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 September 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) Identification 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
23,721,296 shares outstanding on November 1, 2000
CAIS INTERNET, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 2000
INDEX
Page
PART I - FINANCIAL INFORMATION Number
Item 1. Financial Statements:
Consolidated Condensed Balance Sheets as of September 30, 2000
and December 31, 1999. 4
Consolidated Condensed Statements of Operations for the Three
and Nine Months Ended September 30, 2000 and 1999. 5
Consolidated Condensed Statement of Changes in Stockholders'
(Deficit) Equity for the Nine Months Ended September 30, 2000. 6
Consolidated Condensed Statements of Cash Flows for the Nine
Months Ended September 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. 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 24
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 October 25, 2000, 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 data)
September 30, 2000 December 31, 1999
------------------ -----------------
(Unaudited)
Current assets
Cash and cash equivalents $ 10,078 $ 17,120
Short-term investments - 16,501
Accounts receivable, net of allowance for doubtful accounts
of $1,656 and $249, respectively 11,003 3,090
Prepaid expenses and other current assets 7,407 2,571
------------------ -----------------
Total current assets 28,488 39,282
Property and equipment, net 238,649 90,476
Deferred debt financing costs, net 1,130 1,499
Intangible assets and goodwill, net 51,836 51,059
Receivable from officers 450 450
Other assets 10,017 4,185
------------------ -----------------
Total assets $ 330,570 $ 186,951
================== =================
Current liabilities
Accounts payable and accrued expenses $ 111,807 $ 53,779
Obligations under capital lease - 312
Current portion of long-term debt 39,927 2,680
Unearned revenues 1,450 846
------------------ -----------------
Total current liabilities 153,184 57,617
Other long-term liabilities 648 718
------------------ -----------------
Total liabilities 153,832 58,335
------------------ -----------------
Series C cumulative mandatory redeemable preferred stock;
$0.01 par value; 125,000 shares authorized, issued and
outstanding (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; 7,258,249 shares issued and outstanding
as of September 30, 2000 (aggregate liquidation preference
of $103,394) 103,394 -
------------------ -----------------
Series F cumulative mandatory redeemable convertible
preferred stock; $0.01 par value; 56,617 shares
authorized; 40,000 shares issued and outstanding
as of September 30, 2000 (aggregate liquidation preference
of $40,467) 40,467 -
------------------ -----------------
Series G cumulative mandatory redeemable convertible
preferred stock; $0.01 par value; 28,051 shares
authorized; 20,000 shares issued and outstanding
as of September 30, 2000 (aggregate liquidation preference
of $20,350) 20,350 -
------------------ -----------------
Put warrants 1,267 1,267
------------------ -----------------
Commitments and contingencies
Stockholders' (deficit) equity
Common stock, $0.01 par value; 100,000,000 shares
authorized; 24,254,997 and 22,608,331 shares
issued, and 23,608,528 and 22,595,565 shares
outstanding, respectively 242 226
Additional paid-in capital 223,580 188,569
Warrants outstanding 54,702 13,234
Deferred compensation (1,431) (2,673)
Treasury stock, 646,469 and 12,766 shares
of common stock, respectively (17,073) (150)
Accumulated deficit (263,760) (87,176)
------------------ -----------------
Total stockholders' (deficit) equity (3,740) 112,030
------------------ -----------------
Total liabilities and stockholders' (deficit) equity $ 330,570 $ 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 Nine months ended
September 30, September 30,
2000 1999 2000 1999
---------- --------- ---------- ----------
Net Revenues:
Services $ 7,064 $ 2,166 $ 16,604 $ 5,459
Software 271 70 3,262 70
Equipment 3,747 446 6,733 572
---------- --------- ---------- ----------
Total net revenues 11,082 2,682 26,599 6,102
---------- --------- ---------- ----------
Cost of revenues:
Services 8,618 2,191 20,160 4,682
Software - - - -
Equipment 2,276 367 4,346 444
---------- --------- ---------- ----------
Total cost of revenues 10,894 2,558 24,506 5,126
---------- --------- ---------- ----------
Operating expenses:
Selling, general and administrative 23,487 12,886 63,550 22,266
Research and development 1,435 447 3,984 547
Depreciation and amortization 10,173 1,738 24,456 2,485
Non-cash compensation 413 1,009 1,242 4,130
Treasury stock premium and stock charge - - 10,348 -
Fair value of stock issued to third party for
services 190 - 190 723
---------- --------- ---------- ----------
Total operating expenses 35,698 16,080 103,770 30,151
---------- --------- ---------- ----------
Loss from operations (35,510) (15,956) (101,677) (29,175)
Interest income (expense), net:
Interest income 598 1,190 2,039 1,730
Interest expense (1,136) (198) (2,355) (1,330)
---------- --------- ---------- ----------
Total interest income (expense), net (538) 992 (316) 400
---------- --------- ---------- ----------
Loss from continuing operations (36,048) (14,964) (101,993) (28,775)
Loss from discontinued operations - - - (340)
---------- --------- ---------- ----------
Loss before extraordinary item (36,048) (14,964) (101,993) (29,115)
Extraordinary item -- early extinguishment of debt - - - (551)
---------- --------- ---------- ----------
Net loss (36,048) (14,964) (101,993) (29,666)
Dividends and accretion on preferred stock (5,970) (3,851) (74,591) (4,202)
---------- --------- ---------- ----------
Net loss attributable to common stockholders $ (42,018) $ (18,815) $ (176,584) $ (33,869)
========== ========= ========== ==========
Basic and diluted loss per share:
Loss attributable to common stockholders before
discontinued operations and extraordinary item $ (1.80) $ (0.91) $ (7.64) $ (2.20)
Discontinued operations - - - (0.02)
Extraordinary item - - - (0.04)
---------- --------- ---------- ----------
Total $ (1.80) $ (0.91) $ (7.64) $ (2.26)
========== ========= ========== ==========
Basic and diluted weighted-average shares outstanding 23,401 20,586 23,117 14,955
========== ========= ========== ==========
The accompanying notes are an integral part of these consolidated condensed
statements.
5
CAIS INTERNET, INC.
Consolidated Statement of Changes in Stockholders' (Deficit) Equity
(in thousands)
(unaudited)
-----------------------------------------------------------------------
Series C Series D Series F Series G
----------------------------------------------------------------------- Put
Shares Amount Shares Amount Shares Amount Shares Amount Warrants
------- -------- ------ -------- ------ -------- ------ -------- ---------
December 31, 1999 125 $ 15,319 -- $ -- -- $ -- -- $ -- $ 1,267
Issuance of Preferred Stock,
net of offering costs of $7,669,
fair value of beneficial conversion
feature of $21,212 and value of
warrants to purchase preferred and
common stock of $40,537. -- -- 7,143 35,106 40 35,491 20 19,985 --
Accretion of Preferred Stock discount -- -- -- 64,894 -- 4,509 -- 15 --
Accrued and cash dividends on preferred
shares -- (319) -- 1,778 -- 467 -- 350 --
Issuance of preferred share dividends -- -- 115 1,616 -- -- -- -- --
Issuance of common stock and warrants to
third parties -- -- -- -- -- -- -- -- --
Amortization of unearned compensation -- -- -- -- -- -- -- -- --
Issuance of common stock and warrants -- -- -- -- -- -- -- -- --
for acquisition -- -- -- -- -- -- -- -- --
Issuance of common stock for additional
consideration for acquisition and
extinguishment of registration rights
of Atcom shareholders -- -- -- -- -- -- -- -- --
Treasury stock -- -- -- -- -- -- -- -- --
Exercise of stock options and warrants -- -- -- -- -- -- -- -- --
Net loss -- -- -- -- -- -- -- -- --
------- -------- ------ -------- ------ -------- ------ -------- --------
September 30, 2000 125 $ 15,000 7,258 $103,394 40 $ 40,467 20 $ 20,350 $ 1,267
======= ======== ====== ======== ====== ======== ====== ======== ========
(continued)
Stockholders' (Deficit) 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 Preferred Stock,
net of offering costs of $7,669,
fair value of beneficial conversion
feature of $21,212 and value of
warrants to purchase preferred and
common stock of $40,537. -- -- 21,212 40,537 -- -- -- 61,749
Accretion of Preferred Stock discount -- -- -- -- -- -- (69,418) (69,418)
Accrued and cash dividends on preferred
shares -- -- -- -- -- -- (3,557) (3,557)
Issuance of preferred share dividends -- -- -- -- -- -- (1,616) (1,616)
Issuance of common stock and warrants to
third parties 20 -- 190 2,009 -- -- -- 2,199
Amortization of unearned compensation -- -- -- -- 1,242 -- -- 1,242
Issuance of common stock and warrants
for acquisition 40 1 954 148 -- -- -- 1,103
Issuance of common stock for additional
consideration for acquisition and
extinguishment of registration rights
of Atcom shareholders 498 5 10,334 -- -- -- -- 10,339
Treasury stock -- -- (16,923) -- (16,923)
Exercise of stock options and warrants 1,089 10 2,321 (1,226) -- -- -- 1,105
Net loss -- -- -- -- -- -- (101,993) (101,993)
------- ------- ---------- ----------- ------------ -------- ----------- ---------
September 30, 2000 24,255 $ 242 $ 223,580 $ 54,702 $ (1,431) $(17,073) $ (263,760) $ (3,740)
======= ======= ========= =========== =========== ======== =========== =========
(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)
Nine Months Ended
September 30,
2000 1999
-------- --------
Cash flows from operating activities:
Net loss $ (101,993) $ (29,666)
Adjustments to reconcile net loss to net cash used by operating activities-
Non-cash compensation pursuant to stock options 1,242 4,130
Amortization of debt discount and deferred financing costs 318 877
Treasury stock premium and stock charge 8,953 --
Extraordinary item -- early extinguishment of debt -- 551
Fair value of shares issued to third party for services 190 723
Depreciation and amortization 24,456 2,485
Depreciation and amortization of discontinued operations -- 58
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable, net (7,913) (728)
Prepaid expenses and other current assets (2,793) (2,023)
Other assets (1,047) (784)
Accounts payable and accrued expenses 53,268 9,667
Payable to discontinued operations -- (3,892)
Unearned revenues 604 60
Other long-term liabilities (70) 609
Changes in operating assets and libabilites of discontinued operations -- (73)
---------- ---------
Net cash used in operating activities (24,785) (18,006)
---------- ---------
Cash flows from investing activities:
Net purchases of property and equipment (156,600) (43,710)
Purchases of property and equipment of discontinued operations -- (14)
Purchases of short-term investments -- (16,501)
Purchases of restricted investments (3,485) (350)
Sales of short-term investments 16,501 --
Cash paid for acquisitions / investments (5,413) (1,327)
Payments for visitor-based and multi-family network contract rights (5,626) (2,006)
Net payments advanced on notes receivable (258) (538)
---------- ---------
Net cash used in investing activities (154,881) (64,446)
---------- ---------
Cash flows from financing activities:
Net borrowings under receivables-based credit facility
of discontinued operations 313
Repayments under loan (7,000)
Borrowings under debt 37,247
Borrowings under notes payable - related parties - 1,000
Principal payments under capital lease obligations (312) (11)
Payment of loan commitment, debt financing, and offering costs (65) (366)
Net proceeds from issuance of Series A preferred stock -- 11,365
Redemption of Series B preferred stock -- (3,104)
Net proceeds from issuance of Series C preferred stock -- 15,000
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 (907) --
Net proceeds from issuance of Series F preferred stock 39,885 --
Net proceeds from issuance of Series G preferred stock 19,985 --
Repurchase of common stock (16,775) (150)
Proceeds from issuance of common stock 1,105 58
---------- ---------
Net cash provided by financing activities 172,624 135,338
---------- ---------
Net (decrease) increase in cash and cash equivalents (7,042) 52,886
Cash and cash equivalents, beginning of period 17,120 95
---------- ---------
Cash and cash equivalents, end of period $ 10,078 $ 52,981
========== =========
The accompanying notes are an integral part of these consolidated condensed
statements.
7
CAIS INTERNET, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
September 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; 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 initial 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 September 30, 2000, the Company had cash and cash equivalents of
approximately $10.1 million. Total current liabilities as of September 30, 2000
exceeded current assets by approximately $124.7 million. Current liabilities
include $40.0 million due to Nortel Networks and Cisco Systems related to
equipment financing lines of credit (see Note 3).
The Company has signed a definitive agreement to sell certain technology
and other assets to Cisco Systems, Inc. ("Cisco") for approximately $146.8
million of which approximately $40.5 million will be held in escrow for up to
six years (see Note 8). Additionally, certain significant shareholders have
provided the Company with a $20 million bridge facility that matures upon the
earlier of the closing of the Cisco sale or March 31, 2001 (see Note 8).
Management believes that the Cisco sale will be closed by the end of December
2000. Even with the proceeds from the Cisco sale of approximately $103 million
(net of investment banking fees of approximately $4 million) management believes
that the Company will need to raise additional financing to meet its obligations
during 2001.
Management plans to raise additional capital through the sale of equity,
additional borrowings, the sale of non-strategic assets, including intellectual
property and proprietary technology, or the sale of selected operations.
Although management believes it has the ability to generate additional equity
and cash through such financing transactions, those transactions may be dilutive
and there can be no assurances that adequate funds will be available, or
available on terms that are reasonable or acceptable to the Company. If the
Company is unable to generate additional financing and adequate cash, there will
be a material and adverse effect on the financial condition of the Company, to
the extent that a restructuring, sale, or liquidation of the Company will be
required, in whole or in part.
8
The financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company has been advised by its
independent public accountants that if the Company has not raised sufficient
capital to meet its projected obligations for 2001 prior to the completion of
their audit of the Company's financial statements for the year ending December
31, 2000, their auditors' report on those financial statements may be modified
to reflect this contingency.
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 $6,182,000 and $14,790,000 for the three and nine months
ended September 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 siginifcantly larger and have
substantially greater financial, technical, and marketing resources than the
Company.
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 nine months ended September 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: Reporting
the Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extradordinary, Unusual and Infrequently Occurring Events and
Transactions. 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 September 30, 2000, there were options and
warrants to purchase approximately 13,050,000 shares of common stock, and Series
C, D, F and G preferred shares which, upon their conversion, would cause the
issuance of approximately 9,745,000 shares of common stock.
9
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"
for the three and nine months ended September 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 recognition, presentation and disclosure of revenue in financial
statements. SAB 101 is effective no later than the fourth quarter for fiscal
years beginning after December 31, 1999. 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
cash on hand, 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 $3,939,000 and $11,632,000 for the three and nine months ended
September 30, 2000, respectively. Goodwill with respect to the Capital Area
acquisition was fully amortized in May 1999.
10
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
$18,636,000 and $11,153,000 as of September 30, 2000 and December 31, 1999,
respectively, and are 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 nine months ended September 30, 2000
was approximately $1,162,000 and $2,643,000, 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
$413,000 and $1,242,000 for the three and nine months ended September 30, 2000.
Long-lived assets
Long-lived assets and identifiable assets to be held and used are reviewed
for impairment whenever events or changes in circumstances indicated that the
carrying amount should be addressed. Impairment is measured by comparing the
carrying value to the estimated undiscounted future cash flows expected to
result from the use of the assets and their eventual dispositions. The Company
considers expected cash flows and estimated future operating results, trends,
and other available information in assessing whether the carrying value of the
assets is impaired. The Company believes that no such impairment existed as of
September 30, 2000 and December 31, 1999.
The Company's estimates of anticipated net revenues, the remaining estimated
lives of tangible and intangible assets, or both, could be reduced significantly
in the future due to changes in technology, regulation, available financing, or
intense competition, or actual building usage penetration results. As a result,
the carrying amount of long-lived assets could be reduced materially in the
future.
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 September 30, 2000, the Company had borrowed
approximately $15.2 million under this credit facility. Borrowings outstanding
as of September 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 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 September 30, 2000, the Company had borrowed
approximately $24.7 million under this credit facility. Borrowings outstanding
as of September 30, 2000 incur interest expense at approximately 12.8 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 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 priority lien.
At September 30, 2000, the Company was not in compliance with certain
financial covenants under the Nortel Networks and Cisco credit facilities. The
Company has subsequently obtained waivers from Nortel Networks and Cisco for
violation of the financial covenants. See Note 8 for additional discussion of an
amendment to the Nortel credit 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 $1.1 million as of September
30, 2000 in connection with completing the Nortel Networks and Cisco credit
facilities. 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 $104,000 and $318,000 for the three and nine
months ended September 30, 2000, respectively.
11
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 re deemable 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.
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 Prefered 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 $15,000 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.
In August 2000, the Company issued 40,000 shares of Series F Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series F Preferred
Stock") and warrants to acquire 600,000 shares of the Company's common stock at
$24.00 per share to Microsoft Corporation ("Microsoft") for total gross proceeds
of $40,000,000 less approximately $100,000 million in offering costs paid to
third parties. 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. Approximately $4.4 million of the proceeds received were
allocated to the value of the warrants. As the Series F 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) was fully accreted
on the date of issuance and is reflected as a dividend on preferred stock in the
accompanying financial statements. Microsoft may also be eligible for an
additional warrant to purchase up to 900,000 shares of the Company's common
stock at exercise prices between $45.00 and $65.00 per share based upon the
Company's performance with respect to certain operational milestones.
12
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 in the nine months ended September 30, 2000.
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.
13
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 September 30, 2000
--------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 6,182 $ 4,900 $ 11,082
Depreciation and amortization 9,945 228 10,173
Interest income (expense), net (498) (40) (538)
Segment losses (34,048) (2,000) (36,048)
Segment assets 295,263 10,406 305,669
Expenditures for segment assets 82,800 - 82,800
Three Months Ended September 30, 1999
--------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 695 $ 1,987 $ 2,682
Depreciation and amortization 1,738 - 1,738
Interest income (expense), net 921 71 992
Segment losses (11,604) (3,360) (14,964)
Segment assets 117,642 1,036 118,678
Expenditures for segment assets 54,559 - 54,559
Nine Months Ended September 30, 2000
-------------------------------------
Internet
Networks Services Consolidated
-------- -------- ------------
Revenues $ 14,790 $11,809 $ 26,599
Depreciation and amortization 24,210 246 24,456
Interest income (expense), net (308) (8) (316)
Segment losses (94,616) (7,377) (101,993)
Segment assets 295,263 10,406 305,669
Expenditures for segment assets 156,312 - 156,312
Nine Months Ended September 30, 1999
-------------------------------------
Internet
Networks Services Consolidated
--------- -------- ------------
Revenues $ 837 $ 5,265 $ 6,102
Depreciation and amortization 2,479 6 2,485
Interest income (expense), net 414 (14) 400
Segment losses (25,346) (3,429) (28,775)
Segment assets 117,642 1,036 118,678
Expenditures for segment assets 60,789 - 60,789
14
The following is a reconciliation of the reportable segments' losses and assets
to the Company's consolidated totals (in thousands, unaudited):
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
-------- -------- --------- -------
Losses
Total losses for reportable segments $(36,048) $(14,964) $(101,993) (28,775)
Loss from discontinued operations - - - (340)
Extraordinary item - - - (551)
-------- -------- --------- -------
Consolidated net loss $(36,048) $(14,964) $(101,993) $(29,666)
======== ======== ========= =======
Sept 30, Sept 30,
2000 1999
-------- --------
Assets
Total assets for reportable segments $305,669 $118,678
Total current assets, excluding reportable segment assets 14,016 71,342
Deferred financing and offering costs, net 1,130 1,425
Other long term assets, excluding reportable segment assets 9,305 1,130
Receivable from officers 450 400
-------- --------
Consolidated total assets $330,570 $192,975
======== ========
8. Subsequent Events
On October 19, 2000, the Company entered into a definitive agreement with
Cisco to sell the broadband subscriber management software business of the
Company's CAISSoft subsidiary for an aggregate cash purchase price of
approximately $146.8 million, of which $40.5 million will be deposited into an
escrow account. $15 million of the escrowed amount will remain in escrow for up
to 18 months following the transaction closing date to satisfy any unsatisfied
claims, and $25.5 million will remain in escrow until the earlier of the sixth
(6th) anniversary of the closing date, or the date specified by Cisco in a
notice that any patent or other claims have been resolved. The Company expects
the transaction to close by the end of December 2000. At closing, the Company
expects to receive approximately $103 million in cash, net of fees of
approximately $4 million. The Company and Cisco also entered into a software
license agreement under which Cisco will grant the Company up to 1,500 royalty
free, fully paid copies of IPORT software. The parties will negotiate an
agreement for additional license copies.
On October 25, 2000, the Company entered into a credit agreement with Ulysses
G. Auger II (Chairman of the Board), R. Theodore Ammon (Director) and CII
Ventures II, Inc. (CII Ventures, administrative agent for KKR), collectively
called the "Lenders." The Lenders will make up to $20 million of loans available
to the Company, with a maximum of $3 million in any calendar week, with the
exception of the initial borrowing under which the Company borrowed $5 million.
The Company is obligated to repay any borrowings and interest at the earlier of
the closing of the CAISSoft asset sale to Cisco, or March 31, 2001. Borrowings
incur interest at the Alternate Base Rate plus 5 percent or LIBOR plus 6
percent, or approximately 13 percent per annum. In connection with the credit
agreement, the Company granted 2,000,000 warrants to the Lenders at an exercise
price of $4.56 per share (fair market value on the grant date). The warrants
expire on October 25, 2010.
On November 14, 2000, the Company entered into the Fifth Amendment to the
Nortel credit facility. This amendment modified the commitment termination date
of the borrowing facility to November 30, 2000 and also modified the repayment
terms. The Company will be required to pay $4 million of the outstanding
balance by the earlier of two business days after the closing of the sale of
certain CAISSoft assets to Cisco Systems or December 22, 2000 and to repay the
remaining balance in monthly instalments over the 2001 calendar year. If the
Company raises a minimum of $75 million in debt or equity while any outstanding
balance is due, the Company has agreed to pay any remaining balance due to
Nortel at that time. The Company also agreed to increase the interest rate on
the existing borrowings to LIBOR plus 6%. In connection with this amendment,
Nortel has also waived compliance with certain provisions of the credit
facility as of September 30, 2000 and through December 31, 2001, for which the
Company had previously not been in compliance.
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 has
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 may
expand its research and development activities to develop new products and
services.
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, provided the Company can raise
sufficient capital. 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.
As a result of continued losses, negative cash flows, and limited cash on hand
as of September 30, 2000, the Company is changing certain aspects of its
business strategy. See Subsequent Events for a greater discussion.
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 September 30, 2000, the Company had master
contracts to provide its services in approximately 10,800 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 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.
17
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
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 September 30, 2000 Compared to Three Months Ended September
30, 1999
Net revenues. Net revenues for the three months ended September 30, 2000
increased 313% to approximately $11,082,000, from approximately $2,682,000 for
the three months ended September 30, 1999. Net revenues increased primarily due
to an increase of approximately $5,487,000 in visitor-based and multi-family
networks revenue (of which approximately $201,000 was for software sales and
$3,302,000 was for equipment sales), $2,357,000 in DSL revenues, $461,000 in web
hosting services revenues, and $95,000 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 September 30,
2000 totaled approximately $10,894,000 or 98% of net revenues, compared to
approximately $2,558,000 or 95% of net revenues for the three months ended
September 30, 1999. This increase resulted primarily from increases of
approximately $3,899,000 in visitor-based and multi-family network charges for
bandwidth, local loop and network installation, $1,909,000 in charges for
visitor-based and multi-family networks equipment sales, $2,321,000 in DSL
charges for customer connectivity, equipment and installation, and $207,000 in
other Internet access costs.
Selling, general and administrative. Selling, general and administrative
expenses for the three months ended September 30, 2000 totaled approximately
$23,487,000 or 212% of net revenues, compared to approximately $12,886,000 or
480% of net revenues for the three months ended September 30, 1999. This
increase resulted primarily from an increase of $12,783,000 related to visitor-
based and multi-family networks and Internet Services payroll and payroll
related administrative costs, and a decrease of $2,210,000 related to marketing,
advertising, and other administrative expenses.
Research and development. Research and development for the three months ended
September 30, 2000 totaled approximately $1,435,000 or 13% of net revenues,
compared to approximately $447,000, or 17% of net revenues for the three months
ended September 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.
18
Depreciation and amortization. Depreciation and amortization totaled
approximately $10,173,000 for the three months ended September 30, 2000,
compared to approximately $1,738,000 for the three months ended September 30,
1999. This increase resulted from an increase of $4,465,000 in depreciation of
capital assets to support the expansion of the Company's network and to deploy
equipment in hotels and multi-family buildings, $1,193,000 related to the
amortization of purchased contract rights from visitor-based and multi-family
network partners, and $2,777,000 related to the amortization of goodwill and
intangibles as a result of acquisitions.
Non-cash compensation. Non-cash compensation totaled approximately $413,000
for the three months ended September 30, 2000, compared to approximately
$1,009,000 for the three months ended September 30, 1999. This decrease resulted
from the acceleration of deferred compensation charges that occurred as a result
of the IPO in May 1999.
Fair value of stock issued to third party for services. Fair value of stock
issued to third party for services was 190,000 for the three months ended
September 30, 2000. There was no comparable expense for the three months ended
September 30, 1999.
Interest income (expense), net. Interest income (expense), net totaled expense
of approximately $538,000 for the three months ended September 30, 2000,
compared to income of approximately $992,000 for the three months ended
September 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 $36,048,000 for the three months ended September 30, 2000,
compared to approximately $14,964,000 for the three months ended September 30,
1999, due to the foregoing factors.
Nine Months Ended September 30, 2000 Compared to nine Months Ended September 30,
1999
Net revenues. Net revenues for the nine months ended September 30, 2000
increased 336% to approximately $26,599,000, from approximately $6,102,000 for
the nine months ended September 30, 1999. Net revenues increased primarily due
to an increase of approximately $13,953,000 in visitor-based and multi-family
networks revenue (of which approximately $3,192,000 was for software sales and
$6,161,000 was for equipment sales), $5,443,000 in DSL revenues, $854,000 in web
hosting services revenues, and $247,000 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 nine months ended September 30,
2000 totaled approximately $24,506,000 or 92% of net revenues, compared to
approximately $5,126,000 or 84% of net revenues for the nine months ended
September 30, 1999. This increase resulted primarily from increases of
approximately $9,227,000 in visitor-based and multi-family network charges for
bandwidth, local loop and network installation, $3,903,000 in charges for
visitor-based and multi-family network equipment sales, $5,658,000 in DSL
charges for customer connectivity, equipment and installation, and $592,000 in
other Internet access costs.
19
Selling, general and administrative. Selling, general and administrative
expenses for the nine months ended September 30, 2000 totaled approximately
$63,550,000 or 239% of net revenues, compared to approximately $22,266,000 or
365% of net revenues for the nine months ended September 30, 1999. This increase
resulted primarily from increases of $38,286,000 related to visitor-based and
multi-family networks and Internet Services payroll and payroll related
administrative costs, and $2,972,000 related to marketing, advertising, and
other administrative expenses.
Research and development. Research and development for the nine months ended
September 30, 2000 totaled approximately $3,984,000 or 15% of net revenues,
compared to approximately $547,000, or 9% of net revenues for the nine months
ended September 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 $24,456,000 for the nine months ended September 30, 2000, compared
to approximately $2,485,000 for the nine months ended September 30, 1999. This
increase resulted from an increase of $8,862,000 in depreciation of capital
assets to support the expansion of the Company's network and to deploy equipment
in hotels and multi-family buildings, $2,916,000 related to the amortization of
purchased contract rights from visitor-based and multi-family network partners,
and $10,192,000 related to the amortization of goodwill and intangibles as a
result of acquisitions.
Non-cash compensation. Non-cash compensation totaled approximately $1,242,000
for the nine months ended September 30, 2000, compared to approximately
$4,130,000 for the nine months ended September 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 nine months ended September 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 nine months ended September 30, 1999.
Fair value of stock issued to third party for services. Fair value of stock
issued to third party for services totaled approximately $190,000 for the nine
months ended September 30, 1999, compared to $723,000 for the nine months ended
September 30, 1999.
Interest income (expense), net. Interest income (expense), net totaled expense
of approximately $316,000 for the nine months ended September 30, 2000, compared
to income of approximately $400,000 for the nine months ended September 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 $101,993,000 for the nine months ended September 30, 2000,
compared to approximately $28,775,000 for the nine months ended September 30,
1999, due to the foregoing factors.
Loss from discontinued operations. There was no income or loss from
discontinued operations for the nine months ended September 30, 2000 due to the
spinoff of Cleartel in February 1999. Loss from discontinued operations of
Cleartel totaled approximately $340,000 for the nine months ended September 30,
1999.
Extraordinary item - early extinguishment of debt. There was no extraordinary
item - early extinguishment of debt for the nine months ended September 30,
2000. Extraordinary item - early extinguishment of debt totaled approximately
$551,000 for the nine months ended September 30, 1999.
20
Liquidity and Capital Resources
As of September 30, 2000, the Company had cash and cash equivalents and short-
term investments of approximately $10.1 million. Total current liabilities as of
September 30, 2000 exceeded current assets by approximately $124.7 million.
Current liabilities include $40.0 million due to Nortel Networks and Cisco
Systems related to equipment financing lines of credit.
The Company has reached a definitive agreement to sell certain assets of its
CAISSoft subsidiary to Cisco for gross proceeds of approximately $146.8 million,
of which $40.5 million will be held in escrow. The Company expects the
transaction to close by the end of December 2000. At closing, the Company
expects to receive approximately $103 million in cash, net of fees of
approximately $4 million. The Company will require additional financing in
addition to the proceeds from Cisco to meet its planned operational and 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.
Management plans to raise additional capital through the sale of equity,
additional borrowings, the sale of non-strategic assets, including intellectual
property and proprietary technology, or the sale of selected operations.
Although management believes it has the ability to generate additional equity
and cash through such financing transactions, those transactions may be dilutive
and there can be no assurances that adequate funds will be available, or
available on terms that are reasonable or acceptable to the Company. If the
Company is unable to generate additional financing and adequate cash, there will
be a material and adverse effect on the financial condition of the Company, to
the extent that a restructuring, sale, or liquidation of the Company will be
required, in whole or in part.
The Company has been advised by its independent public accountants that if the
Company has not raised sufficient capital to meet its projected obligations for
2001 prior to the completion of their audit of the Company's financial
statements for the year ending December 31, 2000, their auditors' report on
those financial statements may be modified to reflect this contingency.
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.
Prior to the IPO, the Company financed its operations with various debt and
private equity placements. Net cash used in operating activities for the nine
months ended September 30, 2000 and 1999 was approximately $24.8 million and
$18.0 million 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 nine months ended September 30, 2000 and 1999, cash flows used in
investing activities were approximately $154.9 million and $64.4 million,
respectively. Investing activities in the nine months ended September 30, 2000
include approximately $156.6 million in net 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 $5.6 million in network
contract rights.
A description of the Company's stockholders' (deficit) equity is as follows:
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.
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 $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 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.
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 $15,000 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.
21
In August 2000, the Company issued 40,000 shares of Series F Cumulative
Mandatory Redeemable Convertible Preferred Stock (the "Series F Preferred
Stock") and warrants to acquire 600,000 shares of the Company's common stock at
$24.00 per share to Microsoft Corporation ("Microsoft") for total gross proceeds
of $40,000,000 less approximately $0.1 million in offering costs paid to third
parties. 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. Approximately $4.4 million of the proceeds received were
allocated to the value of the warrants. As the Series F 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) was fully accreted
on the date of issuance and is reflected as a dividend on preferred stock in the
accompany financial statements. Microsoft may also be eligible for an additional
warrant to purchase up to 900,000 shares of the Company's common stock at
exercise prices between $45.00 and $65.00 per share based upon the Company's
performance with respect to certain operational milestones.
A description of the Company's capital equipment credit facilities follows:
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 September 30, 2000, the Company had borrowed
approximately $15.2 million under this credit facility. Borrowings outstanding
as of September 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 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 September 30, 2000, the Company had borrowed
approximately $24.7 million under this credit facility. Borrowings outstanding
as of September 30, 2000 incur interest expense at approximately 12.8 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 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 priority lien.
At September 30, 2000, the Company was not in compliance with certain
financial covenants under the Nortel Networks and Cisco credit facilities. The
Company has subsequently obtained waivers from Nortel Networks and Cisco for
violation of the financial covenants. See Subsequent Events for additional
discussion of an amendment to the Nortel credit facility.
22
Subsequent Events
On October 19, 2000, the Company entered into a definitive agreement with
Cisco to sell the broadband subscriber management software business of the
Company's CAISSoft subsidiary for an aggregate cash purchase price of
approximately $146.8 million, of which $40.5 million will be deposited into an
escrow account. $15 million of the escrowed amount will remain in escrow for up
to 18 months following the transaction closing date to satisfy any unsatisfied
claims, and $25.5 million will remain in escrow until the earlier of the sixth
(6th) anniversary of the closing date, or the date specified by Cisco in a
notice that any claims have been resolved. The Company expects the transaction
to close by the end of December 2000. At closing, the Company expects to receive
approximately $103 million in cash, net of fees of approximately $4 million. The
Company and Cisco also entered into a software license agreement under which
Cisco will grant the Company up to 1,500 royalty free, fully paid copies of
IPORT software. The parties will negotiate an agreement for license copies above
1,500.
On October 25, 2000, the Company entered into a credit agreement with Ulysses
G. Auger II (Chairman of the Board), R. Theodore Ammon (Director) and CII
Ventures (administrative agent for KKR), collectively called the "Lenders." The
Lenders will make up to $20 million of loans available to the Company, with a
maximum of $3 million in any calendar week, with the exception of the initial
borrowing under which the company borrowed $5 million. The Company is obligated
to repay any borrowings and interest at the earlier of the closing of the
CAISSoft asset to Cisco, or March 31, 2001. Borrowings incur interest at the
Alternate Base Rate plus 5 percent or LIBOR plus 6 percent, or approximately 13
percent per annum. In connection with the loan, the Company granted 2,000,000
warrants to the Lenders at an exercise price of $4.56 per share. The warrants
expire on October 25, 2010.
On November 6, 2000, the Company announced that it has realigned its operating
management. The Company promoted William Caldwell from President to Chief
Executive Officer and hired Andrew Hines as Chief Operating Officer and Chief
Financial Officer. Ulysses G. Auger, II, outgoing Chief Executive Officer, will
retain the title of Chairman of the Board of Directors. The Company also
announced certain changes to its business strategy, reflecting capital market
and strategic factors. The Company's immediate focus will be on increasing
profitability through a number of tactical initiatives, more controlled growth
and a stronger focus on its core businesses. Under the new management team, the
Company will undertake a complete strategic review of its business lines,
including analysis of capital deployment and profitability. In response to
changing equity market conditions, the Company's strategy, for the present, will
focus on maximizing profits and preserving capital rather than accelerating
growth. While in the short term this will reduce the previously established
building installation volume trends, it is intended to conserve capital and
improve EBITDA results. In 2001, the Company plans to resume the roll-out at its
previously planned levels in the hospitality segment. In the multifamily
business, the Company has decided to significantly decrease its new
installations until wireless hardware costs reductions can be achieved. Future
hotel and multifamily installations are dependent on the availability of
additional capital.
On November 14, 2000, the Company entered into the Fifth Amendment to the
Nortel credit facility. This amendment modified the commitment termination date
of the borrowing facility to November 30, 2000 and also modified the repayment
terms. The Company will be required to pay $4 million of the outstanding
balance by the earlier of two business days after the closing of the sale of
certain CAISSoft assets to Cisco Systems or December 22, 2000 and to repay
the remaining balance in monthly instalments over the 2001 calendar year. If
the Company raises a minimum of $75 million in debt or equity while any
outstanding balance is due, the Company has agreed to pay any remaining balance
due to Nortel at that time. The Company also agreed to increase the interest
rate on the existing borrowings to LIBOR plus 6%. In connection with this
amendment, Nortel has also waived compliance with certain provisions of the
credit facility as of September 30, 2000 and through December 31, 2001, for
which the Company had previously not been in compliance.
23
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
At September 30, 2000, the Company had debt in the aggregate amount of $39.9
million. A change of interest rates would affect its obligations under these
agreements. Increases in interest rates would increase the interest expense
associated with future borrowings and borrowings under its equipment financing
agreements.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On September 11, 2000, the Company filed a complaint against Suite Technology
System Network for injunctive relief and monetary damages under the Patent Laws
of the United States, 35 U.S.C. (S)1 et seq., for infringement of U.S. Letters
Patent No. 5,844,596 ("Two Way RF Communication at Points of Convergence of Wire
Pairs from Separate Internal Telephone Networks"). The relief requested is an
injunction against future infringement, an accounting for monetary damages, and
recovery of costs and attorney's fees.
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 July 1, 2000
through September 30, 2000:
The Company issued 40,000 shares of Series F Preferred Stock to Microsoft for
gross proceeds of approximately $40,000,000, less approximately $115,000 in
offering costs. The Series F Preferred Stock is convertible into common stock of
the Company at a conversion price of $24.00 per share (40,000 shares of Series F
Preferred Stock are convertible into 1,666,667 common shares). The Company also
granted warrants to Microsoft to purchase 600,000 shares of common stock at an
exercise price of $24.00 per share.
The Company issued 117,130 shares of common stock for contingent consideration
for the Business Anywhere acquisition completed in 1999.
The Company issued 20,000 shares to Hilton Hotels Corporation to extend the
deadline for put warrants.
The Company issued 115,392 shares of Series D Preferred Stock to CII Ventures
as dividends.
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
None.
24
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
November 14, 2000.
CAIS Internet, Inc.
/s/ William M. Caldwell, IV
--------------------------------------------
William M. Caldwell, IV, Chief Executive Officer
(Principal Executive Officer)
/s/ Barton R. Groh
--------------------------------------------
Barton R. Groh, Vice President, Treasurer
(Principal Accounting Officer)
25
CAIS INTERNET, INC.
EXHIBIT INDEX
Exhibit
No. Description
- -------- -----------
2.1 Asset Purchase Agreement by and among Cisco Systems, Inc., CAIS
Internet, Inc., CAIS Software Solutions, Inc., and CAIS, Inc.
dated October 19, 2000
2.2 Escrow Agreement by and among State Street Bank and Trust Company
of California, N.A., Cisco Systems, Inc, CAIS Internet, Inc., a
Delaware corporation, CAIS Software Solutions, Inc., and CAIS,
Inc. dated October 19, 2000
2.3 Software License Agreement entered into by and between Cisco
Systems, Inc. and CAIS, Inc.
4.1 Warrant Agreement dated as of October 25, 2000 among CAIS
Internet, INC., CII Ventures II LLC, Ulysses G. Auger II and R.
Theodore Ammon
10.1 Credit Agreement dated as of October 25, 2000, among CAIS
Internet, Inc., the Lenders party hereto, and CII Ventures II LLC,
as Administrative Agent.
27.1 Financial Data Schedule.