<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(MARK ONE)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended JUNE 30, 2000
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period 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 (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2200 WEST PARK DRIVE
WESTBOROUGH, MASSACHUSETTS 01851
(508) 616-7800
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months, (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of June 30, 2000, there were 16,655,581 outstanding shares of the
Registrant's common stock, $0.01 par value per share.
===============================================================================
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NORTHEAST OPTIC NETWORK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 635,596 $ 4,768,389
Short-term restricted cash and investments 23,387,497 22,518,611
Short-term investments 39,965,550 66,803,311
Accounts receivable 2,479,746 1,858,201
Prepaid expenses and other current assets 1,012,489 494,323
------------- -------------
Total current assets 67,480,878 96,442,835
------------- -------------
PROPERTY AND EQUIPMENT, NET 122,164,858 94,924,843
------------- -------------
RESTRICTED CASH AND INVESTMENTS 22,476,861 31,693,543
------------- -------------
INTANGIBLE ASSETS, NET 56,569,349 57,572,155
------------- -------------
$ 268,691,946 $ 280,633,376
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,361,833 $ 3,783,354
Accounts payable - Communications network 1,786,116 9,438,350
Accrued expenses 23,132,964 13,348,296
Accrued right-of-way fees, related party 679,531 886,322
Deferred revenue 77,760 58,380
------------- -------------
Total current liabilities 34,038,204 27,514,702
------------- -------------
DEFERRED REVENUE, NET OF CURRENT PORTION 931,763 969,026
------------- -------------
LONG-TERM ACCOUNTS PAYABLE - COMMUNICATIONS NETWORK 631,269 4,682,858
------------- -------------
LONG-TERM OBLIGATIONS 180,000,000 180,000,000
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value-
Authorized--30,000,000 shares; 16,655,581 and 16,393,534 shares issued and
outstanding June 30, 2000 and December 31, 1999, respectively 166,555 163,935
Additional paid-in capital 113,055,338 110,072,881
Accumulated deficit (60,131,183) (42,770,026)
------------- -------------
Total stockholders' equity 53,090,710 67,466,790
------------- -------------
$ 268,691,946 $ 280,633,376
============= =============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
2
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
JUNE 30, JUNE 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
REVENUES:
Network Services $ 2,309,920 $ 609,961 3,973,112 1,031,440
Other service 1,199,106 432,884 2,188,620 532,361
------------ ------------ ------------ ------------
Total revenues 3,509,026 1,042,845 6,161,732 1,563,801
------------ ------------ ------------ ------------
EXPENSES:
Cost of revenues 2,712,996 1,448,543 4,823,498 2,377,531
Selling, general and
administrative 3,054,694 2,111,799 5,563,308 3,433,172
Depreciation and
amortization 2,882,112 1,205,873 5,341,053 2,000,851
------------ ------------ ------------ ------------
Total expenses 8,649,802 4,766,215 15,727,859 7,811,554
------------ ------------ ------------ ------------
Loss from operations (5,140,776) (3,723,370) (9,566,127) (6,247,753)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income and other, net 1,358,036 2,001,901 2,893,445 4,242,665
Interest expense (5,304,200) (5,189,609) (10,688,475) (10,169,270)
------------ ------------ ------------ ------------
Total other income
(expense) (3,946,164) (3,187,708) (7,795,030) (5,926,605)
------------ ------------ ------------ ------------
NET LOSS $ (9,086,940) $ (6,911,078) $(17,361,157) $(12,174,358)
============ ============ ============ ============
BASIC AND DILUTED LOSS PER
SHARE $ (0.55) $ (0.43) $ (1.05) $ (0.76)
============ ============ ============ ============
BASIC AND DILUTED WEIGHTED
AVERAGE SHARES OUTSTANDING 16,655,581 16,082,142 16,567,648 16,076,085
============ ============ ============ ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
NORTHEAST OPTIC NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX-MONTHS ENDED JUNE 30,
2000 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(17,361,157) $(12,174,358)
Adjustments to reconcile net loss to net cash used in operating
activities-
Depreciation and amortization 5,341,072 2,000,851
Amortization of deferred financing costs 652,550 313,322
Changes in assets and liabilities-
Accounts receivable (621,545) (701,274)
Refundable taxes from related party -- 755,838
Prepaid expenses and other current assets (518,166) (380,184)
Accounts payable 4,578,479 720,935
Accrued expenses 9,577,877 (753,733)
Deferred revenue (17,883) (29,194)
------------ ------------
Net cash provided by (used in) operating activities 1,631,227 (10,247,797)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of short-term investments, net 26,837,761 (24,620,998)
Purchases of property and equipment (31,783,131) (29,076,818)
Increase in intangible assets (447,700) (580,112)
------------ ------------
Net cash used in investing activities (5,393,070) (54,277,928)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Decrease) increase in construction and long-term accounts
payable (11,703,823) 10,530,635
Payments on long-term obligations -- (116,859)
Decrease in restricted cash and investments 8,347,796 10,327,578
Proceeds from exercise of stock options and warrants 2,985,077 255,688
------------ ------------
Net cash (used in) provided by financing activities (370,950) 20,997,042
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,132,793) (43,528,683)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,768,389 57,737,792
------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 635,596 $ 14,209,109
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for-
Interest $ 11,349,050 $ 12,244,324
============ ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
(1) OPERATIONS
NorthEast Optic Network, Inc. (the Company or NEON) and its subsidiaries
are engaged in the ownership, management, operation and construction of
fiber optic telecommunication networks in the Northeast, consisting of
New England and New York.
On November 24, 1999, the Company entered into preliminary agreements
with Consolidated Edison Communications, Inc. (CEC) and Exelon. Upon
closing of these Agreements, the Company will provide network transport
and carrier services in the service areas of the Company, CEC and Exelon.
At the same time, each of the parties will provide connectivity from the
Company's backbone system to their respective local loops and each will
manage their local distributions into New York, Philadelphia, Baltimore
and Washington, DC. The communications network will operate under the
NEON brand. The term of the CEC agreement is for no less than 25 years
and the term of the Exelon agreement is for 20 years with five-year
extension periods. Under these agreements, we have agreed to issue
2,448,240 shares of our common stock to Consolidated Edison
Communications and 2,106,625 shares of our common stock to Exelon
Corporation (in each case subject to adjustment as set forth in the
agreements), which would result in Consolidated Edison Communications and
Exelon Corporation owning approximately 10.75% and 9.25% of our
outstanding common stock, respectively. Each of these companies also
would receive the right to nominate one member to our board of directors.
The Company expects that a substantial portion of the value of the stock
paid to CEC and Exelon under these agreements will be recorded as an
intangible and will result in significant amortization expense and an
increase in the Company's net loss per share over the terms of the
related agreements. CEC and Exelon have also agreed to contribute to the
Company $3,500,000 and $1,950,000, respectively, for the build-out of
local points of presence (POP) and the related optronics. Also, CEC and
Exelon have agreed to pay the Company $7,900,000 and $6,000,000,
respectively, over four years for the cost of POP rental, POP operating
expenses, optronics maintenance and sales and marketing expenses. These
agreements are subject to termination by either party if the respective
closings thereunder have not occurred by September 7, 2000, and are
subject to substantial closing conditions that may not be satisfied by
that date. The CEC transaction has encountered regulatory delays, and the
Company cannot predict when this transaction will close.
To date, the Company has recorded revenues principally from contract and
other services and has incurred cumulative operating losses of
approximately $60,000,000. The market for fiber optic telecommunications
in which the Company operates is changing rapidly due to technological
advancements, the introduction of new products and services and the
increasing demands placed on equipment in worldwide telecommunications
networks. 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.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the
application of certain accounting policies as described below and
elsewhere in these notes to consolidated financial statements.
(a) PRINCIPLES OF CONSOLIDATION
5
<PAGE>
The accompanying unaudited consolidated financial statements
include the results of operations of NorthEast Optic Network, Inc.
and its wholly owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
(b) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have
been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission, and reflect all
adjustments, consisting of only normal recurring adjustments,
which, in the opinion of management, are necessary for a fair
statement of the results of the interim periods presented. These
financial statements do not include disclosures associated with
the annual financial statements and, accordingly, should be read
in conjunction with the attached Management's Discussion and
Analysis of Financial Condition and Results of Operation and the
financial statements and footnotes for the year ended December 31,
1999 included in the Company's Form 10-K.
(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
The services the Company provides include long-term leases of dark
fiber (fiber optic transmission lines leased without optronics
equipment installed by the Company) and short-term leases of lit
fiber (fixed amounts of capacity on fiber optic transmission lines
that use optronics equipment) at fixed-cost pricing over
multi-year terms. Revenues on telecommunications network services
are recognized ratably over the term of the applicable agreements
with customers, which range from 1 to 20 years. Amounts billed in
advance of the service provided are recorded as deferred revenue.
The Company also leases space at its facilities (collocation
services). Other service revenue includes these collocation
service revenues as well as revenues from nonrecurring design,
engineering and construction services. Revenues for these
nonrecurring services are generally recognized as services are
performed as the Company has no further obligations.
The Company has contracts with customers that provide service
level commitments, which may obligate the Company to provide
credits against billings if service is interrupted or does not
meet the customer's operating parameters. These amounts are
accounted for in cost of sales. To date, credits issued under
these arrangements have not been material.
6
<PAGE>
(e) COMPREHENSIVE INCOME (LOSS)
SFAS No. 130 requires disclosure of all components of
comprehensive income (loss) on an annual and interim basis.
Comprehensive income (loss) is defined as the change in equity of
a business enterprise during a period from transactions and other
events and circumstances from nonowner sources. Comprehensive net
loss is the same as reported net loss for all periods presented.
(f) EARNINGS PER SHARE
In accordance with SFAS No. 128, EARNINGS PER SHARE, basic and
diluted loss per share were computed by dividing net loss by the
weighted average number of common shares outstanding during the
first six months of 2000 and 1999. Diluted net loss per share
excludes 2,282,783 shares issuable from the assumed exercise of
stock options, as their effect would be antidilutive.
(g) NEW ACCOUNTING STANDARDS
The SEC issued SAB No. 101, REVENUE RECOGNITION, in December 1999.
The Company is required to adopt this new accounting guidance, as
amended by SAB No. 101A through a cumulative charge to retained
earnings in accordance with Accounting Principles Board (APB)
Opinion No. 20, ACCOUNTING CHANGES, no later than the fourth
quarter of fiscal 2000. Management is currently evaluating the
effects that this guidance is expected to have on the Company's
financial statements.
(h) RECLASSIFICATIONS
Reclassifications were made to previously issued financial
statements to conform to the current year's presentation.
(3) 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:
Period REDEMPTION PRICE
2003 106.375%
2004 104.250
2005 102.125
Thereafter 100.000
7
<PAGE>
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 subordinate 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 condensed consolidated
balance sheets and are being amortized, as interest expense, over the
term of the Notes.
(4) PREFERRED STOCK
The Restated Certificate of Incorporation authorizes the issuance of up
to 2,000,000 shares of preferred stock, $.01 par value per share. Under
the terms of the Certificate of Incorporation, the Board of Directors is
authorized, subject to any limitations prescribed by law, without
stockholder approval, to issue such shares of preferred stock in one or
more series. Each series of preferred stock shall have rights,
preferences, privileges and restrictions, including voting rights,
dividend rights, conversion rights, redemption privileges and liquidation
preferences, as shall be determined by the Board of Directors. At June
30, 2000, no such shares are issued and outstanding.
(5) CONTINGENCIES
Certain claims arising in the ordinary course of business are pending
against the Company. In the opinion of management, these claims are
without merit and they believe there is no potential liability.
(6) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH
OFF BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATION OF
CREDIT RISK, requires disclosure of any significant off-balance sheet and
credit risk concentration. Financial instruments that potentially expose
the Company to concentrations of credit risk consist primarily of cash
and cash equivalents, short-term investments and accounts receivable. The
Company has not experienced significant losses related to receivables
from any individual or groups of customers or any specific industry or
geographic region. Due to these factors, no additional credit risk is
believed by management to be inherent in the Company's accounts
receivable. For the three months ended June 30, 2000 and June 30, 1999, 2
and 3 customers represented 35% and 88% of revenues, respectively. At
June 30, 2000 and December 31, 1999, 2 and 3 customers represented 38%
and 56% of accounts receivable, respectively.
8
<PAGE>
(7) COMMITMENTS
The Company entered into a master agreement to lease dark fiber strands
and collocation sites in the Metro New York and Washington, DC regions,
respectively. The term of each lease is 20 years and requires certain
one-time installation charges and sharing of construction costs to
prepare the fibers for lease. Total annual payments will be approximately
$1,300,000.
In connection with the Company's expansion into New York, the franchise
agreement with the City of New York requires an irrevocable,
unconditional letter of credit and surety bond which total $2,000,000.
The Company has obtained two letters of credit from a bank for $1,000,000
and $750,000 in order to secure the franchise bond with the City of New
York and the related insurance company, respectively. The Company has
pledged $1,925,000 in exchange for the letters of credit, which are
included as restricted investments on the accompanying condensed
consolidated balance sheet. No drawings have been made against these
letters at June 30, 2000.
(8) SEGMENT DISCLOSURE
SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION requires certain financial and supplementary information to
be disclosed on an annual and interim basis for each reportable operating
segment of an enterprise. Operating segments are defined as components of
an enterprise about which separate financial information is available
that is evaluated regularly by the chief operating decision-maker, or
decision-making group, in deciding how to allocate resources and in
assessing performance. The Company's chief operating decision-maker is
the Chief Executive Officer of the Company.
The Company analyzes segment reporting based on dark fiber, lit fiber,
collocation and other services. Dark fiber, lit fiber, collocation and
ancillary network services are reported as revenue only. Cost of
revenues, and property and equipment is primarily the operating costs and
the communications network and equipment that supports each segment,
which is not allocated between the segments for management reporting, or
accordingly segment reporting purposes. Similarly, selling, general and
administrative expenses are not allocated to the segments for management
or segment reporting purposes.
Management utilizes several measurements to evaluate its operations and
allocate resources. However, the principal measurements are consistent
with the Company's financial statements. The accounting policies of the
segments are the same as those described in Note 2.
9
<PAGE>
Financial information for the Company's segments is as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Revenues
Dark fiber $ 813,532 $ 438,708 $ 1,476,836 $ 825,387
Lit fiber 1,496,388 171,253 2,496,276 206,053
Ancillary network services (1) 870,363 362,400 1,586,109 461,877
Collocation 328,743 70,484 602,511 70,484
------------- ------------- ------------- -------------
Total revenues 3,509,026 1,042,845 6,161,732 1,563,801
------------- ------------- ------------- -------------
Cost of revenues 2,712,996 1,448,543 4,823,498 2,377,531
Selling, general and administrative 3,054,694 2,111,799 5,563,308 3,433,172
Depreciation and amortization 2,882,112 1,205,873 5,341,053 2,000,851
------------- ------------- ------------- -------------
Operating loss (5,140,776) (3,723,370) (9,566,127) (6,247,753)
============= ============= ============= =============
Net property and equipment 122,164,858 78,768,826 122,164,858 78,768,826
============= ============= ============= =============
Capital expenditures 18,227,193 14,239,038 31,783,131 29,076,818
============= ============= ============= =============
</TABLE>
(1) Includes nonrecurring revenues associated with design, engineering and
construction services.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT
This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. All statements, other than statements of
historical facts, included or incorporated in this prospectus regarding our
strategy, future operations, financial position, future revenues, projected
costs, prospects, plans and objectives of management are forward-looking
statements. The words "anticipates," "believes," "estimates," "expects,"
"intends," "may," "plans," "projects," "will," "would" and similar expressions
are intended to identify forward-looking statements, although not all
forward-looking statements contain these identifying words. In particular, but
without limiting the foregoing, our statements about, relating to or dependent
on our agreements with Consolidated Edison Communications and Exelon
Corporation, the satisfaction of the conditions under those agreements and the
extent of our network following the consummation of the closing under each of
those agreements constitute forward-looking statements. We cannot guarantee that
we actually will achieve the plans, intentions or expectations disclosed in our
forward-looking statements and you should not place undue reliance on our
forward-looking statements. Actual results or events could differ materially
from the plans, intentions and expectations disclosed in the forward-looking
statements we make. We have included important factors in the cautionary
statements included in this report, particularly under the heading "Risk
Factors," that we believe could cause actual results or events to differ
materially from the forward-looking statements that we make. Our forward-looking
statements do not reflect the potential impact of any future acquisitions,
mergers, dispositions, joint ventures or investments we may make. We do not
assume any obligation to update any forward-looking statements.
10
<PAGE>
OVERVIEW
We own and operate a technologically advanced, high-bandwidth fiber optic
network providing capacity on a wholesale basis to telecommunications service
providers, including local, long distance and wireless telephone companies and
Internet service providers. Our network currently extends from Portland, Maine
to New York City and agreements in place with Exelon and Consolidated Edison
Communications would, subject to regulatory approval, extend our network to
Philadelphia, Baltimore, and Washington D.C. and expand the reach of our network
in and around New York City. Our customers can connect directly to our network
at multiple locations in the larger cities we serve and also in the smaller
communities along our network's routes.
To date we have experienced net losses and negative cash flow from operating
activities. From our inception to present, our principal activities included
building our network, developing our business plans, hiring management and other
key personnel and negotiating and executing customer contracts. In the third
quarter of 1999, we commenced the roll-out of our lit services into New York
City. We expect to continue to generate net losses and negative cash flow as we
expand our operations. Whether or when we will generate positive cash flow from
operating activities will depend on a number of financial, competitive,
regulatory, technical, and other factors. See "Liquidity and Capital Resources".
Our network service revenues include long-term leases of dark fiber and
short-term leases of lit fiber at fixed-cost pricing over multi-year terms. We
also provide collocation services at our facilities. Other service revenues
include nonrecurring design, engineering, and construction services. We
generally receive fixed monthly payments from our customers for the leasing of
capacity on our network and recognize revenues ratably over the term of the
applicable customer agreement. Other service revenues are non-refundable and
generally recognized as services are performed.
In the second quarter of 2000, approximately 34% of our revenue consisted of
other service revenues. We anticipate that as we proceed with the deployment of
our network, the percentage of revenues we receive from network services will
increase as a percentage of revenues.
Our costs consist primarily of cost of sales, selling, general and
administrative expenses, depreciation and amortization, and interest expense.
Cost of sales relates to lease payments for fiber optic facilities, network
surveillance, operations and maintenance costs, and property taxes. Selling,
general and administrative expenses relate to expenses in connection with sales
and marketing infrastructure, including personnel, advertising costs and
promotional activities and management & information technology. Depreciation and
amortization expense is associated with the build-out of our network, as well as
goodwill from our reorganization on July 8, 1998. Interest expense relates to
interest on our $180 million 12 3/4% Senior Notes Due 2008.
All references to "we", "us" or "our" appearing in this Report mean NorthEast
Optic Network, Inc. and its subsidiaries.
11
<PAGE>
RESULTS OF OPERATIONS
Revenues for the quarter ended June 30, 2000 amounted to $3,509,026, compared to
$1,042,845 in the same quarter of 1999, an increase of $2,466,181 or 236%.
Revenues were generated by recurring lease services of $2,309,920 during the
second quarter of 2000 compared to $609,961 during the second quarter of 1999,
and other service revenue of $1,199,106 during the second quarter of 2000
compared to $432,884 during the second quarter of 1999. Other service revenue
consists of collocation revenues and all nonrecurring revenues related to
design, engineering & construction. Revenues for the six months ended June 30,
2000 amounted to $6,161,732, compared to $1,563,801 for the first six months of
1999, an increase of $4,597,931 or 294%. The increase in revenues reflects the
Company's increasing sales to new customers in the Northeast region.
Cost of sales for the quarter ended June 30, 2000 amounted to $2,712,996,
compared to $1,448,543 for the same quarter in 1999, an increase of $1,264,453
or 87%. The increase was primarily due to lease payments for fiber optic
facilities, operations and maintenance costs, right of way fees, and property
taxes resulting from the Company's continuing network expansion throughout its
service territory. Cost of sales for the six months ended June 30, 2000 amounted
to $4,823,498, compared to $2,377,531 for the first six months of 1999, an
increase of $2,445,967 or 103%. The increased costs reflect the continuing build
out and expansion of the Company's communication network into the Northeast and
mid-Atlantic territories.
Selling, general, and administrative expenses amounted to $3,054,694 for the
quarter ended June 30, 2000, compared to $2,111,799 for the same quarter in
1999, an increase of $942,895 or 45 %. Selling, general, and administrative
expenses in the six months ended June 30, 2000 amounted to $5,563,308 compared
to $3,433,172 for the first six months of 1999, an increase of $2,130,136 or
62%. Increased personnel and related costs continue to grow as the Company
expands its efforts to meet customer requirements. The Company's headcount has
increased to 95 from 37, or approximately 157%, since June 30, 1999, primarily
related to sales in the Northeast region.
Depreciation and amortization expense was $2,882,112 for the quarter ended June
30, 2000, compared to $1,205,873 for the same quarter in 1999. Depreciation and
amortization for the six months ended June 30, 2000 amounted to $5,341,053,
compared to $2,000,851 for the same six month in 1999. The increase resulted
from placing additional segments of the NEON system into service in the
Northeast and amortization of goodwill resulting from the reorganization of the
Company on July 8, 1998.
Interest income decreased by 32% to $1,358,036 for the quarter ended June 30,
2000 from $2,001,901 for the same quarter in 1999. Interest income decreased by
32% to $2,893,445 for the six months ended June 30, 2000 from $4,242,665 for the
same six month period in 1999. This decrease was due primarily to lower cash and
investment balances for the quarter and first six months, resulting from capital
expenditures necessary to place additional segments of the NEON system into
service.
Interest expense was $5,304,200 for the quarter ended June 30, 2000, compared to
$5,189,609 for the same quarter in 1999, an increase of 2%. Interest expense was
$10,688,475 for the six
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months ended June 30, 2000 compared to $10,169,270 for the same six month period
in 1999, an increase of 5%. The increase relates primarily to interest expense
resulting from financing costs associated with long term network equipment
accounts payable, in addition to interest on our $180.0 million 12 3/4 % Senior
Notes due 2008.
The Company's net loss for the quarter ended June 30, 2000 was $9,086,940, or a
loss of $0.55 per share. This compares to a net loss of $6,911,078, or a loss of
$0.43 per share, for the same quarter in 1999. The Company's net loss for the
six months ended June 30, 2000 was $17,361,157, or a loss of $1.05 per share.
This compares to a net loss of $12,174,358, or a loss of $.76 per share, for the
same six month period in 1999. The increase in net loss is primarily
attributable to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Our operations have required substantial investment for the design, construction
and engineering of our network and the purchase of telecommunications equipment.
Capital expenditures were approximately $31,783,100 for the six months ended
June 30, 2000. We expect to require substantial capital in connection with the
following:
o expansion and improvement of our network;
o connection of additional buildings and customers to our network;
o purchase of additional telecommunications equipment
o purchase and development of our operating support systems; and
o operation and maintenance of existing facilities
We have funded a substantial portion of these expenditures through our completed
public offerings on August 5,1998, resulting in net proceeds to us of
approximately $218 million (after deducting expenses and before deducting $72
million in escrowed funds to cover the first seven semi-annual interest payments
on our $180 million 12 3/4% Senior Notes due 2008).
The substantial capital investment required to build our network has resulted in
negative cash flow after investing activities over the last three years. This
negative cash flow after investing activities is a result of the requirement to
build a substantial portion of our network before connecting revenue-generating
customers. We expect to continue to produce negative cash flow after investing
activities for the current year due to the continuous expansion and development
of our network. Our ability to continue this expansion will be limited by our
current capital resources until sufficient cash flow after investing activities
is generated unless we seek and obtain additional capital.
Net cash provided by (used in) operating activities was $1,631,227 and
($10,247,797) for the six months ended June 30, 2000 and June 30, 1999,
respectively. Net cash provided by operating activities for the quarter ended
June 30, 2000 was related primarily to an increase in accounts payable, accrued
expenses and depreciation and amortization.
Net cash used in investing activities totaled $5,393,070 and $54,277,928 for the
six months ended June 30, 2000 and June 30, 1999, respectively. Cash
requirements consisted primarily of
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the cost of network construction and equipment, offset by net proceeds from the
sale of short-term investments.
Net cash (used in) provided by financing activities totaled ($370,950) and
$20,997,042 for the six months ended June 30, 2000 and June 30, 1999
respectively. Cash requirements from financing activities during the six months
ended June 30, 2000 was primarily due to a decrease in construction and long
term accounts payable. Cash flow from financing activities during the six months
ended June 30, 1999 was generated from the restricted cash placed in escrow in
connection with the proceeds from the sale of our 12 3/4% Senior Notes due 2008
and proceeds from the exercise of stock options.
We anticipate that we will continue to experience negative cash flow as we
expand our network, construct networks, deploy telecommunications electronic
equipment and market our services to an expanding customer base. Cash provided
by operations will not be sufficient to fund the expansion and development of
our system in the Northeast and its planned expansion to the Mid-Atlantic
region. As a result, we intend to use our cash on hand and the remaining net
proceeds of our 1998 public offerings, and will have to raise additional
financing through some combination of commercial bank borrowings, leasing,
vendor financing, strategic alliances and sale of equity/or debt securities if
we are to complete our expansion as currently planned.
Our capital requirements may vary based upon the timing and the success of
implementation of our business plan and as a result of regulatory, technological
and competitive developments or if:
o demand for our services or cash flow from operations is less than or more
than expected;
o our plans or projections change or prove to be inaccurate;
o we make acquisitions; or
o we accelerate deployment of our network or otherwise alter the schedule or
targets for the implementation of our business plan.
The expectations of required future capital expenditures are based on our
current estimates.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board 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. SFAS No.
133, as amended by SFAS No. 137 and SFAS No. 138, is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. This new standard is not
anticipated to have a significant impact on our consolidated financial
statements based on our current structure and operations.
The Securities and Exchange issued SAB No. 101, REVENUE RECOGNITION, in December
1999. We are required to adopt this new accounting guidance, as amended by SAB
No. 101A through a cumulative charge to retained earnings in accordance with
Accounting Principles Board (APB) Opinion No. 20, ACCOUNTING CHANGES, no later
than the fourth quarter of fiscal 2000. We are
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currently evaluating the effects that this guidance is expected to have on the
Company's financial statements.
In March 2000, the FASB issued Interpretation No. 44, ACCOUNTING FOR CERTAIN
TRANSACTIONS INVOLVING STOCK COMPENSATION--AN INTERPRETATION OF APB OPINION NO.
25. The interpretation clarifies the application of APB Opinion No. 25 in
certain situations, as defined. The interpretation is effective July 1, 2000,
but covers certain events occurring during the period after December 15, 1998
but before the effective date. To the extent that events covered by this
interpretation occur during the period after December 15, 1998 but before the
effective date, the effects of applying this interpretation would be recognized
on a prospective basis from the effective date. Accordingly, upon initial
application of the final interpretation, (i) no adjustments would be made to the
financial statements for periods before the effective date and (ii) no expense
would be recognized for any additional compensation cost measured that is
attributable to periods before the effective date. We expect that the adoption
of this interpretation would not have any effect on the accompanying financial
statements.
RISK FACTORS
There are a number of important factors that could affect our business and
future operating results, including, without limitation, the factors set forth
below, and the information contained in this Quarterly Report on Form 10-Q
should be read in light of such factors. Any of the following factors could have
a material adverse effect on our business and our future operating results.
RISKS RELATING TO OUR BUSINESS STRATEGY
WE HAVE HAD SIGNIFICANT NET LOSSES AND OUR OPERATING RESULTS HAVE VARIED AND
WILL CONTINUE TO VARY SIGNIFICANTLY.
Our current business has a (24 months is limited not necessarily very limited)
limited history. We have incurred net losses since our inception. Our future
operating results will fluctuate annually and quarterly due to several factors,
some of which are outside our control. These factors include pricing strategies
for our services, changes in telecommunications technology, changes in the
regulatory environment, cost and timely availability of equipment, cost of
construction and changes in general and local economic conditions.
OUR BUSINESS STRATEGY DEPENDS UPON ANTICIPATED CUSTOMER DEMAND FOR OUR SERVICES,
AND OUR FAILURE TO OBTAIN CUSTOMERS FOR OUR SERVICES AT PROFITABLE RATES WOULD
ADVERSELY AFFECT OUR BUSINESS RESULTS.
Our ability to become profitable depends upon our ability to secure a market for
our services and obtain service contracts with our communications customers.
Many of our targeted customers may also be our potential competitors. If our
services are not satisfactory or cost competitive, our targeted customers may
utilize other providers where available, or construct their own networks, which
would reduce their need for our services and create future sources of
competition for us.
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INTENSE COMPETITION IN THE TELECOMMUNICATIONS INDUSTRY FROM A BROAD RANGE OF
COMPETITORS MAY PREVENT US FROM OBTAINING CUSTOMERS AND REQUIRE US TO LOWER
PRICES.
The telecommunications industry is highly competitive. We face substantial
competition from companies with significantly greater financial and other
resources whose capacity is interchangeable with the capacity we offer,
including incumbent local telephone companies, competitive local telephone
companies and major long distance companies. In addition, potential competitors
capable of offering services similar to those offered by us include other
communications service providers that own and operate their own networks and
equipment, including cable television companies, electric utilities, microwave
carriers, satellite carriers, wireless communication system operators and
end-users with private communications networks. Two of our principal
stockholders, Northeast Utilities and CMP Group, Inc., an affiliate of the
selling stockholder, each own or have rights to fibers in the cable that
includes a portion of our network, which permits each of them to compete
directly with us in the future if they use these fibers for purposes other than
their corporate requirements. Our rights-of-way are non-exclusive so that other
service providers (including the utilities themselves) could install competing
networks using the same rights-of-way.
BECAUSE WE OFFER A RELATIVELY NARROW RANGE OF SERVICES IN COMPARISON TO SOME OF
OUR COMPETITORS, WE CANNOT ACHIEVE REVENUES COMPARABLE TO COMPANIES OFFERING A
BROADER ARRAY OF SERVICES AND MAY BE AT A COMPETITIVE DISADVANTAGE WITH RESPECT
TO THE SERVICES WE OFFER.
Unlike more diversified telecommunications companies, we derive and expect to
continue to derive substantially all of our revenues from the leasing of fiber
optic capacity on a wholesale basis to our customers, most of whom are
telecommunications companies and Internet service providers serving end-users.
The limited nature of our current services could limit our potential revenues
and result in our having lower revenues than competitors which provide a wider
array of services.
DUE TO RAPIDLY EVOLVING TECHNOLOGIES IN OUR INDUSTRY AND THE UNCERTAINTY OF
FUTURE GOVERNMENT REGULATION, OUR CURRENT BUSINESS PLAN MAY BECOME OBSOLETE AND
WE MAY BE UNABLE TO MAINTAIN A COMPETITIVE POSITION IF WE ARE UNABLE TO
SUCCESSFULLY ADJUST OUR PRODUCTS, SERVICES AND BUSINESS STRATEGIES AS REQUIRED.
In the future, we may become 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 introduction of new
services and products or the emergence of new technologies may change the cost
or increase the supply of services and products similar to those which we
provide. We cannot predict which of many possible future product and service
offerings will be crucial to maintain our competitive position or what
expenditures will be required to develop profitably and provide such products
and services. Prices for our services to carriers specifically, and interstate
services in general, may decline over the next several years due primarily to
price competition to the extent that network providers continue to install
networks that compete with our network. We also believe
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that there will be technological advances that will permit substantial increases
in the transmission capacity of both new and existing fiber.
A LIMITED NUMBER OF CUSTOMERS HAS ACCOUNTED FOR A SIGNIFICANT PERCENTAGE OF OUR
REVENUES.
Historically, a limited number of customers has accounted for a significant
percentage of our revenues. In 1998, three customers accounted for 50%, 19% and
12% of revenues, respectively. In 1999, three customers accounted for 18%, 16%
and 13% of revenues, respectively. We anticipate that our results of operations
in any given period will continue to depend to a significant extent upon
revenues of a small number of customers.
RISKS RELATING TO THE EXPANSION AND OPERATION OF OUR FIBER OPTIC NETWORK
THE SUCCESSFUL, TIMELY AND COST-EFFECTIVE EXPANSION OF OUR FIBER OPTIC NETWORK
WITHIN THE NORTHEAST AND INTO THE MID-ATLANTIC REGION IS CRUCIAL TO OUR BUSINESS
PLAN, AND DEPENDS UPON NUMEROUS FACTORS BEYOND OUR CONTROL.
Our ability to achieve our strategic objectives depends in large part upon the
successful, timely and cost-effective expansion of our fiber optic network
within the Northeast and into the Mid-Atlantic region. Among the major factors
that could affect our success are:
o the inability to consummate, or a delay in consummating, our agreement with
Consolidated Edison Communications, which remains subject to substantial
regulatory conditions which have already resulted in delays; and
o the failure of both affiliated and third-party suppliers or contractors to
meet their obligations to construct and maintain significant portions of
our fiber optic network in a timely and cost-effective manner.
Either of these factors, or other factors, over which we have little control,
could significantly hinder our ability to complete our network and execute our
business plan.
EACH OF OUR AGREEMENTS WITH CONSOLIDATED EDISON COMMUNICATIONS AND EXELON
CORPORATION IS SUBJECT TO POSSIBLE TERMINATION IF THE CLOSING UNDER THAT
AGREEMENT DOES NOT OCCUR BY SEPTEMBER 7, 2000.
Each of our agreements with Consolidated Edison Communications and Exelon
Corporation is subject to termination by either party if the closing conditions
under that agreement have not been satisfied by September 7, 2000. Both of these
agreements are subject to substantial closing conditions that may not be
satisfied by September 7, 2000. If one or both of these agreements is
terminated, our business plan will be adversely affected.
OUR AGREEMENT WITH CONSOLIDATED EDISON COMMUNICATIONS, INC. FOR THE EXPANSION OF
OUR NETWORK IN NEW YORK CITY HAS ENCOUNTERED REGULATORY DELAYS.
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Consolidated Edison Communications' application for a municipal franchise to
operate as a telecommunications carrier in New York City has encountered delays,
and we cannot be sure when they will be granted, if at all. Our agreement with
Consolidated Edison Communications is contingent on this approval, and if the
necessary approvals are not forthcoming, we may be forced to serve New York City
using alternative rights of way shared by other carriers that would not provide
the same route diversity as those offered by Consolidated Edison Communications.
A significant delay in obtaining the necessary approvals, or in our decision to
select an alternative means of serving this area, would delay our expansion into
New York City.
THE EXPENDITURES NECESSARY TO SUFFICIENTLY EXPAND OUR FIBER OPTIC NETWORK AND
DEVELOP OUR SERVICES IN ORDER TO SATISFY THE CURRENT AND FORECASTED DEMANDS OF
OUR CUSTOMERS MAY SURPASS OUR AVAILABLE CASH, AND WE MAY BE UNABLE TO OBTAIN
ADDITIONAL CAPITAL TO DEVELOP OUR SERVICES ON A TIMELY BASIS AND ON ACCEPTABLE
TERMS.
Although we have expended significant resources in building our network from
Portland, Maine to New York City and the development of our customer base, we
will require significant additional cash in order to expand our geographic
coverage and the range of services which we can offer throughout our service
area in order to be competitive in our market. These expenditures for expansion
and for more services, together with associated operating expenses, will reduce
our cash flow and profitability until we establish an adequate customer base
throughout all of our coverage areas. To date, we have expended substantial
amounts on construction of our network from the proceeds of our financing
activities and, accordingly, we have generated negative cash flow. We may need
to obtain additional capital to expand our services and increase our service
territory, and cannot guarantee that additional financing will be available to
us or, if available, that we can obtain it on a timely basis and on acceptable
terms.
WE OBTAIN SOME OF THE KEY COMPONENTS USED IN OUR FIBER OPTIC NETWORK FROM A
SINGLE SOURCE OR A LIMITED GROUP OF SUPPLIERS, AND THE PARTIAL OR COMPLETE LOSS
OF ONE OF THESE SUPPLIERS COULD DISRUPT OUR OPERATIONS AND RESULT IN A
SUBSTANTIAL LOSS OF REVENUE.
We depend upon a small group of suppliers for some of the key components and
parts used in our network. In particular, we purchase cable from Lucent-Fitel
and from Corning, and we purchase fiber optic equipment from Nortel Networks,
Cerent Corporation and Sycamore Networks. Any delay or extended interruption in
the supply of any of the key components, changes in the pricing arrangements
with our suppliers and manufacturers or delay in transitioning a replacement
supplier's product into our network could disrupt our operations.
OUR FIBER OPTIC NETWORK, WHICH IS OUR SOLE SOURCE OF REVENUE, IS VULNERABLE TO
PHYSICAL DAMAGE, CATASTROPHIC OUTAGES, POWER LOSS AND OTHER DISRUPTIONS BEYOND
OUR CONTROL, AND THE OCCURRENCE OF ANY OF THESE FAILURES COULD RESULT IN
IMMEDIATE LOSS OF REVENUE, PAYMENT OF OUTAGE CREDITS TO OUR CUSTOMERS AND, MORE
IMPORTANTLY, THE LOSS OF OUR CUSTOMERS' CONFIDENCE AND OUR BUSINESS REPUTATION.
Our success in marketing our services to our customers requires that we provide
high reliability, high bandwidth and a secure network. Our network and the
infrastructure upon which it depends are subject to physical damage, power loss,
capacity limitations, software defects, breaches of
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security and other disruptions beyond our control that may cause interruptions
in service or reduced capacity for customers. Our agreements with our customers
typically provide for the payment of outage related credits (a predetermined
reduction or offset against our 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. These credits or damages could
be substantial and could significantly decrease our net revenue. Significant or
lengthy outages would also undermine our customers' confidence in our fiber
optic network and injure our business reputation.
RISKS RELATING TO OUR RIGHTS-OF-WAY
WE COULD LOSE THE CONTRACT RIGHTS UPON WHICH WE RELY TO OPERATE AND MAINTAIN OUR
NETWORK IN THE EVENT OF BANKRUPTCY PROCEEDINGS RELATING TO ONE OR MORE OF THE
THIRD PARTIES THAT HAVE GRANTED TO US THE RIGHT TO BUILD AND OPERATE OUR NETWORK
USING THEIR RIGHTS-OF-WAY.
The construction and operation of significant portions of our fiber optic
network depend upon contract rights known as indefeasible rights-of-use.
Indefeasible rights-of-use are commonly used in the telecommunications industry,
but remain a relatively new concept in property law. Although indefeasible
rights-of-use give the holder a number of rights to control the relevant
rights-of-way or fiber optic filaments, legal title remains with the grantor of
the rights. Therefore, the legal status of indefeasible rights-of-use remains
uncertain, and our indefeasible rights-of-use might be voidable in the event of
bankruptcy of the grantor. If we were to lose an indefeasible right-of-use in a
key portion of our network, our ability to service our customers could become
seriously impaired and we could be required to incur significant expense to
resume the operation of our fiber optic network in the affected areas.
DESPITE OUR EXISTING RIGHTS-OF-WAY, WE MAY BE FORCED TO MAKE SUBSTANTIAL
ADDITIONAL PAYMENTS TO THE AFFECTED LANDOWNERS OR REMOVE OUR NETWORK FROM THEIR
PROPERTY, WHICH WOULD SIGNIFICANTLY HARM OUR BUSINESS AND OUR RESULTS OF
OPERATIONS.
Our indefeasible rights-of-use depend on the grantor's interest in the property
on which our network is located. To the extent that a grantor of an indefeasible
right-of-use has a limited easement in the underlying property and not full
legal title, the adequacy of our indefeasible rights-of-use could be challenged
in court. For example, in May 1999, AT&T entered into a costly settlement of a
class action suit brought by landowners who asserted that the railroad-based
rights-of-way upon which AT&T had relied to build portions of its fiber optic
network were insufficient to permit AT&T to use these rights-of-way for
telecommunications purposes.
We believe that it is likely that a number of landowners may make similar claims
against us based on our use of utility rights-of-way for our telecommunications
purposes. In fact, some landowners have already asserted claims against us on
this basis, and, to date, in two cases, rather than electing to contest the
landowners' interpretation of the scope of the easement, we have made a payment
to such landowners to acquire rights-of-way meeting our requirements. We believe
that the easements granted by a substantial number of landowners to grantors of
our indefeasible rights-of-use are similar in scope to those with respect to
which claims have been asserted, and we cannot guarantee that additional claims
will not be made in the future.
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BECAUSE SIGNIFICANT PORTIONS OF OUR FIBER OPTIC NETWORK ARE CONSTRUCTED UPON
RIGHTS-OF-WAY CONTROLLED BY ELECTRIC UTILITY COMPANIES WHICH GENERALLY PLACE THE
OPERATION OF THEIR ELECTRICAL FACILITIES AHEAD OF THE OPERATION OF OUR FIBER
OPTIC NETWORK, WE MAY BE UNABLE TO CONSTRUCT AND OPERATE OUR FIBER OPTIC NETWORK
IN THE AFFECTED AREAS WITHOUT PERIODIC INTERRUPTIONS AND DELAYS CAUSED BY THE
DAY-TO-DAY OPERATIONS OF THESE UTILITY COMPANIES.
Our rights-of-way agreements with Northeast Utilities and Central Maine Power
Company contain provisions which acknowledge the right of Northeast Utilities
and Central Maine Power, respectively, to make the provision of electrical
services to their own customers their top priority. Northeast Utilities and
Central Maine Power are required only to exercise "reasonable care" with respect
to our 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 operation of our network. In
addition, some of our ongoing operational efforts are constrained by the limited
ability of the utilities to de-energize segments of their transmission and
distribution facilities in order to permit construction crews to work safely. We
have experienced construction delays in the past as a result of such inability
to timely de-energize certain segments and we may experience such delays in the
future.
RISKS RELATING TO GOVERNMENT REGULATION
FEDERAL REGULATION OF THE TELECOMMUNICATIONS INDUSTRY IS CHANGING RAPIDLY AND WE
COULD BECOME SUBJECT TO UNFAVORABLE NEW RULES AND REQUIREMENTS WHICH COULD
IMPOSE SUBSTANTIAL FINANCIAL AND ADMINISTRATIVE BURDENS ON US AND INTERFERE WITH
OUR ABILITY TO SUCCESSFULLY EXECUTE OUR BUSINESS STRATEGIES.
Regulation of the telecommunications industry is changing rapidly. Existing and
future federal, state, and local governmental regulations will greatly influence
our viability. Consequently, undesirable regulatory changes could adversely
affect our business, financial condition and results of operations.
REVENUES FROM LIT SERVICES TO INTERNET SERVICE PROVIDERS, WHICH REPRESENT A
PORTION OF OUR REVENUES, ARE SUBJECT TO CONTRIBUTIONS TO THE FCC'S UNIVERSAL
SERVICE FUND.
While we generally do not deal directly with end-users of telecommunications
services and are therefore generally exempt from contributing to the FCC's
Universal Service Fund, the FCC treats Internet service providers purchasing lit
services as end-users for these purposes. Our revenues from providing these
services, which represent a portion of our revenues, are therefore subject to an
assessment of 5.8% of gross interstate revenue for the fourth quarter of 1999,
and this assessment could increase.
IF WE BECOME SUBJECT TO REGULATION AS A COMMON CARRIER IN THE FUTURE, WE WOULD
BE SUBJECT TO ADDITIONAL REGULATORY REQUIREMENTS.
We do not believe that we are currently a "common carrier," but that status
could change based on differing interpretations of current regulations,
regulatory changes and changes in the way we
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conduct our business. If we become regulated as a common carrier, we would have
to file tariffs for our services with the FCC and submit other reports, and
would be required to contribute to federal funds including, but not limited to,
those established for Telecommunications Relay Services and for the management
of the North American Numbering Plan. These regulatory requirements could impose
substantial burdens on us.
A recent FCC decision requiring incumbent local telephone companies to provide
their dark fiber to third parties may increase competition among providers of
dark fiber services.
The Communications Act of 1934 requires incumbent local telephone companies to
provide elements of their networks to competitors on an unbundled basis. In a
recent decision, the FCC determined that dark fiber is a network element that
incumbent local telephone companies must provide to others. The availability of
this alternative source of supply could decrease the demand for our dark fiber.
REGULATORY CHANGES COULD AFFECT RELATIONSHIPS BETWEEN US, OUR COMPETITORS AND
CUSTOMERS IN UNFORSEEABLE WAYS THAT COULD REDUCE OUR BUSINESS OPPORTUNITIES.
Our relationships with the telecommunications companies with whom we deal are
all affected by our respective positions in the FCC's regulatory scheme.
Accordingly, changes in federal telecommunications law may affect our business
by virtue of the interrelationships that exist among us and many of these
regulated telecommunications entities. It is difficult for us to forecast at
this time how these changes will affect us in light of the complex
interrelationships that exist in the industry and the different levels of
regulation.
STATE REGULATION OF COMPANIES PROVIDING TELECOMMUNICATIONS SERVICES VARIES
SUBSTANTIALLY FROM STATE TO STATE AND WE MAY BECOME SUBJECT TO BURDENSOME AND
RESTRICTIVE STATE REGULATIONS AS WE EXPAND OUR FIBER OPTIC NETWORK INTO A
BROADER GEOGRAPHIC AREA, WHICH COULD INTERFERE WITH OUR OPERATIONS AND OUR
ABILITY TO MEET OUR STRATEGIC OBJECTIVES.
We may be subject to state regulation, which can vary substantially from state
to state. Our subsidiaries in New York and Connecticut have obtained authority
to provide intrastate telecommunications services on a competitive common
carrier basis. Therefore, these subsidiaries are subject to the obligations that
applicable law places on all similarly certificated common carriers including
the filing of tariffs, state regulation of certain service offerings, pricing,
payment of regulatory fees and reporting requirements. The costs of compliance
with these regulatory obligations, or any of the regulatory requirements of
other states to which we might become subject, could have a material adverse
effect on our operations. Moreover, some of our rights-of-way depend on our
status as a common carrier in these states, and if that status were to be
successfully challenged, those rights-of-way could be terminated.
MUNICIPAL REGULATION OF OUR ACCESS TO PUBLIC RIGHTS-OF-WAY IS SUBJECT TO CHANGE
AND COULD IMPOSE ADMINISTRATIVE BURDENS THAT WOULD ADVERSELY AFFECT OUR
BUSINESS.
Local governments typically retain the ability to license public rights-of-way,
subject to the federal requirement that local governments may not prohibit the
provision of
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telecommunications services. Changes in local government regulation could impose
additional costs on our business and limit our operations. Local authorities
affect the timing and costs associated with our use of public rights-of-way.
RISKS RELATING TO OUR CAPITALIZATION
BECAUSE WE HAVE A LARGE AMOUNT OF DEBT, WE WILL BE REQUIRED TO DEVOTE A
SIGNIFICANT PORTION OF OUR CASH FLOW TO PAY INTEREST AND WE MAY NOT HAVE
SUFFICIENT REMAINING CASH FLOW TO MEET OUR OTHER OBLIGATIONS AND EXECUTE OUR
BUSINESS STRATEGIES.
We are highly leveraged. Our high degree of debt, including our $180 million 12
3/4% Senior Notes Due 2008, could have adverse consequences to the holders of
our equity securities. Commencing on August 15, 2002, a substantial portion of
our cash flow will be dedicated to the payment of the $22,950,000 per annum of
interest expense associated with our debt and such cash flow may be insufficient
to meet our payment obligations on our debt in addition to paying our other
obligations as they become due. In addition, due to our leverage ratio, our
ability to obtain any necessary financing in the future for completion of our
network or other purposes may be impaired. Also, certain of our future
borrowings may be at variable rates of interest that could cause us to be
vulnerable to increases in interest rates. Because we are highly leveraged, we
may be at a competitive disadvantage to our competitors and may be especially
vulnerable to a downturn in our business or the economy generally, or to delays
in or increases in the costs of operating and constructing our network.
IN CONNECTION WITH OUR SUBSTANTIAL PUBLIC DEBT, WE HAVE AGREED TO SIGNIFICANT
RESTRICTIONS ON OUR OPERATIONS THAT LIMIT OUR ABILITY TO ENTER INTO MAJOR
CORPORATE TRANSACTIONS, AND AS A RESULT WE MAY BE UNABLE TO PURSUE POTENTIAL
CORPORATE OPPORTUNITIES WHICH WOULD BENEFIT US AND OUR STOCKHOLDERS.
The indenture under which our debt was issued imposes significant operating and
financing restrictions on us and our present and future subsidiaries. These
restrictions affect, and in certain cases significantly limit or prohibit, among
other things, our ability to incur indebtedness, pay dividends and make other
restricted payments, create liens, issue and sell capital stock of subsidiaries,
guarantee indebtedness, sell assets or consolidate, merge or transfer all or
substantially all of our assets. These limitations could prevent us from
exploiting corporate opportunities as they arise, which could be detrimental to
the interests of our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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.
The Company maintains a short-term investment portfolio consisting mainly of
corporate debt securities and U.S. government agency discount notes with an
average maturity of less than six months. These held-to-maturity securities are
subject to interest rate risk and will fall in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10% from levels that existed at June 30, 2000, the fair value of the portfolio
would
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decline by an immaterial amount. Since the Company has the ability to hold its
fixed income investments until maturity, the Company would not expect its
operating results or cash flows to be materially affected.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter covered by this
Report.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
By: /s/ VICTOR COLANTONIO Date: August __, 2000
----------------------------------
Victor Colantonio
Vice Chairman and President
By: /s/ WILLIAM F. FENNELL Date: August __, 2000
--------------------------------
William F. Fennell
Vice President, Finance,
Chief Financial Officer and Treasurer
(Principal Financial Officer)
24