<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: JUNE 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 August 9, 2000, a total of 79,005,149 shares of the Registrant's Common
Stock, $0.001 par value, were issued and outstanding.
<PAGE>
RHYTHMS NETCONNECTIONS INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements
<S> <C>
Consolidated Balance Sheets as of December 31, 1999 and
June 30, 2000 (unaudited) 3
Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 1999 and 2000 (unaudited) 4
Consolidated Statements of Comprehensive Income (Loss) for the Three
and Six Months Ended June 30, 1999 and 2000 (unaudited) 5 - 6
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 1999 and 2000 (unaudited) 7
Consolidated Statements of Stockholder's Equity for the Six Months
Ended June 30, 2000 (unaudited) 8
Notes to Consolidated Financial Statements (unaudited) 9 - 12
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 16
ITEM 2 Changes in Securities and Use of Proceeds 16 - 17
ITEM 3 Defaults Upon Senior Securities 17
ITEM 4 Submission of Matters to a Vote of Security Holders 17
ITEM 5 Other Information 18
ITEM 6 Exhibits and Reports on Form 8-K 18
SIGNATURES 19
</TABLE>
2
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
December 31, June 30,
ASSETS 1999 2000
---------------------------------------------------------------------------------------------------------------------------
Current assets: (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 48,247 $ 9,966
Short-term investments 292,008 872,473
Restricted cash 36,707 37,614
Accounts, loans, interest, and other receivables, net 10,844 28,892
Inventory 4,071 8,243
Prepaid expenses and other current assets 8,460 17,589
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Total current assets 400,337 974,777
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Equipment and furniture, net 124,831 163,947
Collocation fees, net 57,421 77,048
Restricted cash 59,526 40,383
Deferred business acquisition costs, net of accumulated amortization of $4,765 and $7,890 18,425 15,300
Deferred debt issue costs, net of accumulated amortization of $924 and $1,452 16,194 24,636
Other assets 8,690 10,303
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TOTAL ASSETS $ 685,424 $ 1,306,394
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LIABILITIES AND STOCKHOLDERS' EQUITY
---------------------------------------------------------------------------------------------------------------------------
Current liabilities:
Current portion of long-term debt $ 333 $ 277
Accounts payable 30,895 26,705
Interest payable 8,787 24,537
Accrued expenses and other current liabilities 23,163 46,182
---------------------------------------------------------------------------------------------------------------------------
Total current liabilities 63,178 97,701
Long-term debt 111 -
Senior notes payable 505,696 818,500
Other liabilities 110 38
---------------------------------------------------------------------------------------------------------------------------
Total liabilities 569,095 916,239
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Mandatorily redeemable common stock warrants 42 42
Mandatorily redeemable preferred stock - 477,199
---------------------------------------------------------------------------------------------------------------------------
Stockholders' equity (deficit):
Common stock, $0.001 par value; 250,000,000 shares authorized;
78,255,707 shares issued as of 1999 and 78,952,132 as of 2000 78 79
Treasury stock, at cost; 988,894 shares as of 1999 and 803,446 as of 2000 (469) (654)
Additional paid-in capital 373,604 373,511
Warrants 10,397 74,373
Deferred compensation (12,320) (14,215)
Accumulated deficit (257,636) (520,386)
Accumulated comprehensive income 2,633 206
---------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 116,287 (87,086)
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 685,424 $ 1,306,394
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
---------------------------------
1999 2000
------------------------------------------------------------------------------------------------------------------
(unaudited)
Revenue:
<S> <C> <C>
Service and installation, net $ 1,641 $ 12,172
------------------------------------------------------------------------------------------------------------------
Operating Expenses:
Network and service costs 12,033 50,975
Selling, marketing, general and administrative 21,349 67,473
Depreciation and amortization 1,493 11,104
Amortization of deferred business acquisition costs 1,521 1,563
Deferred compensation 974 1,690
------------------------------------------------------------------------------------------------------------------
Total operating expenses 37,370 132,805
------------------------------------------------------------------------------------------------------------------
Loss from operations (35,729) (120,633)
------------------------------------------------------------------------------------------------------------------
Other Income (Expense):
Interest income 6,579 15,978
Interest expense (including amortized debt
discount and issue costs) (13,744) (27,647)
Litigation settlement - (7,390)
Other income 37 35
------------------------------------------------------------------------------------------------------------------
Total other income (expense) (7,128) (19,024)
------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
Net Loss $ (42,857) $ (139,657)
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Preferred stock dividends and accretion - 11,675
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Net Loss Available to Common Shareholders $ (42,857) $ (151,332)
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Net Loss Per Common Share:
Basic $ (0.68) $ (2.00)
------------------------------------------------------------------------------------------------------------------
Diluted $ (0.68) $ (2.00)
------------------------------------------------------------------------------------------------------------------
Weighted Average Common Shares Outstanding:
Basic 62,878,429 75,727,219
------------------------------------------------------------------------------------------------------------------
Diluted 62,878,429 75,727,219
------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------------------
1999 2000
-------------------------------------------------------------------------------------------------------------------
(unaudited)
Revenue:
<S> <C> <C>
Service and installation, net $ 2,300 $ 20,309
-------------------------------------------------------------------------------------------------------------------
Operating Expenses:
Network and service costs 18,170 90,869
Selling, marketing, general and administrative 34,543 127,121
Depreciation and amortization 2,144 20,504
Amortization of deferred business acquisition costs 1,652 3,126
Deferred compensation 1,575 3,499
-------------------------------------------------------------------------------------------------------------------
Total operating expenses 58,084 245,119
-------------------------------------------------------------------------------------------------------------------
Loss from operations (55,784) (224,810)
-------------------------------------------------------------------------------------------------------------------
Other Income (Expense):
Interest income 8,329 24,252
Interest expense (including amortized debt
discount and issue costs) (19,372) (49,811)
Litigation settlement - (7,390)
Other income 72 71
-------------------------------------------------------------------------------------------------------------------
Total other income (expense) (10,971) (32,878)
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
Net Loss $ (66,755) $ (257,688)
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Preferred stock dividends and accretion - 14,284
-------------------------------------------------------------------------------------------------------------------
Net Loss Available to Common Shareholders $ (66,755) $ (271,972)
-------------------------------------------------------------------------------------------------------------------
Net Loss Per Common Share:
Basic $ (1.97) $ (3.62)
-------------------------------------------------------------------------------------------------------------------
Diluted $ (1.97) $ (3.62)
-------------------------------------------------------------------------------------------------------------------
Weighted Average Common Shares Outstanding:
Basic 33,820,672 75,060,990
-------------------------------------------------------------------------------------------------------------------
Diluted 33,820,672 75,060,990
-------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE>
RHYTHMS NETCORHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ -------------------------------
1999 2000 1999 2000
------------------------------------------------------------------------------------- -------------------------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net Loss $ (42,857) $ (139,657) $ (66,755) $ (257,688)
Cumulative translation adjustment - 13 - 18
Loss on available-for-sale securities - (4,618) - (2,445)
------------------------------------------------------------------------------------- -------------------------------
Total comprehensive loss $ (42,857) $ (144,262) $ (66,755) $ (260,115)
------------------------------------------------------------------------------------- -------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
6
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------------------
1999 2000
-----------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities: (unaudited)
<S> <C> <C>
Net loss $ (66,755) $ (257,688)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization of equipment, furniture, and collocation fees 2,144 20,504
Amortization of deferred business acquisition costs 1,652 3,126
Amortization of debt discount and deferred debt issue costs 11,515 13,332
Amortization of deferred compensation 1,575 3,499
Other (70) (72)
Changes in assets and liabilities:
Increase in accounts, loans, interest, and other receivables, net (4,165) (18,048)
Increase in inventory (1,077) (4,172)
Increase in prepaid expenses and other current assets (398) (9,130)
Increase in other assets (308) (1,613)
Decrease in accounts payable (3,521) (15,751)
Increase in interest payable 7,827 15,750
Increase in accrued expenses and other current liabilities 5,610 23,052
Increase in other liabilities 71 -
-----------------------------------------------------------------------------------------------------------------
Net cash used for operating activities (45,900) (227,211)
-----------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchases of short-term investments (168,839) (5,405,612)
Maturities of short-term investments 65,494 4,825,147
Maturities (purchases) of government securities as restricted cash (113,211) 18,236
Investment in common stock - (2,427)
Purchases of equipment and furniture (61,509) (56,289)
Payments of collocation fees (26,223) (22,958)
-----------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (304,288) (643,903)
-----------------------------------------------------------------------------------------------------------------
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) (8,970)
Repayments of long-term debt (194) (167)
Proceeds from issuance of common stock 229,476 3,939
Proceeds from issuance of preferred stock and warrants 75,000 526,655
Payments of equity issue costs (16,490) -
Bank overdraft - 11,561
Purchase of treasury stock (2) (185)
-----------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 626,056 832,833
-----------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents 275,868 (38,281)
Cash and cash equivalents at beginning of period 21,315 48,247
-----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 297,183 $ 9,966
-----------------------------------------------------------------------------------------------------------------
Supplemental schedule of cash flow information:
Cash paid for interest $ 30 $ 20,736
-----------------------------------------------------------------------------------------------------------------
Supplemental schedule of non-cash financing activities:
Equipment and furniture purchases payable $ 25,786 $ 4,063
Business acquisition costs from issuance of preferred stock and warrants $ 23,040 $ -
-----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
7
<PAGE>
RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
<TABLE>
<CAPTION>
Common Stock Treasury Stock Additional
$0.001 par value at Cost Paid-In
------------------------- -----------------------
Shares Amount Shares Amount Capital
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1999 78,255,707 $ 78 988,894 $ (469) $ 373,604
Issuance of common stock upon exercise of
options for cash 259,656 - - - 776
Issuance of treasury stock upon settlement
of litigation - - (438,115) - 89
Issuance of Series E preferred stock
warrants for cash - - - - -
Costs arising from issuance of Series E and
F preferred stock - - - - (236)
Purchase of treasury stock for cash - - 252,667 (185) -
Accrued Series E and F preferred stock dividends - - - - (12,786)
Accretion of Series E and F preferred stock - - - - (1,498)
Stock issuance under employee stock
purchase plan 173,079 - - - 3,073
Deferred compensation from grants of common stock - - - - 5,773
Amortization of deferred compensation - - - - -
Reversal of deferred compensation from
cancellation of grants to purchase
common stock - - - - (346)
Series F preferred stock dividend paid 263,690 1 - - 5,062
Net loss - - - - -
Cumulative translation adjustment - - - - -
Unrealized loss on available-for-sale
securities - - - - -
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Balance at June 30, 2000 (unaudited) 78,952,132 $ 79 803,446 $ (654) $ 373,511
------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Accumulated
Other Total
Deferred Accumulated Comprehensive Stockholders'
Warrants Compensation Deficit Income Equity (Deficit)
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1999 $ 10,397 $ (12,320) $ (257,636) $ 2,633 $ 116,287
Issuance of common stock upon exercise of
options for cash - - - - 776
Issuance of treasury stock upon settlement
of litigation - - - - 89
Issuance of Series E preferred stock
warrants for cash 63,976 - - - 63,976
Costs arising from issuance of Series E and
F preferred stock - - - - (236)
Purchase of treasury stock for cash - - - - (185)
Accrued Series E and F preferred stock dividends - - - - (12,786)
Accretion of Series E and F preferred stock - - - - (1,498)
Stock issuance under employee stock
purchase plan - - - - 3,073
Deferred compensation from grants of
common stock - (5,773) - - -
Amortization of deferred compensation - 3,532 - - 3,532
Reversal of deferred compensation from
cancellation of grants to purchase
common stock - 346 - - -
Series F preferred stock dividend paid - - (5,062) - 1
Net loss - - (257,688) - (257,688)
Cumulative translation adjustment - - - 18 18
Unrealized loss on available-for-sale
securities - - - (2,445) (2,445)
------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2000 (unaudited) $ 74,373 $ (14,215) $ (520,386) $ 206 $ (87,086)
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
8
<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, and Rhythms NetConnections
Europe B.V., Rhythms Deutschland GmbH, RGarnet, 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 has been 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 six months ended June 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; entering into
interconnection agreements with ILECs, some of which are competitors or
potential competitors of the Company; deploying network infrastructure;
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. As the Company continues the development of its business, it will
seek additional sources of financing to fund its development. If unsuccessful in
obtaining such financing, the Company will continue expansion of its operations
on a reduced scale based on its existing capital resources.
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, $0.001 par
value per share, of the Company (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 34,848,936 and
15,931,733 at June 30, 2000 and June 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.
9
<PAGE>
2. Accumulated Other Comprehensive Income
Accumulated other comprehensive income of $206,000 and $2.6 million at June 30,
2000 and December 31, 1999, respectively, is attributable to the unrealized gain
on Axxent Corp. held as an available-for-sale security that is carried at fair
value and 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 June 30, 2000 was $18,000 compared to none recorded at
December 31, 1999.
3. Investments
On June 28, 2000, the Company, through its new 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 digital subscriber line (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 a residential DSL
connectivity for @Home in several specific markets outside of @Home's current
cable footprint. @Home is a preferred internet service provider (ISP) for new
consumers in those markets. 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 with
Axxent Corp. (Axxent) (formerly Optel Communications Corporation), a wholly-
owned subsidiary of Axxent Inc. (formerly OCI Communications Inc.), to offer
DSL-based services in selected Canadian markets. The Company and Axxent each
received 100,000 shares of Class A voting stock. Axxent 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 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 Company received net proceeds of
approximately $291.3 million from the issuance. The 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 senior notes may require the Company to purchase
the notes at 101% of the principal amount thereof, plus any accrued and unpaid
interest to the date of purchase. The senior notes contain
<PAGE>
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 June 30,
2000, $52 million was 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. 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 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
<PAGE>
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.
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, and (2) "2000" are to the fiscal year ending December 31,
2000 (3) "Q1" are to the fiscal quarter ended March 31, 2000, and (4) "Q2" are
to the fiscal quarter ended June 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 June 30, 2000, the
Company offered services in 55 markets and 92 of the 314 Metropolitan
Statistical Areas (MSAs) in the U.S., and its national DSL network passed
approximately 41.0 million homes and businesses. The Company intends to continue
its network rollout into an additional 15 markets and an additional 16 MSAs by
the end of 2000. As of June 30, 2000, the Company had 31,100 subscriber lines in
service and 1,530 operational central offices.
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 its evolving service
offerings, 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 June 30, 2000 increased to $12.2 million from
$1.6 million in the same period in 1999, an increase of $10.6 million. Revenue
for the six months ended June 30, 2000, increased to
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$20.3 million from $2.3 million in the same period in 1999, an increase of $18.0
million. Net monthly recurring service fees totaled $9.1 million and $15.2
million for the three and six months ended June 30, 2000, respectively, compared
to $1.0 million and $1.4 million for the same periods in 1999. Nonrecurring net
installation revenue totaled $3.4 million and $5.4 million for the three and six
months ended June 30, 2000, respectively, compared to $0.8 million and $1.1
million for the same periods in 1999. The significant increase in revenue for
the three and six months ended June 30, 2000 compared to the same periods in
1999 is a result of increased subscriber growth and network deployment in 55
markets compared to 17 markets one year ago.
Network and Service Costs
Network and service costs for the three and six months ended June 30, 2000 were
$51.0 million and $90.9 million, respectively, compared to $12.0 million and
$18.2 million for the same periods in 1999. The increase in network and service
costs is attributable to the expansion of the Company's network.
Selling, Marketing, General and Administrative
Selling, marketing, general and administrative expenses for the three and six
months ended June 30, 2000 were $67.5 million and $127.1 million, respectively,
compared to $21.3 million and $34.5 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.
Depreciation and Amortization
Depreciation and amortization for the three and six months ended June 30, 2000
was $11.1 million and $20.5 million compared to $1.5 million and $2.1 million
for the same periods in 1999. This increase reflects the rapid expansion of the
Company's network into 55 markets at June 30, 2000, a 224% increase compared to
17 markets at June 30, 1999. Depreciation and amortization is expected to
continue to increase in the future as the Company continues to expand its
network.
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 six months ended June 30, 2000, $1.6
million and $3.1 million, respectively, in amortization for deferred business
acquisition costs were recorded compared to $1.5 million and $1.7 million for
the same periods in 1999.
Deferred Compensation
Deferred compensation expense increased to $1.7 million and $3.5 million for the
three and six months ended June 30, 2000, respectively, compared to $1.0 million
and $1.6 million for the same periods in 1999. This increase reflects the
granting of stock options to employees and officers with per share exercise
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 stock options.
Net Interest Income and Expense
Interest income during the three and six months ended June 30, 2000 was $16.0
million and $24.3 million, respectively, compared to $6.6 million and $8.3
million for the same periods in 1999. The increase is primarily attributable to
an increase in invested cash balances. As of June 30, 2000, unrestricted cash
and investments
<PAGE>
totaled $882.4 million compared to $516.0 million at June 30, 1999. The increase
in invested cash balances resulted from a variety of financing activities,
including:
. issuing Series C and Series D Preferred Stock (all of which converted into
Common Stock in the IPO, as defined below) and warrants for cash proceeds
totaling $75.0 million in March and April 1999;
. issuing Common Stock in the initial public offering (IPO) in April 1999 for
net cash proceeds of $210.1 million;
. issuing 12 3/4% senior debt in April 1999 for net cash proceeds of $314.5
million;
. obtaining equipment lease lines of $100.0 million in 1998 and 1999, and an
additional $75.0 million in Q1;
. issuing common stock in a secondary public offering in September 1999 for net
cash proceeds of $16.4 million;
. issuing 14% senior debt in February 2000 for net cash proceeds of $291.3
million; and
. issuing shares of 8 1/4% Series E Convertible Preferred Stock (Series E
Preferred Stock), and 6 3/4% Series F Cumulative Convertible Preferred Stock
(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 $27.6
million and $49.8 million, respectively, for the three and six months ended June
30, 2000 as compared to $13.7 million and $19.4 million for the same periods in
1999. This increase primarily resulted from the senior notes issued in April
1999 and March 2000.
Litigation Settlement
See the discussion of the resolution of the Lafleur litigation in PART II, ITEM
1 LEGAL PROCEEDING 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 $79.2 million during
the six months ended June 30, 2000.
During the first six months of 2000, the Company has raised additional financing
from the following:
. issuing 14% senior debt in February 2000 for net cash proceeds of $291.3
million;
. issuing Series E and Series F Preferred Stock and warrants in Q1 for net cash
proceeds totaling $526.7 million; and
. obtaining equipment lease lines of $75.0 million.
Please refer to Note 4 and 5 of the Notes to Consolidated Financial Statements
for the terms and descriptions of these transactions.
<PAGE>
The Company has substantial indebtedness and debt service obligations. At June
30, 2000, total indebtedness was $818.8 million, cash and investments totaled
$960.4 million ($78.0 million of which is restricted in accordance with the
terms of the 1999 senior notes), and the accumulated deficit was $520.4 million.
For the six months ended June 30, 2000 and June 30, 1999, net cash used in
operating activities was $227.2 million and $45.9 million, respectively. This
cash was used for a variety of operating purposes, including salaries,
consulting and legal expenses, network operations and overhead expenses.
Net cash used for investing activities for the six months ended June 30, 2000
and June 30, 1999 was $643.9 million and $304.3 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 six months ended June 30, 2000
and June 30, 1999 was $832.8 million and $626.1 million, respectively, and
resulted primarily from the issuance of preferred stock, Common Stock, and
senior debt.
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 June 30, 2000,
and anticipated future revenue generated from operations, will be sufficient to
fund its operating losses, capital expenditures, lease payments and interest
payments through approximately December 2001. Operating losses and capital
expenditures are expected to increase substantially in the near-term, primarily
due to network expansion. Significant additional financing is expected to be
required in the future. The Company may attempt to raise financing through 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 will continue the
expansion of operations on a reduced scale based on the existing capital
resources.
<PAGE>
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
Lafleur Litigation - On February 18, 1999, the Company filed a complaint for
declaratory relief in San Diego County Superior Court, North County against
Thomas R. Lafleur, seeking a determination as to the ownership of 438,115 shares
of the Company's stock option shares previously granted to him. The trial in
this matter began on May 5, 2000. On June 2, 2000, the court entered a
Stipulated Statement of Decision holding that Thomas R. Lafleur became fully
vested in ownership of the 438,115 shares of Common Stock in question on June 5,
1998. On June 3, 2000, the Company entered into an Agreement of Settlement and
Compromise, pursuant to which the Lafleurs agreed to release and dismiss, with
prejudice, all of their claims against the Company and the Company agreed to
deliver 438,115 shares of treasury stock and to make a cash payment of $8.8
million to the Lafleurs. In addition, the Company incurred legal fees relating
to this litigation totaling $3.1 million. The Company has filed claims with its
insurance carriers seeking reimbursement for litigation and legal fees relating
to this case. As of June 30, 2000, the Company has been reimbursed for $4.5
million.
i2 Technologies, Inc. Litigation - On January 7, 2000, i2 Technologies, Inc.,
filed suit in the United States District Court in the Northern District of
Texas, challenging the Company's use of the name "Rhythms" on various grounds
and alleging that the Company's use of that name infringes certain trademarks
owned by i2 Technologies. See the disclosure regarding this matter in the
Company's 1999 10-K. 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 Bell
Atlantic in New York, Pennsylvania, and Maryland, against SBC in California,
Texas, and Illinois, against Bell South in Georgia and Florida, and against GTE
in California, Texas and Florida. These interconnection agreements and the
results of any arbitrations may not be on terms that are entirely satisfactory
to the Company.
ITEM 2 SECURITIES AND USE OF PROCEEDS
Series E Preferred Stock - In March 2000, the Company sold $250.0 million of
Series E Preferred Stock to Hicks, Muse, Tate & Furst Inc. (Hicks Muse) in a
private placement. 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 to 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 or
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
<PAGE>
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. The Series E Preferred Stock is subject to mandatory redemption on or
after March 31, 2005.
Series F Preferred Stock - In February and March 2000, the Company issued
3,000,000 shares of 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 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.
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.
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 will be
delivered to Mr. Shaneyfelt in October 2000. 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.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting on May 5, 2000. At the annual meeting, the
Company's security holders voted to elect two directors, Keith B. Geeslin and
Edward J. Zander, to serve for three-year terms ending in the year 2003 or until
their successors are duly elected and qualified. In addition, the Company's
security holders voted to increase the number of shares of preferred stock
authorized for issuance by an additional 5,000,000 shares to a total of
10,000,000 shares of preferred stock. The Company's security holders ratified
the appointment of PricewaterhouseCoopers LLP as independent auditors of the
Company for 2000.
<PAGE>
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. Under the
Company's Insider Trading Policy, employees of the Company are permitted to sell
stock of the Company only during quarterly selling windows (as announced from
time to time by the Company), which correspond with the public release of the
Company's quarterly financial results (Selling Window). Since establishment of
the program in 1999, Ms. Hapka has consistently followed this quarterly share
distribution. The sales of the Common Stock will comply with volume restrictions
imposed by Rule 144 of the Securities Act of 1933, as amended, and will be
completed regardless of the trading price of the Common Stock during such
Selling Window. The purpose of this program is to diversify Ms. Hapka's
personal holdings.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
Exhibit
Number Description
------ -----------
3.1 Restated Certificate of Incorporation of the Company (1)
3.2 Certificate of Amendment of Restated Certificate of Incorporation (2)
4.1 Rhythms NetConnections Inc. 2000 Stock Award Plan (3)
4.2 Rhythms NetConnections Inc. Amended and Restated 2000 Stock Award
Plan (4)
10.1 Sublease, dated January 1, 2000, by and between the Company and
Cyprus Amax Minerals Company (1)
10.2 Purchase and Sale Agreement, dated April 6, 2000, by and between the
Company and MGA Development Associates, L.P.
10.3 Special Warranty Deed, dated May 8, 2000, by and between the Company
and MGA Development Associates, L.P.
10.4 Dividend Payment Agreement, dated June 2, 2000, by and between
Rhythms NetConnections Inc. and American Securities Transfer & Trust,
Inc.
27 Financial Data Schedule
(1) Included as an exhibit to the Company's Registration Statement, Form S-4
(Reg. No. 333-37618), as filed with the SEC on May 23, 2000.
(2) Included as exhibits to the Company's Amendment No. 1 to its Registration
Statement, Form S-4 (Reg. No. 333-37618), as filed with the SEC on June 16,
2000.
(3) Included as exhibits to the Company's Registration Statement, Form S-8
(Reg. No. 333-38986), as filed with the SEC on June 9, 2000.
(4) Included as exhibits to the Company's Registration Statement, Form S-8
(Reg. No. 333-41874), as filed with the SEC on July 20, 2000.
Reports on Form 8-K
-------------------
None
<PAGE>
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: August 14, 2000 /s/ J.W. Braukman
------------------
J.W. Braukman
Chief Financial Officer
