<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, 1998
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: 16,334,377 shares of common
stock, no par value, as of August 13, 1998.
<PAGE> 2
PREFERRED NETWORKS, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
NUMBER
-----------
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets, June 30, 1998
(Unaudited) and December 31, 1997.................................... 3
Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 1998 and 1997, respectively
(Unaudited).......................................................... 4
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 1998 and 1997 (Unaudited)...................... 5
Notes to Condensed Consolidated Financial Statements (Unaudited) .... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 8
PART II. OTHER INFORMATION
Item 4. Submission of Matters to A Vote of Security Holders.................. 13
Item 6. Exhibits and Reports on Form 8-K..................................... 13
Signatures........................................................... 14
</TABLE>
2
<PAGE> 3
PREFERRED NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
---------------- ----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents...................................... $ 9,428,257 $ 7,562,978
Accounts receivable, net....................................... 3,657,401 3,969,026
Inventory...................................................... 3,330,074 2,890,647
Prepaid expenses and other current assets...................... 880,784 325,130
------------ ------------
Total current assets......................................... 17,296,516 14,747,781
Property and equipment, net....................................... 23,904,277 25,569,209
Goodwill, net..................................................... 12,900,590 13,396,459
FCC licenses, net................................................. 9,206,468 9,544,622
Other assets, net................................................. 2,732,643 2,974,409
============ ==============
$ 66,040,494 $ 66,232,480
============ ==============
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable............................................... $ 1,915,319 $ 3,091,994
Accrued liabilities............................................ 641,424 832,656
Accrued compensation........................................... 721,845 797,302
Current portion of notes payable and capital lease obligations. 2,598,028 2,123,248
------------ -------------
Total current liabilities.................................... 5,876,616 6,845,200
Notes payable and capital lease obligations, less current portion. 16,803,960 17,658,608
Class A Redeemable Preferred Stock, no par value, $1.50 per
share redemption price; 13,500,000 shares authorized,
10,000,000 shares issued and outstanding (including $750,000
and $808,333 of undeclared dividends in 1998 and 1997,
respectively).................................................. 14,917,715 13,956,123
Class B Senior Redeemable Preferred Stock, no par value, $1.50
per share redemption price; 5,500,000 shares authorized in
1998, 5,333,336 shares issued and outstanding in 1998
(including $345,161 of undeclared dividends in 1998)........... 7,369,703 -
------------ -------------
Total liabilities and Redeemable Preferred Stock............. 44,967,994 38,459,931
Stockholders' equity
Preferred stock, no par value, 11,000,000 and 16,500,000 shares
authorized in 1998 and 1997, respectively; no shares issued
and outstanding.............................................. - -
Common Stock, no par value, 100,000,000 shares authorized
in 1998 and 1997; 16,334,377 and 16,200,552 issued and
outstanding in 1998 and 1997, respectively................... 62,770,130 62,900,973
Accretion of Redeemable Preferred Stock. ...................... (516,860) (245,726)
Accumulated deficit............................................ (41,180,770) (34,882,698)
------------ -------------
21,072,500 27,772,549
============ =============
$ 66,040,494 $ 66,232,480
============ =============
</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,
-------------------------------- --------------------------------
1998 1997 1998 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues
Network services................................ $ 3,295,398 $ 3,250,921 $ 6,558,416 $ 5,816,509
Product sales................................... 3,620,890 3,473,108 7,515,484 6,406,433
Other services.................................. 2,946,601 2,864,809 5,453,466 5,482,247
----------- ------------ ----------- -----------
Total revenues......................... 9,862,889 9,588,838 19,527,366 17,705,189
Costs of revenues
Network services ............................... 2,186,420 2,195,442 4,340,792 4,103,650
Product sales................................... 3,104,771 3,558,806 6,337,071 6,638,724
Other services.................................. 2,254,080 2,358,656 4,218,760 4,384,817
----------- ------------ ----------- -----------
Total costs of revenues................ 7,545,271 8,112,904 14,896,623 15,127,191
----------- ------------ ----------- -----------
Gross margin......................................... 2,317,618 1,475,934 4,630,743 2,577,998
Selling, general and administrative expenses......... 3,493,616 4,127,679 7,116,663 8,219,955
Depreciation and amortization........................ 1,631,602 1,803,814 3,391,255 3,449,716
Other expenses - 277,707 - 277,707
----------- ------------ ----------- -----------
Operating loss......................... (2,807,600) (4,733,266) (5,877,175) (9,369,380)
Interest expense..................................... (294,450) (379,587) (621,033) (606,383)
Interest income...................................... 125,867 79,152 200,262 217,588
----------- ----------- ----------- -----------
Net loss............................... (2,976,183) (5,033,701) (6,297,946) (9,758,175)
Accretion of Redeemable Preferred Stock.............. (159,241) (34,769) (271,134) (34,769)
Redeemable Preferred Stock dividend requirements..... (675,000) (58,333) (1,095,161) (58,333)
----------- ----------- ----------- -----------
Net loss attributable to Common Stock.. $(3,810,424) $ (5,126,803) $(7,664,241) $(9,851,277)
=========== ============ =========== ===========
Net loss per share of Common Stock................... $ (0.23) $ (0.32) $ (0.47) $ (0.62)
=========== ============ =========== ===========
Weighted average number of common shares
used in calculating net loss per share of
Common Stock...................................... 16,242,004 16,099,603 16,210,627 15,979,804
=========== ============ =========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
PREFERRED NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------------------------
1998 1997
----------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ............................................................ $ (6,297,947) $ (9,758,175)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization..................................... 3,391,255 3,449,716
Bad debt expense.................................................. 157,663 265,695
Stock option and restricted stock grant compensation expense...... 33,162 244,455
Changes in operating assets and liabilities:
Accounts receivable............................................. 153,827 (1,567,252)
Inventory....................................................... (461,527) 1,444,981
Prepaid expenses and other assets............................... (50,048) (280,328)
Accounts payable................................................ (1,176,675) (860,133)
Accrued liabilities............................................. (191,232) (184,864)
Accrued compensation............................................ (75,457) 65,325
--------------- ---------------
Net cash used in operating activities......................... (4,516,979) (7,180,580)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment............................................... (851,603) (3,734,426)
Purchases of other assets and FCC licenses........................... (346,667) (762,900)
Payment for acquisitions, net of cash acquired....................... - (10,629,768)
--------------- ---------------
Net cash used in investing activities......................... (1,198,270) (15,127,094)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings............................................. 900,000 10,000,000
Repayments of borrowings............................................. (995,627) (1,234,002)
Payment of deferred loan costs ...................................... (220,000) -
Net proceeds from issuance of Redeemable Preferred Stock ............ 6,965,000 2,884,553
Net proceeds from issuance of Common Stock purchase warrants......... 810,000 1,930,963
Issuance of Common Stock upon exercise of stock options.............. 121,155 -
--------------- ---------------
Net cash provided by financing activities..................... 7,580,528 13,581,514
Net increase (decrease) in cash and cash equivalents................. 1,865,279 (8,726,160)
Cash and cash equivalents, beginning of period....................... 7,562,978 21,645,354
--------------- ---------------
Cash and cash equivalents, end of period............................. $ 9,428,257 $ 12,919,194
=============== ===============
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE> 6
PREFERRED NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
(UNAUDITED)
1. THE COMPANY
Preferred Networks, Inc. ("PNI"), headquartered in metropolitan Atlanta,
provides outsourcing solutions to the wireless industry which allow
companies to offer branded wireless services directly to subscribers,
while relying on PNI to provide high-quality network, technical, and
product services. PNI offers its services through its Network Services
Division, a provider of wholesale paging network service as one of the
largest carrier's carriers in the U.S., and through its wholly-owned
subsidiaries: Preferred Technical Services, Inc. ("PTS"), a provider of
paging network equipment installation, maintenance and engineering
services; and 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.
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 ("GAAP") 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, 1997, 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, 1998 and 1997 were
approximately $622,000 and $575,000, respectively. There were no
significant federal or state income taxes paid or refunded for the six
months ended June 30, 1998 and 1997.
4. LOSS PER SHARE
Net loss per share was computed and restated, in the case of periods
prior to the fourth quarter of 1997, using the requirements of Statement
of Financial Accounting Standards No. 128, Earnings per Share, and Staff
Accounting Bulletin No. 98. Net loss per share-basic was computed by
dividing net loss attributable to common stock by the weighted average
number of shares of common stock outstanding during the period excluding
unvested shares of restricted stock. The denominator for net loss per
share-diluted also considers the dilutive effect of outstanding stock
options, warrants, and convertible preferred stock. Due to the Company's
net loss, the amounts reported for basic and diluted are the same. The
following securities could potentially dilute basic earnings per share
in the future and were not included in the computation of diluted net
loss per share because they would have been antidilutive for the period
presented:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------------
1998 1997
--------------- --------------
<S> <C> <C>
Common Stock Options........... 2,134,113 1,772,023
Common Stock Warrants.......... 17,322,353 11,922,354
Unvested Restricted Stock...... 69,000 60,000
------------ ------------
Total.......................... 19,525,466 13,754,377
============ ============
</TABLE>
6
<PAGE> 7
PREFERRED NETWORKS, INC.
5. ACQUISITIONS
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 $10.0 million was
paid in cash and the remainder by the issuance of 624,321 shares of
Common Stock. Proceeds from the Comprevolving 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.
6. ISSUANCE OF CLASS B SENIOR REDEEMABLE PREFERRED STOCK AND COMMON STOCK
PURCHASE WARRANTS
In March 1998, the Company issued 5,333,336 shares of Class B Senior
Redeemable Preferred Stock (the "Class B Preferred") and warrants to
purchase up to 5.4 million shares of Common Stock for a total purchase
price of $8 million. Dividends accrue at the rate of 15% per annum, are
cumulative and compound annually. The Class B Preferred 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 Class B Preferred must be redeemed by the
Company at a price equal to $1.50 per share plus accrued dividends. In
the event of redemption of the Company's Class A Redeemable Preferred
Stock (the "Class A Preferred"), the Company must simultaneously redeem
the Class B Preferred. Each warrant is exercisable for five years
following the issuance of the Class B Preferred 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 for less than $1.50 per share. The
Class B Preferred is recorded at cost, net of expenses, plus accretion
and undeclared dividends.
7. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131 "Disclosures about Segments of an Enterprise and Related
Information" ("FAS 131"), which establishes standards for the way public
business enterprises report information about operating segments in
their financial statements. FAS 131 also establishes standards for
related disclosures about products and services, geographic areas, and
major customers. FAS 131 is effective for annual financial statements
for periods beginning after December 15, 1997. The Company will adopt
FAS 131 in 1998 and does not expect the effect of adoption to be
material to its consolidated financial statements but additional
disclosures may be required.
In April 1998, the Accounting Standards Executive Committee (AcSEC)
issued Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities" ("SOP 98-5"). SOP 98-5 requires entities to charge to
expense start-up costs, including organizational costs, as incurred. In
addition, SOP 98-5 requires a write-off of any previously capitalized
start-up or organization costs, and must be reported as the cumulative
effect of a change in accounting principle. SOP 98-5 is effective
January 1, 1999. The Company will adopt SOP 98-5 by the required date
and will write off the unamortized balance of its market entry costs and
cease to capitalize such costs at that time. Market entry costs net of
accumulated amortization at June 30, 1998 were approximately $1.9
million. Additional amounts capitalized, net of amortization expense,
during the three months ended June 30, 1998 and 1997 were ($20,000) and
$226,000, respectively, and during the six months ended June 30, 1998
and 1997 were ($117,000) and $451,000, respectively.
7
<PAGE> 8
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 table below provides the components of the Company's consolidated
statements of operations and EBITDA for each of the three months and the six
months ended June 30, 1998 and 1997, respectively, as a percentage of total
revenues.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- ------------------------------
1998 1997 1998 1997
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues
Network services ........................... 33.4% 33.9% 33.6% 32.9%
Product sales............................... 36.7 36.2 38.5 36.2
Other services.............................. 29.9 29.9 27.9 30.9
------------- ------------- ------------- -------------
Total revenues............................ 100.0 100.0 100.0 100.0
Cost of revenues
Network services ........................... 22.3 22.9 22.2 23.2
Products sales.............................. 31.5 37.1 32.4 37.5
Other services ............................. 22.9 24.6 21.6 24.7
-------------- --------------- -------------- -------------
Total cost of revenues.................... 76.7 84.6 76.2 85.4
Gross margin 23.3 15.4 23.8 14.6
Selling, general and administrative expenses... 35.4 43.0 36.4 46.4
Depreciation and amortization.................. 16.5 18.8 17.4 19.5
Other expenses - 2.9 - 1.6
-------------- --------------- -------------- --------------
Operating loss............................ (28.6) (49.3) (30.0) (52.9)
Interest expense............................... (3.0) (4.0) (3.2) (3.4)
Interest income................................ 1.3 0.8 1.0 1.2
-------------- --------------- -------------- --------------
Net loss ................................. (30.3)% (52.5)% (32.2)% (55.1)%
============== =============== ============== ==============
EBITDA......................................... (11.9)% (30.5)% (12.7)% (33.4)%
============== =============== ============== ==============
</TABLE>
The table below provides information about the Company's units in service
on the Company's networks by customer type.
<TABLE>
<CAPTION>
JUNE 30, PERCENTAGE INCREASE IN
------------------------------- ------------------------------
1998 1997 1998 1997
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Units in service
Reseller units............................... 317,446 317,386 4.4% 121.5%
Colocation/interconnection units............. 184,070 107,605 22.2% 137.9%
-------------- ---------------
Total units in service...................... 501,516 424,991 10.3% 97.0%
============== ===============
</TABLE>
8
<PAGE> 9
PREFERRED NETWORKS, INC.
RESULTS OF OPERATIONS
Total revenues increased by $274,000, or 2.9%, to $9.9 million for the three
months ended June 30, 1998 from $9.6 million for the three months ended June 30,
1997. Total revenues increased by $1.8 million, or 10.3%, to $19.5 million for
the six months ended June 30, 1998 from $17.7 million for the six months ended
June 30, 1997.
Revenues from network services increased by $44,000, or 1.4%, to $3.3 million
for the three months June 30, 1998 from $3.3 million for the three months ended
June 30, 1997. Revenues from network services increased by $742,000, or 12.7%,
to $6.6 million for the six months ended June 30, 1998 from $5.8 million for the
six months ended June 30, 1997. The Company has experienced an increase in
network services revenue as unit growth and the associated recurring revenue
stream have continued both in existing markets and in new markets as well as
from the acquisition of Mercury Paging & Communications, Inc., ("Mercury"), a
reseller-based paging carrier acquired in January 1997. The Company expanded to
27 markets at June 30, 1998 from 23 markets at June 30, 1997. Units in service
increased by 76,525, or 18.0%, to 501,516 from 424,991 over the prior year three
month period. Airtime revenue per unit decreased by $0.37 for the three months
ended June 30, 1998 compared to the three months ended June 30, 1997. Airtime
revenue per unit decreased by $0.23 for the six months ended June 30, 1998
compared to the six months ended June 30, 1997. This decrease is primarily due
to an increase in units in service from colocation/interconnection customers as
a percentage of total units in service. The Company incurs minimal marginal cost
in supplying only airtime to its colocation/interconnection customers and
therefore charges these customers substantially less per unit in service per
month than it charges its reseller customers.
Revenues from product sales increased by $148,000, or 4.3%, to $3.6 million for
the three months June 30, 1998 from $3.5 million for the three months ended
June 30, 1997. Revenues from product sales increased by $1.1 million, or 17.3%,
to $7.5 million for the six months ended June 30, 1998 from $6.4 million for
the six months ended June 30, 1997. The increase in revenues from product sales
resulted from growth during 1998 of sales of new, used and refurbished pager
and cellular products.
Other services revenues increased by $82,000, or 2.9%, to $2.9 million for the
three months ended June 30, 1998 from $2.9 million for the three months ended
June 30, 1997. Other services revenues decreased by $29,000 or 0.1%, to $5.5
million for the six months ended June 30, 1998. The decrease for the six months
ended June 30, 1998 is primarily due to decreased revenue charged per unit for
pager repair and refurbishment services, at EPS, which the Company believes will
be offset in the future by higher volumes of units serviced. This decrease is
offset in the second quarter of 1998 by increases in technical services revenue
at PTS.
Cost of network services decreased by $9,000, or 0.4%, to $2.2 million for the
three months ended June 30, 1998 from $2.2 million for the three months ended
June 30, 1997, and decreased as a percentage of network services revenue to
66.3% for the three months ended June 30, 1998 from 67.5% for the three months
ended June 30, 1997. Cost of network services increased by $237,000, or 5.8%,
to $4.3 million for the six months ended June 30, 1998, but decreased as a
percentage of network services revenue to 66.2% for the six months ended June
30, 1998 from 70.6% for the six months ended June 30, 1997. As markets generate
increased revenue, the decrease in costs as a percentage of revenue is expected
due to the fixed nature of many of these expenses.
Cost of product sales decreased by $454,000, or 12.8%, to $3.1 million for the
three months ended June 30, 1998 from $3.6 million for the three months ended
June 30, 1997. Cost of product sales decreased by $302,000, or 4.5%, to $6.3
million for the six months ended June 30, 1998 from $6.6 million for the six
months ended June 30, 1997. Cost of product sales as a percentage of product
sales decreased to 85.7% for the three months ended June 30, 1998 from 102.5%
for the three months ended June 30, 1997. Cost of product sales decreased
primarily due to EPS's profitable product sales, and to a lesser extent due to
decreasing losses on pagers sold to its network customers. The Company also
reduced the carrying cost of its inventory by $186,000 as of June 30, 1998 to
the lower of cost or market compared to a $612,000 writedown as of June 30,
1997.
Cost of other services decreased by $105,000, or 4.4% to $2.3 million for the
three months ended June 30, 1998 from $2.4 million for the three months ended
June 30, 1997. Cost of other services decreased by $166,000, or 3.8%, to $4.2
million for the six months ended June 30, 1998 from $4.4 million for the six
months ended June 30, 1997. The decrease in cost of other services is primarily
due to the decrease in pager repair and refurbishment services revenue offset in
part by increases in costs associated with increased technical services
revenues.
Selling, general and administrative expenses (SG&A) decreased by $912,000, or
20.7%, to $3.5 million for the three months ended June 30, 1998 from $4.1
million for the three months ended June 30, 1997. SG&A decreased as a
percentage of total revenues to 35.4% for the three months ended June 30, 1998
from 43.0% for the three months ended June 30 1998. SG&A expenses decreased to
$7.1 million for
9
<PAGE> 10
PREFERRED NETWORKS, INC.
the six months ended June 30, 1998 from $8.5 million for the six months ended
June 30, 1997. The decrease in SG&A expenses is primarily due to certain
non-recurring severance expenses incurred in the second quarter of 1997 related
to personnel cost reduction measures. SG&A decreased as a percentage of total
revenues to 36.4% for the six months ended June 30, 1998, from 48.0% for the six
months ended June 30, 1997. The decrease in SG&A expenses is primarily due to
personnel cost reduction measures taken in the second quarter of 1997. In
addition, because the Company does not market directly to end-users, it does
not incur subscriber-related acquisition costs and, accordingly, its SG&A
expenses do not increase in direct proportion to its revenue growth.
Depreciation and amortization decreased by $172,000, or 9.5%, to $1.6 million
for the three months ended June 30, 1998 from $1.8 million for the three months
ended June 30, 1997. Depreciation and amortization decreased as a percentage of
total revenues to 16.5% for the three months ended June 30, 1998 from 18.8% for
the three months ended June 30, 1997. Depreciation and amortization decreased by
$58,000 or 1.7%, to $3.4 million for the six months ended June 30, 1998 from
$3.4 million for the six months ended June 30, 1997. Depreciation and
amortization decreased as a percentage of total revenues to 17.4% for the six
months ended June 30, 1998 from 19.5% for the six months ended June 30, 1977.
Depreciation and amortization decreased primarily due to less amortization
expense incurred in the current year as market start-up costs become fully
amortized offset in part by increased depreciation expense on additional assets
placed in service in 1998.
Other expenses decreased by $278,000, or 100.0% to $0 for the three and six
months ended June 30, 1998. The decrease is due to certain non-recurring
severance expenses incurred in the second quarter of 1997 related to personnel
cost reduction measures.
Interest expense, net of capitalized amounts, decreased by $85,000, or 22.4%,
to $294,000 for the three months ended June 30, 1998 from $380,000 for the
three months ended June 30, 1997. Interest expense increased $15,000, or 2.4%,
to $621,000 for the six months ended June 30, 1998, from $606,000 for the six
months ended June 30, 1997 due to the financing of the network buildout and
borrowings related to the January 1997 acquisition of Mercury.
Interest income increased by $47,000 or 59.0% to $126,000 for the three months
ended June 30, 1998 from $79,000 for the three months ended June 30, 1997.
Interest income decreased $17,000, or 8.0%, to $200,000 for the six months
ended June, 30, 1998 from $218,000 for the six months ended June 30, 1997.
Net loss for the three months ended June 30, 1998 as compared to the three
months ended June 30, 1997 decreased to $3.0 million from $5.0 million. Net
loss for the six months ended June 30, 1998, as compared with the six months
ended June 30, 1997 decreased to $6.3 million from $9.8 million due to
substantial increases in gross margin combined with decreases in SG&A, as
described above. The net loss attributable to Common Stock decreased due to the
lower net loss, offset in part by higher accretion and dividends related to the
Class A Redeemable Preferred Stock ("the Class A Preferred") and the Class B
Senior Redeemable Preferred Stock ("the Class B Preferred"), issued in June
1997 and March 1998, respectively.
The net loss per share of Common Stock for the three months ended June 30, 1998
decreased to $0.23 from $0.32 for the three months ended June 30, 1997. The net
loss per share of Common Stock for the six months ended June 30, 1998 decreased
to $0.47 from $0.62 for the same six months ended in 1997, due to the Company's
decreased net loss, which was offset in part by higher accretion and dividends
on the Company's outstanding preferred stock. All prior year net loss per share
amounts have been restated to conform to Statement of Financial Accounting
Standards No. 128 and Staff Accounting Bulletin No. 98.
LIQUIDITY AND CAPITAL RESOURCES
The Company's expansion strategy has historically required 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. Because the Company's network expansion is in its later
stages, the Company expects that its capital expenditures in 1998 will be
reduced compared to 1997. The timing and construction of additional markets
will depend, among other things, on customer requirements and the timing and
availability of capital.
The Company's net cash used in operations was $4.5 million and $7.2 million for
the six months ended June 30, 1998 and 1997, respectively. The primary reasons
for the reduction in net cash used in operations were the decrease in the net
loss from operations and a decrease in accounts receivable compared to the prior
year period.
Capital expenditures were $852,000 and $3.7 million for the six months ended
June 30, 1998 and 1997, respectively, reflecting the later stage of the
Company's network expansion. The Company has funded its expansion in the past by
equity infusions, bank and finance company debt, loans from stockholders, and
vendor and seller financing.
In 1997 and prior years, the Company expanded and augmented its local and
wide-area 157.740 MHz networks by purchasing and consolidating existing local
network assets licensed on the 150 MHz, 450 MHz and 900 MHz
10
<PAGE> 11
PREFERRED NETWORKS, INC.
frequency bands to offer additional capacity and flexibility to its customers.
In June 1997, the Company sold $15 million of Class A Preferred with warrants
to certain existing stockholders. The Class A Preferred accrues cumulative
dividends at a rate of 10.0% of its original principal value per annum. The
holders of the Class A Preferred were issued warrants to purchase 11.5 million
shares of Common Stock at an exercise price of $1.50 per share. No dividends on
the Class A Preferred have been paid as of June 30, 1998.
In March 1998, the Company sold $8.0 million of Class B Preferred with
warrants to one institutional investor and certain of its existing
stockholders. The Class B Preferred accrues cumulative dividends at a rate of
15.0% of its liquidation value, compounded annually. The holders of the Class B
Preferred were issued warrants to purchase 5.4 million shares of Common Stock
at an exercise price of $1.50 per share. No dividends on the Class B Preferred
have been paid as of June 30, 1998.
The Company has a secured credit facility for $12.0 million of vendor financing
bearing interest at the five-year U.S. Treasury rate plus 6.5% payable in
various monthly installments of principal and interest over 60 months. This
credit facility contains various conditions, financial covenants and
restrictions and is secured by paging equipment. As of June 30, 1998, there was
$5.5 million outstanding under this facility with $5.7 million available.
The Company has a secured credit facility for $5.0 million to finance paging
system equipment from a finance company bearing interest between 10% and 11%
payable in various monthly installments of principal and interest over 60
months. This credit facility contains various conditions, financial covenants
and restrictions and is secured by paging equipment. As of June 30, 1998, there
was $3.4 million outstanding under this facility with no additional
availability.
The Company has a $11.0 million credit facility with a financial institution,
which is to be used to finance paging network acquisitions and for general
working capital purposes. The outstanding balance under this facility bears
interest at either (i) 1% plus the higher of the Federal Funds Rate for each
day plus 1/2% or prime, or (ii) LIBOR plus 3.75%, at the Company's option.
Borrowings under this facility are secured by substantially all the assets of
the Company. This credit facility contains various conditions and financial
covenants, including but not limited to a requirement to maintain a minimum
cash balance of $4 million at all times. The amount outstanding under this
facility as of June 30, 1998 was $10.0 million, with $118,000 in additional
availability.
At June 30, 1998, the Company had $7.6 million invested in short-term
investment grade securities at various interest rates.
Management believes that cash and cash equivalents on hand together with the
secured credit facilities described above, will be sufficient to meet the
Company's working capital, capital expenditure and debt covenant requirements
to the end of the second quarter of 1999 without requiring additional vendor or
other financing. The Company may need additional funds in the form of equity,
bank debt or other debt financing in the future to execute its business plan.
However, no assurances can be given that if additional funds are required, such
funds will be available on terms acceptable to the Company, if at all, and the
failure to obtain such funds could have a material adverse effect on the
Company.
ACQUISITIONS
In January 1997, the Company acquired the stock of Mercury and its affiliated
companies for a total purchase price of $14.2 million. The transaction was
accounted for as a purchase as of January 31, 1997. Of this amount, the Company
paid $10.0 million in cash and issued 624,321 shares of Common Stock. Mercury
was 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.
YEAR 2000 COMPUTER ISSUE
Many computer systems in use today were designed and developed using two
digits, rather than four, to specify the year. As a result, such systems will
recognize the year 2000 as "00." This may cause many computer applications to
fail completely or to create erroneous results unless corrective measures are
taken.
The Company utilizes software and related computer technologies essential to
its operations that will be affected by the Year 2000 issue. Although the
Company's evaluation is continuing, the Company currently believes that most of
its software is already Year 2000 compliant and the cost, if any, of modifying
its remaining software will not be material, or require extensive time.
11
<PAGE> 12
PREFERRED NETWORKS, INC.
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, timing of the Company's need for
additional capital, financing sources and availability 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 leverage and debt service
(including availability of financing terms acceptable to the Company), risks
relating to the ability of the Company to obtain additional funds in the form
of debt or equity, risks relating to 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.
12
<PAGE> 13
PREFERRED NETWORKS, INC.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On May 28, 1998, the Company held its Annual Meeting of Shareholders. The
following were the results of the meeting:
(a) The shareholders approved the Company's 1995 Stock Option Plan, as amended.
Votes Cast For. . . . . . . . . . . . . . . . . . . . . . 25,905,078
Votes Cast Against. . . . . . . . . . . . . . . . . . . . 1,805,111
Abstentions/Broker Non-Votes. . . . . . . . . . . . . . . 6,800
(b) The shareholders elected Robert Van Degna, Jeffrey H. Schutz, and Robert
F. Benbow as Class II directors until the annual meeting of shareholders
in 2001 or until their successors are elected and shall have been
qualified. In addition, the shareholders elected Richard P. Campbell, Jr.
as a Class III director until the annual meeting of shareholders in 1999
or until his successor is elected and shall have been qualified.
<TABLE>
<CAPTION>
Van Degna Schutz Benbow Campbell
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Votes cast For. . . . . . . . 29,700,478 29,700,478 5,293,336 10,000,000
Abstentions/Broker
Non-Votes. . . . . . . . . . 7,400 7,400
</TABLE>
In addition to Messrs. Van Degna, Schutz, Benbow, and Campbell, the terms
of Mark H. Dunaway, Michael J. Saner, William H. Bang, John J. Hurley, and
Ronald W. White (who are Class I and III directors) continued after the
Company's 1998 annual meeting of the shareholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit:
27 Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K:
The registrant did not file any reports on Form 8-K during the three
months ended June 30, 1998.
13
<PAGE> 14
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 13, 1998 By: /s/ Mark H. Dunaway
-------------------------------------------------
Mark H. Dunaway
Chief Executive Officer
Date: August 13, 1998 By: /s/ Michael J. Saner
-------------------------------------------------
Michael J. Saner
President
Date: August 13, 1998 By: /s/ Kathryn Loev Putnam
-------------------------------------------------
Kathryn Loev Putnam
Senior Vice President and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
14
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
PREFERRED NETWORKS INC. RESTATED BALANCE SHEET AND STATEMENT OF OPERATIONS AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q FOR THE SIX
MONTH PERIOD ENDED JUNE 30, 1998.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 9,428,257
<SECURITIES> 0
<RECEIVABLES> 4,048,637
<ALLOWANCES> 391,236
<INVENTORY> 3,330,074
<CURRENT-ASSETS> 17,296,516
<PP&E> 32,893,230
<DEPRECIATION> 8,988,953
<TOTAL-ASSETS> 66,040,494
<CURRENT-LIABILITIES> 5,876,616
<BONDS> 16,803,960
22,287,418
0
<COMMON> 62,770,130
<OTHER-SE> (41,697,630)
<TOTAL-LIABILITY-AND-EQUITY> 66,040,494
<SALES> 7,515,484
<TOTAL-REVENUES> 19,527,366
<CGS> 6,337,071
<TOTAL-COSTS> 14,896,623
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 157,663
<INTEREST-EXPENSE> 621,033
<INCOME-PRETAX> (6,297,946)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,297,946)
<EPS-PRIMARY> (.47)
<EPS-DILUTED> (.47)
</TABLE>
