<PAGE>
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, 1999
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)
9012 NEW TRAILS DRIVE, THE WOODLANDS, TEXAS 77381
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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 [X] No [_]
The number of shares of Common Stock, par value $.001 per share, of the
Registrant outstanding at October 15, 1999 was 56,830,759.
<PAGE>
SPLITROCK SERVICES, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
INDEX
Part I -- Financial Information
Item 1 -- Financial Statements
<TABLE>
<CAPTION>
PAGE
<S> <C>
Condensed Balance Sheets as of December 31, 1998 and September 30, 1999 (unaudited).... 2
Condensed Statements of Operations and Comprehensive Loss for the Three Months Ended
September 30, 1998 and 1999 (unaudited)................................................ 3
Condensed Statements of Operations and Comprehensive Loss for the Nine Months Ended
September 30, 1998 and 1999 (unaudited)................................................ 4
Condensed Statements of Cash Flows for the Nine Months Ended
September 30, 1998 and 1999 (unaudited)................................................ 5
Notes to Condensed Financial Statements (unaudited).................................... 6
Item 2 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................................... 8
Item 3 -- Quantitative and Qualitative Disclosures About Market Risk............................ 21
Part II -- Other Information
Item 1 -- Legal Proceedings..................................................................... 23
Item 2 -- Changes in Securities and Use of Proceeds............................................. 23
Item 3 -- Defaults upon Senior Securities....................................................... 23
Item 4 -- Submission of Matters to a Vote of Security Holders................................... 23
Item 5 -- Other Information..................................................................... 23
Item 6 -- Exhibits and Reports on Form 8-K...................................................... 24
Signatures....................................................................................... 25
</TABLE>
1
<PAGE>
SPLITROCK SERVICES, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $ 28,330 $ 91,544
Unrestricted investments -- short term............... 120,475 33,745
Restricted investments -- short term................. 39,476 25,870
Accounts receivable, net............................. 3,205 7,215
Prepaid expenses and other current assets............ 480 1,737
-------- --------
Total current assets............................... 191,966 160,111
Restricted investments -- long term................... 19,001 4,038
Deposits.............................................. 270 11,914
Property and equipment, net........................... 73,899 88,736
Intangibles, net...................................... 11,005 18,477
-------- --------
$296,141 $283,276
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of capital lease obligations...... $ 9,121 $ 7,779
Accounts payable..................................... 21,582 5,622
Accrued interest payable............................. 13,375 6,474
Accrued liabilities.................................. 15,894 22,182
-------- --------
Total current liabilities.......................... 59,972 42,057
Senior notes payable ($261,000 face value net of
unamortized discount)................................ 258,217 258,340
Capital lease obligations............................. 8,243 2,294
-------- --------
Total liabilities.................................. 326,432 302,691
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $.001 par value, 25,000,000 shares
authorized, no shares issued........................ -- --
Common stock, $.001 par value, 150,000,000 shares
authorized, 46,624,845 and 56,763,016 shares issued and
outstanding as of December 31, 1998, and September 30, 1999,
respectively........................................ 47 57
Additional paid-in capital........................... 34,717 123,958
Common stock warrants................................ 2,849 2,247
Accumulated other comprehensive income (loss)........ 47 (346)
Accumulated deficit.................................. (67,951) (145,331)
-------- --------
Total stockholders' equity (deficit)............... (30,291) (19,415)
-------- --------
$296,141 $283,276
======== ========
The accompanying notes are an integral part of these unaudited condensed
financial statements.
</TABLE>
2
<PAGE>
SPLITROCK SERVICES, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1999
------------------ ------------------
<S> <C> <C>
Revenues....................................... $ 15,378 $ 23,703
Operating expenses:
Splitrock network costs..................... 10,211 22,832
Legacy network costs........................ 15,489 6,652
Selling, general and administrative......... 1,728 6,070
Depreciation and amortization............... 2,804 8,039
-------- --------
Total operating expenses.................... 30,232 43,593
-------- --------
Loss from operations........................... (14,854) (19,890)
Other income (expense):
Interest income............................. 2,664 2,001
Interest expense............................ (6,294) (8,125)
-------- --------
Net loss....................................... (18,484) (26,014)
-------- --------
Other comprehensive gain (loss):
Unrealized net gain (loss) on securities.... 345 (11)
-------- --------
Comprehensive net loss......................... $(18,139) $(26,025)
======== ========
Net loss per share - basic and diluted......... $ (.42) $ (.49)
======= ========
Weighted average shares - basic and diluted.... 44,321,563 52,979,209
========== ==========
The accompanying notes are an integral part of these unaudited condensed
financial statements.
</TABLE>
3
<PAGE>
SPLITROCK SERVICES, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1999
------------------ ------------------
<S> <C> <C>
Revenues....................................... $ 47,592 $ 57,944
Operating expenses:
Splitrock network costs..................... 20,935 56,982
Legacy network costs........................ 42,600 28,523
Selling, general and administrative......... 4,169 12,408
Depreciation and amortization............... 7,711 19,276
-------- --------
Total operating expenses............. 75,415 117,189
-------- --------
Loss from operations........................... (27,823) (59,245)
Other income (expense):
Interest income............................. 2,847 6,336
Interest expense............................ (7,136) (24,471)
-------- --------
Net loss....................................... (32,112) (77,380)
-------- --------
Other comprehensive gain (loss):
Unrealized net gain (loss) on securities.... 345 (393)
-------- --------
Comprehensive net loss......................... $(31,767) $(77,773)
======== ========
Net loss per share - basic and diluted......... $ (.74) $ (1.59)
======== ========
Weighted average shares - basic and diluted.... 43,636,418 48,804,809
========== ==========
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
4
<PAGE>
SPLITROCK SERVICES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1999
------------------ ------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss............................................................................. $(32,112) $(77,380)
Adjustments to reconcile net loss to net cash (used in) or provided by
operating activities -
Depreciation and amortization.................................................... 7,711 19,276
Amortization of debt discount and deferred financing costs....................... 189 834
Changes in operating assets and liabilities:
Accounts receivable, net......................................................... 1,490 (4,010)
Prepaid expenses and other current assets........................................ (184) (1,257)
Accounts payable and accrued liabilities......................................... 19,401 (9,672)
Accrued interest payable......................................................... 5,688 (6,901)
-------- --------
Net cash (used in) or provided by operating activities....................... 2,183 (79,110)
-------- --------
INVESTING ACTIVITIES:
Purchases of equipment............................................................... (17,120) (32,683)
Use of unrestricted investments...................................................... -- 86,698
Use (purchase) of restricted investments, net........................................ (783) 28,208
Increase in intangible assets........................................................ (1,323) (9,613)
Increase in deposits................................................................. (1,569) (11,644)
-------- --------
Net cash (used in) or provided by investing activities....................... (20,795) 60,966
-------- --------
FINANCING ACTIVITIES:
Proceeds from initial public offering, net of offering costs......................... -- 88,419
Proceeds from senior notes payable and warrants issued............................... 261,000 --
Proceeds from note payable to stockholder............................................ 10,000 --
Repayments of notes payable to stockholder........................................... (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 and exercise of stock options and warrants...................... 4,225 230
Proceeds from sale leaseback of equipment............................................ 960 --
Principal payments on capital lease obligations...................................... (9,312) (7,291)
Release of restriction of cash under credit agreement................................ 3,472 --
-------- --------
Net cash provided by financing activities.................................... 193,224 81,358
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS............................................... 174,612 63,214
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD........................................ 7,710 28,330
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.............................................. $182,322 $ 91,544
======== ========
</TABLE>
The accompanying notes are an integral part of these unaudited condensed
financial statements.
5
<PAGE>
SPLITROCK SERVICES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements of Splitrock
Services, Inc. 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. Certain amounts
previously reported have been reclassified in order to ensure comparability
among the periods reported.
The accompanying unaudited interim condensed financial statements reflect all
adjustments (consisting of normal recurring adjustments) which, in the opinion
of management, are necessary for a fair presentation of the results for the
interim periods presented. Accordingly, they do not include all information and
notes required by generally accepted accounting principles for complete
financial statements. The results for the interim period ended September 30,
1999, are not necessarily indicative of results to be expected for the entire
year ending December 31, 1999, or future operating results.
The Company effected a 0.563-for-1 reverse stock split of its common stock on
July 12, 1999. All share and per share amounts included in these financial
statements have been retroactively adjusted to give effect to the reverse stock
split.
The financial statements should be read in conjunction with the Company's
annual audited financials statements for the year ended December 31, 1998 as
filed with the Securities and Exchange Commission on Form 10-K.
2. NET LOSS PER SHARE
Basic and diluted net loss per share have been computed in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
No. 128). SFAS No. 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, options to acquire 1,506,306 shares
of common stock at the weighted-average exercise price of $1.23 and warrants to
acquire 1,487,791 shares of common stock at an exercise price of $0.02 were not
included in the computation of diluted earnings per share because their effect
is anti-dilutive. At September 30, 1999, options to acquire 4,117,173 shares of
common stock at the weighted average exercise price of $6.82 and warrants to
acquire 1,173,868 shares of common stock at an exercise price of $.02, were not
included in the computation of diluted earnings per share because their effect
is anti-dilutive.
6
<PAGE>
3. ACCRUED LIABILITIES
At December 31, 1998 and September 30, 1999 and the Company's accrued
liabilities consisted of the following:
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
----------- ------------
<S> <C> <C>
Telecommunication network equipment and shelters $ 9,900 $ 7,903
Access and transmission telecommunications line costs 3,172 8,212
Other 2,822 6,067
------- -------
$15,894 $22,182
======= =======
</TABLE>
4. STOCKHOLDERS' EQUITY
On August 6, 1999, the Company completed its initial public offering of its
common stock pursuant to a Registration Statement filed with the Securities and
Exchange Commission. The Company sold 9,692,628 shares of common stock at a
price of $10.00 per share, which resulted in net proceeds of approximately $88.4
million after deducting the underwriting discount and other fees and expenses.
The underwriters purchased 692,628 of these shares pursuant to an over-allotment
option. In addition 157,372 additional shares were sold, under the same
agreement, by certain existing shareholders. The Company did not receive any of
the proceeds from the sale of the 157,372 shares.
5. COMMITMENTS
In April 1999, the Company entered into a cost sharing agreement with Level
3 Communications, LLC (Level 3), a national telecommunications provider. The
agreement grants the Company an exclusive indefeasible right of use (IRU) in 4
dark fibers in the nationwide fiber optic communication system currently under
construction by Level 3 with an option to acquire the indefeasible rights to use
an additional 12 dark fibers. The Company made an initial payment of $11.2
million to Level 3 and is required to make additional payments as dark fiber
segments are accepted, which is expected to occur from the end of 1999 through
the first quarter of 2001. The Company expects to incur approximately $170.0
million in capital expenditures over the next three years related to its current
network fiber optic deployment plans, including the electronic equipment
necessary to operate its fiber optic network. The Company may terminate the
agreement prior to October 31, 1999, under certain circumstances, but the
Company would forfeit up to 80% of its initial payment to the Provider if it
exercises that termination right. The Company does not intend to terminate the
agreement.
6. SUBSEQUENT EVENTS
In October 1999, the Company agreed to purchase additional equipment and
services from Nortel Networks, Inc. (Nortel). The equipment and services
include (i) dial access modems expected to be delivered over the next three
quarters, and (ii) fiber optronics equipment and related network management
systems and installation services expected to be delivered over the next six
quarters. Under its agreement with Nortel, the Company committed to acquire
not less than $114.0 million of equipment. In addition, the Company will be
required to return to Nortel certain existing modems as the new modems are
placed in service. To finance its commitment under this agreement, the Company
has entered into leasing arrangements with a third party to fund up to $122.0
million. Initially the lease will be treated for accounting purposes as an
operating lease. The Company has the right to convert to a capital lease.
Subject to obtaining the necessary consents or waivers from senior note holders
under the Company's senior note indenture, the Company intends to exercise its
right to convert the lease to a capital lease.
7
<PAGE>
SPLITROCK SERVICES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
FORWARD-LOOKING STATEMENTS
All references to "we", "us", "Splitrock", or "our" refer to Splitrock
Services, Inc. This section contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act, which are intended to be covered by safe harbors created thereby.
Investors are cautioned that all forward-looking statements involve risks and
uncertainty, including, without limitation, our ability to continue building the
Splitrock network, our ability to diversify our services and customers, the
ability to obtain necessary supplies, the ability to make projected capital
expenditures, and the ability to achieve projected quarterly results, as well as
general market conditions, competition, and pricing. All statements, other than
statements of historical facts, included or incorporated by reference in this
report that address activities, events or developments that we expect or
anticipate will or may occur in the future, including such things as future
capital expenditures (including the amount and nature hereof), business strategy
and measures to implement such strategy, competitive strengths, goals, expansion
and growth of Splitrock's business and operations, plans, references to future
success as well as other statements which include words such as "anticipate,"
"believe," "plan," "estimate," "expect," and "intend" and other similar
expressions, constitute forward-looking statements. Although we believe that
the assumptions underlying the forward-looking statements contained herein are
reasonable, any of the assumptions could be inaccurate, and the inclusion of
such information should not be regarded as a representation by us or any other
person that our objectives and plans will be achieved.
Investors should also be aware that while we do, from time to time,
communicate with securities analysts, it is against our policy to disclose to
them any material non-public information or other confidential commercial
information. Accordingly, investors should not assume that we agree with any
statement or report issued by any analyst irrespective of the content of the
statement or report. Furthermore, we have a policy against issuing or
confirming financial forecasts or projections issued by others. Thus, to the
extent that reports issued by securities analysts contain any projections,
forecasts or opinions, we are not responsible for those reports.
OVERVIEW
We are a facilities-based provider of advanced data communications services.
We market our services to Internet service providers (ISPs), telecommunications
carriers and other businesses throughout the United States. Our services
include an array of Internet access and data communications services delivered
over our high capacity, facilities-based network.
We were founded in March 1997. In July 1997, we acquired the existing legacy
network infrastructure of Prodigy Communications Corporation, and agreed to
build and operate a nationwide communications network and to provide network
services for Prodigy's customers. We initially provided service to Prodigy's
subscribers using Prodigy's legacy network. For locations outside the coverage
area of the legacy network, we have used the AT&T Global Services network
(formerly IBM's Global Services Network). Since September 1997, we have deployed
our broadband access network in metropolitan areas across the country. Over
time, as more coverage became available on our access network, we decommissioned
the Prodigy legacy network POPs and have substantially discontinued the use of
the AT&T network. As of September 30, 1999, our broadband access network
included 329 installed POPs, 320 of which were operational. When complete, we
expect to have approximately
8
<PAGE>
340 operational broadband access POPs. We have realized efficiencies in our
network and have made economic decisions regarding coverage of certain markets
that have allowed us to decrease our expected number of POPs to give us a
physical presence in all 50 states, and target 90% of U.S. businesses and 87% of
U.S. households with a local call. Our expanding network is managed and
supported by our state-of-the-art network operations center in Houston, Texas.
Based on updated information provided by the Company's expanded sales force
and the growth of its current customer base, the Company has increased its
expectation of the demand for dial access services. In order to accommodate
this increase, the Company plans on significantly expanding the capacity of its
broadband dial access network over the next three quarters.
As part of our ongoing efforts to further expand and enhance our network and
service offerings, we have agreed to acquire indefeasible rights to use four
dark fiber strands in a state-of-the-art fiber optic network currently under
construction by Level 3 Communications, LLC, with an option to acquire
indefeasible rights to use an additional 12 fibers. This nationwide fiber
network will cover approximately 15,000 route miles and will be delivered in
segments that are expected to become available from the end of 1999 through the
first quarter of 2001. The combination of this fiber optic backbone with our
broadband access network positions us to:
. deliver, on our own facilities, a broad array of end-to-end data
communications services at the high level of quality and reliability
increasingly demanded by customers;
. reduce significantly our network costs as a percentage of revenues as we
substitute the acquired bandwidth for existing leased circuit
arrangements with various telecommunications carriers;
. expand our service offerings by providing bandwidth leasing services on a
stand alone basis or bundled with our other services;
. increase the reliability and redundancy of our network; and
. increase the variety of service options and speeds available to
customers.
In July 1998, we raised $261.0 million through the issuance of our 11 3/4%
senior notes and warrants to purchase common stock, principally to finance
capital expenditures related to the construction and installation of our
broadband access network. In August 1999, we completed our initial public
offering which resulted in net proceeds of $88.4 million after deducting
commissions and other fees and expenses. We intend to use the proceeds from the
initial public offering to fund a portion of the fiber acquisition and to fund
operational losses, working capital needs and certain other capital
expenditures.
In October 1999, in order to expand the capacity of our dial access network
and to begin deployment of our fiber optic backbone, we agreed to purchase
additional equipment and services from Nortel Networks, Inc. The equipment and
services include (i) dial access modems expected to be delivered over the next
three quarters, and (ii) fiber optronics equipment and related network
management systems and installation services expected to be delivered over the
next six quarters. Under our agreement with Nortel, we committed to acquire not
less than $114.0 million of the equipment. In addition, we will be required to
return to Nortel certain existing modems as the new modems are placed in
service. To finance our commitment under this agreement, we have entered into
leasing arrangements with a third party to fund up to $122.0 million. Initially,
the lease will be treated for accounting purposes as an operating lease, which
means that any actual lease payments up to the date of conversion, if any, will
be included in Splitrock network costs and will reduce net loss plus interest
expense, provision for income taxes, depreciation and amortization (EBITDA). The
Company has the right to convert the operating lease to a capital lease. Subject
to obtaining the necessary consents or waivers from senior note holders under
our senior note indenture, we intend to exercise our right to convert the lease
to a capital lease, in which case the lease payments will be capitalized,
resulting in increased interest expense, depreciation and amortization.
9
<PAGE>
REVENUES
Historically, Prodigy has been our primary customer and has accounted for
substantially all of our revenues since our inception. We have experienced a
significant increase in revenue from Prodigy as a result of Prodigy's subscriber
growth, particularly in the third quarter of 1999. Even with Prodigy's growth,
we have reduced our concentration of Prodigy revenue by almost 20% by expanding
our customer base. For the year ended December 31, 1998, nine months and three
months ended September 30, 1999, Prodigy accounted for 99%, 88% and 81% of our
revenues, respectively. While we expect revenues from Prodigy to decrease as a
percentage of our total revenues in future periods, we believe that Prodigy will
continue to account for a significant portion of our revenues.
We provide network services, including Internet dial services and other
network connections, to Prodigy in exchange for a monthly service charge. Since
April 1998 the service charge has been calculated based on the total number of
subscribers. The minimum monthly service charge is $4.0 million and will
increase to $4.5 million on July 1, 2000. Through March 31, 1998, our Prodigy
revenues were a function of the amount of usage rather than the number of
subscribers. In addition, if the average monthly hours per subscriber exceed a
target amount, we will be entitled to receive additional fees.
Our original four-year agreement with Prodigy expires on June 30, 2001. After
the initial term, either party may terminate the agreement upon 12 months prior
written notice. If no notice is received, the term of the agreement is
automatically extended for successive 12-month terms. Under the agreement, we
are required, among other things, to provide Prodigy with financial and other
information and to meet network performance standards. We are required to
provide credits to Prodigy if we fail to meet these standards. Prodigy may
terminate the agreement following a cure period if we fail to meet specified
service level objectives or otherwise fail to comply with our agreement. Prodigy
may also terminate the agreement during the initial term without cause by
providing 12 months' prior written notice and paying a termination charge of
$3.0 million. We are currently Prodigy's primary provider of dial access
services. Under our agreement with Prodigy, Prodigy may enter into agreements
with third parties provided that it may not replace our services in their
totality or to any substantial extent. In September 1999, Prodigy announced that
it had entered into an agreement with a third party to supplement its dial in
service in specific regions.
Prodigy has decided to discontinue Prodigy Classic, its original on-line
service, on October 31, 1999 because of a shift in business focus to Internet-
based products and services and a determination not to make Prodigy Classic Year
2000 compliant. For the month ended September 30, 1999, revenue from Prodigy's
Classic subscribers accounted for approximately 5% of the Company's monthly
total revenue. After October 31, 1999, Splitrock will no longer support Prodigy
Classic service.
In addition to providing Internet dial access and related services to
Prodigy, we provide Internet dial access, Internet dedicated services, and
virtual private network (VPN) services to other customers. Currently, and during
the year 2000, we plan to focus on providing Internet dial and dedicated access,
virtual Internet service, dial VPN, and web hosting. Given the nature of our
network costs and the fact that current network utilization peaks in the evening
hours to support Prodigy's residential Internet subscribers, we are targeting
providers of daytime intensive traffic as well as providers of evening intensive
traffic to maximize network utilization throughout a 24-hour period.
10
<PAGE>
We cannot assure you that we will achieve the balance of utilization of the
network facilities necessary to attain or maximize profitability or positive
cash flow from operations.
Leveraging our demonstrated network capabilities, in the second quarter we
entered into significant new customer relationships with Juno Online Services
and InfiNet. Juno, a leading provider of Internet and e-mail services,
currently has more than 200,000 subscribers for its Internet services launched
in July 1998 and has created more than 6.8 million free e-mail accounts since
April 1996. InfiNet, a consortium sponsored by Knight-Ridder, Gannett and
Landmark Communications, provides Internet access and Web publishing solutions
to nearly 100,000 subscribers nationwide. We began providing Internet dial
access to InfiNet's subscribers in the second quarter of 1999.
Splitrock launched its virtual Internet service (VIS) to Internet service
provider (ISP) customers in the third quarter of 1999. VIS is marketed to ISPs
which desire to outsource certain back office and support functions, such as
billing and customer service, in addition to Internet dial access services. The
Company expects to begin billing its first VIS customers in the quarter ending
December 31, 1999.
We are currently building our first data center in Houston to offer web
hosting services, and we plan to build three more over the next year. Revenues
from these facilities are expected to commence in the first half of 2000, but
there can be no assurances that we will generate revenues from this new product
line.
Splitrock is focusing its current VPN efforts on dial VPN services for
corporations with remote offices or business travel users. We expect to begin
billing our first dial VPN customers in the quarter ending December 31, 1999.
In future periods, Splitrock expects to expand its VPN offerings to include
dedicated access services such as frame relay and ATM.
As segments of our fiber backbone are constructed, we plan to use the
additional network capacity to offer bandwidth leasing services. However,
overcapacity could result from the construction of competing networks,
technological advances, strategic alliances, or a decline in the growth rate of
demand for bandwidth capacity. If this occurs, we could encounter significant
pricing pressure, which could limit the amount we could competitively charge for
these services.
SPLITROCK NETWORK COSTS
Our Splitrock network costs include all expenses incurred in connection with
operating our network. These costs primarily include leased telecommunication
line charges for connecting our POPs to local central offices and for backbone
transmission, personnel expenses, and operating expenses related to network
operations, maintenance, field operations and facility management.
Increases in Splitrock network operating costs relate to the increase in
Splitrock network facilities and line charges incurred in connection with the
growth in total subscriber usage. As of September 30, 1999, we had 329
installed POPs, 320 of which were operational, and we expect to have
approximately 340 operational POPs when our broadband access platform is
complete.
We are increasing our network operating expenditures to significantly expand
our broadband access network and backbone capacity in anticipation of expected
increases in dial access and other services. We may incur expenditures to
increase our capacity to serve customers in advance of entering into new
customer relationships.
11
<PAGE>
Our current lease arrangements related to the acquisition of equipment and
services from Nortel are structured as an operating lease, but may be converted
to a capital lease if we are able to obtain the necessary consents or waivers
from holders of our senior notes. We cannot assure that we will be able to
secure the amendments or waivers necessary to permit capital lease financing. If
we are unable to obtain capital lease treatment, Splitrock network costs would
increase significantly as the monthly lease payments would be classified as
Splitrock network costs.
Beginning in 2000, we expect our network operating costs to decrease as a
percentage of revenues as we substitute our acquired fiber optic backbone
network for existing leased circuit arrangements with various telecommunications
carriers. Although we expect to incur new costs for maintenance, colocation and
software in connection with the fiber optic network, we expect these new costs
to be offset in future years by a larger reduction in charges for backbone
transmission. Certain of the Company's fiber optic facilities will also contain
data centers to be used in connection with web hosting services, and we expect
to have four sites completed for web hosting during the year 2000.
LEGACY NETWORK COSTS
Legacy network costs include all expenses incurred in connection with
operating and decommissioning the Prodigy legacy network, including the AT&T
network, and legacy network costs of servicing the InfiNet legacy network until
we transition the InfiNet traffic to our network. These costs include facility
leases, line charges, occupancy costs, equipment maintenance costs, access fees,
as well as significant transition costs which will be incurred until the traffic
from these networks is migrated to our network.
Legacy network costs are expected to continue to decline through the end of
the year. The largest component of our legacy network costs are paid to AT&T
for usage incurred on their network (formerly IBM's Global Services Network). We
are moving the traffic currently on the AT&T network to the Splitrock network
and expect to have all the traffic migrated by the end of this year. In
addition, we will continue to incur certain legacy network costs associated with
the InfiNet traffic during the fourth quarter of 1999. We do not expect to incur
any significant legacy network costs beyond the end of 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist of personnel and
operating costs relating to executive management, accounting and finance,
information systems, human resources, sales and marketing, customer support,
network planning, development, and administrative employees. We expect our
selling, general and administrative expenses to continue to increase in dollar
amount and as a percentage of revenue in 1999, 2000 and 2001 principally due to
the following factors:
. expansion of our sales and marketing force; and
. expansion of our back-office, customer care, billing, and administrative
functions.
We expect to make a substantial investment in our sales and marketing
programs to achieve and properly support the intended expansion in our customer
base. Through the combination of a direct sales force and alternative
distribution channels, we believe that we will be able to access markets and
increase revenue-producing traffic on our network.
12
<PAGE>
In the second quarter of 1999, we began to implement our distribution
strategy by developing an in-house direct sales force. We intend to utilize our
direct sales force to market our services directly to Internet service
providers, carriers, value added service providers, and medium and large
businesses. As of September 30, 1999 our direct sales force included
approximately 70 sales and sales management staff. We intend to utilize
alternate distribution channels, such as agents, resellers and wholesalers, to
market our services to medium and small businesses. We cannot assure you that we
will be successful in our marketing plan.
In addition to the expanded sales force, we anticipate continued back-office
expansion, including the continued implementation of a new customer care and
billing system in the fourth quarter of 1999. During the quarter ended September
30, 1999 we completed the implementation of PeopleSoft's financial and human
resource management information system. We also signed a lease for 69,000 square
feet of additional office space, which we began to occupy in August 1999.
This office lease and related occupancy costs increased selling, general and
administrative costs.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense consists primarily of depreciation of
network equipment. We anticipate that our depreciation and amortization expenses
will increase significantly as we deploy our fiber network and significantly
expand the capacity of our broadband dial access network. Our current lease
arrangements relating to the acquisition of equipment and services from Nortel
are structured as an operating lease, but may be converted to a capital lease if
we are able to obtain the necessary waivers or consents from our senior note
holders. We cannot assure you that we will be able to secure the amendments or
waivers necessary to permit capital lease financing. If we are able to obtain
capital lease treatment, depreciation expense is expected to increase
significantly as the assets under lease are placed in service.
INTEREST EXPENSE
Interest expense represents interest on our 11 3/4% Senior Notes and interest
at various rates on our capital leases. Subject to obtaining the necessary
amendments or waivers from holders of our senior notes, the lease arrangements
we recently entered into would be treated as a capital lease and would result in
a significant increase in our interest expense. If we are not able to convert
these lease arrangements to a capital lease, the operating lease would have no
impact on interest expense.
NET LOSSES
We have incurred net losses since our inception in March 1997. We anticipate
that we will continue to incur net losses while we complete the construction and
installation of our fiber backbone network and expand our sales and marketing
force. The extent to which we continue to incur net losses is largely dependent
upon the timely deployment of the fiber backbone network, the rate at which we
can expand our customer and revenue base and our ability to maximize use of our
nationwide network.
13
<PAGE>
RESULTS OF OPERATIONS
Three Months Ended September 30, 1999 Compared to Three Months Ended
September 30, 1998
Revenues. Revenues for the three months ended September 30, 1999 totaled
$23.7 million, an increase of $8.3 million from revenues of $15.4 million for
the three months ended September 30, 1998. This 54.1% increase was due to
increased Prodigy revenue as a result of their subscriber growth and an increase
in revenue from our expanding customer base.
Splitrock Network Costs. Splitrock network costs for the three months ended
September 30, 1999 were $22.8 million compared to $10.2 million for the three
months ended September 30, 1998. This $12.6 million increase was due to the
growth in the size of our network from 77 operational POPs as of September 30,
1998 to 320 operational POPs as of September 30, 1999. As a percentage of
revenues, Splitrock network costs increased to 96.3% of revenue for the three
months ended September 30, 1999 from 66.4% of revenues for the three months
ended September 30, 1998.
Legacy Network Costs. Legacy network costs for the three months ended
September 30, 1999 were $6.7 million compared to $15.5 million for the three
months ended September 30, 1998. This $8.8 million or 57.1% decrease was
primarily attributable to a decrease in access charges incurred for use of the
AT&T network, as a result of the expanded coverage becoming available on our
network and the migration of additional traffic from the legacy networks to our
network. As a percentage of revenues, legacy network costs decreased to 28.1%
of revenue for the three months ended September 30, 1999 from 100.7% of revenues
for the three months ended September 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended September 30, 1999 were $6.1
million compared to $1.7 million for the three months ended September 30, 1998.
The majority of this increase was due to personnel costs incurred in building
our direct sales force beginning in the second quarter of 1999 and the increase
in personnel to support the growth in the size of our network. As a percentage
of revenues, selling, general and administrative expenses increased to 25.6% of
revenue for the three months ended September 30, 1999 from 11.2% of revenues for
the three months ended September 30, 1998.
Depreciation and Amortization. Depreciation and amortization was $8.0 million
for the three months ended September 30, 1999 compared to $2.8 million for the
three months ended September 30, 1998. This increase was due to the increase in
equipment and facilities placed in service between the two periods.
Interest Expense. Interest expense was $8.1 million for the three months
ended September 30, 1999, compared to $6.3 million for the three months ended
September 30, 1998. This increase is the result of the 11 3/4% Senior Notes
being issued at the end of July 1998 and therefore not outstanding for the full
quarter ended September 30, 1998.
Interest Income. Interest income relates to the interest earned on
investments of cash on hand in investment grade commercial paper and money
market accounts. Interest income was $2.0 million for the three months ended
September 30, 1999, compared to $2.7 million for the three months ended
September 30, 1998. This decrease is due to the decrease in the cash balances
between the two periods. In August 1999 the Company raised net proceeds of
$88.4 million through its initial public offering. The proceeds have been
invested in short-term investments which began earning interest upon the
Company's receipt of the funds in the third quarter of 1999.
14
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1998
Revenues. Revenues for the nine months ended September 30, 1999 totaled $57.9
million, an increase of $10.4 million from revenues of $47.6 million for the
nine months ended September 30, 1998. This 21.8% increase was due primarily to
increase in Prodigy's subscriber growth and the increase in revenue from our
expanding customer base.
Splitrock Network Costs. Splitrock network costs for the nine months ended
September 30, 1999 were $57.0 million compared to $20.9 million for the nine
months ended September 30, 1998. This increase was primarily due to the growth
in the size of our network from 77 operational POPs as of September 30, 1998 to
320 operational POPs as of September 30, 1999. As a percentage of revenues,
Splitrock network costs increased to 98.3% of revenue for the nine months ended
September 30, 1999 from 44.0% of revenues for the nine months ended September
30, 1998.
Legacy Network Costs. Legacy network costs for the nine months ended
September 30, 1999 were $28.5 million compared to $42.6 million for the nine
months ended September 30, 1998. This 33.0% decrease was primarily attributable
to a decrease in access charges incurred for use of the AT&T network, as a
result of the expanded coverage becoming available on our network and the
migration of additional traffic from the legacy networks to our network. Our
legacy network costs in total decreased 24.8% from the second quarter of 1999 to
the third quarter of 1999. As a percentage of revenues, legacy network costs
decreased to 49.2% of revenue for the nine months ended September 30, 1999 from
89.5% of revenues for the nine months ended September 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the nine months ended September 30, 1999 were $12.4
million compared to $4.2 million for the nine months ended September 30, 1998.
The majority of this increase was due to personnel costs incurred in building
our direct sales force beginning in the second quarter of 1999 and the increase
in personnel throughout 1998 and 1999 to support the growth in the size of our
network. As a percentage of revenues, selling, general and administrative
expenses increased to 21.4% of revenues for the nine months ended September 30,
1999 from 8.8% of revenues for the nine months ended September 30, 1998.
Depreciation and Amortization. Depreciation and amortization was $19.3
million for the nine months ended September 30, 1999 compared to $7.7 million
for the nine months ended September 30, 1998. This increase was due to the
increase in equipment and facilities placed in service between the two periods.
Interest Expense. Interest expense was $24.5 million for the nine months
ended September 30, 1999, compared to $7.1 million for the nine months ended
September 30, 1998. This increase is the result of the issuance of $261.0
million of 11 3/4% Senior Notes in July 1998. Historical interest expense was
related to capital leases on equipment and loans from a stockholder prior to
completion of the senior notes offering in July 1998.
Interest Income. Interest income relates to the interest earned on
investments of cash on hand in investment grade commercial paper and money
market accounts. Interest income was $6.3 million for the nine months ended
September 30, 1999, compared to $2.8 million for the nine months ended September
30, 1998. This increase was due to the interest earned on the proceeds from our
senior notes offering and interest earned in the third quarter of 1999 from the
investment of our proceeds from our initial public offering.
15
<PAGE>
Income Taxes. No provision for income taxes has been recognized because we
had operating losses for both tax and financial reporting purposes in all
periods.
On September 30, 1999, we had approximately $48.2 million of gross deferred
tax assets comprised primarily of net operating loss carryforwards. Given our
history of operating losses, it is uncertain that we would realize these assets,
and so we have provided a reserve to reduce the carrying value of the assets to
zero. We will continue to assess the ability to realize the deferred tax assets
based on actual and forecasted results.
LIQUIDITY AND CAPITAL RESOURCES
Our operations have required funding of substantial operating losses and
capital investment for the purchase of communications equipment and the design
and development of our network.
Since our inception, we have satisfied our cash requirements primarily
through the issuance of equity or debt securities. As of September 30, 1999, we
had raised approximately $386.6 million, including:
. $34.9 million through private sales of our equity securities, including
$18.0 million invested by our senior management and directors and $15.6
million invested by another major stockholder; and
. $263.3 million through the issuance of debt.
. $88.4 million in net proceeds from the Company's initial public offering.
On August 6, 1999, we completed our initial public offering of 9,692,628
shares of our common stock at a price of $10.00 per share resulting in net
proceeds of approximately $88.4 million after deducting the underwriting
discount and other estimated fees and expenses payable by us. The underwriters
purchased 692,628 of the shares from us pursuant to an over-allotment option.
Additionally, 157,372 shares were sold by certain of our stockholders under the
same over-allotment option and we did not receive any proceeds from the sale of
those shares. We intend to use our net proceeds for capital expenditures,
including:
. the acquisition of rights to use dark fiber;
. the completion of our broadband access platform;
. the enhancement of our network to provide additional value-added services;
and
. the improvement of our network management, billing and other back-office
services.
We will also use a portion of the net proceeds from the offering to fund
operating losses, working capital requirements and other general corporate
purposes.
In addition we have incurred $30.6 million in equipment financing, primarily
from equipment vendors and leasing companies. In October 1999, we entered into
lease financing arrangements with a third party leasing company to fund up to
$122.0 million of our purchase commitments to Nortel. These lease arrangements
are currently structured as an operating lease, but may be converted to a
capital lease if we are able to obtain the necessary consents or waivers from
the holders of our senior notes. We cannot assure you that we will be able to
secure the
16
<PAGE>
amendments or waivers necessary to permit capital lease financing. If we are
unable to obtain capital lease treatment, the operating lease would require that
the payments be made over a shorter period than the amounts that could be
financed under a capital lease structure.
As of September 30, 1999, we had an accumulated deficit of $145.3 million,
cash and cash equivalents of $91.5 million, and restricted and unrestricted
investments of $63.7 million.
We expect our future liquidity and capital requirements to relate primarily
to:
. capital expenditures;
. operating losses;
. debt service payments; and
. working capital and other corporate purposes.
Net cash used in operating activities was $79.1 million during the nine
months ended September 30, 1999. The net cash used in operating activities in
this period was primarily attributable to the Company's net losses. Net cash
used in operating activities was $0.7 million for the year ended December 31,
1998. During the year-ended December 31, 1998, the cash flow effect of net
losses were largely offset by increases of $42.0 million in current liabilities
due to the timing of payments for purchases to equipment vendors and accrued
interest to bond holders.
Net cash provided by investing activities during the nine months ended
September 30, 1999 was $61.0 million. This consisted primarily of net proceeds
of $86.7 million from the liquidation of unrestricted investments, $28.2 million
net liquidation of restricted investments which were used to pay the interest on
the senior notes, offset by $32.7 million used for purchases of property and
equipment, the payment of a deposit of $11.2 million related to dark fiber
acquisition agreement, $0.5 million for other deposits and approximately $9.6
million primarily for costs incurred in connection with the construction of our
broadband access platform and other intangible costs. Net cash used by
investing activities for the year ended December 31, 1998 was $169.5 million and
consisted primarily of the purchase of unrestricted investments of $119.5
million and $45.3 million in equipment purchases.
Net cash provided by financing activities for the nine months ended September
30, 1999 was $81.4 million and consisted primarily of $88.4 million in net
proceeds from the Company's initial public offering offset primarily by
principal payments on capital leases. Net cash provided by financing activities
for the year ended December 31, 1998 was $190.9 million, which was derived
primarily from the issuance of our senior notes, net of issuance costs and
proceeds restricted to finance future interest payments.
As of September 30, 1999, we had aggregate operating and capital lease
payments of $3.8 million remaining in 1999, and $12.3 million, $5.8 million,
$5.0 million and $4.8 million due in each of the next four years. We expect
lease payments to increase under the lease financing commitments obtained in
October 1999 to expand the capacity of our broadband access network and for the
related facilities and telecommunications equipment for our fiber optronic
backbone.
The principal amount of our 11 3/4% Senior Notes ($261,000) are payable in
2008 subject to early redemption upon the occurrence of a change of control.
Interest payments on the notes are due semi annually. Interest payments due on
January 15, 2000 and July 15, 2000 are funded by certain of the proceeds,
together with interest thereon,
17
<PAGE>
escrowed in connection with the issuance of the 11 3/4 Senior Notes to provide
for the first four interest payments of the Senior Notes. The remaining escrow
amounts for the last two payments are recorded as Restricted Investments at
September 30, 1999. Beginning in year 2001 the interest payments will be funded
from our cash and unrestricted investments.
We have agreed to acquire indefeasible rights to use four dark fibers, with
an option to use up to 12 additional fibers, in the fiber optic network under
construction by Level 3. We are required to pay for the dark fiber in segments
as they become available, which is expected to occur from the end of 1999
through the first quarter of 2001.
Capital expenditures were $32.7 million and $45.3 million for the nine months
ended September 30, 1999 and the year ended December 31, 1998, respectively.
We estimate that our capital expenditures (including the anticipated capital
leases) for 1999, 2000 and 2001 will be approximately $105.0 million, $220.0
million and $40.0 million, respectively, including capital expenditures for:
. the acquisition of rights to use four dark fiber strands and the related
electronics necessary to transmit data over the fiber;
. the completion and expansion of our broadband access network;
. the enhancement of our network to provide additional value added
services; and
. the improvement of our network management, billing and other back office
systems.
Our estimated capital expenditures have increased by $77.0 million since our
last filing on Form S-1 with the Securities and Exchange Commission, primarily
due to the following:
. Planned capacity expansion on our broadband dial access network,
based upon our revised expectation of an increase in the demand for
dail access services.
. The buildout of data centers and facilities to house and support our
new lines of business, including virtual Internet services and web
hosting.
If we are not able to obtain the necessary amendments or waivers to obtain
capital lease treatment under the lease commitment, then the expected capital
expenditures (including capital leases) as noted above will decrease by
approximately $36.0 million, and $80.0 million in the years ended 1999 and 2000
and the cash required from operations will increase by the amount of the lease
payments.
Actual capital expenditures will depend on numerous factors beyond our
control or ability to predict, including the availability of financing, the
timing of our acquisition of dark fiber, customer demand, competition,
regulatory developments, and general economic conditions. Moreover, our capital
requirements would increase significantly if we were to exercise our options to
acquire rights to use up to 12 additional dark fiber strands over and above the
four strands for which we have committed.
We currently anticipate that our available cash resources would be sufficient
to meet our anticipated cash needs through the second quarter of the year 2000.
However, we cannot assure you that our financial resources will be adequate to
fund all of our anticipated or unanticipated losses, working capital
requirements and capital expenditures during this period. We expect that full
implementation of our current business plan will require that we raise
substantial additional capital for the needs that we anticipate funding during
the second half of the year 2000, and for the years 2001 and 2002. We intend to
18
<PAGE>
finance additional cash requirements by raising additional funds through the
issuance of equity or debt securities, vendor financing, bank financing,
strategic relationships or some combination of the foregoing. The terms of our
debt securities restrict our ability to incur indebtedness, create liens, and
make dividend payments and investments, and may make it more difficult for us to
raise the capital we will need to fully implement our business plan.
We cannot assure you that the additional financing we will need, will be
available on terms acceptable to us, or at all. If we are unable to obtain the
funds necessary to finance our expected capital requirements, we may have to
revise our business plans and this may materially and adversely affect our
financial condition, results of operations and prospectus. Furthermore, any
additional equity financing may be dilutive to stockholders, and debt financing,
if available, may involve restrictive covenants and significant interest
expense.
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. 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 our
financial condition and results of operations, the nature and extent of which
cannot reasonably be determined by us on the basis of information currently
available to us.
OUR YEAR 2000 PROGRAM
We have established a program to ensure that, to the extent reasonably
possible, all systems are or will be year-2000 compliant prior to the end of
1999. Our Year-2000 Program, designed with the assistance of an outside
consultant, consists of five phases:
. inventory of our potential exposures, including significant third-party
supplier and customer relationships;
. analysis of the assets to determine compliance or non-compliance;
. remediation and contingency plan development;
. remediation; and
. testing of affected systems.
A team consisting of Splitrock managers from Information Technology, Finance
and Operations has been established as the Year-2000 Readiness Team. With the
assistance of its outside consultant, the team has designed an aggressive
schedule to identify information technology (IT) and non-IT assets requiring
compliance upgrades and a timetable for performance and testing of the affected
systems. In addition, the Year-2000 Program calls for validation of compliance
by significant suppliers and customers.
CURRENT STATUS
Our Year-2000 inventory, analysis and remediation plan development is
complete. We are in the final stages of remediation and testing on affected
systems and have materially completed all necessary modifications to the
affected systems.
19
<PAGE>
The inventory of our potential exposures including computing, communications
and facility systems has been prepared and validated. Significant suppliers,
including competitive local exchange carriers, have also been identified and
validated.
We have performed a technical review of significant third party suppliers and
customers and, if available, have surveyed the public year-2000 statements
issued by them. In addition, we have sent inquiry letters to certain third party
suppliers and customers requesting information regarding their vulnerability to
year-2000 issues. We have responded to these inquiries and have evaluated the
responses we received to determine if alternative business actions are
necessary. At present, we have determined that no alternate business actions
are necessary. We continue to monitor new software and vendors to insure their
compliance.
All of our operational, financial and information systems software that has
been procured from a third party has been certified as year-2000 compliant by
the vendor. All internally developed software has been tested and does not
appear to contain any material year-2000 deficiencies. All hardware and software
that operate in our data centers have been through our remediation process and
do not appear to contain any material year-2000 deficiencies.
Our network equipment remediation process is also complete. Other than
equipment that we intend to retire, our equipment vendors have certified that
the hardware and software we use is year-2000 compliant.
To date, we have not incurred and do not anticipate incurring a significant
amount of costs to implement remedial actions required for year-2000 compliance.
We have not separately tracked internal costs incurred to implement our Y2K
Program. The costs are principally the fees to the outside consultant and the
payroll costs for our information systems group.
CONTINGENCY PLANS
Although we have not determined that any significant systems, customers or
suppliers have questionable remediation potential, we have prepared a
comprehensive vendor escalation list to assist our response to any issues
concerning third party network service providers.
Risks
The failure to correct a year-2000 problem could result in the interruption
or failure of certain normal business activities or operations. We believe that
the most reasonably likely worst-case scenario would result from interruption or
failure of third party services. Because we are dependent on a number of third
party vendors to provide network services, a significant year-2000-related
disruption of these network services could cause customers to consider seeking
alternate service providers, decrease Internet traffic generally or cause a
significant burden on customer service and technical support.
We are not presently aware of any vendor-related year-2000 issue that is
likely to result in any disruption of this type. Although there is inherent
uncertainty in the year-2000 issue, we expect that as we conclude the final
stages of our Year-2000 Program, this uncertainty will continue to diminish.
20
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discusses our exposure to market risk related to changes in
interest rates, equity prices and foreign currency exchange rates. Market risk
generally represents the risk of loss that may result from the potential change
in the value of a financial instrument as a result of fluctuations in interest
rates and market prices. We have not traded or otherwise bought and sold
derivatives nor do we expect to in the future. We also do not invest in market
risk sensitive instruments for trading purposes.
This discussion contains forward-looking statements that are subject to risks
and uncertainties. Actual results could vary materially as a result of a number
of factors including those set forth under "Item 2. Management's Discussion and
Analysis of Financial Condition - Forward Looking Statements."
INTEREST RATE RISK
We may be exposed to market risk related to changes in interest rates. At
this time, we have not entered into any interest rate risk arrangements, and
while we may enter into interest rate risk hedging arrangements in the future,
we cannot assure you that we will be able to find commercially satisfactory
terms at that time. Our investment policy is to manage our investment portfolio
to preserve principal and liquidity while maximizing the return on the
investment portfolio through the full investment of available funds. We
diversify our marketable securities portfolio by investing in multiple types of
investment-grade securities. Our investment portfolio is primarily invested in
short-term securities with at least an investment grade rating to minimize
interest rate and credit risk as well as to provide for an immediate source of
funds. Although changes in interest rates may affect the fair value of the
investment portfolio and cause unrealized gains or losses, such gains or losses
would not be realized unless the investments are sold.
Our Short-Term Investments. As of September 30, 1999, we had unrestricted
short-term investments of $33.7 million and restricted short-term investments
of $25.9 million. These short-term investments are highly liquid investments
with original maturities at the date of purchase of between three and twelve
months and consist primarily of money market funds and high-grade securities
such as corporate notes, municipal securities and U.S. Treasury notes. We value
these investments at fair market value. These investments are subject to
interest rate risk and will fall in value if market interest rates increase. A
hypothetical increase in market interest rates by 10% from levels at September
30, 1999 would cause the fair value of these short-term investments to decline
by an immaterial amount. We have the ability to hold these investments until
maturity, and therefore would not expect the value of these investments to be
affected to any significant degree by the effect of a sudden change in market
interest rates. Declines in interest rates over time will, however, reduce our
interest income, especially from money market funds whose rates change on a
daily basis.
Our Long-Term Investments. As of September 30, 1999, we maintained restricted
long-term investments totaling $4.0 million in connection with our 11 3/4%
senior notes due 2008. These long-term investments consist of high-grade
securities such as corporate notes, municipal securities and U.S. Treasury
notes, all of which are considered liquid and available for sale. Certain of
these securities will not be held to maturity. A hypothetical increase in market
interest rates by 10% from levels at September 30, 1999 would cause the fair
value of these securities to decline by an immaterial amount.
Outstanding Debt. As of September 30, 1999, the carrying value of our
outstanding senior notes was approximately $258.3 million at a fixed interest
rate of 11 3/4%. In certain circumstances, we may redeem this long-term debt.
Because the interest rates on these instruments are fixed, a hypothetical 10%
decrease in interest rates
21
<PAGE>
would not have a material impact on our financial condition, revenues or
operations. Increases in interest rates could, however, increase the interest
expense associated with future borrowings, if any. We do not hedge against
interest rate increases.
EQUITY PRICE RISK
We do not own an equity stake or investment in another company or business
entity and therefore we do not believe that we have any direct equity price
risk. We do not hedge against equity price changes.
FOREIGN CURRENCY EXCHANGE RATE RISK
All of our revenues are realized in dollars and all of our revenues are from
customers in the United States. Therefore, we do not believe that we have any
significant direct foreign currency exchange rate risk. We do not hedge against
foreign currency exchange rate changes.
22
<PAGE>
SPLITROCK SERVICES, INC.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not a party to any material pending legal proceedings, other than
ordinary routine litigation incidental to our business.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 12, 1999, we effected a .563-for-1 reverse stock split of our common
stock.
On August 6, 1999, we completed our initial public offering of common stock
pursuant to a registration statement on Form S-1 (file no. 333-79909) filed with
the Securities and Exchange Commission and declared effective on August 3, 1999.
The offering commenced on August 3, 1999 and was completed on August 6, 1999.
All the securities registered were sold. The managing underwriter was Bear,
Stearns & Co., Inc. The Company sold 9,692,628 shares of common stock at a price
of $10.00 per share which resulted in gross proceeds of $96.9 million, $6.5
million of which was for the underwriting discount and $2.0 million of which was
used for other fees and expenses. The net proceeds of $88.4 million were
predominately held in a money market account at September 30, 1999. None of the
net proceeds of the offering was paid by us, directly or indirectly, to any
director, officer or general partner of ours or any of their associates, or to
any persons owning ten percent or more of any class of our equity securities, or
to any of our affiliates. The underwriters purchased 692,628 of the shares
pursuant to an over-allotment option. Additionally, 157,372 additional shares
were sold, under the same agreement, by certain existing shareholders. We did
not receive any of the proceeds from the sale of the 157,372 shares sold by the
selling stockholders.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 1, 1999, our stockholders approved (1) the election of Kwok L. Li,
James M. Nakfoor and Marshall C. Turner to our board of directors, and William
R. Wilson and Roy Wilkens continued to serve as directors (2) the adoption of
our 1999 Stock Incentive Plan, (3) the amendment and restatement of our charter
effecting a 0.563 for 1 reverse stock split of our common stock. These matters
were approved by written consent of the holders of a majority of our outstanding
shares of common stock in accordance with Section 228 of the Delaware General
Corporation Law.
ITEM 5. OTHER INFORMATION
None.
23
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit Number Description
-------------- -----------
27.1 Financial data schedule
27.2 Restated financial data schedule
(b) Reports on Form 8-K:
None.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SPLITROCK SERVICES, INC.
Dated: October 29, 1999 By: /s/ William R. Wilson
------------------------------
William R. Wilson, President and
Chief Executive Officer
By: /s/ J. Robert Fugate
------------------------------
J. Robert Fugate, Executive Vice
President and Chief Financial Officer
25
<TABLE> <S> <C>
<PAGE>
<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, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B)
FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S FORM 10-Q FOR THE PERIOD ENDED
SEPTEMBER 30, 1999.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 91,544
<SECURITIES> 33,745
<RECEIVABLES> 8,051
<ALLOWANCES> (836)
<INVENTORY> 0
<CURRENT-ASSETS> 160,111
<PP&E> 123,394
<DEPRECIATION> (34,658)
<TOTAL-ASSETS> 283,276
<CURRENT-LIABILITIES> 42,057
<BONDS> 258,340
0
0
<COMMON> 57
<OTHER-SE> (19,472)
<TOTAL-LIABILITY-AND-EQUITY> 283,276
<SALES> 57,944
<TOTAL-REVENUES> 57,944
<CGS> 56,982
<TOTAL-COSTS> 117,189
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 24,471
<INCOME-PRETAX> (77,380)
<INCOME-TAX> 0
<INCOME-CONTINUING> (77,380)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (77,380)
<EPS-BASIC> (1.59)
<EPS-DILUTED> (1.59)
<FN>
<F1>All share and per share amounts included in these financial statements have
been retroactively adjusted to give effect to a 0.563-for-1 reverse stock split,
which was effected on July 12, 1999. Prior Financial Data Schedules have not
been restated for the recapitalization.
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<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 INCLUDED IN THE COMPANY'S FORM 10-Q FOR THE PERIOD ENDED
SEPTEMBER 30, 1999.
</LEGEND>
<RESTATED>
<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> 28,330
<SECURITIES> 120,475
<RECEIVABLES> 3,742
<ALLOWANCES> (537)
<INVENTORY> 0
<CURRENT-ASSETS> 191,966
<PP&E> 91,097
<DEPRECIATION> (17,198)
<TOTAL-ASSETS> 296,141
<CURRENT-LIABILITIES> 59,972
<BONDS> 258,217
0
0
<COMMON> 47
<OTHER-SE> (30,338)
<TOTAL-LIABILITY-AND-EQUITY> 296,141
<SALES> 47,592
<TOTAL-REVENUES> 47,592
<CGS> 20,935
<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-BASIC> (.74)
<EPS-DILUTED> (.74)
<FN>
<F1>All share and per share amounts included in these financial statements have
been retroactively adjusted to give effect to a 0.563-for-1 reverse stock split,
which was effected on July 12, 1999. Prior Financial Data Schedules have not
been restated for the recapitalization.
</FN>
</TABLE>
