areas on acceptable terms, if at all, or that delays in
obtaining such rights will not have a material adverse effect on the Company's
development or results of operations.
Dependence on Information and Processing Systems
Sophisticated information and processing systems are vital to the
Company's growth and its ability to monitor network performance, provision
customer orders for telecommunications capacity, bill customers accurately,
provide high-quality customer service and achieve operating efficiencies. As the
Company grows, any inability to operate its billing and information and
processing systems, or to upgrade internal systems and procedures as necessary,
could have a material adverse impact on the Company's ability to reach its
objectives, or on its business, financial condition and results of operations.
Risk of Rapid Technological Changes
The telecommunications industry is subject to rapid and significant
changes in technology. Although the Company believes that, for the foreseeable
future, these changes will neither materially affect the continued use of its
network equipment, nor materially hinder its ability to acquire necessary
technologies, the effect of technological changes on the business of the
Company, such as changes relating to emerging wireline (including fiber optic)
and wireless (including broadband) transmission technologies, cannot be
predicted. There can be no assurance that (i) the Company's network will not be
economically or technically outmoded by technology or services now existing or
developed and implemented in the future, (ii) the Company will have sufficient
resources to develop or acquire new technologies or to introduce new services
capable of competing with future technologies or service offerings or (iii) the
cost of the equipment used on its network will decline as rapidly as that of
competitive alternatives. The occurrence of any of the foregoing events may have
a material adverse effect on the operations of the Company.
Regulation
The Company's arrangements with Incumbents contemplate that the
Company's digital network will provide largely "common carrier fixed
point-to-point microwave" telecommunications services under Part 101 of the
FCC's Rules ("Part 101"), which services are subject to regulation by
24
<PAGE>
federal, state and local governmental agencies. Changes in existing federal,
state or local laws and regulations, including those relating to the provision
of Part 101 telecommunications services, any failure or significant delay in
obtaining necessary licenses, permits or renewals, or any expansion of the
Company's business that subjects the Company to additional regulatory
requirements could have a material adverse effect on the Company's business,
financial condition, and results of operations.
Licensing by the Company and Incumbents. Many Incumbents whose existing
systems operate in the 2 GHz band of the frequency spectrum will be required to
relocate their systems and operations to the 6 GHz band or other alternate
spectrum. In most instances the Company will enter into a strategic relationship
with an Incumbent and, as part of the upgrade of such Incumbent's system, the
Company will license the upgraded network in the 6 GHz band, which will depend
on its obtaining newly issued Part 101 licenses for the use of existing
facilities and infrastructure of such relocated Incumbents.
The Company intends to establish any such arrangement so as to ensure
that there is no de facto transfer of control of a FCC license from an
Incumbent, which has obtained authorization from the FCC to operate a Part 101
telecommunications system at the newly occupied 6 GHz location (a "Licensed
Incumbent"), to the Company, because such a transfer without FCC consent would
violate the FCC's rules. Because any review by the FCC of such an arrangement
would be fact specific and would involve the review of conduct that has not yet
occurred, there can be no assurance that, if such an arrangement between the
Company and a Licensed Incumbent were challenged, the FCC would not deem such an
arrangement to constitute an unauthorized transfer of control. Such a finding
could result in a restructuring of the arrangement with a Licensed Incumbent or
the loss of the FCC license.
Mutual Exclusivity. Pursuant to its arrangements with Incumbents, the
Company will, in most cases, apply to the FCC for new Part 101 licenses to
operate in the 6 GHz band. As each such Part 101 license is granted by the FCC
with respect to the frequencies to be used between two specific points as
designated by specific latitude and longitude coordinates, and as Incumbents
already own the infrastructure and sites that comprise each such licensed point
along the network, the Company expects to be the first and only entity to apply
for these licenses at or near the specific locations and in the frequencies to
be designated by the Company, and hence to have licensing priority under the
FCC's procedures. There can be no assurance, however, that other entities will
not seek licenses to operate in the same portion of the frequency spectrum as
the Company in locations geographically close to those designated by the
Company.
In the event that a mutually exclusive situation were to arise, the FCC
may hold a comparative hearing to decide which applicant will be awarded the
relevant licenses, in which case there can be no assurance that the Company
would be able to obtain the desired license. In the event that numerous mutually
exclusive applications were to be filed, the FCC may decide to impose a filing
freeze with respect to additional applications, and would, in the interim,
decide on the most appropriate manner in which to resolve the mutual
exclusivity. In this vein, the FCC may decide to seek from Congress enabling
legislation that would permit the FCC to hold an auction in order to determine
which of the competing applicants would obtain the sought-after licenses, in
which case the Company could be required to pay potentially large sums in order
to obtain the necessary license, and there would be no assurance that the
Company would be able to obtain any auctioned licenses. The FCC might also
25
<PAGE>
decide to impose fees on the use of the desired spectrum, in which case the
Company would be required to pay potentially large sums in order to obtain and
use its FCC licenses.
Frequency Coordination. Prior to applying to the FCC for authorization
to use portions of the 6 GHz band, the Company must coordinate its use of the
frequency with any existing licensees, permittees, and applicants in the same
area whose facilities could be subject to interference as a result of the
Company's proposed use of the spectrum. There can be no assurance in any
particular case that the Company will not encounter other entities and proposed
uses of the desired spectrum that would interfere with the Company's planned
use, and that the Company will be able to coordinate successfully such usage
with such entities. If the Company were unable to coordinate effectively with
other users of or applicants for the spectrum at a substantial number of
proposed sites, there can be no assurance that the Company would be able to
obtain and retain the licenses necessary for the successful operation of the
Company's network.
FCC License Requirements. As part of the requirements of obtaining a
Part 101 license, the FCC requires the Company to demonstrate the site owner's
compliance with the reporting, notification and technical requirements of the
Federal Aviation Administration ("FAA") with respect to the construction,
installation, location, lighting and painting of transmitter towers and
antennae, such as those to be used by the Company in the operation of its
network. Specifically, the FCC requires compliance with the FAA's notification
requirement, and where such notification is required, a "no hazard"
determination from the FAA before granting a license with respect to a
particular facility. Any failure by the Company to comply with the FAA's
notification procedures, any finding of a hazard by the FAA with respect to a
proposed new or substantially modified facility, or any delay on the part of the
FAA in making such a finding, may have an adverse effect on the Company's
ability to obtain in a timely manner all necessary FCC licenses in accordance
with its business plan.
In addition to FAA requirements, in order to obtain the Part 101
licenses necessary for the operation of its network, the Company, and in some
cases Licensed Incumbents, must file applications with the FCC for such licenses
and demonstrate compliance with routine technical and legal qualification to be
an FCC licensee. The Company must also obtain FCC authorization before
transferring control of any of its licenses or making certain modifications to a
licensed facility. Such requirements for obtaining such Part 101 licenses and
for transferring such licenses include items such as certifying to the FCC that
frequency coordination has been completed, disclosing the identity and
relationship of all entities directly or indirectly owning or controlling the
applicant, and demonstrating the applicant's legal, technical and other
qualifications to be an FCC licensee. Nevertheless, there can be no assurance
that the Company or any Licensed Incumbent will obtain all of the licenses or
approvals necessary for the operation of the Company's business, the transfer of
any license, or the modification of any facility, or that the FCC will not
impose burdensome conditions or limitations on any such license or approval.
Construction of Facilities and Channel Loading Requirements. Under the
FCC's rules, the Company is required to have each licensed Part 101 facility
constructed and "in operation" (i.e., capable of providing service), and to
complete each authorized modification to an existing facility, within 18 months
of the grant of the necessary license or approval. Failure to meet the FCC's
timetable for construction or operation or to obtain an extension of said
timetable will automatically
26
<PAGE>
cancel the underlying license or approval, to the detriment of the Company's
ability to execute its business plan. A license or authorization will also lapse
if, after construction and operation, the facility is removed or altered to
render it non-operational for a period of 30 days or more. Similarly, the FCC's
rules provide that, in the absence of the Company obtaining a waiver of such
rule, any authorized Part 101 station that fails to transmit operational traffic
during any 12 consecutive months after construction is complete is considered
permanently discontinued under the FCC's rules, and its underlying license is
forfeited. In addition, the FCC requires that a certain portion of the available
channels on Part 101 digital systems be loaded with traffic within 30 months of
licensing. There can be no assurance that the Company's Part 101 licenses will
not lapse because of failure to meet the FCC's construction or channel loading
benchmarks or to obtain an extension of such deadlines, or because of the
Company's failure to comply with the FCC's requirements with respect to
operational traffic.
FCC License Renewal. The Part 101 licenses obtained by the Company or a
Licensed Incumbent have been and will be issued for a term of 10 years, after
which such licenses will have to be renewed by the filing of applications with
the FCC. Although such renewals are typically granted routinely, there can be no
assurance that necessary license renewals will be granted by the FCC.
Provision of Common and Private Carrier Services. The Company's and
Licensed Incumbents' Part 101 licenses allow the Company to sell excess capacity
on its network to the customers targeted under the Company's business plan.
Although the Part 101 licenses that the Company and Licensed Incumbents hold are
designated for "common carriers," under the FCC's rules, a Part 101 licensee may
provide both common carriage and private carriage over Part 101 facilities. The
Company is currently offering, and expects to offer in the future, its services
on a private carrier basis. The Company's private carrier services are
essentially unregulated, while any common carrier offerings would be subject to
additional regulations and reporting requirements including payment of
additional fees and compliance with additional rules and regulations including
that any such services must be offered pursuant to filed tariffs and
non-discriminatory terms, rates and practices. There can be no assurance that
the FCC will not find that some or all of the private carrier services offered
by the Company are in fact common carrier services, and thus subject to such
additional regulations and reporting requirements including the
non-discrimination and tariff filing requirements imposed on common carriers, in
which case the Company may be required to pay additional fees or adjust, modify
or cease provision of certain of its services in order to comply with any such
regulations, including offering such services on the same terms and conditions
to all of those seeking such services, and pursuant to rates made public in
tariff filings at the FCC.
Foreign Ownership. As the licensee of facilities designated for common
carriage, the Company is subject to Section 310(b)(4) of the Communications Act
of 1934, as amended (the "Communications Act"), which by its terms restricts the
holding company of an FCC common carrier licensee (the Company is such a holding
company, because it expects to hold all FCC licenses indirectly, through
subsidiaries) to a maximum of 25% foreign ownership and/or voting control. The
FCC has determined that it will allow a higher level (up to 100%) on a blanket
basis with respect to all common carrier licensees, but only for foreign
ownership by citizens of, or companies organized under the laws of, World Trade
Organization ("WTO") member countries. The FCC continues to
27
<PAGE>
apply the 25% foreign ownership limitation with respect to citizens or
corporations of non-WTO nations.
Although the Company is presently within the 25% foreign ownership
limitation, there can be no assurance that, as a result of future financings,
the Company will not exceed this limitation, in which case the Company would
have to analyze its foreign ownership with respect to the WTO status of the
nations with which the Company's foreign owners are associated. In addition, if
any Incumbent elects to be a Licensed Incumbent on the portion of the Company's
network relating to its system, such Licensed Incumbent would also be subject to
such foreign ownership restrictions. If such analysis showed that the Company or
any Licensed Incumbent had more than 25% foreign ownership from non-WTO member
nations, the Company or such Licensed Incumbent, as the case may be, would have
to seek a further ruling from the FCC and/or reduce its non-WTO foreign
ownership. In the event that a Licensed Incumbent were to choose to hold the
relevant Part 101 license itself, and not through a holding company, that
Licensed Incumbent would be subject to Section 310(b)(3) of the Communications
Act, which limits direct foreign ownership of FCC licenses to 20%. The FCC does
not have discretion to waive this limitation, and there can be no assurance than
such a Licensed Incumbent would not exceed the 20% limitation, in which case the
Licensed Incumbent would be required to reduce its foreign ownership in order to
obtain or retain its Part 101 license.
State and Local Regulation. Although the Company expects to provide
most of its services on an interstate basis, in those instances where the
Company provides service on an intrastate basis, the Company may be required to
obtain a certification to operate from state utility commissions in certain of
the states where such intrastate services are provided, and may be required to
file tariffs covering such intrastate services. In addition, the Company may be
required to obtain authorizations from or notify such states with respect to
certain transfers or issuances of capital stock of the Company. The Company does
not expect any such state or local requirements to be burdensome; however, there
can be no assurance that the Company will obtain all of the necessary state and
local approvals and consents or that the failure to obtain such approvals and
consents will not have a material adverse affect on the Company's business,
financial condition and results of operations. In addition, there can be no
assurance that Incumbents will be able to obtain all necessary authorizations or
permits from state or local authorities, or that state or local authorities will
not impose burdensome taxes, requirements or conditions on the Incumbent or the
Company.
Radio Frequency Emission Concerns
The use of wireless equipment may pose health risks to humans due to
radio frequency ("RF") emissions from the radios and antennae. Any allegations
of health risks, if proven, could result in liability on the part of the
Company. The FCC recently adopted new guidelines and methods for evaluating the
environmental effects of RF emissions from FCC regulated transmitters, including
wireless antennae which are more stringent than those previously in effect. The
FCC also incorporated into its rules provisions of the Communications Act which
preempt state or local government regulation of wireless service facilities
based on environmental effects, to the extent such facilities comply with the
FCC's rules concerning such RF emissions. The Company cannot predict whether
more stringent laws or regulations will be enacted in the future. Compliance
with more stringent laws or regulations regarding RF emissions could in the
future require material expenditures by the
28
<PAGE>
Company which could have a material adverse effect on the Company's business,
financial condition and results of operations.
Investment Company Act Considerations
The Company has substantial cash, cash equivalents and short-term
investments. The Company has invested and intends to invest the proceeds of its
financing activities so as to preserve capital by investing primarily in
short-term instruments consistent with prudent cash management and not primarily
for the purpose of achieving investment returns. Investment in securities
primarily for the purpose of achieving investment returns could result in the
Company being treated as an "investment company" under the Investment Company
Act of 1940 (the "1940 Act"). The 1940 Act requires the registration of, and
imposes various substantive restrictions on, investment companies that are, or
hold themselves out as being, engaged primarily, or propose to engage primarily
in, the business of investing, reinvesting or trading in securities, or that
fail certain statistical tests regarding the composition of assets and sources
of income and are not primarily engaged in businesses other than investing,
reinvesting, owning, holding or trading securities.
The Company believes that it is primarily engaged in a business other
than investing, reinvesting, owning, holding or trading securities and,
therefore, is not an investment company within the meaning of the 1940 Act. If
the Company were required to register as an investment company under the 1940
Act, it would become subject to substantial regulation with respect to its
capital structure, management, operations, transactions with affiliated persons
(as defined in the 1940 Act) and other matters. Application of the provisions of
the 1940 Act to the Company would have a material adverse effect on the
Company's business, financial condition and results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
29
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
On April 8, 1998, the Company completed the issuance and sale of
1,879,699 shares of Series C Preferred Stock at an aggregate price of $20.0
million. As of September 30, 1998, the Company had used these proceeds for the
purchase of property and equipment, and to fund general corporate purposes.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
On July 13, 1998 the Company solicited written consents from holders of
its Common Stock, Series A Convertible Preferred Stock, Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock to (i) approve the
proposed initial public offering of up to 5,390,625 shares of the Company's
Common Stock (the "Initial Public Offering"), (ii) approval of the appointment
of certain investment banking firms to act as the managers on behalf of the
underwriters in connection with the Initial Public Offering, (iii) approval of
certain amendments to the Company's Certificate of Incorporation, (iv) approval
of certain amendments to the Company's Amended and Restated Bylaws, (v) approval
of certain Board actions, including, but not limited to, a 2.9-for-one stock
split with respect to all issued and outstanding shares of Common Stock
outstanding as of August 3, 1998, (vi) consenting to the implementation of a
401K Plan, (vii) approval of an agreement between the Company and Bellcore,
(vii) approval of the contribution of certain of the Company's wireless assets
to wholly owned subsidiaries of the Company, (viii) approval of certain new
hires by the Company, (ix) ratification of certain stock option grants by the
Company, (x) ratification of the Fixed Point Microwave Services Agreement
between the Company and KN Telecommunications, Inc., (xi) approval of the Lease
between the Company and Richardson Investment Associates, Ltd., (xii) approval
of the Amendment to the Lease between the Company and Independence Company
Offices, (xiii) approval of the Amendment to the Lease between the Company and
6715 Kenilworth Avenue General Partnership and (xiv) approval of the
expenditures and agreements required for the Dallas Office Fit Out. Effective
July 24, 1998, the Company received written consents approving such proposals
from holders representing and aggregate of 2,902,358 shares of Common Stock and
an aggregate of 5,470,595 shares of Series A Convertible Preferred Stock, Series
B Convertible Preferred Stock and Series C Convertible Preferred Stock.
Item 5. Other Information
(a) Forward-Looking Statements
Certain statements in this Report, in future filings by the
Company with the Securities and Exchange Commission, in the Company's
press releases and in oral statements made by or
30
<PAGE>
with the approval of an authorized executive officer of the Company
constitute forward-looking statements, including statements which can
be identified by the use of forward-looking terminology such as
"believes," "anticipates," "expects," "may," "will," or "should" or the
negative of such terminology or other variations on such terminology or
comparable terminology, or by discussions of strategies that involve
risks and uncertainties. All statements other than statements of
historical facts in this Report, including, without limitation, such
statements under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations," regarding the Company
or any of the transactions described in this Report or the timing,
financing, strategies and effects of such transaction, are
forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove
to have been correct. Important factors that could cause actual results
to differ materially from expectations include, without limitation,
those described in conjunction with the forward-looking statements in
this Report, as well as, the amount of capital needed to deploy the
Company's network; the Company's substantial leverage and its need to
service its indebtedness; the restrictions imposed by the Company's
current and possible future financing arrangements; the ability of the
Company to successfully manage the cost effective and timely completion
of its network and its ability to attract and retain customers for its
services; the ability of the Company to retain and attract
relationships with the incumbent owners of the telecommunications
assets with which the Company expects to build its network; the
Company's ability to retain and attract key management and other
personnel as well as the Company's ability to manage the rapid
expansion of its business and operations; the Company's ability to
compete in the highly competitive telecommunications industry in terms
of price, service, reliability and technology; the Company's dependence
on the reliability of its network equipment, its reliance on key
suppliers of network equipment and the risk that its technology will
become obsolete or otherwise not economically viable and the Company's
ability to conduct its business in a regulated environment. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations - Risk Factors". The Company does not intend to
update these forward-looking statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Index
(b) Reports on Form 8-K
On August 5, 1998, the Company filed a report on Form 8-K
comprising items 5 and 7. The Report, dated August 3, 1998, gave notice
of the adjustment of the exercise rate of the Company's warrants on
account of a 2.9-for-1 stock split of the Company's Common Stock
31
<PAGE>
effected by a stock dividend paid to stockholders of record as of
August 3, 1998. The Report also gave notice that the Company had
decided not to include any Registrable Securities under the Warrant
Registration Rights Agreement in the Initial Public Offering.
On September 18, 1998, the Company filed a report on Form 8-K
comprising items 5 and 7. The Report, dated September 17, 1998,
provided details of a press release issued by the Company in respect of
a contract secured by the Company.
32
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
PATHNET, INC.,
a Delaware corporation
(Registrant)
Date: November 11, 1998 By: /S/ RICHARD A. JALKUT
--------------------------
Richard A. Jalkut
President and Chief Executive Officer
Date: November 11, 1998 By: /S/ WILLIAM R. SMEDBERG, V
-------------------------------
William R. Smedberg, V
Vice President, Finance
(Principal Accounting &
Financial Officer)
33
<PAGE>
EXHIBIT INDEX
Pursuant to Item 601 of Regulation S-K
Exhibit No. Description of Exhibit
10.1 Amendment No. 1 to Fixed Point Microwave Services Agreement
dated September 17, 1997, between PathNet, Inc. and KN Energy,
Inc. *
10.2 Amendment to License Agreement dated July 23, 1998 by and
between Pathnet, Inc. and American Tower Corporation.
27.1 Financial Data Schedule for the nine months ended September
30, 1998.
99.1 Press release dated November 4, 1998 announcing the
appointment of Bob Ferry as Chief Information Officer of the
Company.
99.2 Press release dated November 10, 1998 announcing the
Company's results for the third quarter of 1998.
* - Portions of this document have been omitted pursuant to a request for
confidential treatment.
34
Exhibit 10.1
Note: Certain material has been omitted from this document pursuant to a request
for confidential treatment and has been filed separately with the SEC. Notations
of [ * * * ] have been used to indicate such an omission.
Amendment No. 1
to Fixed Point Microwave Services Agreement
Dated September 17, 1997,
between PathNet, Inc. and KN Energy, Inc.
This amendment no. 1 (the "Amendment") entered into as of September 2, 1998,
supplements and amends the terms of the Fixed Point Microwave Services Agreement
("Agreement"), dated September 17, 1997, between PathNet, Inc. and KN Energy,
Inc. Capitalized terms not otherwise defined herein shall have the meanings set
forth in the Agreement.
The Agreement is hereby amended and supplemented as follows:
1. Section 1.1.40: The following shall be added as a new sentence at the
end of Section 1.1.40: "Facilities shall include any Interconnection
Sites, as defined in Section 4.7, whether owned by Incumbent or a third
party."
Section 2.3: The following shall be added as a new clause to the end of
Section 2.3: "; provided, however, Incumbent may (i) operate the PCS,
cellular or other communication services for such Facilities, so long
as such services do not Interfere with the System or (ii) provide a
singular telecommunications path for the limited purposes of
interconnecting from such Facilities."
2. Section 4.1.6: The following section shall be added to the Agreement:
4.1.6 Certain Additional Costs. Subject to Section 4.1.3, Incumbent
shall pay for the Incumbent Estimated Costs incurred as a result of
(i)[ * * * ]. Notwithstanding the foregoing, Incumbent shall pay for
the [ * * * ].
3. Section 4.7: The following section shall be added to the Agreement:
4.7 Interconnections. Pathnet and Incumbent shall jointly develop
Interconnection sites at the following locations: (i) Scott's
Bluff, Nebraska; (ii) Casper, Wyoming; and (iii) Kearney,
Nebraska (each an "Interconnection Site"). Pathnet, at its
discretion and with Incumbent's cooperation, shall determine
the site specific location of each Interconnection Site
(including the latitude and longitude of such site). [ * * * ]
<PAGE>
4. Section 5.2: The entire Section 5.2 is deleted and replaced as follows:
5.2.1 Capacity. Pathnet shall pay to Incumbent, as consideration for
the Leased Premises:
(a) commencing on Commissioning of the Initial System and
ending at the end of the [ * * * ] after Commissioning of the
Initial System, an allocation of up to[ * * * ] (the equivalent
of [ * * * ]) on the System, with a maximum cross sectional
density of up to [ * * * ] of digital capacity, as set forth by
the Parties in the Channel Plan; provided, that Incumbent and
Incumbent's Affiliates use such allocation of DS-1's only for
their own respective internal communications needs; and
(b) commencing at the [ * * * ] after Commissioning of the
Initial System, an allocation of up to [ * * * ] (the equivalent
of [ * * * ]), with a maximum cross sectional density of up to [*
* * ] of digital capacity, as set forth by the Parties in the
Channel Plan; provided, that Incumbent and Incumbent's Affiliates
use such allocation of DS-1's only for their own respective
internal communications needs.
5.2.2 Revenue. Pathnet shall pay to Incumbent, as consideration for the
Leased Premises:
(a) commencing on Commissioning and ending at the end of the
[ * * * ] after Commissioning of the Initial System and any
Capacity Expansion, [ * * * ] of the Revenue, if any, from the
sale of PathNet Excess Capacity relating to the Initial System or
any Capacity Expansion (PathNet shall retain the remaining [ * *
* ] of such Revenue, except as required as a referral fee to be
paid by Incumbent pursuant to Section 9.2.2) on a
Segment-by-Segment basis; and
(b) commencing at the [ * * * ] after Commissioning of the
Initial System and any Capacity Expansion, [ * * * ] of the
Revenue, if any, from the sale of PathNet Excess Capacity
relating to the Initial System or any Capacity Expansion (PathNet
shall retain the remaining [ * * * ] of such Revenue except as
required as a referral fee to be paid by Incumbent pursuant to
Section 9.2.2) on a Segment-by-Segment basis.
5. Section 5.4.2: The following shall be added as a new clause at the end
of the first and second sentences of Section 5.4.2: "or with Pathnet's
ability to maintain, operate, expand or extend the System."
6. Section 9.1.4: The following shall be deleted from the second sentence
of Section 9.1.4: " to KN Field Services, Inc. which may provide,
<PAGE>
market, sell or lease circuits to its customers for the limited purpose
of monitoring data from oil and/or gas wells" and replaced with "to KN
Field Services, Inc. or any other KN Energy, Inc. subsidiary for the
purpose of providing voice or data services to such subsidiary or
customers of such subsidiary; provided such customers shall in no event
purchase greater than one (1) DS-1 of capacity."
7. Section 9.3: The following shall be added as a new sentence at the end
of Section 9.3: "If and to the extent Incumbent purchases Available
Excess Capacity, Incumbent shall receive any and all Revenue pursuant
to Section 5.2; provided, however, Incumbent shall not receive any
Revenue pursuant to Section 9.2.2."
8. Section 9.11.1: The following shall be deleted from the first sentence
of Section 9.11.1 "any and all revenue generated" and replaced with
"any and all past-due revenue generated."
9. Section 10.3: The following shall be deleted from the first sentence of
Section 10.3 "compliance with all United States" and replace with
"compliance with all requirements imposed by lessors of any of the
Facilities or sites, including the United States."
10. Section 11.3: The following shall be added as a new sentence to the end
of Section 11.3. "Incumbent shall promptly repair and replace any
damaged property to the extent reasonably necessary to permit Pathnet
to operate the System and exercise its rights and obligations
hereunder."
11. Section 13.1.6: The following shall be added as a new sentence to the
end of Section 13.1.6: "Each Party shall take all necessary steps to
keep in full force and effect any leases, licenses or other conditional
use agreements pertaining to the Facilities, site, Equipment or System
such that for the Term of this Agreement, Pathnet and Incumbent shall
have all rights reasonably necessary or appropriate to enable them to
perform their respective obligations and exercise their respective
rights hereunder."
12. Section 18.14: The following shall be deleted from the end of Section
18.14 "at least eighteen (18) months" and replaced with "at least six
(6) months."
13. SCHEDULE B: The following modifications shall be made to Schedule B:
o Delete: "Guernsey, WY 42-13-53 W104-41-12"
and replace it with: "Wheatland, WY" 42-02-33 W104-41-39
o Delete "Beacon Hill, WY 42-20-45 W105-02-11"
and replace it with: "Glendo, WY 42-27-24 W104-48-24
o Add the following at the end of Schedule B:
Interconnection Sites with facilities at the sites listed below:
Scott's Bluff, NE 41-52-30 W103-40-08
Casper, WY 42-51-0.6 W106-19-18.6
Kearney, NE 40-40-48 W99-04-58
<PAGE>
IN WITNESS WHEREOF, the undersigned have caused this Amendment to be executed by
their respective authorized representative as of the date first set above.
KN Energy, Inc.
By: /s/ Mort Aaronson
---------------------
Name: Mort Aaronson
---------------------
Title: President
Pathnet, Inc.
By: /s/ Richard A. Jalkut
---------------------
Title: President and C.E.O.
---------------------
Date: September 2, 1998
---------------------
<PAGE>
ADDENDUM A
STATEMENT OF WORK
A. KEARNEY, NE
-----------
1) SITE WORK
No additional site work is required.
2) TOWERS
Minor tower structural strengthening is expected on the 120'
self-support tower.
3) BUILDINGS
Floor space in KNT's existing building will be required.
4) GENERATORS
No emergency generator power is planned for this city terminal site.
5) DC PLANT
A new 700 AH -48 VDC power system will be required.
6) ANTENNAS
One (1) Andrew UHX6-59W antenna is required.
7) TRANSMISSION LINE
One (1) 130' run of EWP-52 waveguide is required.
8) RADIO
One (1) rack of NEC 2000 SDH 6 GHz radio is required. Radio will be
configured as a 1:1 with ATPC and no space diversity.
9) MULTIPLEX
One (1) shelf of NEC IMT-150 MUX is required. The MUX will be
configured as a terminal with twelve (12) DS-1's.
10) MISCELLANEOUS EQUIPMENT
A DSX-1 panel and Raven orderwire will be required.
<PAGE>
B. MINDEN, NE
----------
1) SITE WORK
No additional site work is required.
2) TOWERS
The new 300' tower will be utilized.
3) BUILDINGS
The existing 11.5 x 28' building will be utilized.
4) GENERATORS
The existing 25KW Generac generator will be utilized.
5) DC PLANT
The existing 900 AH -48 VDC plant will be utilized.
6) ANTENNAS
Two (2) each Andrew UHX8-59H antennas will be required.
7) TRANSMISSION LINE
Two (2) runs of EWP-52 waveguide totaling 780' will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 6 GHz radio is required. Radio will be
configured as a 1:1 with space diversity and ATPC.
9) MULTIPLEX
One (1) shelf of NEC IMT-150 MUX is required. The MUX will be
configured as a terminal with twelve (12) DS-1's.
10) MISCELLANEOUS EQUIPMENT A DSX-1 panel will be required.
<PAGE>
C. AT&T CHAPPELL, NE
-----------------
1) SITE WORK
No additional site work is required.
2) TOWERS
All tower work to be handled by AT&T.
3) BUILDINGS
Floor space in the AT&T existing building will be utilized.
4) GENERATORS
Existing emergency power will be utilized.
5) DC PLANT
AT&T existing -48 VDC system will be utilized.
6) ANTENNAS
A new Andrew UHX4-107A antenna will be required.
7) TRANSMISSION LINE
One (1) 250' run of EWP-90 waveguide will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 11 GHz radio will be required. Radio will
be configured as a 1:1 without space diversity or ATPC.
9) MULTIPLEX
One (1) shelf of Fujitsu FLM-150 MUX is required. The MUX will be
configured as a terminal with two (2) each DS-3's.
10) MISCELLANEOUS EQUIPMENT
A dual buss 20 position fuse panel and DSX-3 panel will be required. A
Raven orderwire unit will also be required.
<PAGE>
D. BIG SPRINGS, NE
---------------
1) SITE WORK
A new tower base foundation is required.
2) TOWERS
A 40' Rohn stub tower from the existing tower sections will be erected
next to the existing 300' Pirod tower.
3) BUILDINGS
All equipment will be installed in the existing building on the site.
Building modifications were completed under the backbone project.
4) GENERATORS
Generator power will be provided by the existing compressor site
generators.
5) DC PLANT
The new 900 AH -48 VDC plant will be utilized.
6) ANTENNAS
A new Andrew UHX4-107A antenna will be required.
7) TRANSMISSION LINE
One (1) 75' run of EWP-90 waveguide will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 11 GHz radio will be required. Radio will
be configured as a 1:1 without space diversity or ATPC.
9) MULTIPLEX
One (1) shelf of Fujitsu FLM-150 MUX is required. The MUX will be
configured as a terminal with two (2) each STS-1's.
10) MISCELLANEOUS EQUIPMENT
An additional 22 position DC distribution panel and 400 amp ground buss
bar is required. A DSX-3 panel will also be required.
<PAGE>
E. CASPER, WY COMPRESSOR STATION
-----------------------------
1) SITE WORK
No additional site work is required.
2) TOWERS
No additional tower strengthening is required. A new antenna pipe mount
is required.
3) BUILDINGS
A new Andrew 11.5 x 34' building will be utilized.
4) GENERATORS
The new 35KW Generac generator will be utilized.
5) DC PLANT
The new 900 AH battery plant and dual 22 position DC distribution
panels will be utilized.
6) ANTENNAS
A new Andrew UHX4-107A antenna will be required.
7) TRANSMISSION LINE
One (1) 90' run of EWP-90 waveguide will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 11 GHz radio will be required. Radio will
be configured as a 2:1 without space diversity or ATPC.
9) MULTIPLEX
One (1) shelf of Fujitsu FLM-150 MUX is required. The MUX will be
configured as a terminal with two (2) each STS-1's and 12 DS-1's.
10) MISCELLANEOUS EQUIPMENT An additional DSX-1 panel will be required.
<PAGE>
F. CASPER, WY U.S. WEST
--------------------
1) SITE WORK
No site work is expected to be required.
2) TOWERS
Roof mount antenna structure may require minor reinforcement.
3) BUILDINGS
Existing space on the second floor (AT&T) of U.S. West's four-story
building is planned.
4) GENERATORS
Existing emergency generator owned by U.S. West is planned.
5) DC PLANT
-48 VDC power is expected to be provided by AT&T.
6) ANTENNAS
A new Andrew UHX4-107A antenna will be required.
7) TRANSMISSION LINE
One (1) 100' run of EWP-90 waveguide will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 11 GHz radio will be required. Radio will
be configured as a 2:1 without space diversity or ATPC.
9) MULTIPLEX
One (1) shelf of Fujitsu FLM-150 MUX is required. The MUX will be
configured as a terminal with two (2) each DS-3's and 12 DS-1's.
10) MISCELLANEOUS EQUIPMENT
A DSX-1 and DSX-3 path panel along with a dual buss fuse panel and
Raven orderwire will be required.
<PAGE>
G. SCOTTSBLUFF, NE M/W SITE
------------------------
1) SITE WORK
No additional site work will be required.
2) TOWERS
No tower strengthening required.
3) BUILDINGS
The new Andrew 11.5 x 28' shelter will be utilized for the additional
radio and MUX equipment.
4) GENERATORS
The new 25KW Generac generator will be utilized.
5) DC PLANT
The existing 900 AH battery plant and dual 22 position DC distribution
panels will be utilized.
6) ANTENNAS
A new Andrew UHX4-107A antenna will be utilized at 100' AGL on the
tower.
7) TRANSMISSION LINE
One (1) 115' run of EWP-90 waveguide will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 11 GHz radio will be required. Radio will
be configured as a 2:1 without space diversity or ATPC.
9) MULTIPLEX
One (1) shelf of Fujitsu FLM-150 MUX is required. The MUX will be
configured as a terminal with two (2) each STS-1's and 12 DS-1's.
10) MISCELLANEOUS EQUIPMENT An additional DSX-1 panel will be required.
<PAGE>
H. SCOTTSBLUFF, NE SPRINT UNITED
-----------------------------
1) SITE WORK
No site work will be required.
2) TOWERS
A tower analysis by a Sprint approved contractor is required. An
extended waveguide bridge is to be provided by Sprint.
3) BUILDINGS
Sprint United will provide a 10' x 10' secured area with 24' x 7'
access within their existing building.
4) GENERATORS
Emergency power to be provided by Sprint United.
5) DC PLANT
Dual 30 amp -48 VDC "A" & "B" buss power will be provided by Sprint
United.
6) ANTENNAS
One (1) Andrew UHX4-107A antenna will be required.
7) TRANSMISSION LINE
One (1) 150' run of EWP-90 waveguide will be required.
8) RADIO
One (1) rack of NEC 2000 SDH 11 GHz radio will be required. Radio will
be configured as a 2:1 without space diversity or ATPC.
9) MULTIPLEX
One (1) shelf of Fujitsu FLM-150 MUX is required. The MUX will be
configured as a terminal with 68 DS-1's.
10) MISCELLANEOUS EQUIPMENT
A dual buss fuse panel, DSX-1 panel, Raven orderwire, and DSX-3 panel
will be required.
Exhibit 10.2
AMENDMENT TO LICENSE AGREEMENT
By and Between
Pathnet, Inc. and American Tower Corporation
Dated July 23, 1998
In further consideration of the mutual promises contained in the License
Agreement, dated July 23, 1998, by and between Pathnet, Inc. and American Tower
Corporation, the parties hereby agree to amend EXHIBIT A to include the
additional locations and use of towers as set forth in the attachment hereto.
Agreed to and accepted as of
- ----------------------------
the date written below:
AMERICAN TOWER CORPORATION
By: /s/ D.G. Norman
--------------------
Name: D.G. Norman
Title: Vice President
Date: September 24, 1998
PATHNET, INC.
By: /s/ Richard A. Jalkut
---------------------
Name: Richard A. Jalkut
Title: President & CEO
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
Exhibit 27.1
<ARTICLE> 5
<LEGEND>
The schedule contains summary financial information extracted from the Company's
balance sheet as of September 30, 1998 and the Statements of Operations for the
nine months ended September 30, 1998 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<CIK> 0001061148
<NAME> Pathnet, Inc.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 59,559
<SECURITIES> 122,658
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 186,321
<PP&E> 33,507
<DEPRECIATION> 371
<TOTAL-ASSETS> 393,132
<CURRENT-LIABILITIES> 36,802
<BONDS> 346,110
35,970
0
<COMMON> 29
<OTHER-SE> (25,779)
<TOTAL-LIABILITY-AND-EQUITY> 393,132
<SALES> 1,050
<TOTAL-REVENUES> 1,050
<CGS> 5,386
<TOTAL-COSTS> 5,386
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,862
<INCOME-PRETAX> (25,015)
<INCOME-TAX> 0
<INCOME-CONTINUING> (25,015)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (25,015)
<EPS-PRIMARY> (8.62)
<EPS-DILUTED> (8.62)
</TABLE>
Exhibit 99.1
FOR IMMEDIATE RELEASE Contact: Laurie Parker or
November 4, 1998 JuliAnne Forrest
(202) 333-0700
PATHNET TAPS BOB FERRY AS
CHIEF INFORMATION OFFICER
Washington, D.C. - Pathnet today announced Bob Ferry as Chief Information
Officer (CIO). Mr. Ferry, formerly Chief Technology Officer for Sector
Communications, brings over 16 years of telecommunications, technology and
corporate development experience to Pathnet's growing management team.
Pathnet is fast becoming a leading provider of high-quality, low cost, long
haul telecommunications capacity to second- and third-tier U.S. markets by
upgrading existing wireless infrastructure to a state-of-the-art SONET network.
As CIO, Mr. Ferry will be responsible for developing and managing Pathnet's
information technology architecture strategy and planning processes associated
with systems expansion. "Bob's experience will be instrumental in developing and
managing Pathnet's strategic information systems to maximize business
effectiveness," said Dick Jalkut, President and CEO.
During his tenure at Sector Communications, Mr. Ferry set the technical
direction for two European subsidiaries: a fiber optic telecommunications
services provider, and a developer of distributed systems management software.
He also managed all local-area-network and data communications systems for the
U.S. office, and oversaw all U.S. marketing and sales efforts.
(more)
<PAGE>
-2-
Prior to his work with Sector, Mr. Ferry was the President and Founder of
Insight Information, where he advised companies on how to maximize information
technologies as competitive business tools. Insight Information specialized in
evaluating new communications and computing products, technologies, vendors and
services for potential use by client companies.
Before starting Insight Information, Mr. Ferry was Director of Information
Systems for Temps & Co., where he managed all aspects of technology, computing,
telecommunications, systems and information services staff for fourteen sites in
five states. Previously, Mr. Ferry served as Senior Systems Engineer for
Spectrum Analysis & Frequency Engineering and as Systems Engineer for DDL-Omni
Engineering.
As of the beginning of June, 49 companies, controlling over 95,000 route
miles of private microwave communications systems, have authorized Pathnet in
writing to prepare preliminary engineering evaluations of their networks.
Pathnet is positioning itself primarily as a "carriers' carrier" to provide a
high-capacity, dedicated network to interexchange carriers, local exchange
carriers, Internet service providers, Regional Bell Operating Companies,
cellular operators and resellers. Pathnet headquarters are located in
Washington, D.C., at 1015 31st Street, N.W., Washington, D.C., 20007. For
additional information about Pathnet, visit the company website located at
www.pathnet.net.
This press release contains some matters that are forward-looking
statements. The reader is cautioned that these forward-looking statements, such
as plans to sign additional agreements with private network operators; offer
services to telecom service providers; build a digital network; and statements
regarding the development of Pathnet's business, and other statements contained
herein regarding matters that are not historical facts, are only predictions. No
assurance can be given that the future results will be achieved; actual events
may differ materially as a result of risks facing Pathnet. For a discussion of
factors that could affect the forward-looking statements, see Pathnet's public
filings on file with the Securities and Exchange Commission.
Exhibit 99.2
PRESS RELEASE
Contacts:
Becky Haight, Investor Relations
1-202-295-3292
Kye Presley-Dowd, Media
1-202-625-7284
PATHNET REPORTS THIRD QUARTER RESULTS
WASHINGTON, DC, NOVEMBER 10, 1998--Pathnet, Inc., a privately-held wholesale
provider of high-quality, low-cost telecommunications capacity to second- and
third-tier markets, today announced its results for the quarter ended September
30, 1998. The company reported revenue of $475,000, earnings before interest,
taxes, depreciation and amortization (EBITDA) losses of $3.8 million, and a net
loss of $11.9 million for the quarter. As a development stage enterprise,
year-over-year comparisons of Pathnet's financials may not serve as a meaningful
indication of the company's progress or future financial performance.
Pathnet is executing its operating plan to build a digital network by upgrading,
integrating and leveraging existing telecommunications assets, sites and rights
of way, including those utilized by railroads, utility and pipeline companies,
and state and local governments (stategic partners). Substantially all of the
company's revenue for the three and nine month periods ended September 30, 1998
is derived from construction management services for strategic partners. With
the recent activation of Pathnet's first customers and the imminent completion
of several additional network routes, the company expects to begin reporting
revenue from the sale of telecommunications services in the fourth quarter.
In addition to third quarter operating expenses of $4.5 million, the company
recorded a one-time charge of $1.4 million in costs related to the company's
postponed initial public offering. As a result of general weakness in the
capital markets, Pathnet elected to postpone its planned IPO in August 1998.
Operating expenses for the third quarter resulted primarily from costs
associated with Pathnet's priority focus on sales and marketing efforts and
network construction management.
During the quarter, Pathnet announced a contract with the Burlington Northern
Santa Fe Railroad (BNSF) to initiate construction to overbuild its private
microwave system from Chicago, Illinois to St. Paul, Minnesota. BNSF owns one of
the largest private networks in the United States.
Commenting on the company's results, Pathnet president and chief executive
officer, Dick Jalkut said, "We're extremely pleased with our progress and
development through all three quarters of this year. Despite our start-up
status, we've succeeded in greatly enhancing our credibility with both our
strategic partners and our targeted carrier market. In addition, we've
solidified our management team, built out our sales and operations
infrastructure, and delivered on our first contract with a major carrier. The
Burlington Northern contract is another significant step along the way and each
of these successes has a measurable impact on our momentum going forward." he
added.
As of September 30, 1998, the company had over $250 million in cash and
marketable securities available for its use. That amount does not include
approximately $81 million in pledged securities set aside to service interest
payments to bondholders through April, 2000. Capital expenditures for the third
quarter were $18.4 million, bringing total plant and equipment deployed to $33.5
million. Capital expenditures are expected to continue to increase as Pathnet
progresses with the build-out of its network.
Company Highlights for the Third Quarter
o Contract with Burlington Northern Santa Fe to over-build its
private network from Chicago, Illinois to St. Paul, Minnesota.
o First order with a major carrier.
o Completed 400 route miles of network, bringing total route
miles completed to 1,200.
o Added 1,400 additional route miles to construction schedule,
bringing total route miles under construction to 5,500.
This press release contains some matters that are forward-looking statements.
The reader is cautioned that these forward-looking statements, such as plans to
sign additional agreements with private network operators; offer services to
telecom service providers; build a digital network; and statements regarding the
development of Pathnet's business, and other statements contained herein
regarding matters that are not historical facts, are only predictions. No
assurance can be given that the future results will be achieved; actual events
may differ materially as a result of risks facing Pathnet. For a discussion of
factors that could affect the forward-looking statements, see Pathnet's public
filings on file with the Securities and Exchange Commission.
<PAGE>
PATHNET, INC.
(A Development Stage Enterprise)
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In thousands except per share data)
.
<TABLE>
For the three months For the nine months
ended ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue $ 475 $ -- $ 1,050 $ 63
-------- -------- -------- --------
Expenses:
Cost of revenue 1,621 -- 5,386 --
Selling, general and administrative 2,695 1,188 6,722 2,538
Depreciation expense 204 11 315 27
-------- -------- -------- --------
Total expenses 4,520 1,199 12,423 2,565
-------- -------- -------- --------
Net operating loss (4,045) (1,199) (11,373) (2,502)
Interest expense (11,151) -- (21,862) --
Interest income 4,729 23 9,574 60
Initial public offering costs (1,355) -- (1,355) --
Other income, net 2 -- 1 --
-------- -------- -------- --------
Net loss $(11,820) $ (1,176) $(25,015 $ (2,442)
======== ======== ======== ========
Basic and diluted loss per
Common share $ (4.07) $ (0.41) $ (8.62) $ (0.84)
======== ======== ======== ========
Weighted average number of
Common shares outstanding 2,902 2,900 2,902 2,900
===== ===== ===== =====
Other Data:
EBITDA (3,841) (1,188) (11,058) (2,475)
====== ====== ======= ======
</TABLE>
<PAGE>
PATHNET, INC.
(A Development Stage Enterprise)
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
September 30, December 31,
1998 1997
---- ----
(Unaudited)
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 59,559 $ 7,831
Marketable securities available for sale, at market 122,658 --
Other current assets 4,105 49
------------- -------------
Total current assets 186,322 7,880
Property and equipment, net 33,136 7,207
Deferred financing costs, net 10,792 251
Restricted cash 10,647 760
Marketable securities available for sale, at market 69,011 --
Pledged marketable securities held to maturity 83,224 --
------------- -------------
Total assets $ 393,132 $ 16,098
============= =============
LIABILITIES, MANDATORILY REDEEMABLE
PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Accounts payable $ 14,159 $ 5,593
Accrued interest 20,485 -
Other current liabilities 2,158 300
------------- -------------
Total current liabilities 36,802 5,893
Bonds payable, net of unamortized bond discount of $3,890,250 346,110 -
Total mandatorily redeemable preferred stock 35,970 15,970
Total stockholders' deficit (25,750) (5,765)
------------- -------------
Total liabilities, mandatorily redeemable preferred stock and $ 393,132 $ 16,098
============= =============
stockholders' deficit
</TABLE>
Selected statistical data:
Route miles under construction 5,500
Route miles complete 1,200
