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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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, Georgia 30071
(Address of principal executive offices, including zip code)
(770) 582-3500
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, no par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant based upon the closing sales price of the Registrant's Common
Stock on the Over The Counter Bulletin Board on April 9, 1999 was approximately
$2.0 million. As of April 9, 1999, 16,369,302 shares of the Registrant's Common
Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically identified portions of the Proxy Statement for the 1999
Annual Meeting of Stockholders to be held on June 10, 1999 are incorporated by
reference in Part III.
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TABLE OF CONTENTS
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PART I Page
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<S> <C> <C> <C>
Item 1. Business................................................................... 3
2. Properties................................................................. 13
3. Legal Proceedings.......................................................... 13
4. Submission of Matters to a Vote of Security Holders........................ 13
Executive Officers of the Registrant
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.................................................................. 15
6. Selected Financial Data.................................................... 15
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 17
7A. Quantitative and Qualitative Disclosures About Market Risk................. 27
8. Financial Statements and Supplementary Data................................ 27
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................................. 46
PART III
Item 10. Directors and Executive Officers of the Registrant......................... 46
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............ 46
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PART I
ITEM 1. BUSINESS
GENERAL
Preferred Networks, Inc. (the "Company") is a leading provider of
outsourcing services to the wireless marketplace and currently serves over 2,100
companies nationwide. The Company does not market its services directly to
end-users and therefore does not compete with its customers for their
subscribers. The Company's outsourcing service offering consists of (i) one-way
wireless networks, whereby companies purchase non-branded, wholesale network
services from the Company for resale to their customers (through its PNI Access
Services Division); (ii) network engineering and maintenance services,
supporting one-way and two-way wireless technologies (through Preferred
Technical Services, Inc. - "PTS", a wholly-owned subsidiary); and (iii) pager
and cellular product repair services, product sales and inventory management and
fulfillment (through EPS Wireless, Inc. - "EPS", a wholly-owned subsidiary.) The
Company provides its services to network carriers, resellers, agents and
manufacturers, and its customers include nine of the ten largest paging
companies, the two largest manufacturers of wireless network infrastructure and
two of the largest cellular product manufacturers.
The Company's strategy is to create customer value as a leading provider of
high-quality, cost-effective outsourcing solutions to companies in the wireless
marketplace. The Company's outsourcing services enable companies to offer
branded wireless products and services directly to their customers while
incurring associated costs on an as-needed basis. The Company is able to provide
high quality, cost effective outsourcing services due to: (i) the cost benefits
of providing its services to many companies with many subscriber bases rather
than to a single subscriber base; (ii) its reduced overhead costs as a result of
not having to support the cost of sales, marketing and customer support
organizations directed to subscribers; and (iii) the reduced operating costs
associated with its centralized network architecture and its primary use of a
low cost, high power paging frequency.
INDUSTRY BACKGROUND
The commercial mobile wireless communications industry began in 1949 when
the Federal Communications Commission (the "Commission" or the "FCC") allocated
a group of radio frequencies for use in providing one-way and two-way paging
services. Historically, the wireless industry has consisted of a highly
fragmented, large number of small operators, providing one-way paging services
principally to professional business segments. The paging industry has expanded
to serve an increasingly broad customer base as business customers and consumers
have become increasingly aware of the benefits of one-way and two-way wireless
services, including cellular telephone services, personal communication services
("PCS") and premium one-way paging services. According to industry sources, the
largest component of the wireless market today remains one-way signaling.
Industry sources estimate that the U.S. market for one-way, traditional paging
services has grown from approximately one million subscribers in 1980 to 48.1
million subscribers in 1997 and is estimated to reach 60.5 million subscribers
by 2003. Factors contributing to this growth include: (i) greater penetration of
paging services into mainstream consumer markets; (ii) reduced pager and service
costs to subscribers driven by technological improvements and competition; (iii)
wider area coverage; (iv) increased reliability of paging services; (v) enhanced
applications of one-way paging services, such as voice mail, Internet, facsimile
and other methods of data transmission; and (vi) the FCC auction process of new
spectrum for one-way paging services.
Historically, wireless companies held a license for a radio frequency,
constructed and maintained network facilities over which to deliver their
services ("carriers") and marketed products and services to subscribers through
direct sales forces. As the market for wireless services has expanded,
additional channels of distribution have evolved, including companies that do
not build and maintain their own networks but instead purchase network services
from carriers on a wholesale basis in order to resell wireless services to
subscribers ("resellers"). Many carriers also operate as resellers in certain
geographic markets where they outsource network services to another carrier to
expand their coverage and capacity without additional network infrastructure
investment.
Increased consumer demand for wireless services has resulted in greater
competition for subscribers and emphasis on direct sales and marketing to
non-commercial users, with retail distribution emerging as an effective sales
outlet for products. Expansion into consumer markets has also created
opportunities for direct marketing and customer billing organizations to bundle
services with other offerings and outsource the network and product support
requirements to companies such as the Company. Such potential distributors of
branded wireless services include utility companies, credit card companies, mail
order catalogs and televised home shopping companies.
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While the number of pagers in service has grown dramatically since the FCC
authorized additional paging channels in the 1980s, increased competition has
forced wireless carriers and resellers to lower their prices, with monthly
average revenue per unit ("ARPU") for one-way paging services steadily declining
from $16.92 in 1990 to $9.57 in 1997, according to industry sources. At the same
time, competition has caused high subscriber turnover (an average churn rate of
2.9% per month in 1997, according to industry sources), requiring companies to
incur a higher gross customer acquisition cost for every net subscriber added.
Furthermore, consumer demands for enhanced services are requiring carriers to
continually invest in expanding and upgrading their networks. The Company
believes that ARPU will remain low while competition will continue to increase,
requiring distribution channels to focus on cost reduction and increased
marketing of value-added products and services in order to achieve increased
cash flow per subscriber.
The Company believes these trends will result in growing demand for
outsourcing of fixed cost centers and capital intensive functions so that
companies selling branded wireless services can achieve revenue growth while
incurring costs on an as-needed basis. Outsourcing of network services has
emerged as the fastest growing method of fulfilling paging services, with the
reseller channel of distribution growing from 11% of total pagers in service in
1991 to 34% in 1997, according to industry sources. At the same time, high
subscriber churn rates have resulted in service providers selling subscriber
devices to their new customers below cost in order to add net recurring service
revenue, creating an active secondary market for used and refurbished products
and a need to reduce product costs. The Company believes that it is well
positioned to benefit from the trends which are driving growth in the wireless
marketplace and that these trends will lead to increased outsourcing of all of
the services it offers.
OUTSOURCING SERVICES FOR THE WIRELESS MARKETPLACE
NETWORK SERVICES - PNI ACCESS SERVICES DIVISION
The Company's one-way paging networks provide wide-area coverage and
flexible service options, enabling PNI Access Services' customers to offer
competitive, branded paging services to their subscribers, while incurring costs
on an as-needed basis. The Company currently owns and operates paging networks
in four regions of the United States, including the Southeast, Mid-Atlantic,
Northeast and Midwest regions. PNI Access Services offers unique "Direct Access"
options to its customers that enable carriers and large resellers to directly
connect their own terminal switching equipment with the Company's networks in
order to purchase network services from the Company. As of December 31, 1998,
PNI Access Services provided network services to more than 1,500 companies,
which collectively had 525,274 units in service on the Company's networks. PNI
Access Services' customers include six of the ten largest paging companies in
the U.S.
The Company employs an efficient network architecture utilizing regional
Technical Control Centers ("TCCs") that centrally control its networks in
multiple local markets within a wide geographic region. As of December 31, 1998,
the Company had six TCCs and operated paging networks in 28 markets. TCCs enable
the Company to rapidly open new markets and cost-efficiently operate multiple
local markets. PNI Access Services' strategy is to provide local and regional
network services, primarily on a common frequency, in multiple large U.S.
metropolitan markets and adjacent areas. The Company had previously planned to
construct one additional TCC to service additional markets in its expansion
strategy. However, the Company believes that due to a number of factors, it will
be able to cost efficiently operate new and existing network markets more
remotely than previously contemplated. Factors contributing to this include: (i)
the ongoing reduction of telephone expenses resulting from the
Telecommunications Act of 1996; and (ii) the deployment of internally developed,
patent pending technologies that, among other things, enable more cost efficient
utilization of the Company's network telephone facilities as well as reliable
remote network monitoring. Accordingly, the Company does not anticipate
constructing any additional TCCs. Additionally, the Company may have an
opportunity to further reduce its network operating costs through the
consolidation of certain existing markets into fewer TCCs, enabling an
elimination of certain TCC facilities and their associated costs. The timing of
any such consolidations will depend, among other things, on customer
requirements and the effective internal development and successful deployment of
the Company's proprietary technologies. The timing of expansion into additional
network markets will depend, among other things, on customer requirements and
the availability of capital.
The Company is licensed to build and operate 157.740 MHz frequency networks
in numerous markets, which serves as the foundation for its local and regional
paging networks. In addition, the Company has augmented its 157.740 MHz networks
by purchasing and consolidating existing networks licensed on other frequencies
in order to offer additional capacity and flexibility to its customers. The
Company believes that its wholesale, centrally operated network strategy enables
it to achieve greater cost and usage efficiency of existing networks by
consolidating them into its TCC platform.
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In addition, successful deployment of its proprietary patent pending
switching technology, "PLATFORM 1(TM)", may establish points of presence
("POPs") for inexpensive and flexible local telephone number access throughout
the Company's network markets. The Company believes that in addition to this
technology potentially enabling a significant reduction of its own network
operating costs, there is a demand among information service providers for
inexpensive, flexible, local access to subscriber telephone numbers. The Company
may utilize its planned network of local telephone number POPs to resell this
access on a variable cost basis to both existing customers and new distribution
channels, which will in turn market subscriber information services.
The Company believes that it is the largest carrier's carrier of
exclusively wholesale one-way paging network services in the United States,
although the number of units on the Company's networks currently represents only
a small percentage of the total number of paging subscribers industry-wide.
TECHNICAL SERVICES - PREFERRED TECHNICAL SERVICES, INC. ("PTS").
PTS provides network engineering and technical services, supporting one-way
and two-way wireless technologies. PTS' services include installation of network
equipment; maintenance of installed equipment and tower sites; sales of network
equipment; engineering site surveys; and network equipment repair. PTS' services
also include system design, Electromagnetic Energy ("EME") and Environmental
Safety Industrial & Hygiene ("ESIH") testing, and project management. In 1998,
PTS provided its services to over 60 companies in the U.S. as well as in Japan.
PTS' customers include six of the ten largest paging companies, four operators
of PCS services and two national network tower site owners. PTS is also an
authorized sales agent of network equipment for the two largest manufacturers of
wireless infrastructure.
Established in 1991, PTS was acquired by the Company in July 1996. At the
time of its acquisition by the Company, PTS operated exclusively in the
Southeast region and was a provider of its services primarily to the Company.
PTS today operates from the Company's TCC locations, as well as several
independent locations across the country. In December 1998, PNI Access Services
transferred the majority of its engineering personnel to PTS. PNI Access
Services has in turn contracted with PTS to provide field and TCC engineering
and maintenance services on a variable cost basis. PTS intends to utilize these
transferred personnel to also provide its services to other customers.
PRODUCT SERVICES - EPS WIRELESS, INC. ("EPS")
EPS provides paging and cellular product repair services, sales of new,
used and refurbished paging and cellular products and inventory management and
fulfillment services. The Company believes that EPS is one of the largest
independent wireless product repair facilities in the U.S. Operating in a 57,000
square foot facility in Dallas, Texas, EPS serves more than 600 companies,
including seven of the ten largest paging companies, and in 1998, processed more
than one million pager and cellular devices for its customers.
Increased competition for subscribers has resulted in service providers
selling new pager and cellular products to their customers below cost in order
to add recurring subscriber service revenue. With declining service ARPU and
subscriber churn requiring that the gross number of product units sold must be
greater than the number of net subscriber unit additions, companies require
cost-effective product solutions that enable the resulting service revenue
stream to be profitable. Subscriber churn combined with the continued
introduction of new product technologies has created a growing market for
recycled and refurbished product. This has created a significant opportunity for
EPS to repair and refurbish its customers' existing inventory as well as to
source, refurbish and sell products for its customers.
Established in 1987, EPS was acquired by the Company in December 1996. EPS
provided a further expansion of the Company's outsourcing services platform by
enabling it to provide product and inventory solutions to companies in the
wireless marketplace. Additionally, EPS' product sourcing capabilities, repair
services and inventory management and fulfillment expertise have enabled the
Company to offer expanded product services to its network customers.
STRATEGY AND CUSTOMERS
The Company's strategy is to create customer value as a leading provider of
high-quality, cost-effective outsourcing solutions to companies in the wireless
marketplace. The Company supports the growth of its customers by enabling them
to focus their capital resources on sales and marketing of value-added, branded
wireless services to subscribers, while incurring associated costs on an
as-needed basis by purchasing services from the Company. The Company believes
its strategy enables its customers to compete more effectively for subscribers
and to increase their cash flow contribution per subscriber.
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The Company currently serves over 2,100 companies, including one-way and
two-way wireless carriers, resellers and manufacturers. Nine of the ten largest
paging companies currently purchase services from the Company.
NETWORK SERVICES
PNI Access Services' customers and potential customers include any type of
organization that offers or seeks to offer branded paging and other wireless
services. These organizations generally fall into one of four broad categories:
- large carriers whose principal business is to sell paging services in
multiple markets;
- small, single market paging carriers and resellers;
- large telecommunications companies such as local exchange carriers,
long distance carriers, cable companies and cellular telephone
companies, for which paging is one of many services offered and not a
principal business; and
- non-traditional wireless service providers whose principal business is
not telecommunications, such as utility companies and distributors of
mass-market consumer products and services, that seek to bundle
wireless services with other offerings.
The Company believes that by enabling companies to purchase network
services on an as-needed basis, the Company's customers are able to focus more
capital resources on sales and marketing. Accordingly, the Company believes its
customers are able to compete more effectively and profitably for subscribers.
The Company groups its network customers into three principal categories
based on the nature of the services it provides: (i) traditional, or
non-facilities-based, "resellers" that purchase both airtime and switching
services from the Company on a fixed monthly per unit basis; (ii) "Direct
Access" customers that utilize their own switching equipment and purchase only
airtime from the Company on a fixed monthly per unit basis
("co-location/interconnection" services); and (iii) companies that utilize both
switching and airtime services of the Company to provide "Caller Pays" service,
pursuant to which the initiator of each page (the "caller") is charged on their
telephone bill and the local telephone exchange carrier in turn pays the Company
a percentage of the amount collected for the actual number of billable pages per
month from the caller, rather than a fixed monthly charge.
- TRADITIONAL RESELLERS. Traditional resellers do not own their own
terminal switching equipment or procure their own telephone numbers
from local exchange carriers. Traditional resellers route their
subscriber paging traffic through the Company's TCCs, utilize local
telephone numbers procured by the Company and purchase airtime on the
Company's networks from the Company. The Company charges its
traditional reseller customers a monthly fixed price per unit in
service based on a number of factors, including type of paging
service, extent of coverage area, unit volume and utilization of
switch-based, value-added services such as voice mail and custom
prompts. These customers generally consist of local and regional
resellers.
- DIRECT ACCESS CUSTOMERS. Direct Access customers own their own
terminal switching equipment and procure their own telephone numbers
from local exchange carriers. These customers purchase airtime and, in
the case of co-location services, terminal equipment maintenance
services from the Company. These customers either locate their
switching terminal equipment in the Company's TCC facilities
("co-location"), or remotely connect their equipment to the Company's
TCC through a direct circuit, such as a telephone line or satellite
link ("interconnection"). By owning their own switching equipment and
procuring their own telephone numbers, Direct Access customers are
able to maintain flexibility in the design of their terminal-based
service offerings, such as custom prompts and voice mail services. The
Company incurs minimal marginal cost in supplying only airtime to its
Direct Access customers and therefore charges these customers
substantially less per unit in service per month than it charges its
traditional reseller customers. Direct Access customers generally
consist of larger resellers and paging carriers.
- CALLER PAYS CUSTOMERS. The Company's Caller Pays customers interface
with the Company's TCCs in a similar fashion to that of traditional
resellers in that they utilize telephone numbers procured by the
Company from the local exchange carriers which are then routed through
Company-owned switching equipment. Consumers of Caller Pays service
purchase a pager unit from one of the Company's customers but do not
receive any monthly subscriber bill. Each time a call is sent to the
pager a charge appears on the caller's monthly telephone bills. The
Company is then paid by the local telephone exchange carrier based
upon a percentage of the amount collected for the actual monthly
number of billable pages on the Company's networks, rather than a
fixed monthly charge. The Company's Caller Pays customers include
traditional resellers as well as non-traditional distributors of
paging services, such as utility companies and
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distributors of mass-market consumer products and services.
TECHNICAL SERVICES
The Company provides its technical services through PTS. PTS' services
include installation of network equipment; maintenance of installed equipment
and tower sites; sales of network equipment; engineering site surveys; and
network equipment repair. PTS' services support one-way and two-way paging
technologies, and PCS services, as well as network tower site owners.
PTS' customers consist of manufacturers, wireless carriers and network site
owners who contract with the Company to install equipment or maintain their
sites. PTS provides cost and capital savings alternatives to its customers by
enabling them to outsource technical requirements on an as-needed basis, which
the Company believes enables them to focus more capital resources on sales and
marketing of their respective customer products and services. PTS' customers are
also able to benefit from PTS' investments in maintaining state-of-the art
technology expertise and various regulatory certifications. PTS typically
contracts with customers on a project-by-project basis.
PRODUCT SERVICES
The Company provides its product services through EPS. EPS' customers
consist of carriers, resellers and agents that market branded wireless products
and services. EPS also provides repair services directly to wireless equipment
manufacturers. The Company believes these customers are able to benefit from the
Company's sophisticated repair facilities, inventory management systems and
product fulfillment resources and therefore are able to offer expanded product
options to their subscribers and customers and reduce their own product costs.
EPS employs automated information management systems to track customer
inventory and is able to receive, service and ship thousands of pager and
cellular devices per day. Accordingly, EPS is well positioned to serve the needs
of large companies that provision and handle a significant daily volume of
product and are seeking cost reduction alternatives. In addition, EPS serves
many of the same customers that purchase pagers to add service units to the
Company's paging networks.
GROWTH STRATEGY
The rapid expansion of the wireless marketplace provides significant growth
opportunities for the Company's services. Increasing consumer adoption of
wireless services and continued expansion of distribution channels is resulting
in greater competition for subscribers. The Company believes its outsourcing
service offering positions it to serve all of these companies by providing cost
reduction alternatives and enabling companies to invest more of their capital in
sales and marketing of branded products and services to their customers. The
Company believes this enables its customers to cost-effectively increase their
revenue and cash flow per subscriber.
SERVE MULTIPLE DISTRIBUTION CHANNELS. Because the Company does not compete
with its customers for subscribers, its services are utilized to support the
subscriber requirements of many companies. Accordingly, the Company benefits
from the sales and marketing efforts of many companies utilizing many brands,
rather than a single company with a single brand. In addition, the Company does
not incur the expense associated with subscriber sales and support, nor does it
bear the cost of subscriber product returns and service disconnects.
PROVIDE UNIQUE, FLEXIBLE SERVICE OFFERINGS. The Company provides the full
service network support required by traditional resellers, as well as Direct
Access options for carriers and large resellers. The Company encourages large
resellers to purchase their own switching equipment to connect directly into the
Company's networks. The Company also provides Direct Access services to other
carriers. Direct Access customers generally consist of larger customers since
they have invested in terminal switching and related equipment themselves. In
addition, these larger companies generally have additional outsourcing
requirements and tend to purchase multiple services from the Company.
EXECUTE REGIONAL AND NATIONAL CONTRACTS. The Company is focused on
executing regional and national contracts. The Company's historical investments
in network expansion have enabled it to execute multi-market contracts to serve
large carriers and resellers. In the case of EPS, the Company is focused on
serving large companies that have high unit volume requirements for repair,
product fulfillment and inventory management.
CONTINUE TO IMPROVE NETWORK EFFICIENCY AS LOW COST PROVIDER. Due to the
relatively fixed nature of the Company's network costs, the Company is able to
generate increasingly better financial returns from increased network units in
service. Accordingly, the Company is focused on achieving continued operating
efficiencies. The Company believes that the successful deployment of its
proprietary network switching and monitoring technologies in its networks may
enable it to achieve further operating cost reductions. As of December 31, 1998,
the Company had
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successfully deployed certain of these technologies in its Chicago TCC. The
Company plans to substantially complete deployment of these technologies
throughout all of its network markets by the end of 1999.
EXPAND SERVICE OFFERINGS; UTILIZE PROPRIETARY TECHNOLOGIES. The successful
deployment of the Company's proprietary switching technology, "PLATFORM 1(TM)",
may establish points of presence ("POPs") for inexpensive and flexible local
telephone number access throughout the Company's network markets. The Company
believes that in addition to this technology potentially enabling a significant
reduction of its own network operating costs, there is a demand among
information service providers for inexpensive, flexible, local access to
subscriber telephone numbers. The Company may utilize its planned network of
local telephone number POPs to resell this access on a variable cost to both
existing customers and new distribution channels, which will in turn market
subscriber information services.
SELECTIVELY EXPAND TO ADDITIONAL NETWORK MARKETS. The Company intends to
selectively expand its network operations to provide local and regional paging
network services in multiple large U.S. metropolitan markets and adjacent areas,
primarily on one or more common frequencies. As of December 31, 1998, the
Company operated paging networks in 28 markets in four major U.S. regions: the
Southeast, Mid-Atlantic, Northeast and the Midwest. The Company currently has
six TCCs and believes that, due to a number of factors, it may have an
opportunity to further reduce its network operating costs through the
consolidation of certain existing markets into fewer TCCs, enabling an
elimination of certain TCC facilities and their associated costs. The timing of
any such consolidations will depend, among other things, on the successful
internal deployment of the Company's proprietary technologies. The timing of
expansion into additional network markets will depend, among other things, on
customer requirements and the timing and availability of capital.
OPERATIONS
PNI ACCESS SERVICES - NETWORK DESIGN AND OPERATIONS
HUB AND SPOKE ARCHITECTURE. The Company controls its local and regional
networks from TCCs located centrally within wide geographic regions. Each TCC is
a switching center, housing paging terminals, satellite facilities, network
monitoring systems, local and long distance telephone lines, and emergency power
backup. Each TCC has the capability, via satellite transmission, to monitor any
other TCC operation. Furthermore, the Company's network operating expenses are
reduced by centralizing engineering, telephone access and technical and
maintenance support in the TCCs.
The TCCs are linked to each other via digital satellite channels, which
provide low-cost, flexible transmission. Each TCC is connected to Remote Points
of Presence ("R-POPs"), located in other cities, which house local telephone
lines, power back-ups and alarm systems. Each R-POP is connected to a TCC via a
dedicated T-1 circuit that transports local paging traffic from the R-POP city
to the TCC for central processing. The T-1 lines enable TCCs to process
telephone numbers that are local to the R-POP city. The T-1 connections between
TCCs make possible certain network redundancies and provide fully integrated
engineering, billing and customer support capabilities. The satellite up-link
station at each TCC transmits the paging traffic to other TCCs and to
satellite-controlled transmitters and networks, allowing the Company to extend
its network coverage beyond the metropolitan areas in which the TCCs and R-POPs
are located more rapidly and economically.
HIGH-POWER 157.740 MHZ FREQUENCY/MULTIPLE FREQUENCY UTILIZATION. In 1990,
the FCC authorized the 157.740 MHz frequency for high-power, wide-area paging
transmission on a non-exclusive basis. Historically, the 157.740 MHz frequency
was used for small paging networks to service local customers, such as hospitals
and small businesses. The Company is licensed to build and operate 157.740 MHz
frequency networks, which serves as the foundation for its local and regional
paging networks. Implementation of the Company's strategy, however, does not
depend on the exclusive use of the 157.740 MHz frequency. In those areas where
157.740 MHz networks are already operating, the Company intends either to
purchase those networks or to enter into co-channel sharing arrangements with
the paging carriers in accordance with FCC rules and regulations. The Company
has also selectively purchased and consolidated existing network assets and
acquired licenses on the 150 MHz, 450 MHz and 900 MHz bands to provide greater
customer flexibility in densely populated markets and may continue to do so in
the future.
PTS OPERATIONS
PTS operates from regional offices located throughout the United States,
including the Company's TCCs as well as several independent locations. Operating
from these offices, PTS provides engineering and technical services to its
customers on a project basis or through maintenance contracts.
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PTS' multi-city operations enable it to serve national customers who seek a
single point of contact with consistent quality of service in multiple markets.
By establishing a local presence through regional offices, PTS has the
flexibility to be responsive to its customers' needs, allowing wireless carriers
and site owners to work directly with PTS field engineers and technical staff.
In instances where a customer requires additional resources for a large project
or for an emergency situation, PTS can draw personnel from its other locations
to fulfill the scope of work.
PTS invests in state-of-the-art tools and test equipment in order to
provide accurate analysis and service work to its customers. PTS' engineers and
technicians are available for on-call emergency services and are fully trained
and experienced in each of the services they provide. The Company believes that
this enables PTS to reduce the amount of down time a carrier or site owner may
have.
In December 1998, PNI Access Services transferred the majority of its
engineering personnel to PTS. PNI Access Services has in turn contracted with
PTS to provide field and TCC engineering and maintenance services on a variable
cost basis. PTS intends to utilize these transferred personnel to also provide
its services to other customers.
EPS OPERATIONS
EPS operates three primary business units: pager and cellular product
repair services; pager and cellular product sales; and pager and cellular
inventory management and fulfillment. Each operating unit is supported by an
automated inventory production and tracking system which provides customers with
detailed invoicing and shipping information.
The Company believes EPS is able to achieve efficient, high volume repair
production by utilizing a combination of automation, skilled technicians and
technical support staff. Additionally, the Company believes that EPS' monthly
unit volume enables it to achieve a lower cost of parts than many of its smaller
competitors. The Company believes that it is cost competitive in serving the
high volume needs of large wireless companies.
EPS' product sales unit serves as a sourcing and placement arm for its
customers that are seeking to either sell excess pager or cellular inventory or
are in need of obtaining specific product. EPS' repair unit also provides
internal support to its product sales unit when repair or refurbishment of
product is required prior to its sale to a customer.
In addition to managing the daily inbound and outbound flow of product to
support its repair and product sales business units, EPS provides its customers
with an alternative solution for inventory management and distribution. These
solutions include housing, sorting and shipping its customers' own inventory by
stock keeping unit ("SKU"), shipping inventory to its customers' branch or
customer locations, and disposing of obsolete equipment.
SALES, MARKETING AND CUSTOMER SERVICE
As an outsourcing company, the Company does not market any of its services
directly to end users and therefore does not compete with its customers for
their subscribers. The Company provides selling, marketing and customer service
directly to relatively few network customers (currently approximately 1,500)
rather than directly to its customers' many subscribers who have units on the
Company's networks (525,274 at December 31, 1998) and therefore has relatively
fewer sales, marketing and customer service personnel. Additionally, although
EPS processed over one million subscriber devices in 1998, it provided these
services to approximately 600 companies, rather than directly to their
subscribers. Similarly, PTS provides its services to companies, rather than to
subscribers. Each of the Company's business units employs sales personnel
dedicated to that business unit.
PNI ACCESS SERVICES
PNI Access Services' sales personnel are geographically positioned in
markets within and adjacent to the Company's TCCs, with the Company's network
customer service group providing "home office" support. The Company's
engineering professionals also support sales and marketing efforts with the
Company's Direct Access customers to address the technical requirements
associated with these customers' direct connections with the Company's networks.
PTS
PTS markets its services through referrals from other customers, and
through the business development efforts of its President, a staff of corporate
sales executives and its staff engineers that are located in field offices. In
addition, PTS focuses on establishing contracts with large national companies,
so that by continuing to expand its number of engineers and the markets in which
it operates, it can increase the amount of services it provides to existing as
well as new customers.
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<PAGE> 10
EPS
EPS markets its services primarily through the efforts of its sales
personnel and senior management. EPS participates as an exhibitor at industry
trade shows, advertises in trade magazines and solicits customer referrals to
generate new sales activity. EPS' sales personnel are focused specifically on
either cellular sales or pager sales and are also responsible for sourcing and
selling new, used and refurbished pager and cellular equipment. EPS markets its
repair and inventory management and fulfillment sales activities jointly, as the
Company believes that management and fulfillment of its customers' inventory is
a natural extension of its repair services. In addition, EPS employs a team of
customer services representatives to respond to customer inquiries and provide
support to sales representatives for customer product repair and order shipment
status.
PRODUCTS AND EQUIPMENT
The Company does not manufacture any pagers, cellular telephones,
transmitters, paging terminals or other equipment used in the Company's
business. The Company purchases pagers, cellular telephones and network
equipment for sale to its customers. The Company currently purchases new pagers
from Motorola, NEC America, Inc. and Samsung Telecommunications America, Inc.,
among others, and achieves cost savings through volume purchases. EPS purchases
new pager and cellular inventory from both manufacturers and resellers who may
have excess supply, and purchases used product from resellers and other
retailers, then resells it to other companies on an "as is" or refurbished
basis. PTS purchases network equipment for the Company's own networks as well as
for resale to customers from Motorola and Glenayre. The Company anticipates that
network equipment, pagers and cellular telephones will continue to be available
from these suppliers in the foreseeable future.
COMPETITION
The wireless industry is highly competitive and has few barriers to entry.
Companies in the industry generally compete on the basis of price, and quality,
and in the case of network services, on the basis of coverage area, speed of
transmission, system reliability and service. Many of the Company's network
services competitors currently offer broader geographic coverage than that
provided by the Company's existing networks. Several companies offer national
paging services to their subscribers. By contrast, the Company markets network
services primarily on a local or regional level. The Company also competes with
numerous other local, regional and national paging companies. In addition, the
United States Congress and the FCC have authorized the use of newly-allocated
spectrum for mobile and portable radio communications services, including
specifically for narrowband PCS. Through its auction process, the FCC has issued
some narrowband PCS licenses, and the licensees are in the process of
constructing their facilities. Some of the primary uses envisioned by narrowband
PCS licensees are advanced voice paging and two-way acknowledgment paging. It is
expected that companies offering narrowband advanced paging will compete with
one-way paging companies. In addition, some companies may utilize their
broadband PCS licenses to offer paging services in conjunction with other
offerings. Additional competitors may enter markets served or proposed to be
served by the Company. PTS and EPS each compete with wireless equipment
manufacturers and independent providers of similar services, primarily on the
basis of quality, price, and service.
REGULATION
The Company's paging operations are subject to regulation by the FCC under
the Communications Act of 1934, as amended (the "Communications Act"). The FCC
permits the provision of paging services on a significant number of frequencies
under its regulatory authority. The majority of these frequencies are allocated
in low band (30-44 MHz), high band (150-170 MHz), UHF (450-470 MHz) or 900 MHz.
Some of the frequencies are available for one-way paging only, while paging is
permitted on an ancillary basis to the primary service on other channels. There
also are differences in the paging transmitter power levels permitted on
different frequencies, which affect the range and penetration capability of a
paging system.
I. LICENSING
Historically, the FCC distinguished between Radio Common Carrier ("RCC")
paging, which was authorized under Part 22 of the FCC rules, and private paging
systems, including Private Carrier Paging ("PCP") systems, which were authorized
under Part 90 of the FCC rules. RCC systems were considered common carriers
under the Communications Act, and were subject to statutory and FCC common
carrier obligations, but were granted exclusive use of their authorized
frequencies within a defined geographic area. By contrast, private paging
systems, including PCPs, were not regulated as common carriers under the
Communications Act and were assigned paging frequencies on a shared,
non-exclusive basis. Under the PCP regulatory approach several unrelated
licensees might be required to
10
<PAGE> 11
share the use of a frequency in a given geographic area. Efficient shared
channel use typically is accomplished by sharing airtime using a single paging
terminal, by physically linking the co-channel systems, or by sharing airtime on
a party-line basis. Traditionally, under this type of shared frequency usage,
FCC licenses were obtained relatively easily for minimal frequency coordination
and FCC filing fees.
The Company has 235 FCC licenses and 9 applications pending, to build and
operate high power PCP 157.740 MHz frequency networks in 28 markets in the
Northeast, Mid-Atlantic, Southeast, North Central, and Midwest regions. In
addition, the Company has 8 FCC licenses and 2 applications pending to operate
the following nonexclusive PCP paging systems: 1) a 462.825 MHz network in the
Atlanta metropolitan area and, 2) a 462.75 MHz network in the Augusta, Georgia
metropolitan area. Finally, the Company has 14 FCC licenses to operate the
following exclusive RCC paging systems: 1) a 158.10 MHz network in and around
Jacksonville, Florida, 2) a 152.60 MHz network in New York metropolitan area, 3)
a 152.840 MHz frequency network in the Atlanta metropolitan area, 4) a 454.475
MHz network in and around Albany, New York, 5) a 931.2625 MHz network in the
Orlando, Florida metropolitan area and; 6) a 931.2625 MHz network in New York
metropolitan area. The FCC licenses set forth the technical parameters, such as
signal strength and tower height, under which the Company is authorized to use
those frequencies. The Company's FCC licenses are issued to its wholly owned
subsidiary, PNI Spectrum, LLC.
In August 1993, Congress amended the Communications Act and redefined the
regulatory classifications for all land mobile services as either Commercial
Mobile Radio Services ("CMRS"), considered common carrier offerings, or Private
Mobile Radio Services ("PMRS"). The FCC subsequently classified both RCC and PCP
services as CMRS. All of the Company's RCC and PCP paging systems currently are
regulated as CMRS.
As a CMRS provider, the Company is subject to certain regulations as a
common carrier under the Communications Act, including the duty to offer service
on a non-discriminatory basis at just and reasonable rates. The Company files
the required CMRS Licensee Qualification Report and Employment Report with the
Commission annually and pays the annually assessed CMRS and Satellite regulatory
fees. The Company is also subject to the complaint process for violations of the
Communications Act or FCC rules. In addition, the Company must obtain FCC
approval prior to consummating any assignments of license or authorizations or
any transfer of control of the Company.
In the 1993 legislation, the Commission was given statutory authority to
award licenses by competitive bidding, or auction procedures, when there are
mutually exclusive applications from entities proposing to provide a commercial
service to subscribers. PCPs and RCCs fall within the definition of applications
subject to the FCC's auction authority. In conjunction with its enactment of a
CMRS/PMRS regulatory framework, Congress directed the FCC to review and revise
its regulations to develop comparable regulatory schemes for CMRS services
determined to be substantially similar to one another. In the proceeding in
which the FCC addressed this statutory directive, the FCC determined that RCC
and PCP services were substantially similar to one another and to other CMRS
services to the extent that they are offered on exclusive frequencies. The FCC
commenced a proceeding to align more closely the regulatory frameworks for RCC
(Part 22) services and PCP (Part 90) services.
On February 9, 1996, the FCC released the Notice of Proposed Rulemaking
("NPRM"), which addressed potential changes in the FCC's regulation and
licensing of the paging industry. Among other things, the FCC considered
converting some or all of the non-exclusive PCP frequencies, including the
157.740 MHz frequency, to exclusive use frequencies, in which event the Company
could be required to engage in competitive bidding to obtain additional paging
licenses. The NPRM also proposed several changes to the current system of
licensing in the paging industry, including potential geographic licensing and
competitive bidding for mutually exclusive applications.
During the pendency of this paging rulemaking proceeding, the FCC initially
suspended acceptance of all new applications for paging licenses except
applications for minor modifications of existing RCC and 929 PCP channels (the
"Application Freeze"). Under this initial order, as of February 8, 1996, the FCC
would not accept new applications for non-exclusive PCP channels.
On April 22, 1996, the FCC adopted an order (the "Interim Licensing
Procedure") in which it eased the Application Freeze on the acceptance of
applications for licenses for paging channels, including the shared channel
primarily utilized by the Company (157.740 MHz). Under the Interim Licensing
Procedure, the FCC allowed applications to be filed for new sites on these
channels if the applicant certified that the proposed site is within 40 miles of
an operating transmission site which was licensed to the same applicant on the
same channel prior to February 8, 1996. On June 11, 1996, by its own motion, the
Commission modified the Interim Licensing Procedure to allow incumbent licensees
also to add sites within 40 miles of an operating transmission site for which an
application from the same applicant on the same channel was pending at the FCC
on or before September 30, 1995. Additionally, the
11
<PAGE> 12
Commission stated that all non-mutually exclusive paging applications received
through July 31, 1996 would be processed under the Interim Licensing Procedure.
Applications received after July 31, 1996 and any application considered
mutually exclusive would be subject to the final rules adopted in the paging
rulemaking proceeding. As a result of the NPRM and the subsequent actions of the
FCC noted above, the Company determined to concentrate on filling out its
facilities in markets in which it was currently established and to selectively
expand into new market areas as customers may require and as capital becomes
available.
On February 19, 1997, the Commission 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 PCP
frequencies, including the 157.740 MHz frequency, to exclusive use frequencies.
The Further Notice, however, sought additional guidance in connection with the
continued licensing procedure of the non-exclusive PCP channels. The Commission
expressed its concern, 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, sought comment on what methods could be used to eliminate or
reduce the problem. Primarily, the Commission proposed to modify the application
form, but also asked whether the frequency coordination process could be
modified to reduce fraudulent or speculative applications.
The Commission also determined to process all non-mutually exclusive
applications filed on or before July 31, 1996. All pending mutually exclusive
applications, however, regardless of when filed are to be dismissed. On December
14, 1998 the Commission notified the Company that 13 of its pending applications
for expansion of its PCP paging systems were dismissed due to mutual
exclusivity. This includes eight 931.2625 MHz applications for 11 sites in its
Orlando, Florida paging system, four 931.3125 MHz applications for its New York
paging system, and one application for its 158.10 MHz Jacksonville, Florida
paging system. All applications (other than applications on nationwide and
shared channels) filed after July 31, 1996 will also be dismissed. Finally,
during the pendency of the Further Notice, the Interim Licensing Procedure for
the non-exclusive PCP channels will continue for incumbent licensees only,
allowing those incumbents to file for additional licenses anywhere. The
Commission also stated it 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 is now able to file applications for new
sites on its 157 MHz and 462 MHz PCP paging systems whenever needed.
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 157 MHz and 462 MHz paging systems.
The Commission, however, adopted a geographic licensing scheme and
implemented a competitive bidding process for the exclusive RCC and PCP
channels, including the Company's 931 MHz paging 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 the service areas for its
exclusive 931 MHz systems or its 152 MHz and 454 MHz RCC systems unless it
participates in a competitive bidding process or it can reach an agreement with
the applicable geographic licensee. In the Further Notice, the FCC proposed to
permit a geographic licensee to either disaggregate 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 CMRS services, 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 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
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<PAGE> 13
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.
II. RESALE AND INTERCONNECTION
The FCC also has other various ongoing rulemaking proceedings that may
affect the Company. These include proceedings involving resale and
interconnections obligations in a competitive paging marketplace and universal
service obligations.
On July 15, 1993, the Commission adopted rules that require all providers
of interstate telecommunications services to contribute to the provision of
Telecommunications Relay Service (TRS) based on their proportionate share of
gross interstate revenues. The Company files the required TRS Worksheet and pays
the calculated fees annually.
On June 12, 1996, the Commission adopted a First Report and Order that
became effective August 23, 1996 in which it declined to impose a resale
obligation on either RCC or PCP licensees. The Commission found that resale is
an established practice in the paging service and competition appears to be
vigorous.
EMPLOYEES
On December 31, 1998, the Company had 339 employees; 44 in administration,
61 in marketing and sales, 124 in engineering and operations and 110 in product
repair. The Company's employees are not unionized, and the Company believes that
its relations with its employees are good.
ITEM 2. PROPERTIES
The Company leases a total of approximately 43,000 square feet of office
space in two different locations, including Norcross, Georgia, and Syosset, New
York and 57,000 square feet of office and repair facility space in Dallas,
Texas. The Company also currently leases a total of approximately 39,000 square
feet at six different locations for its TCCs. The Company has approximately 470
site and tower leases for the operation of its network transmitters and other
equipment on commercial broadcast towers and at other fixed sites. These leases
expire at various dates from 1998 to 2007.
The Company believes that in general the terms of its leases are
competitive based on market conditions. The Company believes its facilities are
suitable and adequate for its purposes.
ITEM 3. LEGAL PROCEEDINGS
The Company may become subject to various legal proceedings arising out of
its operations in the ordinary course of business. The Company is not a party to
any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of 1998.
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<PAGE> 14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET AND DIVIDEND INFORMATION
Beginning March 1, 1996, and continuing through March 22, 1999, the
Company's Common Stock traded on the Nasdaq Stock Market's National Market under
the symbol "PFNT." The Company's Common Stock was delisted from the Nasdaq Stock
Market's National Market effective as of the close of business on March 22,
1999. Since March 23, 1999, the Company's Common Stock has been traded on the
Over The Counter Bulletin Board under the symbol "PFNT." Prior to March 1, 1996,
there was no established public trading market for the Common Stock.
Set forth below are the high and low sales prices for the shares of the
Company's Common Stock for each quarterly period in 1997 and 1998.
<TABLE>
<CAPTION>
1997 1998
---- ----
QUARTER ENDED HIGH LOW HIGH LOW
- ------------- ---- --- ---- ---
<S> <C> <C> <C> <C>
March 31...................................................... $ 6.25 $ 2.50 $2.19 $1.38
June 30....................................................... 3.13 1.88 1.88 1.00
September 30 ................................................. 3.00 1.88 1.50 0.69
December 31................................................... 2.38 1.00 0.88 0.25
</TABLE>
On April 12, 1999 there were approximately 1,238 stockholders of the
Company, based on the number of holders of record and an estimate of the number
of individual stockholders represented by securities position listings.
Since organization, the Company has not paid any cash dividends on its
Common Stock and does not anticipate paying any cash dividends in the
foreseeable future. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for a discussion of dividends paid with
respect to previously outstanding Redeemable Convertible Preferred Stock.
The Company intends to retain all working capital and earnings, if any, to
use in the Company's operations and the expansion of its business. Any future
determination with respect to the payment of dividends will be at the discretion
of the Board of Directors and will depend upon, among other things, the
Company's results of operations, financial condition and capital requirements,
the terms of any then existing indebtedness, general business conditions and
such other factors as the Board of Directors deems relevant.
The Company's credit facilities contain covenants which, among other
things, prohibit the payment of dividends.
RECENT SALES OF UNREGISTERED SECURITIES
In March 1998, the Company received $8.0 million from the sale of 5 million
shares of Class B Senior Redeemable Preferred Stock and warrants to purchase up
to 5.4 million shares of Common Stock to one institutional investor and certain
of its existing stockholders. The warrants are exercisable at a price of $1.50
per share.
This transaction was exempt from the Securities Act of 1933 by reason of
Section 4(2) thereof and Rule 506 of Regulation D promulgated thereunder.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial and operating data as of and for each of
the five years in the period ended December 31, 1998 are derived from the
consolidated financial statements and other records of the Company. The data
should be read in conjunction with the consolidated financial statements and
related notes and other financial information included herein.
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<PAGE> 15
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1994 1995 1996 1997 1998
-------- --------- --------- --------- ---------
(in thousands, except per share, unit and ARPU amounts)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues
Network services .......................... $ 1,959 $ 3,549 $ 6,121 $ 12,456 $ 13,204
Product sales ............................. 2,097 3,651 5,818 13,603 15,255
Other services ............................ 26 153 1,411 9,922 10,667
-------- --------- --------- --------- ---------
Total revenues .......................... 4,082 7,353 13,350 35,981 39,126
-------- --------- --------- --------- ---------
Cost of revenues
Network services .......................... 977 1,768 4,621 8,316 8,537
Product sales ............................. 2,103 4,558 8,329 13,553 13,248
Other services ............................ -- -- 662 9,140 9,392
-------- --------- --------- --------- ---------
Total cost of revenues .................. 3,080 6,326 13,612 31,009 31,177
-------- --------- --------- --------- ---------
Gross margin ................................... 1,002 1,027 (262) 4,972 7,949
Selling, general and administrative expenses ... 1,506 3,180 8,338 16,030 14,312
Other .......................................... -- -- -- 278 170
Depreciation and amortization .................. 492 764 2,479 6,993 6,963
-------- --------- --------- --------- ---------
Operating loss .......................... (996) (2,917) (11,079) (18,329) (13,496)
Interest expense ............................... (337) (317) (242) (1,277) (2,048)
Interest income ................................ 7 364 1,122 454 352
-------- --------- --------- --------- ---------
Net loss ................................ $ (1,326) $ (2,870) $ (10,199) $ (19,152) $ (15,192)
======== ========= ========= ========= =========
Net loss per share of common stock (1) ......... $ (0.32) $ (1.75) $ (0.91) $ (1.26) $ (1.12)
======== ========= ========= ========= =========
Weighted average number of common shares used in
calculating net loss per share of common
stock(1) .................................... 4,088 4,138 12,815 16,060 16,258
======== ========= ========= ========= =========
OTHER NETWORK OPERATING DATA:
Reseller units (at end of period) .............. 61,055 129,983 186,482 304,133 326,511
Co-location/interconnection units (at end of
period) ..................................... 3,393 23,918 89,236 150,662 198,763
-------- --------- --------- --------- ---------
Total units in service .................... 64,448 153,901 275,718 454,795 525,274
Units under agency agreement (at end of period)
-- -- 86,763 -- --
-------- --------- --------- --------- ---------
Total units ............................. 64,448 153,901 362,481 454,795 525,274
======== ========= ========= ========= =========
Average revenue per unit (ARPU) (2) ............ $ 3.38 $ 2.94 $ 2.48 $ 2.49 $ 2.23
======== ========= ========= ========= =========
EBITDA (3) ..................................... $ (504) $ (2,153) $ (8,600) $ (11,336) $ (6,533)
Capital expenditures (including network
asset purchases) ............................ $ 1,166 $ 4,226 $ 16,495 $ 19,214 $ 1,781
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------
1994 1995 1996 1997 1998
--------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets ................................. $ 1,236 $ 11,757 $30,725 $14,748 $14,659
Property and equipment, net .................... 3,375 6,885 21,559 25,569 21,556
Total .......................................... 4,650 20,046 66,125 66,233 60,032
Notes payable, including current portion........ 2,998 5,413 17,025 19,782 19,033
Redeemable preferred stock ..................... 1,155 21,659 -- 13,956 23,968
Stockholders' equity (deficit) ................. (669) (7,806) 40,583 27,773 10,556
</TABLE>
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<PAGE> 16
(1) All net loss per share amounts were computed using the requirements of
Statement of Financial Accounting Standards No. 128, Earnings per
Share, and SEC Staff Accounting Bulletin No. 98. Basic and diluted
amounts are identical. See note 1 to the consolidated financial
statements included in Item 8, "FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA".
(2) "ARPU" represents average revenue per unit and is calculated by
dividing network service revenues for the month by total units in
service at month end. ARPU for periods greater than one month equals
the average of the monthly ARPUs during the period.
(3) "EBITDA" 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), as an
alternative to cash flows from operating activities (as determined in
accordance with generally accepted accounting principles), or as a
measure of liquidity.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
consolidated financial statements and notes thereto.
OVERVIEW
The Company provides outsourcing services to the wireless industry and
currently provides services to more than 2,100 companies, including nine of the
ten largest paging companies, the two largest manufacturers of wireless network
infrastructure, and two of the largest cellular product manufacturers. The
Company commenced operations in 1991 as a carrier's carrier of one-way paging
networks, whereby the Company's customers purchase and resell airtime on the
Company's networks to their subscribers. During the second half of 1996, the
Company broadened its service offerings and expanded its customer base through
two acquisitions of businesses which provide non-network based services. In July
1996, the Company acquired PTS, a provider of network equipment installation,
maintenance and engineering services, supporting one-way and two-way wireless
technologies, including PCS services. In December 1996, the Company acquired
EPS, a national provider of paging and cellular product repair services, sales
of new, used and refurbished paging and cellular products and inventory
management and fulfillment services.
Historically, the Company's operating expenses and capital expenditures
have increased as it has pursued its nationwide expansion of networks, which
require upfront capital investment for the installation of paging equipment and
network facilities. Such investments and related operating expenses have
resulted in net losses, negative cash flows from operations and negative EBITDA,
although the Company has experienced positive cash flow from operations and
positive EBITDA in many of the local markets in which it operates. The Company's
technical services offered through PTS and product services offered through EPS,
have not generally required the same up front expenses and capital investment as
its network operations. The combination of the three business lines, as well as
the later stage of the Company's network build-out strategy, resulted in a
positive overall company gross margin of 20.3% in 1998 compared to positive
13.8% in 1997. In addition, because the Company does not market directly to
end-users, it does not incur subscriber-related sales, marketing and customer
service expenses. Accordingly, its S,G&A expenses do not increase in direct
proportion to its revenue growth and the Company has experienced a reduction in
S,G&A expenses as a percentage of revenues to 36.6% in 1998 from 44.6% in 1997.
The following definitions are relevant to the discussion of the Company's
operating results.
- Customers on its networks: The Company groups its network customers
into two principal categories in its financial statements based on the
nature of the services it provides:
(i) non-facilities-based, resellers of paging services (consisting of
traditional resellers and caller pays customers) and
(ii) customers that own their own switching terminals and equipment
and interconnect with the Company's TCC facilities to resell
paging services to their subscribers ("Direct Access" customers,
generally consisting of carriers and large resellers).
- Reseller units: Pagers in service on the Company's networks which were
added by its customers that purchase airtime and switching services
from the Company and in the case of caller pays customers, units
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<PAGE> 17
that utilize both switching and airtime services of the Company for
which the Company is paid by the local telephone exchange carrier.
- Direct Access units: Pagers in service on the Company's networks which
were added by its customers that own their own terminal switching
equipment and purchase airtime from the Company
("co-location/interconnection" by carriers and large resellers).
- Units in service: Pagers in service on the Company's networks.
- Units under agency agreement: Pagers in service on a network which the
Company later acquired. During the time between the signing of a
definitive agreement and the completion of certain acquisitions, the
Company provided certain services to the prospective seller under an
agency agreement related to pagers in service on the networks being
acquired.
- Subscribers: The end users who own or rent pagers and receive paging
services from the Company's customers. The Company does not sell or
rent pagers or paging services directly to end-user subscribers.
- Revenues:
(i) Network services: periodic (usually monthly) fees charged to
customers for network services (airtime and/or switching
services) which they purchase in order to resell paging services
to their subscribers, based on units in service at the beginning
of each month; or in the case of caller pays customers, based on
actual number of billable pages;
(ii) Product sales: revenues from the sale of paging and cellular
products to customers; and
(ii) Other services: repair and refurbishment services, inventory
management fees, technical services, maintenance fees charged to
co-location customers for terminal installation and maintenance
services and agency fees.
- ARPU: The Company calculates average revenue per unit by dividing
pager airtime revenues for the month by total units in service at
month end. ARPU for periods greater than one month equals the average
of the monthly ARPUs during the period.
- Cost of revenues: Cost of revenues consists of:
(i) Cost of network services: the cost of operating technical
facilities, site rental, engineering personnel and
telecommunications charges, and the cost of providing terminal
maintenance services to co-location customers. The incremental
costs of entering a new geographic market have historically been
capitalized until the Company begins to generate revenue from
the sale of network services to its customers; Pursuant to the
Accounting Standards Executive Committee (AcSEC) issued
Statement of Position 98-5, "Reporting on the Costs of Start-up
Activities ("SOP" 98-5), these costs will be expensed in future
periods.
(ii) Cost of product sales: cost of paging and cellular products; and
(iii) Cost of other services: cost of repair and refurbishment of
paging and cellular products, inventory management services,
technical services and other.
- S,G&A: Selling, general and administrative expenses include salaries,
commissions and administrative costs incurred by the Company relating
to sales personnel and related marketing, executive management,
customer service, accounting, office rents, office maintenance,
information services and employee benefit expenses.
- EBITDA: Earnings before interest expense, interest income, taxes,
depreciation and amortization 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.
- DEPRECIATION AND AMORTIZATION: The Company's network equipment,
computer equipment, other equipment, furniture, fixtures, vehicles and
leasehold improvements are depreciated over their estimated useful
lives ranging from five to seven years. FCC license application fees,
goodwill, market entry costs, and other intangible assets are
amortized over 15 months to 15 years. Since the Company does not lease
pagers to its customers, there is no depreciation expense on pagers.
NETWORK SERVICES. Because the Company sells network services exclusively on
a wholesale basis, the revenues and expenses that the Company generates from its
network operations are significantly different from those of a full-service
vertically integrated paging carrier. The Company has lower revenues per unit in
service than full-service vertically integrated paging carriers, but also has
lower expenses per unit in service because the Company provides
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<PAGE> 18
selling, marketing and customer support services directly to relatively few
network services customers rather than directly to its customers' many
subscribers who have units on the Company's networks.
The Company derives its network services revenue principally from fixed
periodic (usually monthly) fees charged to its customers for network services
that its customers purchase in order to resell paging services to their
subscribers. As long as a customer maintains units in service on the Company's
networks, the Company's future operating results should benefit from the
recurring fees charged to the customer for those units in service with minimal
additional selling expenses to the Company. Although the Company is aware that
its customers experience turnover in their subscriber bases ("churn"), the
Company cannot accurately measure the churn rate among its customers'
subscribers because the Company's services are provided on a wholesale basis to
its customers.
The markets in which the Company and its network services customers operate
have numerous paging and other wireless service providers that compete primarily
on the basis of price, geographic coverage, and quality of service. As a result,
while the number of traditional one-way pagers in service has increased
industry-wide since the Company commenced operations, monthly ARPU with respect
to such services has declined for the Company as well as the industry. The
Company expects these trends to continue and plans to mitigate the effects of
declining monthly ARPU by continuing to increase the number of units in service
on its networks and achieving further operating efficiencies through, among
other things, its network design and economies of scale. The Company believes
that as long as it is able to increase the number of customers it serves and the
capacity of its networks, it will continue to benefit from economies of scale.
The sales of airtime and switching services and the associated cost of revenues
are classified as network services in the Company's financial statements.
OTHER SERVICES. Other services include technical services provided by PTS,
consisting of network equipment installation, maintenance and engineering
services, supporting one-way and two-way wireless platforms. Other services also
include pager and cellular repair, refurbishment and inventory management and
fulfillment services provided by EPS. Accordingly, technical service revenues
and the associated cost of revenues and product repair, refurbishment and
inventory management and fulfillment services revenue and associated cost of
revenues are classified as other services in the Company's financial statements.
PRODUCT SALES. The Company sells pagers to its network customers primarily
to facilitate their growth in subscribers. The Company has not and does not
intend to lease pagers to its customers. As part of the Company's marketing
programs to attract customers to resell on its networks and due to the
competitive pricing of pagers by the industry, the Company sold pagers below its
cost in 1996 and 1997. However, during 1997, the Company reduced its pager
discounting programs to network customers and generated a small profit from such
sales in 1998. In addition, EPS generates positive gross margin from sales of
new, used and refurbished paging and cellular products. As a result, the Company
achieved a gross profit of $2.0 million from total product sales in 1998
compared to $50,000 in 1997 and a loss of $2.5 million in 1996. Sales by the
Company of pager and cellular products and the related cost of revenues are
classified as product sales in the financial statements.
During the year ended December 31, 1996, Arch Communications Group, Inc.
provided approximately 10% of the Company's consolidated revenues. During the
years ended December 31, 1997 and 1998, no customer of the Company provided
greater than 10% of its revenues.
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<PAGE> 19
The table below provides the components of the Company's consolidated
statements of operations and EBITDA for each of the three years ended December
31, 1996, 1997 and 1998, as a percentage of total revenues.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Revenues
Network services ........................ 45.8% 34.6% 33.7%
Product sales ........................... 43.6 37.8 39.0
Other services .......................... 10.6 27.6 27.3
----- ----- -----
Total revenues ........................ 100.0 100.0 100.0
----- ----- -----
Cost of revenues
Network services ........................ 34.6 23.1 21.8
Product sales ........................... 62.4 37.7 33.9
Other services .......................... 5.0 25.4 24.0
----- ----- -----
Total cost of revenues ................ 102.0 86.2 79.7
----- ----- -----
Gross margin ............................... (2.0) 13.8 20.3
Selling, general and administrative expenses 62.5 44.6 36.6
Other expenses ............................. 0.0 0.8 0.4
Depreciation and amortization .............. 18.6 19.4 17.8
----- ----- -----
Operating loss ........................ (83.1) (51.0) (34.5)
Interest expense ........................... (1.8) (3.6) (5.2)
Interest income ............................ 8.4 1.3 0.9
----- ----- -----
Net loss .............................. (76.5)% (53.3)% (38.8)%
===== ===== =====
EBITDA ..................................... (64.5)% (31.6)% (16.7)%
</TABLE>
The table below provides information about the Company's units in service
on the Company's networks by customer type.
<TABLE>
<CAPTION>
DECEMBER 31, PERCENTAGE INCREASE IN
--------------------------------- --------------------------------
1996 1997 1998 1996 1997 1998
------- ------- ------- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Units in service
Reseller units .......... 186,482 304,133 326,511 43.5% 63.1% 7.4%
Direct Access units ..... 89,236 150,662 198,763 273.1 % 68.8% 31.9%
------- ------- -------
Total units in service .. 275,718 454,795 525,274 79.2% 64.9% 15.5%
Units under agency agreement 86,763 -- -- 100.0 % (100.0)% 0.0%
------- ------- -------
Total units ............. 362,481 454,795 525,274 135.5 % 25.5% 15.5%
======= ======= =======
</TABLE>
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Total revenues increased by $3.1 million, or 8.7%, to $39.1 million for the
year ended December 31, 1998 from $36.0 million for the year ended December 31,
1997 due to increased revenue from all three of the Company's revenue
categories: network services, product sales and other services.
Revenues from network services increased by $748,000, or 6.0%, to $13.2
million for the year ended December 31, 1998 from $12.5 million for the year
ended December 31, 1997. The Company has experienced an increase in network
services revenue as units in service and the associated recurring revenue stream
have continued to grow. Total units increased by 70,479, or 15.5%, to 525,274
from 454,795 over the prior year. ARPU decreased $0.26, or 10.5% to $2.23 for
1998 compared to $2.49 for 1997. The Company believes that ARPU has declined due
primarily to increases in units in service from Direct Access customers as a
percentage of total units in service. The Company
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<PAGE> 20
incurs minimal marginal cost in supplying only airtime to its Direct Access
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 $1.7 million, or 12.1%, to $15.3
million for the year ended December 31, 1998 from $13.6 million for the year
ended December 31, 1997. The increase in revenues from product sales resulted
from growth in sales of used and refurbished pager and cellular products offset
in part by a decrease in sales of new pagers sold to network customers.
Other services revenues increased by $745,000, or 7.5%, to $10.7 million
for the year ended December 31, 1998 from $9.9 million for the year ended
December 31, 1997. The increase in revenues from other services resulted from an
increase in technical services revenues, offset in part by a decrease in product
repair and refurbishment services. Management believes the decrease in product
repair and refurbishment services resulted primarily from consolidation among
certain of EPS's customers, and further believes that this consolidation may
result in increased opportunities for its repair and refurbishment services in
the future.
Cost of network services increased by $221,000, or 2.7%, to $8.5 million
for the year ended December 31, 1998 from $8.3 million for the year ended
December 31, 1997, but decreased as a percentage of network services revenue to
64.7% for the year ended December 31, 1998 from 66.8% for the year ended
December 31, 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 $305,000, or 2.2%, to $13.2 million for
the year ended December 31, 1998 from $13.6 million for the year ended December
31, 1997. Cost of product sales as a percentage of product sales decreased to
86.8% for the year ended December 31, 1998 from 99.6% for the year ended
December 31, 1997 due primarily to the decreasing cost to the Company of
purchasing pagers for resale to its network customers. The Company also reduced
the carrying cost of its inventory by $162,000 as of December 31, 1998 to the
lower of cost or market compared to $332,000 as of December 31, 1997.
Cost of other services increased by $252,000, or 2.8% to $9.4 million for
the year ended December 31, 1998 from $9.1 million for the year ended December
31, 1997. The increase was due primarily to the increase in technical services
revenue and the increased associated costs, offset in part by a decrease in
costs associated with the decrease in product repair and refurbishment revenue.
S,G&A decreased by $1.7 million, or 10.7%, to $14.3 million for the year
ended December 31, 1998 from $16.0 million for the year ended December 31, 1997,
and decreased as a percentage of total revenues to 36.6% for the year ended
December 31, 1998 from 44.6% for the year ended December 31, 1997. The decreases
in S,G&A were due to certain cost reduction measures during the second quarter
of 1997 through employee terminations and due to the increased efficiencies the
Company has experienced in supporting large customers. Because the Company does
not market directly to end-users, it does not incur subscriber-related
acquisition costs and accordingly, its S,G&A expenses do not increase in direct
proportion to its revenue growth.
Other expenses were $170,000 for the year ended December 31, 1998 compared
to $278,000 for the year ended December 31, 1997. Other expenses incurred in
1997 represent certain non-recurring severance expenses resulting from cost
reduction measures taken primarily in the area of S,G&A through employee
terminations during the second quarter of the year. Other expenses incurred in
1998 represent severance expenses related to executive management personnel
changes at EPS made in the third quarter of the year.
Depreciation and amortization decreased by $31,000, or 0.4%, to $7.0
million for the year ended December 31, 1998 from $7.0 million for the year
ended December 31, 1997. Depreciation and amortization decreased as a percentage
of total revenues to 17.8% for the year ended December 31, 1998 from 19.4% for
the year ended December 31, 1997. The decrease is due to the lesser amount of
equipment purchased or placed in service during 1998 compared to prior years
combined with certain equipment becoming fully depreciated and certain market
start-up costs becoming fully amortized during the year.
Interest expense, net of capitalized amounts, increased by $770,000, or
60.3%, to $2.0 million for the year ended December 31, 1998 from $1.3 million
for the year ended December 31, 1997. The increase in 1998 is the result of the
absence of interest capitalization due to the lack of construction related
activities in 1998.
Interest income decreased by $103,000 or 22.7% to $351,000 for the year
ended December 31, 1998 from $455,000 for the year ended December 31, 1997 due
to lower balances in short term investments throughout the year.
20
<PAGE> 21
Net loss for the year ended December 31, 1998 as compared to the year ended
December 31, 1997 decreased $4.0 million to $15.2 million from $19.2 million.
The net loss attributable to common stock decreased due to the decreased net
loss, offset in part by higher accretion and higher dividends on the Class A and
Class B Preferred Stock due to both classes being outstanding for most of 1998,
whereas 1997 includes only nine months of Class A related charges.
The net loss per share of Common Stock for the year ended December 31, 1998
decreased to $1.12 from $1.26 for the year ended December 31, 1997, due to the
factors stated above combined with a slight increase in the weighted average
shares outstanding due to the exercise of stock options and vesting of
restricted stock.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenues increased by $22.6 million, or 170.0%, to $36.0 million for
the year ended December 31, 1997 from $13.4 million for the year ended December
31, 1996 due to increased revenue from the Company's existing operations as well
as the inclusion of a full year of revenues of PTS and EPS, each of which were
acquired during 1996. Revenues increased in all three of the Company's revenue
categories: network services, product sales and other services.
Revenues from network services increased by $6.3 million, or 103.5%, to
$12.5 million for the year ended December 31, 1997 from $6.1 million for the
year ended December 31, 1996. 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. During 1997, the Company
expanded into six new markets including Charlotte, Richmond, Boston, Albany,
Indianapolis, and Cleveland, for a total of 27 markets operating at December 31,
1997. Total units increased by 92,314, or 25.5%, to 454,795 from 362,481 over
the prior year. Units associated with the Mercury acquisition were already
included in the Company's December 31, 1996 total units in service via an agency
agreement, and accordingly, these units do not impact the overall increase
during 1997. ARPU increased by only $0.01 for 1997 compared to 1996. However,
the Company believes that due to an anticipated increase in units in service
from Direct Access customers as a percentage of total units in service, its ARPU
will decline in the future. The Company incurs minimal marginal cost in
supplying only airtime to its co-location/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 $7.8 million, or 133.8%, to $13.6
million for the year ended December 31, 1997 from $5.8 million for the year
ended December 31, 1996. The majority of the increase is due to the inclusion of
a full year of revenues in 1997 from EPS, which was acquired in December 1996.
The increase in revenues from product sales also resulted from growth during
1997 of sales of new, used and refurbished pager and cellular products.
Other services revenues increased by $8.5 million, or 603.0%, to $9.9
million for the year ended December 31, 1997 from $1.4 million for the year
ended December 31, 1996. The majority of the increase was due to the inclusion
of a full year of revenues associated with repair and refurbishment of pager and
cellular products, and inventory management resulting from the purchase of EPS
in December 1996. Also contributing to the increase in revenue is the inclusion
of a full year of revenues from PTS, which was acquired in July 1996 and
provides network equipment installation services and maintenance and engineering
services.
Cost of network services increased by $3.7 million, or 80.0%, to $8.3
million for the year ended December 31, 1997 from $4.6 million for the year
ended December 31, 1996, but decreased as a percentage of network services
revenue to 66.8% for the year ended December 31, 1997 from 75.5% for the year
ended December 31, 1996. 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 increased by $5.2 million, or 62.7%, to $13.6 million
for the year ended December 31, 1997 from $8.3 million for the year ended
December 31, 1996. The majority of the increase was due to the inclusion of a
full year of cost associated with sales of pager and cellular products by EPS.
Cost of product sales as a percentage of product sales decreased to 99.6% for
the year ended December 31, 1997 from 143.2% for the year ended December 31,
1996 due primarily to EPS's profits on product sales, and to a lesser extent due
to decreasing cost to the Company of purchasing pagers for resale to its network
customers. The Company also reduced the carrying cost of its inventory by
$332,000 as of December 31, 1997 to the lower of cost or market compared to
$787,000 as of December 31, 1996.
Cost of other services increased by $8.5 million, or 1280.0% to $9.1
million for the year ended December 31, 1997 from $662,000 for the year ended
December 31, 1996. The increase in costs were due to the inclusion of a full
21
<PAGE> 22
year of costs associated with repair and refurbishment of pager and cellular
products and inventory management provided by EPS and paging network equipment
installation services, maintenance and engineering services provided by PTS.
S,G&A increased by $7.7 million, or 92.3%, to $16.0 million for the year
ended December 31, 1997 from $8.3 million for the year ended December 31, 1996,
but decreased as a percentage of total revenues to 44.6% for the year ended
December 31, 1997 from 62.5% for the year ended December 31, 1996. Because the
Company does not market directly to end-users, it does not incur
subscriber-related acquisition costs and accordingly, its S,G&A expenses do not
increase in direct proportion to its revenue growth. The increases in S,G&A
reflect 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 S,G&A costs associated
with PTS and EPS.
Other expenses were $278,000 for the year ended December 31, 1997 compared
to $0 for the year ended December 31, 1996, and represent certain non-recurring
severance expenses. The Company took certain cost reduction measures during the
second quarter of 1997 primarily in the area of S,G&A through employee
terminations.
Depreciation and amortization increased by $4.5 million, or 182.1%, to $7.0
million for the year ended December 31, 1997 from $2.5 million for the year
ended December 31, 1996 due to additional assets purchased or constructed for
expansion into new markets, increased amortization of market entry costs as the
Company opens new markets and they generate revenue, and amortization of
goodwill related to the acquisitions of EPS, Mercury, and PTS. Depreciation and
amortization increased as a percentage of total revenues to 19.4% for the year
ended December 31, 1997 from 18.6% for the year ended December 31, 1996.
Interest expense, net of capitalized amounts, increased by $1.0 million, or
427.1%, to $1.3 million for the year ended December 31, 1997 from $242,000 for
the year ended December 31, 1996 due to the financing of the network buildout,
borrowings related to the January 1997 acquisition of Mercury, and the interest
associated with a $10,000,000 bridge loan which converted in full into Class A
Redeemable Preferred Stock at the end of the second quarter but which was
outstanding during most of the second quarter of 1997.
Interest income decreased by $667,000 or 59.5% to $455,000 for the year
ended December 31, 1997 from $1.1 million for the year ended December 31, 1996
due to the higher level of funds available for investment in 1996 due to the
proceeds of the Company's IPO.
Net loss for the year ended December 31, 1997 as compared to the year ended
December 31, 1996 increased to $19.2 million from $10.2 million due to
substantial increases in S,G&A and depreciation and amortization, as described
above. The net loss attributable to common stock increased due to the increased
net loss, offset by less accretion but higher dividends on the Class A Preferred
Stock as compared to the Company's previously outstanding Series A and Series B
Preferred Stock.
The net loss per share of Common Stock for the year ended December 31, 1997
increased to $1.26 from $0.91 for the year ended December 31, 1996, due to the
increased net loss offset by reduced amounts of accretion on its stock. All 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 has experienced substantial reductions in capital
expenditures in 1998 compared to 1996 and 1997.
The Company's net cash used in operations was $6.3 million, $11.1 million
and $7.2 million for the years ended December 31, 1996, 1997, and 1998,
respectively. The primary reason for the decrease in 1998 is the Company's
increased total revenues and decreased total costs. The increase in 1997 was due
primarily to the increase in accounts receivable and operating expenses
associated with supporting a rapidly growing business.
Capital expenditures including network asset purchases were $16.5 million,
$19.2 million and $1.8 million for the years ended December 31, 1996, 1997, and
1998, respectively, reflecting the later stages 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.
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<PAGE> 23
The Company has historically 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 frequency bands to offer
additional capacity and flexibility to its customers. As of December 31, 1998
the Company had completed 25 network asset purchases (network equipment and
related licenses), resulting in the expansion of the Company's 157.740 MHz
networks into markets served by its Southeast and Northeast TCCs, and the
addition of network assets in the 150 MHz, 450 MHz and 900 MHz bands in certain
markets in the Southeast and Northeast United States. Three of the most
significant of these were the purchase of network assets in Georgia and Florida
from BellSouth Telecommunications, Inc. in the third quarter of 1995; the
purchase of network assets in New York, New Jersey, and Connecticut from Big
Apple in the third quarter of 1996; and the purchase of Mercury in the first
quarter of 1997. As a result, the Company added additional spectrum on a local
basis on radio common carrier 152.84 MHz, 152.60 MHz, 158.10 MHz, 931.2625 MHz
and 931.3125 MHz frequencies. After the 1995, 1996 and 1997 purchases, the
Company was successful in negotiating contracts with the resellers of paging
services on the purchased networks, resulting in the addition of over 30,000,
27,000 and 60,000 units in service, respectively, on the Company's networks.
In the second quarter of 1997, the Company received a bridge loan of $10.0
million from certain of its stockholders that accrued an interest rate of 10.0%
per annum. The Company sold $15 million of Class A Redeemable Preferred Stock
(the "Class A Preferred") with warrants to certain stockholders, into which the
bridge loan plus accrued interest was converted in full. 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 December 31, 1998,
although $2,308,333 has been accrued and is payable in 2002 or after the
redemption of the Class B Preferred described below.
In March 1998, the Company sold $8.0 million of Class B Senior Redeemable
Preferred Stock (the "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 December 31, 1998,
although $945,161 has been accrued and is payable in 2003.
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 December 31, 1998, there
was $4.9 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 December 31, 1998,
there was $3.1 million outstanding under this facility with no additional
availability.
As of December 31, 1998, the Company had an $11.0 million credit facility
with a financial institution, of which $7.25 million was used to finance paging
network acquisitions and $3.75 million represents a revolving credit facility to
be used for working capital purposes. The outstanding balance under this
facility bears interest at 1% plus the higher of the Federal Funds Rate for each
day plus 1/2% or prime. Pursuant to an amendment to the credit facility executed
in March 1998, interest only is payable monthly in arrears with the principal
installments beginning in February 1999, with the remaining principal balance
due in July 2000. This amendment to the credit facility also increased the
Company's availability for working capital purposes by $1.75 million, bringing
the total facility to $11.0 million. Borrowings under this facility are secured
by substantially all the assets of the Company. This credit facility contains
various conditions, financial covenants and restrictions related to a variety of
issues, including but not limited to debt service, and minimum net worth. The
amount outstanding under this facility as of December 31, 1998 was $10.5 million
and there was $495,000 additional availability. The amendment also contained
certain revisions to its financial covenants, including but not limited to a
requirement to maintain a minimum cash balance of $4 million at all times. In
November 1998, the Company requested and received a waiver of a debt covenant
from the financial institution as of September 30, 1998 and executed another
amendment to the credit facility, which modified certain of the financial
covenants for the December 31, 1998 measurement date.
Beginning in 1999, the Company was not in compliance with certain of the
financial covenants under its senior credit facility which would allow the
lender to declare a default and accelerate the maturity of the debt. In
addition,
23
<PAGE> 24
due to cross-default provisions, such noncompliance could trigger an
acceleration of all of the Company's other outstanding debt, excluding its
capital lease obligations. As a result, the debt which totals $18.5 million at
December 31, 1998 is reported as a current liability in the accompanying
consolidated balance sheet. This matter raises substantial doubt about the
Company's ability to continue as a going concern. As of April 13, 1999, the
Company has accepted a non-binding proposal from its senior lender to amend
certain terms and conditions of its senior credit facility. Management believes
that if this proposal is executed by the lender in the form of an amendment to
its senior credit facility, the Company will be able to meet its debt covenants
in 1999 and all of its debt would revert to monthly payments of principal and
interest which the Company believes it would be able to satisfy in 1999. If the
Company is unsuccessful in obtaining an amendment of its credit facility at
terms which it currently anticipates are necessary, it may not have sufficient
resources to meet its debt obligations and working capital requirements in 1999.
Management believes that the amendment of its senior credit facility will
occur during the second quarter of 1999, although there can be no assurances
that the transaction will be consummated or that the terms will be as currently
desired.
At December 31, 1998, the Company had $6.7 million invested in short-term
investment grade securities at various interest rates.
The Nasdaq Stock Market, Inc. has delisted the Company's Common Stock from
the NASDAQ National Market effective as of the close of business on March 22,
1999 because the Company failed to comply with the Nasdaq's compliance criteria
regarding minimum net tangible assets, market value of public float, and minimum
bid price. The Company's Common Stock became listed on the OTC Bulletin Board
effective March 23, 1999. The delisting from NASDAQ could adversely affect the
Company's ability to raise additional funds.
The Company operates in the wireless communications industry which has
experienced and continues to experience significant challenges including
competing technologies, shifts in customers' strategies, changes in the FCC
regulatory environment, and limited sources of capital. As a result, the Company
is continually required to address these and other matters, in its business
strategy and operations.
Since its March 1996 initial public offering, the Company has invested $62
million in building its network infrastructure, acquiring FCC licenses and other
paging networks, and acquiring related companies. As a result of this expansion
and the development of the Company's business and the overall wireless industry,
the Company has experienced net losses and negative cash flows, and future cash
flows have been difficult to project.
The Company's projections include significant growth in revenues, from
existing products and services and also from new switching technologies which it
has recently developed, and improved profitability due to greater utilization of
the existing base of assets. The Company's business plan may change, or
unforeseen events may occur, requiring the Company to raise additional funds.
Additionally, the Company may consider selling certain assets. The amounts of
funds required by the Company will depend on many factors, including successful
deployment of the Company's proprietary patent pending switch technology,
"PLATFORM 1(TM)", its sales to customers, and the expected cost savings to the
Company in its own networks.
The outcome of the uncertainties surrounding the Company and the industry
are difficult to predict. These uncertainties could effect the Company's ability
to recover the carrying value of its long-lived assets from its future cash
flows and operations, although management's current projections indicate that
such values will be recovered. Currently, generally accepted accounting
principles require companies to assess future cash flows and record impairment
losses on long-lived assets based on estimates of future cash flows if
insufficient to recover the carrying values. Should the Company's future
projections not materialize, the Company could experience an impairment of its
long-lived assets requiring a charge to its income statement. As of December 31,
1998, the Company had $45 million in net book value of long-lived assets,
including property and equipment, FCC licenses, market entry costs and goodwill.
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 $10.3 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.
24
<PAGE> 25
In December 1996, the Company acquired the stock of EPS for approximately
$4.8 million. Of this amount, the Company paid $300,000 in cash and issued
673,524 shares of Common Stock. The transaction was accounted for as a purchase
as of December 1, 1996. Additional consideration, if any, will be recorded as
goodwill.
In September 1996, the Company acquired substantially all the assets of Big
Apple for approximately $3.8 million. Of this amount, the Company paid $1.8
million in cash and issued 290,915 shares of Common Stock. 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.
In July 1996, the Company acquired the stock of Paging Services, Inc.
("PSI") for $750,000, paid by the issuance of 58,823 shares of Common Stock and
$250,000 in cash. The name of PSI was changed to Preferred Technical Services,
Inc., and PTS operates as a wholly-owned subsidiary of the Company. The
transaction was accounted for as a purchase as of July 1, 1996.
EFFECT OF INFLATION AND SEASONALITY
Inflation is not a material factor affecting the Company's business. The
cost to the Company of purchasing pagers has declined significantly in recent
years, and this reduction in cost has been reflected in lower prices charged to
the Company's customers and lower cost of product to the Company as a percentage
of its product sales. General operating expenses such as salaries, employee
benefits, and occupancy costs are subject to normal inflationary pressures.
Seasonality is not a material factor affecting the Company's business
although pager sales are generally higher in the fourth quarter of the year due
to higher demand from the Company's customers' subscribers during the holiday
season. Also in certain regions, inclement weather may affect PTS's revenues
either by delaying network equipment installation or increasing opportunities
for maintenance work.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. Certain information included in this
Annual Report on Form 10-K 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, 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 effect 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 related to the deployment and feasibility
of the Company's new patent pending switching technology, 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 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.
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.
In 1998, the Company designated a cross-functional team with members of its
Information Technology, Engineering, Finance and Administration departments to
evaluate the impact of the Year 2000 problem. Initially, this team organized and
explained each member's role in the process. Second, the team established an
inventory of potential areas where a problem could exist. The inventory included
an assessment of the Company's desktop and server hardware; software systems;
telephone system; billing system; accounting system; paging terminals; paging
25
<PAGE> 26
transmitters; and other paging network equipment. Third, the team established a
plan and assigned responsibility. According to the established plan, the
Company's mission critical systems will all be Year 2000 compliant by September
1999. Assessment of mission critical systems and applications has been
substantially completed and most third party vendors who supply these mission
critical systems have been contacted.
The Company intends to bring its mission critical systems into Year 2000
compliance through hardware and software upgrades, software replacement and
internally developed enhanced software. The Company has purchased maintenance
agreements with respect to its desktop and server hardware, software systems and
telephone system. These maintenance agreements have allowed the Company to
upgrade and remedy where necessary in order to become compliant at minimal
additional cost. The Company's subscriber control system is compliant. During
1998, the Company contracted with a consultant to provide services specifically
related to an upgrade of its accounting software package. These consulting
services consist primarily of programming services and this upgrade is expected
to be completed during the third quarter of 1999. The Company's paging
terminals, transmitters and other paging network equipment are not date
sensitive.
The Company has not conducted its assessment of the reasonably likely worst
case scenario of systems failures and their related consequences. It is expected
that the planned testing of systems and the completed testing of systems will
greatly reduce the need for substantial contingency planning.
The Company believes that the cost of modifying its software and related
computer technologies will not exceed $250,000, a portion of which was incurred
in the fourth quarter of 1998 and the remainder of which will be incurred in the
first nine months of 1999. Costs of the Year 2000 project are based on current
estimates and actual results may vary from such estimates once plans are fully
implemented.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company conducts most of its business in the US and therefore, the
Company believes that its exposure to foreign currency exchange rate risk at
December 31, 1998 was not material.
The Company does not engage in trading market risk sensitive instruments.
The Company also does not purchase for investment, hedging or for purposes
"other than trading", instruments that are likely to expose it to market risk,
whether interest rate, foreign currency exchange, commodity price or equity
price risk.
The Company's interest income and expense are most sensitive to changes in
the general level of U.S. interest rates. In this regard, changes in the U.S.
interest rates affect the interest earned on the Company's cash equivalents and
short-term investments and interest paid on its debt. Due to the short term
nature of its debt, the Company does not believe that changes to interest rates
would have a material impact.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
26
<PAGE> 27
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
PREFERRED NETWORKS, INC.
We have audited the consolidated balance sheets of Preferred Networks, Inc.
as of December 31, 1997 and 1998, and the related consolidated statements of
operations, changes in stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Preferred
Networks, Inc. as of December 31, 1997 and 1998 and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
As discussed in Note 2 to the financial statements, in 1999, the Company
was not in compliance with certain financial covenants under its senior credit
facility, which allows the lender to accelerate the maturity of this debt of
$10.5 million. In addition, such non compliance triggers an acceleration of the
Company's other outstanding debt totaling $8.0 million. Although as of April 13,
1999, management has accepted a non-binding proposal from its senior lender to
amend the senior credit facility, there is no assurance that such an amendment
will be executed. More information on management's plans with regard to this
matter are also discussed in Note 2. This matter raises substantial doubt about
the Company's ability to continue as a going concern. The accompanying financial
statements do not include any adjustments that may result from the outcome of
this uncertainty.
ERNST & YOUNG LLP
Atlanta, Georgia
April 15, 1999
27
<PAGE> 28
PREFERRED NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1997 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents ................................................... $ 7,562,978 $ 6,702,178
Accounts receivable, less allowance for doubtful accounts of
$661,300 and $758,952 in 1997 and 1998, respectively ...................... 3,969,026 4,606,462
Inventory ................................................................... 2,890,647 2,928,217
Prepaid expenses and other current assets ................................... 325,130 421,911
------------ ------------
Total current assets ........................................................... 14,747,781 14,658,768
Property and equipment, net .................................................... 25,569,209 21,555,617
Goodwill, net .................................................................. 13,396,459 12,427,579
FCC licenses, net .............................................................. 9,544,622 8,838,444
Other assets, net .............................................................. 2,974,409 2,552,135
------------ ------------
$ 66,232,480 $ 60,032,543
============ ============
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable ............................................................ $ 3,091,994 $ 4,916,542
Accrued liabilities ......................................................... 832,656 1,086,731
Accrued salaries ............................................................ 797,302 472,061
Current portion of notes payable and capital lease obligations .............. 2,123,248 18,687,492
------------ ------------
Total current liabilities .............................................. 6,845,200 25,162,826
Notes payable and capital lease obligations, less current portion .............. 17,658,608 345,946
Class A Redeemable Preferred Stock, no par value, $1.50 per share liquidation
preference and redemption price; 13,500,000 shares authorized in 1997,
10,000,000 shares issued and outstanding in 1997 and 1998 (including $808,333
and $2,308,333 of undeclared dividends in 1997 and 1998, respectively) ...... 13,956,123 15,879,309
Class B Senior Redeemable Preferred Stock, no par value, $1.50 per share
liquidation preference and redemption price; 5,500,000 shares authorized
5,333,336 shares issued and outstanding in 1998 (including
$945,161 of undeclared dividends in 1998) ................................... -- 8,088,693
------------ ------------
Total liabilities and Redeemable Preferred Stock .......................... 38,459,931 49,476,774
Stockholders' equity
Preferred stock, no par value, 16,500,000 shares authorized; none
issued and outstanding .................................................... -- --
Common Stock, no par value, 100,000,000 shares authorized;
16,200,552 and 16,334,377 shares issued and outstanding in
1997 and 1998, respectively ............................................... 62,900,973 61,458,690
Additional paid-in capital .................................................. -- --
Accretion on Class A and Class B Redeemable Preferred Stock ................. (245,726) (828,788)
Accumulated deficit ......................................................... (34,882,698) (50,074,133)
------------ ------------
27,772,549 10,555,769
------------ ------------
$ 66,232,480 $ 60,032,543
============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
28
<PAGE> 29
PREFERRED NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Revenues
Network services .................................. $ 6,121,127 $ 12,456,481 $ 13,204,172
Product sales ..................................... 5,818,074 13,603,312 15,255,483
Other services .................................... 1,411,471 9,921,763 10,666,687
------------ ------------ ------------
Total revenues ........................... 13,350,672 35,981,556 39,126,342
Costs of revenues
Network services .................................. 4,621,126 8,315,721 8,537,012
Product sales ..................................... 8,328,771 13,552,874 13,248,038
Other services .................................... 662,310 9,140,428 9,392,293
------------ ------------ ------------
Total costs of revenues .................. 13,612,207 31,009,023 31,177,343
------------ ------------ ------------
Gross margin ............................................... (261,535) 4,972,533 7,948,999
Selling, general and administrative expenses ............... 8,337,963 16,030,595 14,311,968
Other expenses ............................................. -- 277,707 169,637
Depreciation and amortization .............................. 2,479,080 6,993,116 6,962,519
------------ ------------ ------------
Operating loss ........................... (11,078,578) (18,328,885) (13,495,125)
Interest expense ........................................... (242,337) (1,277,478) (2,047,694)
Interest income ............................................ 1,121,585 454,605 351,384
------------ ------------ ------------
Net loss ................................. (10,199,330) (19,151,758) (15,191,435)
Accretion of redeemable preferred stock .................... (1,121,316) (245,726) (583,062)
Redeemable preferred stock dividend requirements ........... (353,651) (808,333) (2,445,161)
------------ ------------ ------------
Net loss attributable to common stock ............. $(11,674,297) $(20,205,817) $(18,219,658)
============ ============ ============
Net loss per share of common stock ......................... $ (0.91) $ (1.26) $ (1.12)
============ ============ ============
Weighted average number of common shares used in calculating
net loss per share of common stock ...................... 12,814,579 16,059,637 16,257,586
============ ============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
29
<PAGE> 30
PREFERRED NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON ACCRETION OF
STOCK ADDITIONAL COMMON REDEEMABLE
($.0001 PAID-IN STOCK PREFERRED ACCUMULATED
PAR) CAPITAL (NO PAR) STOCK DEFICIT TOTAL
------- ------------ ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 ............... $ 414 $ 1,013,981 $ -- $(3,289,003) $ (5,531,610) $ (7,806,218)
Accretion of Series A and Series B
Redeemable Convertible Preferred Stock . -- -- -- (1,121,316) -- (1,121,316)
Dividends on Series B Redeemable
Convertible Preferred Stock ($21.35
per share) ............................. -- (353,651) -- -- -- (353,651)
Issuance of Common Stock upon Initial
Public Offering ........................ 345 31,152,052 -- -- -- 31,152,397
Conversion of Series A and Series B
Redeemable Convertible Preferred Stock . 683 18,546,627 -- 4,410,319 -- 22,957,629
Issuance of Common Stock upon exercise
of stock options ....................... 1 14,142 -- -- -- 14,143
Issuance of Common Stock pursuant to
Acquisitions ........................... 86 5,909,914 -- -- -- 5,910,000
Non-cash stock option compensation ....... -- 29,334 -- -- -- 29,334
Net loss ................................. -- -- -- -- (10,199,330) (10,199,330)
------- ------------ ------------ ----------- ------------ ------------
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 Warrants ........ -- -- 1,930,963 -- -- 1,930,963
Non-cash stock option compensation ....... -- -- 181,915 -- -- 181,915
Accretion of Class A Redeemable
Preferred Stock ........................ -- -- -- (245,726) -- (245,726)
Undeclared dividends on Class A
Redeemable Preferred Stock ($0.08 per
share) ................................. -- -- (808,333) -- -- (808,333)
Exercise of options ...................... -- -- 6,808 -- -- 6,808
Net loss ................................. -- -- -- -- (19,151,758) (19,151,758)
------- ------------ ------------ ----------- ------------ ------------
Balance at December 31, 1997 ............... -- -- 62,900,973 (245,726) (34,882,698) 27,772,549
Accretion of Class A Redeemable
Preferred Stock ........................ -- -- -- (423,188) -- (423,188)
Undeclared dividends on Class A
Redeemable Preferred Stock ($0.15 per
share) ................................. -- -- -- -- -- (1,500,000)
Accretion of Class B Redeemable
Preferred Stock .......................... -- -- -- (159,874) -- (159,874)
Undeclared dividends on Class B
Redeemable Preferred Stock ($0.18 per
share) ................................. -- -- (945,161) -- -- (945,161)
Issuance of Common Stock Warrants ........ -- -- 810,000 -- -- 810,000
Exercise of options ...................... -- -- 192,878 -- -- 192,878
Net loss ................................. -- -- -- -- (15,191,435) (15,191,435)
------- ------------ ------------ ----------- ------------ ------------
Balance at December 31, 1998 ............. $ -- $ -- $ 61,458,690 $ (828,788) $(50,074,133) $ 10,555,769
======= ============ ============ =========== ============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
30
<PAGE> 31
PREFERRED NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss .................................................. $(10,199,330) $(19,151,758) $(15,191,435)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .......................... 2,479,080 6,993,116 6,962,519
Loss on disposal of property and equipment ............. -- 33,193 --
Bad debt expense ....................................... 248,362 805,022 848,057
Stock option compensation expense ...................... 29,334 277,618 66,323
Changes in operating assets and liabilities:
Accounts receivable .................................. (1,415,629) (1,731,406) (1,485,493)
Receivables from related parties ..................... (26,972) 93,397 --
Inventory ............................................ (3,759,481) 3,104,062 (37,570)
Prepaid expenses and other current assets ............ (109,048) 427,476 (96,781)
Accounts payable ..................................... 3,784,690 (994,399) 1,824,548
Accrued liabilities .................................. 2,518,175 (1,126,951) 254,075
Accrued salaries ..................................... 160,910 175,809 (325,241)
------------ ------------ ------------
Net cash used in operating activities ..................... (6,289,909) (11,094,821) (7,180,998)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment .................................... (8,174,943) (3,856,095) (769,709)
Purchase of other assets and FCC licenses ................. (6,568,426) (1,599,876) (432,398)
Payment for acquisitions, net of cash acquired ............ (379,947) (10,509,544) --
------------ ------------ ------------
Net cash used in investing activities ..................... (15,123,316) (15,965,515) (1,202,107)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings .................................. 10,000,000 10,000,000 1,450,000
Payments of borrowings .................................... (7,243,191) (1,861,875) (1,847,906)
Issuance of Redeemable Preferred Stock .................... -- 2,902,064 6,983,656
Payment of Redeemable Convertible Preferred Stock dividends (176,149) -- --
Issuance of Common Stock upon exercise of stock options ... 14,143 6,808 126,555
Issuance of Common Stock .................................. 31,152,397 -- --
Issuance of Common Stock warrants ......................... -- 1,930,963 810,000
------------ ------------ ------------
Net cash provided by financing activities ................. 33,747,200 12,977,960 7,522,305
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ...... 12,333,975 (14,082,376) (860,800)
Cash and cash equivalents, beginning of year .............. 9,311,379 21,645,354 7,562,978
------------ ------------ ------------
Cash and cash equivalents, end of year .................... $ 21,645,354 $ 7,562,978 $ 6,702,178
============ ============ ============
</TABLE>
SEE ACCOMPANYING NOTES.
31
<PAGE> 32
PREFERRED NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Preferred Networks, Inc. (the "Company") provides outsourcing services to
the wireless industry primarily in the United States. The Company commenced
operations in 1991 as a carrier's carrier of one-way paging networks, whereby
the Company's customers purchase and resell the Company's network services to
their subscribers. In July 1996, the Company acquired Preferred Technical
Services, Inc. ("PTS"), a provider of wireless 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.
INITIAL PUBLIC OFFERING
In March 1996, the Company issued 3,448,000 shares of Common Stock in an
initial public offering ("IPO") and received net proceeds of $32.1 million.
Pursuant to their terms, upon consummation of the IPO all outstanding
shares of Series A and Series B Redeemable Convertible Preferred Stock ("Series
A" and "Series B", respectively) 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 issued upon such conversion and such dividend payment
was 6,830,280 shares. All accretion previously accrued was eliminated upon
conversion to shares of Common Stock.
SIGNIFICANT ACCOUNTING POLICIES
The Company's significant accounting policies are summarized as follows:
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company recognizes revenue on network services when the service is
provided. Revenue from the sale of pagers and cellular products is recognized
when the product is shipped. Other service revenue consists of revenues
generated from repair, maintenance and installation services which the Company
recognizes when the services are provided. Sales to one customer approximated a
total of 10% of total sales during 1996. No one customer provided more than 10%
of sales during 1997 and 1998.
32
<PAGE> 33
CASH AND CASH EQUIVALENTS
The Company considers short-term investments with original maturity dates
of 90 days or less at date of purchase to be cash equivalents. Short-term
investments are carried at cost plus accrued interest, which approximates fair
market value.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist principally of cash equivalents and accounts receivable.
Cash equivalents are held with two financial institutions. Accounts receivable
represent trade receivables and are unsecured. The Company performs periodic
credit evaluations of its customers' financial condition and generally does not
require collateral to support customer receivables. The Company is at risk to
the extent such amounts become uncorrectable. The Company provides an allowance
for doubtful accounts based on factors surrounding the credit risk of specific
customers, historical trends, and other information. At December 31, 1998,
approximately 23% of accounts receivable was with one customer.
INVENTORY
Inventory includes new and refurbished pagers and cellular phones and
related repair parts. The amounts are stated at the lower of cost or market,
with cost of new product and repair parts being determined under the first-in,
first-out (FIFO) method and the cost of refurbished products being determined
principally by use of the specific identification method. Inventory has been
reduced to market value at both December 31, 1997, and 1998.
PROPERTY AND EQUIPMENT
Property and equipment, including items financed through notes payable and
capital leases, is stated at cost including capitalized interest on eligible
assets. Interest capitalized in 1996, 1997 and 1998 totaled $280,749, $781,381
and $0 respectively. The Company depreciates its property and equipment over
their estimated useful lives using the straight-line method for financial
reporting purposes and accelerated methods for tax reporting purposes. Estimated
useful lives range from five to seven years.
FCC LICENSES
Federal Communications Commission ("FCC") licenses consist of costs
associated with the purchase of licenses and license application fees. These
amounts are being amortized over a 15 year period, using the straight-line
method. Accumulated amortization at December 31, 1997 and 1998 totaled $864,058
and $1,558,327, respectively.
OTHER ASSETS
Other assets include deposits with creditors and market entry costs. The
Company capitalizes the incremental costs of entering a new geographical market
until the Company begins to generate revenues from the sale of network services
to its customers in that market. These costs include salaries, rent and the cost
of telecommunications services. Such capitalized amounts are amortized over a 15
month period using the straight-line method, which approximates the Company's
estimated market stabilization period beginning with the date that the market
begins to generate revenues. The Company capitalized $2,407,346 in 1996,
$2,082,021 in 1997, and $593,775 in 1998. Accumulated amortization for other
assets at December 31, 1997 and 1998 totaled $1,969,359 and $2,680,135,
respectively.
33
<PAGE> 34
GOODWILL
Goodwill represents the excess purchase price over the fair value of the
assets acquired in various acquisitions. Goodwill is amortized using the
straight-line method over 15 years. At December 31, 1997 and 1998, accumulated
amortization was $968,115 and $1,936,994, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS
Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of, requires impairment losses to be recognized for long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows are not sufficient to recover the assets' carrying amount. The impairment
loss is measured by comparing the fair value of the asset to its carrying
amount. No impairment losses have been recorded in 1996, 1997, or 1998.
ADVERTISING EXPENSES
The Company expenses all advertising expenses as incurred. Advertising
expense for the years 1996, 1997, and 1998 was approximately $29,000, $218,000
and $170,000, respectively.
INCOME TAXES
The Company uses the liability method of accounting for income taxes.
STOCK-BASED COMPENSATION
The Company uses the intrinsic value method of measuring and recording
compensation expense, if any, related to stock-based compensation. See Note 7
related to pro forma disclosures using the fair value method, as required by
Financial Accounting Standards Board Statement No. 123, Accounting for
Stock-Based Compensation ("FAS 123").
NET LOSS PER SHARE
Net loss per share was computed 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>
1996 1997 1998
--------- ---------- ----------
<S> <C> <C> <C>
Common Stock Options .................................... 1,151,753 1,705,989 2,467,168
Common Stock Warrants ................................... 422,353 11,922,353 17,322,353
Unvested Restricted Stock ............................... -- 60,000 69,000
--------- ---------- ----------
Total Securities ........................................ 1,574,106 13,688,342 19,858,521
========= ========== ==========
</TABLE>
STATEMENTS OF CASH FLOWS
The Company paid interest, net of amounts capitalized, of approximately
$569,000, $1,199,000, and $2,048,289 during the years ended December 31, 1996,
1997 and 1998, respectively.
During 1996, 1997 and 1998, the Company purchased property and equipment of
approximately $7,695,000, $3,248,000 and $229,000 respectively, through the
issuance of notes payable and under capital leases. During 1998, the Company
sold approximately $350,000 in property and equipment in exchange for the
assumption of approximately $350,000 in debt.
34
<PAGE> 35
In 1997, the Company borrowed a total of $10.0 million from the Class A
Redeemable Preferred stockholders under a 10% bridge loan. The Company's
indebtedness under the $10.0 million bridge loan was applied against the
purchase price of the Class A Preferred Stock. See Note 6.
RECLASSIFICATIONS
Certain amounts in the 1996 and 1997 financial statements have been
reclassified to conform to the 1998 presentation.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In April 1998, the Accounting Standards Executive Committee 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 a cumulative effect of a change in accounting principle. SOP 98-5
is effective January 1, 1999. The Company will adopt SOP 98-5 effective January
1, 1999 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 December 31, 1998 were approximately $1.8 million.
2. UNCERTAINTIES
The Company operates in the wireless communications industry which has
experienced and continues to experience significant challenges including
competing technologies, shifts in customers' strategies, changes in the FCC
regulatory environment, and limited sources of capital. As a result, the Company
is continually required to address these and other matters, in its business
strategy and operations.
Since its March 1996 initial public offering, the Company has invested $62
million in building its network infrastructure, acquiring FCC licenses and other
paging networks, and acquiring related companies. As a result of this expansion
and the development of the Company's business and the overall wireless industry,
the Company has experienced net losses and negative cash flows, and future cash
flows have been difficult to project.
The Company's projections include significant growth in revenues, from
existing products and services and also from new switching technologies which it
has recently developed, and improved profitability due to greater utilization of
the existing base of assets. The Company's business plan may change, or
unforeseen events may occur, requiring the Company to raise additional funds.
Additionally, the Company may consider selling certain assets. The amounts of
funds required by the Company will depend on many factors, including the
successful deployment of the Company's proprietary patent pending switch
technology, "PLATFORM 1 (TM)", including its sales to customers and the expected
cost savings to the Company in its own networks. The outcome of the
uncertainties surrounding the Company and the industry are difficult to predict.
These uncertainties could effect the Company's ability to recover the carrying
value of its long-lived assets from its future cash flows and operations,
although management's current projections indicate that such values will be
recovered. Currently, generally accepted accounting principles require companies
to assess future cash flows and record impairment losses on long-lived assets
based on estimates of future cash flows if insufficient to recover the carrying
values. Should the Company's future projections not materialize, the Company
could experience an impairment of its long-lived assets requiring a charge to
its income statement. As of December 31, 1998, the Company had $45 million in
net book value of long-lived assets, including property and equipment, FCC
licenses, market entry costs and goodwill.
Beginning in 1999, the Company was not in compliance with certain of the
financial covenants under its senior credit facility (discussed further in Note
5) which would allow the lender to accelerate the maturity of the debt. In
addition, due to cross-default provisions, such non compliance triggers an
acceleration of all of the Company's other outstanding debt, excluding its
capital lease obligations. As a result, the debt which totals $18.5 million at
December 31, 1998 is reported as a current liability in the accompanying
consolidated balance sheet. This matter raises substantial doubt about the
Company's ability to continue as a going concern. As of April 13, 1999, the
Company has accepted a non-binding proposal from its senior lender to amend
certain terms and conditions of its senior credit facility. Management believes
that if this proposal is executed by the lender in the form of an amendment to
its senior credit facility, the Company will be able to meet its debt covenants
and all of its debt would revert to monthly payments of principal and interest
which the Company
35
<PAGE> 36
believes it would be able to satisfy in 1999. If the Company is unsuccessful in
obtaining an amendment of its credit facility at terms which it currently
anticipates are necessary, it may not have sufficient resources to meet its debt
obligations and working capital requirements in 1999.
Management believes that the amendment of its senior credit facility will
occur during the second quarter of 1999, although there can be no assurances
that the amendment will be consummated or that the terms will be as currently
desired.
3. ACQUISITIONS
In July 1996, the Company acquired the stock of Paging Services, Inc. for
$750,000, paid by the issuance of 58,823 shares of the Company's Common Stock
and $250,000 in cash. Its name was changed to Preferred Technical Services, Inc.
("PTS"), and PTS now operates as a wholly-owned subsidiary of the Company. The
transaction was accounted for as a purchase as of July 1, 1996, and the excess
purchase price over the fair value of the assets acquired has been recorded as
goodwill. The former President and another officer of the Company were majority
stockholders of PTS prior to the acquisition.
In September 1996, the Company acquired substantially all the assets of Big
Apple Paging Corporation ("Big Apple") for approximately $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 the Company's Common Stock in September 1996. In 1997, $1.1
million was paid by the issuance of 165,317 shares of Common Stock and an
additional $380,000 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
operating in the states of New York, New Jersey, and Connecticut.
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. Of
the purchase price, $4.5 million was paid by the issuance of 673,524 shares of
the Company's 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. No additional amounts have been paid or accrued. 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 &
Communication, 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
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.
The following unaudited pro forma summary presents the consolidated results
of operations as if the 1996 and 1997 acquisitions described above had occurred
on January 1, 1996, and does not purport to be indicative of what would have
occurred had the acquisitions been made as of that date or of results which may
occur in the future. Pro forma results are not presented for 1998, as all
acquisitions occurred prior to 1998.
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
Net revenues ............ $ 29,898,405 $ 36,427,428
============ ============
Net loss ................ $(13,634,307) $(19,174,424)
============ ============
Net loss per common share $ (1.12) $ (1.26)
============ ============
</TABLE>
36
<PAGE> 37
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Network services equipment $ 19,794,707 $ 21,477,731
Computer equipment ...... 2,726,232 2,903,600
Other equipment ......... 999,937 1,238,858
Vehicles ................ 817,186 1,072,477
Furniture and fixtures .. 808,572 852,067
Construction in progress 6,602,000 3,781,871
Leasehold improvements .. 997,356 1,045,659
------------ ------------
32,745,990 32,372,263
Less accumulated depreciation (7,176,781) (10,816,646)
------------ ------------
$ 25,569,209 $ 21,555,617
============ ============
</TABLE>
At December 31, 1997 and 1998 substantially all property and equipment is
pledged as collateral under various notes payable and capital lease obligations.
Depreciation expense was approximately $1,820,000, $3,857,000, and $4,432,789
for the years ended December 31, 1996, 1997 and 1998, respectively.
Construction in progress represents equipment acquired, but not yet placed
in service. The Company expects to utilize such equipment in its future
operations, as the market conditions and capital availability permit. These
amounts are not being depreciated.
5. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1997 1998
---------------- -----------------
<S> <C> <C>
Revolving credit facility with a financial institution; maximum borrowings of
$11,000,000, bearing interest either at (1) 1% plus the higher of the
Federal Funds Rate for each day plus 1/2% or prime or (2) LIBOR plus 3.75%,
at the Company's option. At December 31, 1998 $492,000 was available.
Monthly interest installments and monthly principal installments of $120,800
begin in February 1999, balance due July 30, 2000; secured by substantially
all assets of the Company. .................................................. $ 9,247,045 $ 10,504,879
Line of credit with equipment manufacturers, maximum borrowings of $12,000,000
at December 31, 1998, bearing interest at the five-year U.S. Treasury rate
plus 6.5% in 1997 and 1998. At December 31, 1998, $5.7 million was available
and borrowings are payable in various monthly installments of principal and
interest, with maturity dates through 2002;
secured by paging equipment.................................................. 5,921,648 4,930,501
Notes payable to finance company bearing interest at rates between 10% and 11%
payable in various monthly installments of principal and interest with
maturity dates through 2002; secured by paging equipment. No additional
amounts were available at December 31, 1998.................................. 4,089,016 3,055,651
Amounts due under capital leases, due in various monthly installments
until 2001; secured by the related equipment................................. 524,147 542,407
------------- -------------
19,781,856 19,033,438
Less current portion............................................................. (2,123,248) (18,687,492)
------------- -------------
Long-term debt................................................................... $ 17,658,608 $ 345,946
============= =============
</TABLE>
37
<PAGE> 38
In March 1998, the Company amended its revolving credit facility to
increase its availability for working capital purposes for a total facility of
$11.0 million and to extend the maturity, with monthly installments of principal
of approximately $120,800 beginning in February 1999, with the remaining
principal balance due in July 2000. Due to the non-compliance with certain
financial covenants as described in Note 2, all of the debt except capital lease
obligations is classified as current as of December 31, 1998. Certain other
covenants were also modified in the March amendment such that the Company is
required to maintain minimum cash balances of $4 million at all times and
various other conditions, financial covenants and restrictions related to a
variety of issues, including but not limited to debt service, minimum net worth
and acquisitions. Availability under this facility is based on a multiple of
positive EBITDA of certain network markets, eligible receivables and inventory
of the Company. In November 1998, the Company requested and received a waiver of
a debt covenant from the financial institution as of September 30, 1998.
Additionally, the financial institution and the Company executed the fifth
amendment to the credit facility, which modified certain of the financial
covenants for the December 31, 1998 measurement date.
As of December 31, 1998, approximate future principal maturities of notes
payable and capital lease obligations for each of the next five years are as
follows due to the Company's non-compliance with certain financial covenants in
1999:
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
1999................................................. $ 18,687,492
2000................................................. 194,022
2001................................................. 120,571
2002................................................. 31,353
--------------
$ 19,033,438
==============
</TABLE>
6. STOCKHOLDERS' EQUITY
COMMON STOCK SPLITS
Effective January 24, 1996, the Company amended its certificate of
incorporation to increase the authorized Common Stock to 70,000,000 shares, to
reduce Common Stock par value to $.0001, and to provide a 7.35-for-1 Common
Stock split. The Board of Directors and stockholders also approved an amendment
to increase the number of authorized shares of Preferred Stock to 5,000,000,
which was effective upon consummation of the IPO. All common share and per
common share amounts have been adjusted for all periods presented to reflect the
stock split.
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
In 1994, the Company authorized the issuance of 500,000 shares of Preferred
Stock, $.01 par value per share. A total of 159,377 of these shares of Preferred
Stock were previously designated as Series A Redeemable Convertible Preferred
Stock ("Series A") and a total of 159,377 shares were issued in 1995. All of the
outstanding shares of Series A converted to Common Stock upon the IPO in 1996.
The Series A was redeemable, if no Series B was outstanding, any time on or
after June 20, 2001, at the option of the holders of 51% of the outstanding
shares, at the greater of $11.00 per share or fair market value. Each share of
Series A was also convertible into 7.35 shares of Common Stock (subject to
adjustment) at any time at the option of the holders and automatically converted
in the event of certain transactions, including a qualified public offering, as
defined. The Company's IPO triggered the automatic conversion. The number of
shares of Common Stock to which the holders of Series A were entitled was
determined by dividing $11.00 by the "Conversion Price" (originally $11.00, with
subsequent adjustments as provided) applicable to such shares at the date of
conversion. Each holder of Series A was entitled to the number of votes equal to
the number of shares of Common Stock into which such shares of Series A could be
converted. The holders of Series A were entitled to receive, as, when, and if
declared by the Board of Directors, cumulative preferred dividends at the rate
of $0.88 per share as adjusted for any stock dividends, combinations or splits
with respect to such shares) per annum, payable out of funds legally available.
Such preferred dividends were to begin to accrue on October 1, 1996. The Series
A had liquidation preference over the Common Stock (at the greater of (I) $11.00
plus accrued or declared and unpaid dividends or (ii) such amount per share as
would be available to the holders of Common Stock assuming conversion of all
then-outstanding Series A to Common Stock), but ranked in parity with all other
Preferred Stock.
38
<PAGE> 39
The Series A was being accreted to its estimated redemption value (the
greater of $11.00 per share or fair value) over the period until the holders
could demand redemption.
SERIES B REDEEMABLE CONVERTIBLE PREFERRED STOCK
In June 1995, the Company designated 21,000 of its then authorized shares
of Preferred Stock as Series B and issued 16,565 shares of Series B Redeemable
Convertible Preferred Stock ("Series B"). All of the outstanding shares of
Series B converted to Common Stock upon the IPO. Dividends on the Series B
accrued at the rate of 12% of the liquidation value per annum, compounded
quarterly. The Series B had a liquidation value of $1,000 per share, had
priority over all other capital stock of the Company with respect to dividends
and liquidation and voted together with the Common Stock on an as-converted
basis (i.e., each share of Series B converted into 334.09 shares of Common
Stock). The Series B could be converted into shares of Common Stock at any time
at the option of the holder and was subject to mandatory conversion upon a
qualified public offering, as defined. The Company had the option of paying any
unpaid dividends upon conversion in cash or shares of Common Stock. The Company
paid all Series B dividends through January 31, 1996 in shares of Common Stock,
and from that date to the IPO in cash.
Upon certain triggering dates or events including the sale of the Company,
Series B holders had the right to require the Company to redeem the Series B and
underlying Common Stock resulting from any conversion, at a price equal to (i)
for the Series B, the greater of the liquidation value per share (plus accrued
and unpaid dividends) or its fair market value per share and (ii) for the
underlying Common Stock, the greater of $2.99 per share or its fair market value
per share. In January 1996, the shareholders approved the deletion of the
redemption feature on the underlying Common Stock upon the completion of the
IPO.
The Company had the right to call all of the Series B at any time, at a
price equal to its liquidation value per share, plus accrued and unpaid
dividends.
In conjunction with the issuance of the Series B, the holders of the Series
A agreed to subordinate certain of their rights to those of the Series B. As a
result, the number of authorized shares of Series A was reduced to equal the
number of shares of Series A then outstanding and the Series A could not be
redeemed until the redemption or conversion of the Series B.
The difference between redemption value of the Series B (the greater of
$1,000 per share or fair value) and carrying value (excluding accrued dividends)
was being accreted over five years, the period until the holders could demand
redemption.
CLASS A REDEEMABLE PREFERRED STOCK
In June 1997, the Company issued 10.0 million shares of Class A Redeemable
Preferred Stock (the "Class A Preferred") and warrants to purchase up to 11.5
million shares of Common Stock for a total purchase price of $15.0 million.
Dividends accrue at the rate of 10% per annum, are cumulative and compound
annually. The Class A 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. If the
holder so demands and after redemption of the Class B Senior Redeemable
Preferred Stock described below, five years from the date of issuance, the Class
A Preferred 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 Class A 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. A portion of the warrants may be canceled by the
Company in the event of an early redemption of all of the Class A Preferred. The
Class A Preferred is recorded at cost, net of expenses, plus $2,977,247 in
undeclared dividends and accretion.
CLASS B SENIOR REDEEMABLE PREFERRED STOCK
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
39
<PAGE> 40
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 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. A portion of the
warrants may be canceled by the Company in the event of an early redemption of
all of the Class B Preferred. The Class B Preferred is recorded at cost, net of
expenses, plus $1,105,035 in undeclared dividends and accretion.
COMMON STOCK WARRANTS
In addition to the warrants issued in conjunction with the Class A
Preferred and Class B Preferred described above, the Company has other warrants
outstanding. At December 31, 1998, the Company had outstanding warrants to
purchase up to 183,750 shares of Common Stock at $1.50 per share, exercisable
until November 15, 2009, warrants to purchase 238,603 shares of Common Stock at
$4.24 per share, exercisable until June 2005.
RESTRICTED STOCK
The Company has a Non-Employee Directors' Restricted Stock Award Plan which
provides for awards of Common Stock to the non-employee directors upon election
to the board or every five years. In 1997 and 1998 the directors were issued
74,000 and 25,000 shares, respectively. The Company is recognizing the expense
related to this issuance over the vesting period, which ends in 2001 through
2003. The related expense recognized was immaterial in both years. At December
31, 1997 and 1998, 60,000 and 69,000, respectively,
shares were unvested.
7. STOCK PLANS
As of December 31, 1998, the Company has five stock plans (the 1992, 1994,
and 1995 Stock Option Plans, the 1995 Employee Stock Purchase Plan, and the 1995
Non-Employee Directors' Restricted Stock Award Plan). In 1994, the Board of
Directors voted to discontinue the granting of any additional options under the
1992 Stock Option Plan.
The Company has both incentive stock options and nonqualified stock options
outstanding, with varying vesting schedules. As of December 31, 1998, 4,410,613
shares of Common Stock were reserved for issuance under the five plans, of which
1,943,445 were available for future option grants and restricted stock awards. A
summary of the Company's stock option activity and related information is as
follows:
<TABLE>
<CAPTION>
RANGE OF WEIGHTED AVERAGE
NUMBER OF SHARES EXERCISE PRICES EXERCISE PRICE
UNDERLYING OPTIONS PER SHARE PER SHARE
------------------ --------------- -----------------
<S> <C> <C> <C>
Outstanding at December 31, 1995............ 780,723 $0.97 - $10.61 $2.27
Granted.................................. 412,549 $5.75 - $8.62 $7.38
Exercised................................ (14,589) $0.97 $0.97
Forfeited................................ (26,930) $0.97 - $10.61 $5.56
------------------ --------------- -----------------
Outstanding at December 31, 1996............ 1,151,753 $0.97 - $10.61 $3.99
Granted.................................. 1,366,626 $2.25 - $6.50 $2.83
Exercised................................ (7,018) $0.97 $0.97
Forfeited................................ (304,886) $0.97 - $10.61 $4.71
Canceled................................. (500,486) $6.00 - $10.61 $7.31
------------------ --------------- -----------------
Outstanding at December 31, 1997............ 1,705,989 $0.97 - $10.61 $1.97
Granted.................................. 1,256,601 $0.69 - $2.13 $1.55
Exercised................................ (95,774) $0.97 - $1.50 $1.30
Forfeited................................ (307,982) $0.97 - $6.50 $2.74
Canceled................................. (91,666) $2.13 - $2.50 $2.40
------------------ --------------- -----------------
Outstanding at December 31, 1998............ 2,467,168 $0.69 - $10.61 $2.57
================== =============== =================
Exercisable at December 31, 1996............ 152,896 $0.97 - $1.50 $1.05
================== =============== =================
Exercisable at December 31, 1997............ 369,833 $0.97 - $10.61 $1.36
================== =============== =================
Exercisable at December 31, 1998............ 550,360 $0.97 - $10.61 $2.36
================== =============== =================
</TABLE>
40
<PAGE> 41
Additional information regarding stock options by range of exercise prices
as of December 31, 1998 is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------- ----------------------------------
No. of Weighted Average Weighted Average No. of Weighted Average
Exercise Price Options Exercise Price Contract Life Options Exercise Price
- ----------------- ----------- ---------------- ---------------- ---------- -----------------
<S> <C> <C> <C> <C> <C>
$0.68 - $2.13 1,684,216 $1.40 7.83 302,963 $0.90
$2.25 - $10.61 782,952 $3.30 8.65 247,397 $3.04
----------- ================ ================ ========== =================
Total or Average 2,467,168 $2.57 8.32 550,360 $2.36
=========== ================ ================ ========== =================
</TABLE>
As a part of certain employee terminations in 1997, 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 terminated employees have to exercise the options.
PRO FORMA INFORMATION
Pro forma information regarding net income and earnings per share is
required by FAS 123, which also requires that the information be determined as
if the Company has accounted for its stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a minimum value
option valuation method for options granted prior to the IPO and a Black-Scholes
option valuation model for options granted after the IPO with the following
weighted-average assumptions for 1996, 1997, and 1998, respectively: a risk-free
interest rate of 6.15%, 6.20% and 5.64%; a dividend yield of 0%; volatility
factor of the expected market price of the Company's common stock of 0.57, 0.78,
and 0.99; and a weighted-average expected life of the option of 4 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
The weighted average fair value of options granted in 1996, 1997, and
1998 is $3.68, $1.75 and $1.53 per share, respectively.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Pro forma net loss............................................ $(10,451,264) $(19,297,820) $(16,028,422)
Pro forma net loss per share of common stock.................. $(0.93) $(1.27) $(1.17)
</TABLE>
8. INCOME TAXES
The Company has incurred operating losses since inception; accordingly, no
provision for income taxes has been recorded. As of December 31, 1998, the
Company has net operating loss carryforwards of approximately $58 million for
federal income tax purposes. Such carryforwards, which expire at various dates
through 2018, could be available to reduce future federal taxable income subject
to limitations resulting from substantial changes in the Company's ownership.
41
<PAGE> 42
The significant components of the Company's deferred tax assets and liabilities
are:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1997 1998
------------- -------------
<S> <C> <C>
Deferred tax assets
Net operating loss carryforwards $ 15,839,671 $ 21,861,730
Accounts receivable allowance 251,029 288,098
Inventory reserves 134,328 202,837
Vacation accrual 117,754 102,686
Other 90,566 12,480
------------- -------------
16,433,348 22,467,831
Valuation allowance (14,027,641) (20,017,710)
Deferred tax liabilities
Accumulated depreciation (1,348,711) (1,754,542)
Market entry costs (1,056,996) (695,579)
============= =============
Net deferred assets $ - $ -
============= =============
</TABLE>
The net change in the valuation allowance for deferred tax assets was an
increase of $3,921,240, $8,078,609 and $5,990,069 during 1996, 1997 and 1998,
respectively, due mostly to the increase in net operating loss carryforwards.
The reconciliation of income tax attributable to operations computed at the
U.S. Federal statutory rates to income tax expense is:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
Tax at federal statutory rate................................ (34.0)% (34.0)% (34.0)%
State taxes, net of federal tax benefit...................... (4.0) (4.0) (4.0)
Nondeductible expenses....................................... - 1.0 1.1
Effect of valuation allowance................................ 38.0 37.0 36.9
====== ====== ======
-% -% -%
====== ====== ======
</TABLE>
9. COMMITMENTS
The Company leases sites and other facilities for its transmitters,
terminals and other equipment and also leases office space under noncancelable
operating leases which expire at various dates. As of December 31, 1998,
approximate minimum annual rental payments required by these operating leases
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, TOTAL
-------------
<S> <C>
1999................................................... $ 4,088,000
2000................................................... 2,094,585
2001................................................... 1,619,446
2002................................................... 913,188
2003................................................... 772,052
Thereafter............................................. 1,875,492
-------------
$ 11,362,763
=============
</TABLE>
Rental expense for the years ended December 31, 1996, 1997 and 1998, was
approximately $2.0 million, $4.4 million and $4.4 million, respectively.
As of December 31, 1998, the Company had three letters of credit
outstanding for $492,224. These letters of credit expire in 1999, and are
collateralized by certificates of deposits of $492,224.
42
<PAGE> 43
10. RELATED PARTY TRANSACTIONS
During 1996, 1997 and 1998, the Company recognized revenues of
approximately $560,000, $5,553, and $0 respectively, from network services and
product sales, from entities owned by its stockholders. During 1996, 1997 and
1998, the Company expensed $850,000, $104,000 and $0, respectively, for services
purchased (including purchase, installation and maintenance costs and site lease
expense) from entities owned by related parties.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the accompanying consolidated balance
sheets for cash and cash equivalents, accounts receivable, receivables from
related parties, accounts payable, accrued expenses, payables to related parties
and notes payable and capital lease obligations approximate their fair value.
The fair values of the Company's notes payable and capital lease obligations
were estimated using discounted cash flow analyses, based on the Company's
current incremental borrowing rates for similar types of borrowing arrangements.
12. EMPLOYEE BENEFIT PLANS
The Company and one of its subsidiaries provide 401(k) plans that provide
retirement benefits to substantially all employees at least 21 years of age with
at least 90 days of continuous service. Depending on the subsidiary, the Company
is required to match 10% of each participant's contributions up to 1% of their
salary or may make contributions at the discretion of the Board of Directors,
subject to statutory limitations. The Company's contributions were not material
in 1996, 1997, or 1998.
43
<PAGE> 44
13. SEGMENT INFORMATION
The Company has three reportable segments organized by products or services
sold: (i) one-way wireless networks, whereby companies purchase non-branded,
wholesale network services from the Company for resale to their customers
(through its PNI Access Services Division); (ii) network engineering and
maintenance services, supporting one-way and two-way wireless technologies
(through Preferred Technical Services, Inc.) and (iii) pager and cellular
product repair services, product sales and inventory management and fulfillment
(through EPS Wireless, Inc.)
The Company evaluates performance and allocates resources based on earnings
before interest, depreciation and other non-cash items. The accounting policies
of the reportable segments are the same as those described in the summary of
significant accounting policies. Intersegment sales are recorded with profit,
which is then eliminated upon consolidation.
<TABLE>
<CAPTION>
PNI
Access EPS Preferred
Services Wireless Technical
And Other* Inc. Services, Inc. Intersegment Totals
---------------- ----------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Revenue............................. $ 19,566,847 $ 16,525,595 $ 3,992,277 $ (958,377) $ 39,126,342
Interest expense.................... 2,010,178 33,004 4,512 - 2,047,694
Depreciation and amortization
expense.......................... 6,094,758 648,273 219,488 - 6,962,519
Segment income (loss)............... (12,862,701) (2,424,141) 98,897 (3,490) (15,191,435)
Segment assets...................... 89,903,885 3,847,021 1,893,038 (35,611,401) 60,032,543
YEAR ENDED DECEMBER 31, 1997
Revenue............................. 17,914,723 17,425,733 2,361,355 (1,720,255) 35,981,556
Interest expense.................... 1,241,294 36,184 - - 1,277,478
Depreciation and amortization
expense.......................... 6,217,459 608,775 166,882 - 6,993,116
Segment income (loss)............... (18,345,603) (799,069) 50,384 (57,470) (19,151,758)
Segment assets...................... 95,473,367 5,839,235 1,087,976 (36,168,098) 66,232,480
YEAR ENDED DECEMBER 31, 1996
Revenue............................. 11,734,277 1,086,056 856,618 (326,279) 13,350,672
Interest expense.................... 235,732 6,605 - - 242,337
Depreciation and amortization
expense.......................... 2,428,735 15,394 34,951 - 2,479,080
Segment income (loss)............... (10,230,716) (65,588) 151,201 (54,227) (10,199,330)
Revenue from major customer......... 1,297,835 - - - 1,297,835
</TABLE>
* "Other" includes overhead expenses primarily in the area of S,G&A relating to
executive management, information services, public reporting and other similar
expenses.
44
<PAGE> 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH AUDITORS
Not applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the directors of the Company will be set forth
under the captions "Proposal 1 - Election of Directors--Information Regarding
Nominees and Continuing Directors in the Proxy Statement for the 1999 Annual
Meeting of Stockholders (the "1999 Proxy Statement"). Such information is
incorporated herein by reference. Information relating to the executive officers
of the Company will be set forth under the caption "Executive Officers of the
Registrant" in the 1999 Proxy Statement. Such information is incorporated herein
by reference. Information regarding compliance with Section 16(a) of the
Securities Exchange Act of 1934, as amended, by directors and executive officers
of the Company and beneficial owners of more than 10% of the Company's Common
Stock will be set forth under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the 1999 Proxy Statement. Such information is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
The following financial statements of the Company and Reports of
Independent Auditors are filed as part of this Report pursuant to
Item 8.
Report of Independent Auditors
Consolidated Balance Sheets as of December 31, 1997 and 1998
Consolidated Statements of Operations for the years ended
December 31, 1996, 1997 and 1998 Consolidated Statements of
Changes in Stockholders' Equity for the years ended
December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1997 and 1998 Notes to Consolidated Financial
Statements
2. Financial Statement Schedules.
The following financial statement schedule of the Company and
Report of Independent Auditors is filed as a part of this Report
pursuant to Item 8:
Schedule II - Valuation and qualifying accounts
Report of Independent Auditors
All other schedules have been omitted since the required
information is not present or is not present in amounts
sufficient to require submission of the schedules, or because the
information required is included in the consolidated financial
statements, including the notes thereto.
45
<PAGE> 46
3. Index to Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
3.1 Articles of Incorporation of the Company, (incorporated by reference
to Exhibit 3.1 to the Current Report on Form 8-K, no. 0-27658, filed
on June 30, 1997)
3.2 Articles of Amendment to Articles of Incorporation of the Company
(creating Class B Senior Redeemable Preferred Stock) (incorporated
by reference to Exhibit C of Exhibit 10.35 below)
3.3 Bylaws of the Company, as amended (incorporated by reference to
Exhibit 3.2 to the Quarterly Current Report on Form 8-K, No.
0-27658, filed on June 30, 1997)
4.1 Reference is hereby made to Exhibits 3.1 and 3.2 and 3.3
10.1 Preferred Networks, Inc. 1994 Stock Option Plan (incorporated by
reference to Exhibit 10.1 to the Registration Statement filed on
Form S-1, No. 33-80507)
10.2* Preferred Networks, Inc. 1992 Stock Option Plan (incorporated by
reference to Exhibit 10.2 to the Registration Statement filed on
Form S-1, No. 33-80507)
10.3 (1) * Preferred Networks, Inc. 1995 Stock Option Plan, as amended
(incorporated by reference to Exhibit B to the Company's definitive
Proxy Statement on Form 14A filed on April 22, 1997)
10.3 (2) * Preferred Networks, Inc. 1995 Stock Option Plan, as amended
(incorporated by reference to Exhibit A to the Company's definitive
Proxy Statement on Form 14A filed on April 29, 1998)
10.4* Preferred Networks, Inc. 1995 Employee Stock Purchase Plan
(incorporated by reference to Exhibit 10.4 to the Registration
Statement filed on Form S-1, No. 33-80507)
10.5* Preferred Networks, Inc. 1995 Non-Employee Directors' Restricted
Stock Award Plan (incorporated by reference to Exhibit 10.5 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.6 Purchase Agreement dated June 21, 1995, among the Company, Fleet
Equity Partners VI, L.P., Fleet Venture Resources, Inc., Chisholm
Partners II, L.P., Centennial Fund IV, L.P., Saugatuck Capital
Company Limited Partnership III, Primus Capital Fund III Limited
Partnership, PNC Capital Corp. and certain of the Company's
stockholders (incorporated by reference to Exhibit 10.6 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.7 Stockholders Agreement dated June 21, 1995, among the Company, Fleet
Equity Partners VI, L.P., Fleet Venture Resources, Inc., Chisholm
Partners II, L.P., Centennial Fund IV, L.P., Saugatuck Capital
Company Limited Partnership III, Primus Capital Fund III Limited
Partnership, PNC Capital Corp. and certain of the Company's
stockholders (incorporated by reference to Exhibit 10.7 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.8 Registration Rights Agreement dated June 21, 1995 among the Company,
Fleet Equity Partners VI, L.P., Fleet Venture Resources, Inc.,
Chisholm Partners II, L.P., Centennial Fund IV, L.P., Saugatuck
Capital Company Limited Partnership III, Primus Capital Fund III
Limited Partnership, PNC Capital Corp. and certain of the Company's
stockholders (incorporated by reference to Exhibit 10.8 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.9 Warrant to Purchase Common Stock dated June 22, 1995 issued to Legg
Mason Wood Walker, Incorporated (incorporated by reference to
Exhibit 10.9 to the Registration Statement filed on Form S-1, No.
33-80507)
10.10 Promissory Note and Credit Agreement dated April 1, 1995, between
the Company and Glenayre Electronics, Inc. as amended (incorporated
by reference to Exhibit 10.10 to the Registration Statement filed on
Form S-1, No. 33-80507)
10.11 Credit Agreement and Promissory Note, each dated June 16, 1995,
between the Company and Motorola, Inc. (incorporated by reference to
Exhibit 10.11 to the Registration Statement filed on Form S-1, No.
33-80507)
10.12 Sublease Agreement, dated May 8, 1995, between the Company and The
Carter Group for office space in Oakbrook Research Center, Norcross,
Georgia (incorporated by reference to Exhibit 10.12 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.13 Lease Agreement and Addendum, dated October 14, 1992, between the
Company and Connecticut Mutual Life Insurance Company for office
space at Goshen Springs Road, Norcross, Georgia, as amended
(incorporated by reference to Exhibit 10.13 to the Registration
Statement filed on Form S-1, No. 33-80507)
</TABLE>
46
<PAGE> 47
<TABLE>
<S> <C>
10.14* Management Employment Agreement, dated July 8, 1995, between the
Company and Mark H. Dunaway (incorporated by reference to Exhibit
10.14 to the Registration Statement filed on Form S-1, No. 33-80507)
10.15* Management Employment Agreement, dated July 7, 1995, between the
Company and Michael J. Saner (incorporated by reference to Exhibit
10.15 to the Registration Statement filed on Form S-1, No. 33-80507)
10.16* Management Employment Agreement, dated August 16, 1995, between the
Company and Eugene H. Kreeft (incorporated by reference to Exhibit
10.16 to the Registration Statement filed on Form S-1, No. 33-80507)
10.17 Amendment No. 1, dated as of December 12, 1995, to Purchase
Agreement dated June 21, 1995 among the Company, Fleet Equity
Partners VI, L.P., Fleet Venture Resources, Inc., Chisholm Partners
II, L.P., Centennial Fund IV, L.P., Saugatuck Capital Company
Limited Partnership III, Primus Capital Fund III Limited
Partnership, PNC Capital Corp. and certain of the Company's
stockholders (incorporated by reference to Exhibit 10.17 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.18 Amendment No. 1, dated as of December 12, 1995, to Stockholders
Agreement dated June 21, 1995 among the Company, Fleet Equity
Partners VI, L.P., Fleet Venture Resources, Inc., Chisholm Partners
II, L.P., Centennial Fund IV, L.P., Saugatuck Capital Company
Limited Partnership III, Primus Capital Fund III Limited
Partnership, PNC Capital Corp. and certain of the Company's
stockholders (incorporated by reference to Exhibit 10.18 to the
Registration Statement filed on Form S-1, No. 33-80507)
10.19 Lease Agreement, dated August 4, 1993, between Alamac Limited
Partnership and the Company, as amended (incorporated by reference
to Exhibit 10.19 to the Registration Statement filed on Form S-1,
No. 33-80507)
10.20 Sub-Lease Agreement, dated as of December 18, 1995 between PSB
Building Corp. and the Company (incorporated by reference to Exhibit
10.20 to the Registration Statement filed on Form S-1, No. 33-80507)
10.21 Commercial Lease Contract, dated December 6, 1995, between Lantrac
Investments, LLC and the Company (incorporated by reference to
Exhibit 10.21 to the Registration Statement filed on Form S-1 No.
33-80507)
10.22 Promissory Note and Credit Agreement, dated January 26, 1996,
between the Company and Glenayre Electronics, Inc. (incorporated by
reference to Exhibit 10.22 to the Registration Statement filed on
Form S-1, No. 33-80507)
10.23 Letter Confirming Line of Credit with Associates Capital Services
Corporation (incorporated by reference to Exhibit 10 to the
Quarterly Report filed on Form 10-Q, No. 0-27658, for the quarter
ended March 31, 1996)
10.24 Agreement and Plan of Merger, dated July 3, 1996, by and among
Paging Services, Inc., Preferred Networks, Inc., and the
shareholders of Paging Services, Inc. (incorporated by reference to
Exhibit 10.1 to the Quarterly Report filed on Form 10-Q, No.
0-27658, for the quarter ended June 30, 1996)
10.25 Credit Agreement dated August 8, 1996, by and among Preferred
Networks, Inc., PNI Systems, LLC, and NationsBank, N. A. (South)
(incorporated by reference to Exhibit 10.2 to the Quarterly Report
filed on Form 10-Q, No. 0-27658, for the quarter ended June 30,
1996)
10.26 Asset Purchase Agreement, dated as of June 19, 1996 and amended as
of September 5, 1996 and as of September 13, 1996, by and among Big
Apple Paging Corporation, Preferred Networks, Inc. and Gary Hencken
(incorporated by reference to the exhibit to the Current Report
filed on Form 8-K, No. 0-27658, dated September 27, 1996)
10.27 Stock Purchase Agreement by and among Preferred Networks, Inc.,
Mercury Paging & Communications, Inc., HTB Communication, Inc.,
Custom Page, Inc., and M.P.C. Distributors Inc. (collectively,
"Sellers") and the Shareholders of Sellers dated September 30, 1996
(incorporated by reference to Exhibit 10.3 to the Quarterly Report
filed on Form 10-Q, No. 0-27658, for the quarter ended September 30,
1996)
10.28 Agreement and Plan of Merger by and among Preferred Networks, Inc.,
EPS Acquisition Corp., EPS Wireless, Inc. and the Shareholders of
EPS Wireless, Inc. (incorporated by reference to Exhibit 2.1 to the
Current Report on Form 8-K, No. 0-27658, filed December 17, 1996).
10.29 First Amendment to Credit Agreement dated as of December 20, 1996,
by and among Preferred Networks, Inc., PNI Systems, LLC, and
NationsBank, N.A. (South) (incorporated by reference to Exhibit
10.29 to the
</TABLE>
47
<PAGE> 48
<TABLE>
<S> <C>
Annual Report on Form 10-K, No. 0-276548, filed on April 15, 1997)
10.30 Second Amendment to Credit Agreement dated as of March 12, 1997, by
and among Preferred Networks, Inc., PNI Systems, LLC, and
NationsBank, N.A. (South) (incorporated by reference to Exhibit
10.30 to the Annual Report on Form 10-K, No. 0-276548, filed on
April 15, 1997)
10.31 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 (incorporated by
reference to Exhibit 10.31 to the Annual Report on Form 10-K, No.
0-276548, filed on April 15, 1997)
10.32 Third Amendment to Credit Agreement dated as of April 11, 1997, by
and among Preferred Networks, Inc., PNI Systems, LLC, and
NationsBank, N.A. (South) (incorporated by reference to Exhibit
10.31 to the Annual Report on Form 10-K, No. 0-276548, filed on
April 15, 1997)
10.33 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 (incorporated by reference to Exhibit A to the Company's
definitive Proxy Statement on Schedule 14A, filed May 22, 1997).
10.34 Agreement and Plan of Merger, dated May 21, 1997, by and between
Preferred Networks, Inc. and PNI Merger Corp. (incorporated by
reference to Exhibit B to the Company's definitive Proxy Statement
on Schedule 14A, filed on May 22, 1997).
10.35 Class B Senior Redeemable Stock Purchase Agreement dated as of March
17, 1998, by and among the Company, Alta Communications VI, L.P.,
Alta Comm S By S, LLC, Centennial Fund IV, L.P., PNC Capital Corp.,
Saugatuck Capital Company Limited Partnership III, Primus Capital
Fund III Limited Partnership, Fleet Equity Partners VI, L.P., Fleet
Venture Resources, Inc., T/W Alfred W. Putnam GST Exempt, Anne L.
Putnam, Edward B. Putnam, Custodian for Fitzgerald B. Putnam Under
the Uniform Transfers to Minor Act, Pennsylvania, Webbmont Holdings
L.P., Spotted Dog Farm, L.P., RTM, Inc., Mark H. and Marcia M.
Dunaway, and John J. and Sylvia Hurley (incorporated by reference to
the Company's Annual Report on Form 10-K for the 1997 fiscal year,
filed on March 30, 1998).
10.36 Fourth Amendment to Credit Agreement dated as of March 19, 1998, by
and among the Company, PNI Systems, LLC, and NATIONSBANK, N.A., as
successor to NationsBank, N.A. (South) (incorporated by reference
the Company's Annual Report on Form 10-K for the 1997 fiscal year,
filed on March 30, 1998).
10.37 Amendment to Registration Rights Agreement dated as of June 16, 1997
(incorporated by reference to Exhibit E of Exhibit A to the
Company's definitive Proxy Statement on Schedule 14A, filed on May
22, 1997).
10.38 Second Amendment to Registration Rights Agreement dated as of March
17, 1998 (incorporated by reference the Company's Annual Report on
Form 10-K for the 1997 fiscal year, filed on March 30, 1997).
10.39 Fifth Amendment to Credit Agreement and waiver dated as of November
12, 1998, by and among the Company, PNI systems, LLC, and
NATIONSBANK, N.A., as successor to NationsBank, N.A. (South)
(incorporated by reference to the Quarterly Report filed on Form
10-Q, No. 0-27658, for the quarter ended September 30, 1998).
21 Subsidiaries of the Company
23 Consent of Ernst & Young LLP
27 Financial Data Schedule
</TABLE>
* Indicates management contract or compensation plan or arrangement.
(b) Reports on Form 8-K.
The registrant did not file any reports on Form 8-K during the three
months ended December 31, 1997.
48
<PAGE> 49
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 1996, 1997 AND 1998
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO
BEGINNING COSTS AND BALANCE AT
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS (1) END OF PERIOD
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998:
Reserve and allowance deducted from
asset accounts
Allowance for doubtful accounts $ 661,300 $ 736,369 $ 638,717 $ 758,952
Valuation allowance for deferred taxes 14,027,641 5,990,069 - 20,017,710
YEAR ENDED DECEMBER 31, 1997:
Reserve and allowance deducted from
asset accounts
Allowance for doubtful accounts 254,990 805,022 398,712 661,300
Valuation allowance for deferred taxes 5,949,032 8,078,609 - 14,027,641
YEAR ENDED DECEMBER 31, 1996:
Reserve and allowance deducted from
asset accounts
Allowance for doubtful accounts 86,426 393,063 (224,499) 254,990
Valuation allowance for deferred taxes 2,027,792 3,921,240 - 5,949,032
</TABLE>
(1) Uncollectible accounts written off, net of recoveries
49
<PAGE> 50
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Preferred Networks, Inc.
We have audited the consolidated financial statements of Preferred Networks,
Inc. as of December 31, 1997 and 1998, and for each of the three years in the
period ended December 31, 1998, and have issued our report thereon dated April
15, 1999. Our audits also included the financial statement schedule listed in
Item 14 (b) of this Annual Report on Form 10-K. This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Atlanta, Georgia
April 15, 1999
50
<PAGE> 51
Pursuant to the requirements of Section 13 or 15(d) 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: April 15, 1999 By: /s/ Mark H. Dunaway
--------------------------------------
Mark H. Dunaway
Chief Executive Officer (Principal
Executive Officer)
Date: April 15, 1999 By: /s/ Kathryn Loev Putnam
--------------------------------------
Kathryn Loev Putnam
Senior Vice President
and Chief Financial Officer (Principal
Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
Date: April 15, 1999 By: /s/ Mark H. Dunaway
------------------------------------
Mark H. Dunaway
Chairman of the Board of Directors,
Chief Executive Officer and Director
Date: April 15, 1999 By: /s/ William H. Bang
------------------------------------
William H. Bang
Director
Date: April 15, 1999 By: /s/ Richard P. Campbell
------------------------------------
Richard P. Campbell
Director
Date: April 15, 1999 By /s/ John J. Hurley
------------------------------------
John J. Hurley
Director
Date: April 15, 1999 By: /s/ Jeffrey H. Schutz
------------------------------------
Jeffrey H. Schutz
Director
Date: April 15, 1999 By: /s/ Robert Van Degna
------------------------------------
Robert Van Degna
Director
Date: April 15, 1999 By: /s/ Ronald W. White
------------------------------------
Ronald W. White
Director
Date: April 15, 1999 By: /s/ Robert F. Benbow
------------------------------------
Robert F. Benbow
Director
51
<PAGE> 1
PREFERRED NETWORKS, INC.
EXHIBIT 21
SUBSIDIARIES
PNI Systems, LLC
PNI Spectrum, LLC
EPS Wireless, Inc.
Preferred Technical Services, Inc.
PNI Georgia, Inc.
ECC Acquisition Corporation
Mercury Paging & Communications, Inc.
HTB Communications Inc.
M.P.C. Distributors Inc.
Custom Page, Inc.
52
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 333-3962, Form S-8 No. 333-3824, Form S-8 No. 333-3826 and Form
S-8 No. 333-33879) of Preferred Networks, Inc. and in the related Prospectuses
of our reports dated April 15, 1999 with respect to the consolidated financial
statements and schedule of Preferred Networks, Inc. included in the Annual
Report (Form 10-K) for the year ended December 31, 1998.
/s/ ERNST & YOUNG LLP
Atlanta, Georgia
April 15, 1999
53
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 6,702,178
<SECURITIES> 0
<RECEIVABLES> 5,365,414
<ALLOWANCES> (758,952)
<INVENTORY> 2,928,217
<CURRENT-ASSETS> 14,658,768
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23,968,002
0
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<EPS-PRIMARY> (1.12)
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</TABLE>
