<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
Commission file number: 333-94271
TELOCITY DELAWARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0467929
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10355 N. DE ANZA BOULEVARD 95014
CUPERTINO, CALIFORNIA (Zip Code)
(Address of principal executive offices)
(408) 863-6600
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filled 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 30 days. Yes [X] No [ ]
As of June 30, 2000, 84,860,957 shares of Registrants Common Stock, $0.001 par
value, were issued and outstanding.
<PAGE> 2
TELOCITY DELAWARE, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of June 30, 2000
and December 31, 1999.................................................. 3
Condensed Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2000 and 1999.................................... 4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2000 and 1999................................................. 5
Notes to Condensed Consolidated Financial Statements................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.......................................................... 11
Item 3. Qualitative and quantitative disclosures about market risk............. 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................... 19
Item 2. Changes in Securities.................................................. 19
Item 6.. Exhibits and Reports on Form 8-K....................................... 19
SIGNATURES............................................................. 19
INDEX TO EXHIBITS...................................................... 19
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TELOCITY DELAWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER
2000 31, 1999
(UNAUDITED) (NOTE 2)
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................... $ 107,124 $ 66,978
Accounts receivable .......................................... 183 13
Prepaid expenses and other current assets .................... 7,226 7,013
--------- ---------
Total current assets .................................... 114,533 74,004
Property and equipment, net ...................................... 37,231 22,272
Intangibles, net ................................................. 329 380
Other assets ..................................................... 48,715 43,415
--------- ---------
Total assets ............................................ $ 200,808 $ 140,071
========= =========
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ............................................. $ 11,250 $ 9,141
Accrued liabilities .......................................... 16,755 4,383
Deferred revenue ............................................. 262 33
Notes payable, current ....................................... - 2,292
Capital lease obligations, current ........................... 5,481 4,426
--------- ---------
Total current liabilities ............................... 33,748 20,275
Notes payable, net of current portion ............................ - 3,135
Capital lease obligations, net of current portion ................ 9,122 8,859
Other liabilities ................................................ 164 64
--------- ---------
Total liabilities ............................................ 43,034 32,333
--------- ---------
Total mandatorily redeemable convertible preferred stock ..... - 156,020
--------- ---------
Stockholders' equity (deficit):
Common Stock: $0.001 par value, 250,000,000 shares
authorized; issued and outstanding: 84,860,957 in 2000 and
20,282,270 in 1999 ........................................... 82 17
Additional paid-in capital ................................... 339,388 39,478
Receivable from stockholders ................................. (22,868) (5,457)
Unearned stock-based compensation ............................ (14,101) (13,883)
Accumulated deficit .......................................... (144,727) (68,437)
--------- ---------
Total stockholders' equity (deficit) .................... 157,774 (48,282)
--------- ---------
Total liabilities, mandatorily redeemable
convertible preferred stock and stockholders'
equity (deficit) ........................................ $ 200,808 $ 140,071
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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TELOCITY DELAWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Consolidated Statement of Operations:
Revenues ....................................... $ 1,491 $ - $ 1,841 $ -
------------ ------------ ------------ ------------
Operating Expenses:
Network and product costs .................. 6,627 - 11,066 -
Sales and marketing ........................ 17,509 645 30,286 1,287
General and administrative ................. 11,560 1,107 21,955 1,776
Research and development ................... 5,065 3,172 9,960 6,010
Depreciation and amortization .............. 3,223 427 5,304 713
------------ ------------ ------------ ------------
Total operating expenses .............. 43,984 5,351 78,571 9,786
------------ ------------ ------------ ------------
Loss from operations ........................... (42,493) (5,351) (76,730) (9,786)
Interest income/(expense), net ................. 967 (154) 781 (196)
Other income/(expense), net .................... - (216) - (216)
------------ ------------ ------------ ------------
Net loss ....................................... (41,526) (5,721) (75,949) (10,198)
Accretion on mandatorily redeemable
convertible preferred stock .................... - - 341 -
------------ ------------ ------------ ------------
Net loss attributable to common stockholders ... $ (41,526) $ (5,721) $ (76,290) $ (10,198)
============ ============ ============ ============
Net loss per share, basic and diluted .......... $ (0.56) $ (0.71) $ (1.74) $ (1.32)
Shares used in computing net loss per
share, basic and diluted ....................... 74,499,599 8,042,729 43,903,027 7,717,516
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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TELOCITY DELAWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN 000'S, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
2000 1999
--------- ---------
<S> <C> <C>
Net cash used in operating activities .......................... $ (51,398) $ (10,087)
--------- ---------
Cash flow from investing activities:
Proceeds from the sale of assets ................................ - 288
Acquisition of intangibles ...................................... - (15)
Purchase of property and equipment .............................. (16,624) (1,688)
--------- ---------
Net cash used in investing activities ........................... (16,624) (1,415)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of mandatorily redeemable convertible
preferred stock, net of issuance costs ......................... - 14,477
Proceeds from issuance of common stock, net .................... 120,541 3
Proceeds from issuance of warrants for common stock ............ 536 -
Repayments of notes payable .................................... (5,976) (136)
Principal payments on capital lease obligations ................ (2,372) (154)
Restriction of cash related to letters of credit ............... (4,561) -
--------- ---------
Net cash provided by financing activities ...................... 108,168 14,190
--------- ---------
Net increase in cash and cash equivalents .......................... 40,146 2,688
Cash and cash equivalents, beginning of period ..................... 66,978 1,402
--------- ---------
Cash and cash equivalents, end of period ........................... $ 107,124 $ 4,090
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
<PAGE> 6
TELOCITY DELAWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. DESCRIPTION OF BUSINESS
Telocity Delaware, Inc. (the "Company") develops, markets, integrates
and delivers interactive online services to the residential market over
high-speed, or broadband, connections. The Company has a single operating
segment and has no organizational structure dictated by product lines, geography
or customer type.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amount reported in the financial statements. Actual
results may differ from those estimates. The consolidated financial statements
of the Company include the accounts of all its wholly owned subsidiaries.
The consolidated financial statements at June 30, 2000 and for the three
and six month periods ended June 30, 2000 are unaudited, but include all
adjustments (consisting only of recurring adjustments) which, in the opinion of
management, are necessary for a fair presentation of financial position and
operating results. Operating results for the three and six-month periods ended
June 30, 2000 and 1999 are not necessarily indicative of results that may be
expected for any future periods.
The consolidated balance sheet at December 31, 1999 has been derived
from the audited consolidated financial statements at that date, but does not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.
The information included in this report should be read in conjunction
with the Company's audited consolidated financial statements and notes thereto
included on Form S-1 filed with Securities Exchange Commission ("SEC") on March
28, 2000.
Cash and cash equivalents
The Company considers all highly liquid investments with original or
remaining maturities of three months or less at the date of purchase to be cash
equivalents. At June 30, 2000, the Company had restricted cash of approximately
$4.6 million related to letter of credit facilities with a bank, which had terms
in excess of one year. This amount has been included in other assets.
Research and development
Research and development costs are expensed as incurred, except for
certain software development costs. In January 1999 the Company adopted
Statement of Position ("SOP") 98-1, which requires software development costs
associated with internal use software to be charged to operations until certain
capitalization criteria are met. For the six-months ended June 30, 2000 and
1999, software development costs of approximately $1.4 million and zero,
respectively, were capitalized and included in property and equipment.
Advertising Costs
6
<PAGE> 7
Advertising costs are expensed the first time the advertising takes
place. Included in prepaid expenses and other current assets and other assets at
June 30, 2000 and December 31, 1999 is $38.6 million and $38.8 million,
respectively, related to advertising to be received in the future, primarily
from our strategic investors, National Broadcasting Company, Inc. and NBC
Internet, Inc. Advertising expense for the six-months ended June 30, 2000 and
1999 was $15.0 million and zero, respectively.
3. NET LOSS PER SHARE
Basic and diluted net loss per share have been computed using the
weighted-average number of shares of common stock outstanding during the period,
less shares subject to repurchase. Diluted net loss per share includes common
equivalent shares outstanding during the period, if dilutive.
The following table represents the calculation of basic and diluted net
loss per share (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Numerator:
Net loss ............................. $ (41,526) $ (5,721) $ (75,949) $ (10,198)
Accretion on mandatorily redeemable
preferred stock ...................... - - 341 -
------------ ------------ ------------ ------------
Net loss attributable to common
stockholders ......................... $ (41,526) $ (5,721) $ (76,290) $ (10,198)
============ ============ ============ ============
Denominator:
Weighted-average common shares
- basic and diluted ............ 85,206,384 14,180,565 55,868,924 13,678,434
Weighted-average shares
subject to repurchase .......... (10,706,785) (6,137,836) (11,965,897) (5,960,918)
------------ ------------ ------------ ------------
Denominator for basic and
diluted calculation ............ 74,499,599 8,042,729 43,903,027 7,717,516
============ ============ ============ ============
Basic and diluted net loss
per share ...................... $ (0.56) $ (0.71) $ (1.74) $ (1.32)
============ ============ ============ ============
</TABLE>
Options to purchase 795,412 and 640,688 shares of Common Stock at an
average exercise price of $7.32 and $0.34 per share, respectively, and warrants
to purchase 4,657,126 and 2,246,089 shares of Common or Convertible Preferred
Stock at an average exercise price of $5.98 and $0.56 per share, respectively,
and zero and 26,331,818 of convertible preferred stock outstanding, have not
been included in the computation of diluted net loss per share for the six month
periods ended June 30, 2000 and 1999, respectively, as their effect would have
been anti-dilutive.
4. STOCK PLANS
In January and February 2000, the Company granted options to purchase
981,580 and 398,360 shares of Common Stock at an exercise price of $9.00 and
$12.00 per share and subsequently recorded deferred stock compensation expense
of approximately $4.0 million and $1.2 million, respectively, related to the
issuance of these options. Since February 2000, no additional deferred stock
compensation expense has been recorded related to the granting of stock options
to employees.
In January 2000, the Board of Directors approved the adoption of the
2000 Stock Incentive Plan ("2000 Plan") and reserved 24,000,000 common shares
for issuance under this Plan. Shares not yet issued under the 1998 Stock Plan
will also be available under the 2000 Plan. The 2000 Plan allows the grant of
ISO, NSO and restricted stock to employees, non-employee board members and
consultants.
7
<PAGE> 8
In January 2000, the Board of Directors approved the adoption of the
2000 Employee Stock Purchase Plan and reserved 2,500,000 shares of Common Stock
for issuance under this Plan.
In January 2000, The Board of Directors approved the adoption of the
2000 outside Directors' Stock Plan and reserved 400,000 shares of Common Stock
for issuance under this Plan.
Stock-based compensation for employees and third party service providers
was allocated across the relevant functional expense categories within operating
expenses as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Network and product costs ....... $ 78 $- $ 267 $-
Sales and marketing ............. 800 39 1,174 53
General and administrative ...... 1,024 142 3,300 152
Research and development ........ 383 66 744 126
------ ------ ------ ------
$2,285 $ 247 $5,485 $ 331
====== ====== ====== ======
</TABLE>
5. INITIAL PUBLIC OFFERING
On March 29, 2000, the Company completed its initial public offering in
which it sold 11 million shares of Common Stock at $12.00 per share. The net
proceeds of approximately $122.8 million were remitted to the Company on April
3, 2000.
Upon the closing of the offering, all the Company's Preferred Stock
converted to Common Stock. After the offering, the Company's authorized capital
consisted of 250,000,000 shares of Common Stock, of which 84,860,957 shares were
outstanding at June 30, 2000, and 10,000,000 shares of preferred stock, none of
which was issued or outstanding at June 30, 2000.
6. COMPREHENSIVE INCOME
To date, the Company has not had any transactions that are required to
be reported in comprehensive income.
7. NEW ACCOUNTING PRONOUNCEMENT
In June 1998, Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). The new standard requires companies to
record derivatives on the balance sheet as assets or liabilities, measured at
fair value. Under FAS 133, gains or losses resulting from changes in the values
of derivatives are to be reported in the statement of operations or as a
deferred item, depending on the use of the derivatives and whether they qualify
for hedge accounting. The key criterion for hedge accounting is that the
derivative must be highly effective in achieving offsetting changes in fair
value or cash flows of the hedged items during the term of the hedge. The
Company is required to adopt FAS 133 in the first quarter of 2001. To date, the
Company has not engaged in any foreign currency or interest hedging activities
and does not expect adoption of this new standard to have a significant impact
on the Company.
8
<PAGE> 9
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 or SAB 101, Revenue Recognition in Financial
Statements, which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the Commission. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. The
implementation of SAB 101 did not have a material effect on our financial
position or results of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" an interpretation of APB Opinion No. 25 ("FIN 44"). This
Interpretation clarifies the definition of employee for purposes of applying
Accounting Practice Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25"), the criteria for determining whether a plan qualifies as a
non-compensatory plan, the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and the accounting for an
exchange of stock compensation awards in a business combination. This
Interpretation is effective July 1, 2000, but certain conclusions in this
Interpretation cover specific events that occur after either December 15, 1998,
or January 12, 2000. The adoption of certain provisions of FIN 44 prior to March
31, 2000 did not have a material impact on the financial statements. Management
does not expect the adoption of the remaining provisions to have a material
effect on the financial statements.
8. RELATED PARTY TRANSACTIONS:
An executive of the Company is also a member of the Board of Directors
and a shareholder of a supplier of outsourced sales support services to the
Company. This commercial relationship commenced in March 2000. For the three and
six months ended June 30, 2000 expenses of $406,000 and $461,000, respectively,
were attributable to this supplier.
9. COMMITMENTS
GE Sales Agreement
In February 2000, the Company entered into a two-year master broadband
services agreement with GE and its affiliates. Under the services agreement, the
Company will provide residential services to GE and its affiliates'
telecommuters, other employees at discounted rates, as well as non-employee
users introduced to the Company by GE. In addition, under this agreement GE will
help market and promote the Company's services. The Company has issued GE
warrants for the contingent purchase of up to 200,000 shares of our common stock
at an exercise price of $12.00, per share, based upon the achievement of certain
customer-based milestones during the term of the agreement.
GE must meet these milestones within 30 months and the warrants must be
exercised within 12 months of reaching the associated milestone. The warrants
will be valued using the Black-Scholes pricing model and revalued at each
reporting date until the milestones are met. The fair value attributable to
these warrants will be recorded when it is probable that the milestone will be
met.
Citi f/i Sales Agreement
In April 2000, the Company entered into a 27-month affinity agreement
with Citi f/i, the online virtual bank from Citibank and Citicorp Investment
Services. Under the agreement, Citi f/i will promote the use of the Company's
residential services among its on-line banking customers. The Company has issued
warrants for the contingent purchase of up to 1,250,000 shares of our common
stock at an exercise price of $12.00, per share, based upon the achievement of
certain customer-based milestones during the term of the agreement. In July
2000, Citi f/i was disbanded and rolled up into Citibank's online banking
initiative.
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<PAGE> 10
Citibank must meet these milestones within 27 months and the warrants
must be exercised within 6 months of reaching the associated milestone. The
warrants will be valued using the Black-Scholes pricing model and revalued at
each reporting date until the milestones are met. The fair value attributable to
these warrants will be recorded when it is probable that the milestone will be
met.
Early extinguishment of debt
In May 2000, the Company prepaid notes payable to Comdisco, Inc. and
MMC/GATX Partnership #1 with an outstanding principal value of approximately
$6.0 million. These notes were collateralized by all tangible assets owned by
the Company, bore interest at a weighted average rate of 11.1% and were
repayable in installments through January 2002. The loss arising from the early
extinguishment of this debt was $564,000.
Lease
In June 2000, the Company entered into a ten-year facility lease for
51,667 square feet in Chicago, Illinois. The lease term is due to commence in
the second half of 2000 and the following is a schedule, by years, of future
minimum rental payments (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Year 1 $ 839
Year 2 1,310
Year 3 1,362
Year 4 1,403
Year 5 1,445
Later years 7,893
-------
$14,252
=======
</TABLE>
Future lease payments are secured, in part, by a $2.1 million
irrevocable letter of credit issued by Wells Fargo Bank.
10
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding our expectations, beliefs, intentions or strategies
regarding the future. All forward-looking statements included in this document
are based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. Our actual results
could differ materially from those described in our forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, our unproven business model and a limited operating history in a new
and rapidly evolving industry; our ability to implement our business plan; and
our ability to manage our growth, retain and grow our customer base and expand
our service offerings.
Additional risk factors are discussed under the heading "Risk Factors"
both below and in our Registration Statement on Form S-1 declared effective on
March 29, 2000 by the Securities and Exchange Commission (File No. 333-94271).
OVERVIEW
We develop, market, integrate and deliver to the residential market
interactive online services and content designed for use over high-speed, or
broadband, connections. These broadband connections allow our customers to enjoy
services and content that they could not access with traditional slower speed
Internet connections. Through our set of agreements, NBC Internet, Inc., or
NBCi, currently provides all of the content offered on our jointly developed
website, the Telocity/NBCi portal, which is the first Web page a customer views
when accessing our services. Additionally, under these agreements NBCi and we
have each agreed to develop new services and content to be offered and sold over
this website and to share the revenue associated with those sales. We also
intend to develop or acquire additional content if it is not available through
NBCi from other third parties.
Although we currently deliver our services to customers using digital
subscriber line, or DSL, technology, in the future we intend to utilize the
technology we have developed to deliver these services and content over a
variety of broadband technologies, including wireless, cable and satellite, from
a managed nationwide network to and throughout the home. Our goal is to become a
leading provider of broadband access services, content and home networking
services to the residential market.
In July 1999, we began offering services commercially in Chicago. As of
June 30, 2000, our broadband footprint encompassed more than 125 metropolitan
statistical areas with coverage in such major U.S. cities as Atlanta, Boston,
Chicago, Detroit, Los Angeles, Miami, New York, Philadelphia and San Francisco.
At June 30, 2000 we had approximately 23,300 customers of which over 13,000 were
receiving our services and approximately 10,200 pre-qualified customers had
placed orders for our services. Based on our limited historical experience we
estimate that approximately 85% of those placing orders will actually be
converted into customers receiving our services. The major causes of fall out
include customers being unable to receive DSL service due to "false positive"
loop qualification status, customers' in-house wiring may not be of an adequate
quality to support DSL service and pre-installation customer churn. By the end
of 2000, we expect that we will offer services in approximately 150 of the
nation's 349 metropolitan statistical areas which we estimate will allow us to
make our services available to at least 20% of all U.S. households. Our maximum
potential market is limited by the number of homes that are DSL-capable, meaning
homes that are within approximately 2 1/2 and 3 miles from a local telephone
office that has equipment necessary to support DSL service and have voice grade
copper telephone lines that are in good condition. We believe that currently
greater than 1.4% of all U.S. households receive DSL service and in excess of
30% of all U.S.
11
<PAGE> 12
households are DSL-capable, with the percent of DSL-capable households growing
to 50% in 2001 and 75% in 2002.
Since our incorporation in August 1997, our primary activities have
consisted of:
- developing our residential broadband gateway technology;
- obtaining space and locations for our network equipment;
- deploying and installing our network;
- developing and integrating our operational support system and other
back office systems;
- negotiating and executing network agreements with traditional
telephone companies and new competitive carriers;
- launching service in target markets;
- developing a marketing and branding strategy;
- building our customer service and provisioning organizations;
- negotiating agreements for broadband content;
- hiring management and other personnel; and
- raising capital.
We have incurred operating losses, net losses and negative earnings
before interest, taxes, amortization of stock-based compensation, depreciation
and amortization, or EBITDA, for each month since our formation. We intend to
increase substantially our capital expenditures and will incur higher operating
expenses in an effort to build our customer base and our brand rapidly, as well
as expand our infrastructure and network services. We expect to incur
substantial operating losses, net losses and negative EBITDA as we expand our
operations.
We incur network and product costs, sales and marketing expenses and
capital expenditures when we enter a new market. Once we have developed our
network in a market, we incur incremental expenditures as we connect new
customers. These incremental expenditures primarily include local access costs
and gateway device costs. In addition to the capital expenditures, we will be
required to fund our operating and cash flow and working capital deficits as we
build our customer base.
THREE AND SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 1999
Revenues: During the three months ended June 30, 2000, we continued the
development of our business operations, with the expansion of our national
broadband footprint to over 125 metropolitan statistical areas from
approximately 85 metropolitan statistical areas as of March 2000. Our expansion
into Northern and Southern California contributed greatly to the increase.
Subscriber revenues, net of certain deferred revenues, for the three and six
months ended June 30, 2000, were $1.5 million and $1.8 million, respectively. We
did not offer commercial services in the first six months of 1999 and, as a
result, did not record any revenues in the period.
Network and product costs: For the three months ended June 30, 2000, we
recorded network and product costs of $6.6 million, inclusive of stock-based
compensation of $78,000; the total for the six months ended June 30, 2000, was
$11.1 million, inclusive of stock-based compensation of $267,000. Since we did
not offer commercial services in the first six months of 1999, we did not record
any network and product costs in this accounting period. We expect network and
product costs to increase significantly in future periods as our subscriber base
grows and we expand
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<PAGE> 13
our network into additional markets. We believe that these costs will exceed
revenue for the next twelve months.
Sales and marketing expenses: Sales and marketing expenses increased
from $645,000 for the three months ended June 30, 1999 to $17.5 million for the
three months ended June 30, 2000, inclusive of stock-based compensation of
$39,000 and $800,000, respectively. For the six months ended June 30, 1999 and
2000, sales and marketing expenses increased from $1.3 million to $30.3 million,
inclusive of stock-based compensation of $53,000 and $1.2 million, respectively.
The overall increase in expenditure is consistent with the development of our
business. Following the commercial trial of our service deployment platform in
Chicago in July, 1999, we have rapidly expanded our geographical service areas
with commercial launches in the Southeast and Midwest in November 1999; the
Northeast in March 2000; and Northern and Southern California in April 2000. The
table below sets out the primary areas of increased expenditure, net of
stock-based compensation, for the three and the six month periods ended June 30,
2000 compared to the respective, prior year, periods (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 2000
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
<S> <C> <C>
Incremental advertising and
promotional costs $13,821 $22,914
Incremental employee costs $ 2,353 $ 4,852
</TABLE>
We expect sales and marketing expenses to continue to increase as we
incur additional expenses to develop our marketing program and increase brand
awareness and add personnel. We also expect stock-based compensation to become
an increasingly large component of sales and marketing expenditure as we begin
to utilize our $38.6 million inventory of NBC and NBCi advertising commitments
through a broader marketing campaign to build a national brand.
General and administrative expenses: General and administrative expenses
increased from $1.1 million for the three months ended June 30, 1999 to $11.6
million for the three months ended June 30, 2000 inclusive of stock-based
compensation of $142,000 and $1.0 million, respectively. For the six months
ended June 30, 1999 and 2000, general and administrative expenses increased from
$1.8 million to $22.0 million, inclusive of stock-based compensation of $152,000
and $3.3 million, respectively. The increased level of expenditures reflects the
growth in the volume and complexity of our underlying business as we have
evolved from an enterprise primarily focused on research and development to a
commercial operating company following our commercial trial of service in
Chicago in July 1999 and the ongoing expansion of commercial operations to over
125 metropolitan statistical areas by June 30, 2000. The table below sets out
the primary areas of increased expenditure, net of stock-based compensation, for
the three and six month periods ended June 30, 2000 compared to the respective,
prior year, periods (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 2000
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
<S> <C> <C>
Incremental customer delivery
and support expenditure $4,251 $6,770
Incremental executive and
general corporate expenditure $4,680 $8,715
Incremental facilities
expenditure $ 644 $1,546
</TABLE>
We expect general and administrative expenses to increase as we add
personnel and incur additional expenses related to the anticipated growth of our
business and our operation as a public company.
Research and development expenses. Research and development expenses
increased from $3.2 million for the three months ended June 30, 1999 to $5.1
million for the three months ended June 30, 2000, inclusive of stock-based
compensation of $66,000 and $383,000, respectively. For the six months ended
June 30, 1999 and
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<PAGE> 14
2000, research and development expenses increased from $6.0 million to $10.0
million, inclusive of stock-based compensation of $126,000 and $744,000,
respectively. These increases, net of stock-based compensation, are primarily
due to incremental charges, over the comparative periods of the prior year, of
$1.3 million and $3.3 million for the three and six months ended June 30, 2000,
respectively, for the hiring of additional engineers and consultants involved in
increased research and development activities associated with our service
development platform and associated services. We expect to continue to make
substantial investments in research and development and anticipate that these
expenses will continue to increase.
Depreciation and amortization expenses: Depreciation and amortization
expenses increased from $427,000 for the three months ended June 30, 1999 to
$3.2 million for the three months ended June 30, 2000 and from $713,000 for the
six months ended June 30, 1999 to $5.3 million for the six months ended June 30,
2000. This increase was primarily due to additional capital expenditures arising
from the build out of our managed network.
Interest income/(expense): Interest income for the three and six months
ended June 30, 2000, is net of a prepayment penalty of $564,000 arising from the
early extinguishment of debt.
LIQUIDITY AND CAPITAL RESOURCES
From inception through June 30, 2000, we financed our operations
primarily through the proceeds of our initial public offering, net of
underwriting commissions, of $122.8 million; private placements of equity of
approximately $149 million in cash and promotional services; the use of
operating equipment leases totaling $18.3 million; and borrowings under notes
payable of $11.9 million. As of June 30, 2000, we had an accumulated deficit of
$144.7 million, cash and cash equivalents of $107.1 million and restricted cash
of $4.6 million.
During the six months ended June 30, 2000, the net cash used in our
operating activities was $51.4 million. This cash was used for a variety of
operating purposes, including salaries; consulting and legal expenses; network
operations; marketing; customer care; and overhead expense. Net cash used for
operating activities is inclusive of a $170,000 increase in accounts receivable.
This increase is primarily attributable to our increase in revenues and a
limited market trial whereby subscribers were able to pay for services by check
as opposed to credit card. Due to the resource requirements and the costs needed
to administer a check payment option, we are in the process of converting these
trial subscribers from check to credit card or electronic fund transfer payment
over the next few months.
Our net cash used for investing activities for the six months ended June
30, 2000, was $16.2 million and was used for purchases of property and
equipment.
Net cash provided by financing activities for the six months ended June
30, 2000 was $108.2 million and came from initial public offering proceeds, net
of underwriting commissions, legal, accounting and sundry other expenses, of
$120.5 million and $536,000 from the exercise of warrants, partially offset by
$6.0 million in the prepayment and repayment of notes, $2.4 million of principal
payments under capital lease obligations and $4.6 million of restricted cash
related to letters of credit. Notes were prepaid in May 2000 in order to remove
restrictive liens over the Company's assets.
Upon the closing of our initial public offering on March 29, 2000,
mandatorily redeemable preferred stock with a liquidation value of approximately
$148.6 million was converted to common.
While we believe that our existing cash balances will be sufficient to
fund our operating losses, capital expenditures, lease payments and working
capital requirements through at least March 2001, we may make appropriate
mid-course actions to stretch our cash position beyond this point. We expect our
operating losses and capital expenditures to increase substantially as we expand
our network, and we expect to record substantial losses for the foreseeable
future. We expect that
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<PAGE> 15
additional financing will be required in the future. We may attempt to finance
our future capital needs through some combination of commercial bank borrowings,
leasing, vendor financing and the sale of additional equity or debt securities.
Our capital requirements will vary based upon the timing and success of
implementation of our business plan and as a result of competitive,
technological and regulatory developments, or if:
- demand for our services or our cash flow from operations varies from
projections;
- our development plans or projections change or prove to be
inaccurate;
- we make any acquisitions; or
- we accelerate deployment of our network or otherwise alter the
schedule or targets of our business plan implementation.
There can be no assurance that additional capital will be available on
terms acceptable to us, or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133). The new standard requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Under FAS 133, gains or losses resulting from changes in the values of
derivatives are to be reported in the statement of operations or as a deferred
item, depending on the use of the derivatives and whether they qualify for hedge
accounting. The key criterion for hedge accounting is that the derivative must
be highly effective in achieving offsetting changes in fair value or cash flows
of the hedged items during the term of the hedge. The Company is required to
adopt FAS 133 in the first quarter of 2001. To date, the Company has not engaged
in any foreign currency or interest hedging activities and does not expect
adoption of this new standard to have a significant impact on the Company.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 or SAB 101, Revenue Recognition in Financial
Statements, which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the Commission. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. The
implementation of SAB 101 did not have a material effect on our financial
position or results of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" an interpretation of APB Opinion No. 25 ("FIN 44"). This
Interpretation clarifies the definition of employee for purposes of applying
Accounting Practice Board Opinion No. 25, Accounting for Stock Issued to
Employees (`APB 25'), the criteria for determining whether a plan qualifies as a
non-compensatory plan, the accounting consequence of various modifications to
the terms of a previously fixed stock option or award, and the accounting for an
exchange of stock compensation awards in a business combination. This
Interpretation is effective July 1, 2000, but certain conclusions in this
Interpretation cover specific events that occur after either December 15, 1998,
or January 12, 2000. Management believes that the impact of FIN 44 will not have
a material effect on the financial position or results of operations of the
Company
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a
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<PAGE> 16
security that was issued with a fixed interest rate at the then-prevailing rate
and the prevailing interest rate later rises, the principal amount of our
investment will probably decline. To minimize this risk in the future, we intend
to maintain our portfolio of cash equivalents and short-term investments in a
variety of securities, including commercial paper, money market funds,
government and non-government debt securities. In general, money market funds
are not subject to market risk because the interest paid on such funds
fluctuates with the prevailing interest rate. As of June 30, 2000, all of our
cash and cash equivalents were in money market and checking funds.
OTHER RISK FACTORS
OUR FAILURE TO MANAGE OUR GROWTH COULD HARM OUR ABILITY TO RETAIN AND GROW OUR
CUSTOMER BASE AND EXPAND OUR SERVICE OFFERINGS.
We may not be able to install management information and control systems
in an efficient and timely manner, and our current or planned personnel,
systems, procedures and controls may not be adequate to support our future
operations. Failure to manage our future growth effectively could harm our
ability to retain and grow our customer base and expand our service offerings
which would materially and adversely affect our business, prospects, operating
results and financial condition.
BECAUSE OUR CUSTOMER ACQUISITION COSTS ARE HIGH, IF WE FAIL TO RETAIN CUSTOMERS
LONG ENOUGH TO PAY BACK OUR UP FRONT INVESTMENT, WE MAY NOT ACHIEVE
PROFITABILITY.
Our customer acquisition costs comprise a significant portion of our
operating costs, including advertising, order fulfillment, installation,
customer care and the cost of our residential gateway. Because of our
significant up-front investment in each customer, if our customers terminate
their relationships with us before we recover our up front costs, we may fail to
generate a profit. In addition, if we fail to reduce our customer acquisition
costs, including by increasing the efficiency of our customer care organization
and reducing the costs associated with the development and production of our
gateways, our operating results will suffer.
OUR GROWTH DEPENDS ON OUR ABILITY TO HIRE AND RETAIN HIGHLY QUALIFIED EMPLOYEES
AND SENIOR EXECUTIVES.
The loss of the services of any of our senior management team, all but
one of whom are at-will employees, or the failure to attract and retain
additional key employees could harm the continued deployment of our services and
content, the marketing of our services and the development of new services, our
brand and our strategy. Our future growth and ability to sustain this growth
depend upon the continued service of our executive officers and other key
engineering, sales, operations, marketing and support personnel.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY FROM PERIOD TO
PERIOD WHICH MAY CAUSE OUR STOCK PRICE TO BE EXTREMELY VOLATILE. WE MAY ALSO
FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS,
CAUSING OUR STOCK PRICE TO DECLINE.
Our operating results are likely to fluctuate significantly in the
future on a quarterly and an annual basis due to a number of factors, many of
which are outside our control. If we experience such fluctuation, we may fail to
meet or exceed the expectations of securities analysts or investors, causing our
stock price to decline or be extremely volatile.
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<PAGE> 17
WE MAY BE UNABLE TO RAISE ADDITIONAL CAPITAL IN THE FUTURE TO SUPPORT OUR
GROWTH, AND EVEN IF WE ARE ABLE TO RAISE ADDITIONAL CAPITAL, IT MAY BE ON
UNACCEPTABLE TERMS, MAY DILUTE YOUR OWNERSHIP OR MAY RESTRICT OUR FLEXIBILITY IN
RUNNING OUR BUSINESS.
We intend to seek substantial additional financing in the future to fund
the growth of our operations, including funding the significant capital
expenditures and working capital requirements necessary for us to complete our
nationwide rollout. This rollout calls for us to expand our services across the
United States, beginning with major markets, and provide services in our
targeted markets. In order to accomplish this nationwide rollout, we must expand
our network into geographic areas throughout the country, beginning with major
markets, establish relationships with local access providers in those areas and
launch targeted marketing campaigns in those regions. If we are unable to raise
additional capital or are able to raise capital only on unfavorable terms, we
may not be able to complete our network's coverage across the country, develop
or enhance our gateway and services, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements, any or all of
which could hurt our ability to support our growth.
THE SCALABILITY, RELIABILITY AND SPEED OF OUR NETWORK REMAIN LARGELY UNPROVEN
AND MAY NOT SATISFY CUSTOMER DEMAND.
We may not be able to scale our network and operational support system
to meet our projected customer numbers while achieving and maintaining superior
performance. This risk will continue to exist as long as we expand our services
geographically to increasing numbers of customers. Our failure to achieve or
maintain high-speed digital transmissions, for a number of reasons including the
reliability and inter-operability of our network equipment, would significantly
reduce customer demand for our services, resulting in decreased revenues and the
inability to build our business as planned.
FACTORS OUTSIDE OF OUR CONTROL MAY ADVERSELY AFFECT OUR TRANSMISSION SPEED.
LOWER SPEEDS MAY RESULT IN CUSTOMER DISSATISFACTION AND ULTIMATELY A LOSS OF
CUSTOMERS.
Peak digital data transmission speeds currently offered across our
networks when utilizing DSL are 1.5 megabits per second. However, the actual
data transmission speeds over our networks can be significantly slower. These
slower speeds may result in customer dissatisfaction and ultimately in the loss
of customers and revenues. The speeds over our networks depend on a variety of
factors, many of which are out of our control, including:
- the distance an end-user is located from a central office;
- the configuration of the telecommunications line being used;
- the quality of the telephone lines provisioned by traditional
telephone companies;
- the inside wiring of our customers' homes; and
- the limitations of our customers' computers.
AT PRESENT, WE CANNOT PROVIDE OUR SERVICES UNLESS DSL ACCESS PROVIDERS SUPPLY US
WITH DSL CONNECTIONS AND COOPERATE WITH US FOR THE TIMELY PROVISION OF DSL
CONNECTIONS FOR OUR CUSTOMERS.
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<PAGE> 18
We must obtain DSL connections from traditional telephone companies and
new competitive carriers and have their continuing cooperation for the timely
provision of DSL connections for our customers in order for us to provide our
services. DSL operates over local telephone lines, which are under the control
of traditional telephone companies and new competitive carriers and requires a
special connection from our network to the telephone lines. We rely on them to
provide us with these DSL connections, and if we were unable to use these
connections, we would not be able to provide our services. In addition, we
depend on traditional telephone companies and new competitive carriers to test
and maintain the quality of the DSL connections that we use. An inability to
obtain adequate and timely access to DSL connections on acceptable terms and
conditions from traditional telephone companies and competitive carriers and to
gain their cooperation in the timely provision of DSL connections for our
customers could harm our business, as could their failure to properly maintain
the DSL connection we use.
A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS WHICH COULD HURT OUR BRAND IMAGE, LEAD
TO A LOSS OF CUSTOMERS AND RESULT IN A SIGNIFICANT DECREASE OF REVENUES.
Although we have not experienced any system failures or breaches of
network security that materially affected us, if we experience one or more of
the problems described below in the future, our financial performance and
results of operations could be materially affected at that time.
Our operations depend on our ability to avoid damages from fires,
earthquakes, floods, power losses, excessive sustained or peak user demand,
telecommunications failures, network software flaws, transmission cable cuts and
similar events. The occurrence of a natural disaster or other unanticipated
problem at our network operations center, our operational support system, our
managed network of leased communication lines or any metropolitan hubs or
collocation facilities could cause interruptions in the services provided by us
and these interruptions could result in the loss of customers and the attendant
reduction of revenue. Additionally, if a traditional telephone company, new
competitive carrier or other service provider fails to provide the
communications capacity we require, as a result of a natural disaster,
operational disruption or any other reason, then this failure could interrupt
our services.
WE ARE VULNERABLE TO CLAIMS THAT ANY ELEMENT OF OUR SERVICE DEPLOYMENT PLATFORM
INFRINGES THIRD PARTY INTELLECTUAL PROPERTY RIGHTS, AND ANY RESULTING CLAIMS
AGAINST US COULD BE COSTLY TO DEFEND OR SUBJECT US TO SIGNIFICANT DAMAGES.
Infringement claims could materially harm our business. From time to
time, we may receive notice of claims of infringement of third parties'
proprietary rights. The fields of telecommunications and Internet communications
are filled with patents, both pending and issued. We may unknowingly infringe
such a patent. We may be exposed to future litigation based on claims that our
platform infringes the intellectual property rights of others, especially patent
rights. Someone, including a competitor, might file a suit with little merit, in
order to harm us commercially, to force us to re-allocate resources to defending
such a claim, or extract a large settlement. In addition, our employees might
utilize proprietary and trade secret information from their former employers
without our knowledge, even though we prohibit these practices.
Additional risk factors are discussed under the heading "Risk Factors"
in our Registration Statement on Form S-1 declared effective on March 29, 2000
by the Securities and Exchange Commission (File No. 333-94271).
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<PAGE> 19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may be involved in litigation that arises in the
normal course of our business operations. As of the date of this filing, we are
not party to any litigation that we believe could adversely affect our business
relationship and our financial results.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In March 2000, we commenced and completed a firm commitment underwritten
initial public offering of 11,000,000 shares of our common stock, at a price of
$12.00 per share. The shares were registered with the Securities and Exchange
Commission pursuant to a registration on Form S-1 (File No. 333-94271), which
was declared effective on March 29, 2000. The public offering was underwritten
by a syndicate of underwriters led by Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Credit Suisse First Boston Corporation, Donaldson, Lufkin &
Jenrette Securities Corporation and Wit Sound View Corporation, as their
representatives. After deducting underwriting discounts and commissions of $9.2
million, we received net proceeds of $122.8 million on April 3, 2000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
27.1 Financial Data Schedules for the three months ended
June 30, 2000.
</TABLE>
b. Reports on Form 8-K
There have been no reports on Form 8-K filed during the quarter ended
June 30, 2000.
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.
TELOCITY DELAWARE, INC.
Date: August 4, 2000 BY: /s/ EDWARD HAYES
--------------------------------------------
Edward Hayes
Executive Vice President and Chief
Financial Officer
/s/ DAVID WILSON
--------------------------------------------
David Wilson
Vice President, Financial Services and Chief
Accounting Officer
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
27.1 Financial Data Schedules for the three months ended
June 30, 2000.
</TABLE>
