<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20459
-----------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
Commission file number 333-39646
-----------
PF.NET COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
-----------
Delaware 52-2197932
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
555 Herndon Parkway, Suite 100
Herndon, Virginia 20170
(Address of principle executive offices)
(703) 796-6400
(Company's telephone number, including area code)
Indicate by check mark whether Registrant (1) has filed all reports 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 Registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. YES |X| NO | |
The Company had 80,000,000 shares of common stock, $.01 par value,
outstanding at November 14, 2000.
<PAGE>
PF.NET COMMUNICATIONS, INC.
FORM 10-Q SEPTEMBER 30, 2000
INDEX
PART I - FINANCIAL INFORMATION.............................................. 3
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets.............................. 3
Condensed Consolidated Statements Of Operations.................... 4
Condensed Consolidated Statements Of Cash Flows.................... 5
Notes To Condensed Consolidated Financial Statements............... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.............................................. 10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......... 15
PART II - OTHER INFORMATION................................................. 16
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.......................... 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................ 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................... 16
2
<PAGE>
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PF.NET COMMUNICATIONS, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------- -------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................. $ 107,597,674 $ 172,393,587
Accounts receivable ................................... 9,475 19,503,689
Prepaid expenses ...................................... 155,100 494,120
------------- -------------
Total current assets ................................ 107,762,249 192,391,396
PROPERTY AND EQUIPMENT, net ........................... 44,120,563 210,114,605
DEFERRED FINANCING COSTS, net ......................... 21,410,355 19,537,444
OTHER ASSETS .......................................... 23,635 23,000
------------- -------------
$ 173,316,802 $ 422,066,445
============= =============
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES:
Accounts payable ...................................... $ 2,277,456 $ 9,698,534
Accrued liabilities ................................... 2,276,630 17,444,313
Accrued interest payable .............................. 1,797,202 13,458,854
Fiber-optic network obligation ........................ 22,752,982 --
Customer advances ..................................... 4,880 8,836,707
Current portion of capital lease obligations .......... 6,713 7,237
------------- -------------
Total current liabilities ........................... 29,115,863 49,445,645
CAPITAL LEASE OBLIGATIONS ............................. 10,904 4,829
LONG-TERM DEBT, net of debt discount of $4,776,050
(1999) and $51,035,000 (2000) ....................... 61,923,950 173,965,000
CONSTRUCTION RETAINAGE PAYABLE ........................ -- 5,769,604
NOTE PAYABLE TO AFFILIATE ............................. 10,231,333 11,355,069
COMMITMENTS AND CONTINGENCIES ......................... -- --
REDEEMABLE CONVERTIBLE SENIOR PREFERRED STOCK:
1,250,000 shares authorized; $100 per share; 447,368
(1999) and 1,250,000 (2000) shares issued and
outstanding; liquidation preference $137,122,589
(2000) .............................................. 36,541,763 128,712,325
PUT WARRANTS .......................................... 25,764,000 68,000,000
STOCKHOLDERS' (DEFICIT) EQUITY:
Common stock $.01 par value, 400,000,000 shares
authorized; 80,000,000 shares issued and
outstanding 1999 and 2000 ........................... 800,000 800,000
Additional paid-in capital ............................ 9,170,591 14,914,591
Unearned compensation ................................. (905,040) (5,761,942)
Warrants .............................................. 9,713,000 59,112,000
Deficit accumulated during development stage .......... (9,049,562) (84,250,676)
------------- -------------
Total stockholders' (deficit) equity ................ 9,728,989 (15,186,027)
------------- -------------
$ 173,316,802 $ 422,066,445
============= =============
</TABLE>
3
<PAGE>
PF.NET COMMUNICATIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Inception
Three Months Ended Nine Months Ended (November 30,
September 30, September 30, 1998) to
------------------------------------------------------------ September 30,
1999 2000 1999 2000 2000
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
REVENUE:
Communications
services ............... $ 28,425 $ 63,320 $ 51,426 $ 104,730 $ 184,581
----------------------------------------------------------------------------
OPERATING EXPENSES:
Access and network
operations ............. 21,789 231,963 34,526 310,733 367,048
Selling, general and
administrative
expenses ............... 1,685,320 9,212,334 3,795,603 13,598,053 19,487,946
Depreciation and
amortization ........... 19,601 159,641 22,098 317,128 733,476
----------------------------------------------------------------------------
Total operating expenses 1,726,710 9,603,938 3,852,227 14,225,914 20,588,470
----------------------------------------------------------------------------
OPERATING LOSS ........... (1,698,285) (9,540,618) (3,800,801) (14,121,184) (20,403,889)
INCREASE IN FAIR VALUE
OF PUT WARRANTS ........ -- -- -- (42,236,000) (42,236,000)
INTEREST INCOME .......... -- 2,775,441 -- 7,407,665 8,396,046
INTEREST EXPENSE ......... (773) (3,129,814) (773) (14,344,191) (17,200,329)
----------------------------------------------------------------------------
NET LOSS BEFORE INCOME
TAXES .................. (1,699,058) (9,894,991) (3,801,574) (63,293,710) (71,444,172)
PROVISION FOR INCOME
TAXES .................. (2,000)
----------------------------------------------------------------------------
NET LOSS AND
COMPREHENSIVE LOSS ..... (1,699,058) (9,894,991) (3,801,574) (63,293,710) (71,446,172)
ACCRETION OF PREFERRED
STOCK DIVIDENDS AND
OFFERING COSTS ......... -- (3,789,495) -- (11,907,404) (12,804,504)
----------------------------------------------------------------------------
NET LOSS APPLICABLE TO
COMMON STOCK ........... $ (1,699,058) $(13,684,486) $ (3,801,574) $(75,201,114) $(84,250,676)
----------------------------------------------------------------------------
BASIC AND DILUTED LOSS
PER SHARE .............. $ (0.05) $ (0.17) $ (0.11) $ (0.94) $ (1.53)
----------------------------------------------------------------------------
Basic and diluted
weighted average
shares outstanding ..... 33,202,000 80,000,000 35,294,000 80,000,000 55,238,000
============================================================================
</TABLE>
4
<PAGE>
PF.NET COMMUNICATIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Inception
Nine Months Ended (November 30,
September 30, 1998) to
------------------------------- September 30,
1999 2000 2000
-------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................... $ (3,801,574) $ (63,293,710) $ (71,446,172)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Increase in redemption value of put
warrants .............................. -- 42,236,000 42,236,000
Accrued interest on note payable to
affiliate .............................. 1,123,736 1,123,736
Services paid for by affiliates .......... 2,020,268 -- 2,020,268
Amortization of debt discount ............ -- 4,085,217 4,166,167
Write-off bridge loan deferred
finance charges ........................ -- 9,000,000 9,000,000
Depreciation and amortization ............ 22,098 317,128 733,476
Stock based compensation expense ......... -- 2,043,098 2,489,258
Net changes in operating assets and liabilities:
Accounts receivable ................... (18,912) (1,003,984) (1,013,459)
Prepaid expenses ...................... (76,406) (339,020) (494,120)
Other assets .......................... (211,106) 635 (25,807)
Accounts payable ...................... 423,973 (1,314,757) 962,699
Accrued liabilities and interest
payable ............................. 2,345,512 1,359,356 4,183,188
-----------------------------------------------
Net cash (used in) provided by
operating activities ............... 703,853 (5,786,301) (6,064,766)
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property, plant and equipment ...... (2,630,682) (179,337,752) (182,370,550)
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash paid for deferred financing fees .......... -- (9,226,591) (26,156,203)
Payment on obligations under capital leases .... 19,179 (5,551) (9,527)
Customer advances .............................. -- 7,626,397 7,631,277
Contribution of capital ........................ 1,490,000 -- 1,490,000
Proceeds from bridge notes payable ............. -- -- 66,700,000
Proceeds from the issuance of redeemable
convertible senior preferred stock, net ........ 348,547 80,263,158 117,157,821
Proceeds from units offering ................... -- 225,000,000 225,000,000
Repayments of interim credit facility........... -- (66,701,665) (66,701,665)
Proceeds received from AT&T .................... -- 12,964,218 35,717,200
-----------------------------------------------
Net cash provided by financing
activities ............................... 1,857,726 249,919,966 360,828,903
-----------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS .................................... $ (69,103) $ 64,795,913 $ 172,393,587
CASH AND CASH EQUIVALENTS:
beginning of period ............................ -- 107,597,674 --
-----------------------------------------------
CASH AND CASH EQUIVALENTS:
end of period .................................. $ (69,103) $ 172,393,587 $ 172,393,587
===============================================
</TABLE>
5
<PAGE>
PF.NET COMMUNICATIONS, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
<TABLE>
<CAPTION>
Inception
Nine Months Nine Months (November 30,
Ended Ended 1998) to
September 30, September 30, September 30,
1999 2000 2000
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Cash paid for interest (net of amounts
capitalized) .......................... $(773) $(20,383,555) $(20,384,328)
=========================================
SCHEDULE OF NONCASH INVESTING AND FINANCING
TRANSACTIONS:
Issuance of warrants in connection with
executive recruiting services provided ... $ -- $ 1,156,000 $ 1,156,000
=========================================
Reduction in property and equipment from the
decrease in the fiber-optic obligation .. $ -- $ 22,752,982 $ 22,752,982
=========================================
Increase in property and equipment, accounts
payable, accrued interest, construction
retainage, and accrued expenses .......... $ -- $ 21,798,098 $ 21,798,098
=========================================
</TABLE>
6
<PAGE>
PF.NET COMMUNICATIONS, INC. AND SUBSIDIARIES
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Basis of presentation - The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with generally
accepted accounting principles for interim financial information and with
the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete
financial statement presentation.
The interim financial data as of September 30, 2000, and for the
three-month and nine-month periods ended September 30, 1999 and 2000, is
unaudited. The information reflects all adjustments, consisting of only
normal recurring adjustments that, in the opinion of management, are
necessary to present fairly the financial position and results of
operations of the Company for the periods indicated. The condensed
consolidated financial statements and notes thereto should be read in
conjunction with the audited financial statements and notes for the year
ended December 31, 1999 included in the registration statement on Form S-4
filed with the SEC on July 17, 2000. Results of operations for the interim
periods are not necessarily indicative of the results of operations for
the full fiscal year.
Revenue Recognition - The Company records revenue from communications
services as the services are provided. Amounts billed in advance of the
service period are recorded as deferred revenue. Revenue from dark fiber
sales and leases is recorded in accordance with FASB Interpretation No.
43, "Real Estate Sales, an Interpretation of FASB Statement No. 66," which
requires revenue to be recognized over the term of the agreement unless
title transfers to the purchaser or lessee. Authoritative accounting
guidance for dark fiber sales is evolving and any changes in the
authoritative guidance could affect accounting for revenue associated with
future transactions.
Net loss per common share - The Company calculates basic and diluted
earnings per share (EPS) pursuant to SFAS No. 128. The Company had a net
loss during the periods presented and therefore, common stock equivalents
have been excluded from the calculation of diluted EPS, as the effect is
anti-dilutive.
Comprehensive loss - In 1997, the Financial Accounting Standards Board
(FASB) issued SFAS No. 130, Reporting Comprehensive Income, which
established standards for the reporting and displaying of comprehensive
income and its components. For the periods presented, there was no
difference between the Company's net loss applicable to common stock and
comprehensive loss.
Segment reporting - The Company has adopted SFAS No. 131, Disclosures
About Segments of an Enterprise and Related Information, which defines how
operating segments are determined and requires disclosures about products,
services, major customers and geographic areas. The Company currently
operates in one business segment with an anticipated group of similar
products.
Stock split - Effective April 3, 2000, the Company effected a 2-for-1
stock split of its common stock. All share and per share amounts included
in the accompanying condensed consolidated financial statements and
footnotes have been restated to reflect the stock split.
2. Commitments
Fiber-optic swap agreement - In January 2000, the Company entered into a
conduit and fiber-optic swap agreement with Touch America (the Agreement).
Pursuant to the Agreement, the Company will swap a portion of its conduit
and fiber for 18 years, with an option to extend for an additional 20
years, in return for progressive cash payments totaling approximately
$48,500,000, subject to adjustment upon the occurrence of certain events,
and a portion of conduit and fiber from the Touch America fiber network.
Once the Company and Touch America complete the construction of their
networks under the Agreement, the swap transaction will occur.
7
<PAGE>
Credit Agreement - Effective March 31, 2000, all of the commitments under
the Company's credit agreement with Lucent Technologies, Inc. ("Lucent")
were assigned by Lucent to First Union National Bank and the credit
agreement was amended. As amended, the First Union Credit Agreement
provides, among other things, that availability thereunder may be
increased to $475,000,000 if the Company receives additional commitments
for $125,000,000. Borrowings under the credit facility bear interest, at
the Company's option, at the following rates per annum: (i) LIBOR plus an
applicable margin ranging between 3.25% to 4.25% per annum based on the
Company's consolidated leverage ratio or (ii) a base rate, which is equal
to the greater of (A) the current prime rate of certain banks, or (B) the
current U.S. federal funds rate plus 0.5% per annum, plus an applicable
margin, ranging from 2.00% to 3.00% per annum based on the status of
certain financial leverage ratios. The credit facility matures on December
31, 2006. There were no borrowings under the credit agreement as of
September 30, 2000.
Employment agreements - Effective September 1, 2000, the Company entered
into an employment agreement with its President of Internet and Advanced
Data Services. The agreement provides for base compensation over the
initial four-year term of not less than $300,000 per annum and includes a
bonus provision based upon the achievement of pre-established performance
goals. In addition, the agreement provides for the issuance of 1,000,000
stock options at an exercise price of $6.40 per share.
Effective September 7, 2000, the Company entered into an employment
agreement with its Chief Executive Officer. The agreement provides for
base compensation over the initial four-year term of not less than
$500,000 per annum and includes a bonus provision that is based upon the
achievement of pre-established performance goals. In addition, the
agreement provides for the issuance of 4,000,000 stock options at an
exercise price of $6.40 per share.
Litigation - From time to time, the Company may be party to various legal
proceedings arising in the ordinary course of our business, including
issues related to obtaining rights-of-way. As of the date of this filing,
we have not been engaged in any legal proceedings that are expected,
individually or in the aggregate, to have a material adverse effect on the
Company.
3. Common and preferred stock transactions
Common stock - On May 10, 2000, the Company completed the private
placement of 225,000 units consisting of 13.75% senior notes payable, with
a stated principal amount of $225,000,000, and warrants to purchase
8,926,296 shares of the Company's common stock for $0.01 per share. The
estimated value of the warrants, $53,100,000, has been reflected as a debt
discount with a corresponding increase to warrants. The debt discount is
being amortized over the ten-year term of the notes. The Company utilized
approximately $66,700,000 of the net proceeds to repay the outstanding
borrowings under the interim credit facility. In connection with the
repayment of amounts due under the interim credit facility, all warrants
granted pursuant thereto were canceled. The Company has written off
approximately $9,000,000 in deferred financing costs as a result of this
debt repayment.
On July 18, 2000, the Company commenced an exchange offer of publicly
tradable notes for its outstanding senior notes, which had been issued in
the private placement. Holders of the senior notes tendered their private
notes for notes publicly tradable pursuant to a registration statement on
Form S-4 filed with the SEC on July 17, 2000. This exchange offer was open
until August 25, 2000.
Effective September 7, 2000, the Company issued a warrant to an executive
recruiting firm to purchase 333,333 shares of common stock for $6.40 per
share as partial consideration for services rendered in hiring our chief
executive officer. The warrants expire on September 7, 2004. The estimated
value of the warrants of $1,156,000 has been recorded as general and
administrative expense with a corresponding increase to warrants.
Preferred stock - On May 10, 2000, the Company completed the funding of
its private placement of its Preferred Stock through the issuance of
75,063, 33,762 and 693,806 shares in March, April and May 2000,
respectively. The aggregate Preferred Stock offerings to date yielded
proceeds of $125,000,000, of which the aggregate of such offerings for the
nine-month period ended September 30, 2000 was $80,263,158. As of
September 30, 2000, the aggregate liquidation preference of the Preferred
Stock, including cumulative dividends of $12,122,589, was $137,122,589.
8
<PAGE>
4. Subsequent events
The Company's president and chief operating officer has notified the
Company that he intends to resign, and the Company is in the process of
transitioning the duties of that office to its chief executive officer and
other executives. The Company is currently negotiating a severance
arrangement with this officer that it expects will be completed in the
fourth quarter of 2000.
In October 2000, the Company closed a dark fiber sale of approximately
$9.0 million. A portion of the sales proceeds will be shared with AT&T
pursuant to our agreement with them. Cash proceeds will be recorded as
deferred revenue until construction and acceptance of the sold fiber is
complete.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except as otherwise indicated, references in this section to the
"company," "us" or "we" refer to PF.Net Communications, Inc. and its
subsidiaries.
This Report on Form 10-Q contains forward-looking statements made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995, Rule 175 under the Securities Act, Rule 3b-6 under the Exchange Act and
Securities Act Release No. 6084 (June 25, 1979). These forward-looking
statements may be affected by risks and uncertainties, including without
limitation, our ability to (i) remain in compliance with our current debt
agreements and indenture covenants; (ii) obtain additional capital and
financing, as required, at reasonable costs and on satisfactory terms and
conditions; (iii) effectively and efficiently manage the completion of the route
segments of our fiber network by construction and swapping; and (iv) access
markets and enter into contracts to sell or swap dark fiber or lease high-volume
capacity on our fiber network. These forward-looking statements also depend on
the timely performance by third-party contractors and our swap partners of their
obligations. There can be no assurance that we will remain in compliance with
our current debt agreements or indenture covenants, obtain additional capital
and financing as required, successfully manage construction or sell fiber and
capacity to additional customers. A failure of any of the foregoing may
significantly delay or prevent completion of our fiber network, which would have
a material adverse effect on our financial condition and results of operations
and our ability to continue as a going concern. In light of such risks and
uncertainties, our actual results could differ materially from such
forward-looking statements. We encourage you to review the "Risk Factors"
section of our registration statement on Form S-4, which was declared effective
on July 18, 2000. We do not undertake any obligation to publicly release any
revisions to any forward-looking statements contained herein to reflect events
and circumstances occurring after the date hereof or to reflect the occurrence
of unanticipated events.
Overview
Our goal is to become a leading facilities-based provider of
technologically advanced, high-capacity fiber optic network infrastructure and
communications services throughout the continental United States. We initially
intend to pursue a carrier's carrier strategy and position ourselves as the
"Network to the Net" by connecting many of the highest volume telecommunications
markets in the United States to each other and to the Internet. Our services
will include transmission, Internet, data and content distribution services to
Internet service providers, telecommunications carriers, corporate and
governmental entities and institutional consumers of wholesale network capacity.
Through joint construction arrangements and fiber and conduit swaps, sales and
purchases, we intend to initially assemble a low-cost, upgradable nationwide
fiber optic network initially consisting of 10,800 miles passing more than 100
metropolitan areas. We are constructing 6,400 miles of our network and acquiring
4,400 miles of our network through a swap agreement. The initial constructed
portion of our network will include substantial fiber and empty conduit. We
expect to substantially expand our network over time through swaps and sales of
fiber and conduit, fiber and conduit purchases and additional joint construction
arrangements. In addition, the Company is exploring opportunities to expand our
business plan both domestically and internationally.
On October 29, 1999, we entered into an agreement with AT&T Corp. ("AT&T")
to build approximately one-half of the outsourced portion of AT&T's recently
announced, state-of-the-art fiber optic network. The construction contemplated
by the AT&T agreement will represent approximately 5,000 miles of the 6,400-mile
constructed portion of our network, connecting important metropolitan areas
along AT&T's network. We believe that this agreement will provide us with many
business, operational and marketing advantages. AT&T will pay us for our
construction services, thus reducing our overall network construction costs. In
addition, we will design and construct this portion of the network to AT&T's
specifications, which will ensure network quality and reliability and provide us
with a key marketing advantage in offering our services. AT&T has also agreed to
provide its private rights of way for use on the AT&T portion of our network. We
and AT&T intend to jointly dispose of up to 96 dark fibers along these 5,000
route miles, which will further reduce our overall network construction costs.
We will each contribute up to 48 fibers to these joint dispositions.
We are a development stage company and, accordingly, we have a limited
operating history. The development, construction and expansion of our network
will require significant capital to be invested before any material revenue
is generated. We expect to continue to incur significant and increasing
operating losses and negative EBITDA while we construct our network and
develop our customer base. We expect to generate substantial cash proceeds
from dispositions of dark fiber rights in order to finance a portion of our
network construction costs. However, we do not anticipate significant
revenues from sales of broadband services until late 2001 or early 2002. In
order for us to meet our strategic objectives, we must complete the initial
6,400 miles of our network according to our build schedule and generate a
substantial volume of traffic on our network. In addition, we will rely upon
Touch America for timely completion of the segments of our network we will
receive from it.
10
<PAGE>
On October 29, 1999, we entered into a series of related financing
transactions that provided us with financing to begin the construction of our
network. We received a $125 million commitment from controlled affiliates of
Odyssey Investment Partners, LLC (collectively, "Odyssey") and other
co-investors to purchase our newly created senior convertible preferred stock
that was fully funded by May 10, 2000. In addition, our wholly-owned subsidiary,
PF.Net Corp., entered into a secured credit facility with Lucent that provides
for borrowings of up to $350 million. On March 31, 2000, Lucent assigned the
credit facility to First Union National Bank. The First Union credit facility
provides that availability thereunder may be increased to $475 million if we
receive additional commitments for $125 million. On October 29, 1999, we also
entered into an interim credit facility with UBS AG and Credit Suisse First
Boston. On May 10, 2000 we received $225 million in gross proceeds from the
offering of units consisting of senior notes and warrants, and we fully repaid
$66.7 million outstanding under the interim credit facility. We believe that the
net proceeds from the units offering, the Odyssey preferred stock investment,
borrowings under the credit facility, proceeds from dispositions of dark fiber
rights, payments under joint construction contracts and cash on hand will be
sufficient to satisfy our anticipated cash requirements for our initial business
model through the second quarter of 2002. See "Liquidity and Capital Resources."
Business Update
We are continuing to increase the number of our employees and the amount
of our construction. As of November 10, 2000, we had 104 full time employees,
double the number of employees we had at the end of June 2000. This number
included 11 employees seconded from one of our stockholders, PF Telecom Holdings
LLC. Construction expenditures approximated $40 million during September 2000,
and we anticipate construction spending in the near term will approximate, or
exceed, the September level as we continue our network build and begin pulling
fiber on our first phase network routes. We began pulling fiber through conduit
in August 2000 and we anticipate that we will light our first route (Houston to
Jacksonville) in the first quarter of 2001. We have experienced some permitting
and construction delays on certain routes, but our network build plan remains on
track to be substantially completed by early 2002. To date we have constructed
approximately 2,500 miles, obtained permitting for 3,500 miles and engineered
4,500 miles of our network. Our recurring operating expenditures currently
approximate $2 million per month and we anticipate this amount will increase as
we continue to bring on new employees and build out our operations. Our EBITDA,
or earnings before interest, taxes, depreciation and amortization, is consistent
with our business plan. AT&T is making payments to us for our progressive
construction of its portion of our network. Touch America is also making
payments to us for our progressive construction of network links that will be
swapped with them pursuant to our swap agreement with them.
As of October 31, 2000, we had four primary communications services
customers to whom we resell capacity that we purchase from AT&T. We are pursuing
additional resale customers and we plan to migrate these customers to our
network upon its completion on a segment-by-segment basis. In October 2000, we
closed our second dark fiber disposition for over $9 million and are continuing
to pursue a number of dark fiber sales opportunities. We expect to account for
this transaction in accordance with FASB Interpretation No. 43.
In September 2000, we hired a President of Internet and Data Services. In
connection with his hiring and the anticipated resignation of our president and
chief operating officer, we have realigned the sales and marketing organization
as well as the data and network services engineering groups under our President
of Internet and Advanced Data Services. In this realignment, we are expanding
our emphasis on data and Internet services, including high speed Internet
access, data services, virtual private networks and other broadband related
services, to complement our original business plan and physical network.
We are currently evaluating optronic and data service equipment vendors
and their products. We anticipate selecting equipment providers during late 2000
and early 2001 to allow us to begin lighting our first routes in the first
quarter of 2001.
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Results of Operations
Three months ended September 30, 2000 compared to the three months ended
September 30, 1999
We are a development stage company without a significant history of
operating revenues. During the three months ended September 30, 2000, private
line resale revenues totaled $63,320, an increase of 123% over the three months
ended September 30, 1999 due to the increased installation of circuits for
resale customers. As we are in the early stages of our resale activities and
testing our internal processes for them, the results from one period to another
are not comparable in a meaningful way.
During the three months ended September 30, 2000, access costs were
$57,529 to support the resale of those services compared to access costs of
$21,789 for the same preceding period. Selling, general and administrative
expenses increased approximately 447% from $1.7 million in the three months
ended September 30, 1999 to $9.2 million in the three months ended September
30, 2000 due to an increase in our sales and marketing personnel, as well as
other support resources in connection with the development of the network.
Additionally, the three months ended September 30, 2000 include non-recurring
charges of approximately $5.4 million in executive signing bonuses and
recruiting fees. Depreciation and amortization expenses increased from
$19,601 for the three months ended September 30, 1999 to $159,641 for the
three months ended September 30, 2000, due to an increase in the purchase of
office and data processing equipment to support additional operational staff.
Interest expense increased from a nominal amount for the three months
ended September 30, 1999 to $3.1 million for the three months ended September
30, 2000, net of $8.3 million capitalized to property and equipment. The
increase is a result of interest expense on our senior notes and availability
fees for our credit facility, as well as the amortization and write off of
certain deferred finance costs. The majority of our interest costs are
capitalized as we are in the construction phase of our network build-out.
Interest income earned was $2.8 million from continued investment of the
proceeds from our sale of preferred stock and our units offering. Our net losses
continue to reflect our development stage status and future recovery of tax
losses remain uncertain. If we are able to carry these losses forward, future
tax amounts owed will be lower due to these loss carry forwards.
Nine months ended September 30, 2000 compared to the nine months ended September
30, 1999
During the nine months ended September 30, 2000, private line resale
revenues totaled $104,730, an increase of 104% over the nine months ended
September 30, 1999. During the nine months ended September 30, 2000, access
costs were $88,407 to support the resale of those services compared to access
costs of $34,526 for the nine months ended September 30, 1999. Selling, general
and administrative expenses increased approximately 258% from $3.8 million for
the nine months ended September 30, 1999 to $13.6 million for the nine months
ended September 30, 2000 as we began to increase our sales and marketing
personnel, as well as other support resources in connection with the development
of the network. Additionally, the nine months ended September 30, 2000 include
non-recurring charges of approximately $5.8 million in executive signing bonuses
and recruiting fees. Depreciation and amortization expenses increased from
$22,098 for the nine months ended September 30, 1999 to $317,128 for the nine
months ended September 30, 2000, reflecting the increase in the purchase of
office and data processing equipment to support additional operational staff.
For the nine months ended September 30, 2000, we recorded a change in the
fair market value of put warrants owned by AT&T in the amount of $42.2 million,
in accordance with Emerging Issues Task Force (EITF) No. 96-13, Accounting for
Derivative Financial Instruments Indexed To, And Potentially Settled In, A
Company's Own Stock. Future changes in the value of the put warrants will be
recognized in earnings in future periods.
Interest expense increased from a nominal amount for the nine months ended
September 30, 1999 to $14.3 million, net of $19.5 million capitalized to network
build-out, for the nine months ended September 30, 2000, as a result of interest
on the interim credit facility and on the senior notes, and availability fees on
the credit facility. Additionally, interest expense in 2000 includes the
write-off of $9.0 million of financing costs related to the interim credit
facility. The majority of our interest costs are capitalized as we are in the
construction phase of the network build-out. Interest income earned was $7.4
million from continued investment in short term cash equivalents of the
preferred stock proceeds and funds from our units offering.
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Our net losses continue to reflect our development stage status and future
recovery of tax losses remain uncertain. If we are able to carry these losses
forward, future tax amounts owed will be lower due to these loss carry forwards.
Liquidity and Capital Resources
During the nine months ended September 30, 2000, our cash levels increased
by $64.8 million. The major elements consisted of cash proceeds from the sale of
senior convertible preferred stock to Odyssey Investment Partners and its
co-investors of $80.3 million and the sale of units for gross proceeds totaling
$225.0 million offset by the repayment of the interim credit facility of $66.7
million and capital expenditures of $179.3 million for the construction of the
network. We also received $12.9 million in cash from AT&T pursuant to our Fiber
Optic System Agreement and $7.6 million in cash from Touch America pursuant to
our swap agreement with them. These cash increases were offset by cash used in
operating activities, comprised primarily of selling, general and administrative
costs and interest costs.
The development of our business model will require significant capital
expenditures, a substantial portion of which will be incurred before any
significant related revenues from the business model are expected to be
realized. These expenditures, along with the associated early operating
expenses, will result in substantial negative operating cash flow and
substantial net operating losses for us for the foreseeable future. Although we
believe that our cost estimates and network build-out schedule are reasonable,
the actual construction costs or the timing of the capital expenditures may
deviate from current estimates. Our capital expenditures were approximately
$179.3 million during the nine months ended September 30, 2000. Total capital
expenditures for fiscal year 2000 are expected to be in excess of $250.0
million. Cash on hand and the undrawn commitments under the credit facility
provided us with approximately $522.4 million of funds available as of September
30, 2000.
Our primary funding sources currently include the following:
o Preferred Stock and Equity Investment. Upon the completion of the
units offering, we received all of the preferred stock funds
committed by Odyssey and the other co-investors of approximately
$125 million. In addition, we had previously received approximately
$8.6 million from PF Telecom Holdings LLC and Koch Telecom Ventures,
Inc. in cash, service and materials as an equity contribution.
o The Credit Facility. Our wholly-owned subsidiary, PF.Net Corp., will
borrow funds under its $350 million credit facility with First Union
National Bank as and when needed. The credit facility consists of
$200 million in term loans and a $150 million revolving credit
facility. The term loans are available for borrowing by PF.Net Corp.
until April 29, 2002 in amounts not greater than 125% of the
aggregate purchase price of products and services purchased from
vendors for use in connection with the network. Any remaining
percentage of the term loan availability that is above 100% but less
than or equal to 125% of that aggregate purchase price and the
$150.0 million revolving credit facility (which became available to
PF.Net Corp. upon the consummation of the units offering and the
funding of the remainder of the Odyssey preferred stock investment)
may be used for capital expenditures associated with our network
development, for operating expenses related to the network and other
working capital expenses and for payment of interest on our
indebtedness, all in accordance with our annual business plan. An
additional $125.0 million of term loans will become available to
PF.Net Corp. under the credit facility if we receive additional
commitments for that amount. Borrowings under the credit facility
bear interest, at PF.Net Corp.'s option, at the following rates per
annum: (1) LIBOR plus an applicable margin ranging between 3.25% to
4.25% per annum based on PF.Net Corp.'s consolidated leverage ratio
or (2) a base rate, which is equal to the greater of (A) the current
prime rate of certain banks or (B) the current U.S. federal funds
rate plus 0.5% per annum, plus an applicable margin, ranging from
2.00% to 3.00% per annum based on PF.Net Corp.'s consolidated
leverage ratio. PF.Net Corp. currently has no outstanding borrowings
under the credit facility. Based on our network construction
expenditures, we have $305.4 million available under the credit
facility as of September 30, 2000. The credit facility matures on
December 31, 2006.
o The Units Offering. On May 10, 2000, we completed the private
placement of 225,000 units consisting of 13.75% senior notes with a
stated principal amount of $225.0 million and warrants to purchase
an aggregate of 8,926,296 shares of our common stock for $0.01 per
share. We received $225.0 million in gross proceeds from the sale
of the units. The estimated value of the warrants, $53.1 million
has been reflected as a debt discount with a corresponding increase
to warrants. The debt discount is being amortized over the ten-year
term of the senior notes. We utilized approximately $66.7 million
of the net proceeds to repay all of the outstanding borrowings
under the interim credit facility. In connection with the repayment
of amounts due under the interim credit facility, all warrants
granted pursuant thereto were canceled. We have written off
approximately $9.0 million in deferred financing costs as a result
of this debt repayment.
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o Proceeds from Sales, Swaps, Leases and IRUs of Dark Fiber. Our
current business plan contemplates that we will receive more than
$150.0 million in cash from sales, swaps and leases of dark fiber
through the end of 2001, including the approximately $48.5 million
we expect to receive in the Touch America swap. The majority of
these proceeds will be applied to the construction and operation of
our network. We plan to sell, grant IRUs or lease up to 48 fibers in
each mile of our constructed network. Pursuant to the AT&T
agreement, we have agreed with AT&T to jointly sell, grant IRUs,
lease or swap up to 96 fibers on the portion of our network to be
built pursuant to the AT&T agreement. We will each contribute 48
fibers to these joint dispositions.
o Joint Construction. We plan to use joint construction contracts to
decrease our construction costs. Under the AT&T agreement, we expect
to receive approximately $220.0 million of payments from AT&T for
construction of the 5,000 miles contemplated by the AT&T agreement.
We have received $35.7 million of these payments to date. We will
seek to enter into similar arrangements with other
telecommunications providers for the remaining 1,400 miles of our
initial network that we plan to build.
o Vendor Financing. We plan to finance the cost of certain fiber optic
and related data equipment through vendor financing arrangements. We
are currently negotiating with selected vendors to obtain financing
as part of our equipment purchase agreements that we plan to enter
into with them.
We expect that our primary cash uses over the next two years will include
the following:
o Network Build Costs. Our primary anticipated cash need is funding
capital expenditures for network build costs. We spent approximately
$182.4 million under our network capital plan through September 30,
2000. We estimate that during the period from January 1, 2000
through December 31, 2001, we will spend a total of approximately
$984 million to construct and light the initial 10,800 miles of our
network assuming the 6,400-mile portion of our network consists of
an average of 136 fibers per route mile. This represents a cost
increase from our original plan due mostly to an increase in the
average fiber count from 96 fibers to 136 fibers and a projected
fiber purchase to allow for network expansion. Our construction is
being performed under construction contracts with third parties
that include liquidated damage provisions and penalties if such
construction is not completed within specified timeframes.
o Debt Service Payments. We estimate that during the period from
January 1, 2000 through December 31, 2001, we will pay approximately
$79.5 million in interest.
o Operating Losses. Over the next two years we expect to generate
substantial operating losses.
We believe that the net proceeds from the units offering and the Odyssey
preferred stock investment, borrowings and additional availability under the
credit facility, proceeds from dispositions of dark fiber, payments under
joint construction contracts, cash on hand, and our planned vendor financing,
which we are currently negotiating, will be sufficient to satisfy our
anticipated cash requirements through June 30, 2002 for our base construction
plan. However, we cannot assure you that our capital needs will not exceed
the amounts we have estimated, that our construction costs or operating
losses will not be larger than we currently anticipate, that cash received
from dark fiber dispositions will be at the levels we currently expect, that
we will be able to finance changes to our base construction plan, or that we
will be able to obtain the necessary funds under the credit facility or from
the sources described above or at all. If we raise additional capital through
a debt or vendor financing, our interest expense will increase and we may
become subject to more restrictive covenants. If we issue additional equity,
the ownership interest represented by our existing equity interests,
including the warrants issued in the units offering, may be diluted. If we
are unable to obtain the necessary funds, we will be required to scale back
or defer our planned capital expenditures and, depending on the cash flow
from our then-existing businesses, reduce the scope of our planned operations
and/or restructure our debts. In that case, if we are unable to restructure
our debts, we may not be able to continue as a going concern. Additionally,
continued increases in interest rates could have a material impact on our
ability to pay interest on variable rate debt that we may obtain under our
credit facilities. In addition, our ability to expand our business and enter
into new customer relationships may depend on our ability to obtain
additional financing for these projects. To the extent that we expand the
scope of our network beyond the initial 10,800 miles or into international
markets, we will need additional capital. Continued weakness in the capital
markets for telecommunications companies could also materially affect our
ability to obtain additional financing.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We have interest rate exposure related to the credit facility. Borrowings
under that facility bear interest at rates that fluctuate with changes in
short-term interest rates. The credit facility requires us to hedge the risks
related to interest rate movements through the use of interest rate protection
agreements or other derivative instruments and as necessary to ensure that at
least 50% of our consolidated indebtedness either bears interest at a fixed rate
or is protected against interest rate fluctuations by a hedging agreement that
fixes or limits our interest cost. As all of the interest on the senior notes is
at a fixed rate and we currently have no borrowings under the credit facility,
no interest rate hedging is currently required. We may choose to manage our risk
associated with interest rate movements through an appropriate balance of fixed
and variable rate obligations as described above. To maintain an effective
balance of fixed and variable obligations, we may elect to enter into specific
interest rate swaps or other derivative instruments as we deem necessary.
New Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivatives and
Hedging Activities. This statement, as amended by SFAS Nos. 137 and 138,
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statements of financial position and measure
those instruments at fair value. We are required to adopt SFAS No. 133 on
January 1, 2001. We currently do not use any derivative instruments and
accordingly, we do not anticipate that adoption of SFAS No. 133 will have a
material impact on our financial statements.
In June 1999, the FASB issued Interpretation No. 43, "Real Estate Sales,
an Interpretation of FASB Statement No. 66," which is effective for transactions
entered into after June 30, 1999. This interpretation considers dark fiber as
integral equipment, and to obtain sales-type lease accounting on fiber sale or
lease transactions, title must transfer to the purchaser or lessee. Transactions
in which title does not transfer must be accounted for as operating leases and
revenue will be recognized over the term of the agreement. The Interpretation
does not affect cash flows from dark fiber sales, leases, or IRU's, however; it
could result in a substantial amount of deferred revenue being recorded.
Authoritative accounting guidance is evolving and any changes in the
authoritative guidance could affect accounting for revenue and expenses
associated with future transactions.
The FASB issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation." This interpretation modifies the
current practice of accounting for certain stock award agreements and is
generally effective beginning July 1, 2000. The initial impact of this
interpretation on our results of operations and financial position was not
material, but its application may have a material impact on future accounting
for stock compensation transactions.
In December 1999, the SEC staff released Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides
interpretive guidance on the recognition, presentation and disclosures of
revenue in the financial statements and its application is retroactive to
January 1, 2000. We believe our existing revenue recognition policies generally
comply with SAB 101 and accordingly, we do not believe that adoption of SAB 101
in the fourth quarter of 2000 will have a material affect on our financial
results.
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PART II - OTHER INFORMATION
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
The following information is furnished with regard to equity securities
sold by us within the fiscal quarter ending September 30, 2000, which were not
registered under the Securities Act.
(a) On September 7, 2000, we issued a four-year warrant to Heidrick &
Struggles, Inc. in partial consideration of services rendered in its
executive search efforts in the hiring of our Chief Executive
Officer. The warrant, when exercised, will entitle the holder to
purchase 333,333 shares of our common stock at a price of $6.40 per
share of common stock.
All of the above shares were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933 as
transactions by an issuer not involving a public offering.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) As of July 12, 2000, a majority of our stockholders approved by
written consent in lieu of a meeting pursuant to Section 228 (a) of
the Delaware General Corporation Law, the adoption of our Amended
and Restated 1999 Equity Incentive Plan.
(b) As of September 27, 2000, our stockholders approved by unanimous
written consent in lieu of a meeting pursuant to Section 228(a) of
the Delaware General Corporation Law, the increase in the number of
members of the Board of Directors to eleven and the election of
Kirby G. Pickle, Jr., our Chief Executive Officer, as a member of
the Board of Directors.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
10.1 1999 Equity Incentive Plan of PF.Net Communications,
Inc., as Amended and Restated as of July 12, 2000
(incorporated by reference to Exhibit 10.28 to the
Company's Registration Statement No. 333-39646 on Form
S-4 filed on July 17, 2000 with the Securities and
Exchange Commission).
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
Report on Form 8-K (Item 5) filed on September 14, 2000, regarding the
hiring of Kirby G. Pickle, Jr. as our Chief Executive Officer.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 14, 2000
PF.NET COMMUNICATIONS, INC.
(Registrant)
By: /s/ David L. Taylor
-------------------------------------
Name: David L. Taylor
Title: Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed on November 14, 2000 by:
SIGNATURE TITLE
--------- -----
/s/ David L. Taylor
--------------------------------- Chief Financial Officer
David L. Taylor
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