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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 2000.
[ ] 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 000-26153
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HIGH SPEED ACCESS CORP.
(Exact name of Registrant as specified in its charter)
DELAWARE 61-1324009
(State or other jurisdiction of (I.R.S. Employer Identification
Number) incorporation or organization)
10901 WEST TOLLER DRIVE
LITTLETON, COLORADO 80127
(Address of principal executive offices, including zip code)
720/922-2500
(Registrant's telephone number, including area code)
FORMER NAME, FORMER ADDRESS, AND FORMER YEAR, IF CHANGED SINCE LAST REPORT:
NOT APPLICABLE
4100 EAST MISSISSIPPI AVENUE
DENVER, COLORADO 80246
303/256-2000
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 [ ]
Number of shares of Common Stock outstanding as of October 31, 2000. . .
58,684,184
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Index
<TABLE>
<CAPTION>
PAGE
<S> <C>
Part I - Financial Information
Item 1 - Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2000 (Unaudited) and
December 31, 1999 3
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 2000 and 1999 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2000 and 1999 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 9
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 26
Part II - Other Information
Item 1 - Legal Proceedings 26
Item 2 - Changes in Securities and Use of Proceeds 26
Item 3 - Defaults upon Senior Securities 26
Item 4 - Submission of Matters to a Vote of Security Holders 27
Item 5 - Other Information 27
Item 6 - Exhibits and Reports on Form 8-K 27
Signatures 28
</TABLE>
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Item I - Financial Information
Part 1 - Financial Statements
HIGH SPEED ACCESS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
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(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 49,808 $ 53,310
Short term investments 43,695 125,420
Accounts receivable, net of allowance for doubtful accounts of $532
and $63, respectively 2,218 393
Prepaid expenses and other current assets 4,477 4,308
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Total current assets 100,198 183,431
Property, equipment and improvements, net 63,796 39,308
Intangible assets, net 27,417 3,300
Deferred distribution agreement costs, net 10,906 4,042
Other assets 540 345
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Total assets $ 202,857 $ 230,426
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 12,737 $ 10,226
Accrued compensation and related expenses 6,286 3,842
Other current liabilities 9,145 3,916
Long-term debt, current portion 3,086 1,527
Capital lease obligations, current portion 6,917 3,176
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Total current liabilities 38,171 22,687
Long-term debt 2,875 4,035
Capital lease obligations 12,129 7,574
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Total liabilities 53,175 34,296
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Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000 shares authorized, none
issued and outstanding
Common stock, $.01 par value, 400,000,000 shares authorized, 58,684,184
and 54,276,130 shares issued and outstanding at September 30, 2000 and
December 31, 1999, respectively 587 543
Class A common stock, 100,000,000 shares authorized, none issued
and outstanding
Additional paid-in-capital 660,036 618,823
Deferred compensation (254) (288)
Accumulated deficit (511,273) (422,807)
Accumulated other comprehensive income (loss) 586 (141)
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Total stockholders' equity 149,682 196,130
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Total liabilities and stockholders' equity $ 202,857 $ 230,426
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</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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HIGH SPEED ACCESS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
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2000 1999 2000 1999
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<S> <C> <C> <C> <C>
Net revenue $ 4,282 $ 1,070 $ 9,033 $ 2,010
Costs and expenses:
Operating 18,133 7,194 48,923 13,344
Engineering 6,048 2,547 16,439 6,103
Sales and marketing 5,928 5,126 18,393 10,783
General and administrative (excluding non-cash
compensation expense from stock options) 6,520 3,019 15,660 6,666
Non-cash compensation expense from stock options 95 18 143 2,698
Amortization of distribution agreement costs 796 193 1,912 3,498
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Total costs and expenses 37,520 18,097 101,470 43,092
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Loss from operations (33,238) (17,027) (92,437) (41,082)
Investment income 1,544 2,824 5,535 3,684
Interest expense (544) (122) (1,564) (216)
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Net loss (32,238) (14,325) (88,466) (37,614)
Mandatorily redeemable convertible preferred stock dividends -- -- -- (1,122)
Accretion to redemption value of mandatorily redeemable
convertible preferred stock -- -- -- (229,148)
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Net loss available to common stockholders $ (32,238) $ (14,325) $ (88,466) $ (267,884)
============ ============ ============ ============
Basic and diluted net loss available to
common stockholders per share $ (0.56) $ (0.26) $ (1.59) $ (10.10)
============ ============ ============ ============
Weighted average shares used in computation of basic
and diluted net loss available to common
stockholders per share 57,112,159 54,141,481 55,563,508 26,526,365
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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HIGH SPEED ACCESS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
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<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (88,466) $ (37,614)
Adjustments to reconcile net loss to cash used
in operating activities:
Depreciation and amortization 14,549 4,073
Non-cash compensation expense from stock options 143 2,698
Amortization of distribution agreement costs 1,912 3,498
Changes in operating assets and liabilities excluding the effects of acquisitions:
Accounts receivable (1,125) (153)
Prepaid expenses and other current assets (6) (3,540)
Other non-current assets (195) (477)
Accounts payable 4,101 436
Accrued compensation and related expenses 1,948 1,205
Other current liabilities 4,715 2,279
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Net cash used in operating activities (62,424) (27,595)
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INVESTING ACTIVITIES
Purchase of short-term investments (95,890) (231,732)
Sales and maturities of short-term investments 178,342 94,900
Purchase of property, equipment and improvements, net of leases (27,088) (15,895)
Purchase of customer base -- (491)
Net cash paid in connection with purchase of NetPerformance (3,573) --
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Net cash provided by (used in) investing activities 51,791 (153,218)
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FINANCING ACTIVITIES
Net proceeds from issuance of common stock 10,000 197,754
Net proceeds from issuance of mandatorily redeemable convertible preferred stock -- 24,987
Payments on capital lease obligations (3,940) (226)
Proceeds from long-term debt 1,213 2,639
Payments on long-term debt (814) (234)
Proceeds from exercise of stock options 672 746
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Net cash provided by financing activities 7,131 225,666
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Net change in cash and cash equivalents (3,502) 44,853
Cash and cash equivalents, beginning of period 53,310 17,888
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Cash and cash equivalents, end of period $ 49,808 $ 62,741
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SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Equipment acquired under capital leases $ 11,346 $ 6,286
Property and equipment purchases payable $ 1,460 $ 4,769
Distribution of Darwin Networks, Inc. subsidiary to shareholders $ 923
Warrants issued in connection with acquisitions $ 208
Warrants issued in connection with Microsoft Corp. agreements $ 3,235
Warrants earned in connection with distribution agreements $ 8,846 $ 4,530
Issuance of common stock and employee stock options in connection
with the purchase of NetPerformance $ 21,611
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
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Item 1 - Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 - The Company and Basis of Presentation
The Company
High Speed Access Corp. and Subsidiaries (hereinafter referred to as the
Company, we, us, or our) provides high speed Internet access via cable modem to
residential and commercial customers primarily in exurban areas. We enter into
long-term exclusive contracts with cable system operators to provide them with
either a comprehensive "full turnkey" or "partial turnkey" service. These
services enable a cable system's customers to receive high speed Internet
access.
In exchange for providing us with access to its customers in the full
turnkey solution, we pay the cable operator a portion of the monthly fees
received from an end user that subscribes to the services. In a partial turnkey
or "Network Services" solution, we deliver fewer services and incur lower costs
than in a full turnkey solution but also earn a smaller percentage of the
subscription revenue or a fixed fee on a per subscriber basis. For partial
turnkey services, our cable partners will typically bill the end user and remit
to us our percentage of the revenue or the fixed fee. Partial turnkey solutions
have become a significant part of our business mix, and we anticipate that this
trend will continue.
The Company also provides standard Internet access through traditional
dial-up service to residential and commercial customers. We are also expanding
our offering of services to include digital subscriber line ("DSL") Internet
access on a reseller basis, as well as expanded web site hosting and a range of
other value-added and ongoing support services, all primarily for commercial
customers. In August, we acquired Digital Chainsaw, Inc., d/b/a NetPerformance
("NetPerformance"), a one-stop provider of strategic Internet services primarily
to small and medium sized enterprises, including web hosting, web site and
creative design, legacy systems integration and overall strategic consulting.
Moreover, we are conducting technical and customer trials for
voice-over-Internet-Protocol ("VoIP") telephone service in collaboration with
Lucent Technologies ("Lucent") and other major vendors. We also intend to
continue expanding our suite of core connectivity and related value-added
services as broadband technology proliferates and additional services become
viable.
Basis of Presentation
The unaudited condensed consolidated financial statements included herein
reflect all adjustments, consisting only of normal recurring adjustments, which
in the opinion of management are necessary to fairly present the Company's
financial position, results of operations and cash flows for the periods
presented. Certain information and footnote disclosures normally included in
audited financial information prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the Securities
and Exchange Commission's rules and regulations.
The results of operations for the period ended September 30, 2000 are not
necessarily indicative of the results to be expected for any subsequent quarter
or for the entire fiscal year ending December 31, 2000. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in our Annual Report on Form 10-K for the fiscal year ended
December 31, 1999.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported results of operations during the reporting period.
Actual results could differ from those estimates.
Note 2 - Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging
Activities" (SFAS 133), which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities. SFAS 133, as amended by SFAS 137 and 138, is effective for the
Company's year ending December 31, 2001. Management is currently evaluating the
impact of SFAS 133 but does not expect the adoption to have a significant impact
on our results of operations, financial position or cash flows.
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In December 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in
Financial Statements". SAB 101 summarizes some of the staff's interpretations of
the application of generally accepted accounting principles to revenue
recognition. All registrants are expected to apply the accounting and disclosure
requirements that are described in SAB 101, as amended, no later than the fourth
quarter of the fiscal year beginning after December 15, 1999. Management of the
Company has analyzed the impact of SAB 101 and believes that adoption will not
have a material effect on the Company's results of operations or financial
position.
Note 3 - Net Loss Per Share
The Company computes net loss per share under the provisions of SFAS No.
128 "Earnings per Share" (SFAS 128) and SEC Staff Accounting Bulletin No. 98
(SAB 98). Under the provisions of SFAS 128, basic and diluted net loss per share
is computed by dividing the net loss available to common stockholders for the
period by the weighted average number of shares of common stock outstanding
during the period. The calculation of diluted net loss per share excludes
potential common shares if the effect is anti-dilutive.
Basic and diluted net loss available to common stockholders per share for
the three months ended September 30, 2000 and 1999, were $0.56 and $0.26 based
on weighted average shares outstanding of 57,112,159 and 54,141,481,
respectively. For the nine months ended September 30, 2000 and 1999, basic and
diluted net loss available to common stockholders were $1.59 and $10.10 based on
weighted average shares outstanding of 55,563,508 and 26,526,365, respectively.
Diluted earnings per share is determined in the same manner as basic
earnings per share except that the number of shares is increased assuming
exercise of dilutive stock options and warrants using the treasury stock method
and assuming conversion of the Company's preferred stock. In addition, income or
loss is adjusted for dividends and other transactions relating to preferred
shares for which conversion is assumed. The diluted earnings per share amount
equals basic earnings per share because the Company has a net loss, thus the
impact of the assumed exercise of the stock options and warrants and the assumed
preferred stock conversion is anti-dilutive. Options and issued warrants to
purchase 7,857,519 shares of common stock at September 30, 2000 were excluded
from the calculation above because they are anti-dilutive.
In addition, there is a potential to issue additional warrants pursuant to
the agreements set forth in Note 5 and additional preferred shares as set forth
in Note 8. These potential warrants have been excluded from the calculation
above because they are not currently measurable and would be anti-dilutive. In
the future, the Company also may issue additional stock or warrants to purchase
its common stock in connection with its efforts to expand the distribution of
its services. Stockholders could face additional dilution from these possible
future transactions.
Note 4 - Comprehensive Loss
Comprehensive loss, comprised of net loss before mandatorily redeemable
convertible preferred stock dividends and accretion to redemption value of
mandatorily redeemable convertible preferred stock and net unrealized holding
gains and losses on investments, totaled $32.2 million and $87.7 million for the
three and nine months ended September 30, 2000, respectively, and $14.8 million
and $38.1 million for the three and nine months ended September 30, 1999,
respectively.
Note 5 - Distribution Agreements
As an inducement to certain cable partners to commit systems to the
Company, we issue warrants to purchase our common stock in connection with
network service agreements and other agreements, collectively referred to as
distribution agreements.
The Company values warrants to purchase its common stock using an accepted
options pricing model based on the value of the stock when the warrants are
earned. The Company recognizes an addition to equity for the fair value of any
warrants issued, and recognizes the related expense over the term of the
agreement with the cable system to which the warrants relate, generally five
years, in accordance with Emerging Issues Task Force Issue No. 96-18,
"Accounting for Equity Instruments that are Issued to other than Employees for
Acquiring or in Conjunction with Selling, Goods or Services."
In May 2000, the Company entered into a second network services agreement
with Charter Communications ("Charter"). Under this agreement, Charter committed
to provide the Company exclusive right to provide network services related to
the delivery of Internet access to homes passed in certain cable systems. We
will provide partial turnkey services or "Network Services", including system
monitoring and security as well as call center support. Charter will receive the
warrants described in the following paragraph
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as an incentive to provide the Company additional homes passed, although it is
not obligated to do so. Charter can terminate these exclusivity rights, on a
system-by-system basis, if the Company fails to meet performance specifications
or otherwise breaches the agreement. The agreement has an initial term of five
years and may be renewed at Charter's option for additional successive five-year
terms.
In connection with the network services agreement, the Company and Charter
entered into an amended and restated warrant to purchase up to 12,000,000 shares
of our common stock at an exercise price of $3.23 per share and terminated two
warrants that had been issued to Charter in November 1998. The new warrant
becomes exercisable at the rate of 1.55 shares for each home passed committed to
us by Charter under the network services agreement entered into by Charter and
us in November 1998. The warrant also becomes exercisable at the rate of .775
shares for each home passed committed to us by Charter under the network
services agreement entered into in May 2000 up to 5,000,000 homes passed, and at
a rate of 1.55 shares for each home passed in excess of 5,000,000. Charter also
has the opportunity to earn additional warrants to purchase shares of our common
stock upon any renewal of the May 2000 agreement. Such a renewal warrant will
have an exercise price of $10 per share and will be exercisable to purchase .50
shares for each home passed in the systems for which the May 2000 agreement is
renewed. With respect to each home passed launched or intended to be launched on
or before the second anniversary date of the second network services agreement,
the Company will pay Charter, at Charter's option, a launch fee of $3.00 per
home passed committed. As of September 30, 2000, Charter had requested payment
of approximately $6.0 million of launch fees related to systems to be deployed
in the near future. These fees are expected to be paid during the fourth quarter
of 2000.
As of September 30, 2000, various cable partners had earned 1,658,464
warrants under distribution agreements of which 442,841 of these warrants were
earned at a cost of $2.2 million in the three months ended September 30, 2000.
Deferred distribution agreement costs of $10.9 million, net of accumulated
amortization of $2.4 million were recorded in conjunction with these warrants at
September 30, 2000. Amortization of distribution agreement costs of $0.8 million
and $1.9 million was recognized in the statement of operations for the three and
nine months ended September 30, 2000. Additional deferred distribution agreement
costs may be recorded and amortized in future periods should the cable partners
earn the right to purchase additional common shares based on the number of homes
passed committed to the Company. At September 30, 2000, there were 16.1 million
additional warrants available to be earned under distribution agreements.
Note 6 - Commitments and Contingencies
The Company is not a party to any material legal proceedings. In the
opinion of management, the amount of ultimate liability with respect to any
known actions will not materially affect the financial position of the Company.
Note 7 - Business Developments
In May 2000, Lucent purchased 1,250,000 shares of the Company's common
stock at fair value for total proceeds to the Company of $10.0 million. In
addition, Lucent and the Company entered into a general agreement whereby Lucent
will provide equipment and services to the Company with an initial purchase
commitment by the Company of $5.0 million.
In August 2000, the Company completed its acquisition of NetPerformance, a
Florida-based web hosting and systems integration company. The Company issued
approximately 3.0 million shares of common stock valued at $18.0 million in
connection with this transaction in exchange for all of the outstanding shares
of NetPerformance. Additionally, the Company issued stock options valued at $3.7
million in exchange for the outstanding options of NetPerformance. Up to $25.0
million of additional purchase price consideration in the form of the Company's
common stock may be issued to NetPerformance shareholders if certain performance
targets are met by NetPerformance during 2000 and 2001. The transaction was
accounted for under the purchase method of accounting. Goodwill recorded in
connection with the acquisition was $25.6 million and is being amortized on a
straight-line basis over 5 years.
Note 8 - Subsequent Event
In October 2000, we signed a definitive agreement with Vulcan Ventures
Incorporated ("Vulcan") and Charter, under which Vulcan and Charter will make an
aggregate preferred equity investment of $75 million. Under the agreement,
Vulcan and Charter will invest approximately equal amounts. The investments take
the form of convertible preferred stock, and may convert into common stock of
the Company at a conversion price of approximately $5 per share, subject to
adjustment for future stock issuances at less than the conversion price and
other customary adjustments. Closing of the transaction is conditioned upon
customary closing conditions, including approval by the Company's stockholders.
However, we anticipate that we will need to seek additional equity or debt
financing to execute our current business plan. Such financing could involve the
issuance, or deemed issuance, of additional shares of capital stock at a price
below the conversion price of the convertible preferred stock we have agreed to
issue to Vulcan and Charter, which would result in a downward adjustment of the
conversion price. In the event of such an adjustment, the number of shares of
common stock issuable upon conversion of the convertible preferred stock would
be increased pursuant to the weighted average formula described below under the
caption "Risk Factors--Our pending financing with Vulcan and Charter contains
anti-dilution adjustments and restrictions on our future activities". Further,
if additional financing is not available on acceptable terms, we may be forced
to curtail our operations, which could have a material adverse effect on our
business and financial results and may require us to delay the deployment of our
services.
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Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains certain statements of a
forward-looking nature relating to future events or the future financial
performance of the Company. Such statements are only predictions, involve risks
and uncertainties, and actual events or results may differ materially from the
results discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include those discussed below under the heading
"Risk Factors" as well as those discussed in other filings with the Securities
and Exchange Commission, including the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1999.
Overview
We are a leading provider of high speed Internet access to residential and
commercial end users primarily using cable modem technology. We primarily focus
on residential and commercial end users in exurban areas although we have
recently begun to provide broadband services in some urban markets. We enter
into long-term exclusive contracts with cable system operators to provide them
with either a comprehensive "full turnkey" or "partial turnkey" service. These
services enable a cable system's customers to receive high speed Internet
access. In our full turnkey solution, we generate revenue primarily from the
monthly fees we receive from end users for our cable modem-based Internet access
service and for the traditional dial-up services we offer as part of our end
user acquisition strategy. In our full turnkey solution we generally bill the
end user directly and pay our cable partners a portion of the monthly fee we
receive; in these instances we report our revenues net of the percentage split
we pay to our cable partners. For promotional purposes, we often provide new end
users with 30 days of free Internet access when they subscribe to our services.
As a result, our revenue does not reflect new end users until the end of the
promotional period. We also receive revenues from renting cable modems to end
users.
We also offer to our cable partners a partial turnkey solution. In a
partial turnkey solution, we deliver fewer services and incur lower costs than
in a full turnkey solution but will also earn a smaller percentage of the
subscription revenue or a fixed fee on a per subscriber basis. Our cable
partners typically bill the end user and remit to us our percentage of the
revenue or the fixed fee. In May 2000, the Company entered into a second network
services agreement with Charter in which the Company has agreed to provide
partial turnkey services. Partial turnkey solutions have become a significant
part of our business mix and we anticipate that this trend will continue.
We also provide certain services, primarily engineering services related to
design and installation of data network hardware and software necessary to offer
Internet service via cable modems, on a fee for service basis.
Our revenue from dial-up services, as a percentage of total revenue, has
been decreasing and will continue to decline over time as our high speed
business and other service revenue grows. Moreover, although we expect cable
modem rentals to be a significant part of our revenue during the next few years,
we expect our cable modem rental income to decline as cable modems become
commercially available at lower costs through retail stores and as they become
standard features of personal computers. However, we will save the cost of
purchasing and installing cable modems for end users. In the future we expect to
earn revenues from additional services such as Internet telephony, and to a
lesser extent, from local content.
We are expanding our offering of services to include DSL Internet access on
a reseller basis. Currently, we receive no revenue from the provision of high
speed internet access in DSL but we expect to provide service via DSL to
commercial customers in the future. We offer DSL service as a reseller for
Northpoint Communications on a limited basis. We anticipate that our business
will become more dependent upon providing DSL service to commercial customers in
the future.
We recently completed the acquisition of NetPerformance, a one-stop
provider of strategic Internet services primarily to small- and medium-sized
enterprises, including web hosting, web site and creative design, legacy systems
integration and overall strategic consulting. Moreover, we are conducting
technical and customer trials for VoIP telephone service in collaboration with
Lucent and other major vendors, and plan to introduce second-line VoIP services
late this year. We also intend to continue expanding our suite of core
connectivity and related value-added services as broadband technology
proliferates and additional services become viable.
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Our expenses consist of the following:
o Operating costs, which consist primarily of salaries for help desk, field
technical support and network operations center employees and web site
design and development personnel; telecommunications expenses, including
charges for Internet backbone and telecommunications circuitry; allocated
cost of facilities; costs of installing cable modems for our end users; and
depreciation and maintenance of equipment. In one-way cable systems, where
the end user transmits data back to the cable headend via a standard
telephone line, we must support the telephone return path from the local
telephone company's central office to the cable headend. Accordingly, we
incur greater telecommunications costs in a one-way system than we incur in
a two-way system. Consequently, the rate at which our cable partners
upgrade their systems to two-way capability will affect our operating
margins. We expect our operating costs to grow significantly as we roll out
services in new systems. We may also incur significant fees if we cancel
our telecommunications contracts in advance of the expiration of the term
of the contract. Many of our operating costs are relatively fixed in the
short term. However, as we add new end users we hope to be able to spread
these costs over a larger revenue base, and, accordingly, decrease our
costs per subscriber and improve our operating margins.
o Engineering expenses, which consist primarily of salaries and related costs
for network design and installation of the telecommunications and data
network hardware and software; system testing and project management
expenses; the development and support of our information systems; allocated
cost of facilities; and depreciation and maintenance on the equipment used
in our engineering processes. We expect our engineering expenses to grow
significantly as we introduce our services in new markets and expand our
network.
o Sales and marketing expenses, which consist primarily of salaries,
commissions and related personnel expenses and costs associated with the
development of sales and marketing materials, database market analytics,
direct mail and telemarketing. We expect that our sales and marketing
expenses will increase significantly as we pursue our growth strategy.
o General and administrative expenses, which consist primarily of salaries
for our executive, administrative, finance and human resource personnel;
amortization of goodwill; and fees for professional services.
o Non-cash compensation expense from stock options, which equals the excess
of the fair market value of our stock at the time of grant over the
exercise price of the stock options granted to employees and directors
amortized over the vesting period.
o Amortization of distribution agreement costs, which relates to warrants
issued to cable and strategic partners in connection with network services
and other distribution related agreements, collectively referred to as
distribution agreements. We measure the cost of warrants issued to cable
and strategic partners based on the fair values of the warrants when earned
by those partners. Because the fair value of the warrant is dependent to a
large extent on the price of our common stock, the cost of warrants earned
in the future may vary significantly. Costs of warrants granted in
connection with distribution agreements are amortized over the term of the
underlying agreement. Warrants not directly associated with long-term
distribution agreements are expensed as earned.
Our operating results have varied on a quarterly basis during our short
operating history and may fluctuate significantly in the future due to a variety
of factors, many of which are outside our control. In addition, the results of
any quarter do not indicate the results to be expected for a full fiscal year.
The factors that may contribute to fluctuations in our operations are set forth
generally under the caption "Risk Factors" and particularly in that section
under the heading "Our quarterly operating results are likely to fluctuate
significantly and may be below the expectations of analysts and investors". As a
result of the foregoing factors, our annual or quarterly results of operations
may be below the expectations of public market analysts or investors, in which
case the market price of the common stock could be materially and adversely
affected.
Results Of Operations For The Three and Nine Months Ended September 30, 2000
Compared With The Three and Nine Months Ended September 30, 1999
Revenues
Net revenue consists primarily of net monthly subscription fees for cable
modem based and traditional dial-up Internet services, monthly fees for web
hosting services, cable modem rental income, fees for engineering services
provided to cable partners, installation fees and other up front fees from end
users, fees from web site and creative design, legacy systems integration and
overall strategic consulting.
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Total net revenue for the three months ended September 30, 2000 and 1999
was $4.3 million and $1.1 million respectively, an increase of $3.2 million. For
the quarters ended September 30, 2000 and 1999, cable modem based subscription
fees contributed approximately 48% and 41% of the net revenue, traditional
dial-up service fees contributed 10% and 30%, cable modem rental fees
contributed 19% and 19%, engineering services provided to cable partners
contributed 8% and 7%, design systems integration and related services to
commercial customers contributed 10% and 0%, web hosting contributed 3% and 0%,
and other fees from end users contributed 2% and 3%, respectively.
Total net revenue for the nine months ended September 30, 2000 and 1999 was
$9.0 million and $2.0 million respectively, an increase of $7.0 million. For the
nine months ended September 30, 2000 and 1999, cable modem based subscription
fees contributed approximately 50% and 41% of the net revenue, traditional
dial-up service fees contributed 14% and 35%, cable modem rental fees
contributed 21% and 17%, engineering services provided to cable partners
contributed 6% and 4%, design systems integration and related services to
commercial customers contributed 5% and 0%, web hosting contributed 1% and 0%,
and other fees from end users contributed 3% and 3%, respectively.
Costs and Expenses
Operating. Operating costs for the three months ended September 30, 2000
and 1999 were $18.1 million and $7.2 million, respectively, an increase of $10.9
million. Operating costs for the nine months ended September 30, 2000 and 1999
were $48.9 million and $13.3 million, respectively, an increase of $35.6
million. The increase in operating costs resulted primarily from an increase in
personnel and personnel related costs for additional staff in our network
operations centers, help desk and field technical support departments as well as
the additional personnel costs associated with the purchase of NetPerformance,
an increase in telecommunications expense from the rollout of our service to new
markets, our larger subscriber base, depreciation of capital equipment from the
expansion of our network and the installation of cable modems for additional
subscribers.
Engineering. Engineering expenses for the three months ended September 30,
2000 and 1999 were $6.0 million and $2.5 million, respectively, an increase of
$3.5 million. Engineering expenses for the nine months ended September 30, 2000
and 1999 were $16.4 million and $6.1 million, respectively, an increase of $10.3
million. The increase in engineering expenses resulted from continued network
design, system testing, development and support of information systems and
project management, for the evaluation of new equipment and possible new product
offerings, including the offering of service via DSL, and from personnel and
personnel related costs for additional technical staff to support the
installation of cable headend hardware and software in our cable partners'
systems.
Sales and Marketing. Sales and marketing expenses for the three months
ended September 30, 2000 and 1999 were $5.9 million and $5.1 million,
respectively, an increase of $0.8 million. Sales and marketing expenses for the
nine months ended September 30, 2000 and 1999 were $18.4 million and $10.8
million, respectively, an increase of $7.6 million. The increase in sales and
marketing expenses resulted primarily from an increase in personnel and
personnel related costs to expand our residential and commercial end user sales
force, new cable partner sales force and telemarketing sales force, as well as
an increase in direct marketing and advertising expenses, as we expanded into
more geographic markets.
General and Administrative. General and administrative expenses, excluding
non-cash compensation expense from stock options and amortization of
distribution agreement costs, for the three months ended September 30, 2000 and
1999 were $6.5 million and $3.0 million, respectively, an increase of $3.5
million. General and administrative expenses, excluding non-cash compensation
expense from stock options and amortization of distribution agreement costs, for
the nine months ended September 30, 2000 and 1999 were $15.7 million and $6.7
million, respectively, an increase of $9.0 million. The increase in general and
administrative expenses resulted from additional personnel and personnel related
costs as we hired personnel to implement procedures and controls to support our
planned expansion and to administer finance, legal and human resource functions.
Non-cash compensation expense from stock options. Non-cash compensation
expense from stock options for the three months ended September 30, 2000 and
1999 was $95,000 and $18,000, respectively, an increase of $77,000. Non-cash
compensation expense from stock options for the nine months ended September 30,
2000 and 1999 was $143,000 and $2.7 million, respectively, a decrease of $2.6
million. These expenses represent the excess of the fair market value of our
common stock over the exercise price of the stock options granted to employees
and directors amortized over the vesting period. The expense for the nine months
ended September 30, 1999 is principally related to a charge for 189,875
compensatory options issued to our directors which vested upon grant and 227,695
options issued under the 1998 stock option plan that vested upon execution of
the initial public offering.
Amortization of distribution agreement costs. Amortization of distribution
agreement costs for the three months ended September 30, 2000 and 1999 was $0.8
million and $0.2 million, respectively, an increase of $0.6 million.
Amortization of distribution agreement
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costs for the nine months ended September 30, 2000 and 1999 was $1.9 million and
$3.5 million, respectively, a decrease of $1.6 million. Included in the nine
months ended September 30, 1999 was $3.2 million of amortization expense related
to 387,500 warrants issued to Microsoft. The 2000 costs consist of the
amortization of the value of 1,658,464 warrants earned under distribution
agreements for commitments of homes passed. We expect to incur additional
material non-cash charges related to further issuance of common stock purchase
warrants to our cable and strategic partners in the future. We will recognize an
addition to equity for the fair value of any warrants issued, and will recognize
the related expense over the term of the service agreement with the cable or
strategic partner to which the warrants relate. The amount of any such charges
is not determinable until the related warrants are earned. The use of warrants
in these and similar transactions may increase the volatility of our earnings in
the future.
In May 2000, the Company and Charter entered into an amended and restated
warrant to purchase up to 12,000,000 shares of our common stock at an exercise
price of $3.23 per share. The restated warrant becomes exercisable at the rate
of 1.55 shares for each home passed committed to us by Charter under the network
services agreement entered into by Charter and us in November 1998. The warrant
also becomes exercisable at the rate of .775 shares for each home passed
committed to us by Charter under the second network services agreement entered
into in May 2000 up to 5,000,000 homes passed and at a rate of 1.55 shares for
each home passed in excess of 5,000,000. Charter also has the opportunity to
earn additional warrants to purchase shares of our common stock upon any renewal
of the May 2000 agreement. Such a renewal warrant will have an exercise price of
$10 per share and will be exercisable to purchase one-half of a share for each
home passed in the systems for which the May 2000 agreement is renewed.
Net Investment Income. Net investment income for the three months ended
September 30, 2000 and 1999 was $1.0 million and $2.7 million, respectively. The
decrease in investment income for the three months ended September 30, 2000, is
the result of lower investment balances during the third quarter of 2000. Net
investment income for the nine months ended September 30, 2000 and 1999 was $4.0
million and $3.5 million, respectively. Net investment income represents
interest earned on cash, cash equivalents and short term investments. The
increase in investment income for the nine months ended September 30, 2000, is
the result of interest on investments purchased using the net proceeds of our
initial public offering in June of 1999.
Income Taxes. At December 31, 1999, we had accumulated net operating loss
carry forwards for federal and state tax purposes of approximately $63.6
million, which will expire beginning in 2018. At December 31, 1999, we had net
deferred tax assets of $26.5 million, relating principally to our accumulated
net operating losses. Our ability to realize the value of our deferred tax
assets depends on our future earnings, if any, the timing and amount of which
are uncertain. We have recorded a valuation allowance for the entire net
deferred tax asset as a result of those uncertainties. Accordingly, we did not
record any income tax benefit for net losses incurred for the year ended
December 31, 1999 or for the quarter and nine months ended September 30, 2000.
Liquidity and Capital Resources
At September 30, 2000, we had cash, cash equivalents and short-term
investments of $93.5 million, compared with $178.7 million of cash, cash
equivalents and short-term investments at December 31, 1999. We had significant
negative cash flow from operating activities for the nine months ended September
30, 2000. Cash used in operating activities for the nine months ended September
30, 2000 was $62.4 million, caused primarily by a net loss of $88.5 million
offset by depreciation and amortization of $14.5 million, an increase in
accounts payable and other liabilities of $10.8 million.
Cash provided by investing activities for the nine months ended September
30, 2000 was $51.8 million, the result of sales and maturities of short term
investments of $178.3 million, offset by the purchase of short term investments
of $95.9 million. Also, cash paid for capital expenditures totaled $27.1 million
for the nine months ended September 30, 2000. The principal capital expenditures
incurred during this period were for the purchase of headend data network
hardware and software, billing and customer care systems and furniture and
telephone and computer equipment for new leased customer care and corporate
headquarters facilities, cable modems and central network hardware and software,
reflecting our expansion into new markets.
Cash provided by financing activities for the nine months ended September
30, 2000 was $7.1 million, comprised primarily of $10.0 million in proceeds from
issuance of common stock to Lucent, partially offset by net payments on capital
lease obligations and long-term debt.
We expect to experience substantial negative cash flow from operating
activities and negative cash flow from investing activities for at least the
next several years due to continued deployment of our services into new markets
and the enhancement of our network and operations. Our future cash requirements
will depend on a number of factors including:
o The pace of the rollout of our service to our cable partners,
including the impact of substantial capital expenditures and related
operating expenses;
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o The extent to which we expand our services into new geographical
markets, particularly international markets.
o The rate at which we enter into contracts with cable operators for
additional systems;
o The rate at which end users subscribe to our cable modem and DSL
connectivity and web hosting services;
o Changes in revenue splits with our cable partners;
o The terms under which we contract for and resell DSL;
o Price competition in the Internet, telephony and cable industries;
o The mix of services offered by us, including DSL, web hosting, legacy
systems and e-commerce integration, and whether we provide our cable
modem services on a full or partial turnkey basis;
o Capital expenditures and costs related to infrastructure expansion;
o The rate at which our cable partners convert their systems from
one-way to two-way systems;
o End user turnover rates;
o Our ability to protect our systems from telecommunications failures,
power loss and software-related system failures;
o Changes in our operating expenses including, in particular, personnel
expenses;
o The introduction of new products or services by us or our competitors
including our initiatives into DSL reseller services, VoIP, web
hosting and other value added services;
o Our ability to enter into strategic alliances with application service
providers and other content providers; and
o Economic conditions specific to the Internet and cable industries, as
well as general economic and market conditions.
Investment Portfolio. Cash equivalents are highly liquid investments with
insignificant interest rate risk and original maturities of 90 days or less and
are stated at amounts that approximate fair value based on quoted market prices.
Cash equivalents consist principally of investments in interest-bearing money
market accounts with financial institutions and highly liquid investment-grade
debt securities of corporations and the United States government.
Short term investments are classified as available-for-sale and, as a
result, are stated at fair value. Short term investments are comprised
principally of highly liquid debt securities of corporations and the U.S.
government. We record changes in the fair market value of securities held for
short term investment as an equal adjustment to the carrying value and equity.
Loan and Lease Facilities. The Company has approximately $11.7 million in
unused lease facilities at September 30, 2000.
We expect to incur approximately $45 million of capital expenditures in
2000 principally related to the installation of headend data network hardware
and software, cable modems, central network hardware and software for e-mail,
network monitoring, provisioning, web hosting, billing and customer care
systems, and furniture and telephone and computer equipment for new leased
customer care and corporate headquarters facilities. Actual capital expenditures
will be significantly affected by the rate at which end users subscribe to our
cable modem internet access services, which requires us to purchase a cable
modem for each new end user where we provide full turnkey services, as well as
the pace of the rollout of our systems, which requires us to purchase headend
data network hardware and software. Additionally, the amount of capital
expenditures will be affected by the number of systems deployed under the
partial turnkey services model, where the investment in equipment is
significantly less than those choosing full turnkey services. Since inception,
we have financed our operations primarily through a combination of private and
public sales of equity securities, capital equipment leases and debt.
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In May 2000 we entered into an agreement with Lucent under which we will
purchase equipment and services in connection with our deployment of IP
telephony services. Our minimum commitment under this agreement is $5 million.
In addition, Lucent has agreed to assist us in arranging third party equipment
financing.
The development of our business may require significant additional capital
in the future to fund our operations, to finance the substantial investments in
equipment and corporate infrastructure needed for our planned expansion, to
enhance and expand the range of services we offer and to respond to competitive
pressures and perceived opportunities, such as investment, acquisition and
international expansion activities. To date, our cash flow from operations has
been insufficient to cover our expenses and capital needs. We believe our
current cash, cash equivalents and short term investments, together with $11.7
million of available lease financing through various facilities, as well as
additional loan and lease financing facilities will be sufficient to meet our
working capital requirements, including operating losses, and capital
expenditure requirements into 2002, assuming we achieve our business plan. At
such time, or sooner if we do not achieve our business plan, we will require
additional equity and/or debt financing.
In this regard, in October 2000 we signed a definitive agreement with
Vulcan Ventures Incorporated and Charter, under which Vulcan and
Charter will make an aggregate preferred equity investment of $75 million. Under
the agreement, Vulcan and Charter will invest approximately equal amounts. The
investments take the form of convertible preferred stock, and may convert into
common stock of the Company at a conversion price of approximately $5 per share,
subject to adjustment for future stock issuances at less than the conversion
price and other customary adjustments. Closing of the transaction is conditioned
upon customary closing conditions, including approval by the Company's
stockholders. If the financing is completed, we expect these funds to last into
2002.
However, we anticipate that we will need to seek additional equity or debt
financing to execute our current business plan. Such financing could involve the
issuance, or deemed issuance, of additional shares of capital sock at a price
below the conversion price of the convertible preferred stock we have agreed to
issue to Vulcan and Charter, which would result in a downward adjustment of the
conversion price. In the event of such an adjustment, the number of shares of
common stock issuable upon conversion of the convertible preferred stock would
be increased pursuant to the weighted average formula described below under the
caption "Risk Factors - Our pending financing with Vulcan and Charter contains
anti-dilution adjustments and restrictions on our future activities". Further,
if additional financing is not available on acceptable terms, we may be forced
to curtail our operations, which could have a material adverse effect on our
business and financial results and may require us to delay the deployment of our
services. Furthermore, additional equity or debt financing could give rise to
any or all of the following:
o Additional dilution to our current stockholders;
o The issuance of securities with rights, preferences or privileges
senior to those of the existing holders of our common stock; and
o The issuance of securities with covenants imposing restrictions on our
operations.
Charter can require any lender with liens on our equipment placed in
Charter head ends to deliver to Charter a non-disturbance agreement as a
condition to such financing. We can offer no assurance that we will be able to
obtain additional secured equipment financing for Charter systems subject to
such a condition or that a potential lender will be able to negotiate acceptable
terms of non-disturbance with Charter.
Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivatives and Hedging
Activities (SFAS 133), which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities. SFAS 133, as amended by SFAS 137 and 138, is effective for our year
ending December 31, 2001. Management is currently evaluating the impact of SFAS
133 but does not expect the adoption to have a significant impact on our results
of operations, financial position or cash flows.
On December 3, 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in
Financial Statements. SAB 101 summarizes some of the staff's interpretations of
the application of generally accepted accounting principles to revenue
recognition. All registrants are expected to apply the accounting and disclosure
requirements that are described in SAB 101, as amended, no later than the fourth
quarter of the fiscal year beginning after December 15, 1999. Management of the
Company has analyzed the impact of SAB 101 and believes that adoption will not
have a material effect on the Company's results of operations or financial
position.
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Risk Factors
You should carefully consider the following factors and other information
in this Form 10-Q and other filings we make with the Securities and Exchange
Commission before trading in our common stock. If any of the following risks
actually occur, our business and financial results could be materially and
adversely affected. In that case, the trading price of our common stock could
decline and you could lose all or part of your investment.
Risks Related To Our Operations
Our Business Is Difficult To Evaluate Because We Have A Limited Operating
History.
Our predecessor companies began offering services to cable operators in
October 1997. Most of our cable modem deployments occurred within the last
twelve months. We do not consider any of the markets in which we operate to be
mature. We have recognized limited revenues since our inception. In addition,
our senior management team and other employees have worked together at our
company for only a short period of time. Consequently, we have a limited
operating history upon which our business can be evaluated.
We Have Not Been Profitable And Expect Future Losses.
Since our founding, we have not been profitable. We have incurred
substantial costs to create and introduce our broadband Internet access
services, to operate these services, and to grow our business. We incurred net
losses of approximately $159.4 million from April 3, 1998 (Inception) through
September 30, 2000. Our limited operating history, the dynamic nature of our
industry, changes in our business model and our ambitious growth plans make
predicting our operating results, including operating expenses, difficult.
We expect to incur substantial losses and experience substantial negative
cash flow from operations for at least the next several years as we expand our
business. The principal costs of expanding our business will include:
o Substantial direct and indirect selling, marketing and promotional
costs;
o System operational expenses, including the lease of our Internet
backbone, which has a traffic capacity in excess of our current needs;
o Costs incurred in connection with higher staffing levels to meet our
growth;
o The acquisition and installation of the equipment, software and
telecommunications circuits necessary to enable our cable partners to
offer our services or to add additional products and services; and
o Costs in connection with acquisitions, divestitures, business
alliances or changing technologies.
If any of these costs or expenses is not accompanied by an increase in
revenues, then our business and financial results could be materially and
adversely affected.
We Cannot Predict Our Success Because Our Business Model Is Unproven, Has
Changed In The Past And May Continue To Change.
Our success depends on continued growth in the use of the Internet and high
speed access services. Although Internet usage and popularity have grown
rapidly, we cannot be certain that this growth will continue in its present
form, or at all. Critical issues concerning the increased use of the
Internet--including security, reliability, cost, ease of access, ease of
installation and customer acquisition and quality of service--remain unresolved
and are likely to affect the development of the market for our services. We do
not believe any cable-based internet access services currently offered by cable
companies have been profitable. Moreover, many industry analysts believe that
Internet access providers will become increasingly reliant upon advertising,
barter and subscription-based revenues from content due to competitive pressures
to provide low cost or even free Internet access.
The success of our business ultimately will depend upon the acceptance of
our services by end users, who in our comprehensive turnkey service will
purchase or rent a cable modem from us and pay both monthly service and
installation fees. As of September 30, 2000 we deployed our services in only 148
cable systems and we have approximately 56,000 residential cable modem end
users. We
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began offering our services on a partial turnkey basis in the third quarter of
1999. As of the September 30, 2000, we had initiated partial turnkey services in
22 systems. In our partial turnkey solution, we deliver fewer services and incur
lower costs than in a full turnkey solution but will also earn a smaller
percentage of the subscription revenue or a fixed fee on a per subscriber basis.
As a result of our network services agreement with Charter, we anticipate that
partial turnkey services will become a more significant part of our business
mix, affecting our future revenues and profitability per subscriber.
Although our primary service offering is high bandwidth Internet access, we
currently derive a portion of our revenue from standard dial-up Internet access,
which we offer as a feeder for our high speed offerings. We cannot predict
whether demand for our high speed Internet access services will develop,
particularly at the volume or prices we need to become profitable. Nor can we
predict whether we can adequately supply services to satisfy that demand if it
develops. We may also not be able to acquire and install customers quickly
enough to meet demand, and the bandwidth we provide may prove to be inadequate.
Additionally, we believe that partial turnkey services will become an
increasingly important part of our business. Under the partial turnkey
arrangements, such as the one we signed with Charter in May 2000, covering a
minimum of five million homes passed, we will earn less revenue and absorb less
operating expense per customer than under a full turnkey arrangement.
We have begun to offer DSL on a limited basis, as a reseller for NorthPoint
Communications. We expect to rollout DSL connectivity and related services on a
bundled basis, and will absorb significant operating losses in doing so. In this
effort, the Company intends to target markets in which it has existing DSL
re-seller arrangements and/or existing infrastructure or facilities. We
anticipate that our business will become more dependent upon providing DSL
service to commercial customers in the future.
We recently acquired NetPerformance, a one-stop provider of strategic
Internet services primarily to small and medium sized enterprises, including web
hosting, web site and creative design, legacy systems integration and overall
strategic consulting.
We have also initiated technical trials of IP Telephony in collaboration
with Charter and Lucent, as additional services for our cable partners to offer
their customers.
We do not know whether our new services will become significant to our
business or whether we will continue to offer them at all. Moreover, we may
continue to introduce new services or to make changes to our product offerings
to meet our customer demands or to respond to changes in our evolving industry.
Consequently, our business model is likely to continue to change.
We Will Need Additional Capital In The Future And It May Not Be Available On
Acceptable Terms.
The development of our business will require significant additional capital
in the future to fund our operations, to finance the substantial investments in
equipment and corporate infrastructure needed for our planned expansion, to
enhance and expand the range of services we offer and to respond to competitive
pressures and perceived opportunities, such as investment, acquisition and
international expansion activities. To date, our cash flow from operations has
been insufficient to cover our expenses and capital needs. We believe our
current cash, cash equivalents and short term investments, together with the
$11.7 million of available lease financing through various facilities, as well
as additional loan and lease financing facilities will be sufficient to meet our
working capital requirements, including operating losses, and capital
expenditure requirements into 2002, assuming we achieve our business plan. At
such time, or sooner if we do not achieve our business plan, we will require
additional equity and/or debt financing. In this regard, in October 2000, we
signed a definitive agreement with Vulcan and Charter, under which Vulcan and
Charter will make an aggregate preferred equity investment of $75 million. Under
the agreement, Vulcan and Charter will invest approximately equal amounts. The
investments take the form of convertible preferred stock, and may convert into
common stock of the Company at a conversion price of approximately $5 per share,
subject to adjustment for future stock issuances at less than the conversion
price and other customary adjustments. Closing of the transaction is conditioned
upon customary closing conditions, including approval by the Company's
stockholders. If the financing is completed, we expect these funds, to last into
2002.
However, we anticipate that we will need to seek additional equity or debt
financing to execute our current business plan. Such financing could involve the
issuance, or deemed issuance, of additional shares of capital sock at a price
below the conversion price of the convertible preferred stock we have agreed to
issue to Vulcan and Charter, which would result in a downward adjustment of the
conversion price. In the event of such an adjustment, the number of shares of
common stock issuable upon conversion of the convertible preferred stock would
be increased pursuant to the weighted average formula described below under the
caption "Risk Factors - Our pending financing with Vulcan and Charter contains
anti-dilution adjustments and restrictions on our future activities". Further,
if additional financing is not available on acceptable terms, we may be forced
to curtail our operations, which could have a material adverse effect on our
business and financial results and may require us to delay the deployment of our
services. Furthermore, additional equity or debt financing could give rise to
any or all of the following:
o Additional dilution to our current stockholders;
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o The issuance of securities with rights, preferences or privileges
senior to those of the existing holders of our common stock; and
o The issuance of securities with covenants imposing restrictions on our
operations.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
Our Ability To Attract And Retain End Users Depends On Many Factors We Cannot
Control.
Our ability to increase the number of our end users, and our ability to
retain end users, will depend on a number of factors, many of which are beyond
our control. These factors include:
o Our ability to enter into and retain agreements with cable operators
and DSL wholesalers;
o The speed at which we are able to deploy our services, particularly if
we cannot obtain on a timely basis the telecommunications circuitry
necessary to connect our DSL customers and cable headend equipment to
the Internet;
o Our success in marketing our connectivity, web hosting and other
advanced services to new and existing end users;
o Competition, including new entrants advertising free or lower priced
Internet access and/or alternative access technologies;
o Whether our cable partners maintain their cable systems or upgrade
their systems from one-way to two-way service;
o Whether our DSL wholesalers and incumbent local exchange carriers
maintain and upgrade their loops to support DSL services;
o The quality of the customer and technical support we provide; and
o The quality of the content we offer.
In addition, our service is currently priced at a premium to many other
online services and many end users may not be willing to pay a premium for our
service. Because of these factors, our actual revenues or the rate at which we
will add new end users may differ from past increases, the forecasts of industry
analysts, or a level that meets the expectations of investors.
Our Quarterly Operating Results Are Likely To Fluctuate Significantly And May Be
Below Our Expectations And The Expectations Of Analysts And Investors.
Our revenues and expenses, and in particular our quarterly revenues,
expenses and operating results have varied in the past and may fluctuate
significantly in the future due to a variety of factors, many of which are
outside of our control. These factors include:
o The pace of the rollout of our DSL services to end users and our cable
modem service to our cable partners, including the impact of
substantial capital expenditures and related operating expenses;
o Whether and the rate at which we enter into contracts with cable
operators for additional systems;
o The rate at which new end users subscribe to our services, the rate at
which these customers are installed and provisioned for service, and
the rate at which we retain these customers net of customers who
disconnect;
o Changes in revenue splits with our cable partners;
o Price competition in the Internet, Telephony and cable industries;
o The extent to which we provide partial, rather than full turnkey
access;
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o Capital expenditures and costs related to infrastructure expansion;
o The rate at which our cable partners convert their systems from
one-way to two-way systems;
o Our ability to protect our systems from telecommunications failures,
power loss and software-related system failures;
o Changes in our operating expenses including, in particular, personnel
expenses;
o The introduction of new products or services by us or our competitors;
o Our ability to enter into strategic alliances with content providers;
and
o Economic conditions specific to the Internet and cable industries, as
well as general economic and market conditions.
In addition, our operating expenses are based on our expectations of the
future demand for our services and are relatively fixed in the short term. We
may be unable to adjust spending quickly enough to offset any unexpected demand
surge or shortfall in demand. A shortfall in revenues in relation to our
expenses could have a material and adverse effect on our business and financial
results.
The quarter-to-quarter comparisons of our results of operations should not
be relied upon as an indication of future performance. It is possible that in
some future periods our results of operations may be below our expectations and
the expectations of public market analysts and investors. In that event, the
price of our common stock is likely to fall.
We May Not Be Able To Establish Or Maintain Acceptable Relationships With Cable
Operators.
Our success depends, in part, on our ability to gain access to cable
customers. We gain that access through our agreements with cable operators.
There can be no assurance that we will be able to establish or maintain
relationships with cable operators. Even if we are able to establish and
maintain those relationships, there can be no assurance that we will be able to
do so on terms favorable to us or in the quantities we need to become
profitable. If we fail to form partnerships rapidly with a large number of cable
operators, we can be effectively excluded from providing our services in the
systems owned by those operators. Not only can other cable-based broadband
service providers compete against us for an exclusive contract, the cable
operator may decide to offer cable-based Internet services directly without
assistance from us or our competitors. Delays in forming relationships and
deploying our cable-based services also create windows of time for alternative
broadband access providers to enter the market and acquire customers.
Furthermore, in order to rapidly deploy our services within a market, we
typically begin installation of our equipment and related telecommunications
circuits prior to the execution of final documentation. If we are unable to
finalize our contractual relationship with a cable operator, if the exclusive
relationship between us and our cable partners, or between our cable partners
and their cable customers, is impaired, or if we do not become affiliated with a
sufficient number of cable operators, our business and financial results could
be materially and adversely affected.
Our Largest Cable Partner Can Terminate Its Contract With Us.
Our largest cable partner is Charter. Charter is an affiliate of Vulcan,
which owns 34.5% of our outstanding common stock as of September 30, 2000. We
have entered into several agreements with Charter, including two network
services agreements. The first network services agreement was entered into in
November 1998 and the second in May 2000. Under both agreements, Charter
committed to provide the Company exclusive rights to provide network services
related to the delivery of Internet access to homes passed in certain cable
systems.
Under the May 2000 agreement, the Company will provide partial turnkey
services, including call center support for cable modem customers as well as
network monitoring, troubleshooting and security services. The agreement has an
initial term of five years and may be renewed at Charter's option for additional
successive five-year terms. In a partial turnkey solution, we deliver fewer
services and incur lower costs than in full turnkey solutions, but will also
earn a smaller percentage of the subscription revenue based on a fixed fee per
subscriber. Under the November 1998 agreement the Company has primarily provided
comprehensive turnkey services.
Subject to the provisions of the network service agreements, Charter can
terminate our exclusivity rights, on a system-by-system basis, if we fail to
meet performance specifications or otherwise breach our agreement. Moreover,
Charter can terminate the November 1998 agreement, for any reason, as long as it
purchases the associated cable headend equipment and modems at book value
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and pays us a termination fee based on the net present value of the revenues we
otherwise would earn for the remaining term of the agreement from those end
users subscribing to our services as of the date of termination. There can be no
assurances we will meet the benchmarks related to our customer penetration rates
or that Charter will not decide to terminate either agreement for any other
reason. If Charter were to terminate either agreement, in whole or for any
material system, regardless of any termination fee we may receive, our business
and financial results would be materially and adversely affected.
Our Agreements With Vulcan Could Constrain Our Ability To Generate Revenues From
Providing Content And Future Services Our End Users May Demand.
Under our programming content agreement with Vulcan, Vulcan has the right
to require us to carry, on an exclusive basis in all cable systems we serve,
content it designates. Vulcan content may include start-up and related web
pages, electronic programming guides, other multimedia information and telephony
services. We will not share in any revenues Vulcan may earn through the content
or telephony services it provides. We must provide all equipment necessary for
the delivery of Vulcan content, although Vulcan will reimburse us for any costs
we incur in excess of $3,000 per cable headend. Vulcan cannot charge us for any
Vulcan content through November 2008; after that date we will be obligated to
pay Vulcan for this content at the lowest fee charged to any Internet service
provider who subscribes to Vulcan content.
Vulcan has the right to prohibit us from providing content or telephony
services that compete with Vulcan content at Vulcan's discretion and can require
us to remove competing content. Many industry analysts believe that Internet
access will become increasingly reliant upon revenues from content due to
competitive pressures to provide low cost or even free Internet access. If
Vulcan were to require us to remove our content or substitute its telephony
services for any we might provide, we could lose a source of additional revenues
and might not recover all related costs of providing our content or telephony
services. Vulcan's ability to prohibit us from providing content and telephony
services means that Vulcan's interests are not necessarily aligned with those of
our other stockholders.
Our Pending Financing with Vulcan and Charter Contains Anti-dilution
Adjustments and Restrictions on our Future Activities.
On October 19, 2000, the Company entered into a Stock Purchase Agreement
with Vulcan and Charter. Upon satisfaction of the conditions set forth in the
purchase agreement (including stockholder approval of the proposal), Vulcan and
Charter will purchase 38,000 and 37,0000 shares, respectively, of our Series D
Convertible Preferred Stock at a price of $1,000 per share, for an aggregate
purchase price of $38,000,000 and $37,000,000, respectively. Paul G. Allen
controls Vulcan and Charter. The shares of convertible preferred stock initially
are convertible at a conversion price of $5.01875 per share into 14,943,960
shares of common stock. The conversion price would be subject to an
anti-dilution adjustment which would increase the number of shares issuable to
Vulcan and Charter upon conversion of the convertible preferred stock if we
issue common stock (or are deemed to issue common stock) at below the conversion
price.
If completed, the transaction also would place significant restrictions on
our activities in the future. Among other things, these constraints will require
us to:
o Obtain the approval of Vulcan and Charter before declaring a dividend,
entering into a merger, acquisition, consolidation, business
combination, or other similar transaction, or issuing any debt or
equity securities;
o Provide Vulcan and Charter with a right of first refusal to purchase
any shares of stock, common or otherwise, that we may offer in the
future; and
o Offer and make available to Vulcan, Charter and their affiliates
licensing and business arrangements relating to our technologies,
products and services, of any combination thereof, on terms and
conditions at least as favorable as those agreed to with any third
party at substantially the same level of purchase or other financial
commitment.
You should be aware that conversion of the convertible preferred stock into
shares of common stock will have a dilutive effect on earnings per share and the
relative voting power of our present stockholders. In addition, you should note
that we may issue additional shares of common stock in connection with the
payment of dividends or conversion price adjustments on the convertible
preferred stock, which may increase the number of shares of common stock issued
in connection with the transaction.
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Investors May Suffer Substantial Dilution From Other Transactions.
As an inducement to cause Charter to commit additional systems to us in
connection with network services agreements entered into in November 1998 and
May 2000, we have granted Charter warrants to purchase up to 12,000,000 shares
of our common stock at an exercise price of $3.23 per share. These warrants
become exercisable, in respect of full turnkey systems at the rate of 1.55
shares for each home passed in excess of 750,000, and partial turnkey systems at
the rate of .775 shares for each home passed for up to 5,000,000 homes passed;
and at a rate of 1.55 shares for each additional home passed in excess of
5,000,000. To the extent that Charter becomes eligible to exercise all or a
significant portion of these warrants, the Company's stockholders will
experience substantial dilution.
In addition, we have granted Microsoft a warrant to purchase 387,500 shares
of our common stock at an exercise price of $16.25, with additional warrants
issuable for homes passed above 2,500,000 homes passed committed to us by
Comcast. Our agreement with ServiceCo LLC provides for granting of warrants to
purchase one share of our common stock at a price of $5 per share up to a
maximum of 5,000,000 shares. The Company has also granted Classic Cable, Inc.
and CMA Associates, both cable operators, a warrant to purchase 600,000 and
200,000 shares at an exercise price of $13, respectively, in connection with the
distribution of our services. We have issued and may in the future issue
additional stock or warrants to purchase our common stock in connection with our
efforts to expand the distribution of our services and retain various consulting
services. Stockholders could face additional dilution from these possible future
transactions.
One-Way Cable Systems Increase Our Operating Costs And May Not Provide The
Quality Necessary To Attract Customers.
Although our service can operate in one-way cable systems, where data can
be transmitted at high speeds from the cable headend to the end user, the end
user in a one-way system can only transmit data back to the cable headend via a
standard phone line. Because we must support the telephone return component of
the system, we incur higher operating costs in one-way systems. Presently only
one-third of the systems where we are or will soon operate our services are
two-way systems. Over time, however, we expect most, if not all, of our cable
partners to upgrade and or rebuild their plants to provide increased bandwidth
and two-way capabilities. We believe faster uploads and the elimination of phone
line return costs make our service more valuable and may lead to higher customer
penetration rates, which in turn benefits the cable operator through higher
revenue. However, upgrading a cable system can be expensive and time-consuming
for the cable operator. Delays in upgrading one-way cable plants also makes our
services vulnerable to competition from alternative broadband technologies, and
may make our cable partner vulnerable to overbuilds by competitors.
Moreover, we do not require our cable partners to make these upgrades and they
have no legal obligation to do so. Consequently, if our cable partners do not
upgrade to two-way capability at the rate we anticipate, our financial results
may be negatively affected.
We May Have Difficulty Managing Our Growth Plans.
To manage our anticipated growth, we must continue to implement and improve
our operational, financial and management information systems; hire, train and
retain additional qualified personnel; continue to expand and upgrade core
technologies; and effectively manage our relationships with our end users,
suppliers and other third parties. Our expansion could place a significant
strain on our services and support operations, sales and administrative
personnel, and other resources. While we believe that we generally have adequate
controls and procedures in place for our current operations, our billing
software is not adequate to meet our growth plans. We are in the process of
replacing our billing software with an integrated billing and customer care
software system that we believe is capable of meeting our planned future needs,
but can offer no assurances that it will successfully achieve such replacement,
or if it does achieve such replacement that it will do so within a time frame
that will permit it to achieve its growth objectives. We could also experience
difficulties meeting demand for our products and services. Additionally, if we
are unable to provide training and support for our products, the implementation
process will be longer and customer satisfaction may be lower. Our growth plan
may include acquisitions. If we acquire a company, we could have difficulty
assimilating its operations, or assimilating and retaining its key personnel. In
addition if the demand for our service exceeds our ability to provide our
services on a timely basis, we may lose customers. There can be no assurance
that our systems, procedures or controls will be adequate to support our
operations or that our management will be capable of exploiting fully the market
for our products and services. The failure to manage our growth effectively
could have a material adverse effect on our business and financial results.
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The Market For Internet Services Is Highly Competitive.
We face competition from many competitors with significantly greater
financial, sales and marketing resources, larger customer bases, longer
operating histories, greater name recognition and more established relationships
with advertisers, content and application providers and/or other strategic
partners than we have. We expect the level of this competition in cable and DSL
Internet access markets to intensify in the future. We face competition from
both cable modem service providers and from providers of other types of data, IP
telephony and Internet services for end users. Due to this intense competition,
there may be a time-limited market opportunity for our cable-based high speed
access and IP telephony services. There can be no assurance that we will be
successful in achieving widespread acceptance of our services before competitors
offer services similar to our current offerings, which might preclude or delay
purchasing decisions by potential customers.
Our competitors in the cable-based Internet access and IP Telephony markets
are those companies that have developed their own cable-based services and
market those services to cable system operators. Other competitors in the
cable-based Internet access and IP telephony access markets are those companies
seeking to establish distribution arrangements with cable system operators in
exurban markets and/or provide one-way system capability. In addition, other
cable system operators have launched their own cable-based Internet services
that could limit the market for our services. Our agreement with Charter and
other operators provides us exclusive rights to provide high speed Internet
access to the customer's personal computer. However, Charter and other online
service providers may deploy TV-based Internet access services through set-top
boxes or other devices. Widespread commercial acceptance of any of these
competitors' products could significantly reduce the potential customer base for
our services, which could have a material adverse effect on our business and
financial results.
We also compete with traditional Internet service providers and other
competing broadband technologies including ISDNs, DSLs, wireless and satellite
data services. Moreover, our competitors include long distance inter-exchange
carriers, regional Bell operating companies and other local exchange carriers.
Many of these carriers are offering diversified packages of telecommunications
services, including Internet access, and could bundle these services together,
putting us at a competitive disadvantage. Widespread commercial acceptance of
any of these competing technologies or competitors' products could significantly
reduce the potential customer base for our services, which could have a material
adverse effect on our business and financial results.
Our Ability To Increase The Capacity And Maintain The Speed Of Our Network Is
Unproven.
We may not be able to increase the transmission capacity of our network to
meet expected end user levels while maintaining superior performance. While peak
downstream data transmission speeds across the cable infrastructure approach 10
Mbps in each 6 megahertz (Mhz) channel, actual downstream data transmission
speeds are almost always significantly slower depending on a variety of factors.
These factors include our intentional throttling of data traffic flowing through
the local network out in order to optimize the use our network capacity and to
sell tiered price-service packages, bandwidth capacity constraints between the
cable headend and the Internet backbone, the type and location of content,
Internet traffic, the number of active end users on a given cable network node,
the number of 6 Mhz channels allocated to us by our cable partner, the
capabilities of the cable modems used and the service quality of the cable
operators' fiber-coax facilities. The actual data delivery speed that an end
user realizes also will depend on the end user's hardware, operating system and
software configurations. There can be no assurance that we will be able to
achieve or maintain a speed of data transmission sufficiently high to enable us
to attract and retain our planned number of end users, especially as the number
of the end users grows. Because end users will share the available capacity on a
cable network node, we may underestimate the capacity we need to provide in
order to maintain peak transmission speeds. A perceived or actual failure to
achieve or maintain sufficiently high speed data transmission could
significantly reduce end user demand for our services or increase costs
associated with customer complaints and have a material adverse effect on our
business and financial results.
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Our Network May Be Vulnerable To Security Risks.
Despite our implementation of industry-standard security measures the
networks we operate may be vulnerable to unauthorized access, computer viruses
and other disruptive problems. Internet and online service providers in the past
have experienced, and in the future may experience, interruptions in service as
a result of the accidental or intentional actions of Internet users. Because the
cable infrastructure is a shared medium, it is inherently more vulnerable to
security risks than dedicated telephony technologies such as digital subscriber
lines. Moreover, we have no control over the security measures that our cable
partners and end users adopt. Unauthorized access could also potentially
jeopardize the security of confidential information stored in the computer
systems maintained by us and our end users. These events may result in liability
to us or harm to our end users. Eliminating computer viruses and alleviating
other security problems may require interruptions, delays or cessation of
service to our end users, which could have a material adverse effect on our
business and financial results. In addition, the threat of these and other
security risks may deter potential end users from purchasing our services, which
could have a material adverse effect on our business and financial results.
We May Become Subject To Risks Of International Operations.
We are currently evaluating international expansion opportunities. If we
expand internationally or enters into joint venture arrangements to pursue
international business opportunities, we would become subject to the risks of
conducting business internationally, including:
o Foreign currency fluctuations, which could result in reduced revenues
or increased operating expenses;
o Inability to locate qualified local partners and suppliers;
o The burdens of complying with a variety of foreign laws and trade
standards;
o Tariffs and trade barriers;
o Difficulty in accounts receivable collection;
o Potentially longer payment cycles;
o Foreign taxes;
o Unexpected changes in regulatory requirements including the regulation
of Internet access; and
o Uncertainty regarding liability for information retrieved and
replicated in foreign countries.
If we expand internationally, we will also be subject to general
geopolitical risks, such as political and economic instability and changes in
diplomatic and trade relationships. There can be no assurance that the risks
associated with our proposed international operations will not materially and
adversely affect our business and financial results.
We Have Recently Made Acquisitions And Expect To Make Future Acquisitions Where
Advisable And Acquisitions Involve Numerous Risks.
Our growth is dependent upon market growth, our ability to enhance our
existing products and our ability to introduce new products on a timely basis.
One of the ways we have addressed and will continue to address the need to
develop new products is through acquisitions of other companies. In particular,
we recently acquired NetPerformance in order to allow us to offer additional
services to our customers, including web hosting, web site and creative design,
legacy systems integration and overall strategic consulting. Acquisitions
involve numerous risks, including the following:
o difficulties in integration of the operations, technologies, and
products of the acquired companies;
o the risk of diverting management's attention from normal daily
operations of the business;
o potential difficulties in completing projects associated with
purchased in-process research and development;
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o risks of entering markets in which we have no or limited direct prior
experience and where competitors in such markets have stronger market
positions; and
o the potential loss of key employees of the acquired company.
Mergers and acquisitions of high-technology companies are inherently risky,
and no assurance can be given that our previous or future acquisitions will be
successful and will not materially adversely affect our business, operating
results or financial condition.
We must also maintain our ability to manage any such growth effectively.
Failure to manage growth effectively and successfully integrate acquisitions we
made could harm our business and operating results.
Risks Related To The Market For High Speed Internet Access
Our Cable Partners Could Sell Their Systems Or Be Acquired.
In recent years, the cable television industry has undergone substantial
consolidation. If one of our cable partners is acquired by a cable operator that
already has a relationship with one of our competitors or that does not enter
into a contract with us, we could lose the ability to offer our cable modem
access services in the systems formerly served by our cable partner, which could
have a material and adverse effect on our business and financial results. Many
of the cable operators with whom we have contracts operate multiple systems,
thus increasing the risk to us if they are acquired. Moreover, it is common in
the cable industry for operators to swap systems, which could cause us to lose
our contract for a swapped system. Even though many of our contracts obligate
our cable partners to pay us a termination fee if they sell their system to
another operator who does not assume our contract, the potential termination fee
may not be adequate to ensure that the successor operator assumes our contract,
or to compensate us fully for the loss of future business in that system.
Our Cable Partners Could Lose Their Franchises.
Cable television companies operate under franchises granted by local or
state authorities that are subject to renewal and renegotiation from time to
time. A franchise is generally granted for a fixed term ranging from five to 15
years, although in many cases the franchise is terminable if the franchisee
fails to comply with the material provisions of its franchise agreement. No
assurance can be given that the cable operators that have contracts with us will
be able to retain or renew their franchises. The non-renewal or termination of
any of these franchises would result in the termination of our contract with the
applicable cable operator. Moreover, cable television operators are sometimes
subject to overbuilding by competing operators who offer competing video and
Internet access services. Moreover, many direct broadcast satellite (DBS)
operators can compete with cable operators and provide Internet access services
to their subscribers. Any such dilution of our cable operator market base can
adversely affect our potential market base.
Our Market Is Characterized By Rapid Technological Change And Our Services Could
Become Obsolete Or Fail To Gain Market Acceptance.
The market for our services is characterized by rapid technological
advances, evolving industry standards, changes in end user requirements and
frequent new service introductions and enhancements. For example, the North
American cable industry has adopted a set of interface specifications, known as
"DOCSIS," for hardware and software to support cable-based data delivery using
cable modems. Our ability to adapt to rapidly changing technology and industry
standards, such as DOCSIS, and to develop and introduce new and enhanced
products and service offerings will be significant factors in maintaining or
improving our competitive position reducing our costs, and our prospects for
growth. If technologies or standards applicable to our services become obsolete
or fail to gain widespread consumer acceptance, then our business and financial
results will be materially and adversely affected.
We currently anticipate that we will use a significant portion of our
working capital to acquire headend, cable modem and other related capital
equipment. The technology underlying that equipment is continuing to evolve. It
is possible that the equipment we acquire could become obsolete prior to the
time we would otherwise intend to replace it, which could have a material
adverse effect on our business and financial results.
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We Depend On A Data Transmission Infrastructure Largely Maintained By Third
Parties Or Subject To Disruption By Events Outside Our Control.
Our success will depend upon the capacity, reliability and security of the
infrastructure used to carry data between our end users and the Internet. A
significant portion of that infrastructure is owned by third parties.
Accordingly, we have no control over its quality and maintenance. For example,
we rely on our cable partners to maintain their cable infrastructures. We also
rely on other third parties to provide a connection from the cable
infrastructure to the Internet. Currently, we have transit agreements with
UUNet, a division of MCI WorldCom, and others to support the exchange of traffic
between our data servers, the cable infrastructure and the Internet. Our
operations also depend on our ability to avoid damages from fires, earthquakes,
floods, power losses, telecommunications failures, network software flaws,
transmission cable cuts, Year 2000 problems and similar events. The occurrence
of any of these events could interrupt our services. The failure of the Internet
backbone, our servers, or any other link in the delivery chain, whether from
operational disruption, natural disaster or otherwise, resulting in an
interruption in our operations could have a material adverse effect on our
business and financial results.
We May Be Held Liable For Defamatory Or Indecent Content, As Well As Information
Retrieved Or Replicated.
In part, our business involves supplying information and entertainment to
customers over the cable systems of our cable system partners. Accordingly we
face the same types of risks that apply to all businesses that publish or
distribute information, such as potential liability for defamation, libel,
invasion of privacy and similar claims, as well as copyright or trademark
infringement and similar claims. A number of third parties have claimed that
they hold patents covering various forms of online transactions or online
technologies. In addition, our errors and omissions and liability insurance may
not cover potential patent or copyright infringement claims and may not
adequately indemnify us for any liability that may be imposed.
The law relating to the liability of Internet and online service providers
for information carried or disseminated through their networks is unsettled.
There are some federal laws regarding the distribution of obscene or indecent
material over the Internet under which we are subject to potential liability.
These risks are mitigated by two federal laws. One, passed in 1996, immunizes
Internet service providers from liability for defamation and similar claims for
materials the Internet service provider did not create, but merely distributed.
The other, passed in 1998, creates a "safe harbor" from copyright infringement
liability for Internet service providers who comply with its requirements, which
we intend to do. These laws apply only in the United States; if we expand our
operations to other countries, our potential liability under the laws of those
countries could be greater.
We May Become Subject To Burdensome Government Regulation Or "Open Access"
Competition.
The regulatory climate impacting our business is uncertain at this time,
and we may become subject to burdensome governmental regulation in the future.
Historically, the Company and its cable partners believed that for regulatory
purposes we would be considered a cable service provider, or an unregulated
information service provider. However, a federal appeals court (AT&T v. City of
Portland, 9th Cir. 6/22/00) recently concluded that a cable operator's provision
of transmission facilities in some instances is a telecommunications service
under the Communications Act. This classification could subject our cable
partners, and possibly US, to federal and state regulation as
"telecommunications carriers." If we or our cable partners were classified as
telecommunications common carriers, or otherwise subject to common carrier-like
access and non-discrimination requirements in the provision of our Internet over
cable service, the Company or its cable partners could be subject to burdensome
governmental regulations. In particular, the government might seek to regulate
us and our cable partners with respect to the terms, conditions and prices for
Internet connection services and interconnections with the public switched
telephone network, and require that we make contributions to the universal
service support fund. The Internet telephony services over cable, or Voice over
IP, we expect to offer and deploy may also be regulated as a common carrier
telecommunications service. Accordingly, the Company or its cable partners might
then have to get a "telecommunications franchise" or a license to operate as a
"competitive local exchange carrier" from some states or localities, which might
not be available on reasonable terms, or at all.
In addition, some local cable franchising authorities seek to impose
"non-discrimination" or "open access" obligations on our cable partners. Other
local franchising authorities might claim that our cable partners need a
separate franchise to offer our cable service. This franchise may not be
obtainable on reasonable terms, or at all. A consortium of dial-up Internet
service providers and large telephone companies are encouraging local
franchising authorities and the Federal Communications Commission to ban the
type of exclusive ISP-cable operator arrangements that we have with our cable
partners that make it the exclusive supplier of high speed data on the cable
systems where our service is offered. If such arrangements are banned, the
Company could face additional competition from other Internet access providers
using the cable system to connect to their customers, which could have a
material adverse effect on our business and financial results. Both AOL-Time
Warner and AT&T-Mindspring have announced plans to open their networks to
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competing Internet service providers in the coming years, and AT&T and Time
Warner Cable have initiated "open-access" trials with selected ISPs in several
markets. Other ISPs are petitioning the FCC and various large cable operators
for access to cable plants. The Company cannot predict the degree to which such
voluntary or involuntary "open access" will affect its business.
In addition, regulatory decisions that make DSL technology services easier
for competing telephone companies to deploy over normal telephone lines and less
expensive for customers to buy, could negatively affect the Company's business.
The Federal Communications Commission issued a line-sharing ruling in December
1999 that allows DSL providers to simply lease the data spectrum of the
customer's local loop from the incumbent carrier. This obviates the need for the
customers to lease a secondary DSL-provisioned loop from the incumbent carrier
in order to obtain high speed DSL data service, which in turn could make DSL
service a more cost-competitive alternative to our services. Finally, firms
controlling digital broadcast spectrum have announced plans to utilize a portion
of that spectrum to offer consumers high-bandwidth data delivery via broadcast.
Some direct broadcast satellite video companies are also deploying
higher-bandwidth data delivery products. The Company cannot predict when or
whether these services will be offered, but if offered they could present
material competition to our services and could materially and adversely affect
our success in the marketplace.
We Depend On Our Key Personnel And May Have Difficulty Attracting And Retaining
The Skilled Employees We Need To Execute Our Growth Plan.
Our future success depends on the continued service of our key personnel,
especially our Chief Executive Officer ("CEO") and Chief Operating Officer
("COO"). We do not carry key person life insurance on most of our personnel.
Given our early stage and plans for rapid expansion, the loss of the services of
any of our executive officers or the loss of the services of other key employees
could have a material adverse effect on our business and financial results. Our
future success also depends on our ability to attract, retain and motivate
highly skilled employees, particularly engineering and technical personnel.
Competition for employees in our industry is intense. We may not be able to
retain our key employees or attract, assimilate or retain other highly qualified
employees in the future. From time to time we have experienced, and we expect to
continue to experience in the future, difficulty in hiring and retaining highly
skilled employees.
Risk Related To Trading In Our Stock
Because Of Our Relationship With Vulcan Ventures, New Investors Will Have Little
Influence Over Management Decisions.
Vulcan currently owns 34.5% of our outstanding stock. Charter, also has a
warrant to purchase up to 12,000,000 shares of our common stock at an exercise
price of $3.23 per share. Additionally, in October 2000 we signed a definitive
agreement with Vulcan and Charter, under which they will make an aggregate
preferred equity investment of $75 million. Paul G. Allen is the controlling
stockholder of Charter and Vulcan. Accordingly, Mr. Allen will be able to
significantly influence and possibly exercise control over most matters
requiring approval by our stockholders, including the election of directors and
approval of significant corporate transactions. This concentration of ownership
may also have the effect of delaying or preventing a change in control. In
addition, conflicts of interest may arise as a consequence of Mr. Allen's
control relationship with us, including:
o Conflicts between Vulcan, Charter and other affiliates of Mr. Allen
and our other stockholders, whose interests may differ with respect
to, among other things, our strategic direction or significant
corporate transactions;
o Conflicts related to corporate opportunities that could be pursued by
us, on the one hand, or by Vulcan, Charter or other affiliates of Mr.
Allen, on the other hand; or
o Conflicts related to existing or new contractual relationships between
us, on the one hand, and Mr. Allen and his affiliates, such as Vulcan
and Charter, on the other hand. In particular Mr. Allen controls
Charter, our largest cable partner.
Additionally, Vulcan has the exclusive right to provide or designate the
first page our end users see when they log on to our service and, if it provides
that first page, will be entitled to all of the related revenues. Moreover,
Vulcan can prohibit us from providing content that competes with content it
chooses to provide, and can prohibit us from providing telephony service if it
chooses to provide those services.
If we complete our pending financing with Vulcan and Charter, Mr. Allen's
beneficial ownership of our outstanding stock would be increased to 49.6%.
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The Future Sale Of Shares May Hurt Our Market Price.
A substantial number of shares of our common stock are available for
resale. If our stockholders sell substantial amounts of our common stock in the
public market, the market price of our common stock could fall. These sales also
might make it more difficult for us to sell equity securities in the future at
times and prices that we deem appropriate.
Our Stock Price Is Likely To Be Highly Volatile.
The stock market has experienced extreme price and volume fluctuations. In
particular, the market prices of the securities of Internet-related companies
have been especially volatile. In the past, companies that have experienced
volatility in the market price of their stock have been the object of securities
class action litigation. If we were the object of securities class action
litigation, it could result in substantial costs and a diversion of our
management's attention and resources.
We Have Anti-Takeover Provisions.
Certain provisions of our certificate of incorporation, our bylaws and
Delaware law, in addition to the concentration of ownership in Vulcan, could
make it difficult for a third party to acquire us, even if doing so might be
beneficial to our other stockholders.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk is limited to interest rate sensitivity, which
is affected by changes in the general level of U.S. interest rates. Our cash
equivalents are invested with high-quality issuers and limit the amount of
credit exposure to any one issuer. Due to the short-term nature of our cash
equivalents, we believe that we are not subject to any material market risk
exposure.
We do not have any foreign currency hedging or other derivative financial
instruments.
Part II - Other Information
Item 1 - Legal Proceedings.
None.
Item 2 - Changes in Securities and Use of Proceeds.
a. In May 2000, Lucent purchased 1,250,000 shares of the Company's common stock
for $10.0 million. This common stock was sold in reliance on the exemption from
registration provided by section 4(2) of the Securities Act.
b. In June 1999, we completed our initial public offering of Common Stock.
Concurrent with the initial public offering, we sold Common Stock to Cisco
Systems, Com21 and Microsoft under stock purchase agreements. The initial
proceeds to the Company after deducting underwriting discounts and commissions
of $13,081,250 were $199,768,750. Through September 30, 2000 the gross proceeds
of the offering have been applied as follows:
Direct or Indirect payment to others for:
<TABLE>
<S> <C>
Underwriting discounts and commissions $ 13,081,250
Other offering expenses $ 1,828,854
Working Capital $104,436,896
</TABLE>
None of such payments were direct or indirect payments to investors or officers
or 10% stockholders of the Company. The remainder of the proceeds is invested in
short term, interest bearing investment grade securities.
Item 3 - Defaults upon Senior Securities.
None.
26
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Item 4 - Submission of Matters to a Vote of Security Holders.
None
Item 5 - Other Information.
None.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits
FDS Exhibit 27
(b) Reports on Form 8-K
On October 23, 2000, the Company filed a report on Form 8-K which announced
that we had entered into a $75 million stock purchase agreement, dated as of
October 19, 2000, with Vulcan and Charter. A copy of the Agreement, as well as
the Press Release announcing this matter, were attached as Exhibits to the
filing.
27
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934 as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
High Speed Access Corp.
Date November 14, 2000 By /s/ Daniel J. O'Brien
----------------- --------------------------------
Daniel J. O'Brien
President
Date November 14, 2000 By /s/ George Willett
----------------- --------------------------------
George Willett
Chief Financial Officer
28
<PAGE> 29
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27 FINANCIAL DATA SHEET
</TABLE>
