<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 QUARTER ENDED MARCH 31, 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 NUMBER 000-24653
NORTHEAST OPTIC NETWORK, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3056279
(State or other jurisdiction of incorporation (I.R.S. Identification No.)
or organization)
391 TOTTEN POND ROAD
SUITE 401
WALTHAM, MASSACHUSETTS 02451
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(781) 890-6868
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 / /
At March 31, 1999 there were 16,077,738 shares of the Company's common stock
outstanding.
Page 1 of 20
Exhibit Index at Page 20
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
<TABLE>
<S> <C>
Condensed Consolidated Balance Sheets at March 31, 1999 (Unaudited)
and December 31, 1998.............................................................3
Condensed Consolidated Statements of Operations for the three month periods
ended March 31, 1999 and March 31, 1998 (Unaudited)...............................4
Condensed Consolidated Statements of Cash Flows for the three month periods
ended March 31, 1999 and March 31, 1998 (Unaudited)...............................5
Notes to Condensed Consolidated Financial Statements..............................6
</TABLE>
-------------------
Page 2 of 20
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 43,273,561 $ 57,737,792
Short-term restricted cash and investments 11,256,861 23,149,975
Short-term investments 55,133,067 48,581,949
Accounts receivable 187,999 111,915
Refundable taxes from related party -- 755,838
Prepaid expenses and other current assets 953,542 506,947
------------ ------------
Total current assets 110,805,030 130,844,416
------------ ------------
PROPERTY AND EQUIPMENT, NET 67,364,457 52,922,677
RESTRICTED CASH AND INVESTMENTS 52,081,820 51,371,859
INTANGIBLE ASSETS, NET 56,600,474 56,773,282
------------ ------------
$286,851,781 $291,912,234
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 19,225 $ 127,619
Accounts payable 4,712,979 322,285
Accounts payable construction-in-progress 3,341,924 2,647,719
Accrued expenses 6,948,457 13,526,702
Accrued right-of-way fees, related party 886,322 1,084,325
Deferred revenue 1,071,198 1,168,900
------------ ------------
Total current liabilities 16,980,105 18,877,550
------------ ------------
LONG-TERM ACCOUNTS PAYABLE 2,099,585 --
------------ ------------
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 180,000,000 180,000,000
------------ ------------
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES -- --
COMMITMENTS AND CONTINGENCIES
CMP WARRANT -- --
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value-
Authorized--30,000,000 shares; 16,077,783 and 16,066,333
shares issued and outstanding March 31, 1999 and December 31, 1998,
respectively 160,778 160,663
Warrants 8,595 8,595
Additional paid-in capital 108,106,256 108,105,684
Accumulated deficit (20,503,538) (15,240,258)
------------ ------------
Total stockholders' equity 87,772,091 93,034,684
------------ ------------
$286,851,781 $291,912,234
------------ ------------
------------ ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
Page 3 of 20
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1999 1998
<S> <C> <C>
REVENUES:
Contract $ 421,481 $ 146,257
Other service 99,475 5,106
----------- ---------
Total revenues 520,956 151,363
----------- ---------
EXPENSES:
Cost of sales 928,988 247,386
Selling, general and administrative 1,321,373 225,122
Depreciation and amortization 794,978 302,013
----------- ---------
Total expenses 3,045,339 774,521
----------- ---------
Loss from operations (2,524,383) (623,158)
OTHER INCOME (EXPENSE):
Interest income and other, net 2,240,764 30,322
Interest expense (4,979,661) (91,816)
----------- ---------
Total other income (expense) (2,738,897) (61,494)
Loss before minority interest in subsidiaries' earnings and
benefit from income taxes (5,263,280) (684,652)
MINORITY INTEREST -- 314,498
PROVISION FOR (BENEFIT FROM) INCOME TAXES -- (77,000)
NET LOSS $(5,263,280) $(293,154)
----------- ---------
----------- ---------
BASIC AND DILUTED LOSS PER SHARE $ (0.33) $ (1.03)
----------- ---------
----------- ---------
BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 16,070,027 284,828
----------- ---------
----------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
Page 4 of 20
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,263,280) $ (293,154)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities-
Accretion of long-term obligations -- 26,642
Depreciation and amortization 794,978 302,013
Amortization of deferred financing costs 156,661 --
Changes in assets and liabilities-
Accounts receivable (76,084) 865,651
Refundable taxes from related party 755,838 (126,641)
Prepaid expenses and other current assets (446,595) (96,321)
Accounts payable 4,390,694 (4,122)
Accrued expenses (6,776,248) (7,045)
Deferred revenue (97,702) (14,595)
Deferred tax liability -- 25,192
------------- ------------
Net cash (used in) provided by operating activities (6,561,738) 677,620
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments (6,551,118) --
Purchases of property and equipment (14,837,780) (3,297,062)
Increase in intangible assets (382,831) (243,413)
------------- ------------
Net cash used in investing activities (21,771,729) (3,540,475)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Decrease) increase in construction and long-term accounts
payable 2,793,790 1,587,222
Proceeds from note payable to related party -- 1,875,000
Payments on long-term obligations (108,394) (131,328)
Decrease (Increase) in restricted cash and investments 11,183,153 (19,739)
Proceeds from exercise of stock options and warrants 687 --
Increase in minority interest in subsidiary -- (314,498)
------------- ------------
Net cash provided by financing activities 13,869,236 2,996,657
------------- ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (14,464,231) 133,802
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 57,737,792 1,098,452
------------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 43,273,561 $ 1,232,254
------------- ------------
------------- ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for-
Interest $ 12,244,324 $ 161,555
------------- ------------
------------- ------------
Taxes $ -- $ 28,440
------------- ------------
------------- ------------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
Page 5 of 20
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) OPERATIONS
NorthEast Optic Network, Inc. (the "Company" or "NEON") (formerly
FiveCom, Inc.) and its subsidiaries are engaged in the ownership,
management, operation and construction of fiber optic telecommunication
networks in the Northeast, consisting of New England and New York.
On August 5, 1998, the Company completed an initial public offering
(IPO) of 4,500,000 shares of its common stock at $12.00 per share, and
sold $180 million of 12 3/4% Senior Notes due 2008 (the Senior Notes)
to the public in a debt offering.
To date, the Company recorded limited revenues principally from
contract and other services and has incurred cumulative operating
losses. The Company is dependent upon a single or limited source of
suppliers for a number of components and parts. Shortages resulting
from a change in arrangements with these suppliers and manufacturers
could cause significant delays in the expansion of the NEON systems and
could have a material adverse effect on the Company.
The market for fiber optic telecommunications in which the Company
operates can be characterized as rapidly changing due to technological
advancements, the introduction of new products and services and the
increasing demands placed on equipment in worldwide telecommunications
networks.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the
application of certain accounting policies as described below and
elsewhere in these notes to consolidated financial statements.
(A) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have
been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission, and reflect all
adjustments, consisting of only normal recurring adjustments,
which, in the opinion of management, are necessary for a fair
statement of the results of the interim periods presented. These
financial statements do not include disclosures associated with
the annual financial statements and, accordingly, should be read
in conjunction with the attached Management's Discussion and
Analysis of Financial Condition and Results of Operation and the
financial statements and footnotes for the year ended December 31,
1998 included in the Company's Form 10-K.
(B) MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual amounts could differ from those estimates.
Page 6 of 20
<PAGE>
(C) REVENUE RECOGNITION
Revenues on telecommunications network services are recognized
ratably over the term of the applicable agreements with customers,
which range from 1 to 20 years. Other service revenue, which
consists of design and installation work, is recognized as
services are performed.
(D) EARNINGS PER SHARE
In accordance with SFAS No. 128, EARNINGS PER SHARE, basic and
diluted loss per share were computed by dividing net loss by the
weighted average number of common shares outstanding during the
first three months of 1999 and 1998. Diluted loss per share
excludes shares issuable from the assumed exercise of stock
options, as their effect would be antidilutive.
(E) COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board (FASB)
issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME. SFAS No. 130
requires disclosure of all components of comprehensive income on
an annual and interim basis. Comprehensive income is defined as
the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner
sources. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. This new standard does not have any
impact on the Company's financial statements based on the current
structure and operations.
(F) RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform
with current period presentation.
(3) CONTINGENCIES
Certain claims arising in the ordinary course of business are pending
against the Company. In the opinion of management, these claims are
without merit and they believe there is no potential liability.
(4) 12 3/4% SENIOR NOTES
In August 1998, the Company sold $180 million of 12 3/4% Senior Notes
due 2008 to the public in the debt offering. The Senior Notes are due
on August 15, 2008 and scheduled interest payments are due on February
15 and August 15 of each year, commencing February 15, 1999. Upon
closing of the Senior Notes, the Company purchased approximately $72
million in U.S. government obligations, with an average maturity of 645
days, to provide for payment in full of the first seven scheduled
interest payments on the Senior Notes. Such securities are pledged as
security for the benefit of the holders of the Senior Notes, are
classified as held-to-maturity and reported at amortized cost and are
included as restricted cash and investments in the accompanying
consolidated balance sheet. The Senior Notes are redeemable in whole or
in part at the option of the Company at any time on or after August 15,
2003 at the following redemption prices expressed as a percentage of
principal plus accrued interest through the date of redemption:
Page 7 of 20
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PERIOD REDEMPTION PRICE
<S> <C>
2003 106.375%
2004 104.250
2005 102.125
Thereafter 100.000
</TABLE>
In the event of a change in control, as defined, each holder of the
notes will be entitled to require the Company to purchase all or a
portion of such holder's Senior Notes at a purchase price equal to 101%
of the principal amount thereof, plus accrued and unpaid interest, if
any, to the date of purchase. The Senior Notes are unsecured
obligations and rank PARI PASSU in right of payment with all existing
and future indebtedness of the Company that is not by its terms in
right of payment and priority to the Senior Notes and is senior in
right of payment to all future subordinated indebtedness of the
Company.
In connection with this financing, the Company incurred approximately
$6.3 million of issuance costs. These costs have been classified as
intangible assets in the accompanying condensed consolidated balance
sheets and are being amortized, as interest expense, over the term of
the Notes.
(5) STOCKHOLDERS' EQUITY
(A) PREFERRED STOCK
The Restated Certificate of Incorporation authorizes the issuance
of up to 2,000,000 shares of preferred stock, $.01 par value per
share. Under the terms of the Certificate of Incorporation, the
Board of Directors is authorized, subject to any limitations
prescribed by law, without stockholder approval, to issue such
shares of preferred stock in one or more series. Each series of
preferred stock shall have rights, preferences, privileges and
restrictions, including voting rights, dividend rights, conversion
rights, redemption privileges and liquidation preferences, as
shall be determined by the Board of Directors. At March 31, 1999,
no such shares are issued and outstanding.
(B) COMMON STOCK
In June 1998, the Company's Board of Directors authorized the
issuance of up to 30,000,000 shares of common stock.
In July 1998, the Company's Board of Directors voted to effect a
2.5 - to -1 common stock split. Series A and B convertible
preferred stock will convert at a rate equal to the common stock
split. All share and per share amounts have been retroactively
restated to reflect the stock split.
On August 5, 1998, the Company completed the sale of 4,500,000
shares of its Common Stock at a price of $12.00 per share. Of the
aggregate shares of Common Stock sold, 4,000,000 were sold for the
account of the Company generating net proceeds to the Company of
approximately $44,640,000 and 500,000 shares were sold for account
of certain stockholders of the Company.
Page 8 of 20
<PAGE>
(6) SEGMENT DISCLOSURE
In July 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS
OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 requires certain
financial and supplementary information to be disclosed on an annual
and interim basis for each reportable segment of an enterprise. SFAS
No. 131 is effective for fiscal years beginning after December 15,
1997. Unless impracticable, companies would be required to restate
prior period information upon adoption. The Company analyzes segment
reporting based on dark fiber and lit fiber facilities revenue only.
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
<S> <C> <C>
Dark fiber revenues $386,681 $146,257
Lit fiber revenues 34,800 --
-------- --------
Total contract revenues $421,481 $146,257
-------- --------
-------- --------
</TABLE>
-----------------------------------------
Page 9 of 20
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
In addition to historical information contained herein, this report
contains certain "forward looking statements" within the meaning of
section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities and Exchange Act of 1934, as amended, and are subject
to the safe harbors created thereby. All statements included in this
report regarding the Company's financial position, business strategy
and plans, objectives for the future operations, technical
developments, Year 2000 compliance and industry conditions--other than
statements of historical facts--are forward looking statements. While
these statements reflect the Company's reasonable assumptions, based
upon management's beliefs and information currently available to it,
the company can give no assurance that such expectations will prove to
be correct.
These forward looking statements are subject to certain risks,
uncertainties and assumptions related to certain factors including
without limitation, the factors described under the heading "Certain
Factors That May Affect Future Results" below.
OVERVIEW
The Company is a facilities-based provider of technologically advanced,
high bandwidth, fiber optic transmission capacity for communications
carriers on local loop, inter-city and interstate facilities. The
Company is currently expanding its fiber optic network, the NEON
system, to encompass over 900 route miles, or approximately 70,000
fiber miles, in New York and New England ("the Northeast").
The Company generates revenue primarily through leasing of capacity on
its network and also through the provision of services consisting
principally of design and installation work. The Company generally
receives fixed monthly payments from its customers for the leasing of
capacity on its network and recognizes revenues ratably over the term
of the applicable customer agreement. Other service revenues are
recognized when services are performed.
RESULTS OF OPERATIONS
Revenues for the quarter ended March 31, 1999 amounted to $520,956 an
increase of $369,593 or 244% compared to $151,363 in the same quarter
in 1998. The increase in revenues reflects the Company's continuing
expansion of lit services on the system as well as the recurring lease
services to existing customers that came on line during the years 1998
and 1997.
Cost of sales for the three months ended March 31, 1999 amounted to
$928,988 an increase of $681,602 compared to $247,386 in the same
period last year. The increased costs reflect the addition of lease
expenses, right of way fees and property taxes resulting from the
Company's continuing network expansion into the Northeast service
territory.
Selling, general and administrative expenses amounted to $1,321,373 for
the quarter ending March 31, 1999 compared to $225,122 in the same
quarter in 1998. Increased personnel and related costs continue to grow
as the Company expands its efforts to meet customer requirements. The
Company's headcount has increased to 29 from 8 or approximately 263%
since March 31, 1998.
Depreciation and amortization expense was $794,978 for the quarter
ended March 31, 1999 compared to $302,013 for the quarter ended March
31, 1998. The increase resulted from putting into service
Page 10 of 20
<PAGE>
additional portions of the NEON System and the amortization of goodwill
resulting from the reorganization on July 8, 1998 referred to below.
Net interest expense totaled $2,738,897 and $61,494 for the quarters
ending March 31,1999 and March 31,1998, respectively. The increased
interest expense reflects the sale of $180.0 million of 12 3/4% Senior
Notes partially offset by the higher cash and investment balances
resulting from the public offerings of debt and equity on August 5,
1998. (See Note 1 to the Condensed Consolidated Financial Statements).
The Company's net loss for the quarter ended March 31, 1999 amounted to
$5,263,280 or $0.33 per share loss. This compares to a net loss of
$293,154 or $1.03 per share loss in the same period last year. If the
reorganization had occurred on January 1, 1998 instead of July 8,1998,
the pro forma per share loss for the quarter ended March 31, 1998 would
have amounted to $0.02, respectively. On July 8, 1998, the Company's
entered into a Restructuring and Contribution Agreement (the
"Reorganization") with major shareholders Central Maine Power Company
("CMP"), Maine Com Services, a wholly owned subsidiary of CMP, and Mode
1, an affiliate of Northeast Utilities ("NU") (see Note 1 to the
Consolidated Financial Statements included in the Company's Form 10K
for the year ended December 31, 1998).
LIQUIDITY AND CAPITAL RESOURCES
Net cash (used in) provided by operating activities was ($6,561,738)
and $677,620 for the quarters ended March 31, 1999 and 1998,
respectively. Net cash used by operating activities for the quarter
ended March 31, 1999 was due primarily to a decrease in accrued
interest associated with the payment of interest on the 12 3/4% Senior
Notes.
Cash used in investing activities totaled $21,771,729 and $3,540,475
for the quarters ended March 31, 1999 and 1998, respectively. Cash
requirements consisted primarily of the cost of network construction
and equipment, and purchases of short-term investments.
Cash flow from financing activities totaled $13,869,236 and $2,996,657
for the quarters ended March 31, 1999 and 1998, respectively. Cash flow
from financing activities during the quarter ended March 31, 1999 was
due to a decrease in restricted cash and investments associated with
the payment of interest amounting to $12,240,000 on the 12 3/4% Senior
Notes.
The Company anticipates that it will continue to experience negative
cash flow as it expands the NEON fiber optic network, constructs
additional networks and markets its services to an expanding customer
base. Cash provided by operations will not be sufficient to fund the
expansion and development of the NEON system as currently planned, and,
as a result, the Company intends to use the proceeds from the August 5,
1998 Public Offering to fund this expansion and development. Management
believes it has sufficient funds to substantially complete the NEON
system as currently planned as well as fund the Company's other working
capital requirements. The expectations of future capital expenditures
are based on the Company's current estimates. There can be no assurance
that actual expenditures will not significantly exceed current
estimates or that the Company will not accelerate its capital
expenditures program.
YEAR 2000 READINESS
The Year 2000 issue is faced by substantially every company in the
computer or information technology industries, as well as every company
which relies on computer systems. The
Page 11 of 20
<PAGE>
Company is currently in the process of assessing its exposure to the
Year 2000 problem in the following major areas: (i) Year 2000 problems
relating to the Company's internal systems; (ii) Year 2000 problems of
the Company's critical vendors, namely those that could have a material
adverse effect on the Company's business, results of operations or
financial condition; and (iii) Year 2000 problems of the Company's
customers that could result in a reduction in demand for the Company's
fiber optic products and services.
INTERNAL SYSTEMS. The Company is in the process of determining the
nature and extent of the work required to make its internal information
technology ("IT") and non-IT systems Year 2000 complaint and is using a
third party consultant to assist it in this effort. The Company's
internal information systems consist of accounting and project
management software. The licensors of the software have advised the
Company that their products are Year 2000 compliant. The Company is
also evaluating its non-IT systems such as micro-controllers. The
Company has yet to determine whether these systems will be remedied or
replaced. However, all current hardware and software used by the
Company is less than two years old, and the Company does not foresee a
material adverse effect on the Company's business, operating results
and financial condition from Year 2000 issues related to its internal
software or hardware. The Company is currently unable to estimate the
costs of addressing its Year 2000 issues, if any, or of possible worst
case Year 2000 scenarios, and the Company has not yet developed a
contingency plan for the most reasonably likely worst case scenario.
CRITICAL VENDORS. The Company relies on third party vendors of products
and services in the conduct of its business and as a result, is in the
process of seeking assurances from its critical vendors that there will
not be a material interruption in their supply of those products and
services as a result of the Year 2000 problem. Failure of a critical
supplier to solve a Year 2000 problem in its accounting systems,
production control and/or shipping systems could have a material
adverse effect on the Company's business, operating results and
financial condition. From the responses the Company has received to
date, the Company's critical vendors are either Year 2000 compliant or
have developed or put in place an aggressive and comprehensive
readiness strategy. The Company's fiber optic network system (the
"NEON" system) is also dependent upon the transmission and distribution
infrastructure of electric utilities in the Northeast. Should one or
more of these utilities experience disruption in providing electricity
to their customers as a result of a Year 2000 problem, the utility has
the right under its agreements with the Company to take the necessary
action to restore electrical service to their customers, which could in
turn disrupt the operation of the NEON system. However, these electric
utilities are committed to minimizing risks to the NEON system and to
providing adequate resources to implement any changes necessary to be
Year 2000 compliant. See "Certain Factors That May Affect Future
Results C ROWS AND IRUS" below).
CUSTOMERS. The Company is also conducting a survey of its major
customers to determine their Year 2000 readiness. Although responses to
date indicate that they are either Year 2000 compliant or have put in
place a comprehensive readiness strategy, there can be no assurance
that the Company's customers will not delay scheduled projects as a
result of their own Year 2000 problems. Any such delays could have a
material adverse effect on the Company's business, operating results
and financial condition. To date the Company has not experienced any
lack of demand for its services related to the Year 2000 problem.
The Company through March 31, 1999 has not incurred nor does it expect
to incur any material
Page 12 of 20
<PAGE>
costs directly related to the Year 2000 computer problem. Pending
continuing investigation of its exposure to the Year 2000 problem the
Company is unable to determine the costs of solving any Year 2000
problem that may occur in the future.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The future financial and operating results of the Company remain
difficult to predict and are subject to various risks and uncertainties
described below as well as elsewhere in this Report.
LIMITED OPERATING HISTORY; CASH FLOW. The Company's current business
has only a very limited history. As a facilities-based provider of
fiber optic transmission capacity, the Company is in the early stages
of constructing the NEON system throughout the Northeast. Although
limited portions of the NEON system are currently operational, the
Company does not expect to begin to realize any substantial revenue
until the NEON system is substantially completed. The Company does not
expect to achieve substantial completion of the NEON system as
currently planned until the end of 1999. The Company has incurred net
losses from inception. The Company's future operating results will
fluctuate annually and quarterly due to several factors, some of which
are outside the control of the Company. These factors include the cost
of construction of the NEON system (including any unanticipated costs
associated therewith), the availability of rights-of-way ("ROWs"), the
cost and timely availability of equipment and construction contractors,
pricing strategies for its services, changes in the regulatory
environment, changes in telecommunications technology and changes in
general and local economic conditions. In addition, the extent of the
demand for the Company's services cannot be estimated with any degree
of certainty.
COMPLETION OF THE NEON SYSTEM. The development of the Company's
business, the completion of the NEON system and the development of the
Company's services and customer base will require significant
expenditures, most of which will need to be made before the Company is
able to offer services over substantially all of the NEON system. These
expenditures, together with associated operating expenses, will
adversely impact cash flow and profitability until an adequate customer
base is established. To date, the Company has expended substantial
amounts on construction of the NEON system. Such cash expenditures have
been funded by proceeds from the Company's financing activities.
Accordingly, the Company has generated negative cash flow. There can be
no assurance that the Company will not need to obtain additional
capital to complete the NEON system, that additional financing will be
available to the Company or, if available, that it can be obtained on a
timely basis and on acceptable terms.
The Company's ability to achieve its strategic objectives will depend
in large part upon the successful, timely and cost-effective completion
of the NEON system. Factors that could affect such completion include,
among other things, (i) obtaining adequate ROWs on acceptable terms in
and between major cities in the Northeast not covered by utility ROWs
currently available to the Company,(ii) obtaining required governmental
permits and certifications where necessary and (iii) delays or
disruptions resulting from physical damage, power loss, defective
equipment or the failure of third-party suppliers or contractors to
meet their obligations in a timely and cost-effective manner.
In order to complete the NEON system, the Company must obtain
additional rights-of-way and other permits to install fiber optic
cables from third parties, including electric utilities, transit
Page 13 of 20
<PAGE>
authorities and others. The Company has not yet obtained the necessary
ROWs to expand the NEON system to encompass the planned New York local
loop. The Company may be required to pay cash or provide in-kind
facilities for these ROWs or other ROWs to accommodate extensions to
the NEON system. The Company is unable to predict with certainty the
cost of obtaining necessary ROWs, and there can be no assurance that it
will be able to obtain such ROWs on acceptable terms, if at all. In
addition, if CMP or NU or any other entity with whom the Company has an
agreement seeks bankruptcy or other protection from its creditors, the
Company's ability to exercise rights to obtain route extensions or
other rights under its agreement with such entity may be adversely
affected.
CUSTOMERS; MARKET DEMAND. The Company's ability to implement its
business strategy is also dependent upon the Company's ability to
secure a market for its leased dark and lit fiber optic capacity and
obtain service contracts with communications carriers. Many of the
Company's targeted customers are companies that may also be the
Company's potential competitors. If the Company's services are not
satisfactory or cost competitive, the Company's potential customers may
elect to develop other alternatives in the Company's markets. The
Company has incurred and will continue to incur significant operating
expenses and has made and will continue to make significant capital
investments, in each case based upon certain expectations as to the
anticipated customer demand for the Company's services in its markets.
The Company's business strategy assumes that its current and future
service revenues will come from a limited number of communications
carriers. Therefore, dissatisfaction with the Company's services by a
relatively few number of customers could have a material adverse effect
on the Company's business, financial condition and results of
operations. The Company is aware that certain inter-exchange carriers
are constructing or considering the construction of new networks, or
buying companies with local networks, which could reduce their need for
the Company's services.
DEPENDENCE ON MANAGEMENT. The Company's future performance will depend
to a significant extent upon the efforts and abilities of its senior
executives. There can be no assurance that the Company will be able to
attract and retain qualified executives to achieve its business
operations.
ROWS AND IRUS. The construction and operation of the NEON system by the
Company is dependent upon indefeasible rights of use ("IRUs") granted
to the Company in ROWs and in fiber optic filaments. IRUs, which are
created by contract, have been used extensively in the
telecommunications industry. Although IRUs confer upon the holder
certain indicia of ownership, legal title and the right to control the
ROW or the fiber optic filaments, as the case may be, remain in the
hands of the grantor. Therefore, while IRUs might be construed as
conferring a significant equitable right in the ROW or the fiber optic
filaments, as the case may be, the legal status of IRUs remains
uncertain, and there can be no assurance that a trustee in bankruptcy
would not void an IRU in the event of the bankruptcy of the grantor of
such IRU. In addition, the IRUs granted by CMP and NU are subject to
pre-existing, system-wide mortgages used to secure utility bonds issued
by those companies. The Company has sought acknowledgments from the NU
companies' indenture trustees that the Company's rights under the
agreements with NU would be recognized in the event of the foreclosure
of the related mortgage. Although agreements have been obtained from
certain of the indenture trustees, if such an agreement is not obtained
from the trustees for one or more of the NU companies, a default by any
such company under its mortgage that resulted in the foreclosure of the
mortgage
Page 14 of 20
<PAGE>
could result in the Company losing its rights under the NU Agreements
in the state in which such company operates. The Company has not sought
such acknowledgments from CMP's indenture trustee because, unlike the
NU agreements, under the terms of the agreement with CMP, the Company
is not entitled to such acknowledgments. A default by CMP under its
mortgage that results in the foreclosure of the mortgage could result
in the Company losing its rights under the CMP Agreement.
The Company's IRUs are derivative of the grantor's interest in the real
property on which the NEON system is located. To the extent that the
grantor has a limited easement in such property, the IRUs granted to
the Company may be alleged to be insufficient for the Company's uses.
Certain landowners have asserted claims against the Company on this
basis, and, to date, in one such case, rather than electing to contest
the landowner's interpretation of the scope of the easement, the
Company has made a payment to such landowner to acquire a ROW meeting
the Company's requirements. The Company believes that the easements
granted by a substantial number of landowners to grantors of the
Company's IRUs are similar in scope to those with respect to which
claims have been asserted, and there can be no assurance that
additional claims will not be made in the future.
The agreements with NU and CMP contain provisions which acknowledge the
right of NU and CMP, respectively, to make the provision of electrical
services to their own customers their top priority; NU and CMP are
required only to exercise "reasonable care" with respect to the
Company's facilities and are otherwise free to take whatever actions
they deem appropriate with respect to ensuring or restoring service to
their electricity customers, any of which actions could impair the
operation of the NEON system. In addition, certain of the Company's
construction efforts are constrained by the ability of NU and CMP to
de-energize segments of their transmission and distribution facilities
in order to permit construction crews to work safely. The Company has
experienced construction delays in the past as a result of the
inability to timely de-energize certain segments and may experience
such delays in the future.
COMPETITION. The telecommunications industry is highly competitive. The
Company faces substantial competition from incumbent local exchange
carriers ("ILECs"), which currently dominate their local
telecommunications markets, and competitive local exchange carriers
("CLECs"), most of which have greater financial and other resources
than the Company. In addition to ILECs and CLECs, potential competitors
capable of offering services similar to those offered by the Company
include interchange carriers ("IXCs"), other facilities-based
communications service providers, cable television companies, electric
utilities, microwave carriers, satellite carriers, wireless telephone
system operators and end-users with private communications networks. NU
and CMP each own or have an IRU in certain fibers in the cable that
includes the NEON system, which permit NU and CMP to compete directly
with the Company in the future if they are not using these fibers for
their own corporate requirements. The Company's ROWs are nonexclusive
in that other service providers (including the utilities themselves)
could install competing networks using the same ROWs.
In the future, the Company may be subject to more intense competition
due to the development of new technologies, an increased supply of
domestic and international transmission capacity, the consolidation in
the industry among local and long distance service providers and the
effects of deregulation resulting from the Telecommunications Act of
1996 (the "1996 Act"). The introduction of new products or emergence of
new technologies may reduce the cost or increase
Page 15 of 20
<PAGE>
the supply of certain services similar to those provided by the
Company. The Company cannot predict which of many possible future
product and service offerings will be crucial to maintain its
competitive position or what expenditures will be required to develop
profitably and provide such products and services.
REGULATORY RISKS. Regulation of the telecommunications industry is
changing rapidly. Existing and future federal, state, and local
governmental regulations will greatly influence the viability of the
Company. Consequently, undesirable regulatory changes could adversely
affect the Company's business, financial conditions and results of
operations. For instance, while the Company does not believe that its
fiber are subject to common carrier regulation by the Federal
Communications Commission ("FCC") or under the common carrier
provisions of the Communications Act of 1934, as amended (the
"COMMUNICATIONS ACT"), except to the extent its subsidiaries in New
York and Connecticut offer telecommunications services on a common
carrier basis, the Company cannot predict the future regulatory status
of its business. The FCC has recognized a class of private, non-common
carriers whose practice it is to make individualized decisions on what
terms and with whom to deal. These carriers may be subject to FCC
jurisdiction, but are not currently extensively regulated. Such private
carriers include entities providing "telecommunications" for a fee as
defined in the 1996 Act, which may include certain of the Company's
offerings. In the event that the Company becomes subject to the FCC's
jurisdiction, it will be required to comply with a number of regulatory
requirements, including, but not limited to rate regulation, reporting
requirements, special payments, including universal service assessments
and access charges. Compliance with these regulatory requirements may
impose substantial administrative burdens on the Company. In addition,
ILECs, CLECs and IXCs are subject to various federal telecommunications
laws. Accordingly, changes in federal telecommunications law may affect
the Company's business by virtue of the interrelationships that exist
among the Company and many of these regulated telecommunications
entities. It is difficult for the Company to forecast at this time how
these changes will affect the Company in light of the complex
interrelationships that exist in the industry and the different levels
of regulation.
The Company is subject to state regulation, which can vary
substantially from state to state. The Company's subsidiaries in New
York and Connecticut have obtained authority to provide
telecommunications services on a certificated common carrier basis.
Therefore, such subsidiaries are subject to the obligations that
applicable law places on all similarly certificated common carriers
including: the filling of tariffs, state regulation of certain service
offerings and pricing, requirements for interconnection with, and
resale to, other carriers, payment of regulatory fees and assessments,
and reporting requirements. At present, the Company does not anticipate
that the costs of compliance with these regulatory requirements, or any
of the regulatory requirements of other states to which it might become
subject, will have a material adverse effect on its operations, and
expects its direct competitors to be subject to similar regulatory
requirements to the extent they operate within these states. In some
jurisdictions, the Company's pricing flexibility for intrastate
services may be limited because of regulation, although the Company's
direct competitors are expected to be subject to similar restrictions.
RELIANCE ON THIRD PARTIES; SOURCES OF SUPPLY. The Company has
contracted to NU and CMP substantially all of the engineering, routine
maintenance and construction supervision activities associated with the
construction of that portion of the NEON system located on NU and CMP
properties and the Company has contracted to various third party
contractors, as well as CMP,
Page 16 of 20
<PAGE>
the construction of the NEON system. As a result, the Company may have
less control over the timeliness and quality of the work performed by
such parties than if such work were to be performed by the Company's
own employees. In addition, as a result of their activities on behalf
of the Company, NU, CMP and such contractors may from time to time have
access to certain proprietary information about the Company.
The Company is dependent upon third-party suppliers for a number of
components and parts used in the NEON system. In particular, the
Company purchases cable that includes fiber optic glass manufactured by
Lucent Technologies, Inc. ("Lucent"). The Company believes that there
are alternative suppliers or alternative components for all of the
components contained in the NEON system. However, any delay or extended
interruption in the supply of any of the key components, changes in the
pricing arrangements with its suppliers and manufacturers or delay in
transitioning a replacement supplier's product into the NEON system
could disrupt the Company's operations.
TECHNOLOGICAL CHANGES. The telecommunications industry is subject to
rapid and significant changes in technology. For instance, recent
technological advances permit substantial increases in transmission
capacity of both new and existing fiber and the introduction of new
products or emergence of new technologies may reduce the cost or
increase the supply of certain services similar to those provided by
the Company.
OTHER FACTORS. Implementation of the Company's business strategy also
will require substantial growth in the Company's management staff,
support systems and other operations and may be affected by factors
such as (i) the availability of financing and regulatory approvals;
(ii) the existence of strategic alliances or relationships; (iii)
technological, regulatory or other developments in the Company's
business; (iv) changes in the competitive climate in which the Company
operates; and (v) the emergence of future opportunities.
The Company anticipates that prices for its services to carriers
specifically, and interstate services in general, will continue to
decline over the next several years due primarily to (i) price
competition as various network providers continue to install networks
that compete with the NEON system, (ii) technological advances that
permit substantial increases in the transmission capacity of both new
and existing fiber and (iii) strategic alliances or similar
transactions, such as long distance capacity purchasing alliances among
certain ILECs, that increase customer purchasing power.
The Company is not currently engaged in the transmission of voice, data
or video services and does not provide switched voice and data
services. Accordingly, the Company, unlike some telecommunications
companies, derives and expects to continue to derive substantially all
of its revenues from the leasing of fiber optic capacity to its
customers, many of whom transmit voice, data or video information or
provide switched voice and data services. The limited nature of the
Company's current services could limit potential revenues and result in
the Company having lower revenues than competitors which provide a
wider array of services.
The Company's success in marketing its services to its customers
requires that the Company provide competitive reliability, capacity and
security via its network. The Company's network and the infrastructures
upon which it depends are subject to physical damage, power loss,
capacity limitations, software defects, breaches of security and other
disruptions beyond the
Page 17 of 20
<PAGE>
control of the Company that may cause interruptions in service or
reduced capacity for customers. The Company's agreements with its
customers typically provide for the payment of outage related credits
(a predetermined reduction or offset against the Company's lease rate
when a customer's leased facility is non-operational or otherwise does
not meet certain operating parameters) or damages in the event of a
disruption in service, which credits or damages could be substantial.
The Company is highly leveraged. The Company's high degree of leverage
could have adverse consequences to the holders of the Company's
securities, including, among other things: (i) commencing on August 15,
2002, a substantial portion of the Company's cash flow will be
dedicated to the payment of the Company's interest expense with respect
to the Company's 12 3/4% Senior Notes (the Notes) and such cash flow
may be insufficient to meet its payment obligations on the Notes in
addition to paying other obligations of the Company as they become due;
(ii) the Company's ability to obtain any necessary financing in the
future for completion of the NEON system or other purposes may be
impaired; (iii) certain of the future borrowings by the Company may be
at variable rates of interest that could cause the Company to be
vulnerable to increases in interest rates; (iv) the Company may be more
leveraged than its competitors, which may place the Company at a
competitive disadvantage; and (v) the Company may be vulnerable to a
downturn in its business or the economy generally or to delays in or
increases in the cost of constructing the NEON system. There can be no
assurance that the Company will be able to generate sufficient cash
flow to pay its indebtedness and its other obligations as they become
due.
The indenture under which the Notes were issued imposes significant
operating and financing restrictions on the Company and its present and
future subsidiaries. These restrictions affect, and in certain cases
significantly limit or prohibit, among other things, the ability of the
Company and its subsidiaries to incur certain indebtedness, pay
dividends and make certain other restricted payments, create liens,
issue and sell capital stock or subsidiaries, guarantee certain
indebtedness, sell assets or consolidate, merge or transfer all or
substantially all of their assets.
CONTROLLING STOCKHOLDERS. CMP and NU beneficially own or control a
majority of the outstanding Common Stock of the Company. As a result of
their stock ownership, these stockholders acting together will be able
to continue to elect the members of the Board of Directors and decide
all matters requiring stockholder approval and certain conflicts may
arise between the interests of CMP and NU and the security holders of
the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company is exposed to market risk related to changes in interest
rates, but does not believe that this exposure is material. The Company
does not use derivative financial instruments for speculative or
trading purposes.
INTEREST RATE SENSITIVITY
The Company maintains a short-term investment portfolio consisting
mainly of corporate debt securities and U.S. government agency discount
notes with an average maturity of less than six months. These
held-to-maturity securities are subject to interest rate risk and will
fall in value if
Page 18 of 20
<PAGE>
market interest rates increase. If market interest rates were to
increase immediately and uniformly by 10% from levels that existed at
March 31, 1999, the fair value of the portfolio would decline by an
immaterial amount. Since the Company has the ability to hold its fixed
income investments until maturity, the Company would not expect its
operating results or cash flows to be materially affected.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 - Financial Data Schedule (EDGAR filing only)
(b) REPORTS ON FORM 8-K
No Reports on Form 8-K were filed during the quarter covered
by this Report.
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.
NORTHEAST OPTIC NETWORK, INC.
(Registrant)
Date: May 13, 1999 By: /s/ Vincent C. Bisceglia
-------------------------------------
Vincent C. Bisceglia
Chairman & Chief Executive Officer
Date: May 13, 1999 By: /s/ William F. Fennell
-------------------------------------
William F. Fennell
Chief Financial Officer
Page 19 of 20
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
27 Financial Data Schedule
</TABLE>
Page 20 of 20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 43,273,561
<SECURITIES> 66,389,928
<RECEIVABLES> 411,999
<ALLOWANCES> (224,000)
<INVENTORY> 0
<CURRENT-ASSETS> 110,805,030
<PP&E> 69,048,048
<DEPRECIATION> (1,683,591)
<TOTAL-ASSETS> 286,851,781
<CURRENT-LIABILITIES> 16,980,105
<BONDS> 180,000,000
0
0
<COMMON> 160,778
<OTHER-SE> 87,611,313
<TOTAL-LIABILITY-AND-EQUITY> 286,851,781
<SALES> 520,956
<TOTAL-REVENUES> 520,956
<CGS> 928,988
<TOTAL-COSTS> 2,250,361
<OTHER-EXPENSES> 794,978
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,979,661
<INCOME-PRETAX> (5,263,280)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,263,280)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,263,280)
<EPS-PRIMARY> (0.33)
<EPS-DILUTED> (0.33)
</TABLE>
