<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
----------- ------------
COMMISSION FILE NUMBER 333-61293
SPLITROCK SERVICES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0529757
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
8665 NEW TRAILS DRIVE 77381
THE WOODLANDS, TEXAS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (281) 465-1200
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ ] No [X]
The number of shares of Common Stock, par value $.001 per share, of the
Registrant outstanding at November 13, 1998 was 82,815,000.
<PAGE> 2
SPLITROCK SERVICES, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C> <C> <C>
Part I -- Financial Information
Item 1 -- Financial Statements (Unaudited)
Condensed Balance Sheets as of December 31, 1997 and September 30, 1998................ 1
Condensed Statements of Operations for the
Three Months Ended September 30, 1997 and 1998,
for the Period from Inception (March 5, 1997) through September 30, 1997 and
for the Nine Months Ended September 30, 1998........................................... 2
Condensed Statement of Stockholders' Equity (Deficit) from
December 31, 1997 to September 30, 1998................................................ 3
Condensed Statements of Cash Flows for the
Period from Inception (March 5, 1997) through September 30, 1997 and
for the Nine Months Ended September 30, 1998........................................... 4
Notes to Condensed Financial Statements................................................ 5
Item 2 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations......................................... 7
Part II -- Other Information
Item 1 -- Legal Proceedings...................................................................... 13
Item 2 -- Changes in Securities and Use of Proceeds.............................................. 13
Item 3 -- Defaults upon Senior Securities ....................................................... 13
Item 4 -- Submission of Matters to a Vote of Security Holders.................................... 13
Item 5 -- Other Information...................................................................... 13
Item 6 -- Exhibits and Reports on Form 8-K....................................................... 14
Signatures............................................................................................... 15
</TABLE>
i
<PAGE> 3
SPLITROCK SERVICES, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
---------- ----------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ......................... $ 7,710 $ 182,322
Restricted investments ............................ 3,472 36,653
Accounts receivable, net .......................... 4,252 2,762
Prepaid expenses and other current assets ......... 221 405
---------- ----------
Total current assets ......................... 15,655 222,142
Property and equipment, net ................................ 38,504 51,582
Restricted investments ..................................... --- 21,227
Other assets ............................................... 229 12,490
---------- ----------
Total assets.................................. $ 54,388 $ 307,441
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of capital lease obligations ... $ 11,010 $ 9,399
Accounts payable .................................. 3,086 22,373
Accrued interest payable .......................... --- 5,688
Accrued liabilities and other current
liabilities ....................................... 5,775 5,889
---------- ----------
Total current liabilities .................... 19,871 43,349
Capital lease obligations .................................. 13,110 10,200
Senior notes payable, ($261,000 face value net of
$2,822 unamortized discount, see footnote 4) ............. --- 258,178
Notes payable to stockholder ............................... 1,000 ---
---------- ----------
Total liabilities .................... 33,981 311,727
Commitments and Contingencies
Stockholders' equity (deficit):
Common stock, $.001 par value;
150,000,000 shares authorized: 76,800,000 and
82,800,000 issued and outstanding at
December 31, 1997, and September 30, 1998,
respectively ................................. 77 83
Additional paid-in capital ................... 30,451 34,670
Common stock warrants ........................ --- 2,849
Accumulated other comprehensive income,
see footnote 3 ............................. --- 345
Accumulated (deficit) ........................ (10,121) (42,233)
---------- ----------
Total stockholders' equity (deficit) .... 20,407 (4,286)
---------- ----------
Total liabilities and stockholders'
equity (deficit) $ 54,388 $ 307,441
========== ==========
</TABLE>
The accompanying notes are an integral part of these
unaudited condensed financial statements.
1
<PAGE> 4
SPLITROCK SERVICES, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
THREE MONTHS THREE MONTHS (MARCH 5, 1997) NINE MONTHS
ENDED ENDED THROUGH ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1998 SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
------------------ ------------------ ---------------------- ------------------
<S> <C> <C> <C> <C>
Revenues .................................. $ 10,729 $ 15,378 $ 10,729 $ 47,592
Operating expenses:
Network personnel costs .............. 95 1,176 95 3,332
Network operating costs .............. 561 10,419 561 19,821
Legacy network costs ................. 13,119 14,641 13,119 41,731
Selling, general and administrative .. 471 1,192 596 2,820
Depreciation and amortization ........ 1,708 2,804 1,708 7,711
------------------ ------------------ ------------------ ------------------
Total operating expenses ..... 15,954 30,232 16,079 75,415
------------------ ------------------ ------------------ ------------------
Loss from operations ...................... (5,225) (14,854) (5,350) (27,823)
Other income (expense):
Interest income ...................... 137 2,664 167 2,847
Interest expense ..................... (113) (6,294) (113) (7,136)
------------------ ------------------ ------------------ ------------------
Net loss .................................. $ (5,201) $ (18,484) $ (5,296) $ (32,112)
------------------ ------------------ ------------------ ------------------
Loss per share - basic and diluted ........ $ (0.11) $ (0.23) $ (0.19) $ (0.41)
================== ================== ================== ==================
Weighted average shares - basic
and diluted........................... 48,991 78,724 27,939 77,507
================== ================== ================== ==================
</TABLE>
The accompanying notes are an integral part of these unaudited
condensed financial statements.
2
<PAGE> 5
CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL COMMON OTHER
PAR PAID-IN STOCK COMPREHENSIVE ACCUMULATED
SHARES VALUE CAPITAL WARRANTS INCOME (DEFICIT) TOTAL
------ -------- ---------- -------- ------------- ----------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1997 ......... 76,800 $77 $30,451 $ -- $ -- $(10,121) $20,407
Net loss ............................. -- -- -- -- -- (32,112) (32,112)
Unrealized gain on securities ........ -- -- -- -- 345 -- 345
Issuance of warrants in connection
with senior notes ................... -- -- -- 2,849 -- -- 2,849
Exercise of stock options and
warrant ............................. 6,000 6 4,219 -- -- -- 4,225
------ --- ------- ------ -------- -------- -------
Balance at September 30, 1998 ........ 82,800 $83 $34,670 $2,849 $ 345 $(42,233) $(4,286)
====== ==== ======= ====== ======== ======== =======
</TABLE>
The accompanying notes are an integral part of these unaudited
condensed financial statements.
3
<PAGE> 6
SPLITROCK SERVICES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Period from Inception Nine Months
(March 5, 1997) through Ended
September 30, 1997 September 30, 1998
---------------------- --------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ......................................................... $(5,296) $(32,112)
Adjustments to reconcile net loss to net cash provided by
operating activities -
Depreciation and amortization ............................... 1,708 7,711
Amortization of debt discount and deferred financing costs... --- 189
Changes in operating assets and liabilities:
Accounts receivable, net .................................... --- 1,490
Prepaid expenses and other current assets ................... (312) (184)
Accounts payable ............................................ 333 19,287
Accrued liabilities ......................................... 3,668 114
Accrued interest payable .................................... --- 5,688
------- --------
Net cash provided by operating activities ................. 101 2,183
------- --------
INVESTING ACTIVITIES:
Purchases of property and equipment .............................. (14,320) (17,120)
Reinvestment of interest earned on restricted investment ......... --- (783)
Investment in other assets ....................................... --- (2,892)
------- --------
Net cash used in investing activities ..................... (14,320) (20,795)
------- --------
FINANCING ACTIVITIES:
Proceeds from senior notes payable and warrants issued
(See Footnote 4) .......................................... --- 261,000
Proceeds from note payable to stockholder ........................ 10,750 10,000
Repayments of note payable to stockholder ........................ (750) (11,000)
Proceeds from note payable ....................................... --- 1,477
Repayments of note payable ....................................... --- (1,477)
Financing costs incurred ......................................... --- (9,369)
Restriction of cash under senior note agreement .................. --- (56,752)
Sale of common stock ............................................. 20,527 4,225
Proceeds from sale leaseback on equipment ........................ --- 960
Principal payments on capital lease obligations .................. --- (9,312)
Release of restriction of cash under credit agreement ............ --- 3,472
------- --------
Net cash provided by financing activities ................. 30,527 193,224
------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS ................................. 16,308 174,612
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .......................... --- 7,710
------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................ $16,308 $182,322
======= ========
</TABLE>
The accompanying notes are an integral part of these unaudited
condensed financial statements.
4
<PAGE> 7
NOTES TO CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE, UNIT AND PER SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited interim financial statements of Splitrock
Services, Inc. (the Company) as of September 30, 1998, for the period from
inception (March 5, 1997) through September 30, 1997 and for the nine months
ended September 30, 1998 have been prepared in accordance with generally
accepted accounting principles and the Securities and Exchange Commission's
rules and regulations for reporting interim financial information. Accordingly,
they do not include all information and notes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, such financial statements include all adjustments, consisting only
of normal recurring adjustments necessary for a fair presentation of financial
position, results of operations and cash flows for the periods presented.
Operating results for the three and nine months ended September 30, 1998 are
not necessarily indicative of future operating results.
The financial statements presented herein should be read in conjunction
with the Company's audited financial statements as of December 31, 1997 and for
the period from inception (March 5, 1997) to December 31, 1997 contained in the
Company's Registration Statements on Form S-1 and Form S-4 filed with the
Securities and Exchange Commission and declared effective on October 30, 1998.
2. NET LOSS PER SHARE
In February 1997, Financial Accounting Standards No. 128 ("FAS 128")
Earnings Per Share was issued. FAS 128 is effective for both interim and annual
periods ending after December 15, 1997. The Company adopted the pronouncement
for all periods presented. FAS 128 requires the Company to report both basic
earnings per share, which is based on the weighted average number of common
shares outstanding, and diluted earnings per share, which is based on the
weighted average number of common shares outstanding and all dilutive potential
common shares outstanding. At September 30, 1998, 2,675,500 options to acquire
shares of common stock at the weighted-average exercise price of $0.69 and
warrants to acquire 2,642,613 shares of common stock at an exercise price of
$0.01 were not included in the computation of diluted earnings per share
because their effect is anti-dilutive.
3. COMPREHENSIVE LOSS
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income ("FAS 130"). This
Statement establishes standards for reporting and display of comprehensive
income and its components. For the three months ended September 30, 1997 and
1998 and for the period from inception (March 5, 1997) through September 30,
1997 and for the nine months ended September 30, 1998 comprehensive net loss,
as determined under FAS 130, was:
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION NINE MONTHS
THREE MONTHS ENDED (MARCH 5, 1997) ENDED
SEPTEMBER 30, THROUGH SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1997 1998
------- -------- -------------------- ----------
<S> <C> <C> <C> <C>
Net loss per Condensed Statement of Operations ... $(5,201) $(18,484) $ (5,296) $ (32,112)
Unrealized gains on securities,
net of tax of $0 .............................. 0 345 0 345
------- -------- -------------------- ----------
Comprehensive net loss ........................... $(5,201) $(18,139) $ (5,296) $ (31,767)
======= ======== ==================== ==========
</TABLE>
4. INDEBTEDNESS
Components of indebtedness are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
---------------
<S> <C>
Capital lease obligations ................................... $ 19,599
Senior notes payable ($261,000 face value, net of
$2,822 unamortized discount).............................. 258,178
---------------
277,777
Less-- current maturities ................................... (9,399)
---------------
$ 268,378
===============
</TABLE>
5
<PAGE> 8
On July 24, 1998, the Company sold 261,000 units consisting of $261,000
principal amount of 11 3/4% Senior Notes due 2008 ("Senior Notes") and warrants
to purchase 2,642,613 shares of common stock (the "Senior Notes Offering"). Upon
issuance, the Senior Notes were recorded in the Company's financial statements
net of a $2,849 discount. The discount was attributable to the Company's
estimate of the value of the warrants. Such estimate was based on a valuation of
the Company's common stock as of December 31, 1997 by a third party valuation
firm. The discount will be amortized over the life of the Senior Notes. This
amortization will result in an increase in the financial statement balance of
the Senior Notes to a $261,000 face value by 2008.
In connection with the Senior Notes Offering, the Company repaid the amount
outstanding, $1,477, under the $5,000 credit facility which commenced in April
1998, and refinanced $11,000 of indebtedness, owed to Linsang Partners L.L.C.
("Linsang"), a stockholder of the Company. In connection with the refinancing,
Linsang received 11,000 units in the Senior Notes Offering. The net proceeds to
the Company, after the Senior Notes Offering expenses and retirement of debt,
approximated $239,000.
5. EQUITY
On September 14, 1998, Orient Star Holdings ("Orient Star"), a stockholder
of the Company and a wholly owned subsidiary of Carso Global Telecom, S.A. de
C.V. (the controlling stockholder of Prodigy Communications Corporation
("Prodigy")), exercised a warrant to purchase 5.0 million shares of the
Company's common stock for $0.625 per share.
6
<PAGE> 9
SPLITROCK SERVICES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussions contain forward-looking information. Readers
are cautioned that such information involves risks and uncertainties, including
those created by general market conditions and competition. Although the Company
believes that the assumptions underlying the forward-looking statements are
reasonable, any of the assumptions could be inaccurate and there can be no
assurance that the forward-looking statements included herein will prove to be
accurate. The inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and plans
of the Company will be achieved.
OVERVIEW
Splitrock Services, Inc. ("the Company") is a provider of telecommunications
services, including high speed internet access services, on an advanced
nationwide network, based on Asynchronous Transfer Mode ("ATM") switching
technology. This technology will be deployed in every operational point of
presence ("POP") of the network being constructed by the Company (the "Splitrock
Network" or the "Network"). The Company is providing internet dial access and
related services to Prodigy Communications Corporation ("Prodigy") for its
subscribers (representing 99% of total revenue.) The Company is also providing
dedicated internet access services to four customers as of September 30, 1998.
The Network currently reaches more than 55% of U.S. households by a local
call with 56k modem access (currently the fastest modem speed commercially
available over residential phone lines), providing access to businesses and
households in every market in the United States with a population of at least
100,000 as well as several second tier markets. From September 1997 through
April 1998, the Company deployed the Splitrock Network infrastructure, primarily
targeting densely populated markets. This deployment resulted in the deployment
of the nationwide ATM backbone portion of the Splitrock Network and POPs in 70
metropolitan areas across the nation.
In May 1998, the Company began the second phase of its expansion to
construct approximately 330 new POPs, deploying advanced processing equipment
and software to enhance and accelerate its ability to offer value added
services, such as integrated services, digital network video, web hosting and
virtual private network services, and augmenting its network management
infrastructure (the "Phase II Expansion"). The Company believes that the Phase
II Expansion will be substantially completed at the end of the second quarter of
1999. Upon completion of the Phase II Expansion, the Network will have a
physical presence in all 50 states, reaching over 90% of U.S. businesses and
households with a local call.
The Company has incurred net losses since its inception in March 1997.
Cumulative losses from inception total $42.2 million. The Company anticipates
that losses will continue while the Company completes its Phase II Expansion
and builds its sales and marketing infrastructure. The extent to which the
Company continues to incur net losses is dependent upon the timely deployment
of the Network and the rate at which the Company can expand its customer base.
PRODIGY TRANSACTIONS
On June 24, 1997, the Company and Prodigy entered into the Splitrock Full
Service Agreement (the "Prodigy Agreement") pursuant to which the Company agreed
to provide certain network services to Prodigy for its subscribers. The Prodigy
Agreement became effective on July 1, 1997. In order to provide these services
to Prodigy for its subscribers prior to the completion of the Splitrock Network,
on July 1, 1997 the Company acquired, for temporary use, the legacy network
infrastructure from Prodigy, which consisted of substantially all network assets
and related communications equipment owned or leased by Prodigy (the "Prodigy
Legacy Network"). Consideration for the acquisition of the Prodigy Legacy
Network was in the form of the assumption of $5.9 million of liabilities.
Prodigy Agreement. Under the Prodigy Agreement, the Company provides
Prodigy with network services, including internet dial access services and other
network connections, and Prodigy pays the Company monthly usage-based or
subscriber-based service charges equal to the lower of: (i) total subscriber
hours for the month multiplied by the contracted hourly usage rate (the
"Usage-Based Rate") or (ii) total subscribers for the month, as measured by a
"Subscriber Count," as defined in the Prodigy Agreement, multiplied by the fixed
monthly charge per subscriber (the "Subscriber-Based Rate"). The contracted
hourly Usage-Based Rate increased by 9.5% on January 1, 1998 and will increase
by 8.7% on January 1, 1999. The fixed monthly Subscriber-Based Rate does not
increase over time. The Prodigy Agreement imposes certain minimum monthly
service charges on Prodigy in the event that the lower of the Usage-Based Rate
or Subscriber-Based Rate calculation is below defined levels. The minimum
monthly service charges are $3.5 million through June 30, 1999 and will increase
by $500,000 beginning each subsequent July 1. Additionally, in the event the
average monthly hours per subscriber (calculated as the total subscriber hours
for the month divided by the total subscribers at the month end) exceeds 30
hours, the Prodigy Agreement provides that Prodigy will be subject to additional
fees ("Additional Fees") equal to (a) $1.00, multiplied by (b) the number of
average monthly hours per subscriber in excess of 30 hours, multiplied by (c)
the total subscribers at the month end. Through March 31, 1998 amounts paid by
Prodigy under the Prodigy Agreement were based on the Usage-Based Rate. Since
April 1998 such amounts have been based on the Subscriber-Based Rate. Over the
long-term the Company expects to receive amounts from Prodigy based on the
Subscriber-Based Rate, although there may be short-term periods when the
Usage-Based Rate applies. As a result, amounts received by the Company from
Prodigy since April 1998 have been, and over the long-term (except for any
Additional Fees) are expected to be, a function of the total number of Prodigy
subscribers as opposed to total subscriber hours. Depending on the relative
growth rates of the number of Prodigy subscribers and total subscriber hours,
the amount of the Company's revenues and the Company's operating margins could
be negatively affected.
The initial term of the Prodigy Agreement expires on June 30, 2001. After
the initial term either party may terminate the Prodigy Agreement upon twelve
months prior written notice. If no notice is received, the term of the Prodigy
Agreement is automatically extended for successive twelve month terms. Under the
Prodigy Agreement the Company is required, among other things, to provide
Prodigy with certain financial and other information, meet certain financial
covenants and meet certain network performance standards. The financial
covenants under the Prodigy Agreement require the Company to furnish certain
financial statements on an annual and quarterly basis prepared in accordance
with generally accepted accounting principles and audited by independent
certified public accountants (annual financial reports) or prepared consistent
with normal accounting practices certified as true by a designated officer of
the Company (quarterly reports). Additional covenants include furnishing a
quarterly report of payables if not timely paid, furnishing evidence of payment
of taxes and similar assessments, giving notice of liens and litigation with
respect to claims in excess of a certain amount, providing financial projections
for the immediately succeeding fifteen (15) months based on capacity planning
forecasts for network usage and maintenance of insurance coverage customary to
the industry. Network performance standards contain four service level
objectives, three of which are measured on a monthly basis, and one on a weekly
basis. The Company is required to provide certain credits to Prodigy in the
event it fails to meet such network performance standards. Prodigy has the right
to terminate the Prodigy Agreement following a cure period in the event of the
Company's failure to comply with certain provisions thereof, including certain
network performance standards. In addition, Prodigy has the right to terminate
the Prodigy Agreement during the initial term without cause by providing twelve
months prior written notice and paying a termination charge of $5.0 million
until July 1, 1999 and $3.0 million thereafter. In the event of certain
prolonged network failures, Prodigy also has the right to enter the Company's
premises and cure such failures.
Prodigy Services. Prodigy currently offers two services to its subscribers:
Prodigy Classic and Prodigy Internet. Prodigy Internet subscribers generally
have higher average usage, and therefore when Prodigy pays the Company based on
the Usage-Based Rate such subscribers generate greater revenues for the Company.
Since April 1998, however, amounts paid by Prodigy have been based on the
Subscriber-Based Rate, which the Company expects to continue over the long-term.
Therefore, the Company anticipates that fees received from Prodigy will over the
long term, as they have since April 1998, be a function of number of subscribers
rather than hours of usage. The Subscriber-Based Rate measures subscribers on
the basis of a "Subscriber Count" as defined in the Prodigy Agreement, which to
date has been higher than Prodigy's billable subscribers with respect to any
given period due to free trial periods made available to certain subscribers and
other factors.
7
<PAGE> 10
RESULTS OF OPERATIONS
The following table sets forth selected quarterly statement of operations
data that are the basis of discussion below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------------
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30,
1997 1997 1997 1998 1998 1998
---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
QUARTERLY STATEMENT OF OPERATIONS
DATA:
Revenue ........................... $ -- $ 10,729 $ 11,979 $ 16,494 $ 15,720 $ 15,378
Operating expenses:
Network personnel costs ......... -- 95 342 1,051 1,105 1,176
Network operating costs ......... -- 561 1,364 3,127 6,275 10,419
Legacy network costs ............ -- 13,119 12,222 12,295 14,795 14,641
Severance costs ................. -- -- 463 -- -- --
Selling, general and
administrative ............... 125 471 680 657 971 1,192
Depreciation and amortization ... -- 1,708 1,792 2,820 2,087 2,804
---------- ---------- ---------- ---------- ---------- ----------
Total operating
expenses .............. 125 15,954 16,863 19,950 25,233 30,232
---------- ---------- ---------- ---------- ---------- ----------
Loss from operations .............. (125) (5,225) (4,884) (3,456) (9,513) (14,854)
Other income (expense):
Interest income ................. 30 137 181 107 76 2,664
Interest expense ................ -- (113) (122) (349) (493) (6,294)
---------- ---------- ---------- ---------- ---------- ----------
Net loss .......................... $ (95) $ (5,201) $ (4,825) $ (3,698) $ (9,930) $ (18,484)
========== ========== ========== ========== ========== ==========
Loss per share-- basic and
diluted ......................... $ (0.01) $ (0.11) $ (0.06) $ (0.05) $ (0.13) $ (0.23)
========== ========== ========== ========== ========== ==========
Weighted average shares-- basic and
diluted ......................... 14,648 48,991 76,800 76,800 76,976 78,724
========== ========== ========== ========== ========== ==========
OTHER QUARTERLY DATA:
Cash provided by (used in):
Operating activities ............ $ (1,554) $ 103 $ (2,333) $ (4,874) $ 1,162 $ 5,895
Investing activities ............ (377) (12,242) (2,878) (2,740) (4,974) (13,081)
Financing activities ............ 10,026 19,750 (3,387) 3,253 5,640 184,331
</TABLE>
The Company was formed in March 1997, and has a limited history of
operations. Thus, historical information set forth herein may not be indicative
of the Company's future operating results and financial condition. From its
inception through the end of the second quarter of 1997, the Company had not yet
begun deploying the Splitrock Network nor had it consummated the transactions
with Prodigy. As a result, it did not generate revenue and incurred limited
operating expenses prior to the third quarter of 1997. Thus a comparison of
operations for the nine months ended September 30, 1998 to the period from
inception (March 5, 1997) through September 30, 1997 would essentially result in
a comparison of the nine months ended September 30, 1998 to the three months
ended September 30, 1997. With respect to a comparison of the nine months ended
September 30, 1998 to the period from inception (March 5, 1997) through
September 30, 1997, changes in revenues and operating expenses differed from the
changes indicated below with respect to the comparison of the three months ended
September 30, 1998 to the three months ended September 30, 1997 solely because
the Company generated no revenues and incurred almost no expenses during the
period from inception (March 5, 1997) through June 30, 1997. In addition to the
quarter and year-to-date discussions, management believes it is useful to
include, and has included below, a comparison of the three months ended
September 30, 1998 to the three months ended June 30, 1998.
Revenue. From the formation of the Company until July 1, 1997 the Company
did not generate any revenue. The Company generated $15.4 million and $10.7
million of total revenue for the three months ended September 30, 1998 and 1997,
respectively, representing a 44% increase in total revenue. Total quarterly
Network usage increased by 72% for the third quarter of 1998 compared to the
third quarter of 1997. The revenue impact of the increase in Network usage was
limited by a maximum revenue calculation based on the Prodigy Subscriber Count.
Average Prodigy Subscriber Count for the third quarter of 1998 compared to the
third quarter of 1997 declined by 10%.
The Company generated $15.4 million of total revenue for the three months
ended September 30, 1998 and $15.7 million of total revenue for the three months
ended June 30, 1998. This decrease is a result of a 5% decline in average
Prodigy Subscriber Count between these quarters. The Company's revenue from
Prodigy is currently subject to the maximum revenue calculation based on the
subscriber count. The Company anticipates that the revenue generated from
Prodigy over the long-term will be a function of the total number of Prodigy
subscribers as opposed to total subscriber hours. Depending on the relative
growth rates of the Prodigy Subscriber Count and total Prodigy subscriber
hours, the amount of the Company's revenues and the Company's operating
margins could be positively or negatively affected.
8
<PAGE> 11
Network Costs -- Overview. Network related operating expenses include all of
the direct costs incurred in connection with designing, deploying and expanding
the Splitrock Network, operating the Splitrock Network and the legacy network
structure (the "Legacy Network"), which includes both the Prodigy Legacy Network
and the IBM Global Services Network ("IBM Network"). The Company accounts for
its direct Splitrock Network-related operating expenses in three line items,
Network personnel costs, Network operating costs and Legacy Network costs.
The Company anticipates that a significant amount of Company efforts and
resources through mid-1999 will be spent on the completion of the Phase II
Expansion. During the expansion of the Network, the Company will be making
significant investments in facilities, equipment, telephone circuits, customer
support, field services and sales and marketing in advance of customer growth
and resulting revenues. These expansion efforts have caused and will continue to
cause fluctuations in expenses from period to period, in terms of total dollars
and as a percentage of revenue. The nature and amount of expenses are
expected to fluctuate as the Company continues to expand the Network.
Network Personnel Costs. Network personnel costs include all internal
personnel expenses incurred in connection with deploying, operating and
expanding the Splitrock Network. Network personnel costs were $1.2 million and
$0.1 million for the three months ended September 30, 1998 and 1997,
respectively. This increase was due to hiring technical employees as the
Network expanded.
Network personnel costs were $1.2 million for the three months ended
September 30, 1998 and $1.1 million for the three months ended June 30, 1998.
This slight increase was due to increases in number of employees in other
technical and network operational areas. Network personnel costs are expected
to increase as new POPs are deployed.
Network Operating Costs. Network operating costs include all other expenses
incurred in connection with deploying, operating and expanding the Splitrock
Network. These costs primarily include leased telecommunication line charges for
both access and transmission; operating expenses related to the Network
operations, customer support, engineering, information technology, field
operations, and facility management. Network operating costs were $10.4 million
and $0.6 million for the three months ended September 30, 1998 and 1997,
respectively. This increase is primarily attributable to the deployment of
77 operational POPs since September 1997.
Network operating costs were $10.4 million for the three months ended
September 30, 1998 and $6.3 million for the three months ended June 30, 1998.
Approximately 94% of the increase in Network operating costs was due to
increased line charges. The increase in line charges is a result of several
factors: (i) an increase in the number of access lines installed to support an
increase in the average usage per Prodigy subscriber and the expansion of the
Network, (ii) the full quarterly expense impact of access and transmission lines
installed in the second quarter and (iii) approximately $0.9 million related to
the use of 800 number service to provide 56K modem speed service for certain
Legacy Network sites that did not have 56K coverage. The 800 number facilities
are significantly more expensive than local line access. As more POPs become
operational, this 800 number usage will be transferred to Splitrock POPs. The
Company anticipates that these charges will increase in the fourth quarter, with
a significant decline in the first quarter of 1999.
The Phase II Expansion began in the mid-part of the second quarter of 1998.
As the Company continues to deploy the Phase II Expansion, the Network operating
costs will continue to increase for POP facilities and line charges. Typically,
telecommunication lines are installed and charges are incurred prior to the POP
site being put into productive use. This results in higher expenses during the
startup of a new POP site. The Company is unable to determine the impact of this
startup activity until the Phase II Expansion is substantially complete. The
Company anticipates continued increases in Network operating costs as lines and
facilities are deployed in connection with the remaining POP sites expected to
be deployed by mid-1999.
To date, the Company has performed its own maintenance of equipment and has
relied on initial warranties at no costs from its vendors. The Company is
currently in discussions with various vendors in regard to terms and conditions
relating to equipment maintenance contracts for current and future operations.
Maintenance contract costs will increase the cost of Network operations.
Legacy Network Costs. Legacy Network costs include all expenses incurred in
connection with operating and decommissioning the Prodigy Legacy Network,
including facility leases, line charges, personnel costs, occupancy costs,
equipment maintenance costs and access fees for the IBM Network.
During the third quarter of 1998, the Company incurred $14.6 million of
total Legacy Network costs compared to $13.1 million during the third quarter of
1997. Included in these amounts is $12.0 million and $5.6 million, respectively,
of usage charges paid relating to the IBM Network. This increase was primarily
due to a change in negotiated rates for the IBM Network. Effective April 1,
1998, the Company entered into a new
9
<PAGE> 12
contract with IBM to continue to provide these access services. The
implementation of this new contract between the Company and the IBM Network
resulted in an increase in rates. This new contract provides for significantly
higher hourly usage charges due to the Company's expected short-term use of the
IBM Network, as well as the Company's lack of a long-term relationship with IBM.
Total Legacy Network costs were $14.6 million for the three months ended
September 30, 1998 and $14.8 million for the three months ended June 30, 1998.
The Company experienced a 30% decline in the Prodigy Legacy Network costs offset
by an increase in IBM Network fees. During the quarter ended September 30, 1998,
the Company paid $12.0 million of usage charges related to the IBM Network as
compared to $11.0 million of usage charges incurred during the prior quarter.
This increase in costs is due to an overall increase in average usage per
Prodigy subscriber. The Company anticipates that aggregate IBM Network charges
will begin to decline in 1999, as traffic migrates from the IBM Network to the
Splitrock Network.
As the expansion of the Splitrock Network progresses, the Prodigy Legacy
Network is being decommissioned. As POPs are decommissioned, all occupancy and
telecommunication line charges are terminated. The Company had fully
decommissioned 101 of the original 158 Prodigy Legacy Network POPs through
September 30, 1998. The Company anticipates that few Prodigy Legacy Network
sites will remain at year-end. There is typically a period of time in which the
Splitrock Network runs parallel to the Legacy Network. This parallel period can
range from one to two months. As a result, transition to the Splitrock Network
involves a temporary duplication of costs. Legacy Network costs should be
substantially eliminated by mid-1999, upon completion of the Phase II Expansion.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist of personnel and operating costs relating to
executive management, accounting and finance, human resources, sales and
marketing and administrative employees. The Company incurred approximately $1.0
million of selling, general and administrative expenses in the third quarter of
1998 as compared to $0.5 million in the third quarter of 1997. This increase
reflects the development of the Company's executive, accounting and
administrative support departments.
Selling, general and administrative expenses were $1.0 million for the
three months ended September 30, 1998 and $0.9 million for the three months
ended June 30, 1998. This increase was due to additional staff and expansion
into a new 25,000 square foot office facility in The Woodlands, TX.
To date the Company has had limited staff focused on the sales and marketing
area. The Company anticipates capitalizing on internet growth by aggressively
marketing its services through a variety of distribution channels and evaluating
strategic alliances and acquisitions as they present themselves. The Company
believes that utilizing a range of distribution channels will enable it to cost
effectively reach a broad base of potential customers. The Company intends to
expand its direct sales force and customer service to attract internet service
providers, carriers, value added service providers and medium and large
businesses. In addition, the Company intends to continue to use alternative
distribution channels, including agents, resellers and wholesalers, to gain
access to a substantially larger base of potential customers than the Company
could otherwise initially address through its direct sales force. In addition to
the expanded sales force, the Company anticipates further back-office expansion,
including the implementation of a new customer care and billing software; phase
one of which will be completed in mid-December 1998.
Depreciation and Amortization. The Company incurred depreciation expenses of
$2.8 million in the third quarter of 1998, as compared to $1.7 million in the
third quarter of 1997. Depreciation expense during 1997 related primarily to the
depreciation of Prodigy Legacy Network equipment. The depreciation of this
equipment ended in the first quarter of 1998 and depreciation expense in the
following periods related primarily to new Splitrock Network equipment.
Depreciation and amortization was $2.8 million for the three months ended
September 30, 1998 and $2.1 million for the three months ended June 30, 1998.
This increase in depreciation was due to the new Splitrock Network equipment
placed in production during the second quarter of 1998. Depreciation is
expected to increase as new POPs and equipment are installed to support the
expansion of the Splitrock Network.
10
<PAGE> 13
Interest Expense. Historical interest expense is related to capital leases
on equipment and loans from Linsang, a stockholder of the Company, prior to
completion of the Senior Notes Offering. The Company incurred interest expense
of $0.1 million in the third quarter of 1997. Interest expense was $6.3 million
for the three months ended September 30, 1998 as compared to $0.5 million for
the three months ended June 30, 1998. Interest expense increased significantly
in the third quarter of 1998 due to the interest on the $261.0 million of Senior
Notes issued on July 24, 1998.
Interest Income. Interest income relates to the interest earned on
investments of cash on hand in commercial paper and money market accounts. The
Company recorded interest income of $0.1 million in the third quarter of 1997.
The Company recorded interest income of $2.7 million during the three months
ended September 30, 1998 and $0.1 million during the three months ended June 30,
1998. The increase was due to interest earned on the proceeds from the sale of
the Senior Notes issued on July 24, 1998.
Provision for Income Taxes. No provision for income taxes has been
recognized as the Company had operating losses for both tax and financial
reporting purposes for the period from inception (March 5, 1997) to December
31, 1997 and for the nine months ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash flow used in operating activities can vary significantly from period
to period depending upon the timing of operating cash receipts from Prodigy and
the payments to large vendors. The Company expects this variation to continue
until the Phase II Expansion is completed and the Company's base of customers
has increased. As of September 30, 1998, the Company's primary uses of cash
were almost entirely composed of purchases of capital equipment. During the
third quarter of 1998, the Company began purchasing capital equipment with the
proceeds received from the sale of the Senior Notes. Prior to such time, the
majority of the Company's capital purchases were acquired through
lease financing.
On July 24, 1998, the Company issued and sold $261.0 million aggregate
principal amount of Senior Notes. An amount has been escrowed from the proceeds
received that, together with the interest received thereon, will be sufficient
to pay when due the first four semi-annual payments of interest beginning with
the January 15, 1999 payment. In connection with the Senior Notes Offering, as
of September 30, 1998, the Company had incurred $9.4 million of related costs,
including underwriting fees.
The Company is subject to certain covenants and restrictions pursuant to
and defined in the indenture for the Senior Note Offering. The Company believes
that these restrictions will not adversely affect its operating strategies.
The Company was in compliance with such covenants at September 30, 1998.
On September 14, 1998, Orient Star, exercised a warrant to purchase 5.0
million shares of the Company's Common Stock for $0.625 per share. The $3.1
million proceeds from this exercise will be used for working capital purposes.
The Company expects to incur additional operating losses and will rely
primarily on the proceeds from the sale of the Senior Notes Offering to meet its
anticipated cash needs for working capital, purchases of additional capital
equipment, lease obligations and debt service requirements for at least the next
twelve months.
YEAR 2000
The year-2000 issue is the result of computer programs being written using
two digits, rather than four digits, to define the applicable year. Programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000 (the "year-2000 issue"). This could result in a
major system failure or miscalculations, including an inability to process
transactions, send invoices or engage in similar normal business activities.
Due to its reliance on computer hardware and software, the internet and related
service industries are highly susceptible to the year-2000 issue. If the
year-2000 issue should cause widespread problems across the internet, usage can
be expected to decline dramatically. Such an event would have a material
adverse effect on the Company's financial condition and results of operations,
the nature and extent of which cannot reasonably be determined by the Company
on the basis of information currently available to it. The Company has not
prepared a contingency plan and does not expect to do so in light of the
uncertainty of the impact of year-2000 issues on the internet as a whole and
the Company's own anticipated schedule to be year-2000 compliant before the
end of 1999.
The Company is currently in the process of evaluating its information
technology systems and its non-information technology systems to determine its
own vulnerability to the year-2000 issue. The Company relies heavily on both
information and non-information technology systems in the conduct of its
operations and has determined that substantially all of such systems are
year-2000 compliant. For those software systems that are not currently
year-2000 compliant, there are readily available vendor software upgrades,
which are scheduled to occur in the ordinary course of business, that will
enable the Company to be year-2000 compliant by mid-1999.
11
<PAGE> 14
Certain network-monitoring software, which is used by the Company to monitor
network equipment (POPs) on the Legacy Network, is not year-2000 compliant.
However, as part of the Company's Phase II Expansion, substantially all of the
Prodigy Legacy Network POPs are scheduled to be decommissioned by the end of
1998 and such network-monitoring software will no longer be used by the Company.
With respect to the Company's inventory database software, used to capture data
about the network configuration, including location of equipment and
maintenance, the Company has purchased and is currently installing year-2000
compliant software to replace its existing software. Installation is scheduled
to be completed by the end of 1998, and the cost of such purchase and
installation is not material. The Company has also determined that certain other
of its software systems are not year-2000 compliant. The Company is continuing
its evaluation of the remaining areas impacted by year-2000 issues, including
internet interfaces, facility matters and equipment vendors, but does not expect
to incur material costs in connection with making its software year-2000
compliant. To date, the Company has not incurred material costs in ensuring
year-2000 compliance.
The Company is also dependent upon the ability of its customers to ensure
that their software and equipment is year-2000 compliant. The Company has
initiated formal communications with Prodigy to determine the extent to which
the Company is vulnerable to Prodigy's own year-2000 issues, if any. Prodigy
has informed the Company that Prodigy Classic may not be year-2000 compliant.
Prodigy is in the process of migrating users to Prodigy Internet, which is
year-2000 compliant, and plans to discontinue Prodigy Classic service by the
end of 1999. However, there can be no guarantee that Prodigy Classic or systems
of future customers on which the Company may rely will be converted on a timely
basis, or that a failure to convert, or a conversion that is incompatible with
the Company's systems, would not have a material adverse effect on the Company.
12
<PAGE> 15
SPLITROCK SERVICES, INC.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not currently involved in any legal proceedings, nor are any
material legal proceedings threatened by or against the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 24, 1998, the Company issued and sold to Chase Securities, Inc., as
initial purchaser, units consisting of $261.0 million aggregate principal amount
of Senior Notes and warrants to purchase common stock of the Company. Chase
Securities Inc. resold $250.0 million of such units to qualified institutional
buyers pursuant to Rule 144A promulgated under the Securities Act of 1933, as
amended (the "Securities Act"), and $11.0 million of such units to Linsang, a
stockholder of the Company, in a nonpublic transaction exempt from registration
under Section 4(2) of the Securities Act. Of the proceeds, $56.8 million was
escrowed to secure the first four payments of interest on the Senior Notes, and
the remaining proceeds are being used to finance the Phase II Expansion. The
Company subsequently filed registration statements on Form S-4 (registering the
exchange of its Senior Notes) and Form S-1 (registering the warrants and the
shares of common stock to be issued upon exercise of such warrants); such
registration statements were declared effective on October 30, 1998.
In September 1998, the Company issued 5.0 million shares to Orient Star for
a cash payment of $3.1 million pursuant a warrant issued to Orient Star in
September 1997. The warrant was issued pursuant to an exemption from
registration under Section 4(2) of the Securities Act as a transaction not
involving a public offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
13
<PAGE> 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K:
None.
14
<PAGE> 17
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
SPLITROCK SERVICES, INC.
Dated: November 16, 1998 By: /s/ WILLIAM R. WILSON
---------------------------- ----------------------------------------
William R. Wilson
President and Chief Executive Officer
By: /s/ TRACY E. HAMMOND
---------------------------------------
Tracy E. Hammond
Vice President and Controller
(Chief Accounting Officer)
15
<PAGE> 18
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE
COMPANY'S UNAUDITED CONDENSED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B)
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 182,322
<SECURITIES> 0
<RECEIVABLES> 3,299
<ALLOWANCES> (537)
<INVENTORY> 0
<CURRENT-ASSETS> 222,142
<PP&E> 62,955
<DEPRECIATION> (11,373)
<TOTAL-ASSETS> 307,441
<CURRENT-LIABILITIES> 43,349
<BONDS> 258,178
0
0
<COMMON> 83
<OTHER-SE> (4,369)
<TOTAL-LIABILITY-AND-EQUITY> 307,441
<SALES> 47,592
<TOTAL-REVENUES> 47,592
<CGS> 64,884
<TOTAL-COSTS> 75,415
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,136
<INCOME-PRETAX> (32,112)
<INCOME-TAX> 0
<INCOME-CONTINUING> (32,112)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (32,112)
<EPS-PRIMARY> .41
<EPS-DILUTED> .41
</TABLE>
