<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal quarter ended June 30, 2000
OR
{_} TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number:
000-29515
NET2000 COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 51-0384995
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2180 FOX MILL ROAD 20171
HERNDON, VA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (800) 825-2000
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.
(1) Yes {X} (2) No { }
The number of shares outstanding of the Registrant's common stock as of July 31,
2000, was 38,331,494.
==============================================================================
i
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<TABLE>
<CAPTION>
INDEX
Page
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
<S> <C> <C>
Consolidated Balance Sheets at June 30, 2000 (Unaudited) and December
31, 1999 1
Unaudited Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2000 and 1999 2
Unaudited Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2000 and 1999 3
Notes to the Unaudited Consolidated Financial Statements 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 21
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 21
ITEM 2. Changes in Securities and Use of Proceeds 22
ITEM 3. Defaults upon Senior Securities 22
ITEM 4. Submission of Matters to a Vote of Security Holders 22
ITEM 5. Other Information 22
ITEM 6. Exhibits and Reports on Form 8-K. 22
Signatures 23
</TABLE>
ii
<PAGE> 3
PART I. -- FINANCIAL INFORMATION
NET2000 COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
--------------------- ------------------------
(Unaudited)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents............................................... $ 72,141 $ 5,523
Investments available for sale.......................................... 57,085 --
Restricted cash......................................................... 3,667 3,517
Accounts receivable, net of allowance for doubtful
accounts of approximately $3,128 and $1,919 at
June 30, 2000 and December 31, 1999, respectively..................... 11,791 7,595
Other current assets.................................................... 1,128 1,528
--------------------- ------------------------
Total current assets...................................................... 145,812 18,163
Property and equipment, net of accumulated
depreciation............................................................ 127,344 72,592
Other noncurrent assets................................................... 8,500 3,598
Unamortized debt discount................................................. 2,186 7,315
--------------------- ------------------------
Total assets.............................................................. $ 283,842 $ 101,668
===================== ========================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................................ $ 5,988 $ 792
Accrued expenses and other current liabilities.......................... 26,180 21,635
--------------------- ------------------------
Total current liabilities................................................. 32,168 22,427
Related party noncurrent liabilities...................................... 15,495 26,428
Other noncurrent liabilities.............................................. 98 215
Long-term debt............................................................ 55,252 46,039
Redeemable convertible Series A, B and C preferred stock,
$0.01 par value; 11,738,437 shares authorized, no shares
and 11,738,437 issued and outstanding at June 30, 2000
and December 31, 1999 respectively...................................... -- 80,940
Stockholders' equity (deficit):
Common stock, $0.01 par value; 200,000,000 shares
Authorized, 37,854,951, and 10,189,562 shares issued
and outstanding June 30, 2000 and December 31, 1999,
respectively.......................................................... 379 102
Additional capital........................................................ 317,248 16,707
Deferred stock compensation............................................... (8,005) (7,002)
Accumulated deficit....................................................... (128,793) (84,188)
--------------------- ------------------------
Total stockholders' equity (deficit)............................. 180,829 (74,381)
--------------------- ------------------------
Total liabilities and stockholders' equity (deficit)............. $ 283,842 $ 101,668
===================== ========================
</TABLE>
See accompanying notes that are an integral part of these condensed consolidated
Financial Statements.
1
<PAGE> 4
NET2000 COMMUNICATIONS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDING JUNE 30, ENDING JUNE 30,
------------------------------------ -------------------------------
2000 1999 2000 1999
--------------- ----------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Revenues...................................................... $ 13,176 $ 6,031 $ 23,789 $ 11,088
Operating costs and expenses:
Operating costs............................................. 10,222 4,997 18,741 9,390
Selling, general and administrative (exclusive of non-cash
compensation expense shown below)........................ 18,077 9,013 34,324 15,662
Non-cash compensation expense............................... 970 20 1,630 40
Depreciation and amortization............................... 3,328 648 5,768 1,095
--------------- ----------------- ----------------- ----------------
Loss from operations.......................................... (19,421) (8,647) (36,674) (15,099)
Other income (expenses):
Interest income............................................. 2,855 272 3,940 659
Interest expense............................................ (1,309) (175) (3,392) (283)
Miscellaneous (expenses) income............................. (6) 5 4 8
--------------- ----------------- ----------------- ----------------
Loss before provision for income taxes........................ (17,881) (8,545) (36,122) (14,715)
Provision for income taxes.................................... -- -- -- --
--------------- ----------------- ----------------- ----------------
Loss before extraordinary item................................ (17,881) (8,545) (36,122) (14,715)
Extraordinary debt extinguishment loss........................ -- -- (4,724) --
--------------- ----------------- ----------------- ----------------
Net loss...................................................... (17,881) (8,545) (40,846) (14,715)
Preferred stock accretion..................................... -- (5,258) (3,759) (10,652)
--------------- ----------------- ----------------- ----------------
Net loss available to common stockholders..................... $ (17,881) $ (13,803) $ (44,605) $ (25,367)
=============== ================= ================= ================
Pro forma net loss available to common stockholders........... $ (8,545) $ (40,846) $ (14,715)
=============== ================= ================= ================
Basic and diluted loss per shares:
Available to common stockholders before extraordinary item.. $ (.47) $ (1.37) $ (1.43) $ (2.51)
Extraordinary loss.......................................... -- -- (.17) --
--------------- ----------------- ----------------- ----------------
Available to common stockholders............................ $ (.47) $ (1.37) $ (1.60) $ (2.51)
=============== ================= ================= ================
Pro forma basic and diluted loss per share:
Available to common stockholders before extraordinary item.. $ (.34) $ (1.09) $ (.59)
Extraordinary loss.......................................... -- -- (.14) --
--------------- ----------------- ----------------- ----------------
Available to common stockholders............................ $ (.34) $ (1.23) $ (.59)
=============== ================= ================= ================
Shares used in calculation of loss per share:
Basic and diluted............................................. 37,785,732 10,109,490 27,845,216 10,109,490
Pro forma basic and diluted................................... 24,782,535 33,166,210 24,782,535
</TABLE>
See accompanying notes that are an integral part of these condensed consolidated
Financial Statements.
2
<PAGE> 5
NET2000 COMMUNICATIONS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
JUNE 30,
--------
2000 1999
------------- -------------
OPERATING ACTIVITIES
<S> <C> <C>
Net loss....................................................................................... $ (40,846) $ (14,715)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................................................................ 5,768 1,095
Allowance for doubtful accounts.............................................................. 1,209 270
Deferred stock compensation.................................................................. 1,630 40
Amortization of debt discount................................................................ 405 --
Extraordinary debt extinguishment loss....................................................... 4,724 --
Changes in operating assets and liabilities:
Accounts receivable....................................................................... (5,405) (3,895)
Other current assets...................................................................... (4) (641)
Other noncurrent assets................................................................... (4,497) (112)
Accounts payable.......................................................................... 5,196 55
Accrued expenses and other current liabilities............................................ 4,495 4,703
Other noncurrent liabilities.............................................................. (117) (5,111)
------------- -------------
Net cash used in operating activities.......................................................... (27,442) (18,311)
INVESTING ACTIVITIES
Acquisition of property and equipment.......................................................... (68,190) (11,632)
Purchase of investments available for sale..................................................... (68,151) --
Sale of investments available for sale......................................................... 11,066 --
Increase in restricted cash.................................................................... (150) 3
------------- -------------
Net cash used in investing activities.......................................................... (125,425) (11,629)
FINANCING ACTIVITIES
Proceeds from note payable..................................................................... 99,427 --
Repayments on note payable..................................................................... (90,838) --
Proceeds from issuance of common stock......................................................... 212,261 --
Proceeds from notes payable to related party................................................... -- 15,181
Proceeds from exercise of stock options........................................................ 1,225 --
Repayment of capital leases.................................................................... (2,590) (1,317)
------------- -------------
Net cash provided by financing activities...................................................... 219,485 13,864
Net increase (decrease) in cash................................................................ 66,618 (16,076)
Cash at the beginning of period................................................................ 5,523 34,388
------------- -------------
Cash at the end of period...................................................................... $ 72,141 $ 18,312
============= =============
</TABLE>
See accompanying notes that are an integral part of these condensed consolidated
Financial Statements.
3
<PAGE> 6
NET2000 COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND JUNE 30, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Net2000 Communications, Inc. (the "Company") is a rapidly-growing,
innovative provider of state-of-the- art broadband telecommunications services.
As a competitive local exchange carrier ("CLEC"), the Company offers businesses
located throughout the United States, responsive solutions as an alternative to
traditional telephone companies. The Company focuses on high-end customers,
primarily large- and medium-sized businesses, and offers an integrated package
of high-speed data, internet access, local telephone, long distance services,
and video over a single, high capacity broadband connection.
The Company intends to offer services in major markets throughout the
United States in three phases over the next 15 months. Our completed Phase I
deployment consists of 13 switches that transfer data and long distance traffic
and 5 switches that transfer voice traffic in 10 markets in the
telecommunications-rich Boston to Washington, D.C. corridor. Our partially
completed Phase II deployment will establish our national presence with 10
additional data switches and 2 additional voice switches in 10 new markets and
is scheduled to be completed in December 2000. Our Phase III deployment,
scheduled to be completed by late 2002, entails adding 4 additional markets and
upgrading all of our existing data switches to Internet protocol-based (IP)
switches that can provide both data and voice services.
The accompanying consolidated financial statements as of June 30, 2000,
and for the three and the six months ended June 30, 2000 and June 30, 1999, are
unaudited and, in the opinion of management, include all adjustments (consisting
of normal recurring adjustments and accruals) necessary to present fairly the
results for the periods presented in accordance with generally accepted
accounting principles. Our results of operations for any interim period are not
necessarily indicative of the results of operations for any other interim period
or for a full fiscal year. These financial statements should be read in
conjunction with our audited financial statements for the year ended December
31, 1999, included in the Company's final prospectus, dated March 6, 2000, filed
with the Securities and Exchange Commission in connection with the Company's
initial public offering.
2. INVESTMENTS AVAILABLE FOR SALE
The Company classifies its investments as available-for-sale. Investments
in securities that are classified as available-for-sale and have readily
determinable fair values are measured at fair market value in the balance
sheets. Any unrealized gains or losses, net of taxes, are reported as a separate
component of stockholders' equity, if deemed material. Realized gains and losses
and declines in market value judged to be other than temporary are included in
investment income. Interest and dividends are included in interest income. As of
December 31, 1999 and June 30, 2000, there are no material unrealized gains or
losses on investments.
4
<PAGE> 7
NET2000 COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
3. NET LOSS PER COMMON SHARE
Basic and diluted net loss per common share is calculated by dividing the
net loss by the weighted average number of common shares outstanding. Pro forma
net loss per share is computed using the weighted average number of shares used
for basic and diluted per share amounts and the weighted average redeemable
convertible preferred stock outstanding as if such shares were converted to
common stock at the time of issuance.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDING JUNE 30, ENDING JUNE 30,
----------------------------- -------------------------------
2000 1999 2000 1999
------------- --------------
<S> <C> <C> <C> <C>
Loss before extraordinary item................................ $ (17,881) $ (8,545) $ (36,122) $ (14,715)
Preferred stock accretion..................................... -- (5,258) (3,759) (10,652)
------------- ------------- ------------- --------------
Loss available to common stockholders before
extraordinary item.......................................... -- (13,803) (39,881) (25,367)
Extraordinary item............................................ -- -- (4,724) --
------------- ------------- ------------- --------------
Net Loss available to common stockholders..................... $ (17,881) $ (13,803) $ (44,605) $ (25,367)
============= ============= ============= ==============
Weighted average of common shares, denominator
for basic loss per share.................................... 37,785,732 10,109,490 27,845,216 10,109,490
Effect of dilutive securities:
Stock options............................................... -- -- -- --
Warrants.................................................... -- -- -- --
Convertible stock........................................... -- -- -- --
------------- ------------- ------------- --------------
Denominator for diluted loss per share........................ 37,785,732 10,109,490 27,845,216 10,109,490
Pro forma adjustment for redeemable preferred
stock....................................................... -- 14,673,045 5,320,994 14,673,045
------------- ------------- ------------- --------------
Pro forma denominator for basic and diluted loss
per share................................................... 24,782,535 33,166,210 24,782,535
============= ============= ============= ==============
Loss per share
Basic and diluted before extraordinary item................. $ (.47) $ (1.37) $ (1.43) $ (2.51)
Extraordinary loss.......................................... -- -- (.17) --
------------- ------------- ------------- --------------
Basic and diluted........................................... $ (.47) $ (1.37) $ (1.60) $ (2.51)
============= ============= ============= ==============
Pro forma basic and diluted before extraordinary item $ (.34) $ (1.09) $ (.59)
Extraordinary loss.......................................... -- -- (.14) --
------------- ------------- ------------- --------------
Pro forma basic and diluted................................. $ (.34) $ (1.23) $ (.59)
============= ============= ============= ==============
</TABLE>
Due to their antidilutive effects, outstanding shares of preferred stock, stock
options and warrants to purchase shares of common stock were excluded from the
computation of diluted earnings per share for all periods presented.
5
<PAGE> 8
NET2000 COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
4. PROPERTY AND EQUIPMENT
Property and equipment, including leasehold improvements, are recorded at
cost. Depreciation is calculated using the straight-line method over the
estimated useful life ranging between three and eight years. Leasehold
improvements are amortized over the lesser of the related lease term or the
useful life. Interest capitalized and included in the cost of switch equipment
was $1,027 and $790 for the six months ended June 30, 2000 and the year ended
December 31, 1999, respectively.
Construction in process includes equipment and other costs of switches
which are not complete as of the balance sheet dates. When construction of a
switch is complete, the balance of the assets are transferred to switch
equipment and depreciated in accordance with the Company's policy.
Property and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
2000 DECEMBER 31, 1999
------------------------ ------------------------
(Unaudited)
<S> <C> <C>
Software.................................................... $ 15,606 $ 11,978
Computer equipment.......................................... 12,630 9,005
Office furniture and equipment.............................. 7,130 4,951
Leasehold improvements...................................... 22,997 7,973
Vehicles.................................................... 295 295
Switch equipment............................................ 53,452 21,958
Construction in process..................................... 25,644 21,130
------------------------ ------------------------
137,754 77,290
Less accumulated depreciation and amortization.......... (10,410) (4,698)
------------------------ ------------------------
$ 127,344 $ 72,592
======================== ========================
</TABLE>
5. DEBT
LONG TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JUNE 30,
2000 DECEMBER 31, 1999
------------------------ -------------------------
<S> <C> <C>
Delayed draw term loan facility, face amount $100,000, due
December 30, 2007, effective interest rate of approximately
12.75% .................................................. $ 50,000 $ 41,390
Note payable to bank........................................ 97 118
Capital lease obligations................................... 9,227 8,554
------------------------ -------------------------
Total.................................................... 59,324 50,062
Less current maturities..................................... (4,072) (4,023)
------------------------ -------------------------
Total long-term debt........................................ $ 55,252 $ 46,039
======================== ========================
</TABLE>
Included in accrued expenses and other current liabilities at June 30,
2000 and December 31, 1999, is $4,072 and $4,023, respectively, currently
payable under capital lease obligations and notes payable to bank.
6
<PAGE> 9
NET2000 COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
SECURED CREDIT FACILITIES
On June 28, 2000, the Company completed a $200,000 Senior Secured Credit
Facility ("Facility") transaction with TD Securities (USA), Inc., lead arranger
and syndicate manager for the Company. The new $200,000 Facility consists of a
$100,000 revolving credit facility and a $100,000 delayed draw term loan
facility, and replaces the existing $75,000 Senior Term Loan Facility. The new
Facility will be used to refinance indebtedness under the existing bank credit
facilities and will fund capital expenditures and working capital for general
corporate purposes, including permitted investments and acquisitions. The
Facility is secured by a first priority perfected security interest in all
existing and future assets and all equity interests of the Company. Interest on
both the revolving credit facility and the delayed draw term loan facility will
accrue at ranges (Prime plus 2% to 3.25% for Prime Rate loans or Eurodollar rate
plus 3% to 4.25% for Eurodollar loans) depending on certain debt to annualized
EBITDA ratios as defined in the terms of the Facility agreement. Repayment of
accrued interest on a Prime Rate loan is on each quarterly due date. Repayment
on accrued interest on a Eurodollar loan is on the last day of the interest
period, and in the case of interest period greater than three months, at three
months intervals after the first day of such interest period. The revolving
credit facility will be available on a revolving basis over a 7.5 year period
from the closing date (Revolver Maturity date). Availability of the revolving
credit facility will be permanently reduced beginning December 31, 2003, in
quarterly installments over the remaining four year term as defined in the
Facility agreement. On the Revolver Maturity date, the revolver commitments will
reduce to zero and all principal amounts outstanding will be due and payable.
The delayed draw term loan facility matures 7.5 years from the closing date
(Term Loan Maturity date) and provides for one $50,000 draw at closing and
availability of the remaining $50,000 through a six month period from closing.
Repayment of term loans outstanding begins December 31, 2003 in quarterly
installments over the remaining four year term as defined in the Facility
agreement.
Upon closing of the transaction, $50,000 of the new term loan facility
was drawn and $49,601 of principal, accrued interest, and commitment fees
outstanding on the existing $75,000 Senior Term Loan Facility was repaid. In
addition, underwriting and agency fees of $3,976 for the new Facility were paid.
The Company paid interest related to the notes payable and capital leases
of $1,309 and $175, for the three months ended June 30, 2000 and 1999,
respectively, and $3,392 and $283 for the six months ended June 30, 2000 and
1999, respectively.
6. RELATED PARTY NON-CURRENT LIABILITIES
At June 30, 2000 and December 31, 1999, the Company had outstanding
purchases totaling $15,495 and $26,428, respectively, of Nortel goods and
services which have been classified as a non-current liability as these
purchases are subsequently financed under the Senior Secured Credit Facility.
7. EQUITY
EQUITY TRANSACTIONS
During the three and six months ended June 30, 2000, the Company's
employees exercised options to purchase 174,449 and 1,492,344 shares of common
stock under its 1997 and 1999 stock option plans, respectively, for aggregate
proceeds of $226 and $1,212 for the three and six months ended June 30, 2000,
respectively.
During the three and six months ended June 30, 2000, amortization expense
for stock based compensation of $970 and $1,630, respectively, relates to
employees whose salaries are included in selling, general and administrative
expense.
7
<PAGE> 10
NET2000 COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ACCRETION TO REDEMPTION VALUE OF SERIES A, SERIES B AND SERIES C
PREFERRED STOCK
The Company has accreted its preferred stock to its redemption value
based on the fair market value of the Company using the effective interest
method. The Company recorded accretion totaling $0 and $3,759 for the three and
six months ended June 30, 2000 and $5,258 and $10,652 for the three and six
months ended June 30, 1999, respectively. On March 10, 2000, all outstanding
shares of preferred stock were converted into common stock at the closing of the
Company's initial public offering.
8. COMMITMENTS
OPERATING LEASES
The Company currently leases office space and equipment under
non-cancelable operating lease agreements, with expirations through 2015. Rent
expense for the three and six months ended June 30, 2000 and 1999 was $2,063 and
$3,674 and $462 and $855, respectively.
The future minimum lease payments under non-cancelable operating leases
at June 30, 2000 are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
<S> <C> <C>
2000.................................. $ 4,163
2001.................................. 8,597
2002.................................. 8,237
2003.................................. 8,136
2004.................................. 7,803
Thereafter............................ 46,834
-----------------------
Total $ 83,770
=======================
</TABLE>
9. SUBSEQUENT EVENTS
On July 10, 2000, the Company acquired FreBon International Corporation,
a privately-held provider of interactive video services. The purchase price at
closing consisted of 400,000 shares of common stock valued at $4,800 and cash
payments totaling $9,050. In addition, the Company assumed debt totaling $2,800.
Earnout provisions could provide for additional cash or stock consideration up
to $15,000 based on the achievement of certain revenue targets over the next
year as defined in the purchase agreement. The transaction will be accounted for
as a purchase with the majority of the purchase price being allocated to
acquired intangibles.
8
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a rapidly-growing, innovative provider of state-of-the-art
broadband telecommunications services. We offer businesses located throughout
the United States, responsive solutions as an alternative to traditional
telephone companies. We focus on high-end customers, primarily large- and
medium-sized businesses, having a minimum of 50 business access lines and
spending $50,000 annually for Internet access, data and voice telecommunications
services. Today, we offer an integrated package of high-speed data, Internet
access, local telephone, long distance services, and video primarily delivered
from our own network over a single, high capacity "broadband" connection and
conveniently billed on a single invoice.
We began operations in 1993 as a sales agent selling Bell Atlantic local
telephone services to businesses. Under this program, we received a one-time
commission for selling complex and high-capacity telecommunications services.
From 1994 through 1997, we were the largest producing Bell Atlantic sales agent
based on annual sales revenue.
We initially used the resale of telecommunications services as a market
entry strategy while we began the build-out of our network. In January 1998, we
began offering long distance and non-local data services on a resale basis. In
June 1998, we left the Bell Atlantic sales agent program and began offering
Net2000-branded local telecommunications services on a resale basis directly to
large- and medium-sized businesses. We subsequently ceased acquiring new resale
customers in markets where we deployed our own network. In March 1999, we
deployed our first switch and began offering facilities-based telecommunications
services. In March 1999, we also ceased reselling Bell Atlantic local services
in all markets except New York City and Long Island, where we ceased reselling
in November 1999. We no longer use local resale as a primary customer
acquisition strategy, we do not intend to do so in the future and plan to
migrate as many of our existing resale customers as possible to our network. In
limited circumstances, we use resale to satisfy customer needs for data and long
distance services outside our network area.
We have rapidly deployed our network since commencing services. As of
June 30, 2000, we have deployed a total of twenty switches in our network,
including five voice switches and 15 data switches throughout the United States
under Phase I and II of our network deployment schedule. Upon anticipated
completion of Phase II in December 2000, we are scheduled to have deployed a
total of seven voice and 23 data switches in major markets throughout the United
States, thereby completing our national data backbone network. Our Phase III
deployment, scheduled to be completed by late 2002, entails entering 4
additional markets and upgrading all of our existing data switches to Internet
protocol-based (IP) switches that can provide both data and voice services.
During the second quarter of 2000, we entered six new on- net markets including
Boston, Atlanta, Dallas, Chicago, Tampa, and Orlando.
REGULATORY
GOVERNMENTAL REGULATIONS
Our telecommunications services are subject to regulation by federal,
state and local government agencies. Generally, Internet and certain data
services are not directly regulated, although the underlying telecommunications
services may be regulated in certain instances. We hold various federal, state
and local regulatory authorizations for our regulated service offerings. The FCC
has jurisdiction over our facilities and services to the extent those facilities
are used in the provision of interstate or international telecommunications
services. State regulatory commissions also have jurisdiction over our
facilities and services to the extent they are used in intrastate
telecommunications services. Our network may also be subject to certain local
regulations such as licensing, building codes and generally applicable public
safety and welfare requirements. Many of the regulations issued by these
regulatory bodies may change and are the subject of various judicial
proceedings, legislative hearings and administrative proposals. We cannot
predict what impact, if any, these proceedings or changes will have on our
business or results of operations.
9
<PAGE> 12
FEDERAL REGULATION
The FCC regulates us as a non-dominant common carrier. Non-dominant
carriers are subject to lesser regulation than dominant carriers but remain
subject to the general requirements that they offer just and reasonable rates
and terms of service and do not unreasonably discriminate in the provision of
services. We have obtained authority from the FCC to provide domestic,
interstate long distance services and international services between the United
States and foreign countries and have filed the required tariffs.
THE TELECOMMUNICATIONS ACT
In February 1996, the Telecommunications Act of 1996 ("Telecommunications
Act") was passed by the United States Congress and signed into law by President
Clinton. This comprehensive telecommunications legislation was designed to
increase competition in the long distance and local telecommunications
industries. The Telecommunications Act imposes a variety of duties on the ILECs
to facilitate competition in the provision of local telecommunications and
access services. Like all local telecommunications carriers, where we provide
local telephone services, we are required to provide network interconnection,
reciprocal compensation, resale, number portability, and access to
rights-of-way. ILECs, such as the Regional Bell Operating Companies ("RBOCs"),
are subject to requirements in addition to these, including the duty to:
undertake additional obligations applicable to the interconnection of their
networks; permit collocation of competitors' equipment at their central offices;
provide access to individual network elements, including network facilities,
features and capabilities, on non-discriminatory and cost-based terms; and offer
their retail services for resale at wholesale rates.
The Telecommunications Act also eliminates certain pre-existing
prohibitions on the provision of traditional long distance services by the RBOCs
on a phased-in basis. RBOCs currently are permitted to provide long distance
service outside those states in which they provide local telecommunications
service. RBOCs will be permitted to provide traditional long distance service
within the regions in which they also provide local telecommunications service
upon demonstrating to the FCC that they have complied with a statutory checklist
of requirements intended to open local telephone markets to competition. To
date, only Verizon and SBC Communications ("SBC") have been granted approval to
provide long distance services in their local telephone service regions and that
is restricted to long distance calls originating in New York for Verizon and
Texas for SBC. Verizon and other RBOCs have initiated similar proceedings to
obtain such long distance service authority in other states. Entry of Verizon,
SBC, and other RBOCs into the long distance business could result in substantial
competition to our services and may have a material adverse effect on us.
When the FCC permits the RBOCs to provide traditional long distance
service in their local telephone service regions, they will be able to offer
integrated local and long distance services and may enjoy a significant
competitive advantage. However, the Telecommunications Act imposes restrictions
on the RBOCs after they are permitted to enter the long distance services market
in their local service regions, and the FCC imposed conditions on its approval
of the Verizon and SBC applications for authority to provide long distance
services in New York and Texas, respectively, that are intended to prevent
anti-competitive behavior. The FCC has imposed similar conditions on its
approval of various mergers involving RBOCs, and we expect the FCC to continue
such oversight of RBOCs seeking to enter the long distance market in their
operating regions.
The FCC is charged with establishing national rules implementing certain
portions of the Telecommunications Act. In August 1996, the FCC released an
order adopting an extensive set of regulations governing network
interconnection, network unbundling and resale of ILEC services, under the
Telecommunications Act. In July 1997, the United States Court of Appeals for the
Eighth Circuit issued a decision vacating substantial portions of these rules,
principally on the ground that the FCC had improperly intruded into matters
reserved for state jurisdiction. In January 1999, the United States Supreme
Court reversed many aspects of the Eighth Circuit's decision, concluding that
the FCC has jurisdiction to implement the local competition provisions of the
Telecommunications Act. In so doing, the Supreme Court found that the FCC has
authority to establish pricing guidelines applicable to the provision of
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unbundled network elements and the resale of ILEC services, to prevent ILECs
from disaggregating existing combinations of network elements, and to establish
rules enabling competitors to select all or portions of any existing ILEC
interconnection agreements for use in their own interconnection agreements with
traditional telephone companies. The Supreme Court, however, did not evaluate
the specific pricing methodology adopted by the FCC and remanded the case to the
Eighth Circuit for further consideration. The Eighth Circuit subsequently upheld
the FCC's forward-looking cost methodology as the basis for establishing its
pricing standard, but overturned the FCC's pricing standard that was based on
the use of the most efficient technology available in the industry and, instead,
determined that prices should be based on actual costs. We cannot predict what
impact this decision will have on our business and we are unable to predict the
outcome of the FCC's reconsideration or an appeal of this decision. While the
Supreme Court resolved many issues, including the FCC's jurisdictional
authority, other issues remain subject to further consideration by the courts
and the FCC.
Although most of the FCC's interconnection rules were upheld by the
Supreme Court, the Court found that the FCC had not adequately considered
certain statutory criteria for requiring ILECs to make unbundled network
elements available to competitive telecommunications providers. The FCC then
conducted new proceedings to reexamine which unbundled network elements ILECs
must provide. On November 5, 1999, the FCC released an order in which it
required that ILECs make available most, but not all, of the network elements
specified in its initial order, as well as certain new network elements not
included on the original list. The FCC also clarified the obligation of ILECs to
provide certain combinations of network elements. Various parties have sought
reconsideration and appeal of the FCC's order. We are unable to predict the
outcome of such reconsideration and appellate proceedings.
In March 1999, the FCC adopted a further order strengthening the rights
of CLECs to obtain physical collocation for purposes of interconnecting with
ILEC networks. The order also requires ILECs to permit CLECs to collocate
equipment used for interconnection and/or access to unbundled network elements
even if such equipment includes certain switching or enhanced services
functions. Additionally, the FCC adopted rules designed to limit ILECs' ability
to deny CLECs the ability to deploy transmission hardware in collocation space
by purporting that the equipment will cause electrical interference with other
wires, and it proposed rules making these requirements more specific. In the
recent proceeding addressing unbundled network elements, however, the FCC
declined to require ILECs to provide CLECs with unbundled access to data
switching services, except in limited circumstances. The FCC's decisions on
these matters are currently subject or expected to be subject to judicial
review. On March 17, 2000, the United States Court of Appeals for the District
of Columbia Circuit reversed significant portions of the FCC's collocation order
and rules, and remanded the issue to the FCC for further proceedings. Among
other things, the appeals court decision seemingly overturns the FCC's decision
to require ILECs to permit competitors to collocate certain equipment that has
enhanced services functionality. We cannot be certain of the ultimate outcome or
impact of these proceedings.
ACCESS REGULATION
The FCC regulates the interstate access rates charged by ILECs for the
origination and termination of interstate long distance traffic. Over the past
few years, the FCC has implemented changes in interstate access rules that
result in the restructuring of the access charge system and changes in access
charge rate levels. On remand from an appeals court, the FCC is conducting
further proceedings to explain and refine its recent reforms affecting access
charge rate levels.
The FCC has also raised the issue of whether it should begin to regulate
the access charges imposed by CLECs. Currently, CLECs are free to charge access
rates at any level they deem appropriate, subject to overarching statutory
requirements that such rates must be just, reasonable and non-discriminatory. A
decision by the FCC to regulate CLECs access charges could result in the
reduction of those charges for all CLECs and thereby reduce our access charge
revenues.
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Over the past few years, the FCC has granted ILECs significant
flexibility in pricing their interstate special and switched access services. We
anticipate that this pricing flexibility will result in ILECs lowering their
prices in high traffic density areas, the probable areas of competition with us.
We also anticipate that the FCC will grant ILECs increasing pricing flexibility
as the number of potential competitors increases in each of these markets. In
August 1999, the FCC released an order that granted substantial additional
pricing flexibility to ILECs for certain interstate services. Among other
things, the FCC granted immediate pricing flexibility to many ILECs and also
established a framework for granting greater flexibility in the pricing of all
interstate access services once they satisfy certain prescribed competitive
criteria. The FCC also invited public comment on proposals for additional ILEC
pricing flexibility.
In addition, in various contexts, certain ILECs have asked the FCC to
rule that certain calls made over the Internet are subject to regulation as
telecommunications services including the assessment of interstate switched
access charges and universal service fund assessments. Although the FCC has
suggested that Internet-based telephone-to-telephone calls may be considered
telecommunications services, it has not reached a final decision on that issue.
UNIVERSAL SERVICE
In 1997, the FCC established a significantly expanded universal service
regime to subsidize the cost of telecommunications services to high cost areas,
and to low-income customers and qualifying schools, libraries and rural health
care providers. Providers of telecommunications services, like us, as well as
certain other entities, must pay for these programs. Our share of the payments
into these subsidy funds will be based on our share of certain defined
telecommunications end-user revenues. Various states are also in the process of
implementing their own universal service programs. We are currently unable to
quantify the amount of subsidy payments we will be required to make in the
future or the effect that these required payments will have on our financial
condition. Moreover, the FCC's universal service rules remain subject to change,
which could increase our costs.
DETARIFFING
In November 1996, the FCC issued an order that required non-dominant,
long distance carriers, like us, to cease filing tariffs for domestic, long
distance services. Tariffing is a traditional requirement of telephone companies
whereby such companies publish for public inspection at state and federal
regulatory agencies all terms, conditions, pricing, and available services
governing the sale of all such services to the public. The FCC's order
established a nine-month transition period to allow carriers sufficient time to
adjust for detariffing. The U.S. Court of Appeals for the District of Columbia
Circuit subsequently stayed the detariffing order, pending its decision on
challenges to the FCC's order by several long distance companies. In June 1997,
the FCC issued another order stating that non-dominant local services providers
may withdraw their tariffs for interstate access services provided to long
distance carriers. In March 1999, the FCC adopted further rules that, while
still maintaining mandatory detariffing, required long distance carriers to make
specific public disclosures on the services providers' Internet websites of
their rates, terms and conditions for domestic interstate services. The
effective date of these rules was also delayed until the appeals court rendered
a decision on the appeal of the FCC's detariffing order. In April 2000, the
appeals court affirmed the FCC's mandatory detariffing order in its entirety.
Consequently, the FCC implemented a nine-month transition period ending January
31, 2000 to allow carriers to withdraw federal tariffs and move to contractual
relationships with their customers. Long distance carriers will be required to
comply with the new public information requirements imposed by the FCC in lieu
of tariff filings. In the absence of tariffs, non-dominant, interstate services
providers will no longer be able to rely on the filing of tariffs with the FCC
as a means of providing notice to customers of prices, terms and conditions
under which they offer their domestic, interstate services, and will have to
rely more heavily on individually negotiated agreements with end-users.
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RECIPROCAL COMPENSATION
The Telecommunications Act of 1996 requires both CLECs and ILECs to
establish reciprocal compensation arrangements for the transport and termination
of telecommunications traffic. When two different carriers collaborate to
complete a call, these reciprocal compensation arrangements ensure compensation
both for the originating carrier, which receives payment from the customer, and
for the terminating carrier, which gets paid by the originating carrier.
In late 1998 and early 1999, the FCC determined that both dedicated
access and dial-up calls from a customer to an Internet service provider are
primarily interstate in nature and, therefore, subject to the FCC's
jurisdiction. The FCC initiated a proceeding to determine what effect this
regulatory classification will have on the obligation of a service provider to
pay reciprocal compensation for dial-up calls to Internet service providers and
other customers that originate on one local service provider's network and
terminate on another local service provider's network. The FCC also permitted
existing reciprocal compensation arrangements between service providers, as set
forth in interconnection agreements and approved by state regulatory
commissions, to remain intact. The FCC currently is determining whether a new
compensation mechanism should be implemented. A decision which invalidates
current reciprocal compensation arrangements could result in the reduction, or
elimination, of revenue we receive from reciprocal compensation payments for
traffic terminated over our network to Internet service providers and other
customers. On March 24, 2000, the United States Court of Appeals for the
District of Columbia Circuit vacated the FCC's determination that dial-up calls
to Internet service providers are not "local" calls for purposes of charging
reciprocal compensation, and remanded the matter to the FCC for further
consideration.
STATE REGULATION
The Telecommunications Act preempts state and local statutes and
regulations that would tend to prohibit the provision of competitive
telecommunications services. As a result, we will be free to provide the full
range of local, long distance and data services in all states in which we
currently operate, and in any states into which we may wish to expand. While
this action greatly increases our potential for growth, it also increases the
amount of competition to which we may be subject.
Because we provide intrastate common carrier services, we are subject to
various state laws and regulations. Most state public utility and public service
commissions require some form of certification or registration before commencing
service. In most states, we are also required to file tariffs or price lists
setting forth the terms, conditions and prices for services that are classified
as intrastate. We are required to update or amend these tariffs when we adjust
our rates or add new products and are subject to various reporting and
record-keeping requirements in these states. Many states also require prior
approval for transfers of control of certified providers, corporate
reorganizations, acquisitions of telecommunications operations, assignment of
carrier assets, carrier stock offerings and incurrence of significant debt
obligations. States generally retain the right to sanction a service provider or
to revoke certification if a service provider violates applicable laws or
regulations.
We are authorized to provide intrastate long distance services in every
state except Alaska and are in the process of obtaining intrastate long distance
authority in that state. We have authority to provide competitive local
telecommunications services in Connecticut, Delaware, the District of Columbia,
Georgia, Illinois, Maryland, Massachusetts, New Hampshire, New Jersey, New York,
North Carolina, Pennsylvania, Rhode Island, Texas, Virginia and West Virginia.
We have applied to obtain authority to provide competitive local
telecommunications services in California, Florida, and Maine.
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LOCAL INTERCONNECTION
The Telecommunications Act imposes a duty upon all ILECs to negotiate in
good faith with potential competitive telecommunications providers to provide
interconnection to their networks, exchange local traffic, make unbundled
network elements available and permit resale of most local telephone services.
If negotiations do not succeed, we have a right to seek arbitration with the
state regulatory authority of any unresolved issues. Arbitration decisions
involving interconnection arrangements in several states have been challenged
and appealed to federal courts. We have entered into interconnection agreements
with Verizon in Delaware, the District of Columbia, Maryland, Massachusetts, New
Jersey, New York, Pennsylvania, Rhode Island, Virginia and West Virginia, and
with BellSouth in Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi,
North Carolina, South Carolina, and Tennessee. We have begun to negotiate
similar agreements in the other states where we are authorized to provide
competitive local telecommunications services.
GENERAL - RESULTS OF OPERATIONS
We have been successful in selling services to business customers, with
approximately 109,500 lines sold since beginning our Net2000-branded sales
efforts in June 1998. The table below provides additional selected key
operational data as of:
<TABLE>
<CAPTION>
AS OF JUNE 30, AS OF MARCH 31, AS OF JUNE 30,
2000 2000 1999
------ ---- ----
<S> <C> <C> <C>
On-Net Markets Served....................... 15 9 1
Number of Switches Deployed................. 20 9 7
Addressable Market (Business Lines)......... 14,257,500 9,309,700 1,527,800
Total Lines Sold............................ 109,500 92,600 46,400
Total Lines Installed....................... 85,700 71,800 32,400
Sales Force Employees....................... 225 176 93
Total Employees............................. 613 530 261
Average Access Line Count Per Customer...... 67 72 61
</TABLE>
We are building our network by initially deploying lower-cost data
switches and leasing fiber optic lines from others. As we experience increases
in customer traffic in a given market, we will consider deploying voice switches
and owning a portion of the fiber optic lines. By deploying this "smart-build"
network strategy, we believe it offers a number of competitive advantages over
the traditional build-out strategy by enabling us to:
- improve operating margins;
- broaden service offerings and enhance customer control by
providing more efficient service;
- reduce network capital requirements;
- improve speed to market and mitigate the risk associated with
investing capital in long term assets, thereby preserving capital
for other uses such as sales and marketing; and
- reduce operating expenses.
Although we believe our smart-build strategy will improve our results of
operations over the long-term, this strategy is expected to have a negative
effect on our financial condition and results of operations over the short-term.
We expect significant losses and negative cash flow for at least the next
several years, which we expect will be primarily attributable to the deployment
of our national network and expected expansion of our operations.
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REVENUE
We generate most of our revenue from the sale of local, long distance,
Internet access and other data services to large- and medium-sized businesses.
We are currently offering our full suite of services on our network in markets
where we have deployed our voice and data network. In markets where we have
deployed data switches, we offer data and long distance services on our network
and in markets where we have not deployed either a data or voice switch, we
offer data and long distance services on a resale basis to meet the needs of our
large customers.
Our revenue consists of monthly recurring charges, usage charges and
initial, non-recurring charges. Monthly recurring charges include the fees paid
by our customers for lines in service, additional features on those lines and
collocation space. Usage charges consist of fees paid for each call made
generally measured by the minute but also measured by the call. Non-recurring
revenue is typically derived from fees charged to install new customer lines.
In addition to revenue generated from end-user and carrier customers, we
also generate revenue from access fees charged to long distance companies for
the local origination and termination of long distance calls from or to our
customers. If an imbalance occurs based on inbound versus outbound local calls,
we may also be owed reciprocal compensation from the incumbent local exchange
telephone company ("ILEC"). We bill the access and reciprocal compensation to
the long distance companies and local telephone companies on a monthly basis.
Reciprocal compensation is recognized as revenue when cash is received.
Reciprocal compensation and access charges are not significant components of our
revenue and represented approximately 10% of the Company's first and second
quarter revenues. Although we expect revenue from reciprocal compensation and
access charges to increase as more customers come onto our network, we
anticipate deriving the majority of our revenue from the sale of our
telecommunications services to large- and medium-sized businesses.
Since we began providing Net2000-branded telecommunications services on a
resale basis as a market entry strategy and because we only provisioned our
first customer on our network in May 1999, the majority of our revenue for the
year ended December 31, 1999 was derived from the resale of telecommunications
services. However, because we no longer use resale as a primary customer
acquisition strategy, we expect this revenue to quickly diminish in the future
as a percentage of revenue. Within the next 12 months, we expect to transition
our existing local resale customers to our network or sell such customers to
another carrier.
The expected sale of 10,000 resale lines to AccessOne Communications has
been cancelled due to AccessOne's pending acquisition by Talk.com. Net2000 had
anticipated closing the transaction in the second quarter, but was unable to
reach mutually agreeable terms for the sale.
In the future, we may enter into potential strategic acquisitions which
may further increase revenue.
OPERATING COSTS AND EXPENSES
We expect that our primary operating costs and expenses will consist of
the cost of providing our services and selling, general and administrative
expenses.
OPERATING COSTS. Our most significant expense will be the cost of leasing
certain elements of the full "bundle" of traditional telephone services for sale
to our local service subscribers, the cost of leasing part of the data network
being used by our data customers and the cost of leasing parts of the long
distance network being used by our long distance service customers.
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We purchase local telephone service for our customers on a "wholesale"
basis pursuant to interconnection agreements with the traditional telephone
companies in our targeted markets. Typically, these agreements establish the
terms and conditions of the interconnection arrangements along with the cost per
minute to be charged by each party for the calls that travel between each
carrier's network. We also purchase local telephone service for our customers on
a "retail" basis from ILECs in situations where interconnection arrangements are
not in place due to network or regulatory considerations.
We provide data services to our customers over our own switches in 15
markets and leased fiber optic lines, and in other areas by leasing part of the
data network requirements from various telecommunications companies pursuant to
written agreements.
Our pursuit of a definitive agreement with Williams Communications to
lease intercity and intracity fiber optic connectivity, advanced data services
and collocation services was discontinued. Instead, during the second quarter of
2000, we entered into an agreement with Level 3 Communications, Inc. to lease
7,300 miles of broadband backbone fiber facilities over a five year agreement to
enhance our network and control network operating costs.
We have entered into agreements with long distance providers in order to
originate or terminate long distance traffic in areas where we cannot do so over
our own network. These agreements provide for the origination or termination of
long distance services on a per-minute basis and contain minimum usage volume
commitments. If we fail to meet minimum volume commitments, we may be obligated
to pay underutilization charges. To date, we have met our usage volume
commitments and have not incurred any underutilization charges.
To minimize our costs, we lease fiber optic lines between cities on a
fixed cost basis pursuant to written agreements with the providers of fiber
optic lines. These fiber optic lines interconnect our switches, enabling us to
cost-effectively provide much of the data and long distance network capacity of
our customers. For the needs of our customers beyond our network coverage, we
purchase that capacity on a wholesale basis under our interconnection agreements
with other telecommunications companies.
If we underestimate our need for fiber optic lines, we may be required to
obtain capacity through more expensive means. These costs are usage sensitive
and will increase as our customers' long distance calling volume increases. As
traffic on specific routes increases, we may lease flat-rated long distance
trunk capacity to reduce our variable costs and improve our gross margins.
In construction of a switch for a new market, we capitalize as a
component of property and equipment only the non-recurring charges associated
with our initial network facilities and monthly recurring costs of those network
facilities until the switch begins to carry revenue producing traffic. Once we
have deployed a switch in a particular market, maintenance expense will be a
significant part of our ongoing cost of services.
Our primary expense associated with providing Internet access to our
customers is the cost of interconnecting our network with a national Internet
service provider. Currently, we provide our customers direct connectivity to the
Internet through a national Internet access provider.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Our selling, general and
administrative expenses include our infrastructure costs, including selling and
marketing costs, customer care, billing, corporate administration, personnel and
network maintenance expenses. The nature of these costs have been generally
consistent throughout our history; however, these costs have increased to
support our growth as a telecommunications services provider. Our selling,
general and administrative expenses exclude non-cash compensation expense, which
is classified on our income statement as non-cash compensation expense.
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We employ a direct sales force in each market where we deploy local voice
capability. To attract and retain a highly qualified sales force, we offer our
sales personnel a compensation package that emphasizes commissions. We expect to
incur significant selling and marketing costs as we continue to hire additional
personnel and expand our operations.
In addition to our direct sales force, we utilize sales agents who sell
our services and typically focus on specific niche markets or industries,
augmenting our direct sales initiatives. Customers acquired through agents are
serviced by our customer care representatives, are invoiced by us, and have the
same direct relationship with us as any of our other customers.
We have successfully achieved "electronic bonding" of T-1 circuits
between our operating support systems and Bell Atlantic. As a result, the
Company may achieve the following results:
- significantly reduce the installation interval from order to
billing;
- reduce customer turnover;
- reduce operational expenses; and
- reduce errors and inefficiencies with manually processing orders.
We have deployed a state-of-the-art billing system that provides
consolidated billing on a single invoice for all services we provide to our
customers. We began issuing invoices in the first quarter of 1998, billing long
distance services and, subsequently, local, Internet access and other data
services.
We have developed tailored systems and procedures for operational support
and other back office systems that are required to provision and track a
customer order from point of sale to the installation and testing of service.
These systems are operational on a stand alone basis today and will interface
automatically with trouble management, inventory, billing, collection and
customer care systems by the end of the fourth quarter of 2000. In October 1999,
we implemented e.mpower, our e-commerce, web-based customer interface. During
the second quarter of 2000, we continued to build on the robust feature set of
e.mpower by providing customers the ability to review near real-time network
utilization statistics as well as further enhancements and value-added customer
capabilities.
In addition to the significant development and implementation cost of our
back office systems, we expect to incur expenses to maintain and enhance such
systems and capabilities. Such enhancements will be necessary to ensure our
systems remain current, effective, and meet the changing demands of the
marketplace. We will also incur ongoing expenses for customer care and billing.
As our strategy stresses the importance of personalized customer care, we expect
that the expenses related to our customer care department will remain a
significant part of our ongoing administrative expenses.
We incur other costs and expenses, including the costs associated with
the maintenance of our network, administrative overhead, office leases and bad
debt. We expect that these costs will grow significantly as we expand our
operations and that administrative overhead will be a large portion of these
expenses during the initial phases of our business expansion. However, we expect
these expenses to become smaller as a percentage of our revenue as we build our
customer base and increase revenues.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1999.
TOTAL REVENUE. Total revenue increased 120% to $13.2 million for the
three months ended June 30, 2000 from $6.0 million for the three months ended
June 30, 1999. The increase resulted primarily from increased volume of
providing telecommunications services to large and medium-sized businesses.
Revenue from resale activities increased 37% to $8.2 million for the three
months ended June 30, 2000 from $6.0 million for the three months ended June 30,
2000. Revenue from direct provision of telecommunications services increased to
$5.0 million for the three months ended June 30, 2000 from zero for the three
months ended June 30, 1999.
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OPERATING COSTS. Operating costs increased 104% to $10.2 million for the
three months ended June 30, 2000, from $5.0 million for the three months ended
June 30, 1999. This increase was attributable to the cost of providing the
telecommunications services underlying the increased revenue from
telecommunications services. Operating costs for resale activities increased 44%
to $7.2 million for the three months ended June 30, 2000 from $5.0 million for
the three months ended June 30, 1999. Operating costs for direct provision of
telecommunications services increased to $3.0 million for the three months ended
June 30, 2000 from zero for the three months ended June 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 111% to $19.0 million for the three months ended June 30,
2000, from $9.0 million for the three months ended June 30, 1999. This increase
was primarily attributable to the increase in sales, service delivery and
support associated with the increase in revenue discussed above, the launch of
our telecommunications services and the hiring of key senior management and
other personnel to develop and implement certain infrastructure initiatives to
support our new markets.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased 450% to $3.3 million for the three months ended June 30, 2000, from
$0.6 million for the three months ended June 30, 1999. This increase was
primarily due to depreciation of network elements and amortization of back
office systems and software.
OTHER INCOME (EXPENSES). Interest income increased 867% to $2.9 million
for the three months ended June 30, 2000, from $0.3 million for the three months
ended June 30, 1999. This increase was due to investment income generated from
the net proceeds of the initial public offering and the Senior Discount note.
Interest expense increased 550% to $1.3 million for the three months ended June
30, 2000, from $0.2 million for the three months ended June 30, 1999. The
increase was due to increased levels of debt.
NET LOSS. The net loss increased 30% to $17.9 million for the three
months ended June 30, 2000, from $13.8 million for the three months ended June
30, 1999. The increase resulted primarily from the expansion of our network, the
growth of our sales force, and development of our back office support systems.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1999.
TOTAL REVENUE. Total revenue increased 114% to $23.8 million for the six
months ended June 30, 2000 from $11.1 million for the six months ended June 30,
1999. The increase resulted primarily from increased volume of providing
telecommunications services to large and medium-sized businesses. Revenue from
resale activities increased 48% to $16.4 million for the six months ended June
30, 2000 from $11.1 million for the six months ended June 30, 2000. Revenue from
direct provision of telecommunications services increased to $7.4 million for
the six months ended June 30, 2000 from zero for the six months ended June 30,
1999.
OPERATING COSTS. Operating costs increased 99% to $18.7 million for the
six months ended June 30, 2000, from $9.4 million for the six months ended June
30, 1999. This increase was attributable to the cost of providing the
telecommunications services underlying the increased revenue from
telecommunications services. Operating costs for resale activities increased 49%
to $14.0 million for the six months ended June 30, 2000 from $9.4 million for
the six months ended June 30, 1999. Operating costs for direct provision of
telecommunications services increased to $4.7 million for the six months ended
June 30, 2000 from zero for the six months ended June 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 129% to $36.0 million for the six months ended June 30, 2000,
from $15.7 million for the six months ended June 30, 1999. This increase was
primarily attributable to the increase in sales, service delivery and support
associated with the increase in revenue discussed above, the launch of our
telecommunications services and the hiring of key senior management and other
personnel to develop and implement certain infrastructure initiatives to support
our new markets.
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DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased 427% to $5.8 million for the six months ended June 30, 2000, from $1.1
million for the six months ended June 30, 1999. This increase was primarily due
to depreciation of network elements and amortization of back office systems and
software.
OTHER INCOME (EXPENSES). Interest income increased 457% to $3.9 million
for the six months ended June 30, 2000, from $0.7 million for the six months
ended June 30, 1999. This increase was due to investment income generated from
the net proceeds of the initial public offering and the Senior Discount note.
Interest expense increased 1033% to $3.4 million for the six months ended June
30, 2000, from $0.3 million for the six months ended June 30, 1999. The increase
was due to increased levels of debt.
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS. The net loss available to
common stockholders increased 76% to $44.6 million for the six months ended June
30, 2000, from $25.4 million for the six months ended June 30, 1999. The
increase resulted primarily from the expansion of our network, the growth of our
sales force, and development of our back office support systems.
LIQUIDITY AND CAPITAL RESOURCES
The development of our business, the deployment and start-up of switching
facilities in our targeted markets and the establishment of reliable operations
support systems will require significant capital to fund the following:
- capital expenditures,
- working capital needs,
- debt service, and
- the cash flow deficits generated by operating losses.
Our principal capital expenditure requirements include:
- the purchase and installation of digital switches,
- the development and licensing of operations support systems and
other automated back office systems,
- in certain cases, leasing excess fiber optic capacity where
projected traffic volume growth makes it economically attractive
to do so, and
- the consummation of potential strategic acquisitions.
To date, we have funded our start-up expenditures through the initial
public offering, the private sale of equity securities and a Senior Term Loan
Facility with Nortel. We raised approximately $212.0 million from our initial
public offering after the underwriters' discount and related expenses. In
November 1998, May 1998 and October 1997, we raised a combined total of
approximately $50.5 million through the private placement of our preferred
stock. We have entered into a credit agreement with Nortel Networks whereby
Nortel provided funding under a term loan arrangement in an aggregate principal
amount of up to $75 million. On December 23, 1999, TD Securities (USA), Inc. and
Goldman Sachs Credit Partners L.P. purchased this facility. Outstanding under
the Senior Term Loan Facility as of March 31, 2000 and December 31, 1999, were
$48.4 million and $41.4 million, respectively. On June 28, 2000 we completed a
$200 million Senior Secured Credit Facility transaction with TD Securities
(USA), Inc., lead arranger and syndicate manager for the Company. The new $200
million Facility consists of a $100 million revolving credit facility and a $100
million delayed term loan facility. Upon closing of the transaction, $50.0
million of the new term loan facility was drawn and $49.6 million of principal,
accrued interest and commitment fees outstanding on the existing $75 million
Senior Term Loan Facility was repaid.
In July 1999, we issued to Nortel a Senior Discount note with a face
amount of $75 million. On January 7, 2000, we borrowed $41.5 million of
principal, the full amount available under this facility. In conjunction with
that borrowing, in July 1999, we issued to Nortel warrants to purchase 1,119,930
shares of common stock at $0.008 per share. The warrants may be exercised in
whole or in part during the ten year exercise period which is from July 30, 1999
to July 30, 2009. Our Senior Discount note was extinguished
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upon our initial public offering, resulting in an extraordinary loss of
approximately $4.7 million on the extinguishment of debt.
Net cash used in operating activities was $27.4 million for the six
months ended June 30, 2000 and $18.3 million for the six months ended June 30,
1999. The increase of $9.1 million is primarily due to an increase in operating
losses, offset by an increase in non-cash reconciling items for deferred stock
compensation, extraordinary debt extinguishment, depreciation and amortization,
an increase in accounts payable, and a decrease in other noncurrent liabilities.
Net cash used in investing activities was $125.4 million for the six months
ended June 30, 2000 and $11.6 million for the six months ended June 30, 1999.
The increase of $113.8 million represents an increase in purchases of
investments available for sale and capital expenditures expansion into new
markets as well as continued investment in our back office systems. Net cash
provided by financing activities was $219.5 million for the six months ended
June 30, 2000 and $13.9 million for the six months ended June 30, 1999. The
increase of $205.6 million is primarily the result of net proceeds received from
the Company's initial public offering.
Many investment analysts use the measure of earnings before deducting
interest, taxes, depreciation and amortization, also commonly referred to as
"EBITDA," as a way of evaluating a company. EBITDA losses increased 101% to
$16.1 million for the three months ended June 30, 2000, from $8.0 million for
the three months ended June 30, 1999. We expect to experience additional
operating losses and negative EBITDA as a result of our development and market
expansion activities.
We expect to make significant capital outlays for the foreseeable future
to continue the development activities called for in our current business plan
and to fund expected operating losses. Until such time as we begin to generate
positive cash flow from operations, these capital expenditures will need to be
financed with additional debt and equity capital. We believe that our current
resources will be sufficient to satisfy our liquidity needs for the succeeding
18 months; however, we cannot make any assurances to that effect. Thereafter, we
will need substantial additional capital. If our plans or assumptions change, if
our assumptions prove to be inaccurate, or if we experience unexpected costs or
competitive pressures, we will be required to seek additional capital sooner
than currently expected. In particular, if we elect to pursue significant
additional acquisition opportunities, our cash needs may be increased
substantially, both to finance any such acquisitions and to finance development
efforts in new markets. We cannot assure you that our current projection of cash
flow and losses from operations, which will depend upon numerous future factors
and conditions and many of which are outside of our control, will be accurate.
Actual results will almost certainly vary materially from our current
projections. It is likely that actual costs and revenues will vary from expected
amounts which will likely affect our future capital requirements. Our cost of
expanding our network services and sales efforts, funding other strategic
initiatives, and operating our business will depend on a variety of factors,
including, among other things:
- the number of subscribers and the services for which they
subscribe,
- the nature and penetration of services that may be offered by us,
- regulatory and legislative developments, and
- the response of our competitors to a loss of customers to us and
changes in technology.
We believe that we have substantially funded Phases I and II of our
business plan with existing cash and borrowing capacity. We expect to fund the
capital expenditures and operating losses associated with Phase III by raising
additional capital from the equity or debt markets on an opportunistic basis. We
cannot assure you that we will be able to raise additional capital on
satisfactory terms or at all. If we decide to raise additional funds through the
incurrence of debt, our interest obligations will increase and we may become
subject to additional or more restrictive financial covenants. In the event that
we are unable to obtain such additional capital or to obtain it on acceptable
terms or in sufficient amounts, we may be required to delay the development of
our network and execution of our business plans or take other actions that could
materially and adversely affect our business, operating results and financial
condition.
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<PAGE> 23
SUBSEQUENT TRANSACTIONS
On July 10, 2000, the Company acquired FreBon International Corporation,
a privately-held provider of interactive video services. The purchase price at
closing consisted of 400,000 shares of Common Stock valued at $4.8 million and
cash payments totaling $9.1 million. In addition, the Company assumed debt
totaling $2.8 million. Earnout provisions could provide for additional cash or
stock consideration up to $15.0 million based on the achievement of certain
revenue targets over the next year as defined in the purchase agreement. The
transaction will be accounted for as a purchase with the majority of the
purchase price being allocated to acquired intangibles.
Prior to its acquisition by the Company, FreBon was a qualified Section
8(a) Business Development Program participant. Under this Program, which is
administered by the Small Business Administration, FreBon obtained several
federal government contracts that were set-aside for award only to Program
participants. Although FreBon lost its Program eligibility after being acquired
by the Company, the SBA's regulations permit, and the Company is seeking, formal
waivers of the contract termination requirements.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Certain statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and we intend that such forward-looking statements be subject to the
safe harbors created thereby. The words "believes," "expects," "estimate,"
"anticipates," "will be," "should" and similar words or expressions identify
forward-looking statements made by us or on our behalf. These forward-looking
statements are subject to many uncertainties and factors that may cause our
actual results to be materially different from any future results expressed or
implied by such forward-looking statements. We do not undertake any obligation
to update or revise any forward-looking statements made by us or on our behalf,
whether as a result of new information, future events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We do not have operations subject to risks of foreign currency
fluctuations, nor do we use derivative financial instruments in our operations.
Our exposure to financial market risk, relates primarily to our investment
portfolio and outstanding debt. We typically do not attempt to reduce or
eliminate our market exposure on our investment securities because a substantial
majority of our investments are in fixed-rate, short-term securities. Our
earnings are affected by changes in interest rates as our long term debt has
variable interest rates based on either the Prime Rate or LIBOR. If interest
rates for our long term debt average 10% more for the three months ended June
30, 2000 than they did as of December 31, 1999, our interest expense would
increase, and loss before taxes would increase by approximately $1.3 million for
the three months ended June 30, 2000. These amounts are determined by
considering the impact of the hypothetical interest rates on our borrowing cost
and outstanding debt balances. These analyses do not consider the effects of the
reduced level of overall economic activity that could exist in such an
environment. Further, in the event of a change of such magnitude, management
would likely take actions to further mitigate its exposure to the change.
However, due to the uncertainty of the specific actions that would be taken and
their possible effects, the sensitivity analysis assumes no changes in our
financial structure.
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are a party to routine litigation and regulatory
proceedings before various state commissions and the FCC in the ordinary course
of business. We are not aware of any material litigation against us.
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<PAGE> 24
In November, 1999, Teligent, Inc. filed an action against Clara Vista
Corporation claiming that Clara Vista, who developed Teligent's "e.magine" bill
presentment, web interface software application, misappropriated Teligent trade
secrets and breached its agreement with Teligent when it developed our e.mpower
web-based software application. While we have not been named as a party in this
action, the claims raised by Teligent could have affected us because we retained
Clara Vista to develop our "e.mpower" web-based software application. The
parties have entered into a settlement of this matter and the terms of the
settlement will have no material impact on our ability to continue to use and
enhance our "e.mpower" web-based software application.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
10.1 Lease dated April 11, 2000, by and between Net2000 Communications
Real Estate, Inc. and Permiter Center Investors, LLC
10.2 Lease dated May 15, 2000 by and between Net2000 Communications
Real Estate, Inc. and Carlyle Core Chicago, LLC
10.3 Amended 1997 Stock Option Plan dated June 26, 2000
10.4 Second Amended and Restated Credit Agreement dated June 28, 2000,
by and among Net2000 Communications Group, Inc., Toronto Dominion
(Texas), Inc., and certain lenders named therein
27 Financial Data Schedule
</TABLE>
----------------------
REPORTS ON FORM 8-K
On July 6, 2000, the Registrant filed as an Item 5 event, the execution
of a definitive agreement for the acquisition of FreBon International
Corporation.
On July 10, 2000, the Registrant filed as an Item 5 event, the closing of
the acquisition of FreBon International Corporation.
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<PAGE> 25
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.
Date: August 14, 2000 By: /s/ Donald E. Clarke
--------------------
Donald E. Clarke
Chief Financial Officer, Executive Vice President and
Treasurer
23
