<PAGE>
===============================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-24953
FIRSTWORLD COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0521976
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
________________
8390 E. CRESCENT PARKWAY
SUITE 300
GREENWOOD VILLAGE, CO 80111
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(303) 874-8010
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
(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:
[ X ] YES [ ] NO
AS OF NOVEMBER 1, 1999, THE REGISTRANT'S OUTSTANDING COMMON STOCK
CONSISTED OF 10,135,164 SHARES OF SERIES A COMMON STOCK AND 18,577,022 SHARES OF
SERIES B COMMON STOCK.
===============================================================================
<PAGE>
FIRSTWORLD COMMUNICATIONS, INC.
INDEX
<TABLE>
<CAPTION>
<S> <C>
PAGE
--------
FORWARD-LOOKING STATEMENTS 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 1999 (unaudited),
December 31, 1998 (unaudited) and September 30, 1998....................... 4
Consolidated Statements of Operations (unaudited) for the
Three and nine months ended September 30, 1999 and 1998.................... 5
Consolidated Statements of Cash Flows (unaudited) for the
Nine months ended September 30, 1999 and 1998.............................. 6
Notes to Consolidated Financial Statements................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk............. 19
PART II. OTHER INFORMATION
Item 1. Legal Matters.......................................................... 19
Item 6. Exhibits and Reports on Form 8-K....................................... 20
SIGNATURES...................................................................... 21
</TABLE>
2
<PAGE>
FORWORD-LOOKING STATEMENTS
All statements contained herein, as well as statements made in press
releases and oral statements that may be made by the Company or by officers,
directors or employees of the Company acting on its behalf, that are not
statements of historical fact constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such forward-
looking statements involve known and unknown risks, uncertainties and other
factors that could cause the actual results of the Company to be materially
different from historical results or from any future results expressed or
implied by such forward-looking statements. Among the factors that could cause
actual results to differ materially are the following: an unexpected business
interruption due to the failures to remediate Year 2000 issues; the inability of
the Company to retain necessary authorizations from the Federal Communications
Commission ("FCC") or state public utility commissions; an increase in
competition; the introduction of new technologies and competitors into the
Internet and telephony business; a merger of existing Internet and telephony
competitors; a change in the regulations governing the industry; general
business and economic conditions; and other risk factors described from time to
time in the Company's reports filed with the United States Securities and
Exchange Commission. In addition to statements that explicitly describe such
risks and uncertainties, readers are urged to consider statements that include
the terms "believes," "belief," "expects," "plans," "anticipates," "intends" or
the like to be uncertain and forward-looking. All cautionary statements made
herein should be read as being applicable to all forward-looking statements
wherever they appear. In this connection, investors should consider the risks
described herein and should not place undue reliance on any forward-looking
statements. The Company assumes no obligation to update forward-looking
statements.
3
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRSTWORLD COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
<S> <C> <C> <C>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
1999 1998 1998
------------- ------------ -------------
(UNAUDITED) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 58,162 $ 29,659 $ 72,039
Marketable securities 30,523 170,030 165,591
Interest receivable 575 2,228 3,017
Accounts receivable, net 8,154 4,663 493
Revenues in excess of billings 2,068 1,539 --
Prepaid expenses and other 2,963 399 317
------------- ------------ -------------
Total current assets 102,445 208,518 241,457
------------- ------------ -------------
Property and equipment, net 100,825 61,247 44,020
Deferred financing costs, net 7,563 8,259 8,217
Goodwill and intangibles, net 64,727 16,410 --
Other assets 2,139 382 411
------------- ------------ -------------
Total assets $ 277,699 $ 294,816 $ 294,105
============= ============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 21,515 $ 13,573 $ 6,611
Accrued payroll related liabilities 2,962 1,156 222
Other accrued liabilities 7,833 2,866 749
Long-term debt, current portion 115 75 30
Capital lease obligations, current portion 751 259 788
------------- ------------ -------------
Total current liabilities 33,176 17,929 8,400
------------- ------------ -------------
Long-term debt, net of current portion and discount 284,587 258,135 249,726
Capital lease obligations, including interest, net of current portion 7,587 6,958 6,606
------------- ------------ -------------
Total liabilities 325,350 283,022 264,732
------------- ------------ -------------
Stockholders' equity (deficit):
Preferred stock, $.0001 par value per share, 10,000,000 shares authorized;
no shares outstanding
Common stock, voting, $.0001 par value, 100,000,000 shares authorized;
Series A, 10,135,164 shares designated; 10,135,164 shares issued and
outstanding at September 30, 1999, December 31, 1998 and
September 30, 1998 1 1 1
Series B, 89,864,836 shares designated; 18,564,926, 16,137,958 and 15,929,708
shares issued and outstanding at September 30, 1999, December 31, 1998 and
September 30, 1998, respectively 2 2 2
Additional paid-in capital 58,661 45,830 45,617
Warrants 31,963 31,963 31,963
Stockholder receivables (45) (158) (97)
Accumulated deficit (138,233) (65,844) (48,113)
------------- ------------ -------------
Total stockholders' equity (deficit) (47,651) 11,794 29,373
------------- ------------ -------------
Total liabilities and stockholders' equity (deficit) $ 277,699 $ 294,816 $ 294,105
============= ============ =============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
FIRSTWORLD COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ------------ ----------
Revenue:
Internet services $ 6,926 $ -- $ 13,203 $ --
Web integration and consulting services 7,682 -- 20,013 --
Telephony services 1,414 431 3,246 977
--------- --------- --------- ---------
Total revenue 16,022 431 36,462 977
--------- --------- --------- ---------
Operating expenses:
Network and service costs 11,194 446 25,776 885
Selling, general and administrative 21,320 6,442 45,955 13,865
Depreciation and amortization 7,610 585 14,924 1,947
--------- --------- --------- ---------
Total operating expenses 40,124 7,473 86,655 16,697
--------- --------- --------- ---------
Loss from operations (24,102) (7,042) (50,193) (15,720)
Other income (expense):
Interest income 1,481 3,502 5,929 6,742
Interest expense (9,597) (5,826) (28,125) (15,549)
--------- --------- --------- ---------
Total other expense (8,116) (2,324) (22,196) (8,807)
--------- --------- --------- ---------
Loss before extraordinary item (32,218) (9,366) (72,389) (24,527)
Extraordinary loss - extinguishment of debt -- -- -- (4,731)
--------- --------- --------- ---------
Net loss $ (32,218) $ (9,366) $ (72,389) $ (29,258)
========= ========= ========= =========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
FIRSTWORLD COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
<S> <C> <C>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1999 1998
----------- -----------
Cash flows from operating activities:
Net loss $ (72,389) $ (29,258)
Adjustments to reconcile net loss
to net cash used by operating activities:
Depreciation and amortization expense 14,924 1,947
Amortization of deferred financing costs 696 845
Accretion of senior discount notes 26,041 14,451
Extraordinary loss on extinguishment of debt -- 3,731
Charge associated with stock sold by shareholders 1,892 --
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable (1,387) (418)
Interest receivable 1,653 (3,016)
Other assets (1,533) (297)
Accounts payable 5,510 4,702
Accrued payroll related liabilities 1,389 --
Revenue in excess of billings (746) --
Other liabilities 1,473 (1,753)
--------- ---------
Net cash used by operating activities (22,477) (9,066)
--------- ---------
Cash flows from investing activities:
Purchases of held-to-maturity marketable securities (168,991) (236,701)
Maturities of held-to-maturity marketable securities 308,498 71,110
Acquisitions, net of cash acquired (44,761) --
Purchase of property and equipment (42,798) (23,578)
--------- ---------
Net cash provided (used) by investing activities 51,948 (189,169)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of senior discount notes and related warrants -- 250,205
Proceeds from issuance of Series A Common Stock and related warrants -- 26,136
Proceeds from issuance of Series B Common Stock and related warrants -- 18,757
Proceeds from exercise of stock options and warrants 1,015 129
Principal payments on debt and capital leases (1,983) (702)
Payments on revolving credit facility -- (16,300)
Proceeds from short-term borrowings and related warrants -- 426
Payment of deferred financing costs -- (8,647)
--------- ---------
Net cash (used) provided by financing activities (968) 270,004
--------- ---------
Net increase in cash and cash equivalents 28,503 71,769
Cash and cash equivalents, beginning of period 29,659 270
--------- ---------
Cash and cash equivalents, end of period $ 58,162 $ 72,039
========= =========
Supplemental cash flow information:
Effects of acquisition:
Assets acquired $ 63,341 $ --
Liabilities assumed (8,656) --
Common stock issued (9,924) --
Less cash paid (45,431) --
--------- ---------
Net cash acquired from acquisitions $ (670) $ --
========= =========
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
FIRSTWORLD COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of FirstWorld
Communications, Inc. ("FirstWorld" ) and wholly owned subsidiaries
(collectively, the "Company"). All significant intercompany transactions and
balances have been eliminated in consolidation.
In the opinion of management, the accompanying consolidated financial
statements include all adjustments (consisting of normal recurring items)
necessary for a fair presentation of results for the interim periods presented
by the Company. The results of operations for any interim period are not
necessarily indicative of results for the full year. The consolidated financial
statements and footnote disclosures should be read in conjunction with the
audited consolidated financial statements and related notes thereto filed with
the Company's Annual Report on Form 10-K for the fiscal year ended September 30,
1998, as amended on Form 10-K/A. Certain 1998 amounts have been reclassified to
conform to the 1999 basis of presentation.
2. CHANGE IN FISCAL YEAR
At a meeting held on October 16, 1998, the Board of Directors of the Company
voted to change the Company's fiscal year end from September 30 to December 31,
beginning with a short period ending on December 31, 1998. Accordingly, the
Company filed a transition report on Form 10-Q with the Securities and Exchange
Commission for such period.
3. REVENUE RECOGNITION
The Company primarily recognizes revenue on Internet and telephony services in
the month such services are provided. Amounts billed relating to future periods
are recorded as deferred revenue and are recognized in revenue as services are
rendered. Web integration and consulting services revenue consists primarily of
revenue generated by the Company's subsidiary, Optec, Inc., doing business as
FirstWorld Northwest, Inc. ("Optec") (described below). Revenues and expenses
related to web integration and consulting services are recognized under the
percentage-of-completion method of accounting based on the ratio that costs
incurred bear to the total estimated costs for each contract. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are determined.
4. BUSINESS ACQUISITIONS
Optec
On November 24, 1998, the Company acquired Optec, a company providing web
integration services to businesses with operations in Oregon and Washington,
from Enron Communications, Inc. ("Enron"), a related party. As part of this
acquisition, the Company also acquired rights to use fiber optic cable in parts
of Oregon and rights to OC-3 level capacity to connect up to 15 cities on a
long-haul, nationwide network being developed by Enron. As consideration for the
acquisition, the Company paid $18.3 million in cash and repaid $4.0 million of
Optec's outstanding debt. The Company assigned values of $11.1 million, $9.2
million and $2.0 million to the long-haul network rights, Optec and the fiber
optic rights, respectively. Since the long-haul network rights have not yet been
placed into service, the Company is not amortizing this asset. The Company will
amortize the fiber optic rights on a straight-line basis over 20 years.
The acquisition of Optec was accounted for under the purchase method of
accounting. The excess of the purchase price over the estimated fair value of
the acquired net assets, which is approximately $5.6 million, was recorded as
goodwill and will be amortized on a straight-line basis over 10 years.
Slip.Net
On January 7, 1999, the Company purchased all of the outstanding capital stock
of Accelerated Information, Inc., the parent company of Slip.Net, Inc.
("Slip.Net"), an Internet service company providing Internet access, web hosting
services, e-commerce solutions and co-location services, primarily in the San
Francisco Bay Area. The purchase price consisted of approximately $10.5 million
in cash and 187,500 shares of the Company's Series B common stock.
The acquisition was accounted for under the purchase method of accounting. In
order to determine the total consideration paid, the Company assigned a value,
based on a valuation performed by an independent third party, of $3.68
7
<PAGE>
per share to the Series B common stock. This resulted in total consideration of
$11.1 million. The excess of the consideration over the estimated fair value of
the acquired net assets, which is approximately $10.9 million, was recorded as
goodwill and will be amortized on a straight-line basis over three years.
Sirius
On March 2, 1999, the Company purchased all of the outstanding capital stock
of Sirius Solutions, Inc., d/b/a Sirius Connections ("Sirius"), an Internet
service company providing Internet access, web hosting services, e-commerce
solutions and co-location services, primarily in the San Francisco Bay Area.
The purchase price consisted of approximately $7.5 million in cash and 285,000
shares of the Company's Series B common stock.
The acquisition was accounted for under the purchase method of accounting. In
order to determine the total consideration paid, the Company assigned a value,
based on a valuation performed by an independent third party of $4.02 per share
to the Series B common stock. This resulted in total consideration of $8.6
million. The excess of the consideration over the estimated fair value of the
acquired net liabilities, which is approximately $8.6 million, was recorded as
goodwill and will be amortized on a straight-line basis over three years.
Hypercon
On June 1, 1999, the Company purchased all of the outstanding capital stock of
Hypercon, Inc. ("Hypercon"), an Internet service company providing Internet
access, web hosting services, e-commerce solutions and co-location services, in
the Houston metropolitan area. The purchase price consisted of approximately
$2.0 million in cash and 49,993 shares of the Company's Series B common stock.
Subsequent to the acquisition, the Company repaid approximately $215,000 in
debt.
The acquisition was accounted for under the purchase method of accounting. In
order to determine the total consideration paid, the Company assigned a value,
based on a valuation performed by an independent third party, of $6.00 per share
to the Series B common stock. This, combined with the assumption of certain net
liabilities of approximately $500,000, resulted in total consideration of $2.8
million, which was recorded as goodwill and will be amortized on a straight-line
basis over three years.
Internet Express
On June 14, 1999, the Company purchased all of the outstanding membership
interests of Internet Express, LLC ("Internet Express"), an Internet service
company providing Internet access and web hosting services in the Denver/Front
Range metropolitan area, including Colorado Springs and Fort Collins. The
purchase price consisted of approximately $1.0 million in cash and 30,000 shares
of the Company's Series B common stock. Subsequent to the acquisition, the
Company repaid approximately $959,000 in various liabilities.
The acquisition was accounted for under the purchase method of accounting. In
order to determine the total consideration paid, the Company assigned a value,
based on a valuation performed by an independent third party, of $6.00 per share
to the Series B common stock. This, combined with the assumption of certain net
liabilities of approximately $1.0 million resulted in total consideration of
$2.2 million, which was recorded as goodwill and will be amortized on a
straight-line basis over three years.
inQuo
On June 22, 1999, the Company purchased all of the outstanding capital stock
of inQuo, Inc. ("inQuo"), an Internet service company providing dedicated
Internet access in the Salt Lake City metropolitan area. The purchase price was
approximately $844,000 in cash.
The acquisition was accounted for under the purchase method of accounting.
The excess of the consideration over the estimated fair value of the acquired
net liabilities, which is approximately $1.0 million, was recorded as goodwill
and will be amortized on a straight-line basis over three years.
8
<PAGE>
Transport Logic
On July 7, 1999, the Company acquired all of the outstanding capital stock of
Oregon Professional Services, Inc., d/b/a Transport Logic ("Transport Logic"),
an Internet service company providing Internet access, web hosting services, e-
commerce solutions and co-location services in the western and northwestern
United States. The purchase price consisted of approximately $7.2 million in
cash and 392,935 shares of the Company's Series B common stock.
The acquisition was accounted for under the purchase method of accounting. In
order to determine the total consideration paid, the Company assigned a value,
based on a valuation performed by an independent third party, of $6.00 per share
to the Series B common stock. This, combined with the assumption of certain net
liabilities of approximately $1.0 million, resulted in total consideration of
$10.5 million, which was recorded as goodwill and will be amortized on a
straight-line basis over three years.
Intelenet
On July 14, 1999, the Company purchased all of the outstanding capital stock
of Intelenet Communications, Inc. ("Intelenet"), an Internet service company
providing advanced connectivity, data center services and networking consulting
in Southern California. The purchase price consisted of approximately $16.0
million in cash and 875,000 shares of the Company's Series B common stock.
The acquisition was accounted for under the purchase method of accounting.
In order to determine the total consideration paid, the Company assigned a
value, based on a valuation performed by an independent third party, of $6.00
per share to the Series B common stock. This resulted in total consideration of
$21.3 million. The excess of the consideration less the estimated fair value of
the acquired net assets, which is approximately $20.2 million, was recorded as
goodwill and will be amortized on a straight-line basis over three years.
Pro Forma Acquisition Information
The following unaudited condensed pro forma information presents the unaudited
results of operations of the Company as if the acquisitions of the above
mentioned companies had occurred on January 1, 1998:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1999 1998 1999 1998
-------- -------- -------- --------
(In Thousands) (In Thousands)
Revenue............................ $ 16,620 $ 9,861 $ 46,112 $ 29,475
Loss before extraordinary item..... $(32,495) $ (4,923) $(72,805) $(24,096)
Net loss........................... $(32,495) $ (9,654) $(72,805) $(28,827)
These pro forma results do not necessarily represent results that would have
occurred if the consolidated acquisitions had taken place as of January 1, 1998,
nor are they necessarily indicative of the results of future operations.
5. EMPLOYEE BENEFITS PLANS
The 1999 Equity Incentive Plan (the "Incentive Plan") was adopted by the
Company's Board of Directors on March 8, 1999, and approved by the Company's
stockholders at the Company's 1999 Annual Meeting of Stockholders held on June
3, 1999. The principal purposes of the Incentive Plan are to provide incentives
for key employees and consultants of the Company through granting of options and
stock appreciation rights ("SARs").
The aggregate number of shares of Series B Common Stock of the Company
("Shares") or the equivalent in other equity securities which may be issued upon
exercise of options may not exceed 5,000,000. At November 1, 1999, there were
an aggregate of 2,508,850 Shares and 618,700 SARs outstanding under the
Incentive Plan at grant prices ranging from $6.00 to $7.50.
The Quarterly Bonus Program of the Company (the "Bonus Program") was adopted
by the Company's Board of Directors on May 3, 1999, and also approved by the
Company's stockholders at the Company's 1999 Annual Meeting of Stockholders held
on June 3, 1999. The Bonus Program is intended to incentivize both individual
productivity and employee retention. A bonus paid out to each eligible employee
in the Bonus Program is based in part on the productivity of that participant's
profit and loss center and in part on that participant's individual performance.
Certain executive officers may elect to receive shares, in lieu of a cash bonus
payment under the Bonus Program. An aggregate of 200,000
9
<PAGE>
Shares will be available for issuance under the Bonus Program. The Company
incurred expenses related to the Bonus Program of approximately $613,000 and
$1.6 million for the three and nine months ended September 30, 1999,
respectively.
6. SUBSEQUENT EVENTS
The Company has entered into a letter of intent with an entity controlled by
its Chairman, Donald L. Sturm, for a $50.0 million equity commitment. The
letter of intent anticipates that the Company and the Sturm entity enter into an
agreement which will allow the Company to require that the Sturm entity purchase
up to $50.0 million of Series B common stock priced at $7.50 per share. The
agreement will expire on the earlier of 180 days after the effectiveness of the
agreement or upon the closing of an initial public offering by the Company.
The letter of intent outlines three dates on which the Company can require
that the Sturm entity purchase the Company's Series B common stock. These dates
are: February 15, 2000; March 31, 2000; and the expiration date of the
agreement. Additionally, if at any time after closing of the agreement the
cash, cash equivalents and marketable securities position of the Company is
$20.0 million or less, the Company will automatically exercise $25.0 million of
the commitment. Closing of the commitment is subject to certain conditions,
including the documentation of definitive agreements, any required approval
under the Hart Scott Rodino Improvements Anti-Trust Act and final approval from
the Company's Board of Directors. In addition, the Company will agree to pay the
Sturm controlled entity a $5.0 million fee for the commitment.
7. OTHER MATTERS
Dina Partners L.P.
On October 16, 1998, the Company filed a declaratory relief action in San
Diego Superior Court, asking the Court to find that the Company was not
obligated to offer stock to Dina Partners, L.P. ("Dina") in connection with the
December 30, 1997 equity investment by Spectra 3, a Donald L. Sturm entity, and
Enron Capital and Trade Resources, Corp. ("ETC"). On September 3, 1999, the
lawsuit was dismissed with prejudice. The Company did not contribute any
consideration to the settlement.
Prior to the dismissal of the lawsuit, certain shareholders of the Company
agreed to sell certain securities to Dina. In accordance with Securities and
Exchange Commission Staff Accounting Bulletin No. 79, the Company recorded a
capital contribution and corresponding non-cash charge during the three months
ended September 30, 1999 in connection with this transaction in the amount of
$1.9 million.
City of Anaheim
On May 13, 1999, the City of Anaheim (the "City") filed a lawsuit in Orange
County Superior Court, Case Number 809281, against FirstWorld and FirstWorld
Anaheim (collectively "FirstWorld Parties"). The City alleges that the
FirstWorld Parties repudiated their contractual obligations under the Universal
Telecommunications System Participation Agreement (the "Participation
Agreement"), the Agreement for Use of Operating Property (the "Operating
Property Agreement") and the Development Fee Agreement (the "Development
Agreement," and together with the Participation Agreement and the Operating
Property Agreement, the "UTS Agreements"). In addition, the City alleges, among
other things, that the FirstWorld Parties materially breached their obligations
under the UTS Agreements by: (i) failing to commence construction of a
demonstration center in downtown Anaheim and that the FirstWorld Parties will
not commence operation of this downtown demonstration center by June 30, 1999
under the UTS Agreements; (ii) failing to provide verification that Substantial
Completion of Phase I, as each such term is defined in the UTS Agreements, has
been achieved; (iii) failing to provide a "Subsequent Implementation Program"
(as defined in the UTS Agreements); (iv) failing to comply with various auditing
procedures in the UTS Agreements; and (v) failing to make a quarterly payment
due under the Participation Agreement. The City alleges that it is entitled to
damages in excess of $45.0 million as well as costs, pre-judgment interest and
such other relief as the Court deems proper. The City also seeks specific
performance compelling FirstWorld Parties to completely perform certain
obligations under the UTS Agreements.
In response to the lawsuit, the FirstWorld Parties filed a Motion to Compel
Arbitration. On September 16, 1999, the Court granted the Company's motion. On
October 6, 1999, the Court entered an Order finding that there is a valid
arbitration provision in the agreements and that the City has not established
that FirstWorld unequivocally repudiated the UTS Agreements. The court action
has been stayed pending completion of the arbitration. Neither the City nor the
Company has commenced arbitration procedures.
The Company believes that the FirstWorld Parties are not in breach as alleged
and intends to vigorously defend the action; however, there can be no assurance
that an unfavorable outcome of this dispute would not have a material adverse
effect on the Company's results of operations, liquidity or financial position.
Other
The Company is engaged in other legal actions arising in the ordinary course
of its business and believes that the outcome of these actions will not have a
material adverse effect on its results of operations, liquidity or financial
position.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a rapidly growing network-based provider of Internet, data and
communications services. Our service offering includes high-speed Internet
access, such as dedicated access and DSL; web hosting and design; data center
co-location; e-commerce solutions; dial-up Internet access; and web integration
and consulting services. To complement our data services offerings, the Company
also provides local and long distance telephony services in selected markets.
We are also in the process of constructing several data centers that will house
our data, Internet and voice service equipment and provide space for customers
to co-locate their equipment. The Company's business strategy is to offer our
customers a single source solution to meet the full range of their increasingly
complex Internet, data and communications needs. Using a consultative sales
approach, the Company markets its services to small- and medium-sized
businesses, and also selectively to larger businesses, consumers and wholesale
customers.
To date, the Company has experienced significant operating and net losses and
negative cash flow from operations. To achieve positive operating margins over
time, the Company must significantly increase the number of customers and
increase the products and services that it can provide to its customers. It is
anticipated that operating and net losses and negative operating cash flow from
operations will increase significantly for at least the next several years as
the Company implements its growth strategy of expanding its operations. See "-
- -Liquidity and Capital Resources."
REVENUE
The Company derives revenue from three primary sources: Internet services, web
integration and consulting services and telephony services.
Internet services revenue is derived from providing, DSL services, web hosting
and design, e-commerce solutions, dial-up and dedicated high-speed Internet
access and data center services. Revenues for all Internet services, other than
e-commerce, are recognized as the service is provided. Revenues for development
of e-commerce applications are recognized under the percentage-of-completion
method of accounting based upon the ratio that costs incurred bear to the total
estimated costs for each e-commerce application being developed. Amounts billed
relating to future periods are recorded as deferred revenue and are recognized
in revenue as services are rendered.
Web integration and consulting services revenue is derived from network
consulting, design, integration, equipment sales and management services.
Revenues are recognized under the percentage-of-completion method of accounting
based upon the ratio that costs incurred bear to the total estimated cost for
each contract.
Telephony services revenue is generated from local and long distance telephone
services. The Company generates telephony services revenue by replacing the
basic telephony services currently provided by incumbent local exchange
carriers, interexchange carriers and competitive local exchange carriers,
including local, long distance and other telephony services. Revenues are
recognized in the month telephony services are provided. Amounts billed
relating to future periods are recorded as deferred revenue and are recognized
in revenue as services are rendered.
OPERATING EXPENSES
Network and Service Costs
Network and service costs include a variety of service and network operations
costs. Network costs consist of payments to other communications carriers and
DSL wholesalers for monthly recurring and non-recurring communications line
charges incurred to provide DSL, integrated services digital network, frame
relay and telephony services as well as backbone transport charges and payments
to municipalities or local governmental agencies for permitting and related
expenses. Service costs include labor and materials associated with web
integration and consulting services. Network and service costs include rent and
utilities associated with co-locations, points of presence and network
operations centers. We currently enter into operating leases for a significant
portion of our infrastructure and we currently expect this practice to continue
as we enter into new markets. Labor associated with technical support, customer
service and line repair is also included in network and service operations
costs.
11
<PAGE>
Selling, General and Administrative
Selling, general and administrative expenses consist of costs related to
selling, marketing, customer care, provisioning, billing and collections,
information technology, general management and overhead and other administrative
expenses. We currently expect that selling, general and administrative expenses
will increase in the future as we expand operations into new markets and grow
our sales and marketing staff.
Depreciation and Amortization
Depreciation and amortization expenses include charges relating to
depreciation of property and equipment, which consists principally of network
infrastructure, communications equipment, buildings and leasehold improvements,
furniture and equipment, and amortization of intangibles, including goodwill.
We depreciate our assets and network infrastructure on a straight-line basis
over the estimated useful life of each asset. Estimated useful lives for our
assets currently range from three to 20 years. In addition, we have recorded
goodwill in connection with our acquisitions, which we amortize over a
period generally expected to be three years, with the exception of goodwill
associated with the acquisition of Optec, which we amortized over 10 years.
Interest
Interest expense consists of interest expense associated with our debt. On
April 13, 1998, we completed the issuance of our senior notes. Interest expense
subsequent to this date primarily relates to our senior notes and capital
leases.
Interest income during 1998 and subsequent to 1998 primarily represents
interest earned on our investments in high-grade, short-term marketable
securities. Marketable securities consist of commercial paper with original
maturities greater than three months but less than six months. We have
classified our marketable securities as held-to-maturity, as we have the intent
and ability to hold these securities to maturity.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH THE THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 1998
Revenues
Total revenues increased from $431,000 for the quarter ended September 30,
1998 to $16.0 million for the quarter ended September 30, 1999, an increase of
$15.6 million. Additionally, total revenues increased from $977,000 for the
nine months ended September 30, 1998 to $36.5 million, an increase of $35.5
million. The increase was primarily a result of increases in the aggregate
number of our data communications customers. These customers were acquired as a
result of our acquisitions of Optec, Slip.Net, Sirius, Hypercon, Internet
Express, inQuo, Transport Logic and Intelenet. The remaining increase was due
to the continued expansion of our customer base in the Los Angeles metropolitan
area.
Internet services. Internet services revenue was $6.9 million for the
quarter ended September 30, 1999 and $13.2 million for the nine months ended
September 30, 1999. There were no revenues for Internet services during the
three and nine months ended September 30, 1998. Internet services revenue
associated with the Company's acquisitions was $6.4 million for the
quarter ended September 30, 1999 and $11.6 million for the nine months ended
September 30, 1999. The remaining increase is due to the provision of data
services to our customer base in the Los Angeles metropolitan area.
Web integration and consulting services. Web integration and consulting
services revenue was $7.7 million for the quarter ended September 30, 1999 and
$20.0 million for the nine months ended September 30, 1999. The Company had no
web integration and consulting services revenue during the three and nine months
ended September 30, 1998. Optec has generated approximately $6.8 million of web
integration and consulting revenue during the quarter ended September 30, 1999
and $18.2 million for the nine months ended September 30, 1999. The remaining
increase is due to expansion of our customer base in the Los Angeles
metropolitan area.
Telephony services. Telephony services increased from $431,000 for the
quarter ended September 30, 1998 to $1.4 million for the quarter ended September
30, 1999, an increase of $983,000. Telephony services increased from $977,000
for the nine months ended September 30, 1998 to $3.2 million for the nine months
ended September 30, 1999, an increase of $2.3 million. This increase is due to
the continued market penetration and expansion of our customer base in the Los
Angeles metropolitan area.
12
<PAGE>
Operating Expenses
Network and service costs. Network and service costs increased from $446,000
for the quarter ended September 30, 1998 to $11.2 million for the quarter ended
September 30, 1999, an increase of $10.7 million. Additionally, network and
service costs increased from $885,000 for the nine months ended September 30,
1998 to $25.8 million for the nine months ended September 30, 1999, an increase
of $24.9 million. The Company's acquisitions and the support of the customers
acquired in those acquisitions increased network and service costs in aggregate
by approximately $8.6 million and $18.9 million for the three and nine months
ended September 30, 1999, respectively. The remaining increase is due to the
cost of providing service to our expanded customer base in the Los Angeles
metropolitan area.
Selling, general and administrative. Selling, general and administrative
expenses increased from $6.4 million for the quarter ended September 30, 1998 to
$21.3 million for the quarter ended September 30, 1999, an increase of $14.9
million. Additionally, selling, general and administrative expenses increased
from $13.9 million for the nine months ended September 30, 1998 to $46.0 million
for the nine months ended September 30, 1999, an increase of $32.1 million. The
Company's various acquisitions increased selling, general and administrative
expenses in aggregate by approximately $5.8 million for the quarter ended
September 30, 1999 and $12.5 million for the nine months ended September 30,
1999. Salaries and other related expenses, excluding the acquisitions, increased
approximately $4.1 million and $10.6 million for the three and nine months ended
September 30, 1999, primarily due to higher staffing levels in Southern
California and at the Company's headquarters. In addition, as further discussed
in Note 7 to the financial statements, in accordance with Securities and
Exchange Commission Staff Accounting Bulletin No. 79, the Company recorded a
capital contribution and corresponding non-cash charge during the three months
ended September 30, 1999 in the amount of $1.9 million. The remaining increase
was due to higher overall expenses resulting from expansion of operations in
accordance with the execution of the Company's business plan.
Depreciation and amortization. Depreciation and amortization expenses
increased from $585,000 for the quarter ended September 30, 1998 to $7.6 million
for the quarter ended September 30, 1999, an increase of $7.0 million.
Additionally, depreciation and amortization expenses increased from $1.9 million
for the nine months ended September 30, 1998 to $14.9 million for the nine
months ended September 30, 1999, an increase of $13.0 million. The majority of
the increase in depreciation and amortization is due to the amortization of
goodwill associated with the Company's various acquisitions. Amortization of
the goodwill associated with these acquisitions approximated $4.8 million for
the quarter ended September 30, 1999 and $8.0 million for the nine months ended
September 30, 1999. During the nine months ended September 30, 1999, the
Company reached an agreement with a vendor with regards to certain equipment
which was returned to such vendor. As a result, approximately $882,000 of
capitalized engineering and installation costs were written-off. The remaining
increase related primarily to depreciation associated with communications
equipment placed in service.
Other
Interest income. Interest income decreased from $3.5 million for the quarter
ended September 30, 1998 to $1.5 million for the quarter ended September 30,
1999, a decrease of $2.0 million. For the nine months ended September 30, 1999,
interest income decreased $813,000 compared to the nine months ended September
30, 1998. In April 1998, the Company completed a debt offering of senior notes
raising approximately $250.0 million in proceeds. As of September 30, 1999, the
Company had approximately $88.7 million in cash and marketable securities, a
decline of approximately $148.9 million in cash and marketable securities
compared to the same prior year period, this decrease resulted in lower interest
income.
Interest expense. Interest expense increased from $5.8 million for the
quarter ended September 30, 1998 to $9.6 million for the quarter ended September
30, 1999, an increase of $3.8 million. Additionally, interest expense increased
from $15.5 million for the nine months ended September 30, 1998 to $28.1 million
for the nine months ended September 30, 1999, an increase of $12.6 million.
This increase relates primarily to interest expense associated with the senior
notes, partially offset by a reduction in interest expense associated with a
revolving credit facility, which was terminated in April 1998. The Company is
not currently scheduled to make any cash interest payments on the senior notes
until the year 2003. Capitalized interest for the three and nine months ended
September 30, 1999 was $140,000 and $405,000, respectively.
Extraordinary Loss. An extraordinary loss on the extinguishment of debt of
$4.7 million was recorded in the nine months ended September 30, 1998. The
Company reported no extraordinary loss in the three and nine months ended
September 30, 1999. On September 16, 1997, the Company entered into a revolving
credit facility with a syndicate of lenders to provide financing for the
construction of telecommunication networks and for general working capital
purposes. The Company terminated the credit facility concurrently with the
closing of the senior notes and paid the syndicate of lenders a $1.0 million
termination fee pursuant to the terms thereof. The Company recorded an
extraordinary loss of approximately $4.7 million associated with such debt
extinguishment in the nine ended September 30, 1998. This loss was inclusive of
the termination fee and the write-off of unamortized debt discount and deferred
financing costs.
13
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's existing operations have required and will continue to require
substantial capital investment for the installation of communications equipment,
DSL equipment, data center facilities, incumbent local exchange carrier co-
locations, fiber optics and other electronics and related equipment. In
addition, the Company currently expects to incur operating losses during the
start-up phase of new markets targeted by the Company. Such expansion will
require significant additional capital for the design, development and
construction of the Company's network, business acquisitions and the funding of
operating losses as a result of expanding the network into new markets.
As the Company pursues acquisitions and expansion of its network and services
to additional areas or if the Company's available cash resources are not
sufficient to fund all of the Company's operating expenses and capital
expenditures, the Company will require additional capital. The Company may
obtain additional funding through the public or private sale of debt and/or
equity securities or through securing vendor financing and/or a bank credit
facility. However, there can be no assurance that the Company will obtain such
funding.
To date, we have satisfied our cash requirements through the private
placements of debt and equity securities. From our inception through September
30, 1999, we raised approximately $62.4 million in net proceeds from the sale of
equity securities and $241.3 million in net proceeds from the sale of debt
securities.
On December 30, 1997, we consummated a private placement of our Series A
common stock to entities controlled by Donald L. Sturm and ETC. Aggregate
proceeds from this offering totaled approximately $26.1 million, net of offering
commissions and other fees, and were received on January 6, 1998. On April 13,
1998, concurrent with our senior notes offering discussed below, we completed an
additional $18.8 million, net of offering commissions and other fees, private
placement of capital stock to entities controlled by Donald L. Sturm and Enron.
In addition, the Company has raised approximately $16.1 million, net of offering
commissions and other fees, from the issuance of Series A, B and C preferred
stock and $1.3 million from the exercise of options and warrants to purchase our
Series B common stock.
On April 13, 1998, we completed an offering of debt securities pursuant to
Rule 144A under the Securities Act of 1933. In this debt offering, we sold
470,000 units consisting of 13% Senior Discount Notes due 2008 and warrants to
purchase, at $.01 per share, an aggregate of 3,713,094 shares of our Series B
common stock. The aggregate net proceeds of the debt offering was $241.3
million.
As of September 30, 1999, we had $88.7 million of cash and cash equivalents
and marketable securities. We had an accumulated deficit of $138.2 million at
September 30, 1999.
The Company's most significant sources and uses of funds for the nine months
ended September 30, 1999 are as follows (000s):
<TABLE>
<CAPTION>
<S> <C>
Sources of funds:
Maturities of held-to-maturity marketable securities $308,498
Proceeds from the exercise of stock options and warrants 1,015
--------
Total sources of cash $309,513
========
Uses of funds:
Purchases of held-to-maturity marketable securities $168,991
Acquisitions, net of cash acquired 44,761
Purchase of property and equipment 42,798
Net cash used by operating activities 22,477
Payments associated with debt and capital leases 1,983
--------
Total uses of cash $281,010
========
</TABLE>
The substantial capital investment required to initiate the Company's services
and the funding of the Company's initial operations has resulted in negative
cash flow since its inception. This negative cash flow is the result of the
Company's capital expansion, acquisition activities and market development. The
Company currently expects to continue to experience negative cash flow for the
foreseeable future due to expansion through acquisitions and other activities
associated with the development of the Company's markets. There can be no
assurance that break-even cash flow can be attained in subsequent periods. Until
sufficient cash flow is generated, the Company will be required to utilize its
current
14
<PAGE>
and future capital resources to meet its cash flow requirements and may be
required to issue additional debt and/or equity securities. The Company
currently continues to believe that it currently has sufficient capital to
execute its 1999 business plan.
The Company has entered into a letter of intent with an entity controlled by
its Chairman, Donald L. Sturm, for a $50.0 million equity commitment. The
letter of intent anticipates that the Company and the Sturm entity enter into an
agreement which will allow the Company to require that the Sturm entity purchase
up to $50.0 million of Series B common stock priced at $7.50 per share. The
agreement will expire on the earlier of 180 days after the effectiveness of the
agreement or upon the closing of an initial public offering by the Company.
The letter of intent outlines three dates on which the Company can require
that the Sturm entity purchase the Company's Series B common stock. These dates
are: February 15, 2000; March 31, 2000; and the expiration date of the
agreement. Additionally, if at any time after closing of the agreement the
cash, cash equivalents and marketable securities position of the Company is
$20.0 million or less, the Company will automatically exercise $25.0 million of
the commitment. Closing of the commitment is subject to certain conditions,
including the documentation of definitive agreements, any required approval
under the Hart Scott Rodino Improvements Anti-Trust Act and final approval from
the Company's Board of Directors. In addition, the Company will agree to pay the
Sturm controlled entity a $5.0 million fee for the commitment.
Fair Value of Financial Instruments
Management believes that the carrying amounts shown for the Company's
financial instruments reasonably approximate their fair values.
YEAR 2000 READINESS DISCLOSURE
Year 2000 Readiness
We have a comprehensive internal Year 2000 compliance program designed to
enable us to continue our business without interruption as we move into the next
millennium. We established our Year 2000 compliance program to address the
impact of the Year 2000 date transition on our operations, pursuant to the Year
2000 Information and Readiness Disclosure Act of 1998. This program covers not
only our internal information systems and other information technology-based
facilities such as data and telephony communications, building management, and
security systems, but also the readiness and compliance programs of our key
suppliers.
In 1998, we established a dedicated Year 2000 Project Team, consisting of
subject matter experts from relevant departments within FirstWorld. A project
manager coordinates existing projects and oversees management and execution of
our Year 2000 compliance program. Our Chief Information Officer has ultimate
responsibility for the Year 2000 compliance program, and he communicates Year
2000 progress weekly to our senior management, and monthly to our board of
directors.
Policies, procedures, and standard approaches for assessing and resolving
issues and managing compliance have been adapted from both internal and external
sources.
State of Year 2000 Readiness
We have adopted the California Public Utilities Commission's definition of
"Year 2000 Ready" and of "Year 2000 Compliant." Our Year 2000 compliance
program covers several phases, including:
. taking inventory of hardware, software, third-party suppliers and embedded
systems;
. assessing business and customer risks associated with such systems or
supplier and creating, executing and monitoring action plans to address
known risks;
. taking appropriate remedial action; and
. establishing and implementing contingency plans and procedures.
We are continually monitoring new hardware, software and embedded systems
introduced into our environment that could be affected by potential Year 2000
issues. We continue to update our inventory as our business grows. We use this
inventory and the information we derive from it to drive our internal Year 2000
efforts.
15
<PAGE>
Action plans generally consist of:
. assessing the Year 2000 readiness of systems;
. repairing, replacing, or retiring systems that are not Year 2000 Ready; and
. testing repaired or replaced components and systems where possible.
Our Year 2000 compliance program encompasses information technology hardware
and software systems such as communications systems, desktop PCs, and custom-
built software programs, as well as systems with embedded technology, such as
power generators, temperature controls, alarms, security systems and elevators.
We have segregated our systems and applications and their corresponding Year
2000 readiness risk into the following five categories:
. internal information technology enterprise applications, such as billing
and customer service;
. network infrastructure, including corporate local and wide area networks,
user workstations and off-the-shelf software applications;
. customer Internet service provider platform;
. customer telephony platform; and
. corporate facilities, such as offices, phone systems and voice mail.
We are using a variety of software tools to assist us in evaluating our Year
2000 readiness. Where possible, we test our critical applications. These tests
include without limitation transaction processing at various dates before,
during and after the millennium, including the leap day in February 2000. While
we do not anticipate that the Year 2000 will cause disruption in our ability to
provide services, there can be no assurance that all systems, processes and
platforms will be Year 2000 ready given our significant reliance on third-party
systems and providers.
We recently acquired a number of companies and business operations and intend
to continue to make acquisitions from time to time. As a part of our due
diligence prior to closing these acquisitions, we make a preliminary assessment
of the state of each acquired business' Year 2000 readiness. After closing, we
evaluate the systems and applications of the acquired company as part of our
Year 2000 compliance program. We currently expect to substantially complete the
evaluation and any required remediation by November 30, 1999. Although we can
give you no assurance, we currently expect that each of our recently acquired
companies will be Year 2000 ready prior to the century date change.
Our Year 2000 compliance program also addresses third-party vendors. Certain
third-party services or products are critical to our continued day-to-day
operations. These third-parties include without limitation power and other
utilities, switch vendors, network providers, including both local and long-haul
carriers, and other hardware and software vendors.
Most of our third-party vendors are large, national companies, providing
services similar to those provided to many other similar customers. We have no
control over these companies' Year 2000 state-of-readiness. Indeed, if some of
these companies experience Year 2000 difficulties in their systems, it will not
only affect us but whole geographic regions of their customers. For example, if
an incumbent local exchange carrier loses its switching or transmission
platform, we, as well as virtually all of our competitors in that region, will
be impacted.
To mitigate this risk, we are currently assessing our vulnerability to
unexpected business interruptions due to the failure of third-parties to
remediate Year 2000 readiness issues associated with products or services on
which our business relies. In connection with this assessment, we have
collected and cataloged relevant vendor information regarding our vendor's Year
2000 compliance and matched it against our system inventory. We continue to
review that information for updates. We are relying on such information to
accurately describe the state of Year 2000 readiness of third-party products or
components so assessed. We have sent and continue to send Year 2000 compliance
questionnaires and letters to our critical/significant third-party business
partners, suppliers and/or vendors, where we have been unable to match
compliance documentation with our utilized hardware, software and network
services, requesting that they certify their Year 2000 readiness. We are
presently in the process of re-contacting our critical suppliers and vendors who
have either not responded or have not responded adequately to our requests for
proof of certification. We presently expect to complete this process by
November 30, 1999 and will continue to follow-up on unresolved issues
thereafter. There can be no assurance that third-parties who have responded, or
will respond, to our request regarding their Year 2000 readiness have responded,
or will respond, accurately or satisfactorily or that anticipated Year 2000
actions set forth in their responses will be properly conducted.
16
<PAGE>
Since we implemented our Year 2000 compliance program, we have established
many new contractual relationships for services, including carrier agreements,
software and hardware platform purchases and upgrades. Where appropriate, we
have required the vendors to address their Year 2000 readiness as part of the
contract or service agreement.
We believe most hardware components and systems now available are Year 2000
Compliant. However, it is currently expected that manufacturers and vendors
will continue to produce patches until the end of the year. Any such patches
will be installed when they become available.
We presently expect to continue extensive monitoring of our Year 2000
compliance program throughout the remainder of 1999. The status of our Year
2000 readiness efforts is as follows:
. inventory is essentially complete;
. assessment and planning are substantially complete;
. remediation is currently expected to be substantially complete by November
30, 1999; and
. contingency planning is currently expected to be substantially complete by
November 30, 1999.
Risks Associated with Year 2000 Issues
A significant amount of the demand we have experienced in recent months for
our products and services may have been generated by our continuing acquisition
and expansion strategy during 1999. The acquisition of a company or customer
that has failed to address its Year 2000 issues could have a material adverse
effect on our own Year 2000 efforts. To minimize the risk associated with this
acquisition, we have instituted certain guidelines that include Year 2000
readiness as a crucial due diligence factor. In addition, as the Year 2000
approaches, customers may slow down Internet and telephony systems purchases as
they devote more time to preparing and testing their systems for Year 2000
readiness, versus evaluating and implementing new systems. Thus, the
telecommunications industry and FirstWorld may experience a significant
deceleration from the strong annual growth rates historically experienced in the
telecommunications marketplace.
We currently anticipate that our products and services will be Year 2000
Compliant. There can be no assurances, however, that our current products and
services do not contain undetected Year 2000 defects. The most reasonably likely
worst case scenarios would include the partial failure of a widely-sold product
and service of ours that is of mission-critical importance to our customers.
Such a scenario could expose us to litigation that could have a material adverse
impact on us. Some commentators have stated that a significant amount of
litigation will arise out of Year 2000 compliance issues. However, because of
the unprecedented nature of such litigation, it is uncertain to what extent we
could be affected by it. We currently do not believe that we will incur any
material costs or experience material disruptions in our business associated
with preparing our internal systems for the Year 2000. There can be no
assurances however, that we will not experience serious unanticipated negative
consequences caused by undetected Year 2000 defects in our internal systems,
including third-party software and hardware products and services. The most
reasonably likely worst case scenarios related to such undetected Year 2000
defects would include:
. corruption of data contained in our internal information systems, rendering
the data useless unless and until it is corrected;
. failure of hardware, software, or other information technology systems to
correctly process or transmit date-sensitive data, causing an interruption
or failure of normal business operations; and
. failure of any one of a number of third-party systems or interfaces, on
which we rely for our service platform, which could interfere with our
operations.
17
<PAGE>
Such a scenario could have a material adverse impact on us. In addition, there
can be no assurances that we will not experience serious unanticipated negative
consequences caused by the failure of services provided by third-parties, such
as electrical power, communications services, and shipping services. Due to the
impossibility of knowing what failures generally will result from the Year 2000
date change (particularly outside of countries such as the United States where
Year 2000 remediation has progressed the furthest), and what effects such
failures could have on third-party vendors, we are unable to assess the
likelihood of a material adverse impact on our results of operations, liquidity
or financial condition due to such Year 2000 failures. We currently anticipate
that we will experience a significant increase in calls to customer support from
customers seeking:
. Year 2000 product information;
. information on migrating from older, non-compliant products to compliant
products; and
. assistance in handling other Year 2000 issues.
We intend to develop a program to enable us to handle the expected increase in
calls. We may incur significant costs in connection with this program. Among
other things, we currently anticipate that we will be required to reassign
consultants to the customer support organization on an interim basis, which
could cause a decrease in consulting revenues. Such costs or lost revenues
cannot be estimated until the program planning is completed.
If our remediation efforts are not successful or are not completed in a timely
manner, the Year 2000 issue could significantly disrupt our ability to transact
business with our customers and suppliers, and could have a material impact on
our operations. Even if our remediation efforts are successful or we complete
them on time, there can be no assurance that other companies will timely and
effectively address Year 2000 issues and successfully convert their systems with
which our systems interact, or that any such failure to address Year 2000 issues
or failure to convert by another company would not have an adverse effect on our
business or operations. We cannot estimate the potential adverse impact that
may result from non-compliance with the Year 2000 issue by the software and
equipment vendors and others with whom we conduct business.
Contingency Planning
Our services may be adversely affected by potential Year 2000 issues because
of the uncertainties involved in addressing the Year 2000 issues and to the
extent our suppliers, vendors or customers, including incumbent local exchange
carriers over whose networks we provide certain of our services, fail to address
Year 2000 issues in a timely and effective manner. Contingency planning is
therefore an inherent part of our Year 2000 compliance program. We are
identifying and assessing potential points of failures and the resulting impact
to the business. Our methodology includes examining risk reduction measures as
well as the development of detailed contingency plans.
We are preparing a comprehensive contingency plan to address possible failures
caused by the Year 2000 date change. The contingency plan will address, among
other things, access to alternative third-party vendors for services and
products, such as access and transport services, manual ''work-arounds'' for
software and hardware failures, and substitution of hardware and software
systems, if necessary. We currently expect to substantially complete our
contingency planning by November 30, 1999. We have begun addressing potential
and expected effects of the Year 2000 date change by planning for increased
support staffing in late 1999 and early 2000. Such existing activities and
plans will be incorporated into the contingency plan. However, we can not make
any assurances that the contingency plan will resolve any Year 2000 failure that
may occur, in a manner that is satisfactory or desirable to us.
18
<PAGE>
Costs of Addressing Year 2000 Issues
We are continually upgrading and improving our information technology systems
and facilities, and we expense all incremental costs associated with Year 2000
compliance issues as incurred. Through September 30, 1999, such costs incurred
were approximately $250,000 primarily consisting of contract consulting fees.
We currently expect to incur certain internal costs, including salaries and
benefits for two dedicated full-time equivalent employees to address Year 2000
compliance issues, of which such costs represent approximately 8% of the
budgeted information technology staff.
We have not yet determined the full cost of our Year 2000 compliance program
and its related impact on our financial condition. We currently have budgeted
$500,000 for the completion of our Year 2000 program, and have included it as
part of the normal 1999 information technology operating budget. No assurance
can be made, however, as to the total cost for the Year 2000 compliance program
until the program has been completed. While there can be no assurance, we do
not believe that any such additional costs will have a material impact on our
results of operations.
19
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes there has been no significant changes in the market risk
associated with its financial instruments since September 30, 1998.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Dina Partners L.P.
On October 16, 1998, the Company filed a declaratory relief action in San
Diego Superior Court, asking the Court to find that the Company was not
obligated to offer stock to Dina Partners, L.P. in connection with the December
30, 1997 equity investment by Spectra 3, a Donald L. Sturm entity, and ETC. On
September 3, 1999, the lawsuit was dismissed with prejudice.
City of Anaheim
On May 13, 1999, the City of Anaheim (the "City") filed a lawsuit in Orange
County Superior Court, Case Number 809281, against FirstWorld and FirstWorld
Anaheim (collectively "FirstWorld Parties"). The City alleges that the
FirstWorld Parties repudiated their contractual obligations under the Universal
Telecommunications System Participation Agreement (the "Participation
Agreement"), the Agreement for Use of Operating Property (the "Operating
Property Agreement") and the Development Fee Agreement (the "Development
Agreement," and together with the Participation Agreement and the Operating
Property Agreement, the "UTS Agreements"). In addition, the City alleges, among
other things, that the FirstWorld Parties materially breached their obligations
under the UTS Agreements by: (i) failing to commence construction of a
demonstration center in downtown Anaheim and that the FirstWorld Parties will
not commence operation of this downtown demonstration center by June 30, 1999
under the UTS Agreements; (ii) failing to provide verification that Substantial
Completion of Phase I, as each such term is defined in the UTS Agreements, has
been achieved; (iii) failing to provide a "Subsequent Implementation Program"
(as defined in the UTS Agreements); (iv) failing to comply with various auditing
procedures in the UTS Agreements; and (v) failing to make a quarterly payment
due under the Participation Agreement. The City alleges that it is entitled to
damages in excess of $45.0 million as well as costs, pre-judgment interest and
such other relief as the Court deems proper. The City also seeks specific
performance compelling FirstWorld Parties to completely perform certain
obligations under the UTS Agreements.
In response to the lawsuit, the FirstWorld Parties filed a Motion to Compel
Arbitration. On September 16, 1999, the Court granted the Company's motion. On
October 6, 1999, the Court entered an Order finding that there is a valid
arbitration provision in the agreements and that the City has not established
that FirstWorld unequivocally repudiated the UTS Agreements. The court action
has been stayed pending completion of the arbitration. Neither the City nor the
Company has commenced arbitration procedures.
The Company believes that the FirstWorld Parties are not in breach as alleged
and intends to vigorously defend the action; however, there can be no assurance
that an unfavorable outcome of this dispute would not have a material adverse
effect on the Company's results of operations, liquidity or financial position.
Other
The Company is engaged in other legal actions arising in the ordinary course
of its business and believes that the outcome of these actions will not have a
material adverse effect on its results of operations, liquidity or financial
position.
20
<PAGE>
ITEM 6. Exhibits And Reports On Form 8-K
(a) Exhibits:
Exhibit 27.1 Financial Data Schedule
(b) Three reports on Form 8-K were filed in the three-month period ended
September 30, 1999:
<TABLE>
<CAPTION>
<S> <C> <C>
Were any financial
Item Reported statements filed? Date of filing
------------- ------------------ --------------
Item 5 - Other Event - Acquisition of inQuo No July 8, 1999
Item 5 - Other Event - Acquisition of Transport Logic No July 26, 1999
Item 5 - Other Event - Acquisition of Intelenet No August 2, 1999
</TABLE>
21
<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.
<TABLE>
<CAPTION>
FIRSTWORLD COMMUNICATIONS, INC.,
a Delaware corporation
(Registrant)
<S> <C> <C>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ SHELDON S. OHRINGER President, Chief Executive Officer and Director November 15, 1999
- ---------------------------------------------- (Principal Executive Officer)
Sheldon S. Ohringer
/s/ PAUL C. ADAMS Vice President of Finance, Treasurer and Assistant November 15, 1999
- ---------------------------------------------- Secretary (Principal Financial and Accounting
Paul C. Adams Officer)
</TABLE>
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 58,162
<SECURITIES> 30,523
<RECEIVABLES> 9,483
<ALLOWANCES> 754
<INVENTORY> 0
<CURRENT-ASSETS> 102,445
<PP&E> 110,923
<DEPRECIATION> 10,098
<TOTAL-ASSETS> 277,699
<CURRENT-LIABILITIES> 33,176
<BONDS> 284,587
0
0
<COMMON> 3
<OTHER-SE> (47,654)
<TOTAL-LIABILITY-AND-EQUITY> 277,699
<SALES> 16,022
<TOTAL-REVENUES> 16,022
<CGS> 11,194
<TOTAL-COSTS> 40,124
<OTHER-EXPENSES> 0
<LOSS-PROVISION> (24,102)
<INTEREST-EXPENSE> (9,597)
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> (32,218)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (32,218)
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
