<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1997
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: 0-27658
PREFERRED NETWORKS, INC.
(Exact name of Registrant as Specified in its Charter)
GEORGIA 58-1954892
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
850 Center Way, Norcross, GA 30071
(Address of principal executive offices)
(Zip Code)
(770) 582-3500
(Registrant's telephone number including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last year)
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 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: 16,193,534 shares of common
stock, no par value, as of August 11, 1997.
<PAGE> 2
PREFERRED NETWORKS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
NUMBER
------
Item 1. Financial Statements
<S> <C> <C> <C>
Condensed Consolidated Balance Sheets, June 30, 1997
(Unaudited) and December 31, 1996..................................... 3
Condensed Consolidated Statements of Operations for the
three months and six months ended June 30, 1997 and 1996 4
(Unaudited)...........................................................
Condensed Consolidated Statement of Changes in Stockholders'
Equity for the six months ended June 30, 1997 5
(Unaudited)...........................................................
Condensed Consolidated Statements of Cash Flows for the three
months and six months ended June 30, 1997 and 1996 (Unaudited) ....... 6
Notes to Condensed Consolidated Financial Statements (Unaudited) ..... 7
Item 2. Management's Discussion and Analysis of Financial Condition ..........
and Results of Operations............................................. 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................... 17
Item 2. Changes in Securities................................................. 17
Item 3. Defaults under Senior Securities...................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................... 17
Item 5. Other Information..................................................... 18
Item 6. Exhibits and Reports on Form 8-K...................................... 18
Signatures............................................................ 20
</TABLE>
2
<PAGE> 3
PREFERRED NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current assets
Cash and cash equivalents...................................... $ 12,919,194 $ 21,645,354
Accounts receivable, net....................................... 4,640,482 2,909,379
Inventory...................................................... 4,549,728 5,630,478
Prepaid expenses and other current assets...................... 845,785 540,190
------------- ------------
Total current assets......................................... 22,955,189 30,725,401
Property and equipment, net....................................... 26,955,259 21,559,407
Goodwill, net..................................................... 13,710,139 5,779,321
FCC licenses, net................................................. 9,876,532 4,601,792
Other assets, net................................................. 2,869,971 3,459,416
============ ============
$ 76,367,090 $ 66,125,337
============ ============
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable............................................... $ 4,874,965 $ 5,017,467
Accrued liabilities............................................ 1,313,544 2,878,573
Accrued salaries............................................... 686,818 621,493
Current portion of notes payable and capital lease obligations. 1,759,812 995,164
------------ ------------
Total current liabilities.................................... 8,635,139 9,512,697
Notes payable and capital lease obligations, less current portion. 16,667,167 16,029,652
Class A Redeemable Preferred Stock, no par value, $1.50 per
share redemption price; 13,500,000 shares authorized in 1997,
10,000,000 shares issued and outstanding in 1997 .............. 12,977,666 -
------------ ------------
Total liabilities and Redeemable Preferred Stock............. 38,279,972 25,542,349
Stockholders' equity
Preferred stock, no par value, 30,000,000 shares authorized in
1997, 10,000,000 shares issued and outstanding in 1997 ...... - -
Preferred stock, $.01 par value, 5,000,000 shares authorized
in 1996, none issued and outstanding in 1996 ................ - -
Common Stock, no par value, 100,000,000 shares authorized
in 1997, 16,193,534 shares issued and outstanding in 1997 ... 61,680,039 -
Common Stock, $.0001 par value, 70,000,000 shares authorized
in 1996, 15,290,921 shares issued and outstanding in 1996 ... - 1,529
Additional paid-in capital on $.0001 par value Common Stock ... - 56,312,399
Common Stock Purchase Warrants ................................ 1,930,963 -
Accretion on Class A Redeemable Preferred Stock ............... (34,769) -
Accumulated deficit............................................ (25,489,115) (15,730,940)
------------ ------------
38,087,118 40,582,988
------------ ------------
$ 76,367,090 $ 66,125,337
============ ============
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 4
PREFERRED NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- --------------------------------
1997 1996 1997 1996
-------------- --------------- -------------- -------------
<S> <C> <C> <C> <C>
Revenues
Network services....................................... $ 3,250,921 $ 1,444,850 $ 5,816,509 $ 2,744,046
Product sales.......................................... 3,473,108 1,049,797 6,406,433 2,086,177
Other services......................................... 2,864,809 - 5,482,247 32,957
-------------- ------------ ------------ ------------
Total revenues .................................... 9,588,838 2,494,647 17,705,189 4,863,180
Costs of revenues
Network services....................................... 2,195,442 946,521 4,103,650 1,688,080
Product sales.......................................... 3,558,806 1,307,720 6,638,724 2,668,719
Other services......................................... 2,358,656 - 4,384,817 -
-------------- ------------ ------------ ------------
Total costs of revenues ........................... 8,112,904 2,254,241 15,127,191 4,356,799
-------------- ------------ ------------ ------------
Gross margin ............................................. 1,475,934 240,406 2,577,998 506,381
Selling, general and administrative expenses.............. 4,127,679 1,680,135 8,219,955 3,139,846
Depreciation and amortization............................. 1,803,814 399,325 3,449,716 762,701
Other expenses ........................................... 277,707 - 277,707 -
-------------- ------------ ------------ ------------
Operating loss..................................... (4,733,266) (1,839,054) (9,369,380) (3,396,166)
Interest expense.......................................... (379,587) (13,237) (606,383) (155,182)
Interest income........................................... 79,152 374,363 217,588 572,660
-------------- ------------ ------------ ------------
Net loss........................................... (5,033,701) (1,477,928) (9,758,175) (2,978,688)
Accretion of Redeemable Preferred Stock.................... (34,769) - (34,769) (1,121,316)
Redeemable Preferred Stock dividend requirements.......... (58,333) - (58,333) (353,651)
-------------- ------------ ------------ ------------
Net loss attributable to Common Stock.............. $ (5,126,803) $ (1,477,928) $ (9,851,277) $ (4,453,655)
============== ============ ============ ============
Net loss per share of Common Stock........................ $ (.32) $ (.10) $ (.62) $ (.28)
============== ============ ============ ============
Weighted average number of common shares
used in calculating net loss per share of
Common Stock........................................... 16,148,065 14,417,732 16,004,034 12,679,831
============== ============ ============ ============
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
PREFERRED NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON COMMON ACCRETION OF
STOCK ADDITIONAL COMMON STOCK REDEEMABLE
($.0001 PAID-IN STOCK PURCHASE PREFERRED ACCUMULATED
PAR) CAPITAL (NO PAR) WARRANTS STOCK DEFICIT TOTAL
------- ---------- ----------- ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1996...... $1,529 $56,312,399 $ - $ - $ - $(15,730,940) $40,582,988
Corporate
reincorporation ........(1,529) (56,312,399) 56,313,928 -
Issuance of 828,613
shares of Common
Stock pursuant
to acquisitions...... - - 5,179,989 - - - 5,179,989
Issuance of 74,000
shares of Common
Stock pursuant to
Directors' Restricted
Stock Award Plan..... - - 95,703 - - - 95,703
Issuance of Common
Stock Purchase
Warrants............. - - 1,930,963 - - 1,930,963
Non-cash stock option
compensation......... - - 148,752 - - - 148,752
Accretion of Class A
Redeemable
Preferred Stock...... - - - - (34,769) - (34,769)
Undeclared dividends
on Class A
Redeemable
Preferred Stock ..... - - (58,333) - - - (58,333)
Net loss............... - - - - - (9,758,175) (9,758,175)
------ ----------- ----------- ---------- -------- ------------ -----------
Balance at June 30, 1997.. $ - $ - $61,680,039 $1,930,963 $(34,769) $(25,489,115) $38,087,118
====== =========== =========== ========== ======== ============ ===========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE> 6
PREFERRED NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
----------------------------------
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ............................................................ $(9,758,175) $(2,978,688)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization..................................... 3,449,716 762,701
Bad debt expense.................................................. 265,695 101,087
Stock option and restricted stock grant compensation expense...... 244,455 14,666
Changes in operating assets and liabilities:
Accounts receivable............................................. (1,567,252) (30,479)
Inventory....................................................... 1,444,981 (350,941)
Prepaid expenses and other assets............................... (280,328) 81,557
Accounts payable................................................ (860,133) 1,214,808
Accrued liabilities............................................. (184,864) (192,542)
Accrued salaries................................................ 65,325 415,953
----------- -----------
Net cash used in operating activities................................ (7,180,580) (961,878)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment............................................... (3,734,426) (3,076,367)
Purchases of other assets and FCC licenses........................... (762,900) (1,573,848)
Payment for acquisitions, net of cash acquired....................... (10,629,768) -
----------- -----------
Net cash used in investing activities................................ (15,127,094) (4,650,215)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings............................................. 10,000,000 -
Payments of borrowings............................................... (1,234,002) (5,748,316)
Net proceeds from initial public offering of Common Stock............ - 31,160,709
Net proceeds from issuance of Redeemable Preferred Stock ............ 2,884,553 -
Net proceeds from issuance of Common Stock Purchase Warrants......... 1,930,963 -
Payment of Redeemable Convertible Preferred Stock dividends.......... - (176,149)
Issuance of Common Stock upon exercise of stock options.............. - 5,626
----------- -----------
Net cash provided by financing activities............................ 13,581,514 25,241,870
----------- -----------
Net increase in cash and cash equivalents............................ (8,726,160) 19,629,777
Cash and cash equivalents, beginning of period....................... 21,645,354 9,311,379
----------- -----------
Cash and cash equivalents, end of period............................. $12,919,194 $28,941,156
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE> 7
PREFERRED NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(UNAUDITED)
1. THE COMPANY
Preferred Networks, Inc. (the "Company") provides outsourcing services to
the wireless industry. The Company commenced operations in 1991 as a
carrier's carrier of one-way paging networks, whereby the Company's
customers purchase wholesale network services and resell the services to
their subscribers. During the second half of 1996, the Company began to
broaden its service offerings and expand its customer base through two
acquisitions of businesses which provide non-network services. In July
1996, the Company acquired Preferred Technical Services, Inc. ("PTS"), a
provider of paging network equipment installation, maintenance and
engineering services. In December 1996, the Company acquired EPS Wireless,
Inc. ("EPS"), a national provider of paging and cellular product repair
services, sales of new, used and refurbished paging and cellular products
and inventory management services.
In June 1997, pursuant to a merger into a wholly-owned shell subsidiary,
the Company reincorporated from Delaware to Georgia, increased the amount
of its authorized Common Stock and Preferred Stock and provided that all
of its stock was without par value.
The Company has formed wholly-owned subsidiaries and limited liability
companies to execute certain business transactions. All significant
intercompany activity has been eliminated.
2. BASIS FOR PRESENTATION
The interim condensed consolidated financial information contained herein
has been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC") and include
in the opinion of management, all adjustments, which are of a normal
recurring nature necessary for a fair presentation of the financial
position, results of operations and cash flows for the periods presented.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
rules and regulations. The Company believes, however, that its disclosures
are adequate to make the information presented not misleading. These
financial statements and related notes should be read in conjunction with
the financial statements and notes as of December 31, 1996, included in
the Company's Annual Report on Form 10-K (File No. 0-27658). Results of
operations for the periods presented herein are not necessarily indicative
of results to be expected for the full year or any other interim period.
3. SUPPLEMENTAL CASH FLOW INFORMATION
Cash and cash equivalents include investments in money market instruments,
which are carried at fair market value. Cash payments made for interest
during the six months ended June 30, 1997 and 1996, were approximately
$823,000 and $111,000, respectively. There were no significant federal
or state income taxes paid or refunded for the six months ended June 30,
1997 and 1996.
4. INITIAL PUBLIC OFFERING (IPO)
On March 1, 1996, the Company issued 3,300,000 shares of Common Stock in a
public offering. The Company received net proceeds before offering
expenses of $30.7 million. In addition, on March 28, 1996, the
underwriters exercised their over-allotment option to purchase an
additional 148,000 shares of Common Stock and the Company received
additional net proceeds of $1.4 million.
Pursuant to their terms, upon consummation of the IPO all outstanding
shares of Series A Redeemable Convertible Preferred Stock (the "Series A")
and Series B Redeemable Convertible Preferred Stock (the "Series B")
automatically converted into Common Stock. The Company elected to pay
accrued dividends on the Series B through January 31, 1996, in shares of
Common Stock and the remainder of the accrued dividends from February 1 to
March 1, 1996, in the amount of $176,000 in cash. The total number of
shares of Common Stock
7
<PAGE> 8
PREFERRED NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
4. INITIAL PUBLIC OFFERING (IPO)-(CONTINUED)
issued upon such conversion and such dividend payment was 6,860,280
shares. All accretion previously accrued was eliminated upon conversion to
shares of Common Stock.
Approximately $5.6 million of the proceeds of the IPO was used to repay
all debt then outstanding and the balance was used to fund network
expansion, acquisitions, and operations.
5. LOAN AGREEMENTS
The Company has a secured credit facility for $12.0 million of vendor
financing bearing interest at a five-year U.S. Treasury rate plus 6.5%
payable in various monthly installments of principal and interest over 60
months, with maturity dates through 2001. This credit facility contains
various conditions, financial covenants and restrictions and is secured by
paging equipment. As of June 30, 1997, there was $4.7 million outstanding
under this facility with an additional $7.3 million available.
The Company also has a $5.0 million credit facility to finance paging
system equipment from a finance company bearing interest at 10% payable in
various monthly installments of principal and interest over 60 months,
with maturity dates through 2002. This credit facility contains various
conditions, financial covenants and restrictions and is secured by paging
equipment. As of June 30, 1997, there was $4.0 million outstanding under
this facility with an additional $500,000 available.
The Company has a $9.25 million revolving credit facility with a financial
institution, the majority of which is to be used to finance paging network
acquisitions and capital expenditures. The outstanding balance under this
facility bears interest at a rate of prime plus 1% or at a rate of LIBOR
plus 3.75%, at the Company's option. Interest only is payable monthly in
arrears with the entire principal due in full in August 1998. Borrowings
under this facility and the other two credit facilities are secured by
substantially all the assets of the Company. This credit facility contains
various conditions, financial covenants and restrictions related to debt
service, minimum net worth, acquisitions and future requirements for
raising $5.0 million in additional subordinated debt or equity capital by
the end of January 1998, among other things. Availability under this
facility is based on a multiple of the positive EBITDA (defined below) in
certain markets. As of June 30, 1997, there was $9.25 million outstanding
under this facility with no additional availability.
6. LOSS PER SHARE
Net loss per share was computed using the requirements of Accounting
Principles Board Opinion No. 15 and SEC Staff Accounting Bulletin No. 83
and as such equals the net loss increased by accretion on the Class A
Redeemable Preferred Stock (see Note 8) and the portion of accretion of
the Series A which relates to shares which are not considered as cheap
stock, as defined below, and the dividends on the Class A Redeemable
Preferred Stock and the Series B divided by the weighted average number of
shares of Common Stock outstanding, plus cheap stock as defined below up
to the March 1, 1996 closing date of the IPO. The calculation excludes
any antidilutive shares during the period, other than cheap stock.
Pursuant to SEC Staff Accounting Bulletin No. 83, common stock and common
stock equivalents (including preferred stock) issued at prices equal to or
below the IPO price per share ("cheap stock") during the twelve-month
period immediately preceding the initial filing date of the Company's
registration statement for the IPO have been included as if outstanding
for all periods presented, up until the March 1, 1996 closing date for the
IPO (using the treasury stock method at the IPO price) even though the
effect is to reduce the loss per share. A portion of the Series A, all of
the Series B and certain of the stock options and warrants have been
treated as cheap stock.
The computation of fully diluted net loss per share of Common Stock was
antidilutive in each of the periods presented; therefore the amounts
reported for primary and fully diluted are the same.
In 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings Per Share, which generally simplifies the calculation of
earnings per share. The Company will adopt the new accounting statement
effective for the fourth quarter of 1997 and the effect is not expected to
be material.
8
<PAGE> 9
PREFERRED NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
7. ACQUISITIONS
In September 1996, the Company acquired substantially all the assets of
Big Apple Paging Corporation ("Big Apple") for $3.8 million. Of this
amount, $1.4 million was paid in cash and $1.0 million was paid by the
issuance of 125,598 shares of Company's Common Stock in September 1996. In
January 1997, $1.1 million was paid by the issuance of 165,317 shares of
Common Stock and $130,000 was paid in cash. In April 1997, the remaining
$250,000 was paid in cash. The transaction was accounted for as a purchase
as of September 13, 1996. Big Apple is a reseller-based paging carrier in
the states of New York, New Jersey, and Connecticut, and this acquisition
provided the Company with a base of customers upon opening its Northeast
TCC.
In December 1996, the Company acquired the stock of EPS Wireless, Inc.
("EPS") for approximately $4.8 million, and possible additional
consideration of up to an additional $5.0 million in cash based on EPS's
achievement of targeted operating performance during the two year period
ending December 31, 1998. Of the purchase price, $4.5 million was paid by
the issuance of 673,524 shares of Common Stock with the remainder of
$300,000 paid in cash in February 1997. The transaction was accounted for
as a purchase as of December 1, 1996 and the excess purchase price over
the fair value of the assets acquired has been recorded as goodwill.
Additional consideration, if any, will be recorded as goodwill. The
Chairman of the Company was a minority stockholder and member of the Board
of Directors of EPS prior to the acquisition.
In January 1997, the Company acquired the stock of Mercury Paging &
Communications, Inc. ("Mercury") and its affiliated companies for
approximately $14.2 million of which approximately $10.3 million was paid
in cash and the remainder by the issuance of 624,321 shares of Common
Stock, 156,080 of which were held in escrow until April 1997 then released
to the former Mercury shareholders after Mercury achieved certain revenue
targets. Proceeds from the Company's revolving credit facility which were
drawn in December 1996 were used to fund the majority of the cash portion
of the purchase price, with working capital being used to fund the
remainder. The transaction was accounted for as a purchase as of January
31, 1997. Mercury is a reseller-based paging carrier in the states of New
York, New Jersey and Connecticut. Prior to closing, the Company earned
revenues from Mercury under an agency agreement.
In addition, in the second quarter of 1997 the Company purchased network
assets and FCC licenses from two companies for a total purchase price of
$100,000, paid by issuance of 38,975 shares of the Company's Common Stock.
8. ISSUANCE OF CLASS A REDEEMABLE PREFERRED STOCK AND COMMON STOCK PURCHASE
WARRANTS
On June 17, 1997, the Company issued to five of its shareholders and two
affiliates of one of them (collectively, the "Investors") 10.0 million
shares of Class A Redeemable Preferred Stock (the "Preferred Stock") which
will accrue dividends at the rate of 10% per annum and warrants to
purchase up to 11.5 million shares of Common Stock for a total purchase
price of $15.0 million. The Preferred Stock may be redeemed at any time at
the option of the Company at a price equal to $1.50 per share plus accrued
dividends and if the holder so demands, five years from the date of
issuance, the Preferred Stock must be redeemed by the Company at a price
equal to $1.50 per share plus accrued dividends. Each warrant is
exercisable for five years following the issuance of the Preferred Stock
and entitles the holder to purchase one share of Common Stock for $1.50
per share subject to possible downward adjustment based on any private
placement of the Company's Preferred or Common Stock. A portion of the
warrants may be canceled by the Company in the event of an early
redemption of all of the Preferred Stock. The Preferred Stock is recorded
at cost, net of expenses, plus undeclared dividends and accretion. The
Warrants are recorded at cost, net of expenses.
In April 1997 and May 1997, the Company borrowed a total of $10.0 million
from the Investors under a 10% bridge loan. The Company's indebtedness
under the $10.0 million bridge loan was applied against the purchase price
of the Preferred Stock.
9
<PAGE> 10
PREFERRED NETWORKS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
In this section, the Company makes reference to "EBITDA" which represents
earnings before interest expense, interest income, taxes, depreciation and
amortization. EBITDA is a financial measure commonly used in the
telecommunications industry and should not be construed as an alternative to
operating income (as determined in accordance with generally accepted
accounting principles ("GAAP")), as an alternative to cash flows from operating
activities (as determined in accordance with GAAP), or as a measure of
liquidity.
The following table presents certain items in the Consolidated Statements of
Operations as a percentage of total revenues for the three months and six
months ended June 30, 1997 and 1996, respectively.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -------------------
1997 1996 1997 1996
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues
Network services 33.9 % 57.9 % 32.9 % 56.4 %
Product sales 36.2 42.1 36.2 42.9
Other services 29.9 - 30.9 0.7
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Costs of revenues
Network services 22.9 37.9 23.2 34.7
Product sales 37.1 52.5 37.5 54.9
Other services 24.6 - 24.7 -
----- ----- ----- -----
Total cost of revenues 84.6 90.4 85.4 89.6
----- ----- ----- -----
Gross margin 15.4 9.6 14.6 10.4
Selling, general & administrative 43.0 67.3 46.4 64.5
Depreciation and amortization 18.8 16.0 19.5 15.7
Other 2.9 - 1.6 -
----- ----- ----- -----
Operating loss (49.3) (73.7) (52.9) (69.8)
Interest expense (4.0) (0.5) (3.4) (3.2)
Interest income 0.8 15.0 1.2 11.8
----- ----- ----- -----
Net loss (52.5)% (59.2) % (55.1)% (61.2)%
===== ===== ===== =====
EBITDA (30.6)% (57.7) % (33.4)% (54.1)%
</TABLE>
The table below provides information about the Company's units in service by
customer type and average revenue per unit ("ARPU") for the six months ended
June 30. ARPU is calculated by dividing pager airtime revenues for the month by
the total units in service at month end. ARPU for periods greater than one
month equals the average of the monthly ARPUs during the period.
<TABLE>
<CAPTION>
JUNE 30, PERCENTAGE INCREASE (DECREASE)
------------------------ ------------------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Units in service
Reseller units 317,386 143,273 121.5 % 93.4 %
Co-location/interconnection units 107,605 45,228 137.9 288.8
-------- --------
Total 424,991 188,501 125.5 120.0
Units under agency agreement - 27,205 (100.0) -
-------- --------
Total units 424,991 215,706 97.0 % 151.7 %
======== ========
ARPU $ 2.51 $ 2.60 (3.5)% (15.9)%
</TABLE>
10
<PAGE> 11
PREFERRED NETWORKS, INC.
RESULTS OF OPERATIONS
Total revenues increased $7.1 million, or 284.4%, to $9.6 million for the
three-month period ended June 30, 1997, from $2.5 million for the three-month
period ended June 30, 1996. Total revenues increased $12.8 million, or 264.1%,
to $17.7 million for the six-month period ended June 30, 1997, from $4.9
million for the six-month period ended June 30, 1996.
The Company operates networks in 23 markets as of June 30, 1997 as compared to
only 15 markets as of June 30, 1996. Revenues from network services increased
by $1.8 million, or 125.0%, to $3.3 million for the three-month period ended
June 30, 1997, from $1.4 million for the three-month period ended June 30,
1996. Revenues from network services increased by $3.1 million, or 112.0%, to
$5.8 million for the six-month period ended June 30, 1997, from $2.7 million
for the six-month period ended June 30, 1996. Units in service increased by
236,490, or 125.5%, to 424,991 at June 30, 1997, from 188,501 at June 30, 1996.
The increases in revenues from network services were attributable to the growth
in units in service and the associated recurring revenue stream, which resulted
from expansion into 8 new markets (New York, Chicago, Detroit, Boston, Albany
NY, Richmond, Raleigh/Durham, and Charlotte), continued growth in existing
markets and from the acquisition of substantially all of the paging assets of
Big Apple Paging Corporation ("Big Apple") and the acquisition of Mercury
Paging & Communications, Inc. and its affiliated companies ("Mercury"). The
growth in units in service was offset in part by declining ARPU due to
competitive pricing pressures in the industry, a continued shift to
co-location/interconnection customers which were 25.3% of total units in
service as of June 30, 1997 up from 24.0% as of June 30, 1996, and to a lesser
extent, unit volume and airtime usage discounts. Co-location and
interconnection customers generate lower ARPU to the Company because certain
operating expenses customarily incurred by the Company are borne by the
customer.
Revenues from product sales increased $2.4 million, or 230.8%, to $3.5 million
for the three-month period ended June 30, 1997 from $1.0 million for the
three-month period ended June 30, 1996. Revenues from product sales increased
$4.3 million, or 207.1%, to $6.4 million for the six-month period ended June
30, 1997 from $2.1 million for the six-month period ended June 30, 1996. The
majority of the increase results from revenues from the sourcing and sales of
new, used and refurbished pager and cellular products by EPS Wireless, Inc.
("EPS"), which was acquired in December 1996.
Other services revenues increased to $2.9 million for the three-month period
ended June 30, 1997 from $0 for the three-month period ended June 30, 1996.
Other services revenues increased to $5.5 million for the six-month period
ended June 30, 1997 from $33,000 for the six-month period ended June 30, 1996.
The increase was due to the revenues of Preferred Technical Services, Inc.
("PTS") (acquired by the Company in July 1996) from paging network equipment
installation services, maintenance and engineering services and EPS's revenues
associated with repair and refurbishment of pager and cellular products and
inventory management.
Cost of network services increased by $1.2 million, or 131.9%, to $2.2 million
for the three-month period ended June 30, 1997, from $947,000 for the
three-month period ended June 30, 1996. Cost of network services increased by
$2.4 million, or 143.1%, to $4.1 million for the six-month period ended June
30, 1997, from $1.7 million for the six-month period ended June 30, 1996. The
increase was primarily attributable to the expansion into 8 new markets and the
increased number of units in service. Cost of network services as a percentage
of network services revenues was 67.5% and 70.6% for the three-month and
six-month periods ended June 30, 1997 compared to 65.5% and 61.5% for the
three-month and six-month periods ended June 30, 1996, reflecting lower ARPU
and expansion into new markets where there are currently fewer units in service
producing revenue, although the market bears fully-loaded network cost.
Cost of product sales increased by $2.3 million, or 172.1%, to $3.6 million for
the three-month period ended June 30, 1997, from $1.3 million for the
three-month period ended June 30, 1996. Cost of product sales increased by $4.0
million, or 148.8%, to $6.6 million for the six-month period ended June 30,
1997, from $2.7 million for the six-month period ended June 30, 1996. The
increases were due primarily to the cost of sourcing and sales of new, used and
refurbished pager and cellular products by EPS and to a lesser extent due to
costs of pager sales associated with network airtime. Cost of product sales as
a percentage of product sales was 102.5% and 103.6% for the three-month and
six-month periods ended June 30, 1997, compared to 124.6% and 127.9% for the
three-month and six-month periods ended June 30, 1996. The decreases in the
percentages were due to EPS's profits on product sales and decreased losses on
pager sales associated with network airtime. Due to the competitive nature of
pricing in the
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<PAGE> 12
PREFERRED NETWORKS, INC.
industry, the overall loss on product sales reflects the Company's marketing
programs whereby pagers are sold to resellers at a loss to attract customers to
its networks.
Cost of other services increased to $2.4 million for the three-month period
ended June 30, 1997 from $0 for the three-month period ended June 30, 1996.
Cost of other services increased to $4.4 million for the six-month period ended
June 30, 1997 from $0 for the six-month period ended June 30, 1996. The
increases were due to PTS's costs associated with paging network equipment
installation services, maintenance and engineering services and EPS's costs
associated with repair and refurbishment of pager and cellular products and
inventory management. Cost of other services as a percentage of other services
revenues was 82.3% and 80.0% for the three-month and six-month periods ended
June 30, 1997.
SG&A increased by $2.4 million, or 145.7%, to $4.1 million for the three-month
period ended June 30, 1997, from $1.7 million for the three-month period ended
June 30, 1996, but decreased as a percentage of total revenues to 43.0% for the
three-month period ended June 30, 1997, from 67.3% for the three-month period
ended June 30, 1996. SG&A increased by $5.1 million, or 161.8%, to $8.2 million
for the six-month period ended June 30, 1997, from $3.1 million for the
six-month period ended June 30, 1996, but decreased as a percentage of total
revenues to 46.4% for the six-month period ended June 30, 1997, from 64.5% for
the six-month period ended June 30, 1996. The increase in dollars reflects
additional sales and administrative cost to support the increasing number of
customers and expansion into new markets associated with the Company's network
services, and the additional personnel and other SG&A costs associated with PTS
and EPS.
Depreciation and amortization increased by $1.4 million, or 351.7%, to $1.8
million for the three-month period ended June 30, 1997, from $399,000 for the
three-month period ended June 30, 1996. Depreciation and amortization increased
by $2.7 million, or 352.3%, to $3.4 million for the six-month period ended June
30, 1997, from $763,000 for the six-month period ended June 30, 1996. The
increases were primarily due to additional assets purchased or constructed for
expansion into new markets, increased amortization of market entry costs as new
markets begin to generate revenues and amortization of goodwill related to the
acquisition of EPS and PTS. Depreciation and amortization increased as a
percentage of total revenues to 18.8% and 19.5% for the three-month and
six-month periods ended June 30, 1997, from 16.0% and 15.7% for the three-month
and six-month periods ended June 30, 1996.
Other expenses were $278,000 for the three-month and six-month periods ended
June 30, 1997, up from $0 for the three-month and six-month periods ended June
30, 1996 and represent certain non-recurring severance expenses. The Company
took certain cost reduction measures primarily in the area of SG&A through
employee terminations. As a part of the reduction in force, the Company
modified the terms of the terminated employees' stock options to purchase
187,143 shares of Common Stock, to immediately fully vest these options, and to
extend the exercise period that the employees have to exercise the options.
These changes resulted in $138,000 of severance costs which are included in the
severance cost amount described above.
In addition, the Company canceled certain of the outstanding stock options
granted to the Company's remaining employees, covering in the aggregate options
to purchase 485,493 shares of Common Stock with exercise prices ranging from
$2.87 to $10.61 per share and regranted an identical number of options at the
then current market price of $2.50 per share. The newly granted options vest
annually in equal amounts over a three year period beginning with the 1997 date
of grant.
Interest expense increased $366,000, or 2767.7%, to $380,000 for the
three-month period ended June 30, 1997, from $13,000 for the three-month period
ended June 30, 1996. Interest expense increased $451,000, or 290.8%, to
$606,000 for the six-month period ended June 30, 1997, from $155,000 for the
six-month period ended June 30, 1996. The increases were due to the financing
of the network buildout and borrowings related to the acquisition of Mercury on
January 31, 1997. Also contributing to the increase was the repayment of all
outstanding debt with a portion of the proceeds of the IPO in March 1996
resulting in lower debt outstanding in 1996, and the $10,000,000 bridge loan
for the Class A Redeemable Preferred Stock offering which was outstanding in
the second quarter of 1997.
Interest income decreased $295,000, or 78.9%, to $79,000 for the three-month
period ended June 30, 1997, from $374,000 for the three-month period ended June
30, 1996. Interest income decreased $355,000, or 62.0%, to $218,000 for the
six-month period ended June 30, 1997, from $573,000 for the six-month period
ended June 30, 1996. The decreases are due to the higher level of funds
available for investment in 1996 due to the proceeds of the IPO, which was
consummated in March 1996.
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PREFERRED NETWORKS, INC.
Net loss for the three-month period ended June 30, 1997, as compared with the
three-month period ended June 30, 1996, increased to $5.0 million from $1.5
million. Net loss for the six-month period ended June 30, 1997, as compared
with the six-month period ended June 30, 1996, increased to $9.8 million from
$3.0 million. The increase was primarily due to substantial increases in SG&A,
as described above.
The net loss per share of Common Stock for the three-month period ended June
30, 1997 increased to ($.32) from ($.10) for the same three month period ended
in 1996. The net loss per share of Common Stock for the six-month period ended
June 30, 1997 increased to ($.62) from ($.28) for the same six-month period
ended in 1996. The increase in net loss per share was due to the increased net
loss attributable to common stockholders in 1997 as compared to 1996 offset by
the increased number of shares outstanding due to shares issued for
acquisitions. Weighted average shares outstanding includes cheap stock until the
IPO date.
LIQUIDITY AND CAPITAL RESOURCES
The Company's expansion strategy will continue to require substantial funds to
finance the expansion of existing operations, the expansion into new markets as
part of the nationwide build-out of its networks, the purchase of network
assets and related FCC licenses, capital expenditures, debt service and general
corporate purposes.
The Company has augmented its wide-area 157.740 MHz networks by purchasing and
consolidating existing local network assets licensed on the 150 MHz, 450 MHz
and 900 MHz frequency bands to offer new geographical markets, additional
capacity and flexibility to its customers. As of June 30, 1997, the Company was
operating in 23 markets with 6 Technical Control Centers (TCC's) in operation
and was constructing networks in 29 new markets, including a TCC in Southern
California and network expansions into Denver, Seattle, San Francisco, Los
Angeles, Cleveland, Indianapolis, and Minneapolis.
The Company has two secured credit facilities totaling $17.0 million. As of
June 30, 1997, there was $8.7 million outstanding under these facilities with
an additional $7.8 million available for additional paging network equipment
purchases.
The Company also has a $9.25 million secured revolving credit facility with a
financial institution, the majority of which is to be used to finance paging
network acquisitions and capital expenditures. This credit facility contains
various conditions, financial covenants and restrictions related to debt
service, minimum net worth, acquisitions and future requirements for raising
$5.0 million additional subordinated debt or equity capital by the end of
January 1998, among other things. The Company has no commitment for these
additional funds. If additional funds of $5.0 million are not obtained by the
end of January 1998, the Company would be required to seek an amendment to its
debt covenants or refinance its revolving credit facility and the failure to
obtain such additional funds, absent an amendment or refinancing, would have a
material adverse effect on the Company. Availability under this facility is
based on a multiple of the positive EBITDA in certain markets. As of June 30,
1997, there was $9.25 million outstanding under this facility with no
additional availability. The revolving credit facility matures in August 1998.
In June 1997, the Company issued 10.0 million shares of Class A Redeemable
Preferred Stock (the "Preferred Stock") which will accrue dividends at a rate
of 10% per annum and warrants to purchase up to 11.5 million shares of Common
Stock to five of its shareholders and two affiliates of one of them
(collectively, the "Investors") for a total purchase price of $15.0 million. In
April 1997 and May 1997, the Company borrowed a total of $10.0 million from the
Investors under a 10% bridge loan. The Company's indebtedness under the $10.0
million bridge loan was applied against the purchase price of the Preferred
Stock.
As of June 30, 1997, the Company had $11.3 million invested in short-term
investment grade securities at various interest rates. Management believes that
cash and cash equivalents on hand as of June 30, 1997, together with
availability under the secured credit facilities mentioned above, will be
sufficient to meet the Company's working capital, capital expenditure and debt
covenant requirements until January 1998 without obtaining additional
financing.
In addition to the $5.0 million required to be raised per certain debt
agreements, the Company will need to seek financing to satisfy the $9.25
million debt maturity in August 1998 and may need additional funds in the form
of equity, bank debt, or other debt financing to funds its operations or
network expansion. The Company has no commitment for any refinancing or
additional funds, and no assurances can be given that such additional
refinancing or funds will be available on terms acceptable to the Company, if
at all; the failure to obtain such funds
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<PAGE> 14
PREFERRED NETWORKS, INC.
could have a material adverse effect on the Company. In addition, future
acquisitions of paging network assets and licenses or other assets or
businesses or other events may change the Company's capital requirements.
The market price of the Common Stock is likely to be highly volatile. Factors
such as delays by the Company in achieving its expansion goals, fluctuations in
the Company's operating results, announcements of new services offered by the
Company or its competitors, changes in earnings estimates of securities
analysts, regulatory changes and general market conditions, among other things,
could cause the market price of the Common Stock to fluctuate substantially.
Such market fluctuations could adversely affect the market price for the Common
Stock.
ACQUISITIONS
In September 1996, the Company completed the acquisition of substantially all
the assets of Big Apple Paging Corporation ("Big Apple") for $3.8 million. Of
this amount, $1.4 million was paid in cash in 1996, $1.0 million was paid by
the issuance of 125,598 shares of Common Stock in 1996, $1.1 million was paid
in January 1997 by the issuance of 165,317 shares of Common Stock, an
additional $130,000 was paid in cash in first quarter of 1997 and $250,000 was
paid in cash in April 1997. The transaction was accounted for as a purchase as
of September 13, 1996. Big Apple was a reseller-based paging carrier in the
states of New York, New Jersey, and Connecticut. Prior to closing, the Company
earned revenues from Big Apple under an agency agreement. The purchase of Big
Apple provided the Company with a base of customers upon opening its Northeast
TCC.
In December 1996, the Company acquired the stock of EPS Wireless, Inc. ("EPS")
for approximately $4.8 million and possible additional consideration of up to
an additional $5.0 million based on EPS's achievement of targeted operating
performance during the two year period ending December 31, 1998. The Company
issued 673,524 shares of Common Stock in 1996 and paid $300,000 in cash in
February 1997. The transaction was accounted for as a purchase as of December
1, 1996. Additional consideration, if any, will be recorded as goodwill. EPS
repairs or sells more than 70,000 product units per month. The acquisition of
EPS expanded the Company's revenue sources to include paging companies that do
not currently buy network services from the Company due to geography or
frequency and also expands the Company's customer base to include cellular
companies. EPS also provides the Company with a source of lower-cost pager
products.
In January 1997, the Company acquired the stock of Mercury Paging &
Communications, Inc. ("Mercury") and its affiliated companies for approximately
$14.2 million of which approximately $10.3 million was paid in cash and $3.9
million by the issuance of 624,321 shares of Common Stock, 156,080 of which
were held in escrow until April 1997 then released to the former Mercury
shareholders after Mercury achieved certain revenue targets. Proceeds from the
Company's revolving credit facility which were drawn in December 1996 were used
to fund the majority of the cash portion of the purchase price, with working
capital being used to fund the remainder. Mercury is a reseller-based paging
carrier in the states of New York, New Jersey and Connecticut. Prior to
closing, the Company earned revenues from Mercury under an agency agreement.
In addition, in the second quarter of 1997 the Company purchased network assets
and FCC licenses from two companies for a total purchase price of $100,000,
paid by issuance of 38,975 shares of the Company's Common Stock.
FCC MATTERS
On February 19, 1997, the Federal Communications Commission (the "Commission"
or the "FCC") adopted a Second Report and Order (the "Paging Second Report and
Order") and Further Notice of Proposed Rulemaking (the "Further Notice") in
which it declined to convert the non-exclusive Private Carrier Paging ("PCP")
frequencies, including the 157.740 MHz frequency, to exclusive use frequencies.
The Further Notice, however, seeks additional guidance in connection with the
continued licensing procedure of the non-exclusive PCP channels. The Commission
is concerned, in light of its decision to license the exclusive paging channels
on a geographic basis by competitive bidding, that there is a potential for
application fraud by telemarketers for the non-exclusive PCP frequencies. It,
therefore, seeks comment on what methods could be used to eliminate or reduce
the problem. Primarily, the Commission proposes to modify the application form,
but also asks whether the frequency coordination process could be modified to
reduce the fraudulent or speculative applications.
The Commission also ordered that all non-mutually exclusive applications filed
with the Commission on or before July 31, 1996 will be processed. All mutually
exclusive applications which are pending regardless of when filed will be
dismissed. All applications (other than applications on nationwide and shared
channels) filed after July 31, 1996 will be dismissed. Finally, during the
pendency of the Further Notice, the Interim Licensing Procedure for the
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<PAGE> 15
PREFERRED NETWORKS, INC.
non-exclusive PCP channels will continue for incumbent licensees only allowing
those incumbents to file for additional licenses anywhere. The Commission also
will accept applications from new applicants for private, internal-use systems
on the non-exclusive PCP channels, including the 157.740 MHz frequency. The
Company, therefore, believes that its applications currently on file with the
FCC, including its three applications with associated waiver requests, should
be processed. Since May 12, 1997, the Company has been able to file
applications for new sites to use the non-exclusive PCP channels, including the
157.740 MHz frequency.
In addition, the Commission excluded PCP channels from being licensed on a
geographic basis and declined to subject the non-exclusive PCP frequencies,
including the 157.740 MHz frequency, to the competitive bidding process. The
Company, therefore, will not be required to participate in a competitive
bidding process to expand its paging systems operating on the 157.740 MHz
frequency.
The Commission, however, adopted a geographic licensing scheme and implemented
a competitive bidding process for the exclusive RCC and PCP channels.
Specifically, the FCC adopted geographic licensing for all 931 MHz and all
exclusive 929 PCP paging channels based on Rand McNally's Major Trading Areas
("MTAs"). Licenses below 929 MHz will be geographically licensed based on the
Department of Commerce's 172 Economic Areas. The FCC also excluded from its
plan those channels that already have been assigned to single licensees on a
nationwide basis under existing FCC rules.
Consequently, the Company may be unable to expand its service areas for its
exclusive 931 MHz systems or its other RCC systems unless it participates in a
competitive bidding process or it can reach an agreement with the geographic
licensee. In the Further Notice, the FCC proposed to permit a geographic
licensee to either desegregate its spectrum, i.e., assign a discrete portion or
"block" of spectrum licensed to a geographic licensee, or partition its
licensed area, or both. The Commission has adopted, or proposed, a similar
approach in other Commercial Mobile Radio Services ("CMRS"), such as the
broadband Personal Communications Services and the Specialized Mobile Radio
Services. Adoption of the disaggregation and partitioning proposals would
permit the Company to acquire licensing rights to expand its current exclusive
RCC frequencies or further supplement its operation on 157.740 MHz through
agreement with a geographic licensee without requiring participation in a
competitive bidding process. There is no guarantee that the Commission will
adopt this initiative.
The FCC further concluded that each existing paging licensee will be allowed to
either (i) continue operating under existing authorizations or (ii) trade in
its site-specific licenses for a single system-wide license. Geographic
licensees will be required to afford incumbent constructed and operational
stations protection from interference within their service areas. In the 931
MHz and 929 MHz band, the Commission adopted the existing co-channel
interference protection standards used with respect to the 931 MHz band. The
Commission will continue to use the current co-channel interference protection
formulas for the RCC channels below 931 MHz. No incumbent licensees will be
allowed to modify or expand their systems beyond their composite interference
contour without the consent of the geographic licensee (unless the incumbent
licensee is itself the geographic licensee for the relevant channel). The
Company, therefore, may continue to operate the systems as currently authorized
and may make minor modifications to the systems, including adding new sites to
supplement coverage within the current composite contours of the particular
system.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information included in this Quarterly
Report on Form 10-Q and other materials filed or to be filed by the Company
with the Securities and Exchange Commission (as well as information included in
oral statements or other written statements made or to be made by the Company)
contains statements that are or will be forward-looking, such as statements
relating to acquisitions, construction and other business development
activities, future capital expenditures, sufficiency of funds, financing
sources and availability, monthly savings, and the effects of laws and
regulations (including FCC regulations) and competition. Such forward-looking
information involves important risks and uncertainties that could significantly
affect anticipated results in the future and, accordingly, such results may
differ from those expressed in any forward-looking statements made by or on
behalf of the Company. These risks and uncertainties include, but are not
limited to, uncertainties affecting the paging and wireless industries
generally, risks relating to the Company's acquisition, construction and other
business development activities, risks relating to technological change in the
paging and wireless industries, risks relating to the ability of the Company to
obtain additional funds in the form of debt or equity, risks relating to the
ability to control expenses, risks relating to
15
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PREFERRED NETWORKS, INC.
the availability of transmitters, terminals, network project management
services and network engineering support, fluctuations in interest rates, and
the existence of and changes to federal and state laws and regulations.
16
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PREFERRED NETWORKS, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES.
(a) In June 1997, pursuant to a merger ( the "Merger") of Preferred
Networks, Inc., a Delaware corporation, into a wholly-owned shell
subsidiary incorporated in Georgia, Preferred Networks, Inc.
reincorporated from Delaware to Georgia, increased the amount of its
authorized Common Stock from 70,000,000 to 100,000,000 shares,
increased the amount of its authorized Preferred Stock from 5,000,000
to 30,000,000 shares, and provided that all of its stock was without
par value. As a result of the Merger, the rights of the shareholders
of the Company are determined under Georgia rather than Delaware law.
(b) As a result of the Preferred Stock and Warrant Issuance, 10,000,000
shares of the Company's Class A Redeemable Preferred Stock are
outstanding, which have dividend, voting, redemption and liquidation
rights which in some respects are superior to those of the Common
Stock.
(c) On June 17, 1997, the Company issued 10,000,000 shares of
Class A Redeemable Preferred Stock and warrants to purchase
11,500,000 shares of Common Stock to seven accredited investors for
an aggregate consideration of $15,000,000 in cash, a portion of which
was paid by the cancellation of the Company's indebtedness under a
$10,000,000 bridge loan made to the Company by these investors in
April and May 1997. The transaction was exempt from the Securities
Act of 1933 by reason of Section 4(2) thereof and Regulation D
promulgated thereunder. The warrants are exercisable for five years
and entitle the holder to purchase one share of Common Stock for
$1.50 per share, subject to possible downward adjustment based on any
private placement of the Company's Preferred or Common Stock. A
portion of the warrants may be canceled by the Company in the event
of an early redemption of the Class A Redeemable Preferred Stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On June 16, 1997, the Company held its Annual Meeting of Shareholders. The
following were the results of the meeting:
(a) The shareholders approved the issuance of the Company's Class A
Redeemable Preferred Stock and warrants to acquire Common Stock.
Votes Cast For 11,601,416
Votes Cast Against 19,725
Abstentions/Broker
Non-Votes 7,220
(b) The shareholders approved the Company's 1995 Stock Option Plan, as
amended.
Votes Cast For 11,507,692
Votes Cast Against 21,125
Abstentions/Broker
Non-Votes 99,544
(c) The shareholders approved an Agreement and Plan of Merger between the
Company and PNI Merger Corp., a Georgia corporation and wholly-owned
subsidiary of the
17
<PAGE> 18
PREFERRED NETWORKS, INC.
Company, and the merger of the Company with and into PNI Merger Corp. for
the principal purpose of reincorporating the Company in Georgia.
Votes Cast For 11,499,981
Votes Cast Against 23,825
Abstentions/Broker
Non-Votes 104,555
(d) The shareholders elected William H. Bang, John J. Hurley and
Ronald W. White as Class I directors until the annual meeting of
shareholders in 2000 or until their successors are elected and shall
have qualified.
<TABLE>
<CAPTION>
Bang Hurley White
---- ------ -----
<S> <C> <C> <C>
Votes Cast For 13,464,994 13,464,994 13,464,994
Abstentions/Broker
Non Votes 720 720 720
</TABLE>
In addition to Messrs. Bang, Hurley and White, the terms of
directors Mark H. Dunaway, Michael J. Saner, Jeffrey H. Schutz and
Robert Van Degna (who are Class II and III directors) continued after
the Company's 1997 annual meeting of the shareholders.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
<S> <C>
3.1 Articles of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
10.1 Commitment Letter dated April 9, 1997 between the Company, Centennial Fund IV, L.P.,
Saugatuck Capital III, PNC Capital Corp., Fleet Equity Partners, and Primus Venture
Fund III (2)
10.2 Class A Redeemable Preferred Stock Purchase Agreement dated
as of May 21, 1997, by and among the Company and Centennial
Fund IV, L.P., Saugatuck Capital Company Limited
Partnership III, PNC Capital Corp., Fleet Venture
Resources, Inc., Fleet Equity Partners VI, L.P., Chisholm
Partners II, L.P. and Primus Capital Fund III Limited
Partnership (3)
10.3 Form of Common Stock Purchase Warrant (3)
10.4 Agreement and Plan of Merger, dated May 21, 1997, by and between Preferred Networks,
Inc. and PNI Merger Corp. (3)
</TABLE>
---------------------------
(1) Filed on June 30, 1997, as an exhibit to Preferred Networks,
Inc.'s Current Report on Form 8-K (file no. 0-27658) dated June
16, 1997 and incorporated by reference herein.
(2) Filed on April 15, 1997, as an exhibit to Preferred Networks,
Inc.'s Annual Report on Form 10-K (file no. 0-27658) for the
year ended December 31, 1996 and incorporated by reference
herein.
(3) Filed on May 21, 1997, as an exhibit to Preferred Networks,
Inc.'s Proxy Statement (file no. 0-27658) with respect to the
1997 annual meeting of shareholders and incorporated by
reference herein.
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PREFERRED NETWORKS, INC.
11.1 Computation of Net Loss Per Share
27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K:
During the quarter ended June 30, 1997, the Company filed three
reports on Form 8-K:
1. On April 16, 1997, the Company filed a Current Report on Form
8-K/A dated January 31, 1997 with respect to the acquisition
of Mercury Paging & Communications, Inc. and its affiliated
companies. The following financial statements were filed as
part of this report:
The audited combined financial statements of Mercury
Paging & Communications, Inc. and its affiliated
companies as of and for the years ended December 31,
1996 and 1995.
The unaudited pro forma condensed consolidated
balance sheet of Preferred Networks, Inc. as of
December 31, 1996 and the unaudited pro forma
condensed consolidated statement of operations of
Preferred Networks, Inc. for the year ended December
31, 1996.
2. On April 23, 1997, the Company filed a Current Report on Form
8-K dated April 14, 1997 reporting under Item 1 the potential
change of control of the Company at a subsequent date
resulting from the sale of Class A Redeemable Preferred Stock
and warrants to certain of its shareholders. There were no
financial statements filed as part of this report.
3. On June 30, 1997, the Company filed a Current
Report on Form 8-K dated June 16, 1997 reporting under Item
1 the merger of Preferred Networks, Inc., a Delaware
corporation ("Old PNI") into Preferred Networks, Inc., a
Georgia corporation (the "Company") on June 16, 1997 and
the issuance for $15.0 million of Class A Redeemable
Preferred Stock of the Company and warrants with certain of
its shareholders and two affiliates of one of them on June
17, 1997, and under Item 5 the approval of the shareholders
of Old PNI of the reincorporation of Old PNI from Delaware
to Georgia by means of a merger with the Company. There
were no financial statements filed as part of this report.
19
<PAGE> 20
PREFERRED NETWORKS, INC.
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.
PREFERRED NETWORKS, INC.
Date: August 14, 1997 By: /s/ Mark H. Dunaway
--------------------------------
Mark H. Dunaway
Chief Executive Officer
Date: August 14, 1997 By: /s/ Michael J. Saner
--------------------------------
Michael J. Saner
President
Date: August 14, 1997 By: /s/ Kathryn Loev Putnam
--------------------------------
Kathryn Loev Putnam
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
20
<PAGE> 21
PREFERRED NETWORKS, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Description Numbered Page
- ------ ----------- -------------
<S> <C> <C>
3.1 Articles of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
10.1 Commitment Letter dated April 9, 1997 between the Company,
Centennial Fund IV, L.P., Saugatuck Capital III, PNC Capital
Corp., Fleet Equity Partners, and Primus Venture Fund III (2)
10.2 Class A Redeemable Preferred Stock Purchase Agreement dated as
of May 21, 1997, by and among the Company and Centennial Fund
IV, L.P., Saugatuck Capital Company Limited Partnership III, PNC
Capital Corp., Fleet Venture Resources, Inc., Fleet Equity
Partners VI, L.P., Chisholm Partners II, L.P. and Primus Capital
Fund III Limited Partnership (3)
10.3 Form of Common Stock Purchase Warrant (3)
10.4 Agreement and Plan of Merger, dated May 21, 1997, by and between
Preferred Networks, Inc. and PNI Merger Corp. (3)
11.1 Computation of Net Loss Per Share
27 Financial Data Schedule (for SEC use only)
</TABLE>
---------------------------
(1) Filed on June 30, 1997, as an exhibit to Preferred Networks,
Inc.'s Current Report on Form 8-K (file no. 0-27658) dated June
16, 1997 and incorporated by reference herein.
(2) Filed on April 15, 1997, as an exhibit to Preferred Networks,
Inc.'s Annual Report on Form 10-K (file no. 0-27658) for the
year ended December 31, 1996 and incorporated by reference
herein.
(3) Filed on May 21, 1997, as an exhibit to Preferred Networks,
Inc.'s Proxy Statement (file no. 0-27658) with respect to the
1997 annual meeting of shareholders and incorporated by
reference herein.
21
<PAGE> 1
PREFERED NETWORKS, INC.
COMPUTATION OF NET LOSS PER SHARE
EXHIBIT 11.1
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
------------- -------------
<S> <C> <C>
Primary and fully diluted:
Weighted average common stock outstanding
during the period................................................. 16,148,065 14,417,732
Effect of Common Stock equivalents issued
subsequent to December 18, 1994 computed
in accordance with the treasury stock method
as required by the SEC (1)........................................ - -
------------ ------------
Total........................................................... 16,148,065 14,417,732
============ ============
Net loss .............................................................. $ (5,033,701) $ (1,477,928)
Less: Accretion of Redeemable Preferred Stock (2) .................... (34,769) -
Less: Redeemable Preferred Stock dividend requirements................ (58,333) -
------------ ------------
Net loss attributable to Common Stock and Common
Stock equivalents................................................... $ (5,126,803) $ (1,477,928)
============ ============
Net loss per share of Common Stock..................................... $ (.32) $ (.10)
============ ============
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1997 JUNE 30, 1996
------------- -------------
<S> <C> <C>
Primary and fully diluted:
Weighted average common stock outstanding
during the period................................................. 16,004,034 10,969,325
Effect of Common Stock equivalents issued
subsequent to December 18, 1994 computed
in accordance with the treasury stock method - 1,710,506
as required by the SEC (1)........................................ ------------ ------------
Total........................................................... 16,004,034 12,679,831
============ ============
Net loss .............................................................. $ (9,758,175) $ (2,978,688)
Less: Accretion of Redeemable Preferred Stock (2) .................... (34,769) (202,235)
Less: Redeemable Preferred Stock dividend requirements ............... (58,333) (353,651)
------------ ------------
Net loss attributable to Common Stock and Common
Stock equivalents................................................... $ (9,851,277) $ (3,534,574)
============ ============
Net loss per share of Common Stock..................................... $ (.62) $ (.28)
============ ============
</TABLE>
- ------------------------
(1) Pursuant to Securities and Exchange Commission Staff Accounting Bulletin
No. 83, Common Stock equivalents (including a portion of Series A
Redeemable Convertible Preferred Stock and all of Series B Redeemable
Convertible Preferred Stock) issued at prices equal to or below the
initial public offering price per share ("cheap stock") during the
twelve-month period immediately preceding the initial filing date of the
Company's Registration Statement for its initial public offering have been
included as outstanding for all periods presented prior to the initial
public offering.
(2) 1996 amount represents the portion of the accretion related to Series A
Redeemable Convertible Preferred Stock not treated as cheap stock.
22
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AUDITED
CONSOLIDATED BALANCE SHEET AND STATEMENT OF OEPRATIONS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30,
1997.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<EXCHANGE-RATE> 1
<CASH> 12,919,194
<SECURITIES> 0
<RECEIVABLES> 4,936,757
<ALLOWANCES> 296,275
<INVENTORY> 4,549,728
<CURRENT-ASSETS> 22,955,189
<PP&E> 32,190,840
<DEPRECIATION> 5,235,581
<TOTAL-ASSETS> 76,367,090
<CURRENT-LIABILITIES> 8,635,139
<BONDS> 16,667,167
12,977,666
0
<COMMON> 61,680,039
<OTHER-SE> (23,592,921)
<TOTAL-LIABILITY-AND-EQUITY> 76,367,090
<SALES> 6,406,433
<TOTAL-REVENUES> 17,705,189
<CGS> 6,638,724
<TOTAL-COSTS> 15,127,191
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 265,695
<INTEREST-EXPENSE> 606,383
<INCOME-PRETAX> (9,758,175)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,758,175)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,758,175)
<EPS-PRIMARY> (.62)
<EPS-DILUTED> (.62)
</TABLE>
