<PAGE>
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 June 30, 1999
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 /x/ No / /
As of August 9, 1999, there were 2,906,860 shares of the Issuer's common stock,
par value $.01 per share, outstanding.
<PAGE>
PATHNET, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of June 30, 1999 (unaudited) and
December 31, 1998 3
Unaudited Consolidated Statements of Operations for the three and six months
ended June 30, 1999 and 1998 and for the period August 25, 1995 (date of
inception) to June 30, 1999 4
Unaudited Consolidated Statements of Comprehensive Income (Loss) for
the three and six months ended June 30, 1999 and 1998 and for the
period August 25, 1995 (date of inception) to June 30, 1999 5
Unaudited Consolidated Statements of Cash Flows for the six months
ended June 30, 1999 and 1998 and for the period August 25, 1995
(date of inception) to June 30, 1999 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 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 2. Changes in Securities and Use of Proceeds 31
Item 3. Defaults Upon Senior Securities 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 5. Other Information 31
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. AND SUBSIDIARIES
(DEVELOPMENT STAGE ENTERPRISES)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
(UNAUDITED)
------------- -------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 133,873,303 $ 57,321,887
Note receivable -- 3,206,841
Interest receivable 1,526,948 3,848,753
Marketable securities available for sale, at market 37,139,322 97,895,773
Prepaid expenses and other current assets 1,036,619 205,505
------------- -------------
Total current assets 173,576,192 162,478,759
Property and equipment, net 83,953,304 47,971,336
Deferred financing costs, net 9,980,583 10,508,251
Restricted cash 7,890,070 10,731,353
Marketable securities available for sale, at market 33,608,139 71,899,757
Pledged marketable securities held to maturity 41,775,320 61,824,673
Other assets 189,646 --
------------- -------------
Total assets $ 350,973,255 $ 365,414,129
------------- -------------
------------- -------------
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable $ 19,714,034 $ 10,708,263
Accrued interest 8,932,294 8,932,294
Accrued expenses and other current liabilities 1,342,003 639,688
------------- -------------
Total current liabilities 29,988,331 20,280,245
12 1/4% Senior Notes, net of unamortized bond discount of $3,583,125 and $3,787,875
respectively 346,416,875 346,212,125
Other non-current liabilities 184,388 --
------------- -------------
Total liabilities 376,589,595 366,492,370
------------- -------------
Series A convertible preferred stock, $0.01 par value, 1,000,000 shares authorized, issued
and outstanding at June 30, 1999 and December 31, 1998, 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 June 30, 1999 and December 31, 1998, 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, issued
and outstanding at June 30, 1999 and December 31, 1998, respectively (liquidation
preference $30,000,052) 29,961,272 29,961,272
------------- -------------
Total mandatorily redeemable preferred stock 35,969,639 35,969,639
------------- -------------
Common stock, $0.01 par value, 60,000,000 shares authorized at June 30, 1999 and
December 31, 1998, respectively; 2,906,860 and 2,902,358 shares issued and
outstanding at June 30, 1999 and December 31, 1998, respectively 29,068 29,024
Deferred compensation (709,912) (978,064)
Additional paid-in capital 6,161,450 6,156,406
Accumulated other comprehensive (loss) income (121,224) 208,211
Deficit accumulated during the development stage (66,945,361) (42,463,457)
------------- -------------
Total stockholders' equity (deficit) (61,585,979) (37,047,880)
------------- -------------
Total liabilities, mandatorily redeemable preferred stock and stockholders' equity (deficit) $ 350,973,255 $ 365,414,129
------------- -------------
------------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
PATHNET, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE ENTERPRISES)
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE THREE MONTHS ENDED FOR THE SIX MONTH AUGUST 25, 1995
JUNE 30, JUNE 30, (DATE OF INCEPTION)
----------------------------- ----------------------------- TO JUNE 30,
1999 1998 1999 1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenue $ 864,815 $ 475,000 $ 1,690,919 $ 575,000 $ 3,437,958
------------ ------------ ------------ ------------ ------------
Operating expenses:
Cost of revenue 2,669,255 3,019,928 5,320,455 3,764,507 12,868,075
Selling, general and administrative 3,507,704 2,473,078 6,303,064 4,027,357 21,928,413
Depreciation expense 1,033,300 111,522 1,570,939 111,522 2,359,770
------------ ------------ ------------ ------------ ------------
Total operating expenses 7,210,259 5,604,528 13,194,458 7,903,386 37,156,258
------------ ------------ ------------ ------------ ------------
Net operating loss (6,345,444) (5,129,528) (11,503,539) (7,328,386) (33,718,300)
Interest expense (10,060,626) (9,868,348) (20,330,837) (9,868,348) (53,318,648)
Interest income 3,378,137 4,488,172 7,192,745 4,002,189 21,307,981
Write-off of initial public offering costs -- -- -- -- (1,354,534)
Other income (expense), net 71,631 -- 159,727 -- 157,140
------------ ------------ ------------ ------------ ------------
Net loss $(12,956,302) $(10,509,704) $(24,481,904) $(13,194,545) $(66,926,361)
------------ ------------ ------------ ------------ ------------
Basic and diluted loss per
common share $ (4.46) $ (3.62) $ (8.43) $ (4.55) $ (23.07)
------------ ------------ ------------ ------------ ------------
Weighted average number of
common shares outstanding 2,905,383 2,902,358 2,904,166 2,901,693 2,901,214
------------ ------------ ------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
PATHNET, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE ENTERPRISES)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED AUGUST 25, 1995
JUNE 30, JUNE 30, (DATE OF INCEPTION)
----------------------------- ----------------------------- TO JUNE 30,
1999 1998 1999 1998 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net loss $(12,956,302) $(10,509,704) $(24,522,639) $(13,194,545) $(66,926,361)
Other comprehensive income (loss):
Net unrealized gain (loss) on marketable
securities available for sale (195,544) (51,855) (329,435) (51,855) (121,224)
------------ ------------ ------------ ------------ ------------
Comprehensive loss $(13,151,846) $(10,561,559) $(24,852,074) $(13,246,400) $(67,047,585)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
PATHNET, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE ENTERPRISES)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE SIX MONTHS ENDED AUGUST 25, 1995
JUNE 30, (DATE OF INCEPTION)
------------------------------- JUNE 30,
1999 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (24,481,904) $ (13,194,545) $ (66,926,361)
Adjustment to reconcile net loss to net cash used in operating activities
Depreciation expense 1,570,939 111,522 2,359,770
Amortization of deferred financing costs 568,403 278,444 1,411,193
Loss on disposal of asset -- -- 5,500
Write-off of deferred financing costs -- 337,910 581,334
Interest expense resulting from amortization of discount on the
bonds payable 204,750 102,375 511,875
Amortization of premium on pledged securities 315,738 -- 315,738
Stock based compensation 268,152 277,035 969,447
Interest expense for beneficial conversion feature of bridge loan -- -- 381,990
Accrued interest satisfied by conversion of bridge loan to
Series B convertible preferred stock -- -- 33,367
Changes in assets and liabilities:
Interest receivable 2,321,805 (4,371,634) (2,525,147)
Prepaid expenses and other assets (831,114) (302,884) (1,036,619)
Accounts payable (549,190) 140,477 (41,576)
Accrued interest -- 9,765,973 8,932,294
Accrued expenses and other liabilities 348,887 1,735,073 988,574
------------- ------------- -------------
Net cash used in operating activities (20,263,534) (5,120,254) (54,038,621)
------------- ------------- -------------
Cash flows from investing activities:
Expenditures for network in progress (27,294,121) (6,560,612) (62,653,245)
Expenditures for property and equipment (355,655) (1,265,533) (3,561,548)
Sale of marketable securites 98,718,634 -- 98,718,634
Purchase of marketable securities available for sale -- (157,153,445) (169,587,319)
Purchase of marketable securities - pledged as collateral -- (80,829,045) (83,097,655)
Maturity and sale of marketable securities - pledged as collateral 19,733,615 -- 42,004,796
Restricted cash 2,841,283 467,931 (7,890,070)
Repayment of note receivable 3,206,841 9,000 9,000
------------- ------------- -------------
Net cash provided by (used in) investing activities 96,850,597 (245,331,704) (186,057,407)
------------- ------------- -------------
Cash flows from financing activities:
Issuance of voting and non-voting common stock -- -- 1,000
Proceeds from sale of preferred stock -- -- 35,000,052
Proceeds from sale of Series B convertible preferred stock representing the
conversion of committed but undrawn portion of bridge loan to Series B
convertible preferred stock -- 19,999,998 300,000
Proceeds from bond offering -- 350,000,000 350,000,000
Proceeds from bridge loan -- -- 700,000
Exercise of employee common stock options 5,088 81 5,169
Payment of issuance costs for preferred stock offerings -- (256,250) (63,780)
Payment of deferred financing costs (40,735) (11,301,859) (11,973,110)
------------- ------------- -------------
Net cash provided by (used in) financing activities (35,647) 358,441,970 373,969,331
------------- ------------- -------------
Net increase in cash and cash equivalents 76,551,416 107,990,012 133,873,303
Cash and cash equivalents at the beginning of period 57,321,887 7,831,384 --
------------- ------------- -------------
Cash and cash equivalents at the end of period $ 133,873,303 $ 115,821,396 $ 133,873,303
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
6
<PAGE>
1. THE COMPANY
Pathnet, Inc. (Company) is a privately-held carrier's carrier,
providing digital telecommunications capacity to under-served and second- and
third-tier U.S. markets. Pathnet offers telecommunications service to
inter-exchange carriers, local exchange carriers, internet service providers,
Regional Bell Operating Companies, cellular operators and resellers.
During the second quarter of 1999, Pathnet continued to construct and
deploy digital networks utilizing both wireless and fiber-optic technologies.
Pursuant to its agreement with Worldwide Fiber USA (WFI), the Company began to
construct and market a multi-conduit fiber-optic network between Chicago,
Illinois and Denver, Colorado during the second quarter (See note 9 to these
Financial Statements).
As of June 30, 1999, the Company had approximately 3,900 route miles of
completed network and approximately 3,800 route miles of network under
construction.
The Company's business is funded primarily through equity investments
by the Company's stockholders and $350.0 million aggregate principal amount of
12 1/4% Senior Notes due 2008 (Senior Notes) which have been registered under
the Securities Act of 1933, as amended.
A substantial portion of the Company's activities to date has involved
developing strategic relationships with railroads, pipelines, utilities and
state and local governments (Incumbents) and building its network. Accordingly,
a majority of its revenues to date reflect only certain consulting and advisory
services in connection with the design, development and construction of digital
microwave infrastructure. The remainder of its revenues to date (approximately
34.3 per cent) has been derived from the sale of bandwidth along the Company's
digital network. 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.
2. BASIS OF ACCOUNTING
While the Company recently commenced providing telecommunication
services to customers and recognizing the revenue from the sale of such
telecommunication services, its principal activities to date have been securing
contractual alliances with Incumbents and partners, designing and constructing
networkpaths, 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.
7
<PAGE>
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 June 30, 1999, 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. These unaudited consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the period ended December 31, 1998
filed with the Securities and Exchange Commission. The results of operations for
the three and six months ended June 30, 1999 are not necessarily indicative of
the operating results to be expected for the full year.
3. REVENUE RECOGNITION
The Company earns revenue from the sale of telecommunications capacity
and for project management and consulting services. Revenue from the sale of
telecommunications capacity is earned when the service is provided. Revenue for
project management and consulting services is recognized based on the percentage
of the services completed. The Company defers revenue when contractual payments
are received in advance of the performance of services.
Revenue from the sale of telecommunications capacity includes revenue
earned under indefeasible right of use agreements. The Company recognizes
revenue under such agreements on a straight-line basis over their term.
4. LOSS PER SHARE
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 exercise of 3,264,961 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
15,864,715 shares of Common Stock as of June 30, 1999, 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.
5. MARKETABLE SECURITIES
Certain of 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 part of
accumulated other comprehensive income. 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 June
30, 1999:
<TABLE>
<CAPTION>
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 $ 36,176,664 $ 1,083 $ 51,492 $ 36,126,255
Certificates of deposit and money market
funds 2,882,939 -- 19,641 2,863,298
Corporate debt securities 31,809,082 183 51,357 31,757,908
---------------- ---------- ----------- ------------
$ 70,868,685 $ 1,266 $ 122,490 $ 70,747,461
---------------- ---------- ----------- ------------
---------------- ---------- ----------- ------------
</TABLE>
Gross realized gains on sales of available for sale securities were
approximately $72,000 during the three and six months ended June 30, 1999.
9
<PAGE>
The amortized cost and estimated fair value of available for sale
securities by contractual maturity at June 30, 1999 is as follows:
<TABLE>
<CAPTION>
COST MARKET VALUE
--------------- ---------------
<S> <C> <C>
Due in one year or less $ 37,191,270 $ 37,139,322
Due after one year through two years 33,677,415 33,608,139
--------------- ---------------
$ 70,868,685 $ 70,747,461
--------------- ---------------
--------------- ---------------
</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 and are classified as
non-current assets on the consolidated balance sheet. As of June 30, 1999,
pledged marketable securities consisted of U.S. Treasury securities classified
as held to maturity with an amortized cost of approximately $41.0 million and
interest receivable on the pledged marketable securities of approximately $0.8
million. All of the investments contractually mature by March 31, 2000.
6. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, is comprised of the following
at June 30, 1999 and December 31, 1998:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------------- ------------------
<S> <C> <C>
Network in progress $ 43,927,570 $ 38,669,088
Communications network 38,788,289 6,890,686
Office and computer equipment 2,647,243 2,267,647
Furniture and fixtures 768,528 766,013
Leasehold improvements 181,444 166,733
----------------- ------------------
86,313,074 48,760,167
Less: accumulated depreciation (2,359,770) (788,831)
----------------- ------------------
Property and equipment, net $ 83,953,304 $ 47,971,336
----------------- ------------------
----------------- ------------------
</TABLE>
Network in progress includes (i) all direct material and labor costs
incurred on the construction of the network together with related allocable
interest costs, necessary to construct components of a high capacity digital
network which is owned and maintained by the Company, and (ii) network related
inventory of parts and equipment. The Network in progress balance on June 30,
1999 includes
10
<PAGE>
approximately $3.1 million for costs incurred under the Company's
agreement with WFI to construct a digital fiber optic network and $2.4 million
for a right of use under an agreement with Northern Border Pipeline for
microwave access. When a portion of the network has been completed and made
available for use by the Company, the accumulated costs are transferred from
network in process to communications network.
7. RESTRICTED CASH
Restricted cash comprises amounts held in escrow to secure the
Company's obligations under certain of its Fixed Point Microwave Services
Agreements. The funds in each escrow account are available only to fund the
project to which the escrow is related until such project has been completed, at
which time surplus funds will be returned to the Company. Generally, funds are
released from escrow to pay project costs when such costs incurred and agreed
upon under the contract. During the three months ended June 30, 1999,
approximately $3.1 million was released from escrow.
8. COMMITMENTS AND CONTINGENCIES
As of June 30, 1999, the Company had capital commitments of up to
approximately $87.5 million relating to purchases of telecommunication and
transmission equipment and its agreement with WFI. (See note 9 to these
Financial Statements).
9. FIBER AGREEMENT
On March 31, 1999, the Company signed two agreements with WFI to
construct and market a multi-conduit fiber-optic network between Chicago,
Illinois and Denver, Colorado. The total shared projected cost for this project
is in excess of $100 million. The 1,100-mile network between Chicago and Denver
will pass through Des Moines, Iowa; Omaha, Nebraska; and Lincoln, Nebraska. WFI
will lead-manage the project with construction to be completed in two segments.
The first segment, Chicago to Omaha, is expected to be complete in late 1999
with the second segment, Omaha to Denver, scheduled to come on line in 2000.
10. SUBSEQUENT EVENT
On August 6, 1999, the Company announced a co-development agreement
with Tri-State Generation and Transmission Association, Inc. (Tri-State), to
construct a 400-mile fiber network connecting Grand Junction, Colorado to
Albuquerque, New Mexico. The total projected combined cost for this route is
approximately $40 million. Tri-State and some of its member cooperatives will
contribute up to 50% of the network build costs.
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. "FORWARD-LOOKING STATEMENTS" BELOW.
OVERVIEW
During the first quarter of 1999, Pathnet expanded its business
strategy to include construction and deployment of digital networks utilizing
both wireless and fiber-optic technologies. The decision to incorporate
fiber-optic technologies into existing plans for a nationwide network was made
to satisfy demand from potential customers for high-bandwidth facilities.
Due to Pathnet's focus to date on developing its network, the majority
of its revenues to date reflect certain consulting and project management
services in connection with the design, development and construction of digital
microwave infrastructure. The remaining portion of its revenues has resulted
from the sale of bandwidth services along its network. 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.
WORLDWIDE FIBER AGREEMENT
The Company continued to focus on developing its network in the second
quarter of 1999. The Company entered into agreements with Worldwide Fiber USA
(formerly known as Pacific Fiber Link, LLC) ("WFI") in March 1999 to construct
and market a multi-conduit fiber-optic network between Chicago, Illinois and
Denver, Colorado. The 1,100-mile network will pass through Des Moines, Iowa;
Omaha, Nebraska; and Lincoln, Nebraska.
RESULTS OF OPERATIONS
During the three months ended June 30, 1999, the Company continued to
focus on (i) developing relationships with railroads, pipelines, utilities and
state and local governments (collectively, "Incumbents") and partners, (ii) the
buildout of its network and (iii) the development of its infrastructure
including the hiring of key management personnel.
REVENUE
For the three months ended June 30, 1999 and 1998, the Company
generated revenues of approximately $865,000 and $475,000, respectively. For the
three months ended June 30, 1999, the Company generated revenue from the sale of
telecommunications services of approximately $574,000, together with revenue
from consulting and advisory services in connection with the design, development
and construction of digital microwave infrastructure of approximately $291,000.
For the three months ended June 30, 1998, the Company's revenue consisted
primarily of revenue from consulting and advisory services. For the six months
ended June 30, 1999 and 1998, the Company generated revenue of approximately
$1,691,000 and $575,000, respectively. This increase is attributable to revenues
from telecommunications services, which were $1,150,000 in 1999 with no
corresponding revenue in 1998.
12
<PAGE>
The Company expects that the majority of future revenue will be generated from
the sale of telecommunications services.
OPERATING EXPENSES
For the three months ended June 30, 1999 and 1998, the Company incurred
operating expenses of approximately $7.2 million and $5.6 million, respectively.
For the six months ended June 30, 1999 and 1998, the Company incurred
operating expenses of approximately $13.2 million and $7.9 million,
respectively. The increase in both periods is primarily a result of the
continued 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 1999 as additional staff is added. 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 June 30, 1999 and 1998 was
approximately $10.1 million and $9.9 million, respectively. Interest expense for
the six months ended June 30, 1999 and 1998 was approximately $20.3 million and
$9.9 million, respectively. Interest expense primarily represents interest on
the Company's 12 1/4% Senior Notes due 2008 issued in April 1998 (the "Senior
Notes") together with the amortization expense related to bond issuance costs in
respect of the Senior Notes.
INTEREST INCOME
Interest income for the three months ended June 30, 1999 and 1998 was
approximately $3.4 million and $4.5 million, respectively. The decrease in
interest income reflects a decrease in cash and cash equivalents and marketable
securities as those funds were used in building the Company's network and
funding operations. Interest income for the six months ended June 30, 1999 and
1998 was approximately $7.2 million and $4.0 million, respectively. The increase
in interest income is a result of the funds from the Senior Notes generating
income over a six month period versus a three month period in 1998.
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, implementation of the Company's
sales and marketing strategy and constructing and improvement of the Company's
Network Operations Center. During the first six months of 1999, cash used in
operations was $19.5 million; cash provided by investing activities was $96.1
million, including the sale of marketable securities of $98.7 million, partially
offset by $28.1 million of capital expenditures.
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As of June 30, 1999, the Company had capital commitments of
approximately $87.5 million relating to telecommunications and transmission
equipment and its agreement with WFI. It is anticipated that these will be met
with current resources of the Company and with the sale of dark and lit fiber
capacity.
As of June 30, 1999, the Company had approximately $204.6 million of
cash, cash equivalents and marketable securities classified as available for
sale to fund future operations. The Company expects these resources will be
sufficient to fund the implementation of the Company's business plan through
June 30, 2000.
After such time, the Company expects to be required to procure
additional financing which may include commercial bank borrowings, additional
vendor financing or the sale or issuance of equity or debt securities. There can
be no assurance the Company will be successful in raising sufficient capital or
in obtaining such financing on terms acceptable to the Company.
Pursuant to a Commitment Letter between Lucent Technologies, Inc.
("Lucent") and the Company that was executed in connection with the supply
agreement between Lucent and the Company (the "Commitment Letter"), Lucent may
provide financing of up to approximately $400 million for fiber purchases for
the construction of the Company's network and may provide or arrange financing
for future phases of such network. Under the terms of the Commitment Letter, the
total amount of financing provided by Lucent will not exceed $1.8 billion of the
$2.1 billion potential value of the supply agreement. Certain material terms of
the Company's agreements with Lucent, including the terms of the Commitment
Letter, are currently under review by Lucent and the Company. There can be no
assurance that the transactions, including the financing contemplated by
Commitment Letter, will be consummated at all or consummated on the terms
described above. 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.
Because the Company's cost of designing and building 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 and products 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.
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.
In the fourth quarter of 1998, the Company began a corporate-wide
program to ready its technology systems and non-technology systems and software
applications for the Year 2000. The
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Company's objective is to target Year 2000 compliance for all of its
systems, including network and customer interfacing systems, and has grouped
these systems into one of six compliance areas: Network Architecture, Internal
Infrastructure, Software Applications, Financial Relationships, Supply-Chain
Relationships and Customer Relationships. Because the Company has operated for
only a few years, few legacy systems or applications exist. However, the Company
has identified all systems and applications that may need to be modified or
reprogrammed in order to achieve Year 2000 compliance and is working towards
implementing any necessary changes and expects to complete this process by the
end of the third quarter of 1999.
Inventory, assessment and remediation of mission critical software
applications is substantially complete. Inventory and assessment of mission
critical hardware systems, including network computing and network systems
engineering, is also substantially complete. Testing and deployment of upgrades
necessary to complete remediation of mission critical systems is expected to be
completed by September 30, 1999. The Company is currently formulating
contingency plans in the event that certain of its suppliers or service
providers may not be Year 2000 compliant. These plans will continue to be
developed and tested throughout 1999.
As part of its Year 2000 plan, the Company has requested confirmation
from its communications equipment vendors and other key suppliers, financial
institutions and customers that their systems will be Year 2000 compliant.
Responses received to-date indicate a high level of Year 2000 compliance at
these companies, however, there can be no assurance that the systems of
companies with which the Company does business will be Year 2000 compliant. The
Company expects to continue to receive additional responses in the next quarter.
If the vendors important to the Company fail to provide needed products and
services, the Company's network buildout and operations could be affected and
thereby have a material adverse effect on the Company's results of operations,
liquidity and financial condition. Moreover, to the extent that significant
customers are not Year 2000 compliant and that affects their network needs, the
Company's sales could be lower than otherwise anticipated.
The Company's expenditures to implement its Year 2000 plan have not
been material to date and it does not believe its future expenditures on this
matter will be material. Because its existing systems are relatively new, it
does not expect that it will have to replace any of its systems. To the extent
it would have to replace a significant portion of its technology systems, its
expenditures could have material adverse effect on the Company. The Company has
hired outside consultants to assist it with its Year 2000 compliance, but the
Company has relied primarily on its existing employees to develop and implement
its Year 2000 compliance strategy. As a result, its expenditures to ensure Year
2000 compliance have not been material to date. The Company expects to continue
to use existing employees for the significant part of its Year 2000 compliance
efforts.
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 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
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"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 fact 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 be 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 products and services; the ability of the
Company to implement its newly expanded business plan; 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 ability of the Company to obtain and maintain rights-of-way for the
deployment of 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. The Company does not intend to update these forward-looking
statements. These and other risks and uncertainties affecting the Company are
discussed in greater detail in the Company's 1998 Annual Report on Form 10-K.
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. As of June 30, 1999, the Company had approximately 3,900 route
miles of completed network and approximately 3,800 route miles of network under
construction. In addition, as of June 30, 1999, the Company was only providing
commercial telecommunications service to six customers with several additional
customers awaiting installation. There can be no assurance that the Company will
enter into any additional contracts with Incumbents or other owners of
telecommunications assets to obtain rights-of-way or rights to sites, towers and
other assets for the construction of additional network or with customers for
the purchase and sale of bandwidth services, dark or dim fiber or other related
services. 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 $66.9 million and cumulative net
losses before interest income (expense) and income tax benefit of $33.7 million
from inception in 1995 through June 30, 1999.
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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 June 30, 1999, the Company had
approximately $377 million of indebtedness outstanding. The Company will likely
incur substantial additional indebtedness (including secured indebtedness) for
the 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 (the "Indenture") relating to the Senior Notes and
certain of the Company's agreements with Incumbents 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
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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.
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 will need to seek
additional financing to fund capital expenditures and working capital to expand
its network further. The Company may also require additional capital for
activities complementary to its currently planned businesses.
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 or 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 financing. 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 products, including
bandwidth services. 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. The Company has gained experience in budgeting
and scheduling as it has completed segments of its network, and although the
Company believes that its cost estimates and buildout schedules relating to the
currently planned portions of its network are reasonable, only
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approximately 3,900 route miles under contract have been completed as of June
30, 1999. 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 six customers with several additional customers
awaiting installation, there can be no assurances that the Company will attract
additional purchasers of its products, including bandwidth services.
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 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 bandwidth
services and other products 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, (vi) obtain
necessary Federal Communication Commission ("FCC") licenses, state Public
Service Commission (each a "PSC") certifications and other approvals and (vii)
obtain adequate rights-of-way and other property rights necessary to install and
operate the fiber portions of the Company's network. 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 or implementation of other technologies either in lieu of
or as a supplement to the technologies contemplated by the Company's current
business plan. In addition, the Company may enter into relationships with
inter-exchange carriers, incumbent local exchange carriers ("ILECs"),
competitive local exchange carriers ("CLECs"), internet service providers,
Regional Bell Operating Companies ("RBOCs"), cellular operators and resellers
("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 under-served or 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. 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
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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.
RISKS RELATED TO EXPANSION IN STRATEGY.
On February 3, 1999, the Company announced it had expanded its business
strategy to include construction and deployment of digital networks using both
wireless and fiber optic technologies. The Company has limited experience in
designing and budgeting, deploying, operating and maintaining a fiber network.
In addition, the Company could encounter customers with preferences in employing
one technology over another. There can be no assurance the Company will
effectively design and budget, deploy, operate or maintain such facilities or
that it will be able to address such potential customer preferences. Further,
there can be no assurance that the fiber network deployed by the Company will
provide the expected functionality.
To the extent that the Company enters into co-development or other
partnering arrangements where the Company's partner has primary responsibility
for key network development matters such as perfecting rights-of-way or project
management, there can be no assurance that such partners will perform such tasks
adequately or that any failures in such performance will not adversely effect
the Company's financial condition, business or 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 the wireless portion of its network is deployed. Instead,
the Company has entered into and expects to enter into long-term relationships
with Incumbents whereby each such Incumbent agrees to grant to the Company a
leasehold interest in or 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
telecommunications 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
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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 expire 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 the wireless portion of its network.
The Company has entered into maintenance agreements with six 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.
NEED TO OBTAIN AND MAINTAIN RIGHTS-OF-WAY.
The Company expects to obtain easements, rights-of-way, franchises and
licenses from various private parties, ILECs , utilities, railroads, long
distance companies, state highway authorities, local governments and transit
authorities in order to construct and maintain its fiber optic network. If the
Company were to acquire rights-of-way directly from a governmental authority, it
would be directly affected by state and local law. To the extent that the
Company obtains rights-of-way from others, it would be indirectly affected by
state and local law. There is a possibility that disputes may arise with the
licensing authority or a competitor, the result of which may favor a competitor
of the Company. Such disputes could impose legal and administrative costs on the
Company, including out-of-pocket expenses and lost market opportunity because of
delays. Further, the Company may be subject to franchise fees imposed by state
and local governments. In addition, the Company may require pole attachment
agreements with utilities and ILECs to operate existing and future networks, and
there can be no assurance that such agreements will be obtained on reasonable
terms and in a timely manner.
There can be no assurance that the Company will be able to obtain and
maintain the additional rights and permits needed to build its fiber optic
network and otherwise implement its business plan on acceptable terms. The
failure to enter into and maintain required arrangements for the Company's
network could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that,
once obtained, the Company will continue to have access to existing
rights-of-way and franchises after the expiration of such agreements. If a
franchise, license or lease agreement were terminated and the Company were
forced to remove or abandon a significant portion of its network, such
termination could have a material adverse effect on the Company.
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MANAGEMENT OF GROWTH AND RISKS ASSOCIATED WITH POSSIBLE ACQUISITIONS,
STRATEGIC ALLIANCES AND JOINT VENTURES.
The Company's expanded 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 Company believes that a part of its future growth may come from the
formation of strategic alliances with other telecommunications companies
designed to assist and accelerate the building of the Company's digital network
to provide services to customers of the Company which are complementary to those
provided by the Company. The Company intends to pursue joint ventures with, or
acquisitions of, companies that have an existing network infrastructure or
customer base in order to increase the Company's penetration of its markets or
accelerate entry into new markets. Limitations under the Indenture may
significantly limit the Company's ability to make acquisitions and to incur
indebtedness in connection with acquisitions. Such transactions commonly involve
certain risks, including, among others: the difficulty of assimilating the
acquired operations and personnel; the potential disruption of the Company's
ongoing business and diversion of resources and management time; the possible
inability of management to maintain uniform standards, controls, procedures and
policies; the risks of entering markets in which the Company has little or no
direct prior experience; and the potential impairment of relationships with
employees or customers as a result of changes in management. There can be no
assurance that any acquisition or joint venture will be made, that the Company
will be able to obtain additional financing needed to finance such acquisitions
and joint ventures and, if any acquisitions are so made, that the acquired
business will be successfully integrated into the Company's operations or that
the acquired business will perform as expected. The Company has no definitive
agreement with respect to any acquisition, although it has had discussions with
other companies and will continue to assess opportunities on an ongoing basis.
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 Richard
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A. Jalkut, President and Chief Executive Officer, Kevin J. Bennis, Executive
Vice President serving as President of the Company's Communications Services
Division, William R. Smedberg V, Executive Vice President, Corporate
Development, Robert A. Rouse, Executive Vice President, serving as President of
the Company's Network Services Division, James Craig, Executive Vice President
and Chief Financial Officer and Michael L. Brooks, Vice President of Network
Development. Other than its Employment Agreements with Richard A. Jalkut and
Robert A. Rouse, 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 business, financial condition and 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. Recent and anticipated industry
consolidation will strengthen the position of some competitors. In addition,
some potential competitors, such as RBOCs or foreign carriers may no longer face
regulatory or legal obstacles that have kept them out of the market. These
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 supply of telecommunications capacity, the effects of
deregulation and the development of new technologies, including technologies
that will increase the capacity of existing networks. In addition, Federal
legislation or regulations could be approved that would expand competition and
increase pricing pressures, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
RELIANCE ON EQUIPMENT SUPPLIERS FOR THE WIRELESS PORTION OF THE
COMPANY'S NETWORK
The Company currently purchases most of its telecommunications
equipment pursuant to an agreement with NEC Corporation ("NEC") from whom the
Company has agreed to purchase $200 million of equipment by December 31, 2002
and has entered into an equipment purchase agreement with Andrew Corporation
("Andrew"). 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 relating to the wireless portion of its network, 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
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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.
RELIANCE ON LUCENT; LUCENT AGREEMENTS.
The Company and Lucent have entered into a supply agreement under which
Lucent will provide and will deploy personnel to assist in, among other things,
the design and marketing of the Company's network. Any failure or inability by
Lucent to perform these functions could cause delays or additional costs in
providing services to customers and building out the Company's network in
specific markets. Any such failure could materially and adversely affect the
Company's financial condition, business and results of operations.
The Company and Lucent have entered into the Commitment Letter which is
contingent upon various conditions, including the execution of a definitive
financing agreement, compliance with financial covenants, completion of due
diligence and the absence of any material adverse change in the Company. There
can be no assurance that a definitive agreement will be executed with respect to
the financing contemplated by the Commitment Letter or that the financing
contemplated by the Commitment Letter will be consummated. Any failure to
consummate the financing contemplated by the Commitment Letter could materially
and adversely effect the Company's financial condition, business and results of
operations.
TECHNICAL LIMITATIONS OF THE WIRELESS 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 wireless portion of 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
24
<PAGE>
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 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 on the wireless portion of its
network without significant capital expenditures for additional equipment.
RISKS RELATING TO INTERCONNECTION AND COLLOCATION
In order to obtain the necessary access to install its radios, antennae
and other equipment and to collocate such equipment required for interconnection
of the Company's network to the public switched telephone network or to POPs of
the Company's customers, the Company must acquire the necessary rights and enter
into the arrangements to secure such interconnections and collocations and
deploy and operate such interconnection equipment. There can be no assurance
that the Company will succeed in obtaining the rights necessary to secure such
interconnections and collocations and to deploy its interconnection equipment in
its market areas on acceptable terms, if at all, or that delays in or terms for
obtaining such rights will not have a material adverse effect on the Company's
development or results of operations. These interconnection arrangements are
governed by federal and state law, and the Company has no assurance that the
regulations requiring ILECS to provide interconnections and collocations will
remain in place or will be favorable to the Company.
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 has expanded its business plan to
include fiber optic technologies, which may diversify the Company's exposure to
the risk of such technological changes, their effect on the business of the
Company 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
25
<PAGE>
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 the Company's business, financial condition and results of
operations.
UNCERTAIN FEDERAL AND STATE TAX AND OTHER SURCHARGES ON THE COMPANY'S
SERVICES
Telecommunications providers pay a variety of surcharges and fees on
their gross revenues from interstate services and intrastate services.
Interstate surcharges include Federal Universal Service Fees, Common Carrier
Regulatory Fees and TRS Fund fees. In addition, state regulators impose similar
surcharges and fees on intrastate services. The division of the Company's
services between interstate services and intrastate services is a matter of
interpretation and may in the future be contested by the FCC or relevant PSCs. A
change in the characterization of the jurisdiction of the Company's services
could cause its payment obligations pursuant to the relevant surcharges to
increase. In addition, pursuant to the periodic revisions by state and federal
regulators of the applicable surcharges, the Company may be subject to increases
in the surcharges and fees currently paid.
REGULATION
General regulations, regulatory actions and court decisions have had,
and in the future may have, both positive and negative effects on the Company
and its ability to compete. Although, the recent trend in both federal and state
regulation of telecommunications service providers has been in the direction of
lessened regulation, there can be no assurance that future regulatory, judicial
and legislative changes will not have a material adverse effect on the Company's
business, financial condition or results of operations.
The Company is currently subject to federal and state government
regulation of its telecommunications services. The FCC and relevant PSCs have
the authority to regulate interstate and intrastate rates, respectively,
ownership of transmission facilities, and the terms and conditions under which
the Company's services are provided. In general, neither the FCC nor the
relevant state PSCs exercise direct oversight over cost justification for the
Company's services or the Company's profit levels, but either or both may do so
in the future. However, at the Federal level, the Company is required to file
interstate tariffs listing the currently effective rates, terms and conditions
for those services. Although the FCC eliminated the tariffing requirements for
interstate non-dominant carriers, such carriers must continue to file interstate
tariffs while the FCC's decision is reviewed upon appeal. In order to provide
intrastate long distance and local exchanges services the Company generally is
also required to obtain certification from the relevant state PSC prior to the
initiation of intrastate service and, in certain cases, required to file tariffs
with the such states listing the currently effective rates, terms and conditions
for those services. Any failure to maintain proper state and Federal tariffing
or certification or any difficulties or delays in obtaining required
authorization could have a material adverse effect on the Company's business,
financial condition and results of operations.
The FCC and certain state agencies also impose prior approval
requirements on transfers of
26
<PAGE>
control, including pro forma transfers of control and corporate reorganizations,
and assignments of regulatory authorizations. Such requirements may delay,
prevent or deter a change in control of the Company. In addition, in those
instances where the Company provides service on an intrastate basis, the Company
may be required to obtain authorizations from or notify such states with respect
to certain transfers or issuances of capital stock, bonds or other indebtedness
of the Company.
The FCC and state PSCs generally retain the right to sanction a
carrier, impose forfeitures, mandate refunds or impose other penalties in the
event of non-compliance by a carrier. There can be no assurance that future
regulatory, judicial or legislative activities will not have a material adverse
effect on the business, financial condition or results of operations of the
Company or that regulators or third parties will not raise material issues with
regard to the Company's compliance or non-compliance with applicable laws and
regulations.
RISKS RELATING TO REGULATION OF FIBER NETWORK. Pursuant to the
interconnection provisions of the Telecommunications Act of 1996 (the "1996
Telecom Act"), the FCC identified a minimum list of unbundled network elements
("UNEs") that ILECs must make available to other telecommunications carriers.
The FCC declined to include incumbent ILECs' dark fiber in this list, finding
that it did not have adequate information to determine whether dark fiber
qualifies as a network element. The FCC indicated that is would continue to
review or revise its rules regarding UNEs as necessary. State commissions,
however, have the authority to impose additional unbundling requirements so long
as the requirements are consistent with the 1996 Telecom Act and the FCC's
requirements, which could include requiring incumbent ILECs to unbundle their
dark fiber.
In the recent Supreme Court decision regarding the FCC's
interconnection and unbundling rules, the Supreme Court vacated the FCC's rule
establishing the list of UNEs. The Supreme Court found that the FCC had not
interpreted the terms of the 1996 Telecom Act regarding an incumbent ILEC's duty
to provide network elements in a reasonable fashion. The Supreme Court found
that the FCC had given telecommunications carriers complete access to UNEs
without appropriate analysis and justification. The statute limits
telecommunications carriers' access to network elements to those that are
"necessary" or to those where failure to have access would "impair the ability
of the telecommunications carrier" to provide services it seeks to offer. The
FCC is now reviewing its requirements regarding UNEs in light of the "necessary
and impair" standard in the 1996 Telecom Act. The FCC has indicated that it will
attempt to complete this proceeding by the end of this year, but the Company can
give no assurance as to what the FCC will decide or when.
A decision by the FCC or states to require unbundling of incumbent
ILECs' dark fiber could increase the supply of dark fiber and decrease demand
for the Company's dark fiber, and thereby have an adverse effect on the Company'
business, financial condition and results of operations.
RISKS RELATING TO REGULATION OF ACCESS SERVICES AND INTERCONNECTION.
The 1996 Telecom Act introduced widespread changes in the regulation of the
telecommunications industry, including the digital access services segment in
which the Company operates. Among other things, the 1996 Telecom Act removed
barriers to entry in the local exchange telephone market by preempting state and
local laws that restrict competition and by providing competitors
interconnection, access to UNEs and retail
27
<PAGE>
services at wholesale rates. The FCC's primary rules interpreting the 1996 Act
concerning pricing, UNE combination, nondiscrimination and other regulations
were upheld by the Supreme Court, but the FCC's definition of UNEs is subject to
further review, as set forth above. The Company is in the process of entering
into competitive interconnection agreements using the federal guidelines
established in the FCC's interconnection order.
In August 1998, the FCC proposed new rules that would allow ILECs to
provide their own DSL services free from ILEC regulation through a separate
affiliate. If adopted, these new rules would make it easier for RBOCs to offer
digital services to consumers, though the Company cannot predict when the FCC
will act or what rules it will adopt. The FCC has also recently adopted
additional rules requiring ILECs to provide collocation and loops to CLECs such
as the Company on more favorable terms to the CLECs than previously prescribed
by the FCC. These new rules are subject to revision on appeal or
reconsideration, and the Company has no assurance that the rules will be upheld
or that they will be implemented in a timely manner.
RISKS RELATING TO REGULATION OF WIRELESS NETWORK. The Company's
arrangements with Incumbents contemplate that the wireless portion of the
Company's digital network will provide largely "common carrier fixed
point-to-point microwave" telecommunications services under Part 101 ("Part
101") of the rules of the FCC, which services are subject to regulation by
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 (or complying with the terms of) 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.
FCC LICENSE REQUIREMENTS. Prior to applying to the FCC for
authorization to use portions of the 6 GHz band for microwave services, 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. In addition, 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. Furthermore, in order to obtain the Part 101 licenses
necessary for the operation of its network, the Company, and in some cases
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. There can be no assurance that the Company or any Incumbent who
desires to be the licensee with respect to its portion of the Company's network
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
28
<PAGE>
conditions or limitations on any such license or approval.
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 authorize a higher level of foreign ownership
(up to 100%) on a streamlined basis where the indirect foreign investment in the
common carrier licensee is by citizens of, or companies organized under the laws
of World Trade Organization ("WTO") member countries. Where the foreign
ownership is by citizens or corporations of non-WTO nations, FCC authorization
to exceed the 25% limitation must be obtained on a non-streamlined basis and the
licensee must meet a more demanding public interest showing. The Company is
presently within the 25% foreign ownership limitation. In connection with any
future financings, the Company will have to monitor foreign investment to ensure
that its foreign ownership does not exceed the 25% limitation. If it appeared
that foreign ownership of the Company was coming close to exceeding this
benchmark, the Company would have to obtain FCC authorization prior to exceeding
the 25% limitation. In addition, if any Incumbent elects to be the licensee on
the portion of the Company's network relating to its system, such Incumbent
would also be subject to such foreign ownership restrictions. If such analysis
showed that such Incumbent had more than 25% foreign ownership, the Incumbent
would have to seek authorization from the FCC to exceed the 25% limitation or it
would have to reduce its foreign ownership.
In the event that an Incumbent were to choose to hold the relevant Part
101 license itself, and not through a holding company, that 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. If an Incumbent exceeded the 20% limitation it would be
required to reduce its foreign ownership in order to obtain or retain its Part
101 license.
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
29
<PAGE>
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
The Company is exposed to the impact of interest rate changes and
changes in the market value of its investments. As of June 30, 1999, the
Company's investments include certificates of deposit, money market funds, U.S.
Government obligations (primarily fixed income securities) and high-quality debt
securities. The Company employs established policies and procedures to manage
its exposure to changes in the market risk of its marketable securities, which
are classified as available for sale as of June 30, 1999. The Company's Senior
Notes have fixed interest rates and the fair value of these instruments is
affected by changes in market interest rates. The Company has not used
derivative financial instruments in its investment portfolio.
Investments in fixed rate interest earning instruments carry a degree
of interest rate risk. The fair market value of these securities may be
adversely impact due to a rise in interest rates. Investments in certificates of
deposit and money market funds may adversely impact future earnings due to a
decrease in interest rates. Due in part to these factors, the Company's future
investment income may all short of expectations due to changes in interest rates
or the Company may suffer losses in principal if forced to sell securities that
have declined in market value due to changes in interest rates. As of June 30,
1999, a 10% increase or decline in interest rates would not have a material
impact on the Company's future earnings, fair values, or cash flows related to
investments in certificates of deposit or interest earning marketable
securities. In addition, as of June 30, 1999, a 10% decrease in market values
would not have a material impact on the Company's future earnings, fair values,
financial position or cash flows related to investments in marketable
securities.
30
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 13, 1999, the Company solicited written consents
from the holders of the Company's common stock, par value $.01 per
share (the "Common Stock"), Series A Convertible Preferred Stock,
Series B Convertible Preferred Stock and Series C Convertible Preferred
Stock (collectively the "Stockholders") to approve the co-development
transaction with WFI. Effective April 13, 1999, the Company received
written consents approving such proposals from Stockholders
representing 12,541,329 votes with Stockholders representing 6,230,246
votes abstaining.
On May 13, 1999, the Company solicited written consents from
the holders of its Series A Convertible Preferred Stock, Series B
Convertible Preferred Stock and Series C Convertible Preferred Stock
(collectively, the "Preferred Stockholders") to (i) approve the removal
and appointment of certain executive officers of the Company, (ii)
approve a transaction with Nortel Telecom, Inc., (iii) approve a
transaction with Public Service of New Mexico, (iv) approve an
amendment to the Company's 401K Plan, (v) approve and appoint
authorized signatories to the Company's bank accounts, (vi) approve
certain grants of stock option awards, (vii) approve certain new hires
by the Company and (viii) approve the payment of certain outside
counsel fees. Effective May 13, 1999, the Company received written
consents approving such proposals from Preferred Stockholders
representing 14,622,147 votes with Preferred Stockholders representing
1,242,568 votes abstaining.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
31
<PAGE>
Exhibit Index
(B) REPORTS ON FORM 8-K
None
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: August 9, 1999 By: /s/ RICHARD A. JALKUT
------------------------------
Richard A. Jalkut
President and Chief Executive Officer
Date: August 9, 1999 By: /s/ JAMES M. CRAIG
------------------------------
James M. Craig
Executive Vice-President, Chief
Financial Officer (Principal Accounting
& Financial Officer)
33
<PAGE>
EXHIBIT INDEX
Pursuant to Item 601 of Regulation S-K
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ------------- ----------------------
<S> <C>
10.1 Letter Agreement between Pathnet, Inc. and Robert A. Rouse dated
April 7, 1999, relating to Mr. Rouse's employment with the Company.
27.1 Financial Data Schedule for the six months ended June 30, 1999.
99.1 Press release dated August 6, 1999 announcing the Company's results
for the second quarter of 1999.
</TABLE>
34
<PAGE>
EXHIBIT 10.1
April 7, 1999
VIA FACSIMILE & FEDERAL EXPRESS
Mr. Robert Rouse
1307 Alhambra Drive
Apollo Beach, Florida 33572
Dear Bob:
It is with great pleasure that I offer you the position of Executive
Vice President and President, Network Services of Pathnet. You will report
directly to me and be based in our Washington, DC headquarters office beginning
on a date mutually agreeable to both of us.
Your salary will be at the annual rate of $275,000 to be paid in equal
installments twice each month. As part of the executive team, you will be
eligible to participate in the executive bonus plan, which is under development
and will be completed this year. It is expected that the bonus will be in the
20-40% range. You will also be granted an option to purchase 350,000 shares of
common stock at $.01 par value at an exercise price of $5.20 per share. The
option vests over a period of four years in equal installments. The vesting
schedule commences with your date of hire.
In the event of the announcement of a change in control if you are
terminated without cause all of your unvested options will accelerate and become
exercisable as of the termination date.
In the event of a change in control all of your unvested options will
accelerate and become exercisable as of the change in control date/closing date.
In the event that you are terminated without cause resulting in your
being asked to leave Pathnet with a satisfactory or better current appraisal,
your options for that option year will be deemed proportionately earned and
accelerated through the last month you are on the payroll. In addition, you will
be entitled to one year's severance pay equal to your annual salary at that time
payable in accordance with Pathnet's regular payroll procedures.
In the event that you are terminated with cause (cause is defined as
set forth in Amendment No. 1 of the 1997 Stock Incentive Plan which you have
received under separate cover), then no additional compensation or vesting shall
occur after the termination date.
You will be eligible for three (3) weeks of vacation annually and
Company-paid parking. In addition, Pathnet will pay for all reasonable closing
costs on your Florida home and the relocation of your personal belongings to
Virginia. Additionally, Pathnet will reimburse you for up to 60 days of
reasonable expenses in connection with your commutation and living arrangements
while you are relocating to Virginia. All expenses must be approved before they
are incurred.
<PAGE>
Robert Rouse
April 7, 1999
Page Two
Pathnet offers a health and dental insurance package through Phoenix
Group Services. It is a PPO (Preferred Provider Organization) plan. Employees
can elect individual coverage for $.50 per pay period. The Company will provide
employee life/accidental death and dismemberment, long term and short term
disability insurance at no cost to you. Supplemental life insurance coverage is
also available for purchase. You will be eligible to participate in our 401(k)
Plan and Flexible Spending Account Plan as well. Enclosed you will find a
summary of Pathnet's benefit plan, a summary plan description and PPO
directories for our health and dental plan. If you are interested in dependent
insurance premium rates or have questions about the benefit plan, please contact
Tara Merkel at (202) 295-3126. Please note that the benefit plan is subject to
change.
Our Board of Directors requires that you sign a Non-Disclosure,
Assignment of Inventions and Non-Competition Agreement as a condition of your
employment with Pathnet. A copy of the agreement is enclosed, with an extra copy
for your records. Please bring one signed copy with you on your first day of
employment. On or about your first day of employment you will also be required
to provide proof of employment eligibility in the United States. Please call
Tara Merkel if you have any questions about eligibility documents.
This letter is an employment agreement between both parties. Other
benefits to which all Pathnet employees are entitled are outlined elsewhere and
are in addition to the provisions of this agreement.
Please call me if you have any questions.
We look forward to having you join us in building our Company.
Very truly yours,
/s/ Richard A. Jalkut
Richard A. Jalkut
President and CEO
Acknowledged and Agreed:
/s/ Robert Rouse
- ------------------------
Robert Rouse
Enclosures
Cc: Tara Merkel, Director of Human Resources
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
The schedule contains summary financial information extracted from the Company's
balance sheet as of June 30, 1999 and the Statements of Operations for the
six months ended June 30, 1999 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 133,873
<SECURITIES> 70,747
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 173,576
<PP&E> 86,313
<DEPRECIATION> 2,360
<TOTAL-ASSETS> 350,973
<CURRENT-LIABILITIES> 29,988
<BONDS> 346,417
35,970
0
<COMMON> 29
<OTHER-SE> (61,614)
<TOTAL-LIABILITY-AND-EQUITY> 350,973
<SALES> 1,691
<TOTAL-REVENUES> 1,691
<CGS> 5,320
<TOTAL-COSTS> 13,194
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20,331
<INCOME-PRETAX> (24,482)
<INCOME-TAX> 0
<INCOME-CONTINUING> (24,482)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (24,482)
<EPS-BASIC> (8.43)
<EPS-DILUTED> (8.43)
</TABLE>
<PAGE>
EXHIBIT 99.1
FOR IMMEDIATE RELEASE
Contact: Becky Haight
Investor Relations
Pathnet
877 227-5600
[email protected]
Kye Presley-Dowd
Media Relations
Pathnet
202 295-3286
[email protected]
PATHNET REPORTS SECOND QUARTER RESULTS
WASHINGTON, DC, AUGUST 6, 1999--Pathnet, Inc., a privately-held carrier's
carrier of digital telecommunications capacity to under-served and second- and
third-tier markets, today announced revenues of $865,000 for the quarter ended
June 30, 1999, an 82% increase over 1998 second quarter revenues of $475,000.
The majority of the company's revenues for the quarter were derived from
telecommunication services, with the remainder coming from construction
management services for strategic partners. Earnings before interest, taxes,
depreciation and amortization (EBITDA) for the quarter were a loss of $5.3
million, essentially flat with a loss of $5.0 million in the year-ago quarter.
"We're very pleased with our recent progress in executing our business plan of
bringing needed bandwidth to under-served markets," said president and chief
executive officer Richard A. Jalkut. "In terms of developing supply, our
recently announced Grand Junction to Albuquerque route provides an excellent
example of our strategy of capitalizing on opportunities in smaller markets that
have been overlooked. We're also moving forward rapidly on our fiber build from
Denver to Chicago and, on the demand side of the equation, we're clearly
encouraged by a recently signed memorandum of understanding for $5 million in
dark fiber on that route," he added.
The increase in gross plant and equipment for the second quarter of $15.9
million, bringing total plant and equipment acquired to $86.3 million.
Depreciation and amortization expenses for the quarter were $1.0 million,
compared to $0.1 million for the second quarter 1998.
"We've made excellent progress in recent months," said Robert A. Rouse, Pathnet
president of network services. "We now have network available in 18 states with
1,900 additional route miles completed in this quarter alone. We're on schedule
with all of our
<PAGE>
network construction and with over 30 interconnection projects into
under-served areas."
SECOND QUARTER HIGHLIGHTS AND RECENT DEVELOPMENTS
- Announced 400-mile fiber route from Grand Junction to Albuquerque
- Construction initiated on 1,100 mile Denver to Chicago fiber route
- $5 million memorandum of understanding signed for delivery of dark fiber to
a major inter-exchange carrier
- Increased total route miles of network completed to 3,900
- On target for over 30 city interconnections by end of year 1999
- Robert A. Rouse, president of network services, and James M. Craig, chief
financial officer, joined senior management team
Pathnet is a carriers' carrier providing high capacity, fiber and wireless
bandwidth to under-served and second-and third-tier U.S. markets. It provides
service to inter-exchange carriers, local exchange carriers, Internet service
providers, Regional Bell Operating Companies, cellular operators and resellers.
As of June 30, 1999, Pathnet had 3,900 route miles of completed network, 3,800
route miles of network under construction and 7,700 route miles of network under
commitment. The company's headquarters are located in Washington, D.C., at 1015
31st Street, NW, Washington, D.C., 20007. For additional information about
Pathnet, visit the company Web site at WWW.PATHNET.NET.
THE STATEMENTS MADE BY PATHNET IN THIS PRESS RELEASE MAY BE FORWARD LOOKING IN
NATURE. NO ASSURANCE CAN BE GIVEN THAT FUTURE RESULTS WILL BE ACHIEVED; ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE PROJECTED IN FORWARD LOOKING
STATEMENTS. PATHNET BELIEVES THAT ITS PRIMARY RISK FACTORS INCLUDE, BUT ARE NOT
LIMITED TO: SIGNING ADDITIONAL AGREEMENTS WITH PRIVATE NETWORK OPERATORS AND
OTHERS; OFFERING SERVICES TO TELECOM SERVICE PROVIDERS; ENTERING INTO PARTNERING
ARRANGEMENTS; AND BUILDING A DIGITAL NETWORK. ADDITIONAL INFORMATION CONCERNING
THESE AND OTHER POTENTIAL IMPORTANT FACTORS CAN BE FOUND WITHIN PATHNET'S PUBLIC
FILINGS WITH THE U.S. SECURITIES AND EXCHANGE COMMISSION. STATEMENTS IN THIS
RELEASE SHOULD BE EVALUATED IN LIGHT OF THESE IMPORTANT FACTORS.
<PAGE>
PATHNET, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE PERIOD
AUGUST 25, 1995
FOR THE THREE MONTHS ENDED (DATE OF INCEPTION)
JUNE 30, TO JUNE 30,
-------------------------- -------------------
1999 1998 1999
------------ ------------ -------------------
<S> <C> <C> <C>
Revenue $ 865 $ 475 $ 3,438
Expenses:
Cost of revenue 2,669 3,020 12,868
Selling, general and administrative 3,508 2,473 21,928
Depreciation 1,033 112 2,360
-------- -------- --------
Total expenses 7,210 5,605 37,156
-------- -------- --------
Net operating loss (6,345) (5,130) (33,718)
Interest expense (10,061) (9,868) (53,318)
Interest income 3,378 4,488 21,308
Initial public offering costs -- -- (1,355)
-------- -------- --------
Other income, net 72 -- 157
-------- -------- --------
Net loss $(12,956) $(10,510) $(66,926)
-------- -------- --------
-------- -------- --------
Basic and diluted loss per
Common share $ (4.46) $ (3.62) $ (23.07)
-------- -------- --------
-------- -------- --------
Weighted average number of
Common shares outstanding 2,905 2,902 2,901
-------- -------- --------
-------- -------- --------
Other Data:
EBITDA (1) $ (5,312) $ (5,018) $(31,358)
-------- -------- --------
-------- -------- --------
</TABLE>
(1) EBITDA comprises earnings before interest, taxes, depreciation and
amortization
<PAGE>
PATHNET, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT ROUTE MILES)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------ ------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 133,873 $ 57,322
Interest receivable 1,527 3,849
Marketable securities available for sale, at market 37,139 97,896
Other current assets 1,037 3,412
------------ ------------
Total current assets 173,576 162,479
Property and equipment, net 83,953 47,971
Deferred financing costs, net 9,981 10,508
Restricted cash 7,890 10,731
Marketable securities available for sale, at market 33,608 71,900
Pledged marketable securities held to maturity 41,775 61,825
Other Assets 190 --
------------ ------------
Total assets $ 350,973 $ 365,414
------------ ------------
------------ ------------
LIABILITIES, MANDATORILY REDEEMABLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DE FICIT)
Accounts payable $ 19,714 $ 10,708
Accrued interest 8,932 8,932
Other current liabilities 1,342 640
------------ ------------
Total current liabilities 29,988 20,280
Bonds payable, net of unamortized bond discount of $3,685 346,417 346,212
Other non-current liabilities 184
Total mandatorily redeemable preferred stock 35,970 35,970
Total stockholders' equity (deficit) (61,586) (37,048)
------------ ------------
Total liabilities, mandatorily redeemable preferred stoc k and
stockholders' equity (deficit) $ 350,973 $ 365,414
------------ ------------
------------ ------------
Selected statistical data:
Route miles under construction 3,800
Route miles complete 3,900
</TABLE>
