<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended: September 30, 1999
OR
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______ to _________
Commission File Number: 000-25333
PRODIGY COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-3323363
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
44 SOUTH BROADWAY
WHITE PLAINS, NEW YORK 10601
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (914) 448-8000
Former name, former address, and former
year, if changed since last report: Not applicable
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the Issuer's classes of
Common Stock, as of the latest practicable date.
Title of each class
- - -------------------
Common stock $.01 par value
Shares outstanding on October 31, 1999 64,099,307
__________
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
FORM 10-Q
QUARTER ENDED September 30, 1999
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition 8
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 12
Item 2. Changes in Securities and Use of Proceeds 12
Item 6. Exhibits 14
Signatures
________________
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. The important
factors discussed below under the caption "Certain Factors That May Affect
Future Operating Results," among others, could cause actual results to differ
materially from those indicated by forward-looking statements made herein and
presented elsewhere by management from time to time. Such forward-looking
statements represent management's current expectations and are inherently
uncertain. Investors are warned that actual results may differ from management's
expectations.
Prodigy(R), Prodigy Internet(TM), and Prodigy Classic(TM) are trademarks of
the Company. All other trademarks referred to herein are the property of their
respective owners.
2
<PAGE>
PART I.
Item 1. Financial Statements
PRODIGY COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands except share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
- - --------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 10,380 $12,180
Accounts receivable, net of allowance for doubtful 3,997 966
accounts of $1,327 and $367 on September 30,
1999 and December 31, 1998, respectively
Due from affiliate 1,201 -
Restricted cash 52,500 -
Prepaid expenses 3,079 1,691
Other current assets 181 106
- - --------------------------------------------------------------------------------
Total current assets 71,338 14,943
Restricted cash 4,624 5,420
Notes receivable, net of allowance of - -
$16,148 at September 30, 1999 and
December 31, 1998
Property and equipment, net 16,550 12,998
Tradename, net 23,908 26,579
Goodwill, net 10,424 11,587
Deferred network costs 4,157 5,939
Deferred subscriber acquisition costs 144,033 -
Other assets 229 866
- - --------------------------------------------------------------------------------
Total assets $275,263 $78,332
======== =======
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable $ 36,000 $ 2,000
Accounts payable and accrued expenses 73,520 28,635
Accrued compensation 3,805 3,000
Unearned revenue 15,437 10,200
Accrued purchase and restructuring costs 3,851 4,705
- - --------------------------------------------------------------------------------
Total liabilities 132,613 48,540
- - --------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock; $.01, par value; 10,000,000
shares authorized; none issued or outstanding - -
Contingent convertible notes - 30,500
Common stock; $.01 par value; 150,000,000 and
280,000,000 shares authorized; 61,204,083 and
45,034,297 shares issued and outstanding at
September 30, 1999 and December 31, 1998,
respectively 612 450
Additional paid-in capital-common stock 486,882 294,296
Accumulated deficit (343,511) (292,787)
- - --------------------------------------------------------------------------------
143,983 32,459
Less note receivable from stockholder (1,333) (2,667)
- - --------------------------------------------------------------------------------
Total stockholders' equity 142,650 29,792
- - --------------------------------------------------------------------------------
Total liabilities and stockholders' equity $275,263 $78,332
======== =======
</TABLE>
The accompanying footnotes are an integral part of the condensed consolidated
financial statements.
3
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
For the For the For the For the
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
- - ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
Internet and online service revenues:
Prodigy Internet $ 40,080 $ 21,704 $ 98,053 $ 55,902
Prodigy Classic 3,842 10,392 15,569 39,329
------------ ------------ ------------ ------------
43,922 32,096 113,622 95,231
Other (including $1,889 and $4,061 of affiliate
revenue for the three and nine
months ended September 30, 1999,
respectively) 4,977 2,062 8,293 6,237
- - ----------------------------------------------------------------------------------------------------------------
Total revenues 48,899 34,158 121,915 101,468
Operating costs and expenses:
Cost of revenue 27,743 22,202 71,694 70,813
Marketing 13,446 10,435 36,958 25,804
Product development 2,761 2,539 9,616 7,670
General and administrative 16,827 11,075 42,341 33,448
Depreciation and amortization 4,196 3,861 12,477 11,932
Amortization of subscriber acquisition costs 8,604 - 8,604 -
- - -------------------------------------------------------------------------------- ----------------------------
Total operating costs and expenses 73,577 50,112 181,690 149,667
------------ ------------ ------------ ------------
Operating loss (24,678) (15,954) (59,775) (48,199)
Interest (income)/expense, net (1,127) 135 (4,033) 463
Gain on sale of equity investment - (385) (3,319) -
Gain on settlement of note payable - - (1,714) -
Gain on asset sale - - - (785)
Other 59 - 15 -
---------------------------- ----------------------------
Net loss $ (23,610) $ (15,704) $ (50,724) $ (47,877)
============================ ============================
Basic and diluted net loss per share $ (0.39) $ (0.39) $ (0.87) $ (1.30)
============ ============ ============ ============
Weighted average number of shares outstanding
used in computing basic and diluted net loss
per share 61,145,041 40,002,234 58,564,189 36,780,214
============ ============ ============ ============
</TABLE>
The accompanying footnotes are an integral part of the condensed consolidated
financial statements.
4
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
For the For the
Nine Months Nine Months
Ended Ended
September 30, September 30,
1999 1998
- - --------------------------------------------------------------------------------------------------
<S> <C>
Cash flows from operating activities:
Net loss $ (50,724) $ (47,877)
Adjustments to reconcile net loss to net cash used in operating
activities:
Gain on sale of equity investments (3,319) -
Option grants at less than fair value 963 420
Depreciation 5,899 6,200
Amortization of goodwill 1,163 1,163
Amortization of tradename 2,671 2,399
Amortization of deferred network asset 1,782 1,750
Amortization of deferred subscriber
acquisition costs 8,604 -
Change in operating assets and liabilities,
net of effects of acquisitions and disposals
Accounts receivable (3,031) 1,383
Due from affiliate (1,201) -
Other receivables - 674
Prepaid expenses (1,388) 510
Assets held for sale - (370)
Other assets 562 601
Accounts payable and accrued expenses 11,252 (20,324)
Accrued compensation 805 1,205
Unearned revenue 5,237 5,975
Accrued purchase and restructuring costs (854) (2,915)
- - ----------------------------------------------------------------------------------------------
Net cash used in operating activities (21,579) (49,206)
- - ----------------------------------------------------------------------------------------------
Cash flows from investing activities:
Acquisition of property and equipment (9,451) (415)
Proceeds from sale of equity investments 3,319 -
Acquisition of subscribers (119,004) -
Restricted cash (51,704) -
- - ---------------------------------------------------------------------------------------------
Net cash used in investing activities (176,840) (415)
- - ---------------------------------------------------------------------------------------------
Cash flows from financing activities:
Sale of common stock, net of fees 161,285 75,025
Borrowings/(repayments) of notes payable to related
parties 36,000 (10,000)
Repayment of note payable to unrelated party (2,000) -
Repayments of note receivable from stockholder 1,334 1,000
Other - 247
- - ---------------------------------------------------------------------------------------------
Net cash provided by financing activities 196,619 66,272
- - ---------------------------------------------------------------------------------------------
Net increase (decrease) in cash (1,800) 16,651
------------ ----------
Cash and cash equivalents, beginning 12,180 12,363
------------ ----------
Cash and cash equivalents, ending $ 10,380 $ 29,014
============ ==========
Noncash financing activity:
Conversion of contingent convertible notes to common stock 30,500 -
</TABLE>
The accompanying footnotes are an integral part of the condensed consolidated
financial statements.
5
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
(in thousands except share and per share amounts)
For the period ended September 30, 1999
<TABLE>
<CAPTION>
Contingent Additional
Preferred Stock Convertible Common Stock Paid in
Shares Amount Securities Shares Amount Capital
--------------- ----------- ------------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 0 $0 $30,500 45,034,297 $450 $294,296
Sale of common stock
Exercise of options - - 714,520 7 5,752
Sale of stock - - 11,200,000 112 156,377
Conversion of notes into common stock (30,500) 4,255,266 43 30,457
Comprehensive Loss:
Net loss
Comprehensive loss
-------------------------------------------------------------
Balance, September 30, 1999 0 $0 $0 61,204,083 $612 $486,882
====== ====== ====== =========== ===== ==========
</TABLE>
<TABLE>
<CAPTION>
Note
Receivable
Accumulated From
Deficit Shareholder Total
----------- ----------- -----
<S> <C> <C> <C>
Balance, December 31, 1998 $(292,787) $(2,667) $29,792
Sale of common stock 5,759
Exercise of options 1,334 157,823
Sale of stock
Conversion of notes into common stock -
Comprehensive Loss:
Net loss (50,724) (50,724)
----------
Comprehensive loss (50,724)
---------------------------------------------------
Balance, September 30, 1999 $(343,511) $(1,333) $142,650
=========== ========== ===========
</TABLE>
The accompanying footnotes are an integral part of the condensed consolidated
financial statements.
6
<PAGE>
PRODIGY COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(in thousands except share and per share information)
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements,
which include the accounts of Prodigy Communications Corporation (the "Company")
and its wholly owned subsidiaries, have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments, consisting only of normal
recurring accruals, considered necessary for a fair presentation, have been
included in the accompanying unaudited financial statements. All significant
intercompany transactions and balances have been eliminated in consolidation.
Certain amounts in prior years' consolidated financial statements have been
reclassified to conform to the current year presentation. Operating results for
the three and nine month periods ended September 30, 1999 are not necessarily
indicative of the results that may be expected for the full year ending December
31, 1999. For further information, refer to the consolidated financial
statements and notes thereto, included in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998.
Note 2. Common Stock Offering
On February 17, 1999, the Company completed an initial public offering
under the Securities Act of 1933. The Company sold 11,200,000 shares of Common
Stock and raised net proceeds of approximately $156,400.
Upon the completion of the Company's offering both IBM and Sears acquired
an interest in the Company's outstanding common stock in accordance with the
terms of the Contingent Convertible Notes. IBM and Sears each received
approximately 2,127,500 shares for a combined total of approximately 4,255,000.
Additionally, IBM and Sears each received warrants which allow them to
purchase 2,409,145 additional shares each at $19.50 per share. Those warrants
are exercisable for three years from the conversion date.
Note 3. Subscriber Acquisition Costs
In May 1999, the Company entered into an agreement with Cable & Wireless
USA, Inc. to purchase the dial-up access Internet subscriber base of that
entity. At the closing on July 20, 1999, the Company paid Cable & Wireless USA,
Inc. $40,900 in cash and anticipates the final purchase price will not exceed
this amount. The Company has capitalized the costs of the subscribers purchased
under this agreement and is amortizing these costs over 36 months representing
the estimated weighted average term of the subscribers acquired. During the
three months ended September 30, 1999, the Company had recorded gross subscriber
acquisition costs from this transaction of $41,600 and had recognized
amortization expenses of $2,400.
In June 1999 and August 1999, respectively, the Company entered into
agreements with two major retailers of personal computers (the "Retailers") to
make specified payments to the Retailers in exchange for the Retailers enrolling
customers onto Prodigy Internet and obtaining a signed contractual commitment
from these customers to term subscriptions to Prodigy Internet of one, two, or
three years at a monthly charge of $19.95. The Company has capitalized these
payments and is amortizing them over the life of the subscriber contract. During
the three months ended September 30, 1999, the Company had recorded gross
subscriber acquisition costs related to these transactions of $111,000 and had
recognized related amortization expense of $6,200. In addition, at September 30,
1999, the Company had recorded accrued subscriber contract expenses to the
Retailers of $33,600. (See Note 8-Restricted Cash)
The Company reviews subscriber terminations quarterly. Any unamortized
subscriber acquisition costs related to such terminations are written off
immediately.
Note 4. Restructuring Reserves
During the quarter and nine months ended September 30, 1999 the Company
paid $463 and $853, respectively, of expenditures related to the 1997
restructuring reserve. These expenditures related to contractual obligations and
severance payments identified under the original plans. The remaining reserve
consists primarily of contractual obligations that management expects will be
paid in full by December 31, 2001.
Note 5. Settlement of Debt
In January 1999, the Company paid a network company $750 in full settlement
of its 8 1/4% convertible note in the principal amount of $2,000, and all
accrued interest.
Note 6. Gain on Sale of Assets
During 1997 the Company sold a subsidiary which eventually became part of
TCI Music. As a result of the sale, the Company acquired shares in TCI music.
During April of 1999, TCI Music announced its merger with Liberty Media. As a
result, the value of the Company's investment increased and was sold for $3,325,
generating a gain of $3,319 which was realized during the second quarter.
Note 7. Net Loss Per Share
The Company computes basic and diluted earnings per share in accordance
with Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings
per Share". SFAS 128 requires the Company to report both basic earnings per
share, which is based on the weighted average number of common shares
outstanding, and diluted earnings per share, which is based on the weighted
average number of common shares outstanding and all dilutive potential common
shares outstanding. Since the Company incurred losses for all periods presented,
the inclusion of options in the calculation of weighted average common shares is
anti-dilutive; and therefore there is no difference between basic and diluted
earnings per share.
Note 8. Restricted Cash
In connection with its June 1999 agreement with a major personal computer
retailer, the Company was required to establish a $50,000 irrevocable stand-by
letter of credit with a domestic money center bank. This letter of credit was
issued in July 1999 and is collateralized by cash collateral of the Company in
the amount of $52,500. The letter of credit expires on December 31, 1999.
Note 9. Recent Pronouncements
During the first quarter of 1999 the Company adopted the American Institute
of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". All internal software is recorded by the Company in accordance
with the above mentioned pronouncement and is depreciated over three years
beginning on the date the software is put in use. The Company has capitalized
$500 and $3,400 of costs related to internal use of software during the quarter
and nine months ended September 30, 1999, respectively.
In January 1999, the Company adopted SOP 98-5 "Reporting on the Costs of
Start-up Activities." SOP 98-5 provides guidance on the financial reporting of
start-up costs and organization costs. It requires the costs of start-up
activities and organization costs to be expensed as incurred. As the Company has
expensed these costs historically, the adoption of this standard did not have a
significant impact on the Company's results of operations, financial position or
cash flows.
The FASB recently issued Statement No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of Effective Date of FASB Statement
No. 133". The Statement defers for one year the effective date of FASB Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
133 will now be effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000. SFAS No. 133 will require the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not hedges
must be adjusted to fair value through income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be offset against the change in fair value of the hedged assets,
liabilites, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
Company does not believe the adoption of this standard will have a material
effect on the Company's results of operations.
Note 10. Subsequent Events
On October 5, 1999, the Company acquired the BizOnThe.Net web hosting
business and subscribers of U.S. Republic Communications, Inc. ("USR"), an
indirect majority-owned subsidiary of VarTec Telecom, Inc. ("VarTec"). At the
closing, Prodigy issued to USR 2,113,721 shares of Prodigy common stock and
repaid a $9 million loan from VarTec to USR. Prodigy also issued an additional
727,272 shares into an escrow account. Some or all of these escrowed shares will
be released to USR at various times over the two-year period following the
closing. The escrow account collateralizes the indemnification obligations of
USR and USR's shareholders as well as certain post-closing adjustments, as more
fully described in the Asset Purchase Agreement dated September 7, 1999. In
addition to the amounts paid at closing, in 2001 Prodigy will be required to
issue up to 727,272 additional shares, contingent upon the attainment by the
acquired business of specified earn-out targets.
On November 8, 1999, the Company announced a definitive agreement to
acquire FlashNet Communications, Inc. in a stock-for-stock merger. Under the
terms of the merger agreement, Prodigy will issue 0.35 shares of Prodigy common
stock for each share of FlashNet common stock outstanding on the closing date of
the transaction. Based on the number of shares of FlashNet currently
outstanding, Prodigy will issue approximately 4,990,000 shares to complete the
merger.
The foregoing transactions will be accounted for under the purchase method of
accounting.
7
<PAGE>
Item 2. Management's Discussion And Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the
Consolidated Unaudited Financial Statements and Notes thereto contained herein
under Item 1.
Overview
The Company is a leading national ISP. In October 1996, the Company
launched Prodigy Internet, an open standards-based Internet access service.
Since the autumn of 1997, the Company has focused on expanding the Prodigy
Internet subscriber base and introducing additional value-added services. The
Company has also made strategic decisions to outsource its network, most of
its content, and use multiple vendors for outsourced customer service functions.
As a result of these initiatives, the Company has substantially reduced its
fixed operating costs and headcount.
The results of operations of ISPs, including those of the Company, are
significantly affected by subscriber cancellations. Subscriber acquisition
expenses and the administrative expenses of enrolling and assisting new
subscribers are substantial, and in the past the Company typically offered free
service for one or two months to new subscribers. In distribution channels, the
Company has replaced free trial programs with money-back guarantees in order to
attract enrollees who are less likely to terminate service. The failure to
attract and retain subscribers to the Company's services, or an increase in the
rate of subscriber cancellations, would have a material adverse effect on the
Company.
The Company historically has experienced seasonality in its business, with
higher expenses during the last and first fiscal quarters, corresponding to the
Christmas and post-Christmas selling season, and lower timed usage revenues
(revenues from hourly usage charges) during its second and third fiscal quarters
resulting from reduced usage of its services during the summer months. The
seasonal reductions in timed usage revenues historically experienced by the
Company have been mitigated by the movement from timed usage plans to unlimited
usage plans as well as growth in the Company's subscriber base, although the
Company expects to continue to have higher expenses during its first and fourth
quarters due to higher network usage. As a result of the seasonality of its
business, as well as other factors, the Company experiences quarterly
fluctuations in it its operating results.
Results of Operations
Three Months Ended September 30, 1999 Compared to Three Months Ended September
30, 1998
The Company's total revenues have two components: Internet and online
service revenues consist of subscription revenues from subscribers to
Prodigy Internet and Prodigy Classic. Other revenues consist of advertising
and transaction fees, Web hosting fees from the Company's Business Services
division, and fees from a management contract with Telmex under which Prodigy
provides certain management and consulting services to Telmex's Internet
subsidiary Prodigy Internet de Telmex.
The Company defines "billable" subscribers as subscribers who remain
enrolled beyond completion of the applicable trial period or who enroll in a
money-back guarantee program. The Company defines "Internet subscribers managed"
as billable Prodigy Internet subscribers and billable Prodigy Internet
de Telmex subscribers but excluding Prodigy Classic subscribers.
Internet revenues
Subscription revenues for Prodigy Internet increased $18.4 million, or 85%,
from $21.7 million for the three months ended September 30, 1998 to $40.1
million for the three months ended September 30, 1999. The number of Prodigy
Internet billable subscribers increased 522,000, or 121%, from 433,000 at
September 30, 1998 to 955,000 at September 30, 1999. Subscription revenues from
Prodigy Classic decreased $6.6 million, or 63%, from $10.4 million in the three
months ended September 30, 1998 to $3.8 million in the three months ended
September 30, 1999 as the number of Prodigy Classic billable subscribers
decreased from 208,000 at September 30, 1998 to 70,000 at September 30, 1999.
The Company discontinued Prodigy Classic on October 1, 1999. Total Internet
subscribers managed increased by 782,000 or 181%, from 433,000 at September 30,
1998 to 1,215,000 at September 30, 1999. Billable subscribers of Prodigy
Internet de Telmex accounted for approximately 260,000 of the number of Internet
subscribers managed at September 30, 1999.
Other revenues
Other revenues increased $2.9 million, or 138%, from $2.1 million for the
three months ended September 30, 1998 to $5.0 million for the three months ended
September 30, 1999 as a result of the Company's management agreement with Telmex
under which the Company receives a percentage of the monthly net revenues from
Telmex's Internet subscribers.
As a result of the foregoing factors, total revenues increased by $14.7
million, or 43%, from $34.2 million in the three months ended September 30, 1998
to $48.9 million in the three months ended September 30, 1999.
Cost of revenues
Cost of revenues includes network and content expenses. Content expenses
consist of the costs of developing, or obtaining from third parties, content for
inclusion in the Company's service offerings. Cost of revenues increased $5.5
million, or 25%, from $22.2 million in the three months ended September 30, 1998
to $27.7 million in the three months ended September 30, 1999. The current
period increase included $2.2 million of Cable & Wireless network expenses
incurred by Prodigy pursuant to contract to provide network services to Cable &
Wireless subscribers prior to their migration to Prodigy Internet. An additional
$.9 million was incurred for additional Splitrock network charges for those
Cable & Wireless subscribers that did migrate to Prodigy Internet. The remainder
of the increase in the quarter was primarily attributable to network charges of
contract subscribers acquired through the retail channel during the quarter.
Marketing
Marketing expense includes the costs to acquire and retain subscribers,
advertising and other general sales and marketing costs. Marketing expense
increased $3.0 million, or 29%, from $10.4 million in the three months ended
September 30, 1998 to $13.4 million in the three months ended September 30,
1999. The current period increase reflects expenses incurred in connection with
marketing to the Cable & Wireless subscriber base, marketing expenses directed
toward encouraging the migration of Classic subscribers to Prodigy Internet and
media costs incurred in connection with the Company's advertising campaign.
Product development
Product development expense includes research and development costs and
other product development costs. Product development expense increased from $2.5
million in the three months ended September 30, 1998 to $2.8 million in the
three months ended September 30, 1999. The current period increase was the
result of product development activities centered on implementing the billing,
provisioning and customer service infrastructure to support the Company's
Business Services division, improving the system infrastructure supporting the
Prodigy Internet de Telmex subscriber base, including Year 2000 remediation
efforts, developing a new home page for Prodigy Internet, and developing future
Prodigy Internet product offerings and service enhancements.
General and administrative
General and administrative expense increased from $11.1 million in the
three months ended September 30, 1998 to $16.8 million in the three months ended
September 30, 1999. The increase was primarily attributable to substantially
higher subscriber management expenses incurred in connection with the heavy
volume of enrollments achieved from the retail channel as a result of the
contract subscriber program, higher billing charges, increased credit card
processing fees, and higher incentive compensation expense.
Depreciation and amortization
Depreciation and amortization expense increased $.3 million, or 9%, from
$3.9 million in the three months ended September 30, 1998 to $4.2 million in the
three months ended September 30, 1999. The current period increase primarily
reflects depreciation attributable to new accounting and financial reporting
software and subscriber management software implemented during 1999.
Amortization of subscriber acquisition costs
In June and August 1999, respectively, the Company entered into agreements
with two national retailers of personal computers for the purpose of stimulating
Prodigy Internet enrollments by agreeing to make a payment to the retailer in
exchange for the retailer enrolling a customer onto Prodigy Internet and
obtaining a signed contractual commitment from the customer to a term
subscription to Prodigy Internet. These payments amount to $100, $250, or $400,
respectively, for a term subscription of one, two or three years at a monthly
charge of $19.95.
In July 1999 the Company acquired the Internet dial-up business of
Cable & Wireless USA, Inc.
The Company has capitalized these subscriber acquisition costs and
amortizes these costs over the term of the underlying subscriber contract (for
the Retailer Costs) or 36 months which represents the estimated weighted average
term of the subscribers acquired(for the Cable & Wireless Subscribers).
Amortization of subscriber acquisition costs of $8.6 million was incurred
by the Company during the nine months ended September 30, 1999 which encompassed
$2.4 million for amortization of the purchase price of subscribers acquired from
Cable and Wireless and $6.2 million for amortization of payments made to certain
retailers in exchange for obtaining contract subscribers to Prodigy Internet.
Restructuring Reserves
During the three months ended September 30, 1999, the Company incurred
$.5 million of expenditures related to the 1997 restructuring reserve.
These expenditures relate to contractual obligations and severance
payments identified under the original plans. The remaining reserve consists
primarily of contractual obligations that management expects will be paid in
full by December 31, 2001.
Interest and other income
Interest income/expense, net improved from net income of $.3 million in the
three months ended September 30, 1998 to net income of $1.1 million in the three
months ended September 30, 1999. This improvement was due to higher cash levels
following the Company's initial public offering in February 1999.
As a result of the foregoing factors, the Company's operating loss
increased from $16.0 million in the three months ended September 30, 1998 to
$24.7 million in the three months ended September 30, 1999 and its net loss
increased from $15.7 million in the three months ended September 30, 1998 to
$23.6 million in the three months ended September 30, 1999.
Nine Months Ended September 30, 1998 Compared To Nine Months Ended September
30, 1999
Internet revenues
Subscription revenues for Prodigy Internet increased $42.2 million, or 75%,
from $55.9 million for the nine months ended September 30, 1998 to $98.1 million
for the nine months ended September 30, 1999. The number of Prodigy Internet
subscribers increased 522,000, or 121%, from 433,000 at September 30, 1998 to
955,000 at September 30, 1999. Subscription revenues from Prodigy Classic
decreased $23.7 million, or 60%, from $39.3 million in the nine months ended
September 30, 1998 to $15.6 million in the nine months ended September 30, 1999
as the number of Prodigy Classic billable subscribers decreased from 208,000 at
September 30, 1998 to 70,000 at September 30, 1999. The Company discontinued
Prodigy Classic on October 1, 1999. Internet subscribers managed by the Company
increased by 782,000 or 181% from 433,000 at September 30, 1998 to 1,215,000 at
September 30, 1999.
Other revenues
Other revenues increased $2.1 million, or 34%, from $6.2 million for the
nine months ended September 30, 1998 to $8.3 million for the nine months ended
September 30, 1998 due primarily to fees received by the Company in the current
period from its management agreement with Telmex.
As a result of the foregoing factors, total revenues increased by 20% from
$101.5 million in the nine months ended September 30, 1998 to $121.9 million in
the nine months ended September 30, 1999.
Cost of revenues
Cost of revenues increased $.9 million, or 1%, from $70.8 million in the
nine months ended September 30, 1998 to $71.7 million in the nine months ended
September 30, 1999. This increase was primarily attributable to higher network
charges due to the increased level of subscribers and was offset in part by the
Company's content outsourcing agreement with Excite, which substantially
eliminated content expense associated with Prodigy Internet beginning April
1998, and to the sale of the Company's African Internet operations in October
1998. In addition, the Company benefited from its network outsourcing
arrangement with Splitrock by reaching the contractual "cap" of its monthly
network charges in April 1998 and, effective January 1999, by securing a more
favorable rate for a certain category of subscriber. As a result, network usage
costs increased only $4.6 million, or 10%, versus the year earlier period
despite an increase of 59% in network usage hours.
Marketing
Marketing expense increased $11.2 million, or 43%, from $25.8 million in
the nine months ended September 30, 1998 to $37 million in the nine months ended
September 30, 1999. During the current period, the Company increased broadcast
and print media advertising in connection with the launch of the Prodigy
Hispanic Internet offering and the continuation of the "There Is A Choice"
advertising campaign.
In addition, the current period increase reflected expenses incurred in
connection with marketing to the Cable & Wireless subscriber base, marketing
expenses directed toward encouraging the migration of Classic subscribers to
Prodigy Internet and media costs incurred in connection with the Company's media
advertising campaign.
Product development
Product development expense increased $1.9 million, or 25%, from $7.7
million in the nine months ended September 30, 1998 to $9.6 million in the nine
months ended September 30, 1999. In the 1998 period, product development
activities centered on integration and stabilization of the Splitrock network
and transition to the co-branded Prodigy/Excite content platform for Prodigy
Internet. In the nine months ended September 30, 1999, product development
activities centered on the development of the Prodigy Hispanic product,
implementing the billing, provisioning and customer service infrastructure to
support the Company's Business Solutions Group, improving the systems
infrastructure supporting the Prodigy Internet de Telmex subscriber base,
including Year 2000 remediation efforts, developing a new home page for Prodigy
Internet, and developing future Prodigy Internet product offerings and service
enhancements.
General and administrative
General and administrative expense increased $8.9 million, or 27%, from
$33.4 million in the nine months ended September 30, 1998 to $42.3 million in
the nine months ended September 30, 1999. The increase was primarily due to
substantially higher subscriber management expenses attributable to the heavy
volume of retail channel enrollments experienced in the most recent quarter as
well as expenses associated with the transition of the Cable & Wireless
subscribers to Prodigy Internet, increased billing charges, increased credit
card processing fees, and higher incentive compensation expense, including $1.0
million of compensation expense incurred in connection with employee stock
options with exercise prices below fair market value.
Depreciation and amortization
Depreciation and amortization expense increased $.6 million, or 5%, from
$11.9 million in the nine months ended September 30, 1998 to $12.5 million in
the nine months ended September 30, 1999. The current period increase primary
reflects depreciation attributable to new accounting and financial reporting
software and subscriber management software implemented during 1999 as well as
equipment purchases for the Prodigy Internet bosting center.
Amortization of subscriber acquisition costs
In June and August 1999, respectively, the Company entered into agreements
with two national retailers of personal computers for the purpose of stimulating
Prodigy Internet enrollments by agreeing to make a payment to the retailer in
exchange for the retailer enrolling a customer onto Prodigy Internet and
obtaining a signed contractual commitment from the customer to a term
subscription to Prodigy Internet. These payments amount to $100, $250, or $400,
respectively, for a term subscription of one, two or three years at a monthly
charge of $19.95.
In July 1999 the Company acquired the Internet dial-up business of
Cable & Wireless USA, Inc.
The Company has capitalized these subscriber acquisition costs and
amortizes these costs over the term of the underlying subscriber contract (for
the Retailer Costs) or 36 months which represents the estimated weighted average
term of the subscribers acquired(for the Cable & Wireless Subscribers).
Amortization of subscriber acquisition costs of $8.6 million was incurred
by the Company during the nine months ended September 30, 1999 which encompassed
$2.4 million for amortization of the purchase price of subscribers acquired from
Cable and Wireless and $6.2 million for amortization of payments made to certain
retailers in exchange for obtaining contract subscribers to Prodigy Internet.
Restructuring Reserves
During the nine months ended September 30, 1999, the Company incurred
$.9 million of expenditures related to the 1997 restructuring reserve. These
expenditures relate to contractual obligations and severance payments identified
under the original plans. The remaining reserve consists primarily of
contractual obligations that Management expects to be paid in full by December
31, 2001.
Interest and Other Income
Interest income/expense, net improved from a net expense of $5.5 million in
the nine months ended September 30, 1998 to net income of $4.0 million in the
nine months ended September 30, 1999. This improvement was due to higher cash
levels following the Company's initial public offering in February 1999. During
the nine months ended September 30, 1999, the Company recognized a gain of $3.3
million upon sale of an equity investment received as consideration from the
sale of a subsidiary in 1997. In addition, the Company recognized a gain of
$1,714 when it paid $750 in full settlement of its 8 1/4% convertible note in
the principal amount of $2,000, and all accrued interest.
Income Taxes
Management of the Company has evaluated the positive and negative evidence
bearing upon the realizability of its deferred tax assets, which are comprised
principally of net operating loss carryforwards. Under the applicable accounting
standards, management has considered the Company's history of losses and
concluded that it is more likely than not that the Company will not realize
these favorable tax attributes. Accordingly, the deferred tax assets have been
fully reserved. Management revaluates the positive and negative evidence
periodically.
As a result of the foregoing factors, the Company's operating loss increased
from $48.2 million in the nine months ended September 30, 1998 to $59.8 million
in the nine months ended September 30, 1999 and its net loss increased from
$47.9 million in the nine months ended September 30, 1998 to $50.7 million in
the nine months ended September 30, 1999.
Liquidity and Capital Resources
Since formation, the Company has relied on private sales of equity
securities (totaling $294.7 million through December 31, 1998), borrowings and
an initial public offering in February 1999 (with net proceeds of $156.4
million) to fund its operations. The Company has incurred significant losses
since inception and, at September 30, 1999, had an accumulated deficit of $343.5
million and a working capital deficit of $61.3 million comprised of current
liabilities of $132.6 million and current assets of $71.3 million. For the nine
months ended September 30, 1998 and September 30, 1999, the Company incurred
negative cash flow from operations of $49.2 million and $21.6 million,
respectively.
In February 1999, the Company sold 11,200,000 shares of Common Stock in its
IPO, including 2,000,000 shares of Common Stock sold to Telmex, for aggregate
net proceeds of $156.4 million.
In May 1999, the Company entered into an agreement with Cable and Wireless
USA, Inc. to purchase the dial-up Internet access subscriber base of that entity
for a purchase price based on the number of Cable & Wireless customers who
transitioned to Prodigy Internet. At the closing, on July 20, 1999, the Company
paid Cable & Wireless USA, Inc. $40.9 million in cash. Based upon the number of
qualified subscribers received from this source as defined in the contract, the
final purchase price is not expected to exceed the $40.9 million previously
paid.
In June 1999 and August 1999, respectively, the Company entered into
agreements with two major retailers of personal computers (the "Retailers") to
make specified payments to the Retailer in exchange for the Retailers enrolling
customers onto Prodigy Internet and obtaining a signed contractual commitment
from these customers to term subscriptions to Prodigy Internet of one, two, or
three years at a monthly charge of $19.95. The Company has capitalized these
payments and is amortizing them over the term of the subscriber contract. At
September 30, 1999, the Company had capitalized related subscriber acquisition
costs related to these transactions of $104.9 million and had recognized
amortization expense of $6.2 million. In addition, at September 30, 1999, the
Company had recorded accrued subscriber contract expenses to the Retailers of
$33.6 million.
In July 1999, the Company established a $50 million Letter of Credit with a
financial institution to collateralize its financial obligations under terms of
its contract with a major computer retailer. This Letter of Credit expires on
December 31, 1999 and is collateralized by cash collateral of $52.5 million.
This amount is classified on the balance sheet as restricted cash. The Company
estimates the total cost of this agreement and similar agreements will be
approximately $200 million through December 1999. The Company is in the process
of arranging financing to fund the cost of these agreements.
In August 1999, Carso Global Telecom agreed to provide the Company with a
$150 million revolving line of credit entitling the Company to borrow, repay and
reborrow amounts in minimum increments of $1.0 million prior to maturity on
December 2, 1999. Advances are due 30 days after borrowing, but the Company is
permitted to roll over advances into new advances at its election. Advances are
uncollateralized and bear interest at the LIBOR rate plus between one and five
percentage points (as negotiated on a case-by-case basis). As of September 30,
1999, $36 million was outstanding under the revolving line of credit. Carso
Global Telecom is the Company's principal stockholder.
As a result of the Company's outsourcing arrangements, the Company has
significantly reduced the level of capital expenditures needed in its
operations. The Company's July 1997 network agreement with Splitrock eliminated
the need for the Company to maintain and upgrade its own network. The Company's
portal content agreement with Excite eliminated the need, beginning in April
1998, for internal development of content and Prodigy Internet customization and
other programming projects. The Company's capital expenditures for the nine
months ended September 30, 1999 were $9.5 million, primarily for the purchase of
data processing equipment. For the three months ended September 30, 1999, the
Company's capital expenditures were $2.1 million, principally for the purchase
and implementation of a new subscriber management system with enhanced customer
care, data mining and marketing program management capabilities and the purchase
of new equipment for Prodigy Internet.
At September 30, 1999 and October 31, 1999, the Company had available cash
and cash equivalents of $10.4 million and $13.9 million, respectively.
Subsequent to September 30, 1999, the Company has met its financing requirements
by additional drawdowns to the Carso Global Telecom line of credit. The Company
believes this credit facility to be adequate to meet its needs until external
financing can be arranged. Subsequent to September 30, 1999, the Company has met
its financing requirements by additional drawdowns of the Carso Global Telecom
line of credit. The Company believes this credit facility to be adequate to meet
its needs until external financing can be arranged. The Company is currently
experiencing substantial negative cash flow each month and expects to continue
to experience negative flows into the year 2000. The Company's future financing
requirements will depend on a number of factors, including the Company's
operating performance and increases in operating expenses associated with growth
in the Company's business. Based upon its current operating plan and the costs
of its subscriber acquisition programs the Company believes that it will require
significant external financing in order to meet existing contractual obligations
and expand its consumer business. The Company is currently engaged in arranging
this required financing.
Year 2000 Readiness
The Year 2000 issue is the result of computer programs being written using
two digits (rather than four) to define the applicable year. Computer programs
that have time-sensitive software may recognize a date using ''00'' as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices or engage in other
normal business activities. The Company maintains various internal computer
systems and equipment and contracts with third-party vendors for the provision
of computerized customer billing, network operation, Prodigy Internet service
content and certain other information technology and other services.
The Company is incurring costs to resolve the potential impact of the year
2000 on the processing of date-sensitive information by the Company's internal
computer systems and equipment and the computer systems and equipment of the
third-party vendors on which the Company's business relies. During 1998, the
Company established a Year 2000 project office staffed by Company personnel and
assisted by a consulting firm.
The Company has completed an inventory of substantially all of its internal
systems and programs related to both the delivery of the Prodigy Internet
service and the daily operations of the business. The Company estimates that it
will have spent approximately $6.4 million through the end of 1999 to remediate
potential Year 2000 problems with its internal systems and to purchase and
implement a new subscriber management system with enhanced customer care, data
mining and marketing program management capabilities that will replace a system
that is not Year 2000 compliant.
The Company has developed contingency plans in the event that any critical
service component or business process fails due to a Year 2000 problem. In
addition, the Company has successfully completed "end-to-end" testing of its
network provider and its consumer billing system. The majority of the
remediation efforts have been completed as to mission critical systems with
schedules in place to complete remaining remediation and related testing during
the fourth quarter of 1999.
There can be no assurance that the Company will be able to address, in a
timely fashion, all potential Year 2000 problems, or that the systems of the
third-party vendors upon which the Company's business relies (and the
maintenance and operation of which are not within the control of the Company)
will be Year 2000 compliant or will become Year 2000 compliant in a timely
manner. Any Year 2000 problems could impact the provision of products or
services to the Company's customers and could subject the Company to the risk of
litigation, lost revenues and loss of current or future customers.
<PAGE>
Recent Accounting Pronouncements
During the first quarter of 1999 the company adopted the American Institute
of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". All internal software is recorded by the Company in accordance
with the above mentioned pronouncement and is depreciated over three years
beginning on the date the software is put in use.
In January 1999, the Company adopted SOP 98-5 "Reporting on the Costs of
Start-up Activities." SOP 98-5 provides guidance on the financial reporting of
start-up costs and organization costs. It requires the costs of start-up
activities and organization costs to be expensed as incurred. As the Company
has expensed these costs historically, the adoption of this standard did not
have a significant impact on the Company's results of operations, financial
position or cash flows.
The FASB recently issued Statement No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of Effective Date of FASB Statement
No. 133". The Statement defers for one year the effective date of FASB Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS
133 will now be effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000. SFAS No. 133, will require the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives that are not hedges
must be adjusted to fair value through income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
will either be offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
Company does not believe the adoption of this standard will have a material
effect on the Company's results of operations.
Certain Factors That May Affect Future Operating Results
The cautionary statements set forth below and elsewhere in this Report, as
well as in the Company's latest Annual Report on Form 10-K, identify important
risks and uncertainties that could materially adversely affect our business,
financial condition, results of operations or prospects.
Since the Company's inception, it has incurred significant losses. There
can be no assurance that the Company will achieve or sustain profitability.
As a result of the Company's operating losses, negative cash flow and
contractual obligations to two major computer retailers and certain personal
computer manufacturers as a result of the Company's initiative to expand its
consumer business, the Company expects to require significant external financing
by January 2000. Company can give no assurance that such financing will be
available to it on favorable terms and in a timely manner, or at all. If the
Company's not able to obtain financing as required, the Company may be required
to curtail or elimate certain planned expenditures, and we may be unable to meet
certain payment obligations. The Company's future financing requirements will
depend on many factors, including our operating performance, the cost of
subscriber acquisition programs, and increases in operating expenses associated
with growth in our business. Adequate additional financing may not be available
on acceptable terms when needed. This would have a material adverse effect on
the Company.
The Internet services industry is characterized by significant pricing
pressures. As a result of increased competition, pricing pressures are expected
to intensify. In addition, numerous ISPs have begun, or may begin, offering free
Internet access. Pricing pressures and a movement toward Free Internet access
may materially adversely affect the Company's business.
The Internet services industry is intensely competitive and includes many
significant participants, including: ISPs, proprietary online service providers,
major international telecommunications companies, Internet-search services and
various other telecommunications companies. The Company also faces competition
from companies that provide broadband connections to households, including:
local and long-distance telephone companies, cable television companies, and
electric utility companies. Many of the Company's current and future competitors
have substantially greater financial, marketing and technical resources than us.
There can be no assurance the Company will compete effectively. The
Telecommunications Act and strategic alliances or consolidation among ISPs may
result in additional competitive pressures.
Subscriber cancellations may materially adversely affect the results of
operations of ISPs, including Prodigy. Customer acquisition expenses and the
administrative expenses of enrolling and assisting new subscribers are
substantial. The failure to attract and retain subscribers to the Company's
services, or an increase in, or a failure to slow, the rate of subscriber
cancellations, would have a material adverse effect on the Company.
The Internet services industry is highly fragmented, consisting of more
than 5,000 ISPs in the United States, and is expected to undergo substantial
consolidation over the next few years. Any failure to expand the Company's
business through acquisitions may materially adversely affect the Company's
competitive position. Any acquisitions that the Company makes may involve risks,
including the successful integration and management of acquired operations and
personnel. The integration of acquired businesses may also divert management's
attention from other business matters. This could materially adversely affect
the Company's business.
The Company's subscriber traffic is carried on a network owned and operated
by Splitrock. The failure by Splitrock for any reason to provide network
services as required, or any significant
9
<PAGE>
disruption in such services, whether for technical, operational, financial or
other reasons, would have a material adverse effect on us.
The security measures employed by Splitrock and us cannot assure complete
protection from security problems. The occurrence of these problems may result
in claims against us and could adversely affect us or our ability to attract and
retain customers. In addition, the occurrence of a natural disaster or other
unanticipated technical or other problems in Splitrock's network or our data
hosting center, or the failure of telecommunications providers to provide
required data communications capacity for any reason, could cause interruptions
in our services.
In addition to our network arrangements with Splitrock, we have outsourced
our content to Excite and aspects of our customer service and billing functions
to several providers. We also rely on local telephone and other companies to
provide data communications capacity via local telecommunications lines and
leased long-distance lines. The failure of these providers to provide services
as required, or any significant disruption of, or deterioration in, services,
would have a material adverse effect on us.
Our industry is characterized by rapid technological change resulting in
dynamic customer demands and frequent new product and service introductions. As
a result, markets can change rapidly. Our future results will depend in part on
our ability to make timely and cost-effective enhancements and additions to our
services that achieve market acceptance.
Our ability to compete successfully is dependent upon the continued
compatibility of our services with the technologies of others. Although we
intend to support emerging standards in the market for Internet access, we can
give no assurance that our products will conform to new standards in a timely
fashion.
Our business strategy includes the introduction of new services and entry
into new markets. We can give no assurance that we will be successful in
offering new services and entering new markets as planned or that any new
services will achieve market acceptance.
We experience quarterly fluctuations in our operating results due to many
factors, including: the seasonality of our business, changes in the level of
consumer spending during
10
<PAGE>
business cycles, the timing of introduction of new and enhanced services by us,
pricing changes, competitive factors and other factors discussed herein. We
historically have experienced seasonality in our business. Accordingly, we
believe that quarter-to-quarter comparisons of operating results may not be
meaningful or indicative of future results.
Our ability to exploit the market for our products and services and increase
our subscriber base requires an effective planning and management process. Our
ability to plan and manage effectively will require us to continue to implement
and improve our operational, financial and management information systems. We
will also be required to attract and retain skilled personnel. Competition for
key personnel is intense, and there can be no assurance that we will be
successful in attracting and retaining necessary personnel.
Changes in the regulatory environment relating to the telecommunications
and media industry could adversely affect us.
See also "-- Year 2000 Readiness."
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
11
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On April 7, 1999, Prodigy was served with a Summons and Complaint by two former
executives of the Company, Edward A. Bennett and William J. Lansing, in the
Supreme Court of the State of New York, County of New York, alleging breach of
separate contacts between the Company and each of the Plaintiffs. Plaintiffs
assert that their options to acquire 206,254 and 71,875 shares of Common Stock
of Prodigy at $12.00 per share, respectively, are fully vested and have not
expired, and when they tried to exercise their options, Prodigy refused to
acknowledge their exercise on the grounds that the options had expired.
Plaintiffs are claiming damages in an amount to be determined at trail. In May
1999, Prodigy filed a Motion to Dismiss this litigation in the Supreme Court of
the State of New York. Oral arguments took place on July 21, 1999. No decision
has been rendered as of the date hereof. The Company denies the validity of the
claim and intends to defend itself vigorously .
On November 1, 1999, Prodigy was served with a summons and complaint by Mr. Jack
Sharwell in the U.S. District Court for the Northern District of Ohio, Eastern
Division, alleging illegal tie-ins and sales, refusal to accept U.S. currency or
credit cards, and social security number requirement in connection with retail
contract customer acquisition programs. Mr. Sharwell brought the action against
Prodigy, as well as several retailers and CompuServe Interactive Services. The
Plaintiff claims that the defendants "have violated every retail sales practice
and every retail sales law that has ever been written." Plaintiff is seeking
$100,000,000 in damages plus $10,000,000 in punitive damages and "any additional
costs the court deems necessary." Prodigy will vigorously defend itself in
connection with this matter and plans to file a motion to dismiss on November
12, 1999. Prodigy does not believe the matter has any merit and does not believe
it will have any material adverse effect on the Company.
On November 8, 1999, Prodigy was notified of a lawsuit and served with a
Complaint by Irwin Sales, Inc., which was filed in the U.S. District Court,
Southern District of New York. Plaintiff alleges break of contract and fraud
arising out of an independent contractor agreement between Plaintiff and
Prodigy. The Complaint seeks $25,000,000 in alleged damages for the contract
claim and $50,000,000 in alleged damages for the fraud claim. Prodigy's answer
is due December 31, 1999. Prodigy believes it has meritorious defenses and
intends to vigorously contest the claims.
Item 2. Changes in Securities and Use of Proceeds
USE OF PROCEEDS
The effective date of the Company's first registration statement, filed on
Form S-1 under the Securities Act of 1933 (No. 333-64233), relating to the
Company's initial public offering of its Common Stock and simultaneous sale
shares to a stockholder of the Company and registering 11,200,000 shares, was
February 10, 1999.
12
<PAGE>
During the three months ended September 30, 1999, the Company used all the
proceeds from the initial public offering as follows:
<TABLE>
<S> <C>
Acquisition of contract subscribers $ 41,500,000
Cable & Wireless subscriber base acquisition 41,600,000
Retailer letter of credit 52,500,000
Purchase and installation of data processing equipment and software 5,300,000
Marketing 4,700,000
Working capital 10,755,000
------------
Total Use of IPO Net proceeds $156,355,000
============
</TABLE>
13
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K
(i) On August 3, 1999, the Company filed a Form 8-K reporting, under Item
2, that on July 20, 1999 the Company acquired certain of the consumer, business
and campus dial-up subscribers of Cable & Wireless USA, Inc. pursuant to an
Asset Purchase Agreement, dated as May 26, 1999, by and among Cable & Wireless
USA, Inc., Cable & Wireless USA Internet, L.L.C. and the Company. At the
closing, the Company paid Cable & Wireless USA, Inc., $40.9 million in cash,
which amount is subject to certain post-closing adjustments based on the number
of Cable & Wireless customers who transition to Prodigy's service. Prodigy
utilized cash proceeds raised in its initial public offering to pay for the
acquired assets.
(ii) On September 14, 1999, the Company filed a Form 8-K reporting, under
Item 5, that on September 7, 1999, the Company entered into a definitive
agreement to acquire the BizOnThe.Net web hosting business and subscribers of
U.S. Republic Communications, Inc.
(iii) On October 20, 1999, the Company filed a Form 8-K reporting, under
Item 5, that on October 5, 1999, the Company acquired the BizOnThe.Net web
hosting business and subscribers of U.S. Republic Communications, Inc. ("USR"),
an indirect majority-owned subsidiary of VarTec Telecom, Inc. ("VarTec"). At the
closing, Prodigy issued to USR 2,113,721 shares of Prodigy common stock and
repaid a $9 million loan from VarTec to USR. Prodigy also issued 727,272 shares
into an escrow account. Some or all of these escrowed shares will be released to
USR at various times over the two-year period following the closing. The escrow
account collateralized the indemnification obligations of USR and USR's
shareholders as well as certain post-closing adjustments, as more fully
described in the Agreement. In addition to the amounts paid at closing, in 2001
Prodigy will be required to issue up to 727,272 shares, contingent upon the
attainment by the acquired business of specified additional earn-out targets.
14
<PAGE>
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.
PRODIGY COMMUNICATIONS
CORPORATION
Date: November 15, 1999 /s/ David R. Henkel
-------------------------------
David R. Henkel
Executive Vice President, Finance,
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> SEP-30-1999
<PERIOD-END> JAN-01-1999
<CASH> 10,380
<SECURITIES> 0
<RECEIVABLES> 5,198
<ALLOWANCES> 1,327
<INVENTORY> 0
<CURRENT-ASSETS> 71,338
<PP&E> 42,617
<DEPRECIATION> 26,067
<TOTAL-ASSETS> 275,263
<CURRENT-LIABILITIES> 132,613
<BONDS> 0
0
0
<COMMON> 612
<OTHER-SE> 142,650
<TOTAL-LIABILITY-AND-EQUITY> 275,263
<SALES> 113,622
<TOTAL-REVENUES> 121,915
<CGS> 71,694
<TOTAL-COSTS> 181,690
<OTHER-EXPENSES> (9,081)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (50,724)
<INCOME-TAX> 0
<INCOME-CONTINUING> (50,724)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (50,724)
<EPS-BASIC> (.87)
<EPS-DILUTED> (.87)
</TABLE>
