UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 Per Share
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K [X].
At March 1, 1999 the aggregate market value of the voting stock held by
non-affiliates of the registrant was $71,187,721
At March 1, 1999 there were 16,066,333 shares of the Company's common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from a definitive Proxy Statement
to be filed with the Securities and Exchange Commission within 120 days after
the close of the registrant's fiscal year ended December 31, 1998.
Exhibit Index at Page 78
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PART I
Item 1. Business
This Report on Form 10-K contains certain forward-looking statements that
involve risks and uncertainties. The cautionary statements contained in this
Report should be read as being applicable to all related forward-looking
statements wherever they appear in this Report. The Company's actual results
could differ materially from those discussed here. Important factors that could
cause or contribute to such differences include those discussed those discussed
in Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations and elsewhere in this Report.
The Company's principal executive offices are located at 391 Totten Pond Road,
Suite 401, Waltham, Massachusetts 02451 and its telephone number is (781)
890-6868.
General
The Company is a facilities-based provider of technologically advanced,
high-bandwidth, fiber optic transmission capacity for communications carriers on
local loop, intra- and interstate facilities. The Company is currently expanding
its fiber optic network, the NEON system, to encompass approximately 1,000 route
miles, or more than 65,000 fiber miles, in New York and New England (the
"Northeast"). The Company believes that the Northeast, which in 1996 represented
a $28.7 billion telephony services market and which the Company believes has one
of the highest population densities and concentrations of businesses,
universities, phone lines, personal computers and television sets in the
country, is a region characterized by significant and growing demand for
broadband communications infrastructure. The Company is constructing the NEON
system utilizing primarily electric utility rights of way ("ROWs") which allow
the Company to provide secure fiber optic capacity at competitive prices with
potential access to virtually any urban location where the local electrical
utility provides service. The Company is using advanced fiber optic technology
in the NEON system, including non-zero dispersion shifted fiber, dense wave
division multiplexing optronics and SONET ring self-healing technology, to allow
the Company's carrier customers to meet their demand for reliable,
high-bandwidth voice, data and video transmission capacity. For example, a pair
of fiber optic strands on the NEON system can transmit up to approximately 10
gigabits of data per second, or the equivalent of approximately 129,000
simultaneous voice conversations.
The Company has already completed construction of approximately 600 route miles,
or approximately 49,000 fiber miles, of the NEON system as of March 1, 1999, and
currently operates fiber optic routes from Hartford, Connecticut to Springfield,
Massachusetts and from Nashua, New Hampshire to Portland, Maine. The Company is
currently engineering, constructing or acquiring additional routes in New York,
Connecticut, Massachusetts, Rhode Island and New Hampshire to create a
continuous fiber optic link between New York City and Portland, Maine with
access into and around Boston, Massachusetts and numerous other major service
areas in the Northeast. The Company is also planning to complete further
expansion routes in 1999 into and around New York City and other metropolitan
areas along the NEON system. The completion of routes currently planned will
enable the NEON system to connect more than 540 cities and towns in six states
and pass more than 200 points of presence ("POPs"), tandem switches and central
offices, which the Company believes serve over 18 million people and over
470,000 businesses.
Commencing in September 1994, the Company entered into a series of ROW
agreements with the three principal operating subsidiaries of Northeast
Utilities ("NU"), the largest electric utility service provider in New England,
serving over 1.7 million customers in Connecticut, Massachusetts and New
Hampshire, to build fiber optic facilities utilizing NU's transmission and
distribution infrastructure, including transmission structures, underground
ducts and urban conduit systems. In January 1997, the Company
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entered into a similar ROW agreement with Central Maine Power Company ("CMP"),
the largest electric utility service provider in Maine, serving over 500,000
customers, to build fiber optic facilities utilizing CMP's transmission and
distribution infrastructure. NU and CMP financed substantially all of the
construction and operations of the NEON system up to the date of the Company's
initial public offering on July 30, 1998 and currently beneficially own 38.5%
and 29.7%, respectively, of the Company's capital stock. In July 1998, the
Company entered into agreements with NEES Communications, Inc., a subsidiary of
New England Electric System, and BecoCom, Inc., a subsidiary of Boston Edison,
to extend the NEON system from Hudson, New Hampshire to Boston, Massachusetts
terminating at the Company's POP and Company-targeted carrier centers in Boston.
The Company has pursued a strategy of establishing relationships with electric
utilities and building the NEON system utilizing primarily electric utility
ROWs. The Company believes that the use of such ROWs provides significant
advantages, including: (i) inter-city routes and, where permitted by applicable
rights, potentially ubiquitous intra-city coverage in the local electric
utility's urban service territory, including throughout downtown areas and
directly to buildings, (ii) use of existing electric transmission
infrastructures, including transmission structures, ducts and conduits, to
achieve faster, less costly installation, (iii) generally more secure and
reliable routes than other ROWs, (iv) desirable geographically diverse fiber
optic routes for communications carriers and (v) establishment of an extensive
ROW network through negotiation with relatively few parties, rather than with
numerous parties such as municipalities, transit authorities and governmental
agencies.
The Company targets communications carriers as customers, rather than end-users
of telecommunications services. The Company believes that this strategy allows
it to: (i) maximize the Company's opportunities to sell its capacity regardless
of the end-user's selection of a retail provider, (ii) avoid the significant
initial and ongoing investment required in selling, marketing and providing
services to end-users, (iii) attract carrier customers that may be reluctant to
contract with a direct competitor, (iv) generate revenues quickly from easily
identifiable carriers that require large amounts of fiber optic capacity, and
(v) acquire relatively secure long-term revenue streams from customers that are
generally more creditworthy than end-users. Carrier customers typically lease
fiber optic capacity under multi-year contracts with which they enhance or
constitute their own communications networks as a cost-effective alternative to
constructing their own infrastructure or purchasing services from other carriers
with whom they may compete. Carriers targeted by the Company include a broad
range of communications companies such as Incumbent Local Exchange Carriers
("ILECs"), Competitive Local Exchange Carriers ("CLECs"), Interexchange Carriers
("IXCs"), paging, cellular and Personal Communication Services ("PCS")
companies, cable television companies and Internet Service Providers ("ISPs").
Currently, the Company has contracts with Brooks Fiber (now owned by WorldCom),
AT&T Local, MCI/WorldCom, Sprint and Global NAPs, Inc., a regional ISP and
others.
The Company offers its carrier customers leases of both dark fiber (fiber optic
transmission lines leased without optronics equipment installed by the Company)
and lit fiber (fixed amounts of capacity, such as DS-3, OC-3, OC-12, OC-48 and
higher, on fiber optic transmission lines that use the Company's optronics
equipment) at fixed-cost pricing and over multi-year lease terms. The Company
intends to lease approximately one-third of the available fibers in the NEON
system as dark fiber and one-third as lit fiber. In addition, the Company plans
to reserve approximately one-third of its available fibers for future services
that the Company may provide to capitalize on future technological advances or
changes that the Company expects to occur in the communications industry.
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History of the Company
The Company was incorporated in 1989 in Massachusetts under the name "FiveCom,
Inc." to develop fiber-optic networks in secondary and tertiary markets in the
Northeast. Prior to 1994, the Company was the managing general partner of a
venture which built a Competitive Access Provider ("CAP") network in
Springfield, Massachusetts and also built several small private networks in
eastern Massachusetts. In February 1994, as Five Com the Company sold its
interest in the Springfield network to Brooks Fiber. Following this sale, the
Company expanded its business strategy to include intra-Local Access Transport
Area ("LATA") and long distance facilities using electric utility ROWs and
changed its focus to target carrier customers rather than end users. Commencing
in September 1994, the Company entered into the NU Agreements, pursuant to which
the Company obtained ROWs in the service territories of NU and its subsidiaries.
In 1996, the Company raised approximately $16.7 million from private placements
of equity securities to MaineCom Services ("MaineCom"), a wholly-owned
subsidiary of CMP and Mode 1 Communications, Inc. ("Mode 1"), a subsidiary of
Northeast Utilities. In January 1997, the Company entered into an Agreement with
CMP, under which the Company obtained ROWs in CMP's service territory, and
raised an additional $2.6 million from CMP and other investors in a private
equity financing. In 1998 the Company was reincorporated in Delaware under the
name "NorthEast Optic Network, Inc." See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Reorganization."
Market Opportunity
The Company believes that there is a significant demand for high-bandwidth
communications services and a limited supply of technologically advanced dark
and lit fiber optic facilities in the Northeast to meet such demand. The Company
also believes the needs of communications carriers for advanced, high-bandwidth
voice, data and video transmission capacity will increase over the next several
years due to various factors, including the following:
Rapid Growth of Communications Traffic. The Company believes that total
telephony service revenue in the United States grew by approximately 10%
annually from 1993 to 1997, to $256 billion and that data traffic service grew
by 34% from 1997 to 1998 to $21 billion and is projected to grow by 35% to $28
billion in 1999. Much of this growth in data traffic is attributable to
increased Internet traffic and its corresponding demands for increased data
communications bandwidth. For example, the number of Americans using the
Internet is estimated to have grown from fewer than 5 million in 1993 to as many
as 62 million by the end of 1997. The Company believes that the growth of
communications traffic in the Northeast will be enhanced by the favorable
demographic characteristics of the region, including the high population
density, income and education levels, and the number of phone lines per
household. With its advanced fiber optic transmission capacity, the Company
believes that it will be well-positioned to capitalize on this growth.
Capacity Required by New Entrants. Competition and deregulation are attracting
new entrants to the telecommunications market. The Telecommunications Act of
1996 (the "1996 Act") allows the Regional Bell Operating Companies ("RBOCs") to
enter the long distance business upon meeting certain competitive conditions and
also eliminates certain barriers to entry in the local exchange market. The 1996
Act also enables other entities, including entities affiliated with power
utilities and ventures between ILECs and cable television companies, to provide
a wider range of telecommunications products and services. The Company believes
that the deregulation of various telecommunications markets will lead to an
increase in the number of telecommunications providers needing fiber optic
transmission capacity as more parties choose to compete. The Company believes
that many carrier customers will choose to lease fiber optic capacity from
facilities providers such as the Company to create or enhance their own
communications networks as a lower-cost alternative to constructing their own
infrastructure or purchasing measured services from other carriers. The Company
believes that the
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NEON system will provide a cost-effective alternative in a number of
communications industry segments for new market entrants, including ILECs,
CLECs, IXCs, wireless companies, cable companies and ISPs.
Need for Redundant Routing and Geographic Diversity of ROWs. Carriers require
redundant paths throughout their networks to provide reliability in the event of
an equipment failure, break in one of their fiber lines or other outage. In
order to ensure the required redundancy, carriers typically build, swap or lease
capacity along fiber routes that do not share a common point of potential
failure. In the Northeast, however, there are relatively few preassembled ROWs
available to support new telecommunications infrastructure and many of the
carriers' routes currently run within the same ROWs. As a result, many carriers
are unable to establish secure redundant routing. In the event such a common ROW
were to be damaged or cut, the consequences would be severe for the carriers and
their customers. This lack of geographic diversity of fiber optic routes in the
Northeast has created a substantial need for network capacity on new and
alternative ROWs, such as those offered by the Company.
Need for Upgrades to Older Communications Networks. Many of the fiber optic
networks currently operated by existing carriers in the Northeast were
constructed prior to 1990, using asynchronous, non-SONET ring architecture and
using earlier generation fiber that cannot optimally deploy dense wave division
multiplexing ("DWDM") optronics for high capacity transmission. The Company
believes that these carriers will need to improve or replace parts of their
networks to complete the SONET ring architecture and also add more high capacity
fiber optic transmission lines to remain competitive in the future. In addition,
the Company believes that in 1997, approximately 86% of the ILECs networks were
comprised of copper cable. The ILECs will likely need to replace or upgrade
their networks to remain competitive and satisfy their customers' increasing
demand for reliable, high-bandwidth capacity in the coming years. The Company
believes that carriers with older, more limited networks will seek
cost-effective and expedient solutions when faced with the decision to lease,
buy or build fiber optic capacity which could result in increased demand for the
Company's fiber optic capacity.
Accommodation of Multimedia and Other New Applications. The Company believes
that additional transmission capacity and faster response times will be required
to accommodate the needs of multimedia (voice, data and video) and other
potential high-bandwidth applications, including the deployment of corporate
intranets and wide area networks, and the use of the telecommunications
infrastructure for providing cable television and other entertainment services.
In addition, the Company's SONET technology and high-bandwidth fiber optic
capacity support advanced communications applications, such as Frame Relay,
Asynchronous Transfer Mode ("ATM") and IP platforms. The Company believes that
these capacity-intensive requirements will create significant demand for its
high quality, high-bandwidth fiber optic capacity.
Carriers' Desire for Low-Cost Local and Regional Transport. The Company believes
that it has an opportunity to fill the needs of the predominant interstate
carriers that are building or have completed their backbone networks to key
LATAs in the Northeast. Generally, an IXC constructs a network with trunk lines
terminating into tandem switches in LATAs. To get from the tandem switch to the
end-user, or vice versa, IXCs typically pay to a LEC access and egress charges,
which often comprise a significant component of the IXCs' transmission costs.
For this reason, IXCs are seeking less costly, alternative local access within
LATAs. One alternative for the IXCs is to carry their traffic deeper into the
region's telecommunications base and to hand off their traffic at a LEC host
switch, which is located much closer to the end-user than the tandem switch, or
to terminate their traffic directly at the customer's premises. Similarly, the
Company believes that LECs with inter-LATA traffic, including the RBOCs when
they are permitted to provide long-distance traffic, desire to minimize the
transportation costs imposed by the IXCs and are seeking lower cost, alternative
regional transport. The NEON system, which will connect into and around numerous
cities and towns in the Northeast, will be able to provide such local and
regional transport.
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The NEON System
The NEON system is a technologically-advanced, high-bandwidth, fiber optic
network that the Company is constructing primarily using electric utility ROWs
in the Northeast. The Company acquires its ROWs principally from electric
utilities in the territory covered by the NEON system. The Company believes that
such ROWs are superior to alternative ROWs available in the Northeast, because
electric utility ROWs may provide near-ubiquitous urban coverage at lower cost
and because deviations from other ROWs often entail significant expenditures and
a lengthy and expensive community-by-community approval process. Furthermore,
installing cable in electric utility ROWs is often safer, easier and faster,
because the cable is placed in existing underground conduits and ducts or
installed on existing towers and poles. With other ROWs cable must often be
buried in trenches, a process often hampered by accommodating commuter rush
hours, complying with stringent environmental laws, crossing water, trenching
and blasting bedrock. In addition, using primarily electric utility ROWs, the
NEON system has the potential to provide communications connections to nearly
every building, business park and industrial complex in its urban service
territory.
The Company uses three cost-effective methods for installing its fiber optic
cable and taking advantage of the pre-assembled and pre-existing electric
utility infrastructure in the Company's ROWs, including utility transmission
structures (towers) and distribution infrastructure (poles, civil works and
conduit). The first is to replace existing ordinary ground wire (which is used
to provide lightning protection atop utility structures) with optical phased
ground wire ("OPGW"), which is custom-made for the Company and contains up to 96
fiber strands currently and will contain up to 144 fiber strands in future
sheath designs. The second method is to install new all dielectric
(non-conductive) self-support fiber optic cable ("ADSS") under the electrical
conductors on electric transmission structures. ADSS is capable of carrying up
to 288 fiber strands currently and is expected to carry up to 432 fiber strands
in future designs. Finally, in underground utility conduits, the Company uses
conventional optical cable made for underground conditions.
Advanced Technology
The Company uses state-of-the-art technology in the NEON system. The NEON system
consists of fiber optic communication paths, which allow for high speed, high
quality transmission of voice, data and video communications. Fiber optic
systems use laser-generated light waves to transmit voice, data and video in
digital formats through ultra-thin strands of glass. Fiber optic systems are
generally characterized by large circuit capacity, are resistant to external
signal interference and directly interface to digital switching equipment or
digital microwave systems. The Company is currently installing fiber optic cable
containing between 64 and 96 fiber optic strands and in the future may install
up to 144 or 216 fiber optic strands per cable depending on anticipated demand
for the particular route and the number of fiber optic strands allowed by the
Company's ROW agreements. Each of these fiber optic strands is capable of
transmitting significantly greater bandwidth than traditional analog copper
cables. The Company believes that continuing developments in compression
technology and multiplexing equipment will increase the capacity of each fiber
optic strand, thereby providing more bandwidth carrying capacity at attractive
incremental costs.
The technologies employed by the Company in the construction and operation of
the NEON system include Lucent's non-zero dispersion shifted fiber and Nortel's
DWDM optronics possessing forward error correction technology at high OC levels
that enable the highest capacity transmission (OC-192) and data integrity level
(10(-15) Bit Error Rate) that are currently commercially available. The Company
believes that the advanced technical operating characteristics of the NEON
system will enable it to provide highly reliable services to its customers at
low costs by permitting higher capacity transmission over longer distances
between regeneration and amplifier facilities than can be provided by less
advanced fiber systems.
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The Company offers end-to-end fiber optic capacity utilizing bi-directional
SONET ring architecture, which has the ability to route customer traffic in two
directions around a ring design thereby minimizing service interruptions due to
fiber cuts. Currently, the NEON system is continuously monitored to maintain
quality control on a 24-hour basis and to alert the Company of any degradation
of signal or loss of fiber capacity, and to pinpoint the location of such
difficulty and enable the Company to repair or replace impaired fiber quickly.
Right-of-Way Agreements
The following is a summary of the Company's agreements that provide for most of
the ROWs currently used in the NEON system.
Northeast Utilities Agreements. In 1994 and 1995, the Company entered into a
series of agreements (as subsequently amended and restated in February 1998, the
"NU Agreements") with the three principal operating subsidiaries of NU
concerning the provision of ROWs along electric utility towers and inside urban
electric utility ducts. Pursuant to the NU Agreements, the Company acquired
indefeasible rights of use ("IRUs") in fiber optic filaments placed along NU's
ROWs prior to February 1998 and acquired ownership of fiber optic filaments
placed along NU's ROWs subsequent to February 1998 (collectively, the "NU
System"). NU and the Company have both agreed to use their best efforts to
complete installation of the NU System by September 1999. The Company agreed to
pay the cost of installing the cable and to utilize NU's engineering staff in
carrying out the installation. Under the NU Agreements, the Company agreed to
pay to NU mileage-based annual fees and a percentage of the gross revenues that
the Company generates on the portion of the NEON system located on NU ROWs.
A portion of the NU System, comprised of 12 fibers within the cable, is owned by
and has been set aside for NU's use ("NUNet"). NU may lease these fibers to
third parties, provided that prior to September 2001, NU is not permitted to
assign any fibers or resell capacity on NUNet to certain specified carriers
except for certain limited purposes. After September 2001, NU will be free to
use NUNet to compete with the Company.
Under the NU Agreements, if any proposed segment of the NEON system's route
requires material modifications or unusual expense to make it available for the
Company's fiber, or if NU withdraws any segment from the route in order to give
priority to electrical services, the Company has the right to designate
additional or alternative route segments, subject to NU's approval, which may
not be withheld unless the additional or alternative segments would materially
adversely affect NU's ability to provide reliable electric service, cause or
create safety problems, or would not be feasible for structural reasons. If NU
desires to create new route segments in order to extend the NU System, the
Company has a right of first refusal on the provision of any such segments. If
NU obtains such segments from third parties, NU has agreed to use its best
efforts to obtain for the Company the unimpeded use of not less than 12 usable
single mode fibers in such segment on terms no less favorable than those
provided to NU.
The NU Agreements have an initial term of 30 years and expire in September 2024.
Thereafter they automatically renew for five-year terms, unless one of the
parties has given a one-year advance notice of termination. In the event that NU
gives such a notice and terminates the NU Agreements, it must either, at its
option, pay to the Company an amount equal to the fair market value of the NU
System less NUNet or allow the Company to retain its IRUs and receive from the
Company an annual payment equal to 10% of the Company's gross revenue from the
NU System, which payment would be in addition to the other annual payments under
the NU Agreements.
In addition to the foregoing, the NU Agreements may be terminated by NU if the
Company defaults in the performance of certain of its obligations under the NU
Agreements, including the failure to establish NUNet by September 1999, the
failure to obtain and maintain all necessary government permits,
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licenses, franchises and approvals, and the failure to pay amounts due by it
under the NU Agreements, subject in most cases to cure periods of between 30 and
90 days.
Central Maine Power Company Agreement. In January 1997, the Company entered into
an agreement with CMP (the "CMP Agreement") in which CMP granted the Company a
right of use in fiber optic filaments within a cable along a certain route in
CMP's service territory (the "CMP System"). The CMP System has been completed
and the Company also has the right to install additional cable in CMP's service
territory, subject to the approval of CMP, which must not be unreasonably
withheld. The Company is obligated to pay the cost of installing the cable.
In exchange for the rights of use, the Company agreed to pay to CMP an annual
fee beginning, with regard to any particular route segment, in the first
calendar year following the installation date for such route segment (the
"Installation Date").
The Company's rights of use do not apply to 6 fibers that have been set aside
for CMP's use ("CMPNet"). CMP may use these fibers for its own business
purposes, but may not lease them to third parties prior to the seventh
anniversary of any given Installation Date. After such seven-year period, to the
extent that CMP has excess capacity on CMPNet, CMP is required to negotiate in
good faith with the Company to provide such excess capacity to the Company
before making it available to third parties. If the Company does not enter into
an agreement with CMP with respect to such excess capacity, CMP will be able to
use such capacity to compete with the Company.
The CMP Agreement has an initial term of 30 years and expires in January 2027.
Thereafter it is renewable at the option of the Company for an additional
ten-year term. In the event that the Company elects to renew the CMP Agreement,
it must pay to CMP an annual payment equal to 10% of the Company's gross annual
revenue from the CMP System, which payment would be in addition to the other
annual payments under the CMP Agreement.
In addition to the foregoing, the CMP Agreement may be terminated by CMP if the
Company defaults in certain of its obligations under the CMP Agreement and such
default is not cured within a designated cure period.
Boston Agreements. In July 1998, the Company entered into a Fiber Optic Lease
Agreement with NEES Communications, Inc., a subsidiary of New England Electric
System (the "NEES Com Agreement"), and a Fiber Optic Use Agreement with BecoCom,
Inc., a subsidiary of Boston Edison Company (the "BecoCom Agreement"). Pursuant
to the terms of these agreements, the Company acquired the right to use certain
fibers (the "Company Fibers"), to be constructed and maintained by NEES
Communications and BecoCom, respectively, on a route running from Hudson, New
Hampshire to Boston, Massachusetts terminating at the Company's POP and
Company-targeted carrier centers. The Company Fibers are currently in use by the
Company and, under the terms of these agreements, the Company is required to pay
a monthly fee, and has agreed to share a portion of the revenue generated from
the use of the Company Fibers (in excess of a base revenue amount specified in
each agreement). Both the NEES Com Agreement and the BecoCom Agreement have an
initial term of 20 years, with the potential to negotiate for up to two
additional, consecutive five-year extensions. Although the BecoCom Agreement
permits the Company to grant capacity to third parties, the Company may not use
the Company Fibers under the BecoCom Agreement to handle local point to point
services within the service area generally prescribed as the Boston Edison
service territory. Nothing, however, precludes the Company from acquiring other
sources for local point to point services.
Other Agreements. In July 1998, the Company entered into an IRU agreement (the
"Qwest Agreement") with Qwest Communications Corporation ("Qwest") in which
Qwest agreed to grant the Company an IRU in certain fibers along a route to be
constructed between Boston and New York City (the "Boston-New York Segment"). In
consideration of such grant, the Company agreed to pay to Qwest an IRU fee in a
series of installments. The Boston-New York Segment is now expected to become
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available to the Company by mid-1999. Although the Qwest Agreement permits the
Company to grant capacity in lit fiber to third parties, the Company may not
grant IRUs in dark fiber to third parties for five years following the
availability date of the Boston-New York Segment. The term of the Qwest
Agreement is for approximately 20 years, but may be terminated at any time upon
the occurrence of certain uncured defaults by the Company or the loss of certain
underlying rights held by Qwest or other parties upon whom Qwest depends for its
rights in the fiber.
The Company also has a number of agreements with Bell Atlantic to use certain
ROWs along pole lines and within ducts in various areas throughout the Northeast
to supplement its primary means of procuring ROWs.
Payments under Right-of-Way Agreements
The aggregate amount accrued by the Company under its agreements that provide
for its ROWs used in the NEON system was $350,400, $785,535 and $1,084,325 for
the years ended December 31, 1996, 1997 and 1998, respectively.
NEON Services
The Company generally leases high capacity transmission services for use by
various communications carriers. The Company's customers include
facilities-based carriers that require transmission capacity where they have
geographic gaps in their facilities, need additional capacity or require
alternative or redundant routing, and non-facilities-based carriers requiring
transmission capacity to carry their customers' telecommunications traffic.
The Company currently leases lit fiber and dark fiber, as described below, and
has also reserved fibers for future uses.
Lit Fiber Leases. Pursuant to its leases with its customers, the Company
provides a specific amount of capacity between any two or more points on the
NEON system as specified by the carrier. Lit services involve the installation
of optronic terminals by the Company, to the carrier's specifications, that
"light" the fiber and transmit/receive capacity on the network. The Company
intends to provide lit transport capacity initially at SONET OC-3, OC-12, OC-48
and higher rates. In the future the Company intends to provide carriers with
services at the lower DS-3 level.
Dark Fiber Leases. The leasing of dark fiber allows a carrier to interconnect
any two or more specific points on the NEON system. This product requires the
Company to install a fiber optic patch panel ("FOPP"), which is the minimal
customer premise equipment installed by the Company. Dark fiber leases allow a
carrier to install its own optronic equipment and to use as much or as little
capacity as it desires and to customize its capacity with feature rich
technology and its network protocols that differentiate that carrier's product
offerings from others. As a result, the carrier can deploy the dark fiber for
whatever purpose it chooses while the Company remains transparent to the
carrier's end-user.
Whenever possible, the carrier customer is restricted from using the dark fibers
for purposes other than supporting its own customers. To date, the Company has
placed restrictions on the transfer or assignment of the leased fiber from one
carrier to another. In addition, the lease prohibits carriers from accessing its
leased fibers at any point other than those designated in the lease; therefore
carriers cannot add additional traffic or draw off traffic along the path.
Reserved Fiber
Part of the Company's strategy is to reserve approximately one-third of the
fibers comprising the NEON system in order to have the capacity necessary to
take advantage of changes in telecommunications technology and services and to
meet future anticipated market demand. The Company believes that
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continuing improvements in telecommunications technology will alter the way in
which such services are provided as well as the level of demand for such
services. These changes include developments in compression and multiplexing
technology, as well as changes in communications protocols. These changes will
likely effect a change in the nature of services provided by the Company's
customers and, thereby, a change in the nature of the services provided by the
Company. In addition, such changes may open new opportunities for the Company,
including opportunities to serve new classes of customers. Because the exact
nature and effect of such changes are, at present, difficult to measure, the
Company believes it prudent to retain capacity that is not committed to any
particular use or technology but can be brought out of reserve when the impact
of such technological changes becomes clear. In the meantime, the Company may
enter into short-term agreements with respect to such reserved capacity for the
provision of its current services if such opportunities arise.
Sales and Marketing
The Company's sales and marketing strategy includes positioning itself as the
carriers' carrier of choice, emphasizing its capacity, reliability, rapid
deployment, customer service, access in urban areas of its service territory and
the cost advantages that will allow the Company to lease its fiber optic
infrastructure at competitive prices. The Company intends to price its services
below what the Company believes it would cost carriers to construct their own
facilities or to obtain capacity from other sources.
The Company believes that communications carriers will be attracted to the
Company's dark fiber and lit fiber products. The contracts that the Company has
signed to date arose as a result of management's long standing relationships in
the telecommunications industry and the Company intends to leverage those
relationships and increase customer scope and penetration through a dedicated
sales force, which currently numbers five sales persons.
Customers
The Company is targeting other telecommunications carriers as customers and does
not currently intend to offer its services directly to end-users. The NEON
system enables carriers to link geographically separated central offices and
POPs with primary or redundant connections in their networks. The Company's
facilities also enable carriers to connect their networks directly into the
premises of the carriers' end-users.
The Company currently has contracts with AT&T Local, MCI/WorldCom, Sprint,
Hyperion Communications Long Haul, L.P., CTC Communications Corp. and Network
Plus. The terms of certain of these customer contracts are twenty years with
varying lease rates to be paid monthly. The monthly lease rates cover dark fiber
and/or lit fiber leased from the Company. In addition, the contracts typically
provide for "outage related credits," a predetermined reduction or offset
against the customer's lease rate when a customer's leased facility is
non-operational or does not meet the customer's operating parameters, and also
typically require the Company to maintain adequate insurance coverages,
including product liability coverage. In addition, the Company is currently in
the process of negotiating agreements with certain other major communications
carriers. There can be no assurance that such agreements will be consummated or
will be on terms as favorable to the Company as its existing agreements.
The Company's potential carrier customer base includes the following classes of
carriers:
ILECs & Independent Telcos, such as Bell Atlantic, SBC SNET, Standish
Telephone Co. (ME), Wilton Telephone Company, Inc. (NH) and Saco River
Telephone Co. (ME). ILECs typically require some interstate paths for
internal communications, signal control and operator services. ILECs also
require intrastate capacity to connect central offices to one another and
to connect central offices to POPs and customer premises.
Page 10 of 92
<PAGE>
Facilities based IXCs, such as AT&T, Sprint, MCI/WorldCom/LDDS, Williams,
Frontier, Qwest, IXC Communications, Inc., Cable & Wireless PLC, Level 3
Communications, Inc. and others. IXCs typically require (i) regional
short-haul connectivity from their national backbone facilities to
originate and terminate traffic deeper into the customer base; (ii)
redundant routing to ensure reliability in their networks; and (iii)
additional capacity for their customers as minutes-of-use and IP bandwidth
requirements increase.
CLECs, such as MCI/WorldCom, AT&T Local, Hyperion Communications Long Haul,
CTC Communications, Network Plus, RCN Corporation, Intermedia
Communications Inc., NextLink Communications, Inc., ICG Communications,
Inc. and others. CLECs typically require interconnection between their
local networks and extensions further into the community.
ISPs, such as MCI/WorldCom, GTE Corporation/BBN, Bell Atlantic,
WorldCom/Gridnet, WorldCom/UUNet Technologies Incorporated, Sprint, RCN
Corporation, HarvardNet, MediaOne and others. ISPs typically require
distribution channels to IXC and LEC switches and interconnection to ISP
switches.
Cable television companies and Video Carriers, such as MediaOne Group, Inc.
(U S West, Inc.), Cablevision Systems Corporation, Cox Communications,
Inc., Public Broadcasting Service affiliates, broadcasters and others.
Cable companies typically require fiber optic capacity to upgrade their
systems to higher speed bandwidths, which allow them to increase the number
of channels available, add interactive programming and Internet and data
transfer capabilities and to consolidate head-end facilities. Broadcasters
typically require inexpensive video paths to extend their reach to distant
locations.
Wireless Communication Companies, such as SBC SNET Links, Bell Atlantic
Mobile, CellularOne, Sprint PCS, OmniPoint, AT&T Wireless, STV Group, Inc.,
WinStar Communications, Inc., NextWave Telecom Inc., NorthCoast,
Opcse-Galloway, Personal Communications, ACC-PCS (TCG), Devon Mobile, Vtel
Corporation and others. Wireless companies typically require land-based
back-hauling of traffic from towers to their switches and also capacity
between their switches with IXCs, POPs, and ILECs central offices.
Microwave Carriers, such as Eastern Microwave Inc./Intermedia
Communications Inc. Microwave carriers typically require fiber optic
capacity to replace microwave service as their primary source of
communications capacity.
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<PAGE>
Supply Relationships
The Company has entered into agreements and arrangements for the supply of
equipment and services relating to the construction of the NEON system. In
choosing its suppliers, the Company uses such criteria as the quality and
performance of the product for the intended purpose, pricing, and the ability of
the supplier to meet the Company's delivery schedule and technical support
requirements. The Company purchases optronic network multiplexers and network
services from Northern Telecom Ltd. ("Nortel"), and cable from Fitel/Lucent
Technologies, Inc. ("Fitel") and FOCAS, Inc. ("FOCAS"). The cable purchased from
Fitel and FOCAS includes Lucent's patented "TrueWave" and "All Wave" fibers,
which the Company believes contains certain favorable performance
characteristics that reduce the Company's investment in signal enhancing network
equipment. 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 and, if such disruption
continued for an extended period of time, it could have a material adverse
effect on the Company's business, financial condition and results of operations.
Competition
The telecommunications industry is highly competitive, and the Company faces
substantial competition. Many of the Company's existing and potential
competitors have financial, management and other resources that are
substantially greater than those of the Company, as well as other competitive
advantages, including established reputations in the communications market. See
"Risk Factors--Competition."
The Company is currently aware of communications carriers that own or lease
fiber optic networks in New England (such as AT&T, MCI/WorldCom, Sprint, Bell
Atlantic and SNET) and of other carriers (such as IXC Communications, Qwest
Communications International, Metromedia Fiber Network, Level 3 Communications
and RCN) who are planning to own or lease additional networks which, if
constructed, could employ advanced technology comparable to that of the NEON
system.
Qwest Communications International has announced that it has acquired
approximately 288 miles of fiber optic network between New York and Boston,
connecting such cities as Providence and Greenhill in Rhode Island and New
London, New Haven, Bridgeport and Stamford in Connecticut. Similarly, IXC
Communications has announced that it has acquired approximately 280 miles of
fiber optic network between New York and Boston. Another company, RCN, is
engaged in the construction of fiber optic networks in Boston and several
surrounding communities and in New York City. The Company's customers and
potential customers, such as AT&T, MCI and Sprint, also have facilities
available to them in the region which could be used to compete with the Company.
Development of fiber optic networks is also continuing on a national scale. For
example, Frontier Corp. is currently in the midst of constructing a
cross-continental long distance fiber optic network from Los Angeles to New York
and Qwest Communications International is constructing a fiber-based national
backbone network which will connect 115 metropolitan areas and span
approximately 16,000 miles. In addition, other companies, including Level 3
Communications, are planning nationwide and regional networks of their own.
These networks enable their owners either to operate dedicated facilities for
themselves or to install excess fiber to lease to other communications carriers
and large corporate, government or other customers seeking high-bandwidth
capacity. Alternatively, some network owners, typically CLECs, may choose to use
their infrastructure to provide switched voice and data services, competing
directly with ILECs and IXCs. Currently, the Company does not provide such
services or plan to provide such services.
In the cities connected by the NEON system, the Company also faces significant
competition from the ILECs, which currently dominate their respective local
markets. In addition, the Company faces
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<PAGE>
competition from CLECs and wireless competitors in the cities in which the
Company plans to build its networks.
Most communications carriers already own fiber optic cables as part of their
communications networks, and each of these carriers could, and some do, compete
directly with the Company in the market for leasing fiber capacity.
Some local cable television companies have extensive coaxial cable networks in
place that have been or could be further upgraded to fiber optic cable. To the
extent that local cable television companies decide to equip their networks with
fiber optic cable, they are potential direct competitors of the Company.
The Company also faces potential competition from both NU and CMP, both of which
have rights to use fibers in certain portions of the NEON system, which use may
include competition with the Company. See "Right-of-Way Agreements," above, in
this Item 1.
Governmental Regulation
While the Company believes that it is not directly subject to common carrier
regulation (except to the extent it is certified as a common carrier through its
subsidiaries in Connecticut and New York), it is part of an industry that is
highly regulated by federal, state and local governments whose regulatory
actions are often subject to judicial modification. The Company has not been
subject to such regulation because it has not offered its facilities to the
general public or indifferently for a fee, which would subject an entity to such
regulation. In light of the changes that are occurring in the regulation of
telecommunications, the Company cannot forecast whether or not it will be
subject to additional regulation in the future. In Connecticut and New York the
Company has petitioned to be recognized as a regulated telecommunications
service provider because of the nature of its activities in, and the statutory
provisions of, those two states; these subsidiaries, as authorized
telecommunications service providers, would also be subject to certain federal
law and regulation.
Federal Regulation. Federal regulation has the greatest impact on the
telecommunications industry and has undergone major changes in the last two
years as the result of the adoption by Congress of the Telecommunications Act of
1996 (the "1996 Act") on February 8, 1996. The 1996 Act is the most
comprehensive reform of the nation's telecommunications laws since the
Communications Act was enacted. The 1996 Act imposes a number of access and
interconnection requirements on telecommunications carriers and on all local
exchange providers, including CLECs, with additional requirements imposed on
ILECs. The 1996 Act provides a detailed list of items which are subject to these
interconnection requirements, as well as a detailed set of duties for all
affected carriers. All telecommunications carriers must interconnect with the
facilities of other carriers and not install features that will interfere with
the interoperability of networks. All LECs, including CLECs, have a duty to (i)
not unreasonably limit the resale of their services; (ii) provide number
portability if technically feasible; (iii) provide dialing parity to competing
providers and nondiscriminatory access to telephone numbers, directory
assistance, operator services and directory listings; (iv) provide access to
poles, ducts, conduits and rights-of-way; and (v) establish reciprocal
compensation arrangements for the transport and termination of
telecommunications. In addition to those general duties of all LECs, ILECs have
additional duties to (a) interconnect at any technically feasible point and
provide service equal in quality to that provided to their customers or the ILEC
itself; (b) provide unbundled access to network elements at any technically
feasible point at just, reasonable and nondiscriminatory rates, terms and
conditions; (c) offer retail services at wholesale prices for the use of
telecommunication carriers; (d) provide reasonable public notice of changes in
the network or the information necessary to use the network or which affect
interoperability; and (e) provide for physical collocation. "Physical
collocation" is an offering by an ILEC that enables another telecommunications
carrier to enter the ILEC's premises to install, maintain and repair its own
equipment that is necessary for interconnection or access to the
Page 13 of 92
<PAGE>
ILEC's network elements. An ILEC must allocate reasonable amounts of space to
telecommunications carriers on a first-come first-served basis. If space
limitations or practical or technical reasons prohibit physical collocation, an
ILEC must offer "virtual collocation," by which the other telecommunications
carrier may specify ILEC equipment to be dedicated to its use and electronically
monitor and control communications terminating in such equipment.
The FCC adopted pricing and other guidelines to implement the interconnection
provisions of the 1996 Act, but the 8th Circuit Court of Appeals vacated many of
the FCC's guidelines. The Supreme Court has granted a writ of certiorari to
review the 8th Circuit's decision and is expected to decide the case during its
1998-1999 term. The responsibility for setting pricing and other guidelines with
respect to interconnection has thus been left up to the individual state public
service commissions. It is expected that varying pricing and guidelines will
emerge from state to state, and some of these guidelines may eventually have an
indirect adverse effect on the Company's business.
Aside from the impact of the 1996 Act, the Company believes that federal
regulation does not affect the Company directly because the Company is not
currently regulated as a common carrier under federal law. Federal
telecommunications law imposes special legal requirements on "common carriers"
who engage in "interstate or foreign communication by wire or radio for hire."
The Company believes that the leasing of fiber facilities does not constitute
engaging in the transmission of "communications by wire or radio" and therefore
is not subject to these legal requirements. However, this conclusion could be
affected by the FCC's review of its earlier decision, on remand from the U.S.
Court of Appeals for the District of Columbia Circuit, that local exchange
carriers offered dark fiber on a common carrier basis. In any event, the Company
does not intend to offer its fiber facilities as a common carrier. Common
carriers are those who offer telecommunications services directly to the public
for a fee. The Company does not intend to offer its fiber capacity in this
manner, but instead intends to enter into individual agreements on a selective
basis with prospective lessees of its fiber facilities. The Company therefore
does not believe that its fiber offerings are subject to the common carrier
provisions of the Communications Act. These conclusions reflect the Company's
view that there is no material difference from a regulatory perspective between
the leasing of dark and lit fiber, both of which are offered by the Company.
There is no assurance, however, that the FCC may not take the position that in
making fiber transmission capable, in the case of lit fiber, the leasing of such
fiber is subject to regulation under the Communication Act or that even the
offering of dark fiber itself is subject to regulation.
As indicated above, the two subsidiaries of the Company which have applied for
authority to provide telecommunications services on a common carrier basis in
New York and Connecticut will be subject to regulation under the Communications
Act.
In addition to regulation of common carriers, federal telecommunications law
also imposes special legal requirements on "telecommunications carriers." The
law essentially defines "telecommunications carriers" as those offering certain
telecommunication services "directly to the public" or such classes of users as
to be effectively available directly to the public, regardless of the facilities
used. The Company therefore believes that a company has to be a common carrier
in order to be considered a telecommunications carrier. For the reasons stated
above, the Company believes that it is not a common carrier and therefore that
it is also not a telecommunications carrier with respect to its fiber capacity
leases. Nevertheless, the law is not entirely clear as to, and the FCC has not
definitively addressed whether, the term "telecommunications carriers" is meant
to encompass only common carriers, and therefore whether a provider of fiber
facilities on an individualized basis, like the Company, is a "common carrier"
or "telecommunications carrier." The FCC has been petitioned by certain
railroad, power and telecommunications associations, none of which are
affiliated with the Company, to clarify the status of fiber providers in this
respect. The FCC's pending remand, described above, could also definitively
address the application of these requirements to the Company. If the FCC decides
that such
Page 14 of 92
<PAGE>
companies are telecommunications carriers or common carriers, then the Company
would be subject to certain regulatory requirements, which could have a material
adverse effect on the Company.
If the Company were deemed to be a common carrier it would be required, with
respect to its telecommunications services, to (i) provide such services
indiscriminately upon any reasonable request; (ii) charge rates and adopt
practices, classifications and regulations that are just and reasonable; (iii)
avoid unreasonable discrimination in charges, practices, regulations, facilities
and services; (iv) ensure that its services are accessible to and usable by
persons with disabilities; (v) pay into federal funds for Telecommunications
Relay Services and the North American Numbering Administration; (vi) ensure that
its networks comply with the requirements of the Communications Assistance for
Law Enforcement Act; (vii) be subject to government oversight and limitations on
its transactions with affiliates; (viii) limit its use of Customer Proprietary
Network Information ("CPNI") to provisioning of the services in connection with
which the CPNI was obtained; (ix) be subject to the complaint process at the
FCC; and comply with various reporting, regulatory fee payment and other
requirements. The Company might also be required to file tariffs setting forth
the rates for its services. These regulatory requirements could impose
substantial burdens on the Company.
If the Company's offering of fiber facilities were deemed to constitute a
"telecommunications service" or the provision of "telecommunications" for a fee
(unless deemed de minimis), then its revenues from fiber leases to end users
(but not to most other telecommunication carriers) would become subject to
assessment for the FCC's Universal Service Fund, a fund that was established by
the FCC pursuant to the 1996 Act to assist in ensuring the universal
availability of basic telecommunications services at affordable prices. The
Company may be subject to this assessment even if it is found to not be a common
carrier and only provides service on a private contractual basis or through the
leasing of excess capacity to end-users. This assessment could create a
liability equal to a percentage of the gross revenues from these leases although
the FCC has not announced what the annual assessment will be. The Company
anticipates, based on quarterly contribution factors as of May 1998 that the
annual rate of assessment will be approximately 4.5% of gross interstate
end-user revenues for the year 1998, and may be higher in subsequent years. The
Company also may be liable for assessments by state commissions for state
universal service programs. The Company does not anticipate that its aggregate
liability for these universal service programs would be material. In addition,
since the revenues of the Company's competitors will be subject to comparable
assessments; this should not reduce the Company's competitiveness.
Federal telecommunications law may also affect the Company's business by virtue
of the inter-relationships that exist among the Company and ILECs and IXCs. For
example, the FCC recently issued an order requiring, among other things, that
common line access fees charged to IXCs, which previously amounted to more than
what was necessary to recover the costs of providing access, shift from being
usage driven to a fixed flat cost-based structure. While it is not possible to
predict the precise effect the access charge changes will have on the Company's
business or financial condition, the reforms will reduce access charges paid by
IXCs, likely eliminating one of the principal disincentives for use of ILEC
facilities by IXCs, which could have a material adverse effect on the use of the
Company's fiber optic telecommunications networks by IXCs.
The FCC has responsibility under the 1996 Act's interconnection provisions to
determine what elements of an ILEC's network must be provided to competitors on
an unbundled basis. The FCC has decided not to declare fiber an unbundled
network element under these provisions. This decision is currently subject to
petitions for reconsideration before the FCC. An FCC decision to alter this
decision on reconsideration could decrease the demand for fiber provided by the
Company. In addition, the FCC has announced that state commissions may decide to
add network elements to the FCC's list of elements that are required to be
unbundled by all carriers throughout the country.
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State Regulation. The 1996 Act prohibits state and local governments from
enforcing any law, rule or legal requirement that prohibits or has the effect of
prohibiting any person from providing any interstate or intrastate
telecommunications service. In addition, under current FCC policies, any
dedicated transmission service or facility that is used more than 10% of the
time for the purpose of interstate or foreign communication is subject to FCC
jurisdiction to the exclusion of any state regulation. Notwithstanding these
prohibitions and limitations, states regulate telecommunications services,
including through certification of providers of intrastate services, regulation
of intrastate rates and service offerings, and other regulations and retain
jurisdiction under the 1996 Act to adopt regulations necessary to preserve
universal service, protect public safety and welfare, ensure the continued
quality of communications services and safeguard the rights of consumers.
Accordingly, the degree of state involvement in local telecommunications
services may be substantial.
The state regulatory environment varies substantially from state to state. At
present, the Company does not anticipate that the regulatory requirements to
which it will be subject in Connecticut, Maine, Massachusetts, New Hampshire,
New York and Rhode Island will have any material adverse effect on its
operations. In some jurisdictions, the Company's pricing flexibility for
intrastate services may be limited because of regulation, although the Company's
direct competitors will be subject to similar restrictions. However, there can
be no assurance that future regulatory, judicial, or legislative action will not
have a material adverse effect on the Company.
In arbitrating interconnection agreements under the 1996 Act between ILECs and
their potential competitors, some state commissions have considered whether
fiber should be an unbundled network element. The New York Public Service
Commission determined that it would not require NYNEX Corporation to provide
fiber as an unbundled network element. State commissions in Florida, Maryland,
North Carolina, and Virginia have either refused to require the ILECs to offer
fiber to competitors, or have stated that the issue would be addressed at a
later time. On the other hand, state commissions in Illinois, Massachusetts,
Arizona, Georgia, Minnesota, Ohio, Oregon and Tennessee have found fiber to be a
network element and required the ILECs to offer it on an unbundled basis to
CLECs. There can be no assurance that these requirements, and the associated
pricing methodologies, where applicable will not reduce the demand for fiber
provided by the Company.
The Company has determined that there are advantages to having certain of its
subsidiaries subject to state regulation in Connecticut and New York. As a
regulated carrier in those two jurisdictions, these subsidiaries will have
access to poles and rights of way for its fiber lines that would not be
available to it as an unregulated lessor of fiber. Two subsidiaries of the
Company have, therefore, recently filed petitions in those two states requesting
authority to provide telecommunications services. The Company anticipates that
based on past practices these petitions will be granted within the next three or
four months. As a result, these subsidiaries will incur certain costs to comply
with regulatory requirements such as the filing of tariffs, submission of
periodic financial and operational reports to regulators, and payment of
regulatory fees and assessments in Connecticut and New York.
Local Government Regulation. In addition to federal and state laws, local
governments exercise legal authority that may impact the Company's business. For
example, local governments, such as the City of Boston and the City of New York,
typically retain the ability to license public rights-of-way, subject to the
limitation that local governments may not prohibit persons from providing
telecommunications services. Local authorities affect the timing and costs
associated with the Company's use of public rights-of-way. These regulations may
have an adverse effect on the Company's business.
Employees
At March 1, 1999, the Company employed 28 people. The Company's employees are
not represented by any labor union and the Company considers its relationship
with employees to be satisfactory.
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Item 2. Properties.
The NEON system and its component assets are the principal properties currently
owned by the Company or with respect to which the Company has an IRU. The
Company owns substantially all of the communications equipment currently
utilized in its business and holds certain ownership interests in the cable
comprising the NEON system. The Company's installed fiber optic cable is laid
along the various rights-of-way held by the Company. See Item 1. - "Right-of-Way
Agreements." Other fixed assets are located at various leased locations in
geographic areas served by the Company.
The Company's executive, administrative and sales offices are located at its
principal office in Waltham, Massachusetts. The Company leases this space
(approximately 4,375 square feet) under a month-to-month tenancy. The Company
recently entered into a six-year lease for a new, approximately 15,000 square
foot headquarters and network operations center facility in Westborough,
Massachusetts that commences in May 1999.
Item 3. Legal Proceedings. None.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the names, ages, positions and a brief description of the
business experience during at least the last five years of the executive
officers of the Company, all of whom serve until they resign or are removed from
such offices by the Board of Directors of the Company.
Vincent C. Bisceglia, 44, Chairman of the Board of Directors and Chief Executive
Officer. Mr. Bisceglia joined the Company in November 1998 in his current
position. Prior to joining the Company, from February 1994 to December 1997 Mr.
Bisceglia served as President and Chief Executive Officer and a director of
Technology Service Group, Inc. ("TSG"), a manufacturer of advanced technology
pay telephones. Prior to 1994, he served TSG as a consultant and in various
management positions. From 1982 to 1986, Mr. Bisceglia was Executive Vice
President of Transaction Management, Inc., a manufacturer of point-of-sale
systems, and from 1978 to 1982, he held senior marketing positions with National
Semiconductor-DTS and Siemens-Nixdorf Computer Corporation.
Victor Colantonio, 51, President, Vice Chairman of the Board of Directors and a
Director. Mr. Colantonio is the founder of the Company, has been a director of
the Company since 1989 and Vice Chairman since November 1998. Prior to founding
the Company, from 1987 to 1991 Mr. Colantonio was president of International
Communications Services Corp., a provider of network services to New England
Telephone Company, AT&T and others. He served as President of Ireland-based
Murray International from 1986 to 1987, providing network services to SNET,
LiTel, MCI, Sprint and others. From 1983 to 1986, Mr. Colantonio served as
Director of Marketing for Tele-Engineering Corp., an advanced WAN/LAN developer
and video switch and ad-insertion manufacturer, securing contracts with, among
others, USAF Logistic Command, U.S. Navy Underwater Signal Command and NASA.
William F. Fennell, 54, Chief Financial Officer and Treasurer. Mr. Fennell
joined the Company in August 1996 and became its Chief Financial Officer and
Treasurer in May 1997. From October 1986 to January 1996, Mr. Fennell was Chief
Financial Officer of Philips Electronics Group of North America, a manufacturer
and distributor of electronic and electrical products. From 1970 to 1986, Mr.
Fennell served in various positions at GTE Corporation, including Director of
Operations for the Communications Products Group.
James D. Mack, Jr., 54, Vice President, Sales. Mr. Mack joined the Company in
March 1998 as its Vice President, Sales. From March 1997 until joining the
Company, Mr. Mack was General Manager of US Telecenters, an independent
telecommunications dealer, representing Bell Atlantic, Northern Telecom, GTE
Corporation and Southwestern Bell. From 1966 until March 1997, Mr. Mack held
various sales and marketing positions at Bell Atlantic/NYNEX Corporation
(formerly NYNEX), including Branch Manager for NYNEX Systems Marketing.
Michael A. Musen, 50, Vice President, Operations. Mr. Musen has served as an
officer of the Company since its inception, and became Vice President,
Operations in 1996. Prior to joining the Company, Mr. Musen was Vice President
of International Communications Services Corp. from 1988 to 1992.
There are no family relationships among any of the executive officers of the
Company.
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PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's stock is listed and traded on the Nasdaq National Market under the
symbol NOPT and commenced to trade after the Company's initial public offering
("IPO") on July 31, 1998. The following table sets forth for the periods
indicated the high and low bid prices for the Company's common stock as reported
by Nasdaq since the IPO:
Year Ended December 31, 1998
<TABLE>
<CAPTION>
Calendar Quarter High Low
<S> <C> <C>
Third Quarter $10.125 $5.50
Fourth Quarter $12.00 $4.75
Year Ended December 31, 1999
First Quarter though March 1, 1999 $17.75 $8.75
</TABLE>
The stock price ranges reflect inter-dealer prices without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
On March 1, 1999, there were 40 holders of record of the Company's common stock
and approximately 1,955 beneficial holders.
Dividend Policy
The Company intends to retain future earnings, if any, to finance the
development and expansion of its business and, therefore, does not anticipate
paying any cash dividends on its common stock in the foreseeable future. The
payment of dividends is within the discretion of the Company's Board of
Directors and will be dependent upon, among other factors, the Company's results
of operations, financial condition and capital requirements, restrictions
imposed by the Company's financing arrangements and legal requirements.
The terms of the Company's 12 3/4% Senior Notes Due 2008 restrict the Company's
ability to pay cash dividends on its Common Stock.
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Item 6. Selected Financial And Operating Data
The selected consolidated financial and operating data presented below for each
of the years in the three-year period ended December 31, 1998 and as of December
31, 1996, 1997 and 1998 have been derived from the Consolidated Financial
Statements of the Company, which have been audited by Arthur Andersen LLP, the
Company's independent public accountants. The selected consolidated financial
data for each of the years in the two-year period ended December 31, 1995 and as
of December 31, 1994 have been derived from the unaudited consolidated financial
statements of the Company, which have been prepared on the same basis as the
Consolidated Financial Statements of the Company and, in the opinion of
management, reflect all normal recurring adjustments necessary for a fair
presentation of the financial position and results of operations for such
periods and as of such dates. The information set forth below should be read in
conjunction with the discussion under "Management's Discussion and Analysis of
Financial Condition and Results of Operation" and the Consolidated Financial
Statements of the Company and Notes thereto.
<TABLE>
<CAPTION>
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998(1)
------------ ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues $ 326,581 $ 42,598 $ 13,773 $ 394,704 $ 863,672
Operating Expenses 589,250 487,159 1,185,595 2,693,037 9,175,280
------------ ------------ ------------ ------------ ------------
Loss from Operations (262,669) (444,561) (1,171,822) (2,298,333) (8,311,608)
Interest income (expense), net 59,959 (42,401) 125,838 (2,893) (4,464,583)
Minority interest (2) 353,222 1,080,200 1,108,933
Provision for (benefit from)
income taxes 16,000 (261,000) (315,000)
------------ ------------ ------------ ------------ ------------
Loss before extraordinary item (202,710) (486,962) (708,762) (960,026) (11,352,258)
Extraordinary item (3) (1,363,155)
Net loss (202,710) (486,962) (708,762) (960,026) (12,715,413)
Basic and diluted loss per share
before extraordinary item (2.48) (1.71) (2.49) (3.37) (1.70)
Basic and diluted loss per share (2.48) (1.71) (2.49) (3.37) (1.90)
Basic and diluted weighted
average shares outstanding 81,745 284,578 284,735 284,828 6,675,717
As of December 31,
- ---------------------------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998(1)
------------ ------------ ------------ ------------ ------------
Balance Sheet Data:
Working capital $ (29,141) $ (4,526,664) $ 3,209,234 $ (3,463,011) $111,966,866
Total assets(4) 165,081 4,774,827 16,369,663 23,461,000 291,912,234
Note payable to related party 2,100,000
Long-term debt, including
current maturities 348,198 932,713 927,021 2,118,905 180,127,619
Total liabilities 478,332 5,574,589 2,332,963 8,275,154 198,877,550
Minority interest(2) 6,312,554 5,338,786
CMP Warrant (5) 532,836
Stockholder's equity (deficit) (313,251) (799,762) 7,724,146 9,314,224 93,034,684
Year Ended December 31,
- ---------------------------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998(1)
------------ ------------ ------------ ------------ ------------
Other Financial Data:
Cash provided by (used in)
operating activities $ (194,091) $ (413,196) $ (315,762) $ (813,704) 2,954,322
Cash provided by (used in)
investing activities 19,591 (4,619,702) (6,738,898) (8,798,251) (93,772,328)
Cash provided by financing activities 258,374 4,943,300 11,918,703 5,845,482 147,457,346
Net increase (decrease) in cash
and cash equivalents 83,874 (89,598) 4,864,043 (3,766,473) 56,639,340
EBITDA(6) (250,032) (420,386) 794,432 665,271 (6,767,536)
Capital expenditures 26,179 4,596,901 6,711,082 5,609,459 38,947,267
Ratio of deficiency to fixed charges(7) (6.43)x (2.54)x (4.5)x (10.11)x (.45)x
</TABLE>
- ------------------------------------------
(See footnotes on following page)
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<PAGE>
(1) If the Reorganization had occurred on January 1, 1998, the pro forma basic
and diluted weighted average shares outstanding and the loss per share for
the year ended December 31, 1998 would have amounted to 16,065,285 and
$0.79, respectively. See Notes to Consolidated Financial Statements --
Footnote 2(m) "Significant Accounting Policies."
(2) Minority interest consisted of the interests of members other than CMP in
FiveCom LLC, NECOM LLC and FiveCom of Maine LLC. See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Reorganization." Changes in minority interest reflected members' capital
adjusted by their portion of the net loss.
(3) Extraordinary item reflects the write-off of deferred financing cost of
$1,363,155 related to the extinguishment of debt with a portion of the
proceeds of the Public Offerings. See Notes to Consolidated Financial
Statements -- Footnote 6(a) "Note Payable to Related Party and
Extraordinary Item."
(4) In connection with the Reorganization, the Company recorded an intangible
asset of $47,871,068 to reflect the Company's acquisition of NU's minority
interest in a subsidiary, NECOM LLC, in accordance with AICPA Accounting
Interpretation 39 to APB Opinion No. 16, Business Combination (AIN-39).
(5) The exercise of the CMP warrant resulted in an increase in additional
paid-in capital of $531,394, which represents the difference between the
actual book value of the warrant and the par value of the Series B
Convertible Preferred Stock issued upon exercise of the warrant.
(6) EBITDA is defined as net loss before interest income (expense), net; loan
commitment fees; provision for (benefit from) income taxes; and
depreciation and amortization and is presented because it is commonly used
by certain investors and analysts to analyze and compare a company's
operating performance and to determine a company's ability to incur and
service debt. EBITDA should not be considered in isolation from, or a
substitute for, net income, cash flow from operating activities, or other
consolidated income or cash flow statement data prepared in accordance with
generally accepted accounting principles, or as a measure of profitability
or liquidity.
(7) For purposes of calculating the ratio of earnings (deficiency) to fixed
charges: earnings consist of loss before income tax benefit, plus fixed
charges, excluding capitalized interest, and fixed charges consist of
interest expenses and capitalized interest, plus amortization of deferred
financing costs.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with Item 6. "Selected
Financial Data" and the Consolidated Financial Statements and the Notes thereto
included elsewhere in this Report.
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 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 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
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<PAGE>
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 in this Item 7.
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 currently has a
fiber optic network, the NEON system, that encompasses approximately 1,000 route
miles, or more than 65,000 fiber miles, in New York and New England (the
"Northeast").
The Company has already completed construction of approximately 600 route miles,
or approximately 49,000 fiber miles, of the NEON system at December 31, 1998,
and currently operates fiber optic routes from Hartford, Connecticut to
Springfield, Massachusetts and from Nashua, New Hampshire to Portland, Maine.
The Company is currently engineering, constructing or acquiring additional
routes in New York, Connecticut, Massachusetts, Rhode Island and New Hampshire
to create a continuous fiber optic link between New York City and Portland,
Maine with access into and around Boston, Massachusetts and numerous other major
service areas in the Northeast. These additional routes are expected to be
substantially completed in 1999 and will add approximately 400 route miles, or
approximately 16,000 fiber miles, to the NEON system. The completion of routes
currently planned will enable the NEON system to connect more than 540 cities
and towns in six states and pass more than 200 points-of-presence ("POPs"),
tandem switches and central offices, which the Company believes serve over 18
million people and over 470,000 businesses.
The Company generates revenue primarily through the 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 as services are performed.
Reorganization
The Company was incorporated in Massachusetts in July 1989 under the name
"FiveCom, Inc." In May 1996, FiveCom LLC, an operating subsidiary majority-owned
by the Company, was organized in Massachusetts. Also in May 1996, FiveCom LLC
and Mode 1 Communications, Inc. ("Mode 1"), a subsidiary of Northeast Utilities
("NU"), organized NECOM LLC in Massachusetts, with FiveCom LLC owning
approximately 60%, and Mode 1 owning approximately 40% of the membership
interests in NECOM LLC. In December 1996, FiveCom LLC and MaineCom Services
("MaineCom"), a wholly-owned subsidiary of CMP, organized FiveCom of Maine LLC
in Massachusetts, with MaineCom owning 66.67%, and FiveCom LLC owning 33.33%, of
the membership interests in FiveCom of Maine LLC.
In order to simplify the corporate structure and in contemplation of the July
1998 initial public offering of $180.0 million of 12 3/4% Senior Notes (the
"Notes") and 4.0 million shares of the Company's Common Stock at $12.00 per
share (together the "Public Offerings"), the Company's major stockholders
decided to reorganize the Company (the "Reorganization.") In April 1998, prior
to the Reorganization, CMP exercised its warrants to purchase 5,876 shares of
membership interests in FiveCom LLC for an aggregate exercise price of $58.76
and in July 1998, (i) each of the minority members in FiveCom LLC (and each of
Mode 1 and MaineCom) exchanged their membership interests in FiveCom LLC, NECOM
LLC and FiveCom of Maine LLC, respectively, for shares of the Series B
Convertible Preferred Stock of the Company; (ii) FiveCom LLC and NECOM LLC were
each merged with and into a wholly-owned subsidiary of the Company; (iii)
FiveCom of Maine LLC was merged into FiveCom of Maine, Inc., a
Page 22 of 92
<PAGE>
wholly-owned subsidiary of the Company; and (iv) the Company was reincorporated
in Delaware under the name "NorthEast Optic Network, Inc." and the Company's
Certificate of Incorporation was amended and restated.
The shares of membership interest in FiveCom LLC received by CMP upon exercise
of its warrant were exchanged for 144,172 shares of the Series B Convertible
Preferred Stock of the Company, which shares had an estimated value at the time
of the Reorganization of approximately $4.3 million. Mr. Colantonio, the
Company's President, and Mr. Musen, a Vice President of the Company, exchanged
their membership interests in FiveCom LLC for 17,788 shares and 14,549 shares,
respectively, of the Company's Series B Convertible Preferred Stock, which
shares had an estimated aggregate value at the time of the Reorganization of
approximately $542,000 and $443,000, respectively.
Prior to the Reorganization, which was completed on July 8, 1998, the Company
held interests in its majority-owned or controlled subsidiaries, FiveCom LLC,
FiveCom of Maine LLC and NECOM LLC. The interests of the minority owners of
these subsidiaries are reflected on the Company's balance sheet as minority
interest in consolidated subsidiaries. As a result of the Reorganization, such
minority owners became stockholders of the Company, and the value of the stock
of the Company received by them over the tangible book value of their minority
interests was reflected as goodwill.
Prior to the Company's initial public offering of stock and debt, the Company
was included in CMP's consolidated federal income tax return pursuant to the
terms of a tax-sharing arrangement entered into in 1996. The benefit from income
taxes represents refundable income taxes from CMP as a result of this tax
sharing arrangement. The Company has no net operating loss carryforwards as a
result of this tax sharing arrangement.
Results Of Operations
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
The Company's December 31, 1998 revenues increased by $468,968, or 119%, to
$863,672 in the year ended December 31, 1998 from $394,704 in the year ended
December 31, 1997. Revenues in 1998 were generated by recurring lease services
to existing customers, which came on line primarily during the second half of
1997, and to new customers.
Total cost of sales for the year ended December 31, 1998 were $2,176,266, an
increase of 91% over the $1,137,943 recorded in the year ended December 31,
1997. The increase was primarily due to rights-of-way fees and property taxes
resulting from network expansion in the Company's service territory.
Selling, general and administrative expenses increased to $5,200,720 for the
year ended December 31, 1998 from $1,002,232 in the year ended December 31,
1997, reflecting an increase in personnel, a one time bonus payment, and the
cost of developing management, sales and infrastructure resources.
Depreciation and amortization expense was $1,798,294 for the year ended December
31, 1998, compared to $552,862 for the year ended December 31, 1997. The
increase resulted from higher depreciation expense, due to the placement of
additional portions of the NEON system into service and the amortization of
goodwill as a result of the Reorganization on July 8, 1998.
Interest income increased to $4,179,880 for the year ended December 31, 1998
from $138,918 for the year ended December 31, 1997. The increase was due
primarily to higher cash and investment balances resulting from the Public
Offerings.
Interest expense increased to $8,644,463 for the year ended December 31, 1998
from $141,811 for the year ended December 31, 1997. The increase resulted
primarily from interest accrued on the Notes.
Minority interest for the year ended December 31, 1998 amounted to $1,108,933
compared to $1,080,200 in 1997. The increase is due to an increase in the
proportionate share of the net losses of
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<PAGE>
subsidiaries. The elimination of the minority interest in the third quarter of
1998 was in connection with the Reorganization.
Benefit from income taxes increased slightly in the year ended December 31, 1998
to $315,000 from $261,000 for the comparable period of 1997. The benefit related
to refundable income taxes resulting from the Company's tax sharing arrangement
with CMP, which terminated upon the closing of the Public Offerings on August 5,
1998.
For the year ended December 31, 1998, the Company recorded a net loss before
extraordinary item of $11,352,258, compared to $960,026 for the year ended
December 31, 1997. The increase in net loss before extraordinary item is
primarily attributable to the factors discussed above.
The extraordinary item for the year ended December 31, 1998 amounted to
$1,363,155, representing the write off of deferred financing costs associated
with two construction loans repaid in the third quarter with the proceeds from
the Company's Public Offerings.
A net loss after extraordinary item recorded for the year ended December 31,
1998, amounted to $12,715,413, compared to $960,026 for the year ended December
31, 1997. The increase in net loss after extraordinary item is primarily
attributable to the factors discussed above.
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
During the years ended December 31, 1997 and 1996, the Company was continuing in
its development stage and did not generate significant revenues until the last
half of 1997, when customers began using the NEON system. Revenues for 1997 were
$394,704 as compared to 1996 revenues of $13,773. The revenue increase was
generated primarily from services to customers during the last half of 1997 as
the NEON system was placed in service and contracts with carriers commenced.
Cost of sales for 1997 were $1,137,943 as compared to $260,619 in 1996. The
increase resulted primarily from accrued right-of-way fees due to NU under
arrangements for right-of-way extensions and property taxes incurred in
connection with the expansion of the NEON system.
Selling, general and administrative expenses increased to $1,002,232 in 1997
from $900,808 in 1996, an 11% increase. This increase resulted primarily from
increased professional fees and salaries and benefits caused by increased
business activities and growth within the Company.
Depreciation and amortization expense was $552,862 in 1997 as compared to
$24,168 in 1996. The increase resulted from the recognition of depreciation
expense resulting from portions of the NEON system being placed into service at
the end of the second quarter of 1997.
Interest income of $138,918 was recorded in 1997 as compared to $201,473 in
1996. The decline was due primarily to a decrease in cash balances as cash was
used to fund construction of the NEON system.
Interest expense (including the amortization of financing costs) increased in
1997 to $141,811 from $75,635 in 1996. The increase reflects additional debt
incurred in 1997 to finance construction of the NEON system and to fund
operations of the Company.
Minority interest increased in 1997 to $1,080,200 from $353,222 in 1996. The
increase resulted from an increase in the proportionate share of net losses of
subsidiaries.
Provision (benefit) for income taxes decreased in 1997 to $(261,000) from
$16,000 in 1996. The decrease relates to the fact that the Company had
refundable income taxes in 1997 as a result of its tax sharing arrangement with
CMP.
A net loss of $960,026 was recorded in 1997 compared to a net loss of $708,762
in 1996. The increase in net loss is primarily attributable to the factors
discussed above.
Page 24 of 92
<PAGE>
Liquidity and Capital Resources
On August 5, 1998, the Company completed the Public Offerings, resulting in net
proceeds to the Company of approximately $218 million (after deducting
expenses).
Net cash (used in)/provided by operating activities was $(315,762), $(813,704)
and $2,954,322 for the years ended December 31, 1996, 1997 and 1998,
respectively. Net cash provided for the year ended December 31, 1998 was due
primarily to the accrued interest expense in the amount of $9,244,250 on the
Notes and improved working capital, partially offset by a net loss.
Cash flow from financing activities was $11,918,703, $5,845,482 and $147,457,346
in the years ended December 31, 1996, 1997 and 1998, respectively. Cash flow
from financing activities in 1998 was generated from the Public Offerings. Of
the proceeds from the Public Offerings, $19,450,772 were used to repay long-term
construction loans from CMP and Peoples Heritage Bank, and $72,887,041 were used
to establish an escrow account to secure the payment of the first seven
scheduled interest and principal payments on the Notes, of which the first
payment was made on February 15, 1999.
Cash used in investing activities totaled $6,738,898, $8,798,251 and $93,772,328
in the years ended December 31, 1996, 1997 and 1998, respectively. Cash
requirements consisted primarily of the cost of construction to build the NEON
system and purchases of short term investments.
The Company anticipates that it will continue to experience negative cash flow
as it expands the NEON system, 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 cash on hand and the net
proceeds of the Public Offerings to fund this expansion and development.
Management believes that the net proceeds from the Public Offerings in addition
to cash from operations will be sufficient to fund the substantial completion of
the NEON system as currently planned as well as the Company's other working
capital needs. The expectations of required 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.
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<PAGE>
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 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 -- 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 December 31, 1998 has not incurred nor does it expect to
incur any material 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.
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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 a development stage company in the process 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 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
Page 27 of 92
<PAGE>
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 NU
Agreements 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 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 CMP Agreement, 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 NU Agreements and the CMP Agreement 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
Page 28 of 92
<PAGE>
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 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.
Page 29 of 92
<PAGE>
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 as described elsewhere in this Report 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. See Item 1. "Business
Governmental Regulation." 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, 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
Page 30 of 92
<PAGE>
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 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 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. The Company has entered into various agreements with CMP
and NU. Certain conflicts may arise between the interests of CMP and NU and the
security holders of the Company.
Item 7A. 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
Page 31 of 92
<PAGE>
held-to-maturity securities are subject to interest rate risk and will fall in
value if market interest rates increase. If market interest rates were to
increase immediately and uniformly by 10% from levels that existed at December
31, 1998, 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 effected.
Item 8. Financial Statements and Supplementary Data.
Index to Consolidated Financial Statements
NORTHEAST OPTIC NETWORK, INC.
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1998
TOGETHER WITH AUDITORS' REPORT
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Public Accountants 33
Consolidated Balance Sheets as of
December 31, 1997 and 1998 34
Consolidated Statements of Operations for the years ended
December 31, 1996, 1997 and 1998 35
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1996, 1997 and 1998 36
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998 37
Notes to Consolidated Financial Statements 38
</TABLE>
Page 32 of 92
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To NorthEast Optic Network, Inc.:
We have audited the accompanying consolidated balance sheets of NorthEast Optic
Network, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997
and 1998, and the related consolidated statements of operations, stockholders'
equity (deficit) and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of NorthEast Optic
Network, Inc. and subsidiaries as of December 31, 1997 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
January 18, 1999
Page 33 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 31,
1997 1998
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,098,452 $ 57,737,792
Short-term restricted cash and investments (Notes 6(b) and (c)) - 23,149,975
Short-term investments - 48,581,949
Accounts receivable, net of allowance for doubtful accounts of
approximately $224,000 in 1998 1,034,391 111,915
Refundable taxes from related party 368,734 755,838
Prepaid expenses and other current assets 13,572 506,947
--------------- ---------------
Total current assets 2,515,149 130,844,416
--------------- ---------------
PROPERTY AND EQUIPMENT, AT COST:
Communications network construction in progress 1,292,492 27,775,788
Communications network 15,583,770 23,574,533
Machinery and equipment 54,927 2,472,259
Leasehold improvements - 360,930
Furniture and fixtures 11,918 26,758
Motor vehicles 29,426 -
--------------- ---------------
16,972,533 54,210,268
Less--Accumulated depreciation 437,830 1,287,591
--------------- ---------------
16,534,703 52,922,677
--------------- ---------------
RESTRICTED CASH AND INVESTMENTS (Note 6(b)) 819,923 51,371,859
INTANGIBLE ASSETS, NET (Note 5) 3,591,225 56,773,282
--------------- ---------------
$ 23,461,000 $ 291,912,234
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 1,982,911 $ 127,619
Accounts payable 294,758 322,285
Accounts payable construction-in-progress 1,199,293 2,647,719
Accrued expenses 571,493 13,526,702
Accrued right-of-way fees, related party 785,535 1,084,325
Deferred revenue 1,144,170 1,168,900
--------------- ---------------
Total current liabilities 5,978,160 18,877,550
--------------- ---------------
DEFERRED TAX LIABILITY 61,000 -
--------------- ---------------
NOTE PAYABLE TO RELATED PARTY 2,100,000 -
--------------- ---------------
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 135,994 180,000,000
--------------- ---------------
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES 5,338,786 -
COMMITMENTS AND CONTINGENCIES (Notes 6 and 12)
CMP WARRANT 532,836 -
STOCKHOLDERS' EQUITY:
Series A convertible preferred stock, $.01 par value-
Authorized--277,960 shares; 78,324 shares issued and outstanding at
December 31, 1997 783 -
Series B convertible preferred stock, $.01 par value-
Authorized--4,498,371 shares; 962,734 shares issued and outstanding at
December 31, 1997 9,627 -
Common stock, $.01 par value-
Authorized--30,000,000 shares; 284,828 and 16,066,333 shares issued and
outstanding at December 31, 1997 and 1998, respectively 2,848 160,663
Warrants 8,595 8,595
Additional paid-in capital 11,817,216 108,105,684
Accumulated deficit (2,524,845) (15,240,258)
--------------- ---------------
Total stockholders' equity 9,314,224 93,034,684
--------------- ---------------
$ 23,461,000 $ 291,912,234
=============== ===============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 34 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
<S> <C> <C> <C>
REVENUES:
Contract $ - $ 347,718 $ 820,059
Other service 13,773 46,986 43,613
------------- ------------- -------------
Total revenues 13,773 394,704 863,672
------------- ------------- -------------
EXPENSES:
Cost of sales (includes right-of-way fees of approximately
$435,100, $108,000 and $591,000 in 1996, 1997 and 1998,
respectively, paid to related parties) 260,619 1,137,943 2,176,266
Selling, general and administrative 900,808 1,002,232 5,200,720
Depreciation and amortization 24,168 552,862 1,798,294
------------- ------------- -------------
Total expenses 1,185,595 2,693,037 9,175,280
------------- ------------- -------------
Loss from operations (1,171,822) (2,298,333) (8,311,608)
------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest income and other, net 201,473 138,918 4,179,880
Interest expense (75,635) (141,811) (8,644,463)
------------- ------------- -------------
Total other income (expense) 125,838 (2,893) (4,464,583)
------------- ------------- -------------
Loss before minority interest in subsidiaries' earnings
and benefit from income taxes (1,045,984) (2,301,226) (12,776,191)
MINORITY INTEREST 353,222 1,080,200 1,108,933
PROVISION FOR (BENEFIT FROM) INCOME TAXES 16,000 (261,000) (315,000)
------------- ------------- -------------
LOSS BEFORE EXTRAORDINARY ITEM (708,762) (960,026) (11,352,258)
------------- ------------- -------------
EXTRAORDINARY ITEM (Note 6(a)) - - (1,363,155)
------------- ------------- -------------
NET LOSS $ (708,762) $ (960,026) $ (12,715,413)
============= ============= =============
BASIC AND DILUTED LOSS PER SHARE BEFORE EXTRAORDINARY ITEM $ (2.49) $ (3.37) $ (1.70)
============= ============= =============
BASIC AND DILUTED LOSS PER SHARE $ (2.49) $ (3.37) $ (1.90)
============= ============= =============
BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 284,735 284,828 6,675,717
============= ============= =============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 35 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Series A Convertible Series B Convertible Common Stock
Preferred Stock Preferred Stock
Number of $.01 Par Number of $.01 Par Number of $.01 Par
Shares Value Shares Value Shares Value
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 21,180 $ 212 - $ - 284,578 $ 2,846
Issuance of Series B convertible
preferred stock, net of issuance
costs of $775,950 - - 405,024 4,050 - -
Exercise of common stock options - - - - 250 2
Issuance of common stock warrant - - - - - -
Issuance of Series B convertible
preferred stock - - 557,710 5,577 - -
Net loss - - - - - -
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1996 21,180 212 962,734 9,627 284,828 2,848
Issuance of ownership interest - - - - - -
Issuance of Series A convertible
preferred stock 57,144 571 - - - -
Net loss - - - - - -
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997 78,324 783 962,734 9,627 284,828 2,848
Exercise of common stock options - - - - 3,600 36
Reorganization (Note 1) 199,636 1,996 3,470,470 34,705 - -
Conversion of Series A and B
convertible preferred stock (277,960) (2,779) (4,433,204) (44,332) 11,777,905 117,779
Proceeds from initial public
offering, net of issuance costs
of $4,230,011 - - - - 4,000,000 40,000
Net loss - - - - - -
----------- ----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 - $ - - $ - 16,066,333 $ 160,663
=========== =========== =========== =========== =========== ===========
<CAPTION>
Total
Additional Stockholders'
Paid-in Accumulated Equity
Warrants Capital Deficit (Deficit)
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $ - $ 53,237 $ (856,057) $ (799,762)
Issuance of Series B convertible
preferred stock, net of issuance
costs of $775,950 - 9,220,000 - 9,224,050
Exercise of common stock options - 23 - 25
Issuance of common stock warrant 8,595 - - 8,595
Issuance of Series B convertible
preferred stock - (5,577) - -
Net loss - - (708,762) (708,762)
----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1996 8,595 9,267,683 (1,564,819) 7,724,146
Issuance of ownership interest - 1,750,088 - 1,750,088
Issuance of Series A convertible
preferred stock - 799,445 - 800,016
Net loss - - (960,026) (960,026)
----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1997 8,595 11,817,216 (2,524,845) 9,314,224
Exercise of common stock options - 32,040 - 32,076
Reorganization (Note 1) - 52,597,107 - 52,633,808
Conversion of Series A and B
convertible preferred stock - (70,668) - -
Proceeds from initial public
offering, net of issuance costs
of $4,230,011 - 43,729,989 - 43,769,989
Net loss - - (12,715,413) (12,715,413)
----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 1998 $ 8,595 $108,105,684 $(15,240,258) $93,034,684
=========== ============ ============ ===========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 36 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net loss $ (708,762) $ (960,026) $ (12,715,413)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities-
Extraordinary item-write-off of deferred financing costs - - 1,363,155
Minority interest in subsidiaries' earnings (353,222) (1,080,200) (1,108,933)
Loss on disposal of property and equipment - - 6,699
Accretion of long-term obligations - 26,642 62,165
Amortization of deferred financing costs - - 261,102
Depreciation and amortization 24,168 552,862 1,798,294
Changes in assets and liabilities-
Accounts receivable (120,628) (908,851) 922,476
Refundable taxes from related party - (368,734) (387,104)
Prepaid expenses and other current assets 104,565 (8,719) (493,375)
Accounts payable 315,977 (21,219) 27,527
Accrued expenses 197,140 974,371 13,253,999
Deferred revenue 225,000 919,170 24,730
Deferred tax liability - 61,000 (61,000)
--------------- --------------- ---------------
Net cash (used in) provided by operating activities (315,762) (813,704) 2,954,322
--------------- --------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of short-term investments - - (48,581,949)
Proceeds from sale of property and equipment - - 9,500
Purchases of property and equipment (17,480) (7,397) (2,660,719)
Purchases of communications network (6,693,602) (5,602,062) (36,286,548)
Increase in intangible assets (27,816) (3,188,792) (6,252,612)
--------------- --------------- ---------------
Net cash used in investing activities (6,738,898) (8,798,251) (93,772,328)
--------------- --------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Decrease) increase in construction accounts payable (3,361,122) 716,985 1,448,426
Proceeds from issuance of long-term obligations - 1,600,000 180,000,000
Proceeds from note payable to related party - 2,100,000 15,775,000
Payments on long-term obligations (618,621) (408,116) (1,991,286)
Payments on note payable to related party - - (17,875,000)
Increase in restricted cash and investments - (819,923) (73,701,911)
Proceeds from issuance of ownership interest - 1,750,088 -
Proceeds from exercise of stock options and warrants 25 - 32,128
Increase in minority interest in subsidiary 6,665,776 106,432 -
Proceeds from initial public offering, net - - 43,769,989
Proceeds from sale of preferred stock, net 9,232,645 800,016 -
--------------- --------------- ---------------
Net cash provided by financing activities 11,918,703 5,845,482 147,457,346
--------------- --------------- ---------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,864,043 (3,766,473) 56,639,340
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 882 4,864,925 1,098,452
--------------- --------------- ---------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 4,864,925 $ 1,098,452 $ 57,737,792
=============== =============== ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for-
Interest $ 331,505 $ 165,446 $ 660,300
=============== =============== ===============
Taxes $ - $ 45,261 $ 16,875
=============== =============== ===============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Goodwill recorded in connection with the Reorganization $ - $ - $ 47,871,068
=============== =============== ===============
Issuance of warrants in connection with sale of preferred
stock and note payable to related party $ 8,595 $ 532,836 $ -
=============== =============== ===============
Conversion of minority interest into Series A convertible
preferred stock in connection with the Reorganization $ - $ - $ 4,229,853
=============== =============== ===============
Exercise of CMP warrant $ - $ - $ 532,836
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
Page 37 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(1) OPERATIONS AND REORGANIZATION
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.
The Company was incorporated in Massachusetts in July 1989. In May 1996,
FiveCom LLC, an operating subsidiary majority-owned by the Company, was
organized in Massachusetts. Also in May 1996, FiveCom LLC and Mode 1
Communications, Inc. (Mode 1), an affiliate of Northeast Utilities
Services Company (NU), organized NECOM LLC in Massachusetts, with FiveCom
LLC owning 60%, and Mode 1 owning 40% of the membership interest in NECOM
LLC. In December 1996, FiveCom LLC and Central Maine Power Company (CMP),
organized FiveCom of Maine LLC in Massachusetts, with CMP owning 66.7%
and FiveCom LLC owning 33.3% of the membership interests in FiveCom of
Maine LLC. In addition, CMP purchased a 90.9% interest in the Company,
giving it a controlling interest. FiveCom LLC, NECOM LLC and FiveCom of
Maine LLC commenced operations upon their respective dates of
organization. Prior to the Reorganization completed on July 8, 1998 the
Company had a controlling interest in all entities except FiveCom of
Maine LLC (FiveCom of Maine LLC and the Company were commonly controlled
by CMP). After the Reorganization, FiveCom of Maine LLC became a wholly
owned subsidiary of the Company. As a result, the accompanying
consolidated financial statements have been restated to give retroactive
effect to the merger of FiveCom of Maine LLC with and into a subsidiary
of the Company as a reorganization of entities under common control in a
manner similar to a pooling of interests.
In order to simplify the corporate structure and in contemplation of the
Offerings, the Company's major stockholders decided to reorganize the
Company (the Reorganization). In April 1998, prior to the Reorganization,
CMP exercised its warrants to purchase 5,876 shares of membership
interests in FiveCom LLC for an aggregate exercise price of $58.76 and on
July 8, 1998, (i) each of the minority members in FiveCom LLC (and each
of Mode 1 and MaineCom Services, a wholly owned subsidiary of CMP)
exchanged their membership interests in FiveCom LLC, NECOM LLC and
FiveCom of
Page 38 of 92
<PAGE>
Maine LLC, respectively, for 3,470,470 shares of the Series B Convertible
Preferred Stock of the Company; (ii) FiveCom LLC and NECOM LLC were each
merged with and into the Company; (iii) FiveCom of Maine LLC was merged
into FiveCom of Maine, Inc., a wholly-owned subsidiary of the Company;
and (iv) the Company was reincorporated in Delaware as NorthEast Optic
Network, Inc. and the Company's Certificate of Incorporation was amended
and restated. In December 1998 FiveCom of Maine, Inc. was merged with and
into NorthEast Optic Network, Inc.
As a result of the Reorganization, (i) MaineCom Services ownership of the
Company was reduced to 52.82%, with Mode 1 gaining an ownership interest
of 40.84% in the Company, and (ii) FiveCom LLC and NECOM LLC were merged
with and into the Company, and FiveCom of Maine LLC became a wholly owned
subsidiary of the Company which was converted from a Massachusetts
limited liability company into a Delaware corporation.
On July 8, 1998, the Company entered into a Restructuring and
Contribution Agreement with CMP, MaineCom Services and Mode 1 relating to
the restructuring of the Company. Pursuant to this Agreement, each of
MaineCom Services and Mode 1 exchanged membership interests in
subsidiaries of the Company for shares of the Series B Convertible
Preferred Stock of the Company. In addition, pursuant to the
Restructuring and Contribution Agreement, the Company's President and the
Company's Vice President, Operations, exchanged their membership
interests in FiveCom LLC, a subsidiary of the Company, for shares of the
Series B Convertible Preferred Stock of the Company.
Prior to the reorganization, FiveCom, Inc., NU, and other minority
interests owned 82.7%, 9.9% and 7.4%, respectively, of FiveCom LLC
membership interests. CMP through its ownership in FiveCom, Inc. owned a
75.1% interest in FiveCom LLC. In connection with the Reorganization, the
Company recorded an intangible asset of $47,871,068 to reflect the
Company's exchange of membership interest (acquisition) related to NU's
minority interest in NECOM LLC, in accordance with AICPA Accounting
Interpretation 39 to APB Opinion No. 16, Business Combinations (AIN-39).
The intangible will be amortized over 30 years, reflecting assignment of
value to goodwill and to the rights-of-ways, which have 30-year terms.
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 (see Note
8(d)), and sold $180 million of 12-3/4% Senior Notes due 2008 (the Senior
Notes) to the public in a debt offering (see Note 6(b)).
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.
Page 39 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
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.
Page 40 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(a) Principles of Consolidation
The consolidated financial statements include the accounts of
NorthEast Optic Network, Inc. and its majority owned or controlled
subsidiaries, FiveCom LLC, FiveCom of Maine LLC and NECOM LLC. All
significant intercompany transactions and balances have been
eliminated in consolidation.
(b) Minority Interest
Minority interest in consolidated subsidiaries in the Company at
December 31, 1997 consists of other members' interests in the LLCs
identified above. Changes in minority interest reflect other
members' capital adjusted by their portion of the net loss.
(c) 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.
(d) 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.
(e) Income Taxes
Through July 8, 1998, the Company was majority-owned by CMP and
under a tax-sharing agreement was included in the consolidated
federal tax return of CMP (see Notes 3 and 10). Tax provisions
through that date were calculated on a separate return basis. The
Company accounts for income taxes under SFAS No. 109, Accounting
for Income Taxes, the objective of which is to recognize the
amount of current and deferred income taxes payable or refundable
at the date of the financial statements as a result of all events
that have been recognized in the accompanying consolidated
financial statements, as measured by enacted tax laws.
Page 41 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(f) Cash and Cash Equivalents and Short-Term Investments
The Company accounts for investments under Statement of Financial
Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Under SFAS No. 115,
investments for which the Company has the positive intent and
ability to hold to maturity, consisting of cash equivalents, are
reported at amortized cost, which approximates fair market value.
Cash equivalents are highly liquid investments with original
maturities of three months or less. To date, the Company has not
recorded any realized gains or losses. As of December 31, 1998,
all of the Company's short-term investments are classified and
accounted for as held-to-maturity and reported at amortized cost,
which approximates fair market value. Cash and cash equivalents
and short-term investments consist of the following:
<TABLE>
<CAPTION>
December 31,
1997 1998
<S> <C> <C>
Cash and cash equivalents-
Cash $ 194,735 $ 3,238
Money markets 903,717 2,981,789
Commercial paper - 54,752,765
------------ -----------
Total cash and cash equivalents $ 1,098,452 $57,737,792
============ ===========
Short-term-
U.S. treasury notes $ - $ 48,581,949
============= ============
</TABLE>
(g) Deferred Revenue
Deferred revenue represents prepayments on dark fiber optic cable
leases. Lease payments are structured as either prepayments or
monthly recurring charges. Prepayments are accounted for as
deferred revenue and recognized over the term of the respective
customer fiber optic lease agreement. At December 31, 1997 and
1998, the Company has prepaid lease payments totaling $1,144,170
and $1,168,900, respectively.
(h) Depreciation
The Company provides for depreciation using the straight-line
method to allocate the cost of property and equipment over their
estimated useful lives as follows:
<TABLE>
<S> <C>
Communications network 20 years
Machinery and equipment 5-7 years
</TABLE>
Page 42 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
<TABLE>
<CAPTION>
Leasehold improvements Life of lease
<S> <C>
Furniture and fixtures 7 years
Motor vehicles 3-5 years
</TABLE>
Page 43 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(i) Long-Lived Assets
The Company applies SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of.
SFAS No. 121 requires the Company to continually evaluate whether
events or circumstances have occurred that indicate that the
estimated remaining useful life of long-lived assets and certain
identifiable intangibles and goodwill may warrant revision or that
the carrying value of these assets may be impaired. To compute
whether assets have been impaired, the estimated gross cash flows
for the estimated remaining useful life of the assets are compared
to the carrying value. To the extent that the gross cash flows are
less than the carrying value, the assets are written down to the
estimated fair value of the asset. The Company does not believe
that its long-lived assets have been impaired.
(j) Concentrations of Credit Risk and Significant Customers
Financial instruments that subject the Company to significant
concentrations of credit risk consist primarily of cash and cash
equivalents, investments and trade accounts receivable. The
Company's cash equivalents and investments are invested in
financial instruments with high credit ratings. To control credit
risk, the Company performs regular credit evaluations of its
customers' financial condition and maintains allowances for
potential credit losses. Concentration of credit risk with respect
to accounts receivable is limited to customers to whom the Company
makes significant sales.
Significant accounts receivable balances as a percentage of the
Company's total accounts receivable were as follows:
<TABLE>
<CAPTION>
Year Ended Significant Percentage of Total Accounts
December 31, Customers ----------------Receivable-----------------
A B C D
<S> <C> <C> <C> <C> <C>
1996 1 90% - - -
1997 1 90% - - -
1998 3 - 64% 16% 10%
</TABLE>
The Company recorded revenues greater than 10% of total revenues
from the following customers:
<TABLE>
<CAPTION>
Year Ended Significant ------Percentage of Customer Revenues------
December 31, Customers
Page 44 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
A B C D
<S> <C> <C> <C>
1996 1 98% - - -
1997 2 10% 69% - -
1998 3 - 50% 19% 12%
</TABLE>
Page 45 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Sales to Customers A, B and C were for dark fiber services. Sales
to Customer D were for lit fiber services.
(k) Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Value of Financial
Instruments, requires disclosure about fair value of financial
instruments. Financial instruments consist of cash and cash
equivalents, investments, accounts receivable, accounts payable
and notes payable. The estimated fair value of these financial
instruments approximates their carrying value.
(l) 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.
(m) Earnings Per Share
The Company has adopted SFAS No. 128, Earnings Per Share,
effective December 15, 1997. SFAS No. 128 establishes standards
for computing and presenting earnings per share and applies to
entities with publicly held common stock or potential common
stock. The Company has applied the provisions of SFAS No. 128
retroactively for all periods presented. In accordance with
Securities and Exchange Commission (SEC) Staff Accounting Bulletin
(SAB) No. 98, the Company has determined that there were no
nominal issuances of common stock or potential common stock in the
period prior to the Company's planned initial public offering. The
dilutive effect of potential common shares in 1996, 1997 and 1998,
consisting of outstanding stock options and convertible preferred
stock, is determined using the treasury stock method and the if
converted method, respectively, in accordance with SFAS No. 128.
Diluted weighted average shares outstanding for 1996, 1997 and
1998 exclude the potential common shares from warrants, stock
options and convertible preferred stock outstanding because to do
so would have been antidilutive for the periods presented.
Outstanding common stock warrants and stock options excluded in
1996, 1997 and 1998 were 11,450, 11,450 and 1,712,118 shares,
respectively. Convertible preferred stock shares excluded in 1996,
1997 and 1998 related to convertible preferred stock were 983,914,
1,041,058 and 0 shares, respectively.
Page 46 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Pro forma basic and diluted weighted average shares outstanding
for the year ended December 31, 1998 have been calculated as if
the reorganization and offerings had taken place on January 1,
1998.
<TABLE>
<CAPTION>
December 31,
1998
<S> <C>
Basic and diluted loss per share:
Loss before extraordinary item applicable to shareholders $ (11,352,258)
Extraordinary item (1,363,155)
-------------
Net loss applicable to shareholders $ (12,715,413)
-------------
Pro forma weighted average shares outstanding 16,065,285
-------------
Basic and diluted loss per share $ (1.90)
=============
Basic and diluted pro forma loss per share $ (0.79)
=============
</TABLE>
(n) Reclassifications
Certain prior period amounts have been reclassified to conform
with current period presentation.
(o) New Accounting Standards
American Institute of Certified Public Accountants (AICPA)
Statement of Position (SOP) 98-5, Reporting on the Costs of
Start-Up Activities, was issued in April 1998. SOP 98-5 requires
that all non-governmental entities expense the costs of start-up
activities, including organizational costs, as those costs are
incurred. The Company has recorded such costs as expense, in the
period incurred.
In June 1998, the FASB issued SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for
hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of
a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in
Page 47 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated
forecasted transaction. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. This new
standard is not anticipated to have a significant impact on the
Company's financial statements based on the current structure and
operations.
(p) Litigation
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 are not expected to have a material
effect on operations.
(3) RELATED PARTY TRANSACTIONS
Applied Telecommunication Technologies, Inc. (ATTI) has provided the
Company with $1,594,433 of lease financing to date as reflected in Note
6. The principal balance of the obligations is $533,740 and $127,619 as
of December 31, 1997 and 1998, respectively. ATTI and one of ATTI's
investment funds collectively own approximately 1.36% of the Company's
outstanding common stock at December 31, 1998.
During the years ended December 31, 1997 and 1998, the Company reimbursed
CMP and/or its subsidiary, MaineCom Services, for costs related to the
activities of the Company. The amount paid to CMP totaled approximately
$725,000 and $1.2 million for the years ended December 31, 1997 and 1998,
respectively. The Company believes that these costs approximated the
actual costs incurred by CMP and/or MaineCom Services related to such
personnel, and does not believe that such costs would have been
materially different had CMP and/or MaineCom Services not been affiliates
of the Company.
CMP agreed to allow right-of-way payments otherwise payable by the
Company to accrue so long as amounts borrowed by the Company from a bank
under a $1.6 million construction loan agreement were outstanding. The
Company paid approximately $163,000 in right-of-way fees through December
31, 1998.
In addition, CMP included the Company in its consolidated federal income
tax return through July 8, 1998. At December 31, 1997 and 1998, the
amounts due under the tax-sharing agreement to the Company from CMP are
included in refundable taxes from related party and amounted to
approximately $368,700 and $755,800, respectively, for current and
deferred income tax benefits related to CMP's utilization of the
Company's loss carryforwards (see Note 10).
Page 48 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
The Company paid NU $945,667 in 1997 and $1,906,941 in 1998 for
materials, labor and other contractor charges. Approximately $494,500 and
$359,300 was included in accounts payable construction in progress at
December 31, 1997 and 1998, respectively.
In 1994, the Company entered into an agreement with three utility
subsidiaries of NU whereby these companies waived right-of-way fees for
ten years in return for the Company's guarantee to build the fiber optic
network to certain of their facilities and allow them the use of 12
fibers on designated route segments in the NU service territory.
The Company's agreement with the NU companies provides for payments on a
per-mile basis for certain right-of-way extensions. Such payments are
recognized ratably over the 30-year term of the contract. Approximately
$785,500 and $1,084,000 was included in accrued right-of-way
fees--related party at December 31, 1997 and 1998, respectively.
The Company believes that the right-of-way fees payable under the NU
affiliate and CMP agreements are reasonable and are comparable to those
which would have been negotiated on an arm's-length basis with an
unaffiliated third party.
The Company has employment contracts with five of its officers, two of
whom are also common stockholders of the Company. The contracts are for
three-year terms expiring at varying dates through July 2001 with an
annual compensation commitment of $797,000 in the aggregate. In addition,
the Company recorded a one-time bonus for a payment to one individual
totaling $500,000 upon the successful completion of the Company's IPO.
(4) COMMUNICATIONS NETWORK CONSTRUCTION-IN-PROGRESS
The Company is constructing a communications network in the Northeast.
Costs directly related to the construction of the network are being
capitalized and will be depreciated over the 20-year estimated useful
life of the fiber optic transmission plant as individual segments of the
system are placed in service. During 1997 and 1998, approximately 160 and
130 miles, respectively, were placed in service. Approximately $181,000,
$142,000 and $1,500,000 of interest has been capitalized to
communications network construction-in-progress in each of the three
years in the period ended December 31, 1998.
(5) INTANGIBLE ASSETS
Intangible assets subject to amortization have been capitalized and are
amortized on the straight-line basis as follows:
Page 49 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
<TABLE>
<S> <C>
Prepaid right-of-way fees 10 years (term of the agreement)
Goodwill 30 years
Deferred financing costs 3-10 years (term of the debt)
Trademarks 10 years
</TABLE>
Page 50 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Intangible assets consist of the following at December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Prepaid right-of-way fees, related party $ 2,471,743 $ 4,072,148
Goodwill - 47,871,068
Deferred financing costs 1,318,258 6,266,447
Other 2,098 23,810
------------ -----------
3,792,099 58,233,473
Less--Accumulated amortization 200,874 1,460,191
------------ -----------
$ 3,591,225 $56,773,282
============ ===========
</TABLE>
(6) LONG-TERM OBLIGATIONS AND NOTE PAYABLE TO RELATED PARTY
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Note payable to related party $ 2,100,000 $ -
============ ============
12-3/4% Senior Notes $ - $180,000,000
Construction loan payable 1,575,772 -
ATTI notes payable (related party) 533,740 127,619
Capital lease payable to a bank in monthly principal and interest
installments of $482 with interest at 8.25% through August 1999,
collateralized by a motor vehicle 9,393 -
------------ ------------
2,118,905 180,127,619
Less--Current portion 1,982,911 127,619
------------ ------------
$ 135,994 $180,000,000
============ ============
</TABLE>
(a) Note Payable to Related Party and Extraordinary Item
On October 7, 1997 the Company entered into a $30,000,000
construction loan agreement with CMP. Through August 5, 1998, the
date of the IPO, $17,875,000 had been advanced under the loan
agreement. These amounts were repaid in full from the net proceeds
from the Company's IPO and debt offering. In conjunction with the
note, the Company issued a warrant to purchase additional
membership interest (see Note 7). Upon successful completion of
the offerings,
Page 51 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
retirement of the note and expense of the warrant, the Company
recorded an extraordinary charge of $1,363,155 in the consolidated
statement of operations to write off the remaining balance of the
deferred financing costs related to the note payable to related
party and construction loan payable (see Note 6 (c)).
Page 52 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(b) 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:
<TABLE>
<CAPTION>
Period Redemption Price
<S> <C> <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 deferred financing costs in the accompanying
consolidated balance sheet as of December 31, 1998 and are being
amortized, as interest expense, over the term of the Notes.
(c) Construction Loan Payable
Page 53 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
In March 1997, the Company entered into a $1,600,000 construction
loan agreement with a bank. The Company was required to maintain
approximately $800,000 in a reserve account, included in the
accompanying consolidated balance sheet as of December 31, 1997 as
restricted cash and investments. All interest earned on the
deposit becomes part of the reserve account. The reserve account
agreement remains in effect until the note is paid in full;
however, the bank may release the reserve account in the absence
of any material default under the loan agreement and a debt
service coverage ratio greater than 1.5 to 1.0, as defined. The
Company repaid the amounts outstanding under the agreement with
the proceeds from the IPO and all funds in the reserve account
were released.
(d) ATTI Notes Payable
From August 1994 through October 1995, the Company entered into
five notes payable with ATTI. The notes bear interest at 13% and
are payable in monthly principal and interest installments ranging
from $1,194 to $13,270 through August 1999. In addition, the
Company issued common stock warrants in conjunction with the notes
(see Notes 3 and 9(e)).
(7) CMP WARRANT
During October 1997 and in connection with the CMP construction loan
agreement (see Note 6), the Company issued a warrant to purchase 5,876
shares of membership interest in FiveCom LLC to the lender at an exercise
price of $.01 per share. The warrant expires on October 7, 2002. At the
time of issuance, the warrant was recorded as a discount on the loan
agreement as deferred financing costs and as a component of stockholders'
equity in the accompanying consolidated balance sheet at $532,836, the
fair market value of the warrant, as calculated using the Black-Scholes
option pricing model. The discount was being amortized as interest
expense over the term of the debt. In April 1998, CMP exercised the
warrant.
(8) STOCKHOLDERS' EQUITY
(a) Reverse Stock Split
On April 30, 1996, the Company declared a five-for-one reverse
split of each class of its capital stock. All share and per share
amounts have been retroactively adjusted to reflect this split for
all periods presented.
(b) Preferred Stock
Page 54 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
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 December 31,
1998, no such shares are issued and outstanding.
Page 55 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(c) Common Stock
In June 1998, the Company's Board of Directors authorized the
issuance of up to 30,000,000 shares of common stock.
(d) Initial Public Offering
On August 5, 1998, the Company completed an IPO 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 $43,800,000 and 500,000 shares were sold for account
of certain stockholders of the Company. Upon the closing of the
IPO, all shares of the Company's Series A and B convertible
preferred stock automatically converted into 11,777,905 shares of
the Company's common stock.
(9) STOCK-BASED COMPENSATION
(a) 1994 Stock Option Plan
On December 2, 1994, the Company's Board of Directors adopted the
1994 Stock Option Plan (the 1994 Plan). Under the terms of the
1994 Plan, incentive and nonqualified options may be granted to
employees, officers, directors, consultants and advisers to
purchase an aggregate of 4,000 shares of common stock. The
exercise price of the incentive options will be 100% of the fair
market value of the common stock or 110% of the fair market value
in the case of options granted to a greater than 10% stockholder.
Options generally vest quarterly over a two-year period and are
exercisable within five years of the original date of grant. At
December 31, 1998, there are 400 shares available for issuance
under the 1994 Plan.
(b) 1998 Stock Incentive Plan
The Company's 1998 Stock Incentive Plan (the 1998 Plan) was
adopted by the Board of Directors on May 18, 1998 and approved by
the Company's stockholders on May 26, 1998. The 1998 Plan provides
for the grant of incentive stock options, nonstatutory stock
options, restricted stock awards and other stock-based awards,
including the grant of shares based on certain conditions, the
grant of securities convertible into common stock and the grant of
stock appreciation rights (collectively the Awards). Options may
be granted at an exercise price that may be less than, equal to or
greater than the fair market value of the common stock on the date
of grant. Incentive stock options and options intended to qualify
as performance-based compensation may not be granted at an
exercise price less than the fair market value of the
Page 56 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
common stock on the date of grant (or less than 110% of the fair
market value in the case of incentive stock options granted to
optionees holding more than 10% of the voting power of the
Company). Restricted stock awards entitle recipients to acquire
shares of common stock, subject to the right of the Company to
repurchase all or part of such shares from the recipient in the
event that the conditions specified in the applicable Award are
not satisfied prior to the end of the applicable restriction
period established for such Award. Under the 1998 Plan, the Board
of Directors has the right to grant other Awards based on the
common stock having such terms and conditions as the Board of
Directors may determine, including the grant of shares based on
certain conditions, the grant of securities convertible into
common stock and the grant of stock appreciation rights. Officers,
employees, directors, consultant and advisers of the Company and
its subsidiaries are eligible to be granted Awards under the 1998
Plan.
As of December 31, 1998, a total of 2,436,105 shares were reserved
for issuance under the 1998 Plan, of which 1,537,750 shares were
granted to employees having a weighted average exercise price per
share of $10.57
(c) Stock Option Activity
Stock option activity under the 1994 and 1998 plans for the three
years in the period ended December 31, 1998 is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Number of Shares Price
<S> <C> <C> <C>
Outstanding, December 31, 1995 4,000 $ .10
Exercised (250) .10
----------
Outstanding, December 31, 1996 3,750 .10
Canceled (3,750) .10
----------
Outstanding, December 31, 1997 - -
Granted 2,190,978 10.98
Exercised (3,600) .10
Canceled (649,628) 12.00
----------
Outstanding, December 31, 1998 1,537,750 $ 10.57
========== =======
Exercisable, December 31, 1998 352,134 $ 11.95
========== =======
</TABLE>
Page 57 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
<TABLE>
<CAPTION>
------------------Outstanding-----------------------------------Exercisable-----------
Number Weighted
Exercise Outstanding Average Number
Price/Range as of Remaining Weighted Exercisable as Weighted
of Exercise December 31, Contractual Average of December 31, Average
Prices 1998 Life Exercise Price 1998 Exercise Price
<S> <C> <C> <C> <C> <C> <C>
$6.09 350,000 9.88 $ 6.09 - -
$9.38--$9.75 50,901 9.85 9.55 7,020 $ 9.38
$12.00 1,136,849 9.61 12.00 345,114 12.00
---------- ----------
1,537,750 $ 10.57 352,134 $ 11.95
========== ======= ========== =========
</TABLE>
(d) Fair Value of Stock Options
In October 1995, the FASB issued SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123 requires the measurement of
the fair value of stock options to be included in the statements
of income or disclosed in the notes to financial statements. The
Company has determined that it will continue to account for
stock-based compensation for employees under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees,
and elect the disclosure-only alternative under SFAS No. 123.
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the
following assumptions used for grants during the applicable
period:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Risk-free interest rate N/A N/A 4.39-5.52%
Expected dividend yield N/A N/A None
Expected lives N/A N/A 2-5 years
Expected volatility N/A N/A 35.5%
Weighted average fair value of
options granted during the N/A N/A $ 4.31
period
</TABLE>
Page 58 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
Had compensation cost for the Company's stock option plans been
determined consistent with SFAS No. 123, the Company's net loss
available to common stockholders and basic and diluted net loss
per common share would have been the following pro forma amounts:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Net loss available to common
stockholders:
As reported $(708,762) $(960,026) $ (12,715,413)
Pro forma (708,762) (960,026) (13,360,167)
Basic and diluted net loss per
common share:
As reported $ (2.49) $ (3.37) $ (1.90)
Pro forma (2.49) (3.37) (2.00)
</TABLE>
(e) Warrants
From August 1994 to October 1995, the Company issued stock
purchase warrants to ATTI (see Note 3) for the purchase of 11,450
shares of the Company's common stock at an exercise price of $.06
per share. The warrants expire five years from the date of grant.
At the time of issuance, the Company recorded a charge of $178,
representing the fair market value of the warrants, as determined
by the Board of Directors.
During July 1996, the Company issued a warrant to one of its
advisers for the purchase of 2,656 shares of membership interest
in FiveCom LLC at an exercise price of $125.84 per share. The
warrant expires on April 30, 2001. At the time of issuance, the
Company recorded a charge of $8,595, representing the fair market
value of the warrant, as calculated using the Black-Scholes option
pricing model. Upon closing of the IPO, the warrant converted into
a warrant to purchase 162,918 shares of common stock at an
exercise price of $2.052 per share.
(10) INCOME TAXES
As discussed in Note 3, the Company was included in CMP's consolidated
federal income tax return through July 8, 1998. Under the tax sharing
agreement, the Company recognizes a benefit from amounts utilized by CMP
from the Company's net operating losses.
Page 59 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
The income tax provision (benefit) for the years ended December 31, 1996, 1997
and 1998 consists of the following:
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Current-
Federal $ 14,000 $ (291,000) $ (230,000)
State 2,000 (31,000) (24,000)
----------- ----------- ------------
16,000 (322,000) (254,000)
Deferred-
Federal (58,000) 47,000 (4,063,000)
State (6,000) 14,000 (214,000)
----------- ----------- ------------
(64,000) 61,000 (4,277,000)
Less valuation allowance 64,000 - 4,216,000
----------- ----------- ------------
Total $ 16,000 $ (261,000) $ (315,000)
=========== =========== ============
</TABLE>
The provision for income taxes for the year ended December 31, 1996 consists of
alternative minimum and net worth taxes. The benefit from income taxes for the
year ended December 31, 1997 represents refundable income taxes from CMP as a
result of its tax-sharing agreement. The benefit from income taxes for the year
ended December 31, 1998 represents refundable income taxes from CMP as a result
of its tax sharing agreement offset by a provision for net worth taxes.
The components of the deferred taxes are approximately as follows:
<TABLE>
<CAPTION>
1997 1998
<S> <C> <C>
Net operating losses $ - $ 4,324,000
Depreciation (61,000) (164,000)
Reserves and accruals, not currently deductible - 139,000
Prepaid expenses - (83,000)
------------ ------------
(61,000) 4,216,000
Valuation allowances - (4,216,000)
------------ ------------
Deferred tax liability $ (61,000) $ -
============ ============
</TABLE>
As of December 31, 1998, the Company had federal and state net operating
loss carryforwards for the period subsequent to the reorganization
available to offset future taxable income, if any, of approximately $11
million. These carryforwards expire through 2013 and are subject to the
review and
Page 60 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
possible adjustment by the Internal Revenue Service. In addition, the
occurrence of certain events, including significant changes in ownership
interests, may limit the amount of net operating loss carryforwards
available to be used in any given year. A full valuation allowance has
been recorded in the accompanying consolidated financial statements to
offset this carryforward, because its future realizability is uncertain.
(11) NETWORK CONSTRUCTION AND NU AND CMP CONTRACTS
In 1994, the Company contracted for the rights to use certain of NU's
utility subsidiaries property over an initial 30 year term for the
purpose of constructing and operating the fiber optic network facilities.
At the end of the initial 30 year term, these companies will have the
option to purchase the network on their rights-of-way from the Company at
the appraised value at that time, or to extend the agreement for an
additional 30 year term with an added payment incentive of 10% of
revenues generated from the network built on their rights-of-way.
Contractually, the Company is required to build 310 fiber route miles in
the NU affiliate service territory by September 27, 1999.
Pursuant to the Company's agreement with the NU utility subsidiaries, the
right-of-way fees for specified route segments have been waived for ten
years in return for the Company's guarantee to build the fiber optic
network to certain NU subsidiary facilities and allow them the use of 12
fibers on designated route segments in the NU subsidiary service
territory. Costs of $4,072,148 associated with the construction of the 12
fibers are included in prepaid right-of-way fees--related party in the
accompanying consolidated balance sheet and are being recognized as a
cost-of-service ratably over 10 years.
The Company's agreement with the NU utility subsidiaries also provides
for payments on a per-mile basis for certain right-of-way extensions.
Such payments are being recognized ratably over the 30-year term of the
contract.
In 1996, the Company contracted for the rights to use CMP's property over
an initial 30 year term for the purpose of owning and operating fiber
optic network facilities. At the end of the initial 30 year term, CMP
will have the option to purchase the network on CMP rights-of-way from
the Company at the appraised value, or to extend the agreement for an
additional ten-year term with an added payment incentive of 10% of
revenues generated from the network built on CMP rights-of-way.
The Company's agreement with CMP provides for payments on a per-mile
basis. Such payments are payable annually by January 31 of each year and
are recognized ratably over the 30 year term of the contract. The Company
paid approximately $111,000 in right-of-way payments for the year ended
December 31, 1998.
Page 61 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(12) COMMITMENTS
(a) Lease Commitments
The Company leases certain motor vehicles, equipment and office
facilities under noncancelable operating leases which expire at
various dates through December 2008. Future minimum lease payments
required under these leases at December 31, 1998 are approximately
as follows:
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C> <C>
1999 $ 214,000
2000 204,000
2001 178,000
2002 132,000
2003 133,000
Thereafter 666,000
------------
$ 1,527,000
============
</TABLE>
The Company leases fibers from certain electric utility companies
on its segment from Hudson, New Hampshire, to Boston and
Cambridge, Massachusetts, under operating leases that expire
through December 2018. Future minimum lease payments required
under these fiber optic leases at December 31, 1998 are
approximately as follows:
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C> <C>
1999 $ 2,037,000
2000 2,037,000
2001 2,037,000
2002 2,037,000
2003 2,037,000
Thereafter 30,563,000
-----------
$40,748,000
===========
</TABLE>
In addition, the Company is required to pay to the electric
utility companies a portion of the quarterly gross revenue derived
by the Company from the sale, use or lease of the leased fibers,
as defined in the lease agreement.
Page 62 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(b) Purchase Commitments
In December 1998, the Company entered into a three-year agreement
with a vendor to purchase equipment, software and services having
a total value of $20 million. Through December 31, 1998, no
purchases have been made under this agreement.
(13) 401(k) PLAN
The Company maintains the NorthEast Optic Network, Inc. 401(k) Plan (the
Plan) under Section 401(k) of the IRC covering all eligible employees.
Employees of the Company may participate in the Plan after six months of
service. The Company may make discretionary matching contributions, as
determined annually by the Board of Directors. Employee contributions
vest immediately, while Company matching contributions vest ratably over
four years. To date, there have been no discretionary contributions made
to the Plan.
(14) ACCRUED EXPENSES
Accrued expenses at December 31, 1997 and 1998 consist of the following:
<TABLE>
<CAPTION>
December 31,
1997 1998
<S> <C> <C>
Accrued interest $ 92,180 $ 9,244,250
Accrued construction in progress - 2,051,000
Accrued taxes 315,036 889,000
Accrued professional fees 50,000 245,000
Accrued payable to related party 61,793 346,166
Accrued payroll and benefits 22,992 271,345
Accrued commissions - 100,000
Accrued other 29,492 379,941
------------ ------------
$ 571,493 $ 13,526,702
=========== ============
</TABLE>
(15) 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
Page 63 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
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. (See Note 2 (j)).
Page 64 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
(16) SELECTED QUARTERLY OPERATING RESULTS (UNAUDITED)
The following table sets forth certain unaudited quarterly results of
operations for each of the four quarters ended December 31, 1997 and
1998. In management's opinion, this unaudited information has been
prepared on the same basis as the annual financial statements and
includes all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the information for the
quarters presented, when read in conjunction with the financial
statements and notes thereto included elsewhere in this document. The
operating results for any quarter are not necessarily indicative of
results for any subsequent quarter.
<TABLE>
<CAPTION>
--------------------------------------------Quarter Ended------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1997 1997 1997 1997 1998 1998 1998 1998
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Network service $ - $ 106,369 $ 114,784 $ 126,565 $ 146,257 $ 179,661 $ 155,766 $ 338,375
Other service - 5,036 18,221 23,729 5,106 2,752 16,395 19,360
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
Total revenues - 111,405 133,005 150,294 151,363 182,413 172,161 357,735
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
EXPENSES:
Cost of sales 108,358 405,038 289,777 334,770 247,386 810,892 546,504 571,484
Selling, general and
administrative 204,275 445,930 172,554 176,365 225,122 867,637 2,272,808 1,835,153
Depreciation and
amortization 32,987 135,204 137,936 249,843 302,013 313,645 491,633 691,003
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
Total expenses 345,620 986,172 600,267 760,978 774,521 1,992,174 3,310,945 3,097,640
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
Loss from
operations (345,620) (874,767) (467,262) (610,684) (623,158) (1,809,761) (3,138,784) (2,739,905)
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
OTHER INCOME
(EXPENSE):
Interest income and
other, net 56,638 28,118 38,603 15,559 30,322 56,550 1,615,895 2,477,113
Interest expense - (481) (37,297) (104,033) (91,816) (365,223) (3,275,400) (4,912,024)
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
Total other income
(expense) 56,638 27,637 1,306 (88,474) (61,494) (308,673) (1,659,505) (2,434,911)
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
Loss before
minority interest
in subsidiaries'
earnings and
provision for
income taxes (288,982) (847,130) (465,956) (699,158) (684,652) (2,118,434) (4,798,289) (5,174,816)
MINORITY INTEREST 137,620 397,644 218,721 326,215 314,498 794,435 - -
(BENEFIT FROM)
PROVISION FOR INCOME
TAXES (33,000) (96,000) (53,000) (79,000) (77,000) (487,480) - 249,480
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
Page 65 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Continued)
LOSS BEFORE
EXTRAORDINARY ITEM (118,362) (353,486) (194,235) (293,943) (293,154) (836,519) (4,798,289) (5,424,296)
EXTRAORDINARY ITEM - - - - - - (1,335,004) (28,151)
---------- ---------- ---------- ---------- ---------- --------- ----------- ----------
NET LOSS $ (118,362) $ (353,486) $ (194,235) $ (293,943) $ (293,154) $(836,519) $(6,133,293) $(5,452,447)
========== ========== ========== ========== ========== ========= =========== ===========
BASIC AND DILUTED
LOSS PER SHARE $(0.42) $(1.24) $(0.68) $(1.03) $(1.03) $(2.91) $(0.61) $(0.34)
</TABLE>
Page 66 of 92
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To Northeast Optic Networks, Inc.:
We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements included in this Form 10-K, and have issued
our report thereon dated January 18, 1999. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The schedule listed in
Item 14(a)(2) is the responsibility of the Company's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
Boston, Massachusetts
January 18, 1999
Page 67 of 92
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance at Addition Deduction Balance at
Beginning of End of
Item Period Period
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
1998 $ -- $ 224,000 $ -- $ 224,000
</TABLE>
Page 68 of 92
<PAGE>
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosures.
Not applicable.
PART III
Item 10. Directors and Officers of the Registrant.
The information required by this Item regarding the Company's directors will be
included in its Proxy Statement to be filed pursuant to Schedule 14A in
connection with the Company's 1999 Annual Meeting of Stockholders under the
section captioned "Election of Directors" and is incorporated herein by
reference thereto. Information regarding the Company's executive officers is set
forth in Part I, above, under the caption "Executive Officers of the Registrant"
and is incorporated herein by reference thereto.
Page 69 of 92
<PAGE>
Item 11. Executive Compensation.
The information required by this Item regarding the compensation of the
Company's directors and executive officers will be included in its Proxy
Statement to be filed pursuant to Schedule 14A in connection with the Company's
1999 Annual Meeting of Stockholders under the sections captioned "Directors'
Compensation" and "Executive Compensation" and is incorporated herein by
reference thereto.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item regarding the security ownership of
certain beneficial owners and management will be included in the Company's Proxy
Statement to be filed pursuant to Schedule 14A in connection with the Company's
1999 Annual Meeting of Stockholders under the section captioned "Security
Ownership of Certain Beneficial Owners and Management" and is incorporated
herein by reference thereto.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item regarding certain relationships and
related transactions will be included in the Company's Proxy Statement to be
filed pursuant to Schedule 14A in connection with the Company's 1999 Annual
Meeting of Stockholders under the sections captioned "Certain Relationships and
Related Transactions" and "Compensation Committee Interlocks and Insider
Participation" and is incorporated herein by reference thereto.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents Filed as Part of This Report:
1. Financial Statements
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1998
Consolidated Statements of Operations for the years ended December 31,
1996, 1997 and 1998
Consolidated Statements of Stockholders' Equity (Deficit) for the
years ended December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedules: Schedule II - Valuation and Qualifying
Accounts
Page 70 of 92
<PAGE>
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
3.1 Second Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference to Exhibit 3.2 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.4 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
4.1 Specimen certificate for the Company's Common Stock (incorporated
by reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-1, Registration No. 333-53441.)
4.2 Form of Indenture Agreement (incorporated by reference to Exhibit
4.2 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
4.3 Form of [12 3/4]% Senior Notes Due 2008 (incorporated by reference
to Exhibit 4.3 to the Company's Registration Statement on Form
S-1, Registration No. 333-53441.)
4.4 Form of Collateral Pledge and Security Agreement (incorporated by
reference to Exhibit 4.4 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
*#10.1 Amended and Restated 1998 Stock Incentive Plan.
10.2 Form of Indemnity Agreement among the Company and the individual
signatories thereto (incorporated by reference to Exhibit 10.2 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
10.3 Stock Subscription Agreement dated November 22, 1995, as amended
on April 30, 1996, between the Company and MaineCom Services
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.4 Form of Restructuring and Contribution Agreement dated July 8,
1998 (incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.5 Common Stock Warrant dated May 23, 1996 issued to Oppenheimer &
Co., Inc. (incorporated by reference to Exhibit 10.5 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
</TABLE>
Page 71 of 92
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
10.6 Common Stock Purchase Warrant dated August 19, 1994 issued to
Applied Telecommunications Technologies, Inc. ("ATTI") and
assigned to Applied Telecommunications Technologies IV N.V. ("ATT
IV") (incorporated by reference to Exhibit 10.6 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.7 Common Stock Purchase Warrant dated February 15, 1995 issued to
ATTI and assigned to ATT IV (incorporated by reference to Exhibit
10.7 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
10.8 Common Stock Purchase Warrant dated April 3, 1995 issued to ATTI
and assigned to ATT IV (incorporated by reference to Exhibit 10.8
to the Company's Registration Statement on Form S-1, Registration
No. 333-53441.)
10.9 Common Stock Purchase Warrant dated June 30, 1997 issued to ATT IV
(incorporated by reference to Exhibit 10.9 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.10 Common Stock Purchase Warrant dated June 30, 1997 issued to ATT IV
(incorporated by reference to Exhibit 10.10 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.11 Warrant dated October 7, 1997 issued to Central Maine Power
Company (incorporated by reference to Exhibit 10.11 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
10.12 Equipment Lease dated August 19, 1994 between the Company and
Applied Telecommunications Technologies, Inc. ("ATTI")
(incorporated by reference to Exhibit 10.12 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.13 Equipment Lease dated February 15, 1995 between the Company and
ATTI (incorporated by reference to Exhibit 10.13 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.14 Equipment Lease dated April 3, 1995 between the Company and ATTI
(incorporated by reference to Exhibit 10.14 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
+10.15 Master Services Agreement dated January 1, 1994 between the
Company and MCI Telecommunications Corporation ("MCI")
(incorporated by reference to Exhibit 10.15 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
+10.16 Fiber Optic Use Agreement dated January 2, 1997 between the
Company and MCI (incorporated by reference to Exhibit 10.16 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
</TABLE>
Page 72 of 92
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
+10.17 Letter Agreement dated March 1, 1996 between the Company and
Brooks Fiber Communications of Massachusetts, Inc. (incorporated
by reference to Exhibit 10.17 to the Company's Registration
Statement on Form S-1, Registration No. 333-53441.)
+10.18 Fiber Optic Lease Agreement dated March 31, 1998 between the
Company and Sprint Communications Company L.P. (incorporated by
reference to Exhibit 10.18 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.19 Aerial License Agreement dated October 28, 1996 between the
Company and New England Telephone and Telegraph Company and
Western Massachusetts Electric Company (incorporated by reference
to Exhibit 10.19 to the Company's Registration Statement on Form
S-1, Registration No. 333-53441.)
+10.20 Fiber Optic Use Agreement dated September 10, 1997 between the
Company and New England Fiber Communications LLC (incorporated by
reference to Exhibit 10.20 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.21 Fiber Optic Use Agreement dated November 18, 1997 between the
Company and Teleport Communications Boston (incorporated by
reference to Exhibit 10.21 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
10.22 Network Products Purchase Agreement dated March 18, 1998 between
the Company and Northern Telecom Inc. (incorporated by reference
to Exhibit 10.22 to the Company's Registration Statement on
Form S-1, Registration No. 333-53441.)
10.23 Support Services Agreement dated as of April 30, 1996 between the
Company and MaineCom Services (incorporated by reference to
Exhibit 10.23 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
+10.24 Amended and Restated Agreement for the Provision of Fiber Optic
Facilities and Services dated as of February 27, 1998 and
effective as of September 27, 1994 among the Company and the
Northeast Utilities Services Company ("NUSCO"), The Connecticut
Light and Power Company ("CLPC"), Western Massachusetts Electric
Company ("WMEC") and Public Service Company of New Hampshire
("PSNH") (Phase One) (incorporated by reference to Exhibit 10.24
to the Company's Registration Statement on Form S-1, Registration
No. 333-53441.)
</TABLE>
Page 73 of 92
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
10.25 Short Form Agreement for the Provision of Fiber Optic Facilities
and Services entered into on February 27, 1998 among the Company and
NUSCO, CLPC, WMEC and PSNH (Phase One) (incorporated by reference
to Exhibit 10.25 to the Company's Registration Statement on Form
S-1, Registration No. 333-53441.)
+10.26 Amended and Restated Agreement for the Provision of Fiber Optic
Facilities and Services dated as of February 27, 1998 among the
Company and NUSCO, CLPC, WMEC and PSNH (Phase Two) (incorporated
by reference to Exhibit 10.26 to the Company's Registration
Statement on Form S-1, Registration No. 333-53441.)
10.27 Short Form Agreement for the Provision of Fiber Optic Facilities
and Services entered into on February 27, 1998 among the Company
and NUSCO, CLPC, WMEC and PSNH (Phase Two) (incorporated by
reference to Exhibit 10.27 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
10.28 Standard Form of Duct Agreement (incorporated by reference to
Exhibit 10.28 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
10.29 Construction Contract dated August 14, 1996 between the Company
and Seaward Corporation (incorporated by reference to Exhibit
10.29 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
#10.30 Employment Agreement dated October 15, 1997 between the Company
and Victor Colantonio (incorporated by reference to Exhibit 10.30
to the Company's Registration Statement on Form S-1, Registration
No. 333-53441.)
#10.31 Employment Agreement dated September 29, 1994 between the Company
and Michael A. Musen (incorporated by reference to Exhibit 10.31
to the Company's Registration Statement on Form S-1, Registration
No. 333-53441.)
#10.32 Employment Agreement dated May 4, 1998 between the Company and
James D. Mack, Jr. (incorporated by reference to Exhibit 10.32 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
10.33 Loan Agreement dated November 22, 1995 between the Company and
Central Maine Power Company (incorporated by reference to Exhibit
10.33 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
</TABLE>
Page 74 of 92
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
10.34 Construction Loan Agreement dated October 7, 1997 between the
Company and Central Maine Power Company (incorporated by reference
to Exhibit 10.34 to the Company's Registration Statement on Form
S-1, Registration No. 333-53441.)
10.35 Construction Loan Agreement dated March 11, 1997 between FiveCom
of Maine, Inc. and Peoples Heritage Savings Bank (incorporated by
reference to Exhibit 10.35 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.36 Agreement dated January 17, 1997 between the Company and E/Pro
Engineering and Environmental Consulting for the ADSS Cable
Project (incorporated by reference to Exhibit 10.36 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
+10.37 Agreement for the Provision of Fiber Optic Facilities and Services
dated January 7, 1997 between Central Maine Power Company and the
Company (incorporated by reference to Exhibit 10.37 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
#10.38 Employment Agreement dated July 7, 1998 between the Company and
William F. Fennell (incorporated by reference to Exhibit 10.38 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
#10.39 Employment Agreement dated July 1, 1998 between the Company and
Richard A. Crabtree (incorporated by reference to Exhibit 10.39 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
+10.40 IRU Agreement dated July 7, 1998 between the Company and QWEST
Communications Corporation (incorporated by reference to Exhibit
10.40 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
+10.41 Fiber Optic Lease Agreement dated July 2, 1998 between the Company
and NEES Communications, Inc. (incorporated by reference to Exhibit
10.41 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
+10.42 Fiber Optic Use Agreement dated July 2, 1998 between the Company
and BecoCom (incorporated by reference to Exhibit 10.42 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
#10.43 Employment Agreement dated November 12, 1998 between the Company
and Vincent C. Bisceglia (incorporated by reference to Exhibit
10.43 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998.)
</TABLE>
Page 75 of 92
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
<S> <C>
*12.1 Schedule of Earnings to Fixed Charges.
*21.1 List of Subsidiaries of the Company.
*23.1 Consent of Independent Accountants
*27 Financial Data Schedule (EDGAR filing only.)
</TABLE>
- --------------------
* Filed herewith.
# Management contract or compensatory plan or arrangement.
+ Confidential treatment granted as to certain portions.
(b) No Current Reports on Form 8-K were filed during the last quarter
period covered by this Report.
Page 76 of 92
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
NorthEast Optic Network, Inc.
(Registrant)
By: /s/ Vincent C. Bisceglia
----------------------------------
Vincent C. Bisceglia
Chairman & Chief Executive Officer
Power of Attorney
Know All Men by These Presents, that each individual whose signature appears
below constitutes and appoints each of Vincent C. Bisceglia, Victor Colantonio
and William F. Fennell jointly and severally his true and lawful
attorneys-in-fact and agent with full powers of substitution for him and in his
name, place and stead in any and all capacities to sign on his behalf,
individually and in each capacity stated below and to file any and all
amendments to this Annual Report on Form 10-K with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents and each of them
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises as fully as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their substitute or substitutes
may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title(s) Date
<S> <C> <C>
/s/ Vincent C. Bisceglia Chairman of the Board of Directors March 29, 1999
- --------------------------------------- & Chief Executive Officer
Vincent C. Bisceglia (Principal Executive Officer)
/s/ William F. Fennell Chief Financial Officer & Treasurer March 29, 1999
- --------------------------------------- (principal financial and accounting officer)
William F. Fennell
/s/ Victor Colantonio Vice Chairman of the Board of March 15, 1999
- ---------------------------------------- Directors & President
Victor Colantonio
/s/ Katherine Dietze Courage Director March 15, 1999
- ----------------------------------------
Katherine D. Courage
/s/ John H. Forsgren Director March 15, 1999
- ----------------------------------------
John H. Forsgren
Director March __, 1999
- ----------------------------------------
David Marsh
Director March __, 1999
- ----------------------------------------
F. Michael McClain
/s/ Gary D. Simon Director March 16, 1999
- ---------------------------------------
Gary D. Simon
</TABLE>
Page 77 of 92
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT AT
NO. DESCRIPTION PAGE
<S> <C> <C>
3.1 Second Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.2 to the Company's Registration
Statement on Form S-1, Registration No. 333-53441.)
3.2 Amended and Restated Bylaws of the Company (incorporated by
reference to Exhibit 3.4 to the Company's Registration Statement on
Form S-1, Registration No. 333-53441.)
4.1 Specimen certificate for the Company's Common Stock (incorporated
by reference to Exhibit 4.1 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
4.2 Form of Indenture Agreement (incorporated by reference to Exhibit
4.2 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
4.3 Form of [12 3/4]% Senior Notes Due 2008 (incorporated by reference
to Exhibit 4.3 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
4.4 Form of Collateral Pledge and Security Agreement
*#10.1 Amended and Restated 1998 Stock Incentive Plan.
10.2 Form of Indemnity Agreement among the Company and the individual
signatories thereto (incorporated by reference to Exhibit 10.2 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
10.3 Stock Subscription Agreement dated November 22, 1995, as amended on
April 30, 1996, between the Company and MaineCom Services
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.4 Form of Restructuring and Contribution Agreement dated July 8, 1998
(incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.5 Common Stock Warrant dated May 23, 1996 issued to Oppenheimer &
Co., Inc. (incorporated by reference to Exhibit 10.5 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
10.6 Common Stock Purchase Warrant dated August 19, 1994 issued to
Applied Telecommunications Technologies, Inc. ("ATTI") and assigned
to Applied Telecommunications Technologies IV N.V. ("ATT IV")
(incorporated by reference to Exhibit 10.6 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.7 Common Stock Purchase Warrant dated February 15, 1995 issued to
ATTI and assigned to ATT IV (incorporated by reference to Exhibit
10.7 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
</TABLE>
Page 78 of 92
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
10.8 Common Stock Purchase Warrant dated April 3, 1995 issued to ATTI
and assigned to ATT IV (incorporated by reference to Exhibit 10.8
to the Company's Registration Statement on Form S-1, Registration
No. 333-53441.)
10.9 Common Stock Purchase Warrant dated June 30, 1997 issued to ATT IV
(incorporated by reference to Exhibit 10.9 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.10 Common Stock Purchase Warrant dated June 30, 1997 issued to ATT IV
(incorporated by reference to Exhibit 10.10 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.11 Warrant dated October 7, 1997 issued to Central Maine Power Company
(incorporated by reference to Exhibit 10.11 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.12 Equipment Lease dated August 19, 1994 between the Company and
Applied Telecommunications Technologies, Inc. ("ATTI")
(incorporated by reference to Exhibit 10.12 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.13 Equipment Lease dated February 15, 1995 between the Company and
ATTI (incorporated by reference to Exhibit 10.13 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.14 Equipment Lease dated April 3, 1995 between the Company and ATTI
(incorporated by reference to Exhibit 10.14 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
+10.15 Master Services Agreement dated January 1, 1994 between the Company
and MCI Telecommunications Corporation ("MCI") (incorporated by
reference to Exhibit 10.15 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.16 Fiber Optic Use Agreement dated January 2, 1997 between the Company
and MCI (incorporated by reference to Exhibit 10.16 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
+10.17 Letter Agreement dated March 1, 1996 between the Company and Brooks
Fiber Communications of Massachusetts, Inc. (incorporated by
reference to Exhibit 10.17 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.18 Fiber Optic Lease Agreement dated March 31, 1998 between the
Company and Sprint Communications Company L.P. (incorporated by
reference to Exhibit 10.18 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.19 Aerial License Agreement dated October 28, 1996 between the
Company and New England Telephone and Telegraph Company and Western
Massachusetts Electric Company (incorporated by reference to
Exhibit 10.19 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
</TABLE>
Page 79 of 92
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
+10.20 Fiber Optic Use Agreement dated September 10, 1997 between the
Company and New England Fiber Communications LLC (incorporated by
reference to Exhibit 10.20 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.21 Fiber Optic Use Agreement dated November 18, 1997 between the
Company and Teleport Communications Boston (incorporated by
reference to Exhibit 10.21 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
10.22 Network Products Purchase Agreement dated March 18, 1998 between
the Company and Northern Telecom Inc. (incorporated by reference to
Exhibit 10.22 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
10.23 Support Services Agreement dated as of April 30, 1996 between the
Company and MaineCom Services (incorporated by reference to Exhibit
10.23 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
+10.24 Amended and Restated Agreement for the Provision of Fiber Optic
Facilities and Services dated as of February 27, 1998 and effective
as of September 27, 1994 among the Company and the Northeast
Utilities Services Company ("NUSCO"), The Connecticut Light and
Power Company ("CLPC"), Western Massachusetts Electric Company
("WMEC") and Public Service Company of New Hampshire ("PSNH")
(Phase One) (incorporated by reference to Exhibit 10.24 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
10.25 Short Form Agreement for the Provision of Fiber Optic Facilities
and Services entered into on February 27, 1998 among the Company
and NUSCO, CLPC, WMEC and PSNH (Phase One) (incorporated by
reference to Exhibit 10.25 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.26 Amended and Restated Agreement for the Provision of Fiber Optic
Facilities and Services dated as of February 27, 1998 among the
Company and NUSCO, CLPC, WMEC and PSNH (Phase Two) (incorporated by
reference to Exhibit 10.26 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
10.27 Short Form Agreement for the Provision of Fiber Optic Facilities
and Services entered into on February 27, 1998 among the Company
and NUSCO, CLPC, WMEC and PSNH (Phase Two) (incorporated by
reference to Exhibit 10.27 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
10.28 Standard Form of Duct Agreement (incorporated by reference to
Exhibit 10.28 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
10.29 Construction Contract dated August 14, 1996 between the Company and
Seaward Corporation (incorporated by reference to Exhibit 10.29 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
</TABLE>
Page 80 of 92
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
*#10.30 Employment Agreement dated October 15, 1997 between the Company and
Victor Colantonio (incorporated by reference to Exhibit 10.30 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
*#10.31 Employment Agreement dated September 29, 1994 between the Company
and Michael A. Musen (incorporated by reference to Exhibit 10.31 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
*#10.32 Employment Agreement dated May 4, 1998 between the Company and James
D. Mack, Jr. (incorporated by reference to Exhibit 10.32 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
10.33 Loan Agreement dated November 22, 1995 between the Company and
Central Maine Power Company (incorporated by reference to Exhibit
10.33 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
10.34 Construction Loan Agreement dated October 7, 1997 between the
Company and Central Maine Power Company (incorporated by reference
to Exhibit 10.34 to the Company's Registration Statement on Form
S-1, Registration No. 333-53441.)
10.35 Construction Loan Agreement dated March 11, 1997 between FiveCom of
Maine, Inc. and Peoples Heritage Savings Bank (incorporated by
reference to Exhibit 10.35 to the Company's Registration Statement
on Form S-1, Registration No. 333-53441.)
+10.36 Agreement dated January 17, 1997 between the Company and E/Pro
Engineering and Environmental Consulting for the ADSS Cable Project
(incorporated by reference to Exhibit 10.36 to the Company's
Registration Statement on Form S-1, Registration No. 333-53441.)
+10.37 Agreement for the Provision of Fiber Optic Facilities and Services
dated January 7, 1997 between Central Maine Power Company and the
Company (incorporated by reference to Exhibit 10.37 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
*#10.38 Employment Agreement dated July 7, 1998 between the Company and
William F. Fennell (incorporated by reference to Exhibit 10.38 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
*#10.39 Employment Agreement dated July 1, 1998 between the Company and
Richard A. Crabtree (incorporated by reference to Exhibit 10.39 to
the Company's Registration Statement on Form S-1, Registration No.
333-53441.)
+10.40 IRU Agreement dated July 7, 1998 between the Company and QWEST
Communications Corporation (incorporated by reference to Exhibit
10.40 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
+10.41 Fiber Optic Lease Agreement dated July 2, 1998 between the Company
and NEES Communications, Inc. (incorporated by reference to Exhibit
10.41 to the Company's Registration Statement on Form S-1,
Registration No. 333-53441.)
+10.42 Fiber Optic Use Agreement dated July 2, 1998 between the Company
and BecoCom (incorporated by reference to Exhibit 10.42 to the
Company's Registration Statement on Form S-1, Registration No.
333-53441.)
Page 81 of 92
<PAGE>
#10.43 Employment Agreement dated November 12, 1998 between the Company
and Vincent C. Bisceglia (incorporated by reference to Exhibit
10.43 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998.)
*12.1 Schedule of Earnings to Fixed Charges.
*21.1 List of Subsidiaries of the Company.
*23.1 Consent of Independent Accountants
*27 Financial Data Schedule (EDGAR filing only.)
</TABLE>
- --------------------
* Filed herewith.
# Management contract or compensatory plan or arrangement.
+ Confidential treatment granted as to certain portions.
Page 82 of 92
Exhibit 10.1
Northeast Optic Network, Inc.
Amended And Restated 1998 Stock Incentive Plan
(8) Purpose. The purpose of this 1998 Stock Incentive Plan (the "Plan") of
NorthEast Optic Network, Inc., a Delaware corporation (the "Company"), is
to advance the interests of the Company's shareholders by enhancing the
Company's ability to attract, retain and motivate persons who make (or are
expected to make)important contributions to the Company by providing such
persons with equity ownership opportunities and performance-based
incentives and thereby better aligning the interests of such persons with
those of the Company's shareholders. Except where the context otherwise
requires, the term "Company" shall include any present or future subsidiary
corporations of NorthEast Optic Network, Inc., as defined in Section 424(f)
of the Internal Revenue Code of 1986, as amended, and any regulations
promulgated thereunder (the "Code").
(9) Eligibility. All of the Company's employees, officers, directors,
consultants and advisors are eligible to be granted options, restricted
stock, or other stock-based awards (each, an "Award") under the Plan. Any
person who has been granted an Award under the Plan shall be deemed a
"Participant".
(10) Administration, Delegation.
(a) Administration by Board of Directors. The Plan will be administered by
the Board of Directors of the Company (the "Board"). The Board shall
have authority to grant Awards and to adopt, amend and repeal such
administrative rules, guidelines and practices relating to the Plan as
it shall deem advisable. The Board may correct any defect, supply any
omission or reconcile any inconsistency in the Plan or any Award in
the manner and to the extent it shall deem expedient to carry the Plan
into effect and it shall be the sole and final judge of such
expediency. No member of the Board shall be liable for any action or
determination relating to the Plan. All decisions by the Board shall
be made in the Board's sole discretion and shall be final and binding
on all persons having or claiming any interest in the Plan or in any
Award. No director or person acting pursuant to the authority
delegated by the Board shall be liable for any action or determination
under the Plan made in good faith.
(b) Delegation to Executive Officers. To the extent permitted by
applicable law, the Board may delegate to one or more executive
officers of the Company the power to make Awards and exercise such
other powers under the Plan as the Board may determine, provided that
the Board shall fix the maximum number of shares subject to Awards and
the maximum number of shares for any one Participant to be made by
such executive officers.
(c) Appointment of Committees. To the extent permitted by applicable law,
the Board may delegate any or all of its powers under the Plan to one
or more committees or subcommittees of the Board (a "Committee"). At
such time as the common stock, $.01 par value per share, of the
Company (the "Common Stock") is registered under the Securities
Exchange Act of 1934 (the "Exchange Act"), the Board shall appoint one
such Committee of not less than two members, each member of which
shall be an "outside director" within the meaning of Section 162(m) of
the Code and a "non-employee director" as defined in Rule 16b-3
promulgated under the Exchange Act." All references in the Plan to the
"Board" shall mean a Committee or the Board or the executive officer
referred to in Section 3(b) to the extent that the Board's powers or
authority under the Plan have been delegated to such Committee or
executive officer.
Rev. July ___, 1998
Page 83 of 92
<PAGE>
(11) Stock Available for Awards.
(a) Number of Shares. Subject to adjustment under Section 4(c), Awards may
be made under the Plan for up to 2,436,105 shares of Common Stock
(after giving effect to a 2.5-for-1 stock split effected by means of a
stock dividend on or about July 29, 1998). If any Award expires or is
terminated, surrendered or canceled without having been fully
exercised or is forfeited in whole or in part or results in any Common
Stock not being issued, the unused Common Stock covered by such Award
shall again be available for the grant of Awards under the Plan,
subject, however, in the case of Incentive Stock Options (as
hereinafter defined), to any limitation required under the Code.
Shares issued under the Plan may consist in whole or in part of
authorized but unissued shares or treasury shares.
(b) Per-Participant Limit. Subject to adjustment under Section 4(c), for
Awards granted after the Common Stock is registered under the Exchange
Act, the maximum number of shares with respect to which an Award may
be granted to any participant under the Plan shall be 350,000 per
calendar year. The per-Participant limit described in this Section
4(b) shall be construed and applied consistently with Section 162(m)
of the Code.
(c) Adjustment to Common Stock. In the event of any stock split, stock
dividend, recapitalization, reorganization, merger, consolidation,
combination, exchange of shares, liquidation, spin-off or other
similar change in capitalization or event, or any distribution to
holders of Common Stock other than a normal cash dividend, (i) the
number and class of securities available under this Plan, (ii) the
number and class of security and exercise price per share subject to
each outstanding Option, (iii) the repurchase price per security
subject to each outstanding Restricted Stock Award, and (iv) the terms
of each other outstanding stock-based Award shall be appropriately
adjusted by the Company (or substituted Awards may be made, if
applicable) to the extent the Board shall determine, in good faith,
that such an adjustment (or substitution) is necessary and
appropriate. If this Section 4(c) applies and Section 8(e)(1) also
applies to any event, Section 8(e)(1) shall be applicable to such
event, and this Section 4(c) shall not be applicable.
(12) Stock Options.
(a) General. The Board may grant options to purchase Common Stock (each,
an "Option") and determine the number of shares of Common Stock to be
covered by each Option, the exercise price of each Option and the
conditions and limitations applicable to the exercise of each Option,
including conditions relating to applicable federal or state
securities laws, as it considers necessary or advisable. An Option
which is not intended to be an Incentive Stock Option (as hereinafter
defined) shall be designated a "Nonstatutory Stock Option".
(b) Incentive Stock Options. An Option that the Board intends to be an
"incentive stock option" as defined in Section 422 of the Code (an
"Incentive Stock Option") shall only be granted to employees of the
Company and shall be subject to and shall be construed consistently
with the requirements of Section 422 of the Code. The Company shall
have no liability to a Participant, or any other party, if an Option
(or any part thereof) which is intended to be an Incentive Stock
Option is not an Incentive Stock Option.
(c) Exercise Price. The Board shall establish the exercise price at the
time each Option is granted and specify it in the applicable option
agreement.
(d) Duration of Options. Each Option shall be exercisable at such times
and subject to such terms and conditions as the Board may specify in
the applicable option agreement.
(e) Exercise of Option. Options may be exercised only by delivery to the
Company of a written notice of exercise signed by the proper person
together with payment in full as specified in Section 5(f) for the
number of shares for which the Option is exercised.
Rev. July ___, 1998
Page 84 of 92
<PAGE>
(f) Payment Upon Exercise. Common Stock purchased upon the exercise of an
Option granted under the Plan shall be paid for as follows:
(i) in cash or by check, payable to the order of the Company;
(ii) except as the Board may otherwise provide in an Option,
delivery of an irrevocable and unconditional undertaking by a
credit worthy broker to deliver promptly to the Company
sufficient funds to pay the exercise price, or delivery by the
Participant to the Company of a copy of irrevocable and
unconditional instructions to a credit worthy broker to
deliver promptly to the Company cash or a check sufficient to
pay the exercise price;
(iii) (1) by delivery of shares of Common Stock owned by the
Participant valued at their fair market value as determined by
the Board in good faith ("Fair Market Value"), which Common
Stock was owned by the Participant at least six months prior
to such delivery, (2) by delivery of a promissory note of the
Participant to the Company on terms determined by the Board,
or (3) by payment of such other lawful consideration as the
Board may determine; or
(iv) any combination of the above permitted forms of payment.
(13) Restricted Stock.
(a) Grants. The Board may grant Awards entitling recipients to acquire
shares of Common Stock, subject to the right of the Company to
repurchase all or part of such shares at their issue price or other
stated or formula price (or to require forfeiture of such shares if
issued at no cost) from the recipient in the event that conditions
specified by the Board in the applicable Award are not satisfied prior
to the end of the applicable restriction period or periods established
by the Board for such Award (each, "Restricted Stock Award").
(b) Terms and Conditions. The Board shall determine the terms and
conditions of any such Restricted Stock Award, including the
conditions for repurchase (or forfeiture) and the issue price, if any.
Any stock certificates issued in respect of a Restricted Stock Award
shall be registered in the name of the Participant and, unless
otherwise determined by the Board, deposited by the Participant,
together with a stock power endorsed in blank, with the Company (or
its designee). At the expiration of the applicable restriction
periods, the Company (or such designee) shall deliver the certificates
no longer subject to such restrictions to the Participant or if the
Participant has died, to the beneficiary designated, in a manner
determined by the Board, by a Participant to receive amounts due or
exercise rights of the Participant in the event of the Participant's
death (the "Designated Beneficiary"). In the absence of an effective
designation by a Participant, Designated Beneficiary shall mean the
Participant's estate.
(14) Other Stock-Based Awards. The Board shall have the right to grant other
Awards based upon the Common Stock having such terms and conditions as the
Board may determine, including the grant of shares based upon certain
conditions, the grant of securities convertible into Common Stock and the
grant of stock appreciation rights.
(15) General Provisions Applicable to Awards.
(a) Transferability of Awards. Except as the Board may otherwise determine
or provide in an Award, Awards shall not be sold, assigned,
transferred, pledged or otherwise encumbered by the person to whom
they are granted, either voluntarily or by operation of law, except by
will or the laws of descent and distribution, and, during the life of
the Participant, shall be exercisable only by the Participant.
References to a Participant, to the extent relevant in the context,
shall include references to authorized transferees.
Rev. July ___, 1998
Page 85 of 92
<PAGE>
(b) Documentation. Each Award under the Plan shall be evidenced by a
written instrument in such form as the Board shall determine. Each
Award may contain terms and conditions in addition to those set forth
in the Plan.
(c) Board Discretion. Except as otherwise provided by the Plan, each type
of Award may be made alone in addition or in relation to any other
type of Award. The terms of each type of Award need not be identical,
and the Board need not treat Participants uniformly.
(d) Termination of Status. The Board shall determine the effect on an
Award of the disability, death, retirement, authorized leave of
absence or other change in the employment or other status of a
Participant and the extent to which, and the period during which, the
Participant, the Participant's legal representative, conservator,
guardian or Designated Beneficiary may exercise rights under the
Award.
(e) Extraordinary Corporate Transactions.
(i) Change in Control. A "Change of Control of the Company" (as
defined in Section 9) shall have the effects set forth in
Section 9.
(ii) Assumption of Options Upon Certain Events. The Board may grant
Awards under the Plan in substitution for stock and
stock-based awards held by employees of another corporation
who become employees of the Company as a result of a merger or
consolidation of the employing corporation with the Company or
the acquisition by the Company of property or stock of the
employing corporation. The substitute Awards shall be granted
on such terms and conditions as the Board considers
appropriate in the circumstances.
(f) Withholding. Each Participant shall pay to the Company, or make
provision satisfactory to the Board for payment of, any taxes required
by law to be withheld in connection with Awards to such Participant no
later than the date of the event creating the tax liability. The Board
may allow Participants to satisfy such tax obligations in whole or in
part in shares of Common Stock, including shares retained from the
Award creating the tax obligation, valued at their Fair Market Value.
The Company may, to the extent permitted by law, deduct any such tax
obligations from any payment of any kind otherwise due to a
Participant.
(g) Amendment of Award. The Board may amend, modify or terminate any
outstanding Award, including but not limited to, substituting therefor
another Award of the same or a different type, changing the date of
exercise or realization, and converting an Incentive Stock Option to a
Nonstatutory Stock Option, provided that the Participant's consent to
such action shall be required unless the Board determines that the
action, taking into account any related action, would not materially
and adversely affect the Participant.
(h) Conditions on Delivery of Stock. The Company will not be obligated to
deliver any shares of Common Stock pursuant to the Plan or to remove
restrictions from shares previously delivered under the Plan until (i)
all conditions of the Award have been met or removed to the
satisfaction of the Company, (ii) in the opinion of the Company's
counsel, all other legal matters in connection with the issuance and
delivery of such shares have been satisfied, including any applicable
securities laws and any applicable stock exchange or stock market
rules and regulations, and (iii) the Participant has executed and
delivered to the Company such representations or agreements as the
Company may consider appropriate to satisfy the requirements of any
applicable laws, rules or regulations.
(i) Acceleration. The Board may at any time provide that any Options shall
become immediately exercisable in full or in part, that any Restricted
Stock Awards shall be free of all restrictions or that any other
stock-based Awards may become exercisable in full or in part or free
of some or all restrictions or conditions, or otherwise realizable in
full or in part, as the case may be.
Rev. July ___, 1998
Page 86 of 92
<PAGE>
(16) Change in Control.
(a) Acceleration. Notwithstanding any other provision of the Plan and
except as otherwise provided in the relevant option agreement, in the
event of a "Change in Control of the Company" (as defined below), the
exercise dates of all Options (or the vesting of all Restricted Stock
Awards or other stock based Awards, as the case may be) granted to
such Participant then outstanding shall be accelerated in full and any
restrictions on exercising outstanding options or other Awards issued
to such Participant pursuant to the Plan shall terminate. For purposes
of the Plan, the term "Change in Control of the Company" shall have
the following meaning: A "Change in Control of the Company" shall
occur or be deemed to have occurred only if (i) any "person", as such
term is used in Sections 13(d) and 14(d) of the Exchange Act (other
than the Company, any trustee or other fiduciary holding securities
under an employee benefit plan of the Company, or any corporation
owned directly or indirectly by the stockholders of the Company in
substantially the same proportion as their ownership of stock of the
Company), becomes (after the date of the adoption of this Plan) the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act),
directly or indirectly, of securities of the Company representing 50%
or more of the combined voting power of the Company's then outstanding
securities; (ii) during any period of two consecutive years ending
during the term of the Plan (not including any period prior to the
adoption of the Plan), individuals who at the beginning of such period
constitute the Board of Directors of the Company, and any new director
(other than a director designated by a person who has entered into an
agreement with the Company to effect any transaction described in
clause (i), (iii) or (iv) of this Section 9) whose election by the
Board of Directors or nomination for election by the Company's
stockholders was approved by a vote of at least two-thirds of the
directors then still in office who were either directors at the
beginning of the period or whose election or whose nomination for
election was previously so approved, cease for any reason to
constitute a majority of the Board of Directors; (iii) the
stockholders of the Company approve a merger or consolidation of the
Company with any other corporation, other than (A) a merger or
consolidation which would result in the voting securities of the
Company outstanding immediately prior thereto continuing to represent
(either by remaining outstanding or by being converted into voting
securities of the surviving entity) more than 50% of the combined
voting power of the voting securities of the Company or such surviving
entity outstanding immediately after such merger or consolidation or
(B) a merger or consolidation effected to implement a recapitalization
of the Company (or similar transaction) in which no "person" (as
hereinabove defined) acquires more than 50% of the combined voting
power of the Company's then outstanding securities; or (iv) the
stockholders of the Company approve a plan of complete liquidation of
the Company or an agreement for the sale or disposition by the Company
of all or substantially all of the Company's assets.
(b) Consequences of Change in Control of the Company. Upon the occurrence
of a Change in Control of the Company, or the execution by the Company
of any agreement which results in a Change in Control of the Company,
the Board shall take any one or more of the following actions with
respect to then outstanding Awards:
(i) provide that outstanding Options shall be assumed, or equivalent
Options shall be substituted, by the acquiring or succeeding
corporation (or an affiliate thereof), provided that any such
Options substituted for Incentive Stock Options shall satisfy, in
the determination of the Board, the requirements of Section
424(a) of the Code; (ii) in the event of a transaction resulting
in a Change in Control of the Company under the terms of which
holders of Common Stock will receive upon consummation thereof a
cash payment for each share of Common Stock surrendered pursuant
to such transaction (the
Rev. July ___, 1998
Page 87 of 92
<PAGE>
"Acquisition Price"), provide that all outstanding Options shall
terminate upon consummation of such transaction and that
Participants shall receive, in exchange therefor, a cash payment
equal to the amount (if any) by which (A) the Acquisition Price
multiplied by the number of shares of Common Stock subject to
such outstanding Options (whether or not then exercisable),
exceeds (B) the aggregate exercise price of such Options; and
(iii) provide that any other stock-based Awards outstanding shall
be assumed, or equivalent Awards shall be substituted, by the
acquiring or succeeding corporation (or an affiliate thereof).
(17) Miscellaneous.
(a) No Right To Employment or Other Status. No person shall have any claim
or right to be granted an Award, and the grant of an Award shall not
be construed as giving a Participant the right to continued employment
or any other relationship with the Company. The Company expressly
reserves the right at any time to dismiss or otherwise terminate its
relationship with a Participant free from any liability or claim under
the Plan, except as expressly provided in the applicable Award.
(b) No Rights As Stockholder. Subject to the provisions of the applicable
Award, no Participant or Designated Beneficiary shall have any rights
as a stockholder with respect to any shares of Common Stock to be
distributed with respect to an Award until becoming the record holder
of such shares.
(c) Effective Date and Term of Plan. The Plan shall become effective on
the later of (i) date on which it is adopted by the Board and (ii) the
date of the closing of the IPO. No Awards shall be granted under the
Plan after the completion of ten years from the earlier of (i) the
date on which the Plan was adopted by the Board or (ii) the date the
Plan was approved by the Company's shareholders, but Awards previously
granted may extend beyond that date.
(d) Amendment of Plan. The Board may amend, suspend or terminate the Plan
or any portion thereof at any time, provided that no amendment shall
be made without stockholder approval if such approval is necessary to
comply with any applicable tax or regulatory requirements. Amendments
requiring stockholder approval shall become effective when adopted by
the Board, but no Award granted to a Participant designated as subject
to Section 162(m) by the Board shall become exercisable, realizable or
vested (to the extent that such amendment to the Plan was required to
grant such Award to a particular Participant) unless and until such
amendment shall have been approved by the Company's shareholders.
(e) Governing Law. The provisions of the Plan and all Awards made
hereunder shall be governed by and interpreted in accordance with the
laws of the State of Delaware, without regard to any applicable
conflicts of law.
(f) Stockholder Approval. For purposes of the Plan, stockholder approval
shall mean approval by a vote of Stockholders in accordance with
Section 162(m) of the Code.
----------------
Rev. July ___, 1998 Page 88 of 92
Exhibit 12.1
Schedule of Earnings to Fixed Charges
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
EARNINGS
ADD:
Pretax income from continuing operations (1,045,984) (2,301,226) (12,776,191)
Fixed charges 268,086 309,082 10,546,132
Amortization of capitalized interest -- 4,814 4,628
---------- --------- ----------
(777,898) (1,987,330) (2,225,431)
SUBTRACT:
Interest capitalized 180,501 142,457 1,543,520
Minority interest in pre-tax income of subs
that have not incurred fixed charges 248,039 994,000 1,026,001
---------- --------- ----------
428,540 1,136,457 2,569,521
Total Earnings (1,206,438) (3,123,787) (4,794,952)
Ratio of earnings to fixed charges (4.50)x (10.11)x (0.45)x
</TABLE>
Rev. July ___, 1998
Page 89 of 92
Exhibit 21.1
Subsidiaries of the Company:
AlexisCom, Inc., a Delaware corporation
BretteCom, Inc., a Delaware corporation
Rev. July ___, 1998
Page 90 of 92
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our reports included in this Form 10-K into the Company's
previously filed registration statement File No. 333-64969 on Form S-8.
/s/ Arthur Andersen LLP
Boston, Massachusetts
March 29, 1999
Page 91 of 92
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001062233
<NAME> NorthEast Optic Network, Inc.
<MULTIPLIER> 1
<CURRENCY> US Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1.0
<CASH> 2,985,027
<SECURITIES> 126,484,689
<RECEIVABLES> 335,915
<ALLOWANCES> (224,000)
<INVENTORY> 0
<CURRENT-ASSETS> 130,844,416
<PP&E> 54,210,268
<DEPRECIATION> (1,287,591)
<TOTAL-ASSETS> 291,912,234
<CURRENT-LIABILITIES> 18,877,550
<BONDS> 180,000,000
0
0
<COMMON> 160,663
<OTHER-SE> 92,874,021
<TOTAL-LIABILITY-AND-EQUITY> 291,912,234
<SALES> 863,672
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<CGS> 2,176,266
<TOTAL-COSTS> 7,376,986
<OTHER-EXPENSES> 1,798,294
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<INTEREST-EXPENSE> 8,644,463
<INCOME-PRETAX> (11,667,258)
<INCOME-TAX> (315,000)
<INCOME-CONTINUING> (11,352,258)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,363,155)
<CHANGES> 0
<NET-INCOME> (12,715,413)
<EPS-PRIMARY> (1.90)
<EPS-DILUTED> (1.90)
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