<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
[ ] For the Transition Period from ____________ to ____________
COMMISSION FILE NUMBER: 0-29255
FASTNET CORPORATION
-------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-2767197
------------ ----------
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3864 COURTNEY STREET
TWO COURTNEY PLACE, SUITE 130
BETHLEHEM, PA 18017
------------- -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(610) 266-6700
--------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
---
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's Common stock outstanding as of
August 14, 2000 was 14,990,947.
<PAGE>
FASTNET CORPORATION
FORM 10-Q
JUNE 30, 2000
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - December 31, 1999 and June 30,
2000 (unaudited) ................................................3
Consolidated Statements of Operations (unaudited) - Three and Six
Months Ended June 30, 1999 and 2000 ............................4
Consolidated Statements of Cash Flows (unaudited) - Six months Ended
June 30, 1999 and 2000 .........................................5
Notes to Consolidated Financial Statements ...........................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 ..........15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................................15
Item 2. Changes in Securities and Use of Proceeds ...........................16
Item 3. Defaults Upon Senior Securities .....................................17
Item 4. Submission of Matters to a Vote of Security Holders .................18
Item 5. Other Information ...................................................18
Item 6. Exhibits and Reports on Form 8-K ....................................27
2
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<TABLE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<CAPTION>
December 31 June 30
1999 2000
---- ----
ASSETS (Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ........................................ $ 953,840 $ 1,787,256
Marketable securities ............................................ -- 35,695,013
Accounts receivable .............................................. 1,791,422 1,976,370
Offering costs ................................................... 1,336,605 --
Other current assets ............................................. 469,605 892,400
------------- -------------
Total current assets ................................ 4,551,472 40,351,039
------------- -------------
PROPERTY AND EQUIPMENT, net ........................................... 7,363,848 14,750,293
GOODWILL, net ......................................................... 2,115,558 1,705,141
CUSTOMER LIST, net .................................................... 1,722,222 1,388,887
OTHER ASSETS .......................................................... 86,476 344,266
------------- -------------
$ 15,839,576 $ 58,539,626
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt ................................ $ 12,985 $ 12,729
Current portion of capital lease obligations ..................... 1,417,066 3,002,303
Accounts payable ................................................. 2,319,524 1,073,329
Accrued expenses ................................................. 1,708,896 1,457,450
Deferred revenues ................................................ 2,331,258 2,729,980
------------- -------------
Total current liabilities ........................... 7,789,729 8,275,791
------------- -------------
LONG-TERM DEBT ........................................................ 3,081,634 41,893
------------- -------------
CAPITAL LEASE OBLIGATIONS ............................................. 2,794,093 5,458,009
------------- -------------
OTHER LIABILITIES ..................................................... 810,322 30,769
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COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock (10,000,000 shares authorized, 808,629 shares
outstanding at December 31, 1999 and none outstanding at
June 30, 2000) ................................................. 5,460,653 --
Common stock (50,000,000 shares authorized, 7,546,984 and
14,990,947 shares outstanding at December 31, 1999 and
June 30, 2000) ................................................. 4,798,924 64,204,990
Deferred compensation ............................................ (364,149) (1,143,232)
Accumulated deficit .............................................. (7,531,630) (17,328,594)
Less - Treasury stock, at cost ................................... (1,000,000) (1,000,000)
------------- -------------
Total shareholders' equity .......................... 1,363,798 44,733,164
------------- -------------
$ 15,839,576 $ 58,539,626
============= =============
The accompanying notes are an integral part of these statements.
</TABLE>
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<TABLE>
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 2000 1999 2000
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES .................................... $ 1,817,709 $ 3,168,815 $ 3,551,552 $ 6,199,125
OPERATING EXPENSES:
Cost of revenues ......................... 1,328,706 3,072,160 2,522,218 5,543,411
Selling, general and administrative ...... 1,042,174 5,118,487 1,793,503 8,824,324
Depreciation and amortization ............ 119,504 1,113,252 247,795 2,115,241
------------- ------------- ------------- -------------
2,490,384 9,303,899 4,563,516 16,482,976
------------- ------------- ------------- -------------
Operating loss ........................... (672,675) (6,135,084) (1,011,964) (10,283,851)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest income .......................... 7,475 695,955 10,745 1,014,753
Interest expense ......................... (64,278) (135,036) (121,587) (523,115)
Other .................................... 1,017 (1,290) 1,017 (4,751)
------------- ------------- ------------- -------------
(55,786) 559,629 (109,825) 486,887
------------- ------------- ------------- -------------
NET LOSS .................................... $ (728,461) $ (5,575,455) $ (1,121,789) $ (9,796,964)
============= ============= ============= =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE . $ (0.10) $ (0.37) $ (0.16) $ (0.73)
============= ============= ============= =============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING .............................. 7,000,000 14,989,804 7,000,000 13,339,555
============= ============= ============= =============
The accompanying notes are an integral part of these statements.
</TABLE>
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<TABLE>
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
(Unaudited)
Six months ended
June 30,
1999 2000
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ..................................................... $ (1,121,789) $ (9,796,964)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities-
Depreciation and amortization .......................... 247,795 2,115,241
Amortization of debt discount .......................... -- 255,802
Amortization of deferred compensation .................. 58,107 213,650
Changes in operating assets and liabilities-
Decrease (increase) in assets-
Accounts receivable ........................... (323,627) (184,948)
Other assets .................................. 607 (680,585)
Increase (decrease) in liabilities-
Accounts payable and accrued expenses ......... 551,409 (161,036)
Deferred revenues ............................. 614,175 398,722
Other liabilities ............................. -- (779,553)
------------- -------------
Net cash provided by (used in) operating
activities ....................... 26,677 (8,619,671)
------------- -------------
INVESTING ACTIVITIES:
Purchases of property and equipment .......................... (738,320) (3,717,428)
Purchases of marketable securities, net .................... -- (35,695,013)
------------- -------------
Net cash used in investing activities .. (738,320) (39,412,441)
------------- -------------
FINANCING ACTIVITIES:
Proceeds from long-term debt ................................. 1,000,038 1,027,994
Repayments of long-term debt ................................. (1,403) (1,017,991)
Repayments of capital lease obligations ...................... (15,699) (791,353)
Proceeds from issuance of Common stock, net .................. -- 49,646,878
------------- -------------
Net cash provided by financing
activities ....................... 982,936 48,865,528
------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS ......................... 271,293 833,416
CASH AND CASH EQUIVALENTS, beginning of period .................... 256,782 953,840
------------- -------------
CASH AND CASH EQUIVALENTS, end of period .......................... $ 528,075 $ 1,787,256
============= =============
The accompanying notes are an integral part of these statements.
</TABLE>
5
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FASTNET CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Basis of Presentation
FASTNET Corporation and its subsidiaries (formerly You Tools
Corporation) ("FASTNET" or the "Company"), a Pennsylvania corporation, have been
providing Internet access services to its customers since 1994. The Company is a
growing Internet services provider targeting small and medium sized enterprises
in selected high growth secondary markets in the Northeastern area of the United
States. The Company complements its Internet access services by delivering a
wide range of enhanced products and services that are designed to meet the needs
of its target customer base.
The accompanying unaudited financial information as of June 30, 2000
and for the three and six months ended June 30, 1999 and 2000 has been prepared
in accordance with generally accepted accounting principles for interim
financial information. In the opinion of management, all significant
adjustments, consisting of only normal and recurring adjustments, have been
included in the accompanying unaudited financial statements. Operating results
for the three and six months ended June 30, 2000 are not necessarily indicative
of the results that may be expected for the full year.
The accompanying consolidated financial statements include the accounts
of FASTNET and subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation. The preparation of financial
statements in conformity with generally accepted accounting principles require
management to make 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 amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Interim Financial Information
While the Company believes that the disclosures presented are adequate
to make the information not misleading, these Consolidated Financial Statements
should be read in conjunction with the Consolidated Financial Statements and the
notes included in the Company's latest annual report on Form 10-K.
Reclassifications
Certain reclassifications have been made to the prior year to conform
to the current year presentation.
(2) INITIAL PUBLIC OFFERING
On February 7, 2000, the Company completed its initial public offering
of 4,000,000 shares of Common stock at a price of $12.00 per share. An
additional 600,000 shares of Common stock were issued pursuant to the exercise
of the underwriters' over-allotment option. The Company received net proceeds of
approximately $49.6 million from the offering. Immediately prior to the
consummation of the offering, a $3.1 million Convertible Note issued on May 28,
1998 (the "convertible note"), converted into 2,033,334 shares of Common stock
and 808,629 shares of Series A Convertible Preferred stock converted into an
equal amount of Common stock.
6
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(3) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
FASTNET considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.
Management determines the appropriate classification of its investments
in debt and equity securities at the time of purchase and reevaluates such
determinations at each balance sheet date. As of June 30, 2000, all of the
Company's investments are classified as available for sale and are included in
marketable securities in the accompanying consolidated balance sheets.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and accretion
as well as interest are included in interest income. Realized gains and losses
are included in Other income, net in the Consolidated Statements of Operations.
The cost of securities sold is based on the specific identification method.
The Company's investments in debt and equity securities are diversified
among high-credit quality securities in accordance with the Company's investment
policy.
(4) PROPERTY AND EQUIPMENT:
Property and equipment consist of the following:
December 31, 1999 June 30, 2000
----------------- -------------
Equipment ........................ $ 6,524,216 $ 10,700,934
Computer equipment ............... 1,217,455 1,643,577
Computer software ................ 713,480 3,093,652
Furniture and fixtures ........... 279,667 572,577
Leasehold improvements ........... 228,980 1,710,992
------------- -------------
8,963,798 17,721,732
Less- Accumulated depreciation and
amortization ................. (1,599,950) (2,971,439)
------------- -------------
$ 7,363,848 $ 14,750,293
============= =============
Depreciation and amortization expense for the three months ended June 30, 1999
and 2000 and the six months ended June 30, 1999 and 2000 was $120,000,
$1,113,000, $248,000 and $2,115,000, respectively. The net carrying value of
property and equipment under capital leases was $4,098,000 and $8,368,000 at
December 31, 1999 and June 30, 2000, respectively.
(5) DEBT
On January 19, 2000, the Company sold a $1,000,000 note to an investor
with a warrant to purchase 30,000 shares of Common stock. The note bore interest
at 7% per annum and matured upon the completion of the initial public offering.
The warrant is exercisable at $12 per share and expires on January 18, 2007. The
warrant was valued at $256,000 using the Black Scholes pricing model and
recorded as a debt discount, which was amortized to interest expense upon
repayment of the note, which occurred with the proceeds from the initial public
offering.
7
<PAGE>
Immediately prior to the consummation of the Company's initial public
offering, the $3.1 million Convertible Note converted into 2,033,334 shares of
Common stock. In addition, with a portion of the proceeds from the Company's
initial public offering the Company repaid a $500,000 obligation for financial
advisory services rendered during 1999.
(6) COMMON STOCK OPTIONS
On June 23, 2000, the Company's shareholders approved an amendment to
the Equity Compensation Plan (the "Plan"). The Plan provides for the issuance of
up to 3,000,000 shares of Common stock for incentive stock options ("ISOs"),
nonqualified stock options ("NQSOs") and restricted shares. ISOs are granted
with exercise prices at or above fair value as determined by the Board of
Directors. NQSOs are granted with exercise prices determined by the Board of
Directors. Each option expires on such date as the Board of Directors may
determine, generally ten years from the date of grant.
The Company applies APB Opinion No.25, "Accounting for Stock Issued to
Employees," and the related interpretations in accounting for options issued to
employees under the Plan. Accordingly, compensation expense is recognized for
the intrinsic value (the difference between the exercise price and the fair
value of the Company's Common stock) on the date of grant. Compensation, if any,
is deferred and charged to expense over the respective vesting period.
On February 28, 2000, certain members of the Company's Board of
Directors were granted a total of 220,000 options to purchase Common stock of
which 20,000 options vested immediately and the remaining 200,000 will vest
quarterly over a period of five years. The exercise price of these options is
$9.25 per share and the fair value of the Company's Common stock on the date of
grant was $12.44. As a result of these grants, the Company recorded deferred
compensation of $701,800. In addition to these grants during February 2000, the
Company granted Common stock options to certain employees at an exercise price
of $9.25 when the fair value of the Common stock was $14.69, which resulted in
deferred compensation of $290,993. These options generally vest over a five-year
term.
(7) LEASE ARRANGEMENT
During the first quarter of 2000, the Company received a credit line of
$3.0 million from a vendor to purchase equipment. In April 2000, the same vendor
added a second credit facility of $5.0 million to the original credit facility.
These credit facilities expire on August 28, 2000 and are used to secure
computer-related equipment under three-year capital leases. Management believes
these credit lines will be extended beyond the current expiration date. As of
June 30, 2000, the Company had $6.2 million available under these lease
arrangements.
(8) NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." The bulletin is based upon existing accounting rules and provides
specific guidance on how those accounting rules should be applied. SAB No. 101
is effective for the fourth quarter of fiscal years beginning after December 15,
1999. Management believes its revenue recognition accounting policies are in
compliance with the provisions of SAB No. 101.
8
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(9) NET LOSS PER COMMON SHARE
The Company has presented net loss per share pursuant to SFAS No. 128,
"Earnings per Share." Basic loss per share was computed by dividing net loss by
the weighted average number of shares of Common stock outstanding during the
period. Diluted loss per share is the same as net loss per Common share since
the impact on loss per share is antidilutive due to the Company's losses.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH OUR FINANCIAL STATEMENTS AND THE RELATED NOTES TO THE FINANCIAL STATEMENTS
APPEARING ELSEWHERE IN THIS FORM 10-Q. THE FOLLOWING INCLUDES A NUMBER OF
FORWARD-LOOKING STATEMENTS THAT REFLECT OUR CURRENT VIEWS WITH RESPECT TO FUTURE
EVENTS AND FINANCIAL PERFORMANCE. WE USE WORDS SUCH AS ANTICIPATE, BELIEVES,
EXPECTS, FUTURE, AND INTENDS, AND SIMILAR EXPRESSIONS TO IDENTIFY
FORWARD-LOOKING STATEMENTS. YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE
FORWARD- LOOKING STATEMENTS, WHICH APPLY ONLY AS OF THE DATE OF THIS QUARTERLY
REPORT ON FORM 10-Q. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND
UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR OUR PREDICTIONS.
OVERVIEW
FASTNET Corporation began providing Internet access services to its
customers in 1994. In 1998, we began to implement our current strategy of
providing Internet access and enhanced products and services to small and medium
sized enterprises in selected high growth markets beyond our original markets in
Allentown, Pennsylvania and the areas surrounding Philadelphia, Pennsylvania. As
of the date of this report, we have 20 Customer Network Facility (CNF) sites in
operation and 7 more under construction. Our operational CNF sites currently
provide service to selected secondary markets along the Northeastern United
States.
As of June 30, 2000, we provided Internet access and enhanced services
to approximately 550 enterprise customers, approximately 18,300 Home and Small
Office (HASO) customers, and 6,800 customers using our colocation and web
hosting services.
On July 30, 1999 we acquired Internet Unlimited, Inc., a web hosting
and colocation company located in Bethlehem, Pennsylvania. As a result of this
acquisition, we increased the number of customers using our web hosting services
and supplemented our management and technical expertise.
In August 1999, we sold 666,198 shares of Series A Convertible
Preferred stock to purchasers including Lucent Technologies, Inc at $7.13 per
share. The net proceeds from these sales of Series A Convertible Preferred stock
were approximately $4.5 million. All of the outstanding Preferred stock
automatically converted into Common stock immediately prior to the consummation
of the initial public offering.
On January 19, 2000, the Company sold a $1,000,000 note to an investor
with a warrant to purchase 30,000 shares of Common stock. The note bore interest
at 7% per annum and matured upon the completion of the initial public offering.
The proceeds of this note were used to satisfy working capital requirements.
This note was repaid upon consummation of the initial public offering.
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On February 7, 2000 the Company completed its initial public offering
of 4,000,000 shares of Common stock at a price of $12.00 per share. On March 7,
2000 the Company sold 600,000 shares of Common stock at a price of $12.00 per
share pursuant to the exercise of the underwriter's over-allotment option. The
Company received aggregate net cash proceeds of approximately $49.6 million from
the initial public offering and exercise of the over-allotment option.
OUR HISTORY OF OPERATING LOSSES
We have incurred operating losses in each year since our inception and
expect our losses to continue as we execute our business plan to build CNF sites
in high growth secondary markets. Our operating losses as a percent of revenues
were 8% for the year ended December 31, 1997, 20% for the year ended December
31, 1998, and 63% for the year ended 1999. Our operating losses increased to
194% of revenues in the second quarter of 2000 up from 37% of revenues in the
second quarter of 1999.
RESULTS OF OPERATIONS
REVENUES
We provide services to our customers, which we classify in three
general types; Internet access and enhanced services, home and small office
(HASO) access, and Dialplex virtual private network (VPN) services. We target
our Internet access and enhanced services to small and medium sized enterprises
(SME) located within our markets. FASTNET offers a broad range of dedicated
access solutions including T-1, T-3, Frame Relay, SMDS, and enterprise class
Digital Subscriber Line (DSL) services. Our enhanced services are complementary
to dedicated access and include Total Managed Backup, Total Managed Security,
Unified Messaging, and the sale of third party hardware and software. We also
classify our dedicated and shared web hosting and colocation services as part of
our enhanced services. Our business plan focuses on the core service offering of
Internet access coupled with an increased sales of enhanced products and
services as our customers' Internet needs expand. Access and enhanced revenues
are recognized as services are provided. We expect our access and enhanced
revenues to increase as a percentage of our total revenues as we continue our
expansion into new markets and focus additional resources on marketing and
promoting these services.
Our HASO revenues consist of dial-up Internet access to both
residential and business customers, residential DSL Internet access, and
Integrated Services Digital Network (ISDN) Internet access. Customers using our
HASO services generally sign service contracts for one to two years. We
typically bill these services in advance of providing services. As a result,
revenues are deferred until such time as services are rendered. In the future as
we continue to execute our business plan, we expect HASO revenues to decrease as
a percentage of total revenues.
We also offer our customers Dialplex virtual private network (VPN)
solutions. VPN's allow business customers secure, remote access to their
internal networks through a connection to FASTNET's network. The cost of these
services varies with the scope of the services provided. One customer,
Microsoft's WebTV Networks accounted for over 24% of our total revenues during
the three months ended June 30, 2000.
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COST OF REVENUES
Our cost of revenues primarily consists of our connectivity charges and
telecommunications charges. These are our costs of directly connecting to the
Internet backbone. We also classify engineering payroll and related expenses,
the cost of third party hardware and software we sell to our customers, and
rental expense on network equipment financed under operating leases as cost of
revenues.
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1999
REVENUES. Revenues increased by $1.4 million, or 74% to $3.2 million for the
three months ended June 30, 2000, compared to $1.8 million for the three months
ended June 30, 1999. This increase in revenues is primarily attributable to an
increase in the number of customers using our services. Also contributing to
this increase was the acquisition of Internet Unlimited in July 1999, which
accounted for $344,000 of revenues in the second quarter of 2000. Partially
offsetting our increase in customers was a decline in the average revenue per
customer from our directly connected customers. This decline in average revenue
per customer is in part due to lower revenues generated from directly connected
customers that use DSL connections rather than classic T-1 connections and from
downward pricing pressure in response to competition in our new markets for
classic T-1 and higher connection speeds. In addition to the reduction in
average revenues per customer, a large customer reduced the level of service it
purchased from FASTNET, which partially offset customer number growth during the
second quarter of 2000.
During the second quarter of 2000 and the second quarter of 1999, we derived a
significant portion of our revenues from Microsoft's WebTV Networks. In the
second quarter of 2000 we derived $774,000 or 24% of our revenues as compared to
$346,000 or 19% of our revenues for the second quarter of 1999. We expect that
revenues from Microsoft's WebTV Networks will remain in excess of 20% of our
revenues throughout calendar 2000, but will decline as a percentage of revenues
in the third and fourth quarters of 2000 compared with the first and second
quarters of 2000.
COST OF REVENUES. Cost of revenues increased by $1.7 million, or 131%, to $3.1
million for the second quarter of 2000 compared to $1.3 million for the second
quarter of 1999. Cost of revenues increased to 97% of revenues for the second
quarter of 2000 compared to 73% of revenues for the second quarter of 1999. This
increase is primarily attributable to the increase in Internet access and
telecommunication charges as we grew from two CNF sites in operation at the end
of the second quarter of 1999 to 19 CNF sites in operation at the end of the
second quarter of 2000, as well as headcount costs relating to additional
engineering staff needed to support our planned expansion ahead of generating
revenue. We expect our costs to continue to grow as a percentage of revenue as
we continue to add infrastructure ahead of new customers. Gross margins
decreased from 27% in the second quarter of 1999 to 3% in the second quarter of
2000. This decrease in gross margin was a result of installation of
telecommunication circuits in new markets ahead of revenues in those new markets
and an increase in engineering personnel. Management believes gross margins will
continue to decline until such time as a sufficient number of customers are
added to the new markets to offset the operating costs in those markets.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling and general and administrative
expenses increased by $4.1 million or 391% to $5.1 million for the second
quarter of 2000 compared to $1.0 million for the second quarter 1999. This
increase is primarily attributable to an increase in selling, general and
administrative personnel from 44 in the second quarter of 1999 to 123 in the
second quarter of 2000. Another factor causing this increase was the acquisition
of Internet Unlimited, which added personnel, rent expense and other selling,
general and administrative expenses.
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DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased by
$994,000, or 832% to $1.1 million for the second quarter of 2000 compared to
$120,000 for the second quarter of 1999. This increase was primarily
attributable to the purchase of equipment necessary to support the expansion of
our Network Operations Center, as well as, the increased depreciation for the
equipment located in the 19 CNF sites in operation during the second quarter of
2000 compared to the two CNF sites in operation at the end of the second quarter
of 1999. Also contributing to the increase was $371,000 of amortization expense
for the three months ended June 30, 2000 that related to the intangible assets
recorded in the purchase accounting of Internet Unlimited.
OTHER INCOME/EXPENSE. Interest income increased by $688,000 from $7,000 in the
second quarter of 1999 to $696,000 in the second quarter of 2000. This increase
is attributable to the investment of the proceeds from the initial public
offering. Interest expense increased by $71,000 from $64,000 in the second
quarter of 1999 to $135,000 in the second quarter of 2000, as we financed
equipment needed for our CNF deployment under capital lease arrangements. We
expect interest income to decrease and interest expense to increase as we use
our cash to fund our operating losses and continue to use capital leases to
acquire property and equipment.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1999
REVENUES. Revenues increased by $2.6 million, or 75% to $6.2 million for the six
months ended June 30, 2000, compared to $3.6 million for the six months ended
June 30, 1999. This increase in revenues is primarily attributable to an
increase in the number of customers using our services. Also contributing to
this increase was the acquisition of Internet Unlimited in July, 1999, which
accounted for $869,000 of revenues in the six month period ending June 30, 2000.
During the six months ended June 30, 2000, we derived a significant portion of
our revenues from Microsoft's WebTV Networks. In the first six months of 2000,
we derived $1.5 million or 25% of our revenues as compared to $665,000 or 19% of
our revenues for the first six months of 1999. While revenues and customer
numbers have grown in this six month period over the same six month period in
1999, we are experiencing a decline in average revenue per customer from our
directly connected customers. This decline is in part due to lower revenues
generated from directly connected customers that use DSL connections rather than
classic T-1 connections and from downward pricing pressure in response to
competition in our new markets for classic T-1 and higher connection speeds.
COST OF REVENUES. Cost of revenues increased by $3.1 million or 120% to $5.5
million for the six months ended June 30, 2000 compared to $2.5 million for the
six months ended June 30, 1999. Cost of revenues increased to 89% of revenues
for the six months ended June 30, 2000 compared to 71% of revenues for the six
months ended June 30, 1999. This increase is primarily attributable to the
increase in Internet access and telecommunication charges as we grew from two
CNF sites in operation at the end of June 30, 1999 to 19 CNF sites in operation
at the end of June 30, 2000, as well as headcount costs relating to additional
engineering staff needed to support our planned expansion ahead of generating
revenue. We expect our costs to continue to grow as a percentage of revenue as
we continue to add infrastructure ahead of new customers.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by $7.0 million or 392% to $8.8 million for the six months
ended June 30, 2000 compared to $1.8 million for the six months ended June 30,
1000. This increase is primarily attributable to an increase in selling, general
and administrative personnel from 44 for the first six months of 1999 to 123 for
the six months ended June 30, 2000. Another factor causing this increase was the
acquisition of Internet Unlimited, which added personnel, rent expense and other
selling, general and administrative expenses. In addition, the Company recorded
approximately $705,000 in one-time charges during the six months ended June 30,
2000 related to one-time compensation charges and imputed interest associated
with warrants attached to the January 2000 bridge financing.
12
<PAGE>
OTHER INCOME/EXPENSE. Interest income increased by $1.0 million from $11,000 for
the six months ended June 30, 1999 compared to $1,015,000 for six months ended
June 30, 2000. This increase is attributable to the investment of the proceeds
from the initial public offering. Interest expense increased by $402,000 from
$122,000 in the second quarter of 1999 to $523,000 in the second quarter of
2000. We expect interest income to decrease and interest expense to increase as
we use our cash to finance our operating losses and continue to use capital
leases to acquire infrastructure.
13
<PAGE>
<TABLE>
CASH FLOWS ANALYSIS
<CAPTION>
Six Months
Ended June 30,
1999 2000
---- ----
<S> <C> <C>
OTHER FINANCIAL DATA:
Cash flows provided by (used in) operating activities $ 27,000 $ (8,620,000)
Cash flows used in investing activities ............. (738,000) (39,412,000)
Cash flows provided by financing activities ......... 983,000 48,866,000
Net increase in cash and cash equivalents ........... 271,000 833,000
</TABLE>
Cash flows from operating activities decreased by $8.6 million from
cash provided of $27,000 in the six months ended June 30, 1999 to use of $8.6
million in the six months ended June 30, 2000. This decrease is primarily the
result of our net loss of $9.8 million. The increase in net loss is primarily a
result of an increase in personnel from 52 at June 30, 1999 to 158 at June 30,
2000 along with an increase in telecommunication charges and an increase in
general and administrative expenses to support the planned expansion of the
Company. We expect to continue to incur losses until the regional CNF sites
produce sufficient revenues to cover their operating costs and the corporate
overhead expenses.
Cash used in investing activities increased from $738,000 in the six
months ended June 30, 1999 to $39.4 million in the six months ended June 30,
2000, a change of $38.7 million. This increase in cash outflows is primarily
attributable to the Company's investments in marketable securities and an
increase in purchases of property and equipment.
Cash flows from financing activities increased by $47.9 million from
cash inflows of $983,000 during the six months ended June 30, 1999 to $48.9
million during the six months ended June 30, 2000. The increase in cash flows
from financing activities is a result of the proceeds from the Company's initial
public offering and exercise of the underwriters' overallotment partially offset
by the repayments of capital lease obligations and long-term debt.
LIQUIDITY AND CAPITAL RESOURCES
Our business plan has required, and is expected to continue to require,
substantial capital to fund operations, capital expenditures, expansion of sales
and marketing capabilities, and acquisitions.
Prior to our initial public offering, we satisfied our cash
requirements primarily through debt and equity financings.
In May 1998, we issued 1,000,000 shares of our Common stock, a
convertible promissory note of $3.1 million and a warrant to purchase 1,000,000
shares of our Common stock at an exercise price of $1.50 per share to H&Q You
Tools Investment Holding, L.P. for an aggregate of approximately $3.3 million in
cash. In connection with this financing, we granted H&Q You Tools Investment
Holding, L.P. a security interest in substantially all of our assets. H&Q You
Tools Investment Holding, L.P. converted this note into 2,033,334 shares of
Common stock and released its security interest immediately prior to our initial
public offering. We used a portion of the proceeds from this May, 1998 financing
to repurchase outstanding shares of our common stock representing 50% of our
then outstanding shares of Common stock for $1.0 million.
14
<PAGE>
In May 1999, we issued a $1.0 million convertible note to H&Q You Tools
Investment Holding, L.P. for $1.0 million in cash. The principal amount of this
note and accrued interest was converted into 142,431 shares of Series A
Convertible Preferred stock at $7.13 per share in August 1999. In July 1999, we
used a portion of the proceeds from this financing to acquire Internet
Unlimited, Inc. a provider of web hosting and colocation services, for $400,000
in cash and 546,984 shares of Common stock.
In August 1999, we sold 666,198 shares of Series A Convertible
Preferred stock to purchasers including Lucent Technologies, Inc. at $7.13 per
share. The net proceeds from these sales of Series A Convertible Preferred stock
were approximately $4.5 million. All of the outstanding Preferred stock
automatically converted into Common stock immediately prior to the consummation
of the initial public offering.
In June 1999, we entered into an agreement with Ascend Credit
Corporation for a $20 million equipment lease facility. Under this arrangement,
we lease equipment necessary for the construction of our customer network
facilities. Currently, we have approximately $13.1 million available under this
facility.
In January 2000, we entered into an agreement under which we issued a
$1.0 million note to H&Q You Tools Investment Holding, L.P. The note bore
interest at a rate equal to 7% per annum and was fully repaid on March 2, 2000
with proceeds from the initial public offering.
As of June 30, 2000, our cash and cash equivalents and marketable
securities were $37.5 million. We believe that our existing cash and cash
equivalents, marketable securities, and available financing under existing
equipment lease facilities will be sufficient to meet our working capital and
capital expenditure requirements for at least the next 12 months. However, we
may be required to seek additional sources of financing, in order to fund the
planned expansion of the Company. If additional funds are raised through the
issuance of equity securities, our existing shareholders may experience
significant dilution. Furthermore, additional financing may not be available
when needed or, if available, such financing may not be on terms favorable to
our shareholders or us. If such sources of financing are insufficient or
unavailable, or if we experience shortfalls in anticipated revenue or increases
in anticipated expenses, we may need to slow down or stop the expansion of our
regional deployment, including our customer network facility sites and reduce
our marketing and development efforts. Any of these events could harm our
business, financial condition or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk related to changes in interest rates. We
invest excess cash balances in cash equivalents and marketable securities. We
believe that the effect, if any, of reasonably possible near-term changes in the
interest rates on our financial position, results of operations, and cash flows
will not be material.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not involved currently in any legal proceedings that either
individually or taken as a whole, will have a material adverse effect on our
business, financial condition and results of operations.
15
<PAGE>
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) In the preceding three years, we have issued the following
securities that were not registered under the Securities Act:
Since our inception, we have issued to employees and H&Q You Tools
Investment Holding, L.P. an aggregate of 7,000,000 shares of Common stock and to
employees and directors options to purchase 978,650 shares issued pursuant to
our Equity Compensation Plan. All of such sales were made under the exemption
from registration provided under Section 4(2) of the Securities Act.
On May 28, 1998, we sold 1,000,000 shares of Common stock for $0.20 per
share and a warrant to purchase 1,000,000 shares of our Common stock at a per
share exercise price of $1.50. This warrant is exercisable at any time on or
before May 30, 2005 to H&Q You Tools Investment Holding L.P. This sale was made
under the exemption from registration provided under Section 4(2) of the
Securities Act.
Pursuant to our Equity Compensation Plan, we have granted, as of June
30, 2000, options to purchase a total of 978,650 share of Common stock, of which
448,000 are exercisable at a price of $1.50 per share, 113,400 are exercisable
at a price of $2.50 per share, 115,500 are exercisable at prices between $4.09
and $6.25 per share, 20,000 are exercisable at a price of $7.13 per share,
273,250 are exercisable at a price of $9.25 per share, and 8,500 are exercisable
at prices between $9.88 and $13.58 per share. As of June 30, 2000, a total of
2,000 options have been exercised. In granting the options and selling the
underlying securities upon exercise of the options, we relied upon exemptions
from registration set forth in Rule 701 and Section 4(2) of the Securities Act.
On July 30, 1999, we issued 546,984 shares of our Common stock to the
shareholders of Internet Unlimited, Inc. in connection with our acquisition of
Internet Unlimited, Inc. These sales were made under the exemption from
registration provided under Section 4(2) of the Securities Act.
In August 1999, we sold 808,629 shares of Series A Convertible
Preferred stock to H&Q You Tools Investment Holding L.P., Naveen Jain, Everest
Venture Partners I, L.P., Entrepreneurial Investment Corporation, and J.F. SHEA
CO. INC., as nominee, Lucent Technologies, Inc, InterNetworking Systems, at a
price of $7.13 per share. All of these sales were made under the exemption from
registration provided under Section 4(2) of the Securities Act. All of these
shares of preferred stock were converted into 808,629 shares of our Common stock
immediately prior to the consummation of our IPO.
In January 2000, the Company issued 30,000 warrants to an investor
pursuant to the note and warrant purchase agreement. This warrant was
immediately exercisable at a price of $12.00 per share. This sale was made under
the exemption from registration provided under Section 4(2) of the Securities
Act.
No underwriters were involved in the foregoing sales of securities.
These sales were made in reliance upon an exemption from the registration
provisions of the Securities Act set forth in Section 4(2) thereof relative to
sales by an issuer not involving any public offering or the rules and
regulations thereunder, or in the case of options to purchase Common stock
granted prior to February 7, 2000 and in the case of Common stock purchased
pursuant to the Equity Compensation Plan, Rule 701 of the Securities Act. All of
the foregoing securities are deemed restricted securities for purposes of the
Securities Act.
16
<PAGE>
(d) Use of Proceeds of the Initial Public Offering
Our initial public offering, or IPO, was effected through a
Registration Statement on Form S-1 (File No. 333-85465) that was declared
effective by the SEC on February 7, 2000 and pursuant to which we sold an
aggregate of 4,000,000 shares of our Common stock at $12.00 per share. On March
7, 2000, the managing underwriters of our IPO, ING Barings LLC, SoundView
Technology Group, Inc., FAC/Equities, a division of First Albany Corporation and
DLJdirect, Inc., exercised the over-allotment option selling an additional
600,000 shares of our Common stock. The proceeds received net of underwriting
discounts and commissions, and other transaction costs were approximately
$49,644,000.
From the effective date of the Registration Statement through the
quarter ended June 30, 2000, we incurred the following expenses in connection
with the initial public offering:
Underwriting discounts and commissions .............. $ 3,864,000
Other Expenses ..................................... 1,692,000
Total Expenses ...................................... 5,556,000
--------------
Net offering proceeds .............................. $ 49,644,000
==============
None of the expenses incurred by us in connection with the initial
public offering were paid, directly or indirectly, to directors, officers,
persons owning ten percent or more of our equity securities or our affiliates.
From the effective date of the Registration Statement through June 30,
2000, we utilized the proceeds from the initial public offering and
underwriters' over-allotment as follows:
Repayment of notes payable .......................... $ 1,004,000
Payment of other obligations ........................ 544,000
Capital Expenditures ................................ 3,219,000
Working Capital Requirements ........................ 1,800,000
-------------
Total ............................................... $ 6,567,000
=============
Unused proceeds of the initial public offering are currently invested
in debt and equity securities diversified among high-credit quality securities
in accordance with our investment policy.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
We held our Annual Meeting of Stockholders June 23, 2000. Following are
descriptions of the matters voted on and the results of such meeting:
<TABLE>
<CAPTION>
Votes Votes Votes Votes Broker
For Against Abstained Withheld Non-Votes
--- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
1. Election of Directors:
David K. Van Allen 12,792,571 -- -- 18,014 --
Sonny C. Hunt 12,792,171 -- -- 18,414 --
Douglas L. Michels 12,792,036 -- -- 18,549 --
David J. Farber 12,792,666 -- -- 17,919 --
R. Barry Borden 12,792,867 -- -- 17,718 --
Alan S. Kessman 12,793,137 -- -- 17,448 --
2. Amendment of our Equity
Compensation Plan to
increase the number of
authorized shares of Common
stock reserved for issuance
from 1,000,000 to 3,000,000 11,202,105 99,715 6,000 --
3. Proposal to ratify the appoint-
ment of Arthur Andersen LLP
as independent auditors of the
Company for the year ending
December 31, 2000 12,795,721 9,489 5,375 --
</TABLE>
ITEM 5. OTHER INFORMATION
FACTORS AFFECTING FUTURE OPERATING RESULTS
This quarterly report on Form-10-Q contains forward-looking statements
concerning our future products, expenses, revenue, liquidity and cash needs as
well as our plans and strategies. These forward-looking statements are based on
current expectations and we assume no obligation to update this information.
Numerous factors could cause actual results to differ significantly from the
results described in these forward-looking statements, including the following
risk factors.
18
<PAGE>
WE ONLY RECENTLY BEGAN TO IMPLEMENT OUR CURRENT BUSINESS STRATEGY. AS A RESULT,
YOU MAY NOT BE ABLE TO EVALUATE OUR BUSINESS PROSPECTS BASED ON OUR HISTORICAL
RESULTS.
In 1998, we began to implement our current business strategy of
targeting small and medium sized enterprises in high growth secondary markets
not only within the mid-Atlantic area of the United States, but also outside of
this area. Prior to 1998, we conducted business solely in the mid-Atlantic area,
particularly in Eastern Pennsylvania. Consequently, the evaluation of our future
business prospects is difficult because our historical results for periods
during which we were implementing our current business strategy are limited.
WE HAVE A HISTORY OF LOSSES AND EXPECT FUTURE LOSSES.
We have incurred net losses since our inception. For the years ended
December 31, 1996, 1997, 1998 and 1999, we had losses of $115,000, $322,000,
$1.3 million and $5.6 million, respectively. On a pro forma basis, assuming that
the acquisition of Internet Unlimited, Inc. was consummated on January 1, 1998,
we would have incurred net losses of approximately $2.6 million, or 42% of
revenues, for the year ended December 31, 1998 and approximately $6.5 million,
or 71% of revenues, for year ended December 31, 1999. Under our current business
strategy, we expect to continue to operate at a loss for the foreseeable future.
In order to achieve profitability, we must develop and market products
and services that gain broad commercial acceptance by small and medium sized
enterprises and residential customers in our target regions. We cannot give any
assurances that our products and services will ever achieve broad commercial
acceptance among our customers. Although our revenues have increased each year
since we began operations, we cannot give any assurances that this growth in
annual revenues will continue or lead to our profitability in the future.
Therefore, we cannot predict whether we will obtain or sustain positive
operating cash flow or generate net income in the future.
IT IS UNLIKELY THAT INVESTORS WILL RECEIVE A RETURN ON OUR COMMON STOCK THROUGH
THE PAYMENT OF CASH DIVIDENDS.
We have never declared or paid cash dividends on our Common stock and
have no intention of doing so in the foreseeable future. We have had a history
of losses and expect to operate at a net loss for the next several years. These
net losses will reduce our stockholders' equity. For the six months ended June
30, 2000, we had a net loss of $9.8 million. We cannot predict what the value of
our assets or the amount of our liabilities will be in the future.
OUR OPERATING RESULTS FLUCTUATE DUE TO A VARIETY OF FACTORS AND ARE NOT A
MEANINGFUL INDICATOR OF FUTURE PERFORMANCE.
Our operating results have fluctuated in the past and may fluctuate
significantly in the future, depending upon a variety of factors, including:
the timing of costs relating to the construction of our
customer network facilities;
the timing of the introduction of new products and services;
changes in pricing policies and product offerings by us or our
competitors; and
fluctuations in demand for Internet access and enhanced
products and services.
Therefore, we believe that period-to-period comparisons of our
operating results are not necessarily meaningful and cannot be relied upon as
indicators of future performance. If our operating results in any future period
fall below the expectations of analysts and investors, the market price of our
common stock would likely decline.
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<PAGE>
THE MARKET PRICE AND TRADING VOLUME OF OUR COMMON STOCK ARE VOLATILE.
The market price of our Common stock has fluctuated significantly in
the past, and is likely to continue to be highly volatile. In addition, the
trading volume in our Common stock has fluctuated, and significant price
variations can occur as a result. We cannot assure you that the market price of
our Common stock will not fluctuate or continue to decline significantly in the
future. In addition, the U.S. equity markets have from time to time experienced
significant price and volume fluctuations that have particularly affected the
market prices for the stocks of technology and telecommunications companies.
These broad market fluctuations may materially adversely affect the market price
of our Common stock in future. Such variations may be the result of changes in
our business, operations or prospects, announcements of technological
innovations and new products by competitors, new contractual relationships with
strategic partners by us or our competitors, proposed acquisitions by us or our
competitors, financial results that fail to meet public market analyst
expectations, regulatory considerations and domestic and international market
and economic conditions.
FUTURE SALES OF OUR COMMON STOCK COULD REDUCE THE PRICE OF OUR STOCK AND OUR
ABILITY TO RAISE CASH IN FUTURE EQUITY OFFERINGS.
No prediction can be made as to the effect, if any, that future sales
of shares of Common stock or the availability for future sale of shares of
Common stock or securities convertible into or exercisable for our Common stock
will have on the market price of our Common stock. Sale, or the availability for
sale, of substantial amounts of Common stock by existing stockholders under Rule
144, through the exercise of registration rights or the issuance of shares of
Common stock upon the exercise of stock options or warrants, or the perception
that such sales or issuances could occur, could adversely affect prevailing
market prices for our Common stock and could materially impair our future
ability to raise capital through an offering of equity securities.
OUR EXPANSION EFFORTS MAY NOT BE SUCCESSFUL IN OUR NEW TARGET REGIONS BECAUSE
OUR BUSINESS GROWTH STRATEGY IS LARGELY UNTESTED.
Our growth strategy includes building Customer Network Facility sites
in high growth secondary markets where we do not currently operate. In each
market, we will target primarily small and medium sized enterprise customers.
Since our growth strategy is largely untested, we cannot give any assurances
that we will be able to successfully implement it in our target regions.
Our success will depend upon:
our ability to identify attractive target regions outside of
the mid-Atlantic area;
our ability to rapidly deploy additional customer network
facility sites; and
our ability to replicate our sales and marketing efforts.
Our ability to successfully implement our business strategy, and the
expected benefits to be obtained from our strategy, may be adversely affected by
a number of factors, such as unforeseen costs and expenses, technological
change, economic downturns, competitive factors or other events beyond our
control.
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<PAGE>
FOR THE SIX MONTHS ENDED JUNE 30, 2000, OUR LARGEST CUSTOMER ACCOUNTED FOR 25%
OF OUR TOTAL REVENUES. THE LOSS OF THIS CUSTOMER COULD HARM OUR RESULTS OF
OPERATIONS.
Although our primary business is to target small and medium sized
enterprises, we have derived a significant portion of our revenues from a small
number of our business customers that are not small and medium sized
enterprises. For example, Lucent Technologies, Inc. accounted for 7% of total
revenues for the year ended December 31, 1999 and 11% of total revenues for the
fiscal year ended December 31, 1998. Microsoft's WebTV Networks, Inc. accounted
for 25% of total revenues for the six months ended June 30, 2000, 21% of total
revenues for the year ended December 31, 1999 and 9% of total revenues for the
fiscal year ended December 31, 1998. If we are unable to implement our strategy
of targeting small and medium sized enterprises, we will continue to be
substantially dependent upon revenues from our larger customers. We expect
revenues from these customers to vary from year to year. Our agreement with
Microsoft's WebTV Networks may be terminated upon 120 days notice. The loss of
any of our significant customers or a significant decrease in revenues from
these customers could harm our results of operations.
IN THE FUTURE, WE MAY BE UNABLE TO EXPAND OUR SALES, TECHNICAL SUPPORT AND
CUSTOMER SUPPORT INFRASTRUCTURE, WHICH MAY HINDER OUR ABILITY TO GROW AND MEET
CUSTOMER DEMANDS.
We rely upon our centralized sales force and regional marketing
managers to sell our products and services in our new regions. We serve our
existing customers through our sales, technical support and customer support
staff. If, in the future, we are unable to expand our sales force and our
technical support and customer support staff, our business would be harmed
because this would limit our ability to obtain new customers, sell products and
services and provide existing customers with a high level of technical support.
IF WE ARE UNABLE TO RAPIDLY EXPAND INTO OUR TARGET REGIONS, WE MAY NEED TO
MODIFY OUR GROWTH AND OPERATING PLANS.
Our business strategy depends on our ability to rapidly expand into new
regions, which requires significant capital resources. As a result, we may need
significant additional funds to execute our growth strategy. If our existing
cash is not sufficient to meet our cash requirements, our need to fund our
ongoing operations could limit our ability to execute our business strategy.
Therefore, we will need to seek additional capital from public or private equity
or debt sources to fund our growth and operating strategies. We cannot be
certain that we will be able to raise additional capital in the future on terms
acceptable to us or at all. If alternative sources of financing are insufficient
or unavailable, we may be required to modify our growth and operating plans in
accordance with the extent of available financing.
In the past, we have been able to provide limited services to customers
90 days after the date construction begins for a new Customer Network Facility.
There are many factors, however, which may affect our ability to expand rapidly
into target regions, including availability of equipment and telecommunications
services. Therefore, there can be no assurances that we will be able to expand
into our target regions in our anticipated time frame. If we are unable to
rapidly expand into our target regions, our business and results of operations
will be harmed.
21
<PAGE>
WE FACE SIGNIFICANT AND INCREASING COMPETITION IN OUR INDUSTRY, WHICH COULD
CAUSE US TO LOWER PRICES RESULTING IN REDUCED REVENUES.
The growth of the Internet access and related services market and the
absence of substantial barriers to entry have attracted many start-ups as well
as existing businesses from the telecommunications, cable, and technology
industries. As a result, the market for Internet access and related services is
very competitive. We anticipate that competition will continue to intensify as
the use of the Internet grows. Current and prospective competitors include:
national Internet service providers and regional and local
Internet service providers, including providers of free
dial-up Internet access;
national and regional long distance and local
telecommunications carriers;
cable operators and their affiliates;
providers of web hosting, colocation and other Internet-based
business services;
computer hardware and other technology companies that bundle
Internet connections with their products; and
terrestrial wireless and satellite Internet service providers.
We believe that the number of competitors we face is significant and is
constantly changing. As a result, it is extremely difficult for us to accurately
identify and quantify our competitors. In addition, because of the constantly
evolving competitive environment, it is extremely difficult for us to determine
our relative competitive position at any given time.
As a result of an increase in the number of competitors, and vertical
and horizontal integration in the industry, we currently face and expect to
continue to face significant pricing pressure and other competition in the
future. Advances in technology and changes in the marketplace and the regulatory
environment will continue, and we cannot predict the effect that ongoing or
future developments may have on us or the pricing of our products and services.
We believe that the following are the primary competitive factors in
our market:
pricing;
quality and breadth of products and services;
ease of use;
personal customer support and service; and
brand awareness.
Many of our competitors have significantly greater market presence,
brand-name recognition, and financial resources than we do. In addition, all of
the major long distance telephone companies, also known as interexchange
carriers, offer Internet access services. The recent reforms in the federal
regulation of the telecommunications industry have created greater opportunities
for local exchange carriers, including incumbent local exchange carriers and
competitive local exchange carriers, to enter the Internet access market. In
order to address the Internet access requirements of the current business
customers of long distance and local carriers, many carriers are integrating
22
<PAGE>
horizontally through acquisitions of or joint ventures with Internet service
providers, or by wholesale purchase of Internet access from Internet service
providers. In addition, many of the major cable companies and other alternative
service providers, such as those companies utilizing wireless and satellite-
based service technologies, have announced their plans to offer Internet access
and related services. While few of these larger companies have focused on our
key customer base of small and medium sized enterprises in our target markets,
it is possible that they will do so in the future. Accordingly, we may
experience increased competition from traditional and emerging
telecommunications providers. Many of these companies, in addition to their
substantially greater network coverage, market presence, and financial,
technical and personnel resources, also already provide telecommunications and
other services to many of our target customers. Furthermore, they may have the
ability to bundle Internet access with basic local and long distance
telecommunications services, which we do not currently offer. This bundling of
services may harm our ability to compete effectively with them and may result in
pricing pressure on us that would reduce our earnings.
OUR GROWTH DEPENDS ON THE CONTINUED ACCEPTANCE BY SMALL AND MEDIUM SIZED
ENTERPRISES OF THE INTERNET FOR COMMERCE AND COMMUNICATION.
If the use of the Internet by small and medium sized enterprises for
commerce and communication does not continue to grow, our business and results
of operations will be harmed. Our products and services are designed primarily
for the rapidly growing number of business users of the Internet. Commercial use
of the Internet by small and medium sized enterprises is still in its early
stages. Despite growing interest in the commercial uses of the Internet, many
businesses have not purchased Internet access and related services for several
reasons, including:
lack of inexpensive, high-speed connection options;
a limited number of reliable local access points for business
users;
lack of affordable electronic commerce solutions;
limited internal resources and technical expertise;
inconsistent quality of service; and
difficulty in integrating hardware and software related to
Internet based business applications.
In addition, we believe that many Internet users lack confidence in the
security of transmitting their data over the Internet, which has hindered
commercial use of the Internet. Technologies that adequately address these
security concerns may not be developed.
The adoption of the Internet for commerce and communication
applications, particularly by those enterprises that have historically relied
upon alternative means, generally requires the understanding and acceptance of a
new way of conducting business and exchanging information. In particular,
enterprises that have already invested substantial resources in other means of
conducting commerce and exchanging information may be reluctant or slow to adopt
a new strategy that may make their existing personnel and infrastructure
obsolete.
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<PAGE>
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT OF INTERNET INFRASTRUCTURE.
The recent growth in the use of the Internet has caused periods of
performance degradation, requiring the upgrade by providers and other
organizations with links to the Internet of routers and switches,
telecommunications links and other components forming the infrastructure of the
Internet. We believe that capacity constraints caused by rapid growth in the use
of the Internet may impede further development of the Internet to the extent
that users experience increased delays in transmission or reception of data or
transmission errors that may corrupt data. Any degradation in the performance of
the Internet as a whole could impair the quality of our products and services.
As a consequence, our future success will be dependent upon the reliability and
continued expansion of the Internet.
WE RELY ON A LIMITED NUMBER OF VENDORS AND SERVICE PROVIDERS, SOME OF WHICH ARE
OUR COMPETITORS. THIS MAY ADVERSELY AFFECT THE FUTURE TERMS OF OUR
RELATIONSHIPS.
We rely on other companies to supply key components of our network
infrastructure, which are available only from limited sources. For example, we
currently rely on routers, switches and remote access devices from Lucent
Technologies, Inc., Cisco Systems, Inc. and Nortel Networks Corporation. We
could be adversely affected if any of these products were no longer available on
commercially reasonable terms, or at all. From time to time, we experience
delays in the delivery and installation of these products and services, which
can lead to the loss of existing or potential customers. We do not know that we
will be able to obtain such products in the future cost-effectively and in a
timely manner. Moreover, we depend upon MCI WorldCom, Inc. and AT&T as our
primary backbone providers. These companies also sell products and services that
compete with ours. Our agreements with our primary backbone providers are fixed
price contracts with terms ranging from one to three years. Our backbone
providers operate national or international networks that provide data and
Internet connectivity and enable our customers to transmit and receive data over
the Internet. Our relationship with these backbone providers could be adversely
affected as a result of our direct competition with them. Failure to renew these
relationships when they expire or enter into new relationships for such services
on commercially reasonable terms or at all could harm our business, financial
condition and results of operations.
WE DEPEND ON OUR EXECUTIVE OFFICERS TO EXECUTE OUR BUSINESS STRATEGY AND COULD
BE HARMED BY THE LOSS OF THEIR SERVICES.
Our success depends in part upon the continued service and performance
of:
David K. Van Allen, Chief Executive Officer;
Sonny C. Hunt, President;
Stanley F. Bielicki, Chief Financial Officer;
Phillip L. Weller, Chief Technology Officer;
Rafe Scheinblum, Executive Vice President Operations;
Mark A. Horinko, Vice President Engineering; and
Thomas J. Roberts, Vice President Sales.
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We currently do not have employment agreements with any of our named
executive officers. The loss of the services of one or more of our executive
officers could impair our ability to expand our operations and provide a high
level of service to our customers.
WE NEED TO RECRUIT AND RETAIN QUALIFIED PERSONNEL OR OUR BUSINESS COULD BE
HARMED.
Competition for highly qualified employees in the Internet service
industry is intense because there are a limited number of people with an
adequate knowledge of and significant experience in our industry. Our success
depends largely upon our ability to attract, train and retain highly skilled
management, technical, marketing and sales personnel and upon the continued
contributions of such people. Since it is difficult and time consuming to
identify and hire highly qualified employees, we cannot assure you of our
ability to do so. Our failure to attract additional highly qualified personnel
could impair our ability to grow our operations and services to our customers.
WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH COULD RESULT
IN THE LOSS OF OUR CUSTOMERS OR LIABILITY TO OUR CUSTOMERS.
The continued operation of our network infrastructure depends upon our
ability to protect against:
downtime due to malfunction or failure of hardware or
software;
overload conditions;
power loss or telecommunications failures;
human error;
natural disasters; and
sabotage or other intentional acts of vandalism.
Any of these occurrences could result in interruptions in the services
we provide to our customers and require us to spend substantial amounts of money
repairing and replacing equipment. In addition, we have finite capacity to
provide service to our customers under our current infrastructure. Because
utilization of our network is constantly changing depending upon customer use at
any given time, we maintain a level of capacity that we believe to be adequate
to support our current customer base. If we obtain additional customers in the
future, we will need to increase our capacity to maintain the quality of service
that we currently provide our customers. If customer usage exceeds our capacity
and we are unable to increase our capacity in a timely manner, our customers may
experience interruptions in or decreases in quality of the services we provide.
As a result, we may lose current customers or incur significant liability to our
customers for any damages they suffer due to any system downtime as well as the
possible loss of customers.
OUR NETWORK MAY EXPERIENCE SECURITY BREACHES, WHICH COULD DISRUPT OUR SERVICES.
Our network infrastructure may be vulnerable to computer viruses,
break-ins and similar disruptive problems caused by our customers or other
Internet users. Computer viruses, break-ins or other problems caused by third
parties could lead to interruptions, delays or cessation in service to our
customers. There currently is no existing technology that provides absolute
security, and the cost of minimizing these security breaches could be
prohibitively expensive. We may face liability to customers for such security
breaches. Furthermore, such incidents could deter potential customers and
adversely affect existing customer relationships.
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WE FACE POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR NETWORK.
It is possible that claims could be made against Internet service
providers in connection with the nature and content of the materials
disseminated through their networks. The law relating to the liability of
Internet service providers due to information carried or disseminated through
their networks is not completely settled. While the U.S. Supreme Court has held
that content transmitted over the Internet is entitled to the highest level of
protection under the U.S. Constitution, there are federal and state laws
regarding the distribution of obscene, indecent, or otherwise illegal material,
as well as material that violates intellectual property rights which may subject
us to liability. Several private lawsuits have been brought in the past and are
currently pending against other entities which seek to impose liability upon
Internet service providers as a result of the nature and content of materials
disseminated over the Internet. If any of these actions succeed, we might be
required to respond by investing substantial resources or discontinuing some of
our service or product offerings, which could harm our business.
NEW LAWS AND REGULATIONS GOVERNING OUR INDUSTRY COULD HARM OUR BUSINESS.
We are subject to a variety of risks that could materially affect our
business due to the rapidly changing legal and regulatory landscape governing
Internet access providers. For example, the Federal Communications Commission
currently exempts Internet access providers from having to pay per-minute access
charges that long-distance telecommunications providers pay local telephone
companies for the use of the local telephone network. In addition, Internet
access providers are currently exempt from having to pay a percentage of their
gross revenues as a contribution to the federal universal service fund. Should
the Federal Communications Commission eliminate these exemptions and impose such
charges on Internet access providers, this would increase our costs of providing
dial-up Internet access service and could have a material adverse effect on our
business, financial condition and results of operations.
We face risks due to possible changes in the way our suppliers are
regulated which could have an adverse effect on our business. For example, most
states require local exchange carriers to pay reciprocal compensation to
competing local exchange carriers for the transport and termination of Internet
traffic. However, in February 1999, the Federal Communications Commission
concluded that at least a substantial portion of dial-up Internet traffic is
jurisdictionally interstate, which could ultimately eliminate the reciprocal
compensation payment requirement for Internet traffic. Should this occur our
telephone carriers might no longer be entitled to receive payment from the
originating carrier to terminate traffic delivered to us. The Federal
Communications Commission has launched an inquiry to determine a mechanism for
covering the costs of terminating calls to Internet service providers, but in
the interim state commissions will determine whether carriers will receive
compensation for such calls. If the new compensation mechanism that may be
adopted by the Federal Communications Commission increases the costs to our
telephone carriers for terminating traffic to us, or if states eliminate
reciprocal compensation payments, our telephone carriers may increase the price
of service to us in order to recover such costs. This could have a material
adverse effect on our business, financial condition and results of operations.
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We face risks due to possible changes in the way our competitors are
regulated which could have an adverse effect on our business. For example, the
Federal Communications Commission is considering measures that could stimulate
the development of high-speed telecommunications facilities and make it easier
for operators of these facilities to obtain access to customers. Such favorable
regulatory measures could enhance the viability of our competitors in the
Internet access marketplace. In addition, changes in the regulatory environment
may provide competing Internet service providers the right of access to the
cable systems of local franchised cable operators. The adoption of open access
to cable systems by Internet service providers could harm our business.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See attached exhibit index.
(b) Reports on Form 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FASTNET Corporation:
Date: August 14, 2000 /s/ David K. Van Allen
----------------------
David K. Van Allen
Chief Executive Officer
Date: August 14, 2000 /s/ Stanley F. Bielicki
-----------------------
Stanley F. Bielicki
Chief Financial Officer
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
27.1 Financial Data Schedule (for SEC use only)
29
