SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to _________
Commission file number: 000-26103
---------------------------------------------------------
CAIS INTERNET, INC.
(Exact name of registrant as specified in its charter)
---------------------------------------------------------
Delaware 52-2066769
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Idenfication No.)
1255 22nd Street, N.W., Fourth Floor, Washington, D.C. 20037
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (202) 715-1300
Former name, former address, and former
year, if changed since last report: Not applicable
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of outstanding shares of each of the registrant's
classes of Common Stock, as of the latest practicable date.
Title of each class
- -------------------
Common Stock, $.01 par value
23,110,174 shares outstanding on August 1, 2000
CAIS INTERNET, INC.
FORM 10-Q
For the Quarterly Period Ended June 30, 2000
INDEX
Page
PART I - FINANCIAL INFORMATION Number
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets as of June 30, 2000 and
December 31, 1999. 4
Consolidated Condensed Statements of Operations for the Three
and Six Months Ended June 30, 2000 and 1999. 5
Consolidated Condensed Statement of Changes in Stockholders'
Equity for the Six Months Ended June 30, 2000. 6
Consolidated Condensed Statements of Cash Flows for the Six
Months Ended June 30, 2000 and 1999. 7
Notes to Consolidated Condensed Financial Statements. 8
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. 24
Item 2. Changes in Securities and Use of Proceeds. 24
Item 6. Exhibits and Reports on Form 8-K. 24
Signatures 25
2
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects" and similar
expressions are intended to identify forward-looking statements. The important
factors discussed below under the caption "Risks and Other Important Factors,"
among others, and in the Company's 1999 Annual Report on Form 10-K and the
Company's Prospectus dated May 20, 1999, could cause actual results to differ
materially from those indicated by forward-looking statements made herein and
presented elsewhere by management from time to time. Such forward-looking
statements represent management's current expectations and are inherently
uncertain. Investors are warned that actual results may differ from management's
expectations.
This Quarterly Report on Form 10-Q contains trademarks of the Company and
its affiliates, and may contain trademarks, trade names and service marks of
other parties. References to "CAIS" or the "Registrant" are to CAIS Internet,
Inc. and its subsidiaries.
3
CAIS INTERNET, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(in thousands, except share and per share amounts)
June 30, 2000 December 31, 1999
-------------- -----------------
(Unaudited)
Current assets
Cash and cash equivalents $ 25,766 $ 17,120
Short-term investments 9,758 16,501
Accounts receivable, net of allowance for doubtful
accounts of $899 and $249, respectively 7,484 3,090
Prepaid expenses and other current assets 7,437 2,571
--------- --------
Total current assets 50,445 39,282
Property and equipment, net 157,740 90,476
Deferred debt financing costs, net 1,230 1,499
Intangible assets and goodwill, net 53,105 51,059
Receivable from officers 450 450
Other assets 6,232 4,185
--------- --------
Total assets $ 269,202 $186,951
========= ========
Current liabilities
Accounts payable and accrued expenses $ 67,926 $ 53,779
Current portion of long-term debt 12,231 2,680
Obligations under capital lease 44 312
Unearned revenues 1,870 846
--------- --------
Total current liabilities 82,071 57,617
Long-term debt, net of current portion 15,078 -
Other long-term liabilities 668 718
--------- --------
Total liabilities 97,817 58,335
--------- --------
Series C cumulative mandatory redeemable convertible
preferred stock; $0.01 par value; 125,000 shares
authorized, issued and outstanding as of June 30, 2000
and December 31, 1999 (aggregate liquidation preference
of $15,372 and $15,319, respectively) 15,000 15,319
--------- --------
Series D cumulative mandatory redeemable convertible
preferred stock; $0.01 par value; 9,620,393 shares
authorized; 7,159,566 shares issued and outstanding as
of June 30, 2000 (aggregate liquidation preference
of $101,846) 101,846 -
--------- --------
Series G cumulative mandatory redeemable convertible
preferred stock; $0.01 par value; 28,051 shares
authorized; 20,000 shares issued and outstanding
as of June 30, 2000 (aggregate liquidation preference
of $20,017) 20,017 -
--------- --------
Put warrants 1,267 1,267
--------- --------
Commitments and contingencies
Stockholders' equity
Common stock, $0.01 par value; 100,000,000 shares
authorized; 23,717,780 and 22,608,331 shares issued,
and 23,105,014 and 22,595,565 shares outstanding,
respectively 237 226
Additional paid-in capital 222,056 188,569
Warrants outstanding 51,386 13,234
Deferred compensation (1,844) (2,673)
Treasury stock, 612,766 and 12,766 shares of
common stock, respectively (16,838) (150)
Accumulated deficit (221,742) (87,176)
--------- --------
Total stockholders' equity 33,255 112,030
--------- --------
Total liabilities and stockholders' equity $ 269,202 $186,951
========= ========
The accompanying notes are an integral part of these consolidated condensed
balance sheets.
4
CAIS INTERNET, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended Six months ended
June 30, June 30,
2000 1999 2000 1999
-------- ------- --------- --------
Net revenues
Services $ 5,637 $ 1,691 $ 9,722 $ 3,294
Software 1,310 - 2,991 -
Equipment 1,703 120 2,804 126
-------- ------- --------- --------
Total net revenues 8,650 1,811 15,517 3,420
-------- ------- --------- --------
Cost of revenues
Services 6,680 1,435 11,686 2,483
Software - - - -
Equipment 920 83 1,926 85
-------- ------- --------- --------
Total cost of revenues 7,600 1,518 13,612 2,568
-------- ------- --------- --------
Operating expenses:
Selling, general and administrative 21,577 5,633 40,063 9,380
Research and development 1,364 56 2,549 100
Depreciation and amortization 8,531 397 14,283 747
Non-cash compensation 410 2,729 829 3,121
Treasury stock premium and stock charge (Note 5) 10,348 - 10,348 -
Fair value of stock issued to third party for services - 723 - 723
-------- ------- --------- --------
Total operating expenses 42,230 9,538 68,072 14,071
-------- ------- --------- --------
Loss from operations (41,180) (9,245) (66,167) (13,219)
Interest income (expense), net:
Interest income 786 540 1,441 540
Interest expense (902) (455) (1,219) (1,132)
-------- ------- --------- --------
Total interest income (expense), net (116) 85 222 (592)
-------- ------- --------- --------
Loss from continuing operations (41,296) (9,160) (65,945) (13,811)
Loss from discontinued operations - - - (340)
-------- ------- --------- --------
Loss before extraordinary item (41,296) (9,160) (65,945) (14,151)
Extraordinary item -- early extinguishment of debt - (551) - (551)
-------- ------- --------- --------
Net loss (41,296) (9,711) (65,945) (14,702)
Dividends and accretion on preferred stock (9,773) (179) (68,621) (351)
-------- ------- --------- --------
Net loss attributable to common stockholders $(51,069) $(9,890) $(134,566) $(15,053)
======== ======= ========= ========
Basic and diluted loss per share:
Loss attributable to common stockholders before
discontinued operations and extraordinary item $ (2.22) $ (0.65) $ (5.86) $ (1.16)
Discontinued operations - - - (0.03)
Extraordinary item - (0.04) - (0.05)
-------- ------- --------- --------
Total $ (2.22) $ (0.69) $ (5.86) $ (1.24)
======== ======= ========= ========
Basic and diluted weighted-average shares outstanding 23,036 14,307 22,977 12,139
======== ======= ========= ========
The accompanying notes are an integral part of these consolidated condensed
statements.
CAIS INTERNET, INC.
CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY
(in thousands)
(unaudited)
Redeemable Convertible Preferred Stock
-------------------------------------------------------------------
Series C Series D Series G
------------------ ------------------- ------------------- Put
Shares Amount Shares Amount Shares Amount Warrants
------ -------- ------ --------- ------ --------- --------
December 31, 1999 125 $15,319 - $ - - $ - $1,267
Issuance of Series D and Series G
Preferred Stock, net of offering
costs of $8,760, fair value of
beneficial conversion feature
of $21,212 and value of warrants to
purchase Series E Preferred Stock
of $36,143 - - 7,143 35,106 20 18,779 -
Accretion of preferred
stock discount - - - 64,894 - 1,221 -
Accrued and cash dividends on
preferred shares - (319) - 1,612 - 17 -
Issuance of preferred stock
dividends - - 17 234 - - -
Issuance of warrants to
third party - - - - - - -
Amortization of unearned
compensation - - - - - - -
Issuance of common stock for
acquisition - - - - - - -
Issuance of common stock for additional
consideration for acquisition and
extinguishment of registration rights
of Atcom shareholders (Note 5) - - - - - - -
Accrued contingent consideration
for acquisition - - - - - - -
Treasury stock, net of $1,312 premium - - - - - - -
Exercise of stock options - - - - - - -
Net loss - - - - - - -
------ -------- ------ ---------- ------ --------- --------
June 30, 2000 125 $15,000 7,160 $101,846 20 $20,017 $1,267
====== ======== ====== ========== ====== ========= ========
(continued)
Stockholders' Equity
--------------------------------------------------------------------------------------------
Common Stock Additional
----------------- Paid-In Warrants Deferred Treasury Accumulated
Shares Par Capital Outstanding Compensation Stock Deficit Total
-------- ------ ---------- ----------- ------------ -------- ----------- --------
December 31, 1999 22,608 $226 $188,569 $13,234 $(2,673) $(150) $ (87,176) $112,030
Issuance of Series D and Series G
Preferred Stock, net of offering
costs of $8,760, fair value of
beneficial conversion feature
of $21,212 and value of
warrants to purchase Series E
Preferred Stock of $36,143 - - 21,212 36,143 - - - 57,355
Accretion of preferred
stock discount - - - - - - (66,115) (66,115)
Accrued and cash dividends on
preferred shares - - - - - - (2,272) (2,272)
Issuance of preferred
stock dividends - - - - - - (234) (234)
Issuance of warrants to
third party - - - 2,009 - - - 2,009
Amortization of unearned
compensation - - - - 829 - - 829
Issuance of common stock for
acquisition 40 1 954 - - - - 955
Issuance of common stock for
additional consideration
for acquisition and
extinguishment of registration
rights of Atcom shareholders
(Note 5) 381 4 9,335 - - - - 9,339
Accrued contingent consideration
for acquisition - - 1,000 - - - - 1,000
Treasury stock, net of
$1,312 premium - - - - - (16,688) - (16,688)
Exercise of stock options 689 6 986 - - - - 992
Net loss - - - - - - (65,945) (65,945)
-------- ------ ---------- ---------- ------------ --------- ----------- --------
June 30, 2000 23,718 $237 $222,056 $51,386 $(1,844) $(16,838) $(221,742) $ 33,255
======== ====== ========== ========== ============ ========= =========== ========
(concluded)
The accompanying notes are an integral part of these consolidated condensed
statements.
6
CAIS INTERNET, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
June 30,
2000 1999
--------- --------
Cash flows from operating activities:
Net loss $(65,945) $(14,702)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash compensation pursuant to stock options 829 3,121
Amortization of debt discount and deferred
financing costs 214 778
Treasury stock premium and stock charge (Note 5) 8,953 -
Extraordinary item - early extinguishment of debt - 551
Fair value of shares issued to third party for services - 723
Depreciation and amortization 14,283 747
Depreciation and amortization of discontinued
operations - 58
Changes in operating assets and liabilities,
net of effect of acquisitions:
Accounts receivable, net (4,394) (485)
Prepaid expenses and other current assets (3,425) (1,315)
Other assets (1,359) -
Accounts payable and accrued expenses 11,887 3,166
Payable to discontinued operations - (3,892)
Unearned revenues 1,024 47
Other long-term liabilities (50) 694
Changes in operating assets and liabilities
of discontinued operations - (73)
-------- --------
Net cash used in operating activities (37,983) (10,582)
-------- --------
Cash flows from investing activities:
Net purchases of property and equipment (70,784) (5,191)
Purchases of property and equipment of
discontinued operations - (14)
Purchases of restricted investments (3,294) -
Sales of short-term investments 6,743 -
Cash paid for acquisitions (1,213) -
Payment for visitor-based and multi-family
network contract rights (4,131) (146)
Net (payments) received on notes receivable 50 (332)
-------- --------
Net cash used in investing activities (72,629) (5,683)
-------- --------
Cash flows from financing activities:
Net borrowings under receivables-
based credit facility of discontinued operations - 313
Repayments under loan - (7,000)
Borrowings under long-term debt 24,629 -
Borrowings under notes payable--related parties - 1,000
Principal payments under capital lease obligations (268) (11)
Payment of loan commitment, debt financing, and
offering costs (61) (210)
Net proceeds from issuance of Series A preferred stock - 11,365
Redemption of Series B Preferred Stock - (3,104)
Net proceeds from initial public offering - 118,233
Net proceeds from issuance of Series D preferred stock 92,461 -
Payment of Series C preferred stock dividends (588) -
Net proceeds from issuance of Series G preferred stock 18,779 -
Repurchase of common stock (16,688) -
Proceeds from issuance of common stock 994 -
-------- --------
Net cash provided by financing activities 119,258 120,586
-------- --------
Net increase in cash and cash equivalents 8,646 104,321
Cash and cash equivalents, beginning of period 17,120 95
-------- --------
Cash and cash equivalents, end of period $ 25,766 $104,416
======== ========
The accompanying notes are an integral part of these consolidated condensed
statements.
7
CAIS INTERNET, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
June 30, 2000
(unaudited)
1. Business Description:
Overview
CAIS Internet, Inc. (the "Company") is a nationwide provider of broadband
Internet access solutions. The Company operates two business segments: the
visitor-based and multi-family networks segment provides high-speed Internet
access and content solutions for hotels, apartment communities and other
public areas using its patented OverVoice solution and IPORT server software;
and the Internet services segment provides high-speed Internet access and
content solutions for businesses and consumers, including digital subscriber
line ("DSL") services using HyperDSL lines, always-on access solutions for
ISPs and businesses, and web hosting and other Internet services. The Company's
headquarters are in Washington, D.C.
Organization
CAIS Internet, Inc. was incorporated under the name CGX Communications, Inc.
("CGX") as a "C" corporation in Delaware in December 1997 to serve as a
holding company for two operating entities, CAIS, Inc., a Virginia "S"
Corporation, and Cleartel Communications Limited Partnership ("Cleartel"), a
District of Columbia limited partnership. The Company completed a
reorganization in October 1998 such that CAIS and Cleartel became wholly owned
subsidiaries of the Company. In February 1999, the Company spun-off Cleartel
to the Company's stockholders and changed its name from CGX Communications,
Inc. In May 1999, the Company became a public company through the completion of
an intitial public offering ("IPO") of its common stock.
Risks and Other Important Factors
The Company has devoted substantial resources to the buildout of its networks
and the expansion of its marketing programs. As a result, the Company has
historically experienced operating losses and negative cash flows. These
operating losses and negative cash flows are expected to continue for additional
periods in the future. There can be no assurance that the Company will become
profitable or generate positive cash flows.
As of June 30, 2000, the Company had cash and cash equivalents and short-term
investments of approximately $35.5 million. During the six months ended June 30,
2000, the Company issued $100 million of Series D convertible preferred stock
for net proceeds of $92.5 million, and $20 million of Series G convertible
preferred stock for net proceeds of $18.8 million (See Note 4). Additionally, in
August 2000, the Company issued $40 million of Series F convertible preferred
stock (see Note 8). The Company may be obligated to pay up to approximately
$2.5 million in closing fees for the Series F convertible preferred stock
transaction. The Company expects to seek additional financing to meet its
planned capital expenditures over the next twelve months. If such sources of
financing are insufficient or unavailable, or if the Company experiences
shortfalls in anticipated revenues or increases in anticipated expenses, the
Company would curtail the planned roll-out of its services and reduce marketing
and development activities.
The Company is subject to various risks in connection with the operation of
its business. These risks include, but are not limited to, regulations,
dependence on effective billing and information systems, intense competition
and rapid technological change. The Company's future plans are substantially
dependent on the successful roll-out of its visitor-based and multi-family
networks. Net revenues generated from visitor-based and multi-family networks
were approximately $4,544,000 and $8,609,000 for the three and six months ended
June 30, 2000, respectively. There can be no assurance that the Company will be
successful in its roll-out of services nor can there be any assurance that the
Company will be successful in defending its related patent rights. Many of the
Company's competitors are significantly larger and have substantially greater
financial, technical, and marketing resources than the Company.
8
2. Summary of Significant Accounting Policies:
Basis of Presentation
The accompanying unaudited consolidated condensed financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Operating results for the three and six months ended June 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on Form
10-K.
Consolidated Financial Statements
The consolidated condensed financial statements include the results of the
Company and its wholly-owned subsidiaries. These results include CAIS, Inc. for
all periods presented, CAIS Software Solutions Inc. ("CAISSoft") formerly known
as Atcom, Inc. ("Atcom") and Business Anywhere USA, Inc. ("Business Anywhere")
from their respective acquistion dates in September 1999.
In February 1999, the Company spun-off its operator and long-distance services
subsidiary, Cleartel, to its stockholders as a non-cash distribution. The spin-
off has been presented as discontinued operations and, accordingly, the Company
has presented its financial statements for all periods prior to that date in
accordance with Accounting Principles Board ("APB") Opinion No. 30. All expenses
related to members of senior management who continued with the Company are
included within loss from continuing operations.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
Net Loss Per Share
Basic and diluted loss per share is based on the weighted-average number of
shares of common stock outstanding during the period. Stock options, warrants
and preferred shares are not reflected in diluted loss per share since their
effect would be antidilutive. As of June 30, 2000, there were options and
warrants to purchase approximately 12,849,000 shares of common stock, and Series
C, D and G preferred shares which, upon their conversion, would cause the
issuance of approximately 7,880,000 shares of common stock.
Comprehensive Income
Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting of
Comprehensive Income", requires "comprehensive income" and the components of
"other comprehensive income" to be reported in the financial statements and/or
notes thereto. Since the Company does not have any components of "other
comprehensive income", reported net income is the same as "comprehensive income"
9
for the three and six months ended June 30, 2000 and 1999.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards requiring every derivative
instrument to be reported on the balance sheet as either an asset or liability
measured at its fair value. It requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. SFAS No. 133 was initially proposed to be effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999, however, the
FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities -- Deferral of the Effective Date of FASB Statement No. 133," and the
effective date of this SFAS has been deferred until issuance by the FASB. The
Company has not yet determined the impact of adopting this statement on the
financial Statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. SAB 101 is
required to be adopted by June 30, 2000, with retroactive effect to January 1,
2000. The Company does not expect that adoption will have material effect on the
Company's financial position or results of operations.
Cash and Cash Equivalents and Short-Term Investments
The Company considers all short-term investments with original maturities of
90 days or less to be cash equivalents. Cash equivalents consist primarily of
commercial paper and money market accounts that are available on demand.
Short-term investments consist of investment-grade commercial paper with
original maturities greater than 90 days. The carrying amounts of cash and
cash equivalents and short-term investments in the accompanying consolidated
condensed balance sheets approximate fair value.
Excess of Cost over Net Assets Acquired (Goodwill)
Goodwill and other intangibles were recorded as a result of the acquisitions
by the Company of Capital Area Internet Service, Inc. ("Capital Area") in May
1996, Atcom and Business Anywhere in September 1999, QuickATM, LLC ("QuickATM")
and Hub Internet Services, Inc. ("Hub Internet") in March 2000. Additional
purchase consideration of $1,000,000 for the acquisition of Business Anywhere
was recorded in March 2000. Goodwill and acquired intangibles are amortized on a
straight-line basis over three years. Amortization of goodwill and intangibles
was approximately $4,158,000 and $7,976,000 for the three and six months ended
June 30, 2000, respectively. Goodwill with respect to the Capital Area
acquisition was fully amortized in May 1999.
Visitor-based and Multi-family Network Contract Rights
The Company makes up-front contract payments to its contract partners in
connection with entering into long-term master agreements for visitor-based and
multi-family networks. These payments give the Company various installation and
marketing rights to provide high-speed Internet services to customers in hotels
and apartment buildings. The net balances of these payments were approximately
$15,802,000 and $11,153,000 as of June 30, 2000 and December 31, 1999,
respectively, and is included in intangible assets and goodwill in the
accompanying consolidated condensed balance sheets. The payments are amortized
over the term of the agreements, ranging from five to seven years. Amortization
expense of these costs for the three and six months ended June 30, 2000 was
approximately $812,000 and $1,481,000, respectively.
Non-cash compensation
Non-cash compensation is recorded for stock options granted to certain
executives in 1997, 1998, and 1999 at exercise prices less than the estimated
fair market value at the dates of the grants. The non-cash compensation expense
is recorded over the vesting periods of the options and was approximately
$410,000 and $829,000 for the three and six months ended June 30, 2000.
10
3. Financing and Debt:
The Company and Nortel Networks, Inc. ("Nortel Networks") entered into a five-
year, $30 million equipment financing line of credit, dated as of June 4, 1999,
and several amendments. As of June 30, 2000, the Company had borrowed
approximately $7.2 million under this credit facility. Borrowings outstanding as
of June 30, 2000 incur interest expense at rates ranging from 10.9 to 13.3
percent. The facility requires the Company to meet certain financial covenants
including revenue targets and leverage and debt service ratios. The Company
obtained a waiver from Nortel Networks in August 2000 for violation of a certain
financial covenant and non-montetary loan agreement provisions as of June 30,
2000.
The Company and Cisco Systems Capital Corporation ("Cisco") entered into a
three-year, $50 million equipment financing line of credit, dated as of June 30,
1999, and several amendments. As of June 30, 2000, the Company had borrowed
approximately $20.1 million under this credit facility. Borrowings outstanding
as of June 30, 2000 incur interest expense at approximately 12.5 percent.
Under the facility, $50 million is available during the first two years of the
facility provided the Company meets certain financial performance requirements.
The line of credit bears interest at an annual rate equal to the three-month
LIBOR plus 6.0%. The facility requires the Company to meet certain financial
covenants including EBITDA targets, revenue targets and leverage ratios.
Borrowings under the facility are secured by a first priority lien in all assets
of the Company, other than its property securing the Nortel Networks facility,
in which assets Cisco will have a second
11
priority lien. In March 2000, the Company and Cisco amended the financial
covenants of this agreement for the remainder of the term of this facility.
Deferred debt financing costs represent direct financing costs incurred in
connection with entering into the equipment financing agreements. The Company
has recorded debt financing costs of approximately $1.5 million as of June 30,
2000 in connection with completing the Nortel Networks and Cisco lines of
credit. The deferred debt financing costs are being amortized over the terms of
the equipment financing agreements and are included in interest expense. The
amortization was approximately $183,000 and $348,000 for the three and six
months ended June 30, 2000, respectively.
4. Stockholders' Equity:
Initial Public Offering
In May 1999, the Company completed an initial public offering of its common
stock (the "IPO"). The Company sold 6,842,100 shares (including the over-
allotment option), yielding net proceeds to the Company of approximately
$118.2 million, after deducting underwriting discounts and commissions and
other fees and expenses of approximately $11.8 million. The Company used
approximately $12 million of the net proceeds in the second quarter of 1999 to
repay indebtedness and redeem shares of Series B cumulative mandatory
redeemable convertible preferred stock.
Convertible Preferred Stock and Warrants
In September 1999, the Company issued 125,000 shares of Series C Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series C Preferred
Stock") and warrants to acquire 500,000 shares of the Company's common stock at
$12.00 per share to Qwest Communications Corporation ("Qwest") for total gross
proceeds of $15,000,000, less approximately $40,000 of offering costs paid to
third parties. The holders of the Series C Preferred Stock are entitled to
receive dividends, payable quarterly in cash, at a rate of 8.5 percent per
annum.
12
In February 2000, the Company issued 5,276,622 shares of Series D Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series D Preferred
Stock") to CII Ventures LLC, an affiliate of the private investment firm
Kohlberg Kravis Roberts and Company ("KKR") for gross proceeds of $73,873,000,
less approximately $6,285,000 in offering costs. In April 2000, the Company
issued the remaining 1,866,235 shares of Series D Preferred Stock for an
additional net proceeds of $24,873,000. The Series D Preferred Stock is
convertible into common stock of the Company, with an initial conversion price
of $16.50 per share (or 6,060,606 common shares based on the $100 million
investment), subject to adjustment. The Company also issued a one-year option
for CII Ventures LLC to purchase 7,142,857 shares of Series E Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series E Preferred
Stock"). The Series E Preferred Stock is convertible into common stock of the
Company, with an initial conversion price of $20.00 per share (or 5,000,000
common shares based on a $100 million investment), subject to adjustment. The
holders of the Series D and Series E Preferred Stock are entitled to receive
dividends, payable in additional shares, at a rate of 6 percent per annum
compounded quarterly.
On the date of the stock purchase agreement, the conversion price of the
Series D preferred stock was less than the closing market price of the Company's
common stock. Accordingly, approximately $21.2 million of the proceeds were
allocated to additional paid-in capital to recognize the beneficial conversion
feature. Approximately $36.1 million of the proceeds received were allocated to
the value of the option to purchase the Series E Preferred Stock. The option has
been valued at its estimated fair value of $7.23 per share based on the Black-
Scholes valuation model. As the Series D Preferred Stock is immediately
convertible into common stock, the discount on the preferred stock (as a result
of the allocation of proceeds to the warrants and the beneficial conversion
feature) was fully accreted on the date of issuance and is reflected as a
dividend on preferred stock in the accompanying financial statements.
KKR appointed two members to the Company's Board of Directors in February
2000. KKR also has certain stock registration rights, and must consent with
respect to certain corporate actions by the Company, including share issuances
and mergers and other business combinations, subject to certain exceptions.
In June 2000, the Company issued 20,000 shares of Series G Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series G Preferred
Stock") to 3Com Corporation ("3Com") for gross proceeds of $20,000,000, less
approximately $1,221,000 in offering costs. The Series G Preferred Stock is
convertible into common stock of the Company at an initial conversion price of
$36.00 per share (or 555,556 common shares based on the $20 million investment),
subject to adjustment. The holders of the Series G Preferred Stock are entitled
to receive dividends, payable in additional shares, at a rate of 6 percent per
annum, compounded quarterly.
The Company granted a warrant to Cooper Hotel Services, Inc. to purchase
10,368 shares of common stock, in connection with the parties' agreement to
provide the Company's services to Cooper Hotel Services, Inc. properties. The
warrant has an exercise price of approximately $17.31 per share, and expires on
June 9, 2005.
5. Treasury Stock Premium and Stock Charge
Effective March 21, 2000, the Company and Atcom entered into Amendment No. 3
to the Amended and Restated Agreement and Plan of Merger. The Amendment
eliminated certain stock registration rights of the Atcom shareholders. Pursuant
to this Amendment, the Company redeemed 600,000 shares of the Company's common
stock at a redemption price of $30.00 per share in April 2000. The Company
recorded an earnings charge of approximately $1.3 million in the second quarter
for the premium paid over the fair value to acquire the shares. The shares are
held in treasury. Additionally, the Company issued approximately 381,000 shares
of common stock to the Atcom shareholders in April 2000. The Company recorded an
earnings charge of approximately $9.0 million as a result of the additional
consideration.
13
6. Commitments and Contingencies:
Litigation
The Company is not a party to any lawsuit or proceeding which, in the
opinion of its management, is likely to have a material adverse effect on its
business, financial condition or results of operation.
Network Capacity
The Company and Qwest entered into a twenty-year Indefeasible Right of Use
("IRU") agreement, dated as of September 28, 1999. The Company purchased
$44 million of capacity on Qwest's fiber network. The Qwest capacity will
support the delivery of the Company's network services to 38 metropolitan areas
across the United States. The Company also committed to purchase $10 million of
Qwest's communications services over five years.
Regulatory Matters
At the present time, Internet Service Providers ("ISPs") like the Company are
not subject to direct regulation by the Federal Communications Commission
("FCC") even though they provide Internet access through transmission over
public telephone lines. However, as the growth of the Internet industry
continues, there has been considerable discussion and debate about whether the
industry should be subjected to regulation. This regulation could include
universal service subsidies for local telephone services and enhanced
communications systems for schools, libraries and certain health care providers.
Local telephone companies could be allowed to charge ISPs for the use of their
local telephone network to originate calls, similar to charges currently
assessed on long distance telecommunications companies. In addition, many state
and local government officials have asserted the right or indicated a
willingness to impose taxes on Internet-related services and commerce, including
sales, use and excise taxes.
7. Segment Reporting
The Company has two reportable segments: visitor-based and multi-family
networks ("Networks") and Internet Services (see Note 1). Networks includes the
Company's wholly-owned subsidiaries, CAISSoft and Business Anywhere. The
accounting principles of the segments are the same as those applied in the
consolidated condensed financial statements. Since the Company's expansion and
capital expenditures are driven by current and expected growth in the Networks
segment, the revenues and costs of the Internet Services segment are being
reported on an incremental basis, without any allocations of shared network
expenses and corporate overhead. Interest is allocated based upon the respective
percentage of losses before interest of the two segments.
14
The following is a summary of information about each of the Company's
reportable segments that is used by the Company to measure the segment's
operations (in thousands, unaudited):
Three Months Ended June 30, 2000
------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 4,544 $ 4,106 $ 8,650
Depreciation and amortization 8,519 12 8,531
Interest income (expense), net (107) (9) (116)
Segment losses (38,705) (2,591) (41,296)
Segment assets 215,121 7,117 222,238
Expenditures for segment assets 43,371 - 43,371
Three Months Ended June 30, 1999
------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 130 $ 1,681 $ 1,811
Depreciation and amortization 395 2 397
Interest income (expense), net 80 5 85
Segment losses (9,122) (38) (9,160)
Segment assets 9,236 1,003 10,239
Expenditures for segment assets 4,500 - 4,500
Six Months Ended June 30, 2000
------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 8,609 $ 6,908 $ 15,517
Depreciation and amortization 14,265 18 14,283
Interest income (expense), net 190 32 222
Segment losses (60,568) (5,377) (65,945)
Segment assets 215,121 7,117 222,238
Expenditures for segment assets 73,512 - 73,512
Six Months Ended June 30, 1999
------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 142 $ 3,278 $ 3,420
Depreciation and amortization 741 6 747
Interest income (expense), net (507) (85) (592)
Segment losses (13,743) (68) (13,811)
Segment assets 9,236 1,003 10,239
Expenditures for segment assets 6,230 - 6,230
The following is a reconciliation of the reportable segments' losses and assets
to the Company's consolidated totals (in thousands, unaudited):
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
------ ------ ------ ------
Losses
Total losses for reportable segments $(41,296) $ (9,160) $(65,945) (13,811)
Income (loss) from discontinued operations - - - (340)
Extraordinary item - 551 - (551)
---------- --------- --------- --------
Consolidated net loss $(41,296) $ (9,711) $(65,945) (14,702)
========== ========= ========= ========
==========
June 30, June 30,
2000 1999
-------- -------
Assets
Total assets for reportable segments $222,238 $ 10,239
Total current assets, excluding reportable segment assets 39,796 105,959
Deferred financing and offering costs, net 1,230 1,389
Other long term assets, excluding reportable segment assets 5,488 -
Receivable from officers 450 400
-------- --------
Consolidated total assets $269,202 $117,987
======== ========
8. Subsequent Events
In May 2000, the Company and Microsoft Corporation ("Microsoft") entered into
a commercial agreement to distribute Internet content to the Company's target
markets. In connection with the commercial agreement, the Company issued 40,000
shares of Series F Preferred Stock to Microsoft in August 2000 for total gross
proceeds of $40 million. The Company may be obligated to pay up to approximately
$2.5 million in closing costs for the Microsoft investment. The Series F shares
are initially convertible into approximately 1,667,000 shares of common stock at
a conversion price of $24.00 per share. The holders of the Series F preferred
stock are entitled to receive dividends, payable in preferred shares, common
stock or cash, at a rate of 7 percent per annum. The Company also granted
Microsoft a warrant to purchase up to 600,000 shares of common stock at an
exercise price of $24.00 per share, expiring in April 2005. Microsoft could also
be eligible for an additional warrant to purchase up to 900,000 shares of common
stock at exercise prices between $45.00 and $65.00 per share, expiring in April
2005, based upon the Company's performance against certain operational
milestones.
In July 2000, the Company invested $4.2 million in Series A convertible
preferred stock ("INNCOM Series A shares") of INNCOM International, Inc.
("INNCOM"). INNCOM also granted a warrant to the Company to purchase up to an
additional 840,000 INNCOM Series A shares. Additionally, the Company and INNCOM
entered into a commercial agreement to offer integrated, high-speed Internet and
in-room automation solutions for hotel guests.
15
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Condensed Financial Statements and the Notes thereto contained
herein under Item 1.
The cautionary statements set forth below and elsewhere in this Report
identify important risks and uncertainties that could materially adversely
affect the Company's business, financial condition, results of operations or
prospects.
Overview
The Company is a nationwide provider of broadband Internet access solutions.
The Company operates two business segments: the visitor-based and multi-family
networks segment provides high-speed Internet access and content solutions for
hotels, apartment communities and other public areas using its patented
OverVoice solution and IPORT server software; and the Internet services
segment provides high-speed Internet access and content solutions for
businesses and consumers, digital subscriber line ("DSL") services using
HyperDSL lines, always-on access solutions for ISPs and businesses, and web
hosting and other Internet services. The Company operates a clear-channel
Internet and ATM network, and currently peers with public and private partners,
and at national exchange points MAE East, MAE East ATM, MAE West, and AADS. The
Company entered into an agreement with Qwest to expand the Company's network to
38 metropolitan areas across the United States.
During the years ended December 31, 1997, 1998 and 1999, the Company derived a
majority of its revenue from the sale of various Internet services, including
always-on Internet access services, web hosting and domain registration services
and, to a lesser extent, dial-up Internet access. Beginning in the third quarter
of 1999, the Company began to increase its visitor-based and multi-family
networks revenues, as it began to install its services in various hotels and
apartment communities, and acquire complementary businesses. The Company
incurred significant costs and devoted substantial resources associated with the
research, development and deployment of its visitor-based and multi-family
networks services. The costs included equipment, contract labor for surveys and
the actual property installation, and Internet bandwidth and local loop
connection charges. The Company capitalizes the costs of installations in hotels
and apartment buildings, including equipment and labor.
Through its bandwidth purchase in the Qwest IRU, the Company has made a
significant investment in its nationwide network infrastructure. The Company
requires substantial capital to fully develop and implement its business plan,
and to fund start-up losses. The Company devotes considerable resources to sales
and marketing for the sale of its services in hotels and apartment communities
and its DSL services in the commercial and residential markets. The Company
plans to continue to expand its research and development activities to develop
new products and services to be offered using its patented OverVoice and IPORT
technologies.
The Company's nationwide deployment of its services, and the expansion of
its network, will result in increased cost of revenues, selling, general and
administrative expenses and capital expenditures. The Company's ability to
generate positive cash flow from operations and achieve profitability is
dependent upon its ability to successfully expand its customer base for
visitor-based and multi-family networks and other services and achieve further
operating efficiencies. The Company might not be able to achieve or sustain
revenue growth, positive cash flow or profitability in the future.
16
Business Segments
The Company has two reportable business segments, the financial results of which
are included in the Notes in Item 1:
1. Visitor-based and Multifamily Networks. The Company delivers high-speed
Internet access and content solutions to hotels, apartment communities and
other public areas across existing telephone lines at speeds up to 175 times
faster than 56K dial-up modems. As of June 30, 2000, the Company had master
contracts to provide its services in approximately 10,400 properties and 1.5
million units/rooms.
2. Internet Services. The primary services in the Company's Internet Services
segment include business digital subscriber line (HyperLan DSL), always-on
access and web hosting:
a. HyperDSL Services: In 1999 the Company initiated its roll-out of a new
always-on, high-speed Internet access service using DSL technology under
the name HyperLan DSL. The Company partners with Covad Communications Group
17
to provide this service to small and medium-sized businesses.
b. High-Speed Always-On Access and Other Services: The Company provides
dedicated Internet access to businesses and other Internet providers,
including T-1, fractional T-1, DS-3 and fractional DS-3 services. The Company
also provides web hosting and colocation services. In addition, the Company
provides dial-up and other narrowband connectivity services which are not
marketed generally.
Statements of Operations
The Company records revenues for all services when the services are provided
to customers. Amounts for services billed in advance of the service period and
cash received in advance of revenues earned are recorded as unearned revenues
and recognized as revenue when earned. Upfront charges in connection with
service contracts are recognized ratably over the contract period. Customer
contracts for Internet access and web hosting services are typically for
periods ranging from one month to three years. Internet access services
typically require the customer to purchase equipment and pay for the related
installation fees. Revenues from equipment sales are recorded when delivery of
the related equipment is accepted by the customer. Dial-up access customers
typically subscribe to service on a monthly or annual basis.
The Company generates several types of software revenue including the
following:
1. License and Sublicense Fees. The Company's standard license agreement for
the Company's products provides for an initial fee to use the product in
perpetuity up to a maximum number of users. The Company also enters into other
license agreement types, typically with major end user customers, which allow
for the use of the Company's products, usually restricted by the number of
employees, the number of users, or the license term. Fees from licenses are
recognized as revenue upon contract execution, provided all delivery obligations
have been met, fees are fixed or determinable, and collection is probable. Fees
from licenses sold together with consulting services are generally recognized
upon delivery provided that the above criteria have been met and payment of the
license fees is not dependent upon the performance of the consulting services.
In instances where the aforementioned criteria have not been met, both the
license and consulting fees are recognized under the percentage of completion
method of contract accounting.
2. Support Agreements. Support agreements generally call for the Company to
provide technical support and software updates to customers. Revenue on
technical support and software update rights is recognized ratably over the term
of the support agreement and is included in net revenues in the accompanying
statements of operations.
Cost of revenues include recurring expenses for the long haul bandwidth
lease and local interconnection charges from national and local fiber
providers. It also includes wholesale DSL resale charges, equipment costs and
amortization of DSL install and equipment charges incurred in connection with
term contracts.
Research and development costs include internal research and development
activities and external product development agreements.
Selling, general and administrative expenses are incurred in the areas of
18
sales and marketing, customer support, network operations and maintenance,
engineering, research and development, accounting and administration. Selling,
general and administrative expenses will increase over time as the Company's
operations, including the nationwide deployment of hotel and multi-family
services and the expansion of its HyperDSL services, increase. In addition,
significant levels of marketing activity may be necessary for the Company to
build or increase its customer base among hotel guests and apartment residents
to a significant enough size in a particular building or market. Any such
increased marketing efforts may have a negative effect on earnings.
Operating results for any period are not necessarily indicative of results
for any future period. Also, the operating results for interim periods are not
necessarily indicative of the results that might be expected for the entire
year.
Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999
Net revenues. Net revenues for the three months ended June 30, 2000 increased
378% to approximately $8,650,000, from approximately $1,811,000 for the three
months ended June 30, 1999. Net revenues increased primarily due to an increase
of approximately $4,414,000 in visitor-based and multi-family networks revenue
(of which approximately $1,310,000 was for software sales and $1,583,000 was for
equipment sales), $1,839,000 in DSL revenues, $286,000 in web hosting services
revenues, and $300,000 in high speed always-on access and other services
revenues. The increases were due to an increase in the number of properties and
customers for these services.
Cost of revenues. Cost of revenues for the three months ended June 30, 2000
totaled approximately $7,600,000 or 88% of net revenues, compared to
approximately $1,518,000 or 84% of net revenues for the three months ended
June 30, 1999. This increase resulted primarily from increases of approximately
$3,073,000 in visitor-based and multi-family network charges for bandwidth,
local loop and network installation, $836,000 in charges for visitor-based and
multi-family networks equipment sales, $1,852,000 in DSL charges for customer
connectivity, equipment and installation, and $322,000 in other Internet access
costs.
Selling, general and administrative. Selling, general and administrative
expenses for the three months ended June 30, 2000 totaled approximately
$21,577,000 or 249% of net revenues, compared to approximately $5,633,000 or
311% of net revenues for the three months ended June 30, 1999. This increase
resulted primarily from increases of $11,600,000 related to visitor-based and
multi-family networks and Internet Services payroll and payroll related
administrative costs, and $4,346,000 related to marketing, advertising, and
other administrative expenses.
Research and development. Research and development for the three months
ended June 30, 2000 totaled approximately $1,364,000 or 16% of net revenues,
compared to approximately $56,000, or 3% of net revenues for the three months
ended March 31, 1999. This increase resulted from the inclusion of research and
development labor costs incurred by CAISSoft after acquisition in September 1999
and various development projects related to new hotel/multi-family services and
products.
Depreciation and amortization. Depreciation and amortization totaled
approximately $8,531,000 for the three months ended June 30, 2000, compared to
approximately $397,000 for the three months ended June 30, 1999. This increase
resulted from an increase of $3,290,000 in depreciation of capital assets to
support the expansion of the Company's network and to deploy equipment in hotels
and multi-family buildings, $929,000 related to the amortization of purchased
contract rights from visitor-based and multi-family network partners, and
$3,914,000 related to the amortization of goodwill and intangibles as a result
of acquisitions.
Non-cash compensation. Non-cash compensation totaled approximately $410,000
for the three months ended June 30, 2000, compared to approximately $2,729,000
for the three months ended June 30, 1999. This decrease resulted from the
acceleration of deferred compensation charges that occurred as a result of the
IPO in May 1999.
Treasury stock premium and stock charge. Treasury stock premium and stock
charge totaled approximately $10,348,000 for the three months ended June 30,
2000. The expense was for a premium paid on treasury stock and additional
consideration issued to Atcom shareholders in connection with the elimination of
certain stock registration rights held by such shareholders. There was no
comparable expense for the three months ended June 30, 1999.
Fair value of stock issued to third party for services. There was no
expense for the fair value of stock issued to third party for services for the
three months ended June 30, 2000. Fair value of stock issued to third party for
services totaled approximately $723,000 for the three months ended June 30,
1999.
Interest income (expense), net. Interest income (expense), net totaled
expense of approximately $116,000 for the three months ended June 30, 2000,
compared to income of approximately $85,000 for the three months ended June 30,
1999. This expense total was attributable primarily to interest expense and the
amortization of financing costs related to the Company's financing agreements.
Loss from continuing operations. Loss from continuing operations totaled
approximately $41,296,000 for the three months ended June 30, 2000, compared to
approximately $9,160,000 for the three months ended June 30, 1999, due to the
foregoing factors.
Extraordinary item - early extinguishment of debt. There was no extraordinary
item - early extinguishment of debt for the three months ended June 30, 2000.
Extraordinary item - early extinguishment of debt totaled approximately $551,000
for the three months ended June 30, 1999.
Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999
Net revenues. Net revenues for the six months ended June 30, 2000 increased
354% to approximately $15,517,000, from approximately $3,420,000 for the six
months ended June 30, 1999. Net revenues increased primarily due to an increase
of approximately $8,417,000 in visitor-based and multi-family networks revenue
(of which approximately $2,991,000 was for software sales and $2,678,000 was for
equipment sales), $3,075,000 in DSL revenues, $416,000 in web hosting services
revenues, and $189,000 in high speed always-on access and other services
revenues. The increases were due to an increase in the number of properties and
customers for these services.
Cost of revenues. Cost of revenues for the six months ended June 30, 2000
totaled approximately $13,612,000 or 88% of net revenues, compared to
approximately $2,568,000 or 75% of net revenues for the six months ended
June 30, 1999. This increase resulted primarily from increases of approximately
$5,359,000 in visitor-based and multi-family network charges for bandwidth,
local loop and network installation, $1,841,000 in charges for visitor-based and
multi-family network equipment sales, $3,337,000 in DSL charges for customer
connectivity, equipment and installation, and $509,000 in other Internet access
costs.
Selling, general and administrative. Selling, general and administrative
expenses for the six months ended June 30, 2000 totaled approximately
$40,063,000 or 258% of net revenues, compared to approximately $9,380,000 or
274% of net revenues for the six months ended June 30, 1999. This increase
resulted primarily from increases of $25,762,000 related to visitor-based and
multi-family networks and Internet Services payroll and payroll related
administrative costs, and $4,920,000 related to marketing, advertising, and
other administrative expenses.
Research and development. Research and development for the six months ended
June 30, 2000 totaled approximately $2,549,000 or 16% of net revenues, compared
to approximately $100,000, or 3% of net revenues for the six months ended June
30, 1999. This increase resulted from the inclusion of research and development
labor costs incurred by CAISSoft after acquisition in September 1999 and various
development projects related to new hotel/multi-family services and products.
Depreciation and amortization. Depreciation and amortization totaled
approximately $14,283,000 for the six months ended June 30, 2000, compared to
approximately $747,000 for the six months ended June 30, 1999. This increase
resulted from an increase of $4,099,000 in depreciation of capital assets to
support the expansion of the Company's network and to deploy equipment in
hotels and multi-family buildings, $1,439,000 related to the amortization of
purchased contract rights from visitor-based and multi-family network partners,
and $7,997,000 related to the amortization of goodwill and intangibles as a
result of acquisitions.
Non-cash compensation. Non-cash compensation totaled approximately $829,000
for the six months ended June 30, 2000, compared to approximately $3,121,000 for
the six months ended June 30, 1999. This decrease resulted from the acceleration
of deferred compensation charges that occurred as a result of the IPO in May
1999.
Treasury stock premium and stock charge. Treasury stock premium and stock
charge totaled approximately $10,348,000 for the six months ended June 30,
2000. The expense was for a premium paid on treasury stock and additional
consideration issued to Atcom shareholders in connection with the elimination of
certain stock registration rights held by such shareholders. There was no
comparable expense for the six months ended June 30, 1999.
Fair value of stock issued to third party for services. There was no
expense for the fair value of stock issued to third party for services for the
six months ended June 30, 2000. Fair value of stock issued to third party for
services totaled approximately $723,000 for the six months ended June 30, 1999.
Interest income (expense), net. Interest income (expense), net totaled
income of approximately $222,000 for the six months ended June 30, 2000,
compared to expense of approximately $592,000 for the six months ended June 30,
1999. This income total was attributable primarily to interest income earned
from the proceeds of equity offerings, offset by interest expense and the
amortization of financing costs related to the Company's financing agreements.
Loss from continuing operations. Loss from continuing operations totaled
approximately $65,945,000 for the six months ended June 30, 2000, compared to
approximately $13,811,000 for the six months ended June 30, 1999, due to the
foregoing factors.
Loss from discontinued operations. There was no income or loss from
discontinued operations for the six months ended June 30, 2000 due to the
spinoff of Cleartel in February 1999. Loss from discontinued operations of
Cleartel totaled approximately $340,000 for the six months ended June 30,
1999.
Extraordinary item - early extinguishment of debt. There was no extraordinary
item - early extinguishment of debt for the six months ended June 30, 2000.
Extraordinary item - early extinguishment of debt totaled approximately $551,000
for the six months ended June 30, 1999.
19
Liquidity and Capital Resources
Prior to the IPO, the Company financed its operations with various debt and
private equity placements. Net cash used in operating activities for the six
months ended June 30, 2000 and 1999 was approximately $37,983,000 and
$10,582,000, respectively. Cash used in operating activities in each period was
primarily affected by the net losses caused by increased costs relating to the
Company's expansion in infrastructure and personnel and sales and marketing
activities.
During the six months ended June 30, 2000 and 1999, cash flows used in
investing activities were approximately $72,629,000 and $5,683,000,
respectively. Investing activities in the six months ended June 30, 2000 include
approximately $70,784,000 in purchases of property and equipment, primarily
related to the deployment of the Company's nationwide network, and its
technologies and services in hotels, apartment communities and other public
areas. Additionally, the Company spent approximately $4,131,000 in network
contract rights. Management believes that capital expenditures for the balance
of 2000 will approximate spending in the first six months of 2000 assuming
continued availability of capital.
In May 1999, the Company completed the IPO of its common stock. The Company
sold 6,842,100 shares (including the over-allotment option) of common stock
for approximately $130 million, yielding net proceeds to the Company of
approximately $118.2 million after deducting underwriting discounts and
commissions and other fees and expenses. The Company used approximately $12
million of the net proceeds to repay indebtedness and redeem shares of Series
B cumulative mandatory redeemable convertible preferred stock.
In September 1999, the Company issued to Qwest 125,000 shares of Series C
Preferred Stock, which is initially convertible into 1,250,000 shares of
common stock for total gross proceeds of $15,000,000. It also issued warrants
to acquire 500,000 shares of the Company's common stock at an exercise price
of $12.00 per share. The holders of the Series C Preferred Stock are entitled to
receive dividends, payable quarterly in cash, at a rate of 8.5 percent per
annum.
20
In February 2000, the Company issued 5,276,622 shares of Series D Preferred
Stock to CII Ventures LLC, an affiliate of the private investment firm
KKR for gross proceeds of $73,873,000, less approximately $6,285,000 in offering
costs. In April 2000, the Company issued the remaining 1,866,235 shares of
Series D Preferred Stock for net proceeds of $25,000,000. The Series D Preferred
Stock is convertible into common stock of the Company, with an initial
conversion price of $16.50 per share (or 6,060,606 common shares based on the
$100 million investment), subject to adjustment. The Company also issued a one-
year option for CII Ventures LLC to purchase 7,142,857 shares of Series E
Preferred Stock. The Series E Preferred Stock is convertible into common stock
of the Company, with an initial conversion price of $20.00 per share (or
5,000,000 common shares based on a $100 million investment), subject to
adjustment. The holders of the Series D and Series E Preferred Stock will be
entitled to receive dividends, payable in additional shares, at a rate of 6
percent per annum compounded quarterly.
On the date of the stock purchase agreement, the conversion price of the
Series D Preferred Stock was less than the closing market price of the Company's
common stock. Accordingly, approximately $15.7 million of the proceeds were
allocated to additional paid-in capital to recognize the beneficial conversion
feature. Approximately $36.1 million of the proceeds received were allocated to
the value of the option to purchase the Series E Preferred Stock. The option has
been valued at its estimated fair value of $7.23 per share based on the Black-
Scholes valuation model. As the Series D Preferred Stock is immediately
convertible into common stock, the discount on the preferred stock (as a result
of the allocation of proceeds to the warrants and beneficial conversion feature)
was fully accreted on the date of issuance and is reflected as a dividend on
preferred stock in the accompany financial statements.
KKR appointed two members to the Company's Board of Directors in February
2000. KKR also has certain stock registration rights, and must consent with
respect to certain corporate actions by the Company, including share issuances
and mergers and other business combinations, subject to certain exceptions.
In June 2000, the Company issued 20,000 shares of Series G Preferred Stock to
3Com for gross proceeds of $20,000,000, less approximately $1,221,000 in
offering costs. The Series G Preferred Stock is convertible into common stock of
the Company at an initial conversion price of $36.00 per share (or 555,556
common shares based on the $20 million investment), subject to adjustment. The
holders of the Series G Preferred Stock are entitled to receive dividends,
payable in additional shares, at a rate of 6 per cent per annum, compounded
quarterly.
A description of the Company's capital equipment credit facilities follows:
The Company and Nortel Networks entered into a five-year, $30 million
equipment financing line of credit, dated as of June 4, 1999, and several
amendments. As of June 30, 2000, the Company had borrowed approximately $7.2
million under this credit facility. Borrowings outstanding as of June 30, 2000
incur interest expense at rates ranging from 10.9 to 13.3 percent. The facility
requires the Company to meet certain financial covenants including revenue
targets and leverage and debt service ratios. The Company obtained a waiver from
Nortel in August 2000 for violation of a financial covenant and certain non-
montetary loan agreement provisions as of June 30, 2000.
The Company and Cisco entered into a three-year, $50 million equipment
financing line of credit, dated as of June 30, 1999, and several amendments. As
of June 30, 2000, the Company had borrowed approximately $20.1 million under
this credit facility. Borrowings outstanding as of June 30, 2000 incur interest
expense at an interest rate of approximately 12.5 percent. Under the facility,
$50 million is available during the first two years of the facility provided the
Company meets certain financial performance requirements. The line of credit
bears interest at an annual rate equal to the three-month LIBOR plus 6.0%. The
facility requires the Company to meet certain financial covenants including
EBITDA targets, revenue targets and leverage ratios. Borrowings under the
facility are secured by a first priority lien in all assets of the Company,
other than its property securing the Nortel facility, in which assets Cisco will
have a second priority lien. In March 2000 the Company and Cisco amended the
financial covenants of this agreement for the remainder of the term of this
facility.
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As of June 30, 2000, the Company had cash and cash equivalents and short-term
investments of approximately $35.5 million. The Company will seek additional
financing to meet its planned capital expenditures over the next twelve months.
If such sources of financing are insufficient or unavailable, or if the Company
experiences shortfalls in anticipated revenues or increases in anticipated
expenses, the Company would curtail the planned roll-out of its services and
reduce marketing and development activities.
The Company from time to time engages in discussions involving potential
business acquisitions. Depending on the circumstances, the Company may not
disclose material acquisitions until completion of a definitive agreement. The
Company may determine to raise additional debt or equity capital to finance
potential acquisitions and/or to fund accelerated growth. Any significant
acquisitions or increases in the Company's growth rate could materially affect
the Company's operating and financial expectations and results, liquidity and
capital resources.
Subsequent Events
In May 2000, the Company and Microsoft entered into a commercial agreement to
distribute Internet content to the Company's target markets. In connection with
the commercial agreement, the Company issued Microsoft 40,000 shares of Series F
Preferred Stock to Microsoft in August 2000 for total gross proceeds of $40
million. The Company may be obligated to pay up to approximately $2.5 million in
closing costs for the Microsoft investment. The Series F shares are initially
convertible into approximately 1,667,000 shares of common stock at a conversion
price of $24.00 per share. The holders of the Series F preferred stock are
entitled to receive dividends, payable in preferred shares, common stock or
cash, at a rate of 7 percent per annum. The Company also granted Microsoft a
warrant to purchase up to 600,000 shares of common stock at an exercise price of
$24.00 per share, expiring in April 2005. Microsoft could also be eligible for
an additional warrant to purchase up to 900,000 shares of common stock at
exercise prices between $45.00 and $65.00 per share, expiring in April 2005,
based upon the Company's performance against certain operational milestones.
In July 2000, the company invested $4.2 million in INNCOM Series A shares.
INNCOM also granted a warrant to the Company to purchase up to an additional
840,000 INNCOM Series A shares. Additionally, the Company and INNCOM entered
into a commercial agreement to offer integrated, high-speed Internet and in-room
automation solutions for hotel guests.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Company has limited exposure to financial market risks, including changes
in interest rates. At June 30, 2000, the Company had short-term investments of
approximately $9.8 million. These short-term investments consist of highly
liquid investments in debt obligations of highly rated entities with maturities
of between 91 and 270 days. These investments are subject to interest rate risk
and will fall in value if market interest rates increase. The Company expects to
hold these investments until maturity, and therefore expects to realize the full
value of these investments, even though changes in interest rates may affect
their value prior to maturity. If interest rates decline over time, this will
result in a reduction of our interest as our cash is reinvested at lower rates.
At June 30, 2000, the Company had debt in the aggregate amount of $27.3
million. A change of interest rates would affect its obligations under these
agreements. Increases in interest rates would increase the interest
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expense associated with future borrowings and borrowings under its equipment
financing agreements.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to any lawsuit or proceeding which, in the
opinion of its management, is likely to have a material adverse effect on its
business, financial condition or results of operation.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
SALES OF UNREGISTERED SECURITIES
A description of the Company's sales of unregistered securities is set forth
under the headings "Liquidity and Capital Resources" and "Subsequent Events" of
the "Management's Discussion and Analysis of Financial Condition and Results of
Operations" section above. In addition, the following is a description of the
unregistered securities sold by the Company during the period from April 1, 2000
through June 30, 2000:
The Company granted a warrant to Cooper Hotel Services, Inc. to purchase
10,368 shares of common stock, in connection with the parties' agreement to
provide the Company's services to Cooper Hotel Services, Inc. properties. The
warrant has an exercise price of approximately $17.31 per share, and expires on
June 9, 2005.
The Company issued 1,866,235 shares of Series D Preferred Stock to CII
Ventures, Inc., an affiliate of the private investment firm KKR, for gross
proceeds of approximately $26,127,000, less approximately $1,254,000 in offering
costs. The Company also issued 16,709 shares of Series D Preferred Stock in
dividends. The Series D Preferred Stock is convertible into common stock of the
Company at a conversion price of $16.50 per share (7,159,566 cumulative shares
issued of Series D Preferred Stock are convertible into 6,074,783 common
shares).
The Company issued 20,000 shares of Series G Preferred Stock to 3Com
Corporation for gross proceeds of approximately $20,000,000, less approximately
$1,221,000 in offering costs. The Series G Preferred Stock is convertible into
common stock of the Company at a conversion price of $36.00 per share
(20,000,000 shares of Series G Preferred Stock are convertible into 555,555
common shares).
The securities issued in the foregoing transactions were offered and sold in
reliance upon exemptions from registration set forth in Section 4(2) of the
Securities Act of 1933, or regulations promulgated thereunder, relating to sales
by an issuer not involving any public offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
See Exhibit Index.
B. REPORTS ON FORM 8-K
On May 31, 2000, the Company filed a Current Report on Form 8-K solely to
provide additional pro forma financial information with respect to the Company's
acquisition of Atcom, Inc. on September 2, 1999, as required in the Company's
Form S-3 registration statement filed with the Securities and Exchange
Commission on June 1, 2000.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Washington, D.C., on
August 14, 2000.
CAIS Internet, Inc.
/s/ Ulysses G. Auger, II
--------------------------------------------
Ulysses G. Auger, II, Chairman of the Board
and Chief Executive Officer
(Principal Executive Officer)
/s/ Barton R. Groh
--------------------------------------------
Barton R. Groh, Vice President, Treasurer
and Chief Financial Officer
(Principal Financial and Accounting Officer)
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CAIS INTERNET, INC.
EXHIBIT INDEX
Exhibit
No. Description
- -------- -----------
4.1 Certificate of Designation of Series and Determination of Rights
and Preferences of Series G Convertible Preferred Stock of CAIS
Internet, Inc.
4.2 Registration Rights Agreement, dated as of March 20, 2000, by and
between CAIS Internet, Inc. and 3Com Corporation.
4.3 Series G Preferred Stock Purchase Agreement, dated as of March 20,
2000, by and between CAIS Internet, Inc. and 3Com Corporation.
4.4 Certificate of Designation of Series and Determination of Rights
and Preferences of Series F Convertible Participating Preferred
Stock of CAIS Internet, Inc.
4.5 Series F Convertible Participating Preferred Stock Purchase
Agreement, dated as of April 28, 2000, by and between CAIS
Internet, Inc. and Microsoft Corporation.
4.6 Registration Rights Agreement, dated as of April 28, 2000, by and
between CAIS Internet, Inc. and Microsoft Corporation.
4.7 Initial Common Stock Warrant among CAIS Internet, Inc. and
Microsoft Corporation, dated April 28, 2000.
4.8 Conditional Common Stock Warrant among CAIS Internet, Inc. and
Microsoft Corporation, dated April 28, 2000.
4.9 Common Stock Warrant Agreement among CAIS Internet, Inc. and Cooper
Hotel Services, Inc., dated June 9, 2000.
27.1 Financial Data Schedule.
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