<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2000
OR
--- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 333-59393
RHYTHMS NETCONNECTIONS INC.
---------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE
(State or Other Jurisdiction of Incorporation or Organization)
33-0747515
(I.R. S. Employer Identification Number)
9100 East Mineral Circle
Englewood, CO 80112
------------- -----
(Address of Principal Executive Office) (Zip Code)
Registrant's Telephone Number, Including Area Code: (303) 476-4200
Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK,
$.001 PAR VALUE
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 as the Registrant was
required to file such reports) and, (2) has been subject to such filing
requirements for the past 90 days.
(1) Yes X No
--- ---
As of October 31, 2000, a total of 79,610,302 shares of the Registrant's Common
Stock, $0.001 par value, were issued and outstanding.
<PAGE>
RHYTHMS NETCONNECTIONS INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C> <C>
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements
Consolidated Balance Sheets as of December 31, 1999 and
September 30, 2000 (unaudited) 3
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 1999 and 2000 (unaudited) 4
Consolidated Statements of Comprehensive Income (Loss) for the Three
and Nine Months Ended September 30, 1999 and 2000 (unaudited) 5
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1999 and 2000 (unaudited) 6
Consolidated Statements of Stockholders' Equity for the Nine Months
Ended September 30, 2000 (unaudited) 7
Notes to Consolidated Financial Statements (unaudited) 8 - 11
ITEM 2 Management's Discussion and Analysis of Financial Condition and
and Results of Operations 12 - 15
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings 15
ITEM 2 Changes in Securities and Use of Proceeds 16
ITEM 3 Defaults Upon Senior Securities 16
ITEM 4 Submission of Matters to a Vote of Security Holders 16
ITEM 5 Other Information 17
ITEM 6 Exhibits and Reports on Form 8-K 17
SIGNATURES 18
</TABLE>
2
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RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
December 31, September 30,
ASSETS 1999 2000
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<S> <C> <C>
Current assets: (unaudited)
Cash and cash equivalents $ 48,247 $ 1,001
Short-term investments 292,008 669,177
Restricted cash 36,707 37,649
Accounts, loans, interest, and other receivables, net 10,844 49,834
Inventory 4,071 7,183
Prepaid expenses and other current assets 8,460 27,012
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Total current assets 400,337 791,856
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Equipment and furniture, net 124,831 196,751
Collocation fees, net 57,421 77,116
Restricted cash 59,526 40,167
Deferred business acquisition costs, net of accumulated amortization of $4,765 and $9,453 18,425 13,737
Deferred debt issue costs, net of accumulated amortization of $924 and $1,969 16,194 24,213
Other assets 8,690 23,370
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TOTAL ASSETS $ 685,424 $ 1,167,210
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LIABILITIES AND STOCKHOLDERS' EQUITY
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Current liabilities:
Current portion of long-term debt $ 333 $ 193
Accounts payable 30,895 25,760
Interest payable 8,787 25,330
Accrued expenses and other current liabilities 23,163 46,944
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Total current liabilities 63,178 98,227
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Long-term debt 111 -
Senior notes payable 505,696 825,221
Other liabilities 110 3
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Total liabilities 569,095 923,451
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Mandatorily redeemable common stock warrants 42 42
Mandatorily redeemable preferred stock - 489,898
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Stockholders' equity (deficit):
Common stock, $0.001 par value; 250,000,000 shares authorized;
78,255,707 shares issued as of 1999 and 79,610,302 as of 2000 78 80
Treasury stock, at cost; 988,894 shares as of 1999 and 896,504 as of 2000 (469) (906)
Additional paid-in capital 373,604 380,721
Warrants 10,397 74,373
Deferred compensation (12,320) (25,754)
Accumulated deficit (257,636) (673,068)
Accumulated comprehensive income 2,633 (1,627)
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Total stockholders' equity (deficit) 116,287 (246,181)
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 685,424 $ 1,167,210
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</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
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RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------------------------------------------------
1999 2000 1999 2000
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(unaudited)
<S> <C> <C> <C> <C>
Revenue:
Service and installation, net $ 3,317 $ 17,199 5,618 37,508
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Operating Expenses:
Network and service costs 21,800 62,400 39,971 153,269
Selling, marketing, general and administrative 27,686 71,493 62,230 198,614
Depreciation and amortization 3,977 12,213 6,121 32,717
Amortization of deferred business acquisition costs 1,550 1,562 3,202 4,688
Deferred compensation 967 2,905 2,541 6,404
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Total operating expenses 55,980 150,573 114,065 395,692
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Loss from operations (52,663) (133,374) (108,447) (358,184)
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Other Income (Expense):
Interest income 7,344 14,159 15,673 38,411
Interest expense (including amortized debt
discount and issue costs) (16,500) (28,105) (35,871) (77,916)
Litigation settlement - (168) - (7,558)
Equity in losses of affiliate - (167) - (167)
Other income 41 36 112 107
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Total other income (expense) (9,115) (14,245) (20,086) (47,123)
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Net Loss $ (61,778) $ (147,619) $ (128,533) $ (405,307)
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Preferred stock dividends and accretion - 11,609 - 25,893
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Net Loss Available to Common Shareholders $ (61,778) $ (159,228) $ (128,533) $ (431,200)
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Net Loss Per Common Share:
Basic $ (0.89) (2.07) (2.80) (5.70)
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Diluted $ (0.89) $ (2.07) $ (2.80) $ (5.70)
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Weighted Average Common Shares Outstanding:
Basic 69,646,044 76,790,601 45,893,691 75,657,362
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Diluted 69,646,044 76,790,601 45,893,691 75,657,362
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</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
4
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------------------------
1999 2000 1999 2000
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(unaudited)
<S> <C> <C> <C> <C>
Net Loss $ (61,778) $ (147,619) $ (128,533) $ (405,307)
Cumulative translation adjustment - 14 - 32
Loss on available-for-sale securities - (1,847) - (4,292)
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Total comprehensive loss $ (61,778) $ (149,452) $ (128,533) $ (409,567)
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</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1999 2000
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Cash Flows from Operating Activities: (unaudited)
<S> <C> <C>
Net loss $ (128,533) $ (405,307)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization of equipment, furniture, and collocation fees 6,120 32,717
Amortization of deferred business acquisition costs 3,202 4,688
Amortization of debt discount and deferred debt issue costs 17,542 20,570
Amortization of deferred compensation 2,541 6,404
Other (110) 60
Changes in assets and liabilities:
Increase in accounts, loans, interest, and other receivables, net (6,867) (38,990)
Increase in inventory (2,792) (3,112)
Increase in prepaid expenses and other current assets (706) (18,552)
Increase in other assets (362) (4,107)
Decrease in accounts payable (957) (5,135)
Increase in interest payable 18,187 16,543
Increase in accrued expenses and other current liabilities 13,725 23,781
Increase in other liabilities 75 -
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Net cash used for operating activities (78,935) (370,440)
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Cash Flows from Investing Activities:
Purchases of short-term investments (237,273) (6,079,054)
Maturities of short-term investments 181,577 5,701,885
Maturities (purchases) of government securities as restricted cash (113,360) 18,417
Investment in preferred stock - (15,000)
Purchases of equipment and furniture (104,271) (99,779)
Payments of collocation fees (37,746) (24,702)
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Net cash used for investing activities (311,073) (498,233)
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Cash Flows from Financing Activities:
Proceeds from leasing company for equipment 23,755 -
Proceeds from issuance of senior notes 325,000 300,000
Payments of debt issue costs (10,489) (9,064)
Repayments of long-term debt (278) (251)
Proceeds from issuance of common stock 246,756 4,327
Proceeds from issuance of preferred stock and warrants 75,000 526,655
Payments of equity issue costs (17,347) -
Purchase of treasury stock (10) (240)
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Net cash provided by financing activities 642,387 821,427
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Net change in cash and cash equivalents 252,379 (47,246)
Cash and cash equivalents at beginning of period 21,315 48,247
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Cash and cash equivalents at end of period $ 273,694 $ 1,001
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Supplemental schedule of cash flow information:
Cash paid for interest $ 42 $ 40,809
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Supplemental schedule of non-cash financing activities:
Equipment and furniture purchases payable $ 11,972 $ 9,861
Business acquisition costs from issuance of preferred stock and warrants $ 23,190 $ -
----------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
<TABLE>
<CAPTION>
Common Stock Treasury Stock
$0.001 par value at Cost Additional
-------------------- ---------------- Paid-In
Shares Amount Shares Amount Capital Warrants
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1999 78,255,707 $ 78 988,894 $ (469) $373,604 $ 10,397
Issuance of common stock upon exercise of
options for cash 326,381 - - - 1,254 -
Issuance of treasury stock upon settlement
of litigation - - (438,115) - 89 -
Issuance of Series E preferred stock
warrants for cash - - - - - 63,976
Costs arising from issuance of Series E and
F preferred stock - - - - (438) -
Purchase of treasury stock for cash - - 336,684 (240) - -
Issuance of treasury stock upon cashless
exercise of warrants - - 9,041 (197) - -
Accrued Series E and F preferred stock dividends - - - - (24,059) -
Accretion of Series E and F preferred stock - - - - (2,763) -
Stock issuance under employee stock
purchase plan 173,079 - - - 3,073 -
Deferred compensation from grants of
common stock - - - - 22,380 -
Amortization of deferred compensation - - - - - -
Reversal of deferred compensation from
cancellation of grants to purchase
common stock - - - - (2,542) -
Series F preferred stock dividend paid 855,135 2 - - 10,123 -
Net loss - - - -
Cumulative translation adjustment - - - - - -
Unrealized loss on available-for-sale
securities - - - - - -
-----------------------------------------------------------------------------------------------------------------
Balance at September 30, 2000 (unaudited) 79,610,302 $ 80 896,504 $ (906) $380,721 $ 74,373
-----------------------------------------------------------------------------------------------------------------
<CAPTION>
Accumulated
Other Total
Deferred Accumulated Comprehensive Stockholders'
Compensation Deficit Income Equity (Deficit)
--------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1999 $ (12,320) $ (257,636) $ 2,633 $ 116,287
Issuance of common stock upon exercise of
options for cash - - - 1,254
Issuance of treasury stock upon settlement
of litigation - - - 89
Issuance of Series E preferred stock
warrants for cash - - - 63,976
Costs arising from issuance of Series E and
F preferred stock - - - (438)
Purchase of treasury stock for cash - - - (240)
Issuance of treasury stock upon cashless
exercise of warrants - - - (197)
Accrued Series E and F preferred stock dividends - - - (24,059)
Accretion of Series E and F preferred stock - - - (2,763)
Stock issuance under employee stock
purchase plan - - - 3,073
Deferred compensation from grants of
common stock (22,380) - - -
Amortization of deferred compensation 6,404 - - 6,404
Reversal of deferred compensation from
cancellation of grants to purchase
common stock 2,542 - - -
Series F preferred stock dividend paid - (10,125) - -
Net loss - (405,307) - (405,307)
Cumulative translation adjustment - - 32 32
Unrealized loss on available-for-sale
securities - - (4,292) (4,292)
--------------------------------------------------------------------------------------------------------------
Balance at September 30, 2000 (unaudited) $ (25,754) $ (673,068) $ (1,627) $ (246,181)
--------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
RHYTHMS NETCONNECTIONS INC.
Notes to Consolidated Financial Statements
1. Basis of Presentation
The consolidated financial statements included herein include the transactions
and balances of Rhythms NetConnections Inc. and its wholly-owned subsidiaries
Rhythms Links Inc., Rhythms Links Inc. - Virginia, Rhythms NetConnections Europe
B.V., Rhythms Deutschland GmbH, RGarnet, Inc., RHOMS, Inc., Rhythms Winfire,
Inc., RAxxent, Inc., RCanada, Inc. and RATHM, Inc. All significant intercompany
balances and transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared by the Company without
audit, except for the December 31, 1999 balance sheet, which was derived from
the audited financial statements. The statements have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission (the SEC)
and reflect all adjustments, consisting of only normal recurring accruals which
are, in the opinion of management, necessary for a fair statement of the results
of operations for the periods shown. These financial statements should be read
in conjunction with the financial statements and notes thereto (the 1999
Financial Statements) included in the Company's latest report on Form 10-K,
dated December 31, 1999 (the 1999 10-K). The results of operations for the three
and nine months ended September 30, 2000 are not necessarily indicative of the
results to be expected for the full year ending December 31, 2000 (2000).
The Company's ultimate success depends upon, among other factors, rapidly
expanding the geographic coverage of its network services; renegotiating
interconnection agreements with ILECs, some of which are competitors or
potential competitors of the Company; deploying network infrastructure;
developing and maintaining relationships and activities with broadband service
providers; attracting and retaining customers; accurately assessing potential
markets; continuing to develop and integrate its operational support system and
other back office systems; obtaining any required governmental authorizations;
responding to competitive developments; continuing to attract, retain and
motivate qualified personnel; continuing to be able to access financial markets,
when and as needed, on terms acceptable to the Company; and continuing to
upgrade its technologies and commercialize its network services incorporating
such technologies. There can be no assurance that the Company will be successful
in addressing these matters and failure to do so could have a material adverse
effect on the Company's business, prospects, operating results and financial
condition. The Company's significant operating losses are expected to continue,
which will require additional financing. The Company expects to secure
additional financing, in increments, from sources which may include some
combination of commercial bank borrowings, leasing vendor financings, or the
private or public sale of equity or debt securities. Future equity or debt
financings may not be available, or if available, may not be on favorable terms.
If unsuccessful in obtaining such financing, the Company may choose to reduce
the scope of its operations.
Net Loss Per Share
Basic earnings per share (EPS) is calculated by dividing the income or loss
available to common stockholders by the weighted average number of common shares
outstanding for the period without consideration for common stock equivalents.
Diluted EPS is computed by dividing the income or loss available to common
stockholders by the weighted-average number of common shares outstanding for the
period in addition to the weighted-average number of Common Stock equivalents
outstanding for the period. Shares subject to repurchase by the Company are
considered Common Stock equivalents for purposes of this calculation. Shares
issuable upon conversion of preferred stock and the exercise of outstanding
stock options and warrants and shares issued subject to repurchase by the
Company totaling 36,743,506 and 13,261,271 at September 30, 2000 and September
30, 1999, respectively, have been excluded from the computation since their
effect would be antidilutive.
Reclassifications
Certain balances in the 1999 Financial Statements have been reclassified to
conform to the 2000 presentation. The reclassifications had no effect on
financial condition, results of operations or cash flows.
8
<PAGE>
2. Accumulated Other Comprehensive Income
Accumulated other comprehensive income (loss) of ($1.6) million and $2.6
million at September 30, 2000 and December 31, 1999, respectively, is primarily
attributable to the unrealized gain (loss) on Axxent, Inc. (Axxent, formerly
known as OCI Communications Inc.) held as an available-for-sale security that is
carried at fair value with any gain (loss) recorded as a separate component of
stockholders' equity.
Assets and liabilities denominated in foreign functional currencies are
translated at the exchange rate as of the balance sheet date. Translation
adjustments are recorded as a separate component of shareholders' equity.
Revenues, costs and expenses denominated in foreign functional currencies are
translated at the weighted-average exchange rate for the period. The cumulative
translation adjustment at September 30, 2000 was $32,000 compared to none
recorded at December 31, 1999.
3. Investments
In September 2000, the Company entered into a strategic relationship with
FireTap, Inc. (FireTap), an affiliate of Homestore.com. FireTap intends to
offer digital subscriber line (DSL), internet service provider (ISP) and other
telecom services through alliances with persons in the real estate industry and
key technology providers. As part of this transaction, the Company, through its
wholly-owned subsidiary, RHOMS, Inc., acquired three percent of the shares of
FireTap's common stock (on a fully-diluted basis) in exchange for certain past
services and other non-cash consideration. The Company also received the right
to acquire up to an additional two percent of the shares of FireTap's common
stock (on a fully-diluted basis) in exchange for certain future services and
other non-cash consideration, including Catherine Hapka's (the Company's
Chairman and CEO) services as a director. In addition, over the next six
months, the Company has the right to earn up to an additional 0.1% of the shares
of FireTap's common stock (on a fully-diluted basis) for every $1.0 million of
investment accepted by FireTap from an investor that the Company identifies,
refers to or otherwise introduces to FireTap.
On June 28, 2000, the Company, through its wholly-owned subsidiary, RGarnet,
Inc. ("RGarnet"), formed a Japanese joint venture, Garnet Connections Planning
Inc. ("Garnet Connections"), with Mitsui & Co. Ltd. and certain other Japanese
partners to explore the deployment of DSL based services in Japan. RGarnet owns
3,400 shares of common stock of Garnet Connections (representing 34.34% of the
total outstanding shares of Garnet Connections), for which it paid $1.6 million.
In April 2000, the Company entered into a multiyear strategic relationship with
Excite@Home (@Home). @Home is a leading broadband provider. On July 12, 2000,
the Company, through its wholly-owned subsidiary, RATHM, Inc., purchased 473,335
shares of Series B Preferred Stock of @Home Solutions (Solutions), an affiliate
of @Home, for $14,999,986. The Series B Preferred Stock is convertible into
shares of common stock at a conversion price of $10.56 per share, subject to
standard protective conversion price adjustments. In addition, the Company is
entitled to earn warrants to purchase up to 5,250,000 shares of Solutions'
common stock, over the next four years, based upon the number of DSL subscribers
subscribing to Solutions' DSL at a price of $5.01 per share for the first
3,000,000 warrant shares and $6.44 per share for the last 2,250,000 warrant
shares. The Company is Solutions' exclusive provider of residential DSL
connectivity for @Home in several specific markets outside of @Home's current
cable footprint. The new relationship offers broadband connectivity, a custom
software package, Excite for broadband content and ISP services such as e-mail.
In January 2000, the Company formed a Canadian corporate joint venture, known as
Rhythms Canada, Inc. (Rhythms Canada) with Axxent Corp. (Axxent Corp., formerly
Optel Communications Corporation), a wholly-owned subsidiary of Axxent, to offer
DSL-based services in selected Canadian markets. The Company and Axxent Corp.
each received 100,000 shares of Class A voting stock of Rhythms Canada. Axxent
Corp. also purchased 10,000,000 shares of Series A preferred stock with a
redemption amount of US $1.00 per share for $10.0 million. The Series A
preferred stock has no voting or conversion rights, but will earn dividends at a
9
<PAGE>
rate of six percent per annum payable only upon redemption. To the extent the
joint venture is unable to receive sufficient financing through third parties,
the Company and Axxent shall have the option to provide additional capital
contributions through installments. Accounting for the joint venture is on the
equity method.
4. Senior Notes Payable and Lease Financing
In February 2000, the Company issued $300.0 million aggregate principal amount
of 14% senior notes due 2010 (the 2000 Senior Notes). The Company received net
proceeds of approximately $291.3 million from the issuance. The 2000 Senior
Notes are general unsecured obligations of the Company, mature on February 15,
2010, and are redeemable at the Company's option, in whole or in part, at any
time after February 15, 2005, at predetermined redemption prices, together with
any accrued and unpaid interest through the date of redemption. Upon a change
of control of the Company, each holder of the 2000 Senior Notes may require the
Company to purchase such notes at 101% of the principal amount thereof, plus any
accrued and unpaid interest to the date of purchase. The 2000 Senior Notes
contain restrictive covenants, including limitations on future indebtedness,
restricted payments, transactions with affiliates, liens, sale of stock of
subsidiaries, entering new lines of business, dividends, mergers and transfer of
assets.
In January and February 2000, the Company entered into a 36-month lease line for
an aggregate of up to $50.0 million in lease financing with GATX Capital
Corporation to be used for network equipment. In February 2000, the Company
entered into a 36-month lease line for $25.0 million in lease financing with
Cisco Systems Capital Corporation to be used for network equipment. At
September 30, 2000, no amounts were available under these lease lines.
5. Preferred Stock
In March 2000, the Company sold $250.0 million of 8 1/4% Series E Convertible
Preferred Stock (Series E Preferred Stock) to Hicks, Muse, Tate & Furst Inc.
(Hicks Muse). The Company received approximately $236.3 million of proceeds
from the sale. Each share of Series E Preferred Stock is convertible into
shares of Common Stock at any time at a conversion price of $37.50 per share,
subject to adjustment. In addition, the Company issued Hicks Muse warrants to
purchase (a) 1,875,000 shares of Common Stock at an exercise price of $45.00 per
share, exercisable for three years; (b) 1,875,000 shares of Common Stock at an
exercise price of $50.00 per share, exercisable for five years; and (c)
1,875,000 shares of Common Stock at an exercise price of $55.00 per share,
exercisable for seven years.
Holders of Series E Preferred Stock are entitled to vote on all matters upon
which the holders of Common Stock are entitled to vote. In addition, holders
of Series E Preferred Stock affiliated with Hicks Muse have the right to appoint
one representative to the Company's Board of Directors so long as they continue
to hold 40% of the Series E Preferred Stock originally purchased by them or the
underlying Common Stock into which such shares of Series E Preferred Stock are
convertible, or any combination of the two. In March 2000, Hicks Muse appointed
Michael J. Levitt, a partner of Hicks Muse, to the Company's Board of Directors.
Upon a change of control of the Company, each holder of Series E Preferred Stock
may require the Company to purchase any or all of its shares of Series E
Preferred Stock at 101% of the liquidation preference, plus any accrued and
unpaid dividends to the date of purchase and the special dividend amount, if
any, as defined in the Series E Preferred Stock certificate of designation. The
Series E Preferred Stock is subject to mandatory redemption on or after March
31, 2005.
In February and March 2000, the Company issued 3,000,000 shares of 6 3/4% Series
F Cumulative Convertible Preferred Stock (Series F Preferred Stock) to qualified
investors in a private placement. The Company received approximately $291.0
million of net proceeds from the sale. Each share of Series F Preferred Stock
is convertible into 2.35 shares of Common Stock at any time at a conversion
price of $42.56 per share, subject to adjustment. Holders of Series F Preferred
Stock are entitled to dividends on a cumulative basis at an annual rate
10
<PAGE>
of 6 3/4%, payable quarterly in cash. The Series F Preferred Stock is redeemable
at the Company's option, in whole or in part, at any time after March 6, 2003,
at predetermined redemption prices, together with any accrued and unpaid
dividends through the date of redemption. Upon a change of control of the
Company, each holder of Series F Preferred Stock may require the Company to
purchase any or all of its shares of Series F Preferred Stock at 100% of the
liquidation preference, plus any accrued and unpaid dividends to the date of
purchase. The Series F Preferred Stock is subject to mandatory redemption on
March 3, 2012. The holders of the Series F Preferred Stock have limited voting
rights.
6. 2000 Stock Award Plan
In May 2000, the Company adopted its 2000 Stock Award Plan (Plan), a new
incentive compensation program, providing for the direct award to employees, at
no cost, of up to 1.2 million shares of Common Stock. In July 2000, the Company
amended and restated the 2000 Stock Award Plan (the Amended Plan) to increase
(a) the maximum number of shares of Common Stock available for grant under the
Amended Plan by 1,800,000 shares, from 1,200,000 shares to 3,000,000 shares, and
(b) increase the maximum number of stock award shares that may be granted to any
employee in any calendar year under the Amended Plan by 270,000 shares, from
30,000 shares to 300,000 shares. On June 27, 2000, the Company granted 417,850
shares of Common Stock under the Plan. In July 2000, these grants were
cancelled and replaced by awards under the amended plan with substantially the
same terms. The new grants vest in two tranches, with 50% at various times
beginning in November 2000 continuing through May of 2001. The remaining 50%
vest ratably over the subsequent four quarters. As of September 30, 2000, the
Company has awarded approximately 1,814,216 shares under the Plan to more than
700 employees.
7. Subsequent Events
In October 2000, the Company entered into a strategic relationship with Winfire,
Inc., a single-source provider of broadband internet access. As part of that
transaction, the Company's wholly-owned subsidiary, Rhythms Winfire, Inc.,
purchased 2,659,575 shares of Series C preferred stock for $5.0 million. The
Series C preferred stock is convertible into shares of Winfire common stock at a
conversion price of $1.88 per share, subject to standard protective conversion
price adjustments.
In October 2000, the Company contributed all of its Axxent stock, consisting of
763,680 shares of common stock of Axxent, to the equity capital of the Company's
wholly-owned subsidiary, RAxxent, Inc.
In October 2000, the joint venture agreement forming Rhythms Canada was amended
to add the Company's wholly-owned subsidiary, RCanada, Inc. (RCanada), as a
party to that agreement. In addition, the Company contributed all of its
Rhythms Canada stock, consisting of 100,000 shares of Class A voting stock, to
the equity capital of RCanada.
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ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
All statements contained herein, as well as statements made in press releases
and oral statements that may be made by the Company or its officers, directors,
or employees acting on its behalf, that are not statements of historical fact
constitute "Forward-Looking Statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors that
could cause the actual results of the Company to be materially different from
historical results or from any future results expressed or implied by such
forward-looking statements and risk factors described from time to time in the
Company's reports filed with the Securities and Exchange Commission (the SEC).
In addition to statements that explicitly describe such risks and uncertainties,
readers are urged to consider statements that include the terms "believe",
"belief", "expects", "plans", "anticipates", "intends" or the like to be
uncertain and forward-looking. Forward-looking statements also include
projections of financial performance, statements regarding management's plans
and objectives and statements concerning any assumptions relating to the
foregoing. All references herein to (1) "1999" are to the fiscal year ended
December 31, 1999, (2) "2000" are to the fiscal year ending December 31, 2000,
(3) "Q1" are to the fiscal quarter ended March 31, 2000, (4) "Q2" are to the
fiscal quarter ended June 30, 2000, and (5) "Q3" are to the fiscal quarter ended
September 30, 2000.
General
The Company is a leading service provider of DSL-based broadband communication
services to businesses and consumers. The Company began offering commercial
services in the United States (U.S.) in April 1998. As of September 30, 2000,
the Company offered services in 60 markets and 97 of the 314 Metropolitan
Statistical Areas (MSAs) in the U.S., and its national DSL network passed
approximately 44 million homes and businesses in the U.S. As of September 30,
2000, the Company had 46,000 subscriber lines in service and 1,750 operational
central offices in the U.S. The Company expects its network build will be
substantially complete by the end of 2000 with approximately 1,900 operational
central offices in the U.S.
Results of Operations
The Company derives a majority of its revenue from broadband local connection
services, metropolitan area inter-network connection services and installation.
For broadband local connection services, customers are billed a flat, monthly
recurring charge based on the data transfer speeds selected by the end user.
Broadband local connection services customers are billed for nonrecurring
service activation and installation charges on each line. Metropolitan area
internetwork connection services are billed at a fixed, monthly recurring charge
and nonrecurring charge to each customer for the high-speed connection between
the Company's Metro Service Center and the customer's router or switch. The
Company expects that, as a result of competitive forces and evolving service
offerings from the Company's competitors, its prices will decline over time. The
Company expects that the mix of services its customers purchase will change from
time to time and that a mix more heavily weighted toward the lower priced
services would reduce the average revenue per end-user subscriber.
Revenue
Revenue for the three months ended September 30, 2000 increased to $17.2 million
from $3.3 million in the same period in 1999, an increase of $13.9 million.
Revenue for the nine months ended September 30, 2000, increased to $37.5 million
from $5.6 million in the same period in 1999, an increase of $31.9 million. Net
monthly recurring service fees totaled $12.8 million and $28.0 million for the
three and nine months ended September 30, 2000, respectively, compared to $2.2
million and $3.6 million for the same periods in 1999. Nonrecurring net
installation revenue totaled $4.4 million and $9.5 million for the three and
nine months ended
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September 30, 2000, respectively, compared to $1.2 million and $2.3 million for
the same periods in 1999. The significant increase in revenue for the three and
nine months ended September 30, 2000 compared to the same periods in 1999 is a
result of increased subscriber growth and network deployment in 58 markets
compared to 27 markets one year ago.
Network and Service Costs
Network and service costs for the three and nine months ended September 30, 2000
were $62.4 million and $153.3 million, respectively, compared to $21.8 million
and $40.0 million for the same periods in 1999. The increase in network and
service costs is attributable to the expansion of the Company's network and
continued growth in its subscriber base.
Selling, Marketing, General and Administrative
Selling, marketing, general and administrative expenses for the three and nine
months ended September 30, 2000 were $71.5 million and $198.6 million,
respectively, compared to $27.7 million and $62.2 million for the same periods
in 1999. This increase reflects continued growth in staffing levels, sales and
marketing efforts, and legal expenses associated with the development and launch
of new markets, service delivery and customer service efforts.
Depreciation and Amortization
Depreciation and amortization for the three and nine months ended September 30,
2000 was $12.2 million and $32.7 million compared to $4.0 million and $6.1
million for the same periods in 1999. This increase reflects the rapid expansion
of the Company's network into 60 markets in the U.S. at September 30, 2000, a
115% increase compared to the 27 markets at September 30, 1999.
During the first and second quarters of 1999, the Company entered into strategic
arrangements with Microsoft Corp. and Qwest Communications International Inc.
In addition to their investments in the Company totaling $45.0 million, the
strategic arrangements provide for certain other business relationships.
Combined, these business relationships were valued at $23.2 million and have
been capitalized as deferred assets, which are being amortized over three- and
five-year periods. For the three and nine months ended September 30, 2000, $1.6
million and $4.7 million, respectively, in amortization for deferred business
acquisition costs were recorded compared to $1.6 million and $3.2 million for
the same periods in 1999.
Deferred Compensation
Deferred compensation expense increased to $2.9 million and $6.4 million for the
three and nine months ended September 30, 2000, respectively, compared to $1.0
million and $2.5 million for the same periods in 1999. This increase reflects
the granting of stock and stock options to employees and officers with prices
below the per share fair market values of the Company's common stock on the
grant dates. The deferred compensation is amortized over the vesting period of
such grants.
Net Interest Income and Expense
Interest income during the three and nine months ended September 30, 2000 was
$14.2 million and $38.4 million, respectively, compared to $7.3 million and
$15.7 million for the same periods in 1999. The increase is primarily
attributable to an increase in invested cash balances. As of September 30,
2000, unrestricted cash and investments totaled $670.2 million compared to
$444.9 million at September 30, 1999. The increase in invested cash balances
resulted from a variety of financing activities, including:
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. issuing common stock in a secondary public offering in September 1999 for
net cash proceeds of $16.4 million;
. issuing 2000 Senior Notes in February 2000 for net cash proceeds of $291.3
million; and
. issuing shares of Series E Preferred Stock and Series F Preferred Stock and
warrants in Q1 for net cash proceeds totaling $526.7 million.
Interest expense and amortized debt discount and issue costs increased to $28.1
million and $77.9 million, respectively, for the three and nine months ended
September 30, 2000 as compared to $16.5 million and $35.9 million for the same
periods in 1999. This increase primarily resulted from the 2000 Senior Notes
issued in February 2000.
Litigation Settlement
See the discussion of the resolution of the Lafleur litigation in PART II, ITEM
1 LEGAL PROCEEDINGS below.
Liquidity and Capital Resources
The development and expansion of the Company's business requires substantial
capital expenditures. These capital expenditures primarily include network
build costs such as the procurement, design and construction of connection
points and one or two Metro Service Center locations in each market, as well as
other costs that support the network design and development. Capital
expenditures, including payments for collocation fees, were $124.5 million
during the nine months ended September 30, 2000.
During the first nine months of 2000, the Company has raised additional
financing from the following:
. issuing 2000 Senior Notes in February 2000 for net cash proceeds of $291.3
million;
. issuing Series E Preferred Stock and Series F Preferred Stock and warrants
in Q1 for net cash proceeds totaling $526.7 million; and
. obtaining equipment lease lines of $100.0 million.
Please refer to Notes 4 and 5 of the Notes to Consolidated Financial Statements
included herein for the terms and descriptions of these transactions.
The Company has substantial indebtedness and debt service obligations. At
September 30, 2000, total indebtedness was $825.4 million, cash and investments
totaled $748.0 million ($77.8 million of which is restricted in accordance with
the terms of the Company's 1999 senior notes), and the accumulated deficit was
$246.2 million.
For the nine months ended September 30, 2000 and September 30, 1999, net cash
used in operating activities was $370.4 million and $78.9 million, respectively.
This cash was used for a variety of operating purposes, including salaries,
consulting and legal expenses, network operations and overhead expenses. The
increase in the use of cash for the nine months ended September 30, 2000
compared to the same period one year ago is primarily attributable to the
increased net loss.
Net cash used for investing activities for the nine months ended September 30,
2000 and September 30, 1999 was $498.2 million and $311.1 million, respectively.
This cash was used primarily for purchases of short-term investments and
equipment and payments of collocation fees.
Net cash provided by financing activities for the nine months ended September
30, 2000 and September 30, 1999 was $821.4 million and $642.4 million,
respectively, and resulted primarily from the issuance of preferred stock,
Common Stock, and senior debt.
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The Company's capital requirements may vary (1) based upon the timing and
success of the network rollout, (2) as a result of regulatory, technological and
competitive developments, or (3) if:
. demand for the Company's services or its anticipated cash flow from
operations is less or more than expected;
. development plans or projections change or prove to be inaccurate;
. the Company engages in any acquisitions; or
. network services deployment is accelerated or the schedule or targets of
the rollout plan are otherwise altered.
The Company believes that its cash and investment balances as of September 30,
2000, and anticipated future revenue generated from operations and lease
financing proceeds, will be sufficient to fund its operating losses, capital
expenditures, lease payments and interest payments through approximately
December 2001. Significant operating losses are expected to continue, which will
require additional financing. The Company expects to secure additional
financing, in increments, from sources which may include some combination of
commercial bank borrowings, leasing, vendor financings, or the private or public
sale of equity or debt securities. Future equity or debt financings may not be
available or, if available, may not be on favorable terms. If the Company is
unable to obtain financing in the future, it may choose to reduce the scope of
its operations.
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
Lafleur Litigation - See Part II Other Information, Item 1 Legal Proceedings in
the Quarterly Report on Form 10-Q for Q2 (Q2 10Q) for the background information
concerning the Lafleur Litigation and the terms of the settlement thereof which
occurred in Q1. The Company has filed claims with its insurance carriers
seeking reimbursement for litigation and legal fees relating to this case. As
of September 30, 2000, the Company has been received $10.8 million.
i2 Technologies, Inc. Litigation - See Part II Other Information, Item 1 Legal
Proceedings in the 2Q 10Q for background information concerning the i2
Technologies, Inc. Litigation. There have been no new developments with respect
to this matter since the filing of the 1999 10-K.
Other Proceedings -The Company is subject to state commission, Federal
Communications Commission and court decisions as they relate to the
interpretation and implementation of the 1996 Telecommunications Act, the
interpretation of competitive carrier interconnection agreements in general and
its interconnection agreements in particular. In some cases, the Company may be
deemed to be bound by the results of ongoing proceedings of these bodies. The
Company, therefore, may participate in proceedings before these regulatory
agencies or judicial bodies that affect, and allow the Company to advance its
business plans.
The Company is presently pursuing public utility commission arbitrations in
order to establish the terms and conditions of line sharing, against Verizon in
New York, Pennsylvania, Maryland, California, and Texas, and against SBC in
California, Texas, and Illinois. These interconnection agreements and the
results of any arbitrations may not be on terms that are entirely satisfactory
to the Company.
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ITEM 2 SECURITIES AND USE OF PROCEEDS
Amended and Restated Stock Award Plan - In May 2000, the Company adopted the
2000 Stock Award Plan (Plan). In July 2000, the Company amended and restated
the Plan (Amended Plan). Under the Amended Plan, the Company is permitted to
make direct grants of Common Stock, at no cost, to selected employees of the
Company. The Company reserved for issuance under the Amended Plan, 3,000,000
shares of Common Stock. The Amended Plan is administered by the Special Stock
Committee of the Board of Directors of the Company (Plan Committee). The Plan
Committee has complete and total authority to determine those employees of the
Company eligible to receive an award under the Amended Plan and the vesting
schedule, if any, applicable to each award made under the Amended Plan. The
maximum number of shares of common stock, which can be awarded to any one
employee in any calendar year, is 300,000. The Company has registered all of
these shares on Registration Statements, Form S-8, which became effective in
June and July 2000. As of September 30, 2000, the Company has awarded
approximately 1,814,216 shares under the Plan to more than 700 employees.
Issuance of Shares of Common Stock to Randal Shaneyfelt - In May 2000, the
Company hired Randal Shaneyfelt as Senior Vice President, Customer Operations.
Pursuant to his employment offer letter, the Company gave Mr. Shaneyfelt
$2,000,000 worth of Common Stock, at a purchase price of $0.00 per share. The
Company delivered 25% of the shares, or 41,667 shares of Common Stock, to Mr.
Shaneyfelt on July 31, 2000. Another 50% of the shares of Common Stock were to
be delivered to Mr. Shaneyfelt in October 2000 (the October Installment). The
remaining 25% of the shares of Common Stock will be delivered to Mr. Shaneyfelt
in April 2001. The first 41,667 shares of Common Stock delivered to Mr.
Shaneyfelt were registered on Registration Statement, Form S-8, which became
effective in July 2000. The Company, with Mr. Shaneyfelt's consent, paid Mr.
Shaneyfelt $1.0 million in lieu of and as payment in full for his October
Installment.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ITEM 5 OTHER INFORMATION
In the third quarter of 1999, Catherine Hapka, the Chairman and Chief Executive
Officer of the Company, established a program to sell 200,000 shares of her
Common Stock in each of the four quarterly selling windows each year. Ms. Hapka
terminated this program as of November 1, 2000.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
Exhibit
Number Description
------ -----------
10.1 Series B Preferred Stock Purchase Agreement, dated July 12, 2000, by
and between At Home Network Solutions, Inc., RATHM, Inc. and other
Investors signatory hereto.
10.2 Consent and Amendment, dated October 2, 2000, by and between the
Company, Rhythms Links Inc., RAxxent, Inc., RCanada, Inc., Axxent
Corp. and Rhythms Canada Inc.
27 Financial Data Schedule
Reports on Form 8-K
-------------------
None
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RHYTHMS NETCONNECTIONS INC.
SIGNATURE
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.
Date: November 14, 2000 /s/ J.W. Braukman
-----------------------
J.W. Braukman
Chief Financial Officer
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