<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: MARCH 31, 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)
6933 South Revere Parkway
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 May 11, 2000, a total of 78,576,991 shares of the Registrant's Common
Stock, $0.001 par value, were issued and outstanding.
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RHYTHMS NETCONNECTIONS INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
<S> <C> <C>
ITEM 1 Financial Statements
Consolidated Balance Sheets as of December 31, 1999 and
March 31, 2000 (unaudited)............................................ 3
Consolidated Statements of Operations for the Three Months Ended
March 31, 1999 and 2000 (unaudited)................................... 4
Consolidated Statements of Comprehensive Income for the Three Months
Ended March 31, 1999 and 2000 (unaudited)............................. 5
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 1999 and 2000 (unaudited)................................... 6
Consolidated Statements of Stockholder's Equity for the Three Months
Ended March 31, 2000 (unaudited)...................................... 7
Notes to Consolidated Financial Statements (unaudited).................. 8-10
ITEM 2 Management's Discussion and Analysis of Financial Condition and
and Results of Operations.............................................11-14
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings....................................................... 15
ITEM 2 Changes in Securities and Use of Proceeds............................... 15
ITEM 3 Defaults Upon Senior Securities......................................... 16
ITEM 4 Submission of Matters to a Vote of Security Holders..................... 16
ITEM 5 Other Information....................................................... 16
ITEM 6 Exhibits and Reports on Form 8-K........................................ 16
SIGNATURES
</TABLE>
2
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RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
December 31, March 31,
ASSETS 1999 2000
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<S> <C> <C>
Current assets: (unaudited)
Cash and cash equivalents $ 48,247 $ 1,637
Short-term investments 292,008 1,044,736
Restricted cash 36,707 38,863
Accounts, loans, interest, and other receivables, net 10,844 19,570
Inventory 4,071 6,139
Prepaid expenses and other current assets 8,460 11,258
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Total current assets 400,337 1,122,203
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Equipment and furniture, net 124,831 137,170
Collocation fees, net 57,421 64,547
Restricted cash 59,526 59,395
Deferred business acquisition costs, net of accumulated amortization of $4,765 and $6,327 18,425 16,863
Deferred debt issue costs, net of accumulated amortization of $924 and $1,178 16,194 24,561
Other assets 8,690 12,936
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TOTAL ASSETS $ 685,424 $1,437,675
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LIABILITIES AND STOCKHOLDERS' EQUITY
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Current liabilities:
Current portion of long-term debt $ 333 $ 333
Accounts payable 30,895 32,496
Interest payable 8,787 24,397
Accrued expenses and other current liabilities 23,163 38,184
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Total current liabilities 63,178 95,410
Long-term debt 111 56
Senior notes payable 505,696 811,992
Other liabilities 110 74
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Total liabilities 569,095 907,532
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Mandatorily redeemable common stock warrants 42 42
Mandatorily redeemable preferred stock - 465,793
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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 78,452,789 as of 2000 78 78
Treasury stock, at cost; 988,894 shares as of 1999 and 1,107,440 as of 2000 (469) (499)
Additional paid-in capital 373,604 371,562
Warrants 10,397 74,373
Deferred compensation (12,320) (10,350)
Accumulated deficit (257,636) (375,667)
Accumulated comprehensive income 2,633 4,811
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Total stockholders' equity 116,287 64,308
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 685,424 $1,437,675
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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
March 31,
-----------------------------------
1999 2000
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(unaudited)
<S> <C> <C>
Revenue:
Service and installation, net $ 660 $ 8,137
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Operating Expenses:
Network and service costs 6,138 39,894
Selling, marketing, general and administrative 13,064 59,648
Depreciation and amortization 782 9,400
Amortization of deferred business acquisition costs 131 1,563
Deferred compensation 601 1,809
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Total operating expenses 20,716 112,314
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Loss from operations (20,056) (104,177)
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Other Income (Expense):
Interest income 1,749 8,274
Interest expense (including amortized debt
discount and issue costs) (5,627) (22,164)
Other income 35 36
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Total other income (expense) (3,843) (13,854)
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Net Loss $ (23,899) $ (118,031)
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Preferred stock dividends and accretion - 2,609
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Net Loss Available to Common Shareholders $ (23,899) $ (120,640)
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Net Loss Per Common Share:
Basic $ (5.38) $ (1.63)
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Diluted $ (5.38) $ (1.63)
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Weighted Average Common Shares Outstanding:
Basic 4,440,052 74,148,386
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Diluted 4,440,052 74,148,386
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</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
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RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
1999 2000
- -----------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C>
Net Loss $ (23,899) $ (118,031)
Cumulative translation adjustment - 5
Gain on available-for-sale securities - 2,173
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Total comprehensive income $ (23,899) $ (115,853)
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</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
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RHYTHMS NETCONNECTIONS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------
1999 2000
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities: (unaudited)
Net loss $ (23,899) $ (118,031)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization of equipment, furniture, and collocation fees 651 9,400
Amortization of deferred business acquisition costs 131 1,563
Amortization of debt discount and deferred debt issue costs 5,612 6,550
Amortization of deferred compensation 601 1,809
Other (35) (36)
Changes in assets and liabilities:
Increase in accounts, loans, interest, and other receivables, net (94) (8,726)
Increase in inventory (680) (2,068)
Decrease (increase) in prepaid expenses and other current assets 83 (2,798)
Increase in other assets (7) (4,247)
Decrease in accounts payable (869) (11,328)
Increase in interest payable - 15,610
Increase in accrued expenses and other current liabilities 991 15,021
Increase in other liabilities 37 -
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Net cash used for operating activities (17,478) (97,281)
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Cash Flows from Investing Activities:
Purchases of short-term investments (34,048) (2,186,886)
Maturities of short-term investments 33,989 1,434,158
Purchases of government securities as restricted cash - (2,025)
Investment in common stock - 2,178
Purchases of equipment and furniture (19,796) (20,169)
Payments of collocation fees (12,111) (8,696)
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Net cash used for investing activities (31,966) (781,440)
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Cash Flows from Financing Activities:
Proceeds from leasing company for equipment 1,755 -
Proceeds from issuance of senior notes - 300,000
Payments of debt issue costs (1,169) (8,621)
Repayments of long-term debt (111) (55)
Proceeds from issuance of common stock 1,406 728
Proceeds from issuance of preferred stock and warrants 60,000 527,160
Bank overdraft - 12,929
Purchase of treasury stock - (30)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 61,881 832,111
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Net increase in cash and cash equivalents 12,437 (46,610)
Cash and cash equivalents at beginning of period 21,315 48,247
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Cash and cash equivalents at end of period $ 33,752 $ 1,637
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Supplemental schedule of cash flow information:
Cash paid for interest $ 16 $ 5
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Supplemental schedule of non-cash financing activities:
Equipment and furniture purchases payable $ 19,890 $ 428
Business acquisition costs from issuance of preferred stock and warrants $ 10,250 $ -
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
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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 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 194,195 - - - 648 -
Issuance of Series E preferred stock
warrants for cash - - - - - 63,976
Purchase of treasury stock for cash - - 118,546 (30) - -
Accrued Series E and F preferred stock dividends - - - (2,548) -
Accretion of Series E and F preferred stock - - - - (61) -
Stock issuance under employee stock
purchase plan 2,887 - - - 80 -
Amortization of deferred compensation - - - - - -
Reversal of deferred compensation from
cancellation of grants to purchase
common stock - - - - (161) -
Net loss - - - - - -
Total comprehensive income - - - - - -
- -------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2000 (unaudited) 78,452,789 $ 78 1,107,440 $ (499) $ 371,562 $ 74,373
- -------------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
Deferred Accumulated Comprehensive Stockholders'
Compensation Deficit Income Equity (Deficit)
- -----------------------------------------------------------------------------------------------------------
<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 - - - 648
Issuance of Series E preferred stock
warrants for cash - - - 63,976
Purchase of treasury stock for cash - - - (30)
Accrued Series E and F preferred stock dividends - - - (2,548)
Accretion of Series E and F preferred stock - - - (61)
Stock issuance under employee stock
purchase plan - - - 80
Amortization of deferred compensation 1,809 - - 1,809
Reversal of deferred compensation from
cancellation of grants to purchase
common stock 161 - - -
Net loss - (118,031) - (118,031)
Total comprehensive income - - 2,178 2,178
- -----------------------------------------------------------------------------------------------------------
Balance at March 31, 2000 (unaudited) $ (10,350) $ (375,667) $ 4,811 $ 64,308
- -----------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
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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. and Rhythms Links Inc. - Virginia. 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 (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 months ended March 31, 2000 (Q-1) 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 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 61,281,828 and 9,740,703 at March 31, 1999 and March 31,
2000, 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
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2. Accumulated Other Comprehensive Income
Accumulated other comprehensive income of $2.6 million and $4.8 million at
December 31, 1999 and March 31, 2000, respectively, is attributable to the
unrealized gain on 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 March 31, 2000 was $5,000 compared to none recorded at
December 31, 1999.
3. Investment in Joint-Venture
In January 2000, the Company formed a Canadian corporate joint venture with
Optel Communications Corporation (OCC), a wholly-owned subsidiary of OCI
Communications Inc., to offer DSL-based services in selected Canadian markets.
The Company and OCC each received 100,000 shares of Class A voting stock. OCC
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
OCC shall be obligated 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 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.
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. $0.001 par value per share, of
the Company (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.
9
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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. Subsequent Event
In April 2000, the Company entered into a multiyear strategic relationship with
Excite @Home. Excite @Home is a leading broadband provider. Under the terms of
the agreement, the Company will make a $15.0 million investment in @Home
Solutions, an affiliate of Excite @Home. The Company will become @Home
Solutions' exclusive provider of a residential DSL connectivity for Excite @Home
in several specific markets outside of Excite @Home's current cable footprint.
Excite @Home will be a preferred internet service provider (ISP) for new
consumers in those markets. The new relationship will offer broadband
connectivity, a custom software package, Excite for broadband content and ISP
services such as e-mail.
10
<PAGE>
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.
General
The Company is a leading service provider of broadband local access
communication services to businesses and consumers. The Company began offering
commercial services in the United States (U.S.) in April 1998. As of March 31,
2000, the Company offered services in 46 markets and 83 of the 314 Metropolitan
Statistical Areas (MSAs) in the U.S., and its national DSL network passed 34.75
million homes and businesses. The Company intends to continue its network
rollout into an additional 24 markets and an additional 25 MSAs by the end of
2000.
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 March 31, 2000 was $8.1 million, or an
increase of $7.4 million, compared to $0.7 million in the similar period in
1999. Net monthly recurring service fees totaled $0.5 million in the first three
months of 1999 compared to $5.5 million in the first three months of 2000.
Nonrecurring net installation revenue totaled $0.3 million in the first three
months of 1999 compared to $2.6 million in the first three months of 2000. The
significant increase in revenue for the first three months of 2000 compared to
the same period in 1999 is a result of increased sales and marketing efforts and
network deployment in 46 markets compared to 11 markets one year ago.
11
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Network and Service Costs
Network and service costs for the three months ended March 31, 2000 were $39.9
million compared to $6.1 million for the same period in 1999. The increase in
network and service costs is attributable to the expansion of the Company's
network and increased sales and marketing efforts.
Selling, Marketing, General and Administrative
Selling, marketing, general and administrative expenses for the three months
ended March 31, 2000 were $59.6 million compared to $13.1 million for the same
period 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 months ended March 31, 2000 was $9.4
million compared to $0.8 million for the same period in 1999. This increase
reflects the rapid expansion of the Company's network into 46 markets at March
31, 2000, a 318% increase compared to 11 markets at March 31, 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 months ended March 31, 1999 and March 31,
2000, $0.1 million and $1.6 million, respectively, in amortization for deferred
business acquisition costs were recorded.
Deferred Compensation
Deferred compensation expense increased to $1.8 million for the three months
ended March 31, 2000 compared to $0.6 million for the same period in 1999. This
increase reflects the granting of stock options to the Company employees and
officers with per share exercise prices below the per share fair values of the
Company's common stock at the dates of grant. The deferred compensation is
amortized over the vesting period of such stock options.
Net Interest Income and Expense
Interest income during the three months ended March 31, 2000 was $8.3 million
compared to $1.7 million for the same period in 1999. The increase is primarily
attributable to an increase in invested cash balances. As of March 31, 2000,
unrestricted cash and investments totaled $1.0 billion compared to $149.3
million at March 31, 1999. The increase resulted from a variety of financing
activities, including:
. issuing Series C and Series D Preferred Stock and warrants for cash proceeds
totaling $75.0 million in March and April 1999;
. issuing common stock upon initial public offering 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 $175.0 million;
. issuing common stock in a secondary public offering in September 1999 for net
cash proceeds of $16.4 million;
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. issuing 14% senior debt in February 2000 for net cash proceeds of $291.3
million; and
. issuing Series E and Series F Preferred Stock (as defined below) and warrants
in the first quarter of 2000 for net cash proceeds totaling $527.3 million.
Interest expense and amortized debt discount and issue costs increased to $22.2
million for the three months ended March 31, 2000 as compared to $5.6 million
for the same period in 1999. This increase primarily resulted from the senior
notes issued in April 1999 and March 2000.
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 $29.9 million during
the three months ended March 31, 2000.
During the first quarter of 2000, we have 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 the first
quarter of 2000 for net cash proceeds totaling $527.3 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.
The Company has substantial indebtedness and debt service obligations. Total
indebtedness at March 31, 2000 was $812.4 million. Cash and investments totaled
$1.1 billion and the accumulated deficit was $375.7 million at March 31, 2000.
Of this cash, $98.3 million is restricted in accordance with the terms of the
1999 senior notes.
For the three months ended March 31, 1999 and March 31, 2000, net cash used in
operating activities was $17.5 million and $97.3 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 three months ended March 31, 1999
and March 31, 2000 was $32.0 million and $781.4 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 three months ended March 31,
1999 and March 31, 2000 was $61.9 million and $832.1 million, respectively, and
resulted primarily from the issuance of preferred 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
13
<PAGE>
. 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 March 31, 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.
14
<PAGE>
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
Thomas R. Lafleur Litigation - See the disclosure regarding this matter in the
Company's Form 10-K for the period ended December 31, 1999 (the 1999 10-K). The
trial for this matter began on May 5, 2000. There have been no other new
developments with respect to this matter since the filing of the 1999 10-K.
I2 Technologies, Inc. Litigation - 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.
ITEM 2 SECURITIES AND USE OF PROCEEDS
Series E Preferred Stock of the Company
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) 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, $.001 par
value per share, of the Company (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 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 of the Company
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.
15
<PAGE>
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.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
Exhibit
Number Description
- ------ -----------
10.33 Joint Venture Agreement, dated January 1, 2000, by and between the
Company, Rhythms Links, Inc., and Optel Communications (1)
10.34 Preferred Stock and Warrant Purchase Agreement, dated February 6, 2000,
by and between the Company and the Purchasers listed on Schedule I
thereto (1)
10.35 Purchase Agreement, dated February 16, 2000, by and between the Company
and the Initial Purchasers listed on Schedule I thereto (1)
10.36 Purchase Agreement, dated February 28, 2000, by and between the Company
and the Initial Merrill Lynch Pierce Fenner & Smith Incorporated and
Salomon Barney Inc. (1)
(1) Included as exhibits to the Company's 1999 10-K, as filed with the SEC on
March 30, 2000.
Reports on Form 8-K
- -------------------
None
16
<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: May 12, 2000 /s/ J.W. Braukman
------------------
J.W. Braukman
Chief Financial Officer
17
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