1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from_____________to ______________
COMMISSION FILE NUMBER 0-28579
NOVO NETWORKS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2233445
(State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
300 CRESCENT COURT, SUITE 800
DALLAS, TEXAS 75201
(Address of principal executive offices)
(214) 777-4100
(Registrant's telephone number, including area code)
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 shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
On April 6, 2001, 52,494,909 shares of the registrant's Common Stock $.00002 par
value per share were outstanding.
2
NOVO NETWORKS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PAGE NO.
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2001 (unaudited)
and June 30, 2000............................................................................................. 3
Consolidated Statements of Operations for the three and nine
months Ended March 31, 2001 and 2000
(unaudited)................................................................................................... 4
Consolidated Statements of Cash Flows for the nine months ended
March 31, 2001 and 2000
(unaudited)................................................................................................... 5
Notes to Consolidated Financial Statements.................................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................................... 17
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................................................. 18
Item 2. Changes in Securities......................................................................................... 18
Item 3. Defaults Upon Senior Securities............................................................................... 18
Item 4. Submission of Matters to a Vote of Securities Holders......................................................... 18
Item 5. Other Information............................................................................................. 18
Item 6. Exhibits and Reports on Form 8-K.............................................................................. 18
Signatures.................................................................................................................. 19
Exhibit Index............................................................................................................... 20
2
3
NOVO NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
March 31, June 30,
ASSETS 2001 2000
------------- -------------
(unaudited)
CURRENT ASSETS
Cash and cash equivalents ......................................................... $ 21,509,816 $ 40,764,246
Accounts receivable, less allowances for
doubtful accounts ($1,829,450 - March 2001; $793,900 - June 2000) ................. 3,607,053 7,013,800
Prepaid expenses and other receivables ............................................ 1,354,489 2,979,489
Deposits .......................................................................... 359,537 209,491
VAT receivable .................................................................... 1,415,906 2,131,277
Notes receivable, affiliate ....................................................... -- 100,000
------------- -------------
31,653,548 49,791,556
------------- -------------
LONG-TERM ASSETS
Restricted cash ................................................................... 94,180 281,928
Deposits .......................................................................... 1,167,754 811,093
Network equipment under capital leases, net ....................................... 11,125,828 10,151,079
Property and equipment, net ....................................................... 11,740,316 24,293,292
Investments in affiliates ......................................................... 6,121,031 23,373,190
Goodwill and other intangibles, net ............................................... -- 108,639,486
------------- -------------
29,274,360 168,524,817
------------- -------------
$ 60,927,908 $ 218,316,373
============= =============
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Capital leases, current portion ................................................... $ 3,422,402 $ 4,703,053
Accounts payable .................................................................. 4,252,550 5,580,873
Accrued other ..................................................................... 8,529,635 5,688,892
Accrued reorganization and restructuring charge ................................... -- 1,111,396
Accrued interest payable .......................................................... 69,120 78,016
Customer deposits and deferred revenues ........................................... 964,780 619,403
Notes payable, current portion .................................................... -- 229,343
------------- -------------
18,349,883 16,899,580
------------- -------------
LONG-TERM LIABILITIES
Notes payable, net of current portion ............................................. -- 3,685,145
Capital leases, net of current portion ............................................ 5,780,851 5,128,523
------------- -------------
5,128,523 9,465,996
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $0.00002 par value, authorized 200,000,000 shares,
issued and outstanding, 52,494,909 and 51,989,745 shares ............... 1,041 1,051
Common stock to be issued, 71,513 shares .......................................... -- 1
Preferred stock, $0.00002 par value, $1,000 liquidation preference, authorized
25,000,000 shares, issued and outstanding, 26,070 and 20,.70 shares .... -- --
Additional paid-in capital ........................................................ 258,605,462 248,907,665
Accumulated deficit ............................................................... (220,583,032) (54,634,559)
Deferred compensation ............................................................. (573,979) (1,274,479)
Notes receivable from shareholders ................................................ -- (1,048,872)
------------- -------------
37,449,502 191,950,797
------------- -------------
$ 60,927,908 $ 218,316,373
============= =============
See accompanying notes to consolidated financial statements.
3
4
NOVO NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Nine Months
Ended March 31, Ended March 31,
------------------------------ ------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
(unaudited) (unaudited)
Revenues...................................................... $ 19,749,715 $ 16,308,494 $ 58,940,396 $ 38,970,332
Direct costs ................................................. 19,244,797 15,400,305 57,278,922 37,160,085
------------- ------------- ------------- -------------
Gross profit ................................................. 504,918 908,189 1,661,474 1,810,247
Selling, general and administrative expenses ................. 7,256,348 4,506,404 22,260,358 13,087,581
Reorganization and restructuring charge ...................... (19,499) -- 4,305,952 --
Impairment loss .............................................. 111,862,461 -- 111,862,461 --
Depreciation and amortization ................................ 6,539,092 2,431,734 19,479,700 4,205,374
------------- ------------- ------------- -------------
Loss from operations, before
other (income) expense ................................... (125,133,484) (6,029,949) (156,246,997) (15,482,708)
Other (income) expense
Interest (income) expense, net ........................... 40,513 (223,717) (413,812) 374,343
Write off of unamortized debt discount ................... -- -- -- 917,615
Equity in loss of affiliates ............................. 1,880,052 2,296,913 7,292,626 2,328,732
Foreign currency loss (gain) ............................. 40,521 (84) 62,702 (2,116)
Other .................................................... 186,301 422,915 281,321 423,989
------------- ------------- ------------- -------------
2,147,397 2,496,027 7,222,837 4,042,563
------------- ------------- ------------- -------------
Net loss ..................................................... (127,280,871) (8,525,976) (163,469,834) (19,525,271)
Imputed preferred dividend ................................... -- (9,292,011) (2,299,750) (10,407,954)
------------- ------------- ------------- -------------
Net loss available to common
shareholders ............................................. $(127,280,871) $ (17,817,987) $(165,769,584) $ (29,933,225)
============= ============= ============= =============
Net loss per share - (basic and diluted) ..................... $ (2.43) $ (0.38) $ (3.18) $ (0.84)
============= ============= ============= =============
Weighted average number of shares
outstanding - (basic and diluted) ........................ 52,462,631 46,512,853 52,189,118 35,750,889
============= ============= ============= =============
See accompanying notes to consolidated financial statements.
4
5
NOVO NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended March 31,
------------------------------
2001 2000
------------- -------------
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................................... $(163,469,834) $ (19,525,271)
Adjustments to reconcile net loss to net cash used in
net operating activities:
Depreciation and amortization ........................................................... 19,479,700 4,360,729
Equity in loss of affiliates ............................................................ 7,292,626 2,328,732
Impairment loss ......................................................................... 111,862,461 --
Other non-cash expenses ................................................................. 4,711,783 2,470,192
Change in operating assets and liabilities:
Accounts receivable ................................................................... (5,766,382) (963,142)
Prepaid expenses and other receivables ................................................ (192,147) (65,925)
VAT receivable ........................................................................ 715,371 (90,787)
Restricted cash ....................................................................... (94,180) 1,857,437
Accounts payable ...................................................................... (339,320) 5,246,775
Accrued other ......................................................................... 5,806,067 451,542
Accrued interest payable .............................................................. 121,148 161,285
Customer deposits and deferred revenue ................................................ 458,223 (1,221,541)
------------- -------------
Net cash used in operating activities ........................................................... (19,414,484) (4,989,974)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposits ................................................................................... (546,143) (345,083)
Purchase of property and equipment, net .................................................... (2,740,332) (1,777,447)
Net cash resulting from acquisitions (dispositions) ........................................ (262,703) 509,021
Long-term investments ...................................................................... -- (150,000)
Investments in affiliates .................................................................. (1,055,112) (7,233,242)
------------- -------------
Net cash used in investing activities ........................................................... (4,604,290) (8,996,751)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Shareholder repayments ..................................................................... 96,984 --
Payments on capital leases ................................................................. (2,107,544) (968,628)
Advances (repayments) on notes payable ..................................................... 335,000 (823,278)
Issuance of notes receivable - affiliate, net .............................................. (84,096) --
Issuance of common and preferred stock ..................................................... 6,524,000 28,455,828
------------- -------------
Net cash provided by financing activities ....................................................... 4,764,344 26,663,922
------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS ......................................................... (19,254,430) 12,677,197
CASH AND CASH EQUIVALENTS, beginning of year .................................................... 40,764,246 39,379
------------- -------------
CASH AND CASH EQUIVALENTS, end of period ........................................................ $ 21,509,816 $ 12,716,576
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid for interest ..................................................................... $ 1,025,687 $ 425,621
============= =============
Cash paid for taxes ........................................................................ $ -- $ --
============= =============
SUPPLEMENTAL DISCLOSURE OF NON-CASH OPERATING,
INVESTING AND FINANCING ACTIVITIES:
Purchases of equipment under capital leases ................................................ $ 2,311,153 $ 5,288,392
============= =============
Goodwill arising from change in ownership and acquisitions settled through issuance of
stock ..................................................................................... $ -- $ 108,515,172
============= =============
Net assets of subsidiaries acquired through an issue of stock .............................. $ -- $ 197,169
============= =============
Stock issued for settlement of accounts payable ............................................ $ -- $ 6,549,480
============= =============
See accompanying notes to consolidated financial statements.
5
6
NOVO NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Novo Networks, Inc. ("Novo Networks" or the "Company") is a global
broadband network and communication services company providing
broadband and voice services over a facilities-based network, which
consists of digital switching, routing and signal management equipment,
as well as digital fiber optic cable lines. The network presently
reaches 7 domestic and 6 international cities in North America, Europe,
the Middle East and Mexico. Prior to December 12, 2000, the Company was
known as eVentures Group, Inc.
2. LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2001, the Company had current assets of $31.7 million,
including cash and cash equivalents of $21.5 million. The working
capital surplus at March 31, 2001 was $13.3 million. The Company's cash
balance is expected to provide sufficient liquidity to meet its
operating and capital requirements until the Company's third fiscal
quarter of 2002.
Although the Company was able to raise $7.0 million of equity capital
during fiscal 2001, it did not raise all of the capital required to
complete the build-out of its global network. As a result, during the
three months ended March 31, 2001, the Company has taken the following
measures in an effort to reduce costs and streamline operations: (i)
delayed capital expenditures relating to the expansion of its global
network, (ii) downsized its workforce by approximately 40% and (iii)
discontinued the operations of Internet Global Services, Inc.
("iGlobal"), a wholly-owned subsidiary (see Note 14).
In evaluating strategic alternatives, the Company's board of directors
engaged JP Morgan on March 23, 2001 to assist in the sale or merger of
the Company's voice business. Alternatives currently being pursued may
include a merger with another company, potential strategic
acquisitions, the sale of company assets or one or more of the
Company's business units, further measures to significantly reduce the
Company's operating expenses or other potential measures.
The Company hopes that these measures, plus others that may be
implemented in the future, will position Novo Networks to meet the
challenges now posed by the changing telecommunications marketplace.
Nevertheless, the Company continues to face a challenging liquidity
situation. Since the Company did not raise sufficient capital to fund
its global network expansion and staffing needs, the Company continues
to rely on revenues from the provision of voice services, which
typically generate low gross margins. While the Company hopes to be
able to increase the volume of voice traffic, and therefore increase
the absolute amount of gross profit from the sale of voice services,
the Company has historically not been able to fund its operations from
the voice line of services. As a result, in the quarter ended March 31,
2001, the Company recorded write-downs of communication assets,
goodwill and other strategic investments, which cannot reasonably be
expected to be recovered from positive future cash flows. Additionally,
without access to additional capital, Novo Networks might not be able
to add enough capacity to its network to accommodate the volume of
voice traffic required to generate sufficient gross profit to meet
operational and capital expenditure requirements. Therefore, it is
likely that the Company will have to raise additional capital and
further reduce costs. If the Company has to reduce costs further, it
might also have to enact further reductions in sales, management and
engineering staff, which could have an adverse impact on the ability to
increase the volume of voice revenues.
To the extent these matters remain unresolved prior to the issuance of
the Company's audited financial statements for the period ended June
30, 2001, the Company's independent auditors have stated that it is
likely their audit report on the June 30, 2001 consolidated financial
statements will include a going concern explanatory paragraph.
An additional hurdle that Novo Networks faces is the deteriorating
credit quality of some of its customers. The Company's largest
customer, Qwest Communications, accounts for approximately 40% of
revenues for the nine months ending March 31, 2001. The Company has not
experienced any problems in collecting amounts owed by Qwest. However,
while the Company continues to make every effort to ensure that
receivables are collectible, and engages in continuous monitoring of
credit exposure with each customer, the Company has
6
7
experienced a general increase in the amount of uncollectable accounts
and has increased its reserves accordingly. More significantly, in
recent weeks, two of the Company's larger customers, representing
approximately 6% of total revenues for the nine months ending March 31,
2001, have filed for bankruptcy protection. If the deterioration in
credit quality of the Company's customers continues, or if one or both
of the bankrupt customers fail to reorganize or generate sufficient
proceeds from liquidation, the Company could be forced to write off a
significant amount of receivables as uncollectable. Either of these
scenarios would have an adverse effect on the Company's ability to fund
operations.
Historically, Novo Networks has funded its operations primarily through
private placements of common and preferred stock and borrowings under
loan and capital lease agreements. Novo Network's principal uses of
cash have been to fund (i) the expansion of operations; (ii) working
capital requirements; (iii) capital expenditures, primarily for the
Company's network; (iv) operating losses; and (v) acquisitions and
strategic investments. Due to the lack of stability in the capital
markets and the economy's recent downturn, the Company's only source of
funding, in the near term, is cash on hand. There can be no assurance
that additional financing will be available or, if available, that
financing can be obtained on a timely basis and on acceptable terms.
The failure to obtain such financing on acceptable terms could
significantly reduce the Company's ability to fund development and to
continue its operations.
3. GENERAL
The accompanying consolidated financial statements for the three and
nine month periods ended March 31, 2001 and 2000, have been prepared by
the Company without audit, pursuant to the interim financial statements
rules and regulations of the SEC. In the opinion of management, the
accompanying consolidated financial statements include all adjustments
necessary to present fairly the results of the Company's operations and
cash flows at the dates and for the periods indicated. The results of
operations for the interim periods are not necessarily indicative of
the results for the full fiscal year. The accompanying consolidated
financial statements should be read in conjunction with the Company's
audited consolidated financial statements included in the Company's
Annual Report on Form 10-K for the fiscal year ended June 30, 2000
filed with the Securities and Exchange Commission.
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 revenues and expenses during the reporting period. Actual
results could differ from those estimates. The consolidated financial
statements include the accounts of the Company and all wholly owned and
majority owned subsidiaries. The financial results of e.Volve
Technology Group, Inc. ("e.Volve") are included in the financial
statements for all periods presented. The financial results for AxisTel
Communications, Inc. ("AxisTel") are included in the financial
statements since September 22, 1999, the date of acquisition. The
financial results of iGlobal are included in the financial statements
since its acquisition on March 10, 2000. The consolidated balance sheet
of the Company presented as of March 31, 2001 does not include the
accounts of iGlobal due to management's decision to abandon iGlobal
operations during the quarter ended March 31, 2001. On April 2, 2001,
iGlobal filed a voluntary petition for bankruptcy under Chapter 7 of
the United States Bankruptcy Code.
Certain fiscal 2000 balances have been reclassified for comparative
purposes to be consistent with the fiscal 2001 presentation. All
significant inter-company accounts have been eliminated.
4. LONG-LIVED ASSETS
The Company's long-lived assets consisted primarily of goodwill and
property and equipment. In accordance with the Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards
No. 121, Accounting for the Impairment of Long-lived Assets and for
Long-lived Assets to be Disposed of, the Company assesses the
recoverability of long-lived assets by determining whether the net book
value of the assets can be recovered through projected undiscounted
future cash flows. The amount of impairment, if any, is measured based
on fair value and is charged to operations in the period in which
impairment is determined by management.
7
8
During the three months ended March 31, 2001, the Company recorded an
impairment loss totaling $111.9 million related to (i) its investment
in iGlobal, through the write-off of goodwill of $64.5 million, (ii)
the remaining goodwill of $24.2 million relating to the September 1999
and October 1999 reorganization transactions and (iii) property and
equipment and related prepaid maintenance of $11.9 million associated
with the IRU discussed in Note 7. Included in the total impairment loss
is an impairment loss related to the Company's investments in
affiliates of $11.2 million (see Note 8). To the extent the issues
raised in Note 2 remain unresolved, it could result in the Company
evaluating the recoverability of the remaining long-lived assets based
on the estimated fair value of the assets in a liquidation which
could result in additional impairment charges in future periods.
5. GOODWILL
Goodwill arising from the excess of cost over net assets of businesses
acquired by the Company is amortized on a straight-line basis over
periods ranging from five to ten years. The Company assesses the
recoverability of goodwill by determining whether the amortization over
its remaining life can be recovered through projected undiscounted
future cash flows. The amount of impairment, if any, is measured based
on fair value and is charged to operations in the period in which
impairment is determined by management. During the three months ended
March 31, 2001, the Company recorded impairment loss of $88.7 million
relating to goodwill. As a result of the decision to dispose of iGlobal
operations, iGlobal related goodwill of $64.5 million was written off.
Additionally, in assessing the recoverability of the goodwill related
to the September 1999 and October 1999 transactions, the Company
wrote-off the remaining goodwill of $24.2 million.
6. NET LOSS PER SHARE
The Company calculates earnings per share in accordance with Statement
of Financial Accounting Standards (SFAS) No. 128, Earnings per Share
(EPS). SFAS No. 128 requires dual presentation of basic EPS and diluted
EPS on the face of all income statements for entities with complex
capital structures. Basic EPS is computed as net income divided by the
weighted average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur from
common shares issuable through stock options, warrants, convertible
preferred stock and convertible debentures. Diluted EPS has not been
presented for the effects of stock options, warrants, convertible
preferred stock and convertible debentures as the effect would be
antidilutive. Accordingly, basic and diluted EPS did not differ for any
period presented. For purposes of computation of EPS, the shares issued
for the acquisition of e.Volve (11,365,614 shares) are deemed to have
been in existence for the entire nine month period ended March 31,
2000.
7. PROPERTY AND EQUIPMENT
Property and equipment consists of leasehold improvements, network
equipment under capital leases, IRU fiber optic circuits, network
equipment and furniture and fixtures. Each class of assets is
depreciated over its estimated useful life using the straight-line
method. In assessing the recoverability of the Company's IRU fiber
optic circuit, which had an estimated useful life of 20 years, an
impairment charge of $10.3 million was recorded during the three months
ended March 31, 2001. The impairment amount was determined based on the
difference between the unamortized net book value and the current
market rate for an IRU of similar type and duration and, is included in
impairment loss on the accompanying consolidated statement of
operations.
8. INVESTMENTS IN AFFILIATES
The Company has minority investments in development stage Internet and
communications companies. The company accounts for the majority of its
investments using the equity method. For the three and nine months
ended March 31, 2001, the Company continued to record its proportionate
share of equity losses which totaled $1.9 million and $7.3 million,
respectively. Due to declining market conditions, negative operating
results of the investee companies, lack of the investees' liquidity and
other uncertainties surrounding the recoverability of these
investments, an impairment loss of $11.2 million was recorded during
the three months ended March 31, 2001. The impairment charge is
included in impairment loss on the accompanying consolidated statement
of operations. For those investments in affiliates, which have been
impaired completely, the Company will cease recording its share of
losses incurred by the investee.
8
9
9. NOTES PAYABLE
iGlobal has a credit facility with Cisco Systems Credit Corporation for
$12,000,000 with interest payable quarterly at a spread of 600 basis
points above the three-month London Interbank Offering Rate. The
outstanding principal balance at June 30, 2000 was $3,669,488. Also
included in Notes Payable at June 30, 2000 was an unsecured promissory
note with a former officer of iGlobal in the amount of $245,000 bearing
interest at 6.5% payable monthly. As a result of management's decision
to abandon iGlobal's operations, the accounts of iGlobal, including
these notes payable, have not been included in the consolidated balance
sheet of the Company as of March 31, 2001 (see Note 14).
10. SEGMENT INFORMATION
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, established standards for reporting information about
operating segments in the Company's financial statements. Operating
segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly
by the chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. The
Company's chief operating decision maker is its senior management
group.
The Company has determined that it operates in one segment.
11. REORGANIZATION AND RESTRUCTURING CHARGE
In October, the Company began execution of a plan to consolidate the
assets, network and management of its wholly owned operating
subsidiaries into a single broadband network and communication services
company. The plan has a focus on providing broadband and voice
services to other service providers, which resulted in the
discontinuation of retail Internet access services offered,
principally, digital subscriber line access and dial-up access. The
Company recorded reorganization and restructuring expense totaling
approximately $4.3 million during the quarter ended December 31, 2000.
The restructuring charge of $4.3 million includes cash expenditures
totaling $2.0 million related to (i) personnel severance of $0.6
million, of which $0.4 million has been paid as of March 31, 2001, (ii)
lease abandonment of $1.0 million, and (iii) other costs of $0.4
million and non-cash charges of $2.4 million, primarily for the
write-down of impaired assets and the intrinsic value of stock options
granted to a former employee as part of the separation agreement. The
positions eliminated included three senior management positions as a
result of the management consolidation and 16 technical and support
positions related to the discontinuation of retail Internet access
services.
A summary of the completed and planned reorganization and restructuring
activities follows (amounts in thousands):
REORGANIZATION DECEMBER BALANCE AT MARCH BALANCE AT
AND QUARTER DECEMBER 31, QUARTER MARCH 31,
RESTRUCTURING UTILIZATION 2000 UTILIZATION 2001
---------------- ------------ ----------- ------------ ------------
Personnel severance $ 1,517 $ (217) $ 1,300 $ (1,075) $ 225
Property, plant & equipment 1,374 (1,374) - - -
Abandonment of leased facilities 1,025 (75) 950 (64) 886
Discontinuation and divestiture of
retail Internet access operations 390 (228) 162 (162) -
---------------- ------------ ----------- ------------ ------------
$ 4,306 $ (1,894) $ 2,412 $ (1,301) $ 1,111
================ ============ =========== ============ ============
Amounts not utilized for their intended purpose of $19,499 have been reversed to
operating expense as of March 31, 2001.
9
10
12. INCENTIVE PLAN
In December 2000, the Company adopted a new incentive plan, the Novo
Networks 2001 Equity Incentive Plan, (the "Plan") for its officers and
employees. The maximum number of shares of common stock covered by
options to be granted under the Plan is 12,000,000 shares. As of March
31, 2001, 10,024,000 options had been granted.
13. PRIVATE PLACEMENT
On December 5, 2000, the Company issued 7,000 shares of Series D
Convertible Preferred Stock and 450,001 shares of the Company's common
stock for $7.0 million in cash and a minority interest in a private
communications company. The par value of shares of Series D Convertible
Preferred Stock is $0.00002 with a liquidation value of $1,000 per
share. The shares of Series D Convertible Preferred Stock are
convertible into shares of the Company's common stock at a price of
$7.00 per share. The Company has assigned no value to the minority
interest received in this transaction, and has treated the issuance of
the 7,000 shares of Series D Convertible Preferred Stock and 450,001
shares of common stock as a single transaction. Due to the issuance of
common stock and the beneficial conversion feature of the securities
issued, an imputed preferred dividend of approximately $2.3 million was
recorded during the three months ended December 31, 2000.
14. DISPOSAL OF IGLOBAL
In March 2001, the Company made the decision to dispose of its
investment in iGlobal. On April 2, 2001, iGlobal filed a voluntary
petition for bankruptcy under Chapter 7 of the United States Bankruptcy
Code. All of iGlobal's primary product offerings have been discontinued
or abandoned. As a result of the disposition, the Company recorded an
impairment loss of $64.5 million during the quarter primarily related
to non-cash goodwill recorded in connection with the initial
acquisition of iGlobal. The Company no longer controls the operations
of iGlobal and, accordingly, has not included the accounts of iGlobal
in its consolidated balance sheet. As a result of the disposition, the
Company eliminated $3.7 million in assets excluding goodwill and $9.1
million in liabilities from its consolidated balance sheet. The Company
believes it has no further liabilities or contingencies resulting from
the iGlobal disposition.
The following unaudited pro forma financial information assumes the
disposition of iGlobal took place at the beginning of each of the
fiscal periods presented:
For the Three Months For the Nine Months
Ended March 31, Ended March 31,
-------------------------------- --------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Revenues ......................................... $ 19,303,485 $ 16,228,101 $ 57,617,082 $ 38,889,939
Loss from operations, before
other (income) expense ..................... $(123,637,838) $ (90,506,794) $(148,399,357) $ (99,959,553)
Net loss available to common shareholders ........ $(126,538,405) $(102,276,811) $(158,379,936) $(114,392,049)
Net loss per share - (basic and diluted) ......... $ (2.41) $ (2.20) $ (3.04) $ (3.20)
============= ============= ============= =============
10
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements. We have based these
forward-looking statements on our current expectations and projections about
future events. These statements may be identified by the use of words such as
"expects," "anticipates," "intends," "plans" and similar expressions. Factors
that could cause actual results to differ materially from those reflected in the
forward-looking statements include, but are not limited to, those discussed in
this section, elsewhere in this report and the risks discussed in the "Risk
Factors Related to Our Company" section included in our Annual Report on Form
10-K for our fiscal year ended June 30, 2000 filed with the SEC. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
reflect management's analysis, judgment, belief or expectation only as of the
date hereof. We undertake no obligation to publicly revise these forward-looking
statements to reflect events or circumstances that arise after the date of this
report.
BASIS OF PRESENTATION
Prior to September 22, 1999, we were a public company with no material
operations. We changed our name from eVentures, Inc. to Novo Networks, Inc. in
December 2000. We were formerly known as Adina, Inc., which was incorporated in
the state of Delaware on June 24, 1987. In September and October 1999, we
completed a series of transactions whereby we acquired (i) 100% of the
outstanding shares of e.Volve, (ii) 100% of the outstanding shares of AxisTel,
(iii) 17% of the outstanding shares of PhoneFree and (iv) a note receivable from
e.Volve in the amount of approximately $8.5 million ("Notes"), including accrued
interest. All of the acquisitions and the purchase of the Notes were settled
through the issuance of 42,787,863 shares of our common stock and are
collectively referred to as the "Initial Transaction".
Since we had no material operations prior to the Initial Transaction, the
reorganization was accounted for as a recapitalization of e.Volve. Accordingly,
the historical financial statements presented through September 22, 1999 are
those of e.Volve. The consolidated financial statements presented herein reflect
the consummation of the reorganization, and therefore are the consolidated
financial statements of Novo Networks, Inc. and subsidiaries as of March 31,
2001 and June 30, 2000 and for the period from September 22, 1999 through March
31, 2000 and for the three and nine months ended March 31, 2001. On March 10,
2000, we acquired iGlobal, which has been incorporated into our consolidated
financial statements from the date of acquisition through March 31, 2001. The
consolidated balance sheet of the Company as of March 31, 2001 does not include
the accounts of iGlobal due to the decision to dispose of iGlobal during the
quarter ended March 31, 2001. On April 2, 2001, iGlobal filed a voluntary
petition for bankruptcy under Chapter 7 of the United States Bankruptcy Code.
OVERVIEW
Due to the lack of stability in the capital markets, the economy's recent
downturn and our existing lines of business, we did not raise the additional
capital required to complete the build-out of our global network. As a result,
during the three months ended March 31, 2001, we have taken the following
measures in an effort to reduce costs and streamline operations: (i) delayed
capital expenditures relating to our the expansion of our global network, (ii)
downsized our workforce by approximately 40% and (iii) discontinued the
operations of Internet Global Services, Inc. ("iGlobal"), a wholly-owned
subsidiary.
In evaluating strategic alternatives, our board of directors engaged JP Morgan
to assist in the sale or merger of our voice business. Alternatives currently
being pursued may include a merger with another company, potential strategic
acquisitions, or the sale of company assets or one or more of our business
units, further measures to significantly reduce our operating expenses, or other
potential measures. We hope that these measures, plus others that may be
implemented in the future, will position us to meet the challenges now posed by
the changing telecommunications marketplace.
Revenues. Revenues are generated through the sale of our products and services,
which can be divided into two product groups: broadband services and voice
services. Broadband services consist of transport services such as private line,
asynchronous transfer mode and frame relay, co-location services and managed web
hosting. Voice services include software services that leverage the packet-based
infrastructure of our network to deliver advanced communications services to
end-users. Voice services consist principally of voice-over-Internet-protocol or
VoIP services, VoIP integration services and prepaid calling services. The
majority of our products and services are measured and billed on a per minute
basis.
11
12
Historically, we have derived substantially all of our revenues from the sale of
VoIP and transport services. Our agreements with our wholesale customers are
short term in duration and the rates are subject to change from time to time.
Our three largest customers accounted for 39% and 48% of our revenues during the
three and nine-month periods ended March 31, 2001, respectively.
Direct Costs. Direct costs include per minute termination charges and lease
payments and fees for fiber optic cable. Historically, the call termination
expense component of these direct costs has declined as measured on a cost per
minute basis. Additionally, while the direct costs incurred for leasing
communications network capacity have declined, our existing lease agreements are
generally at fixed rates for periods of one year or longer.
Selling, General and Administrative Expenses. These expenses include general
corporate expenses, management and operations salaries and expenses,
professional fees, sales and marketing expenses, travel expenses, benefits,
facilities costs and administrative expenses. Currently we maintain our
corporate headquarters in Dallas, Texas, and have additional offices in Jersey
City, New Jersey, Kansas City, Missouri, Dallas, Texas, Miami, Florida and
Mexico City, Mexico.
Depreciation and Amortization. Depreciation and amortization represent the
depreciation of property, plant and equipment and the amortization of goodwill
resulting from the reorganization transactions and the acquisition of iGlobal.
Equity in Loss of Affiliates. Equity in losses of affiliates results from our
minority ownership in certain investments that are accounted for under the
equity method of accounting. Under the equity method, our proportionate share of
each affiliate's operating losses and amortization of our net excess investment
over our equity in each affiliate's net assets is included in equity in losses
of affiliates.
12
13
SUMMARY OF OPERATING RESULTS
The table below summarizes our operating results:
Three Months Ended March 31,
------------------------------------------------------
2001 % 2000 %
-------------- ------ -------------- ------
(unaudited)
Revenues ......................................... $ 19,749,715 100.0% $ 16,308,494 100.0%
Direct costs ..................................... 19,244,797 97.4% 15,400,305 94.4%
-------------- ------ -------------- ------
Gross profit ..................................... 504,918 2.6% 908,189 5.6%
Selling, general and administrative expenses ..... 7,256,348 36.7% 4,506,404 27.6%
Restructuring charge ............................. (19,499) (0.1%) -- 0.0%
Impairment loss .................................. 111,862,461 566.4% -- 0.0%
Depreciation and amortization .................... 6,539,092 33.1% 2,431,734 14.9%
-------------- ------ -------------- ------
Loss from operations, before
other (income) expense ...................... (125,133,484) (633.6%) (6,029,949) (37.0%)
Other (income) expenses:
Interest expense (income), net .............. 40,513 0.2% (223,717) (1.4%)
Write off of unamortized debt discount ...... -- 0.0% -- 0.0%
Equity in loss of affiliates ................ 1,880,052 9.5% 2,296,913 14.1%
Foreign currency loss (gain) ................ 40,521 0.2% (84) (0.0%)
Other ....................................... 186,301 0.9% 422,915 2.6%
-------------- ------ -------------- ------
2,147,387 10.9% 2,496,027 15.3%
Net loss ......................................... (127,280,871) (644.5%) (8,525,976) (52.3%)
Imputed preferred dividend ....................... -- 0.0% (9,292,011) (57.0%)
============== ====== ============== ======
Net loss available to
common shareholders ......................... $ (127,280,871) (644.5%) $ (17,817,987) (109.3%)
Net loss per share - (basic and diluted) ......... $ (2.43) $ (0.38)
============== ==============
Weighted average number of shares
outstanding - (basic and diluted) ........... 52,462,631 46,512,853
============== ==============
Nine Months Ended March 31,
----------------------------------------------------
2001 % 2000 %
-------------- ------ -------------- ------
(unaudited)
Revenues ......................................... $ 58,940,396 100.0% $ 38,970,332 100.0%
Direct costs ..................................... 57,278,922 97.2% 37,160,085 95.4%
-------------- ------ -------------- ------
Gross profit ..................................... 1,661,474 2.8% 1,810,247 4.6%
Selling, general and administrative expenses ..... 22,260,358 37.8% 13,087,581 33.6%
Restructuring charge ............................. 4,305,952 7.3% -- 0.0%
Impairment loss .................................. 111,862,461 189.8% -- 0.0%
Depreciation and amortization .................... 19,479,700 33.0% 4,205,374 10.8%
-------------- ------ -------------- ------
Loss from operations, before
other (income) expense ...................... (156,246,997) (265.1%) (15,482,708) (39.7%)
Other (income) expenses:
Interest expense (income), net .............. (413,812) (0.7%) 374,343 1.0%
Write off of unamortized debt discount ...... -- 0.0% 917,615 2.4%
Equity in loss of affiliates ................ 7,292,626 12.4% 2,328,732 6.0%
Foreign currency loss (gain) ................ 62,702 0.1% (2,116) (0.0%)
Other ....................................... 281,321 0.5% 423,989 1.1%
-------------- ------ -------------- ------
7,222,837 12.3% 4,042,563 10.4%
Net loss ......................................... (163,469,834) (277.3%) (19,525,271) (50.1%)
Imputed preferred dividend ....................... (2,299,750) (3.9%) (10,407,954) (26.7%)
============== ====== ============== ======
Net loss available to
common shareholders ......................... $ (165,769,584) (281.2%) $ (29,933,225) (76.8%)
Net loss per share - (basic and diluted) ......... $ (3.18) $ (0.84)
============== ==============
Weighted average number of shares
outstanding - (basic and diluted) ........... 52,189,118 35,750,889
============== ==============
THREE MONTHS ENDED MARCH 31, 2001 COMPARED TO THREE MONTHS ENDED MARCH 31, 2000
Revenues. Revenues increased to $19.7 million during the three months ended
March 31, 2001 from $16.3 million during the three months ended March 31, 2000,
an increase of 21%. Revenues for the three months ended March 31, 2001 were
generated through the sale of (i) 96% voice services, (ii) 2% broadband services
and (iii) 2% Internet services. Sales during the three months ended March 31,
2000 were comprised 97% of voice services and 3% broadband services.
The increase in revenues during the three months ended March 31, 2001 primarily
resulted from an increase in the number of minutes transmitted. During the three
months ended March 31, 2001, we transmitted 210.2 million minutes versus 154.8
million minutes during the three months ended March 31, 2000, an increase of
36%. The increase in traffic during the current three-month period was partially
offset by a decrease in the average price per minute and credits given to
certain broadband customers resulting from network outages of approximately $0.3
million during the current fiscal period. The average revenue per minute
decreased to $0.094 during the three months ended March 31, 2001 versus $0.105
during the comparable period in fiscal 2000.
Direct Costs. Direct costs increased to $19.2 million during the three months
ended March 31, 2001 from $15.4 million during the three months ended March 31,
2000, an increase of 25%. Direct costs increased approximately $5.5 million
during the current year period as a result of the increased volume of minutes
transmitted over our network, partially offset by lower average cost per minute.
Selling, General and Administrative. Selling, general and administrative
expenses increased to $7.3 million during the three months ended March 31, 2001
from $4.5 million in the prior year period, an increase of 62%. Selling,
13
14
general and administrative expenses during the three months ended March 31, 2001
increased primarily due to increases related to our global network build-out and
the related expansion of staffing and facilities, offset in part by decreases in
(i) professional fees and consulting expense of $0.7 million, (ii) stock-based
compensation of $0.3 million and (iii) vendor settlement costs included in the
prior year period of $0.3 million. We anticipate that our selling, general and
administrative expense will decrease in the near term as a result of the recent
measures implemented to reduce costs.
Impairment Loss. During the quarter ended March 31, 2001, we recorded an
impairment loss totaling $111.9 million related to (i) our investment in
iGlobal, (ii) goodwill relating to the Initial Transaction, (iii) investments in
affiliates and (iv) property and equipment. As previously discussed, as of March
31, 2001, we had made the decision to discontinue all iGlobal product offerings,
services and operations which resulted in recording an impairment loss of $64.5
million, comprised primarily of the write-off of non-cash goodwill. Further, in
assessing the recoverability of the remaining goodwill related to the Initial
Transaction, we recorded an impairment loss of $24.2 million. We recorded an
impairment loss of $11.2 million related to our investments in affiliates as a
result of the declining market conditions and the uncertainties surrounding the
recoverability of our investments. Additionally, in assessing the recoverability
of the Company's IRU fiber optic circuit, which had an estimated useful life of
20 years, we recorded an impairment charge of $11.9 million, which included the
write-off of $1.6 million in prepaid IRU maintenance fees.
Depreciation and Amortization. As a result of the reorganization transactions in
September 1999 and October 1999 and the acquisition of iGlobal in March 2000, we
recorded approximately $116.0 million in goodwill. Amortization of goodwill
during the three months ended March 31, 2001 totaled $5.1 million. To the extent
there are no future acquisitions, we do not anticipate incurring any additional
amortization expense due to the goodwill impairment charges recorded during the
March 2001 period. Depreciation recorded on fixed assets during the current year
period totaled $1.4 million compared to $0.7 million for the prior year period.
At March 31, 2001 fixed assets, consisting primarily of network equipment,
totaled $21.9 million compared to $16.3 million at March 31, 2000.
Interest (Income) Expense, Net. We recorded interest expense, net of interest
income from cash investments, of $41,000 for the three months ended March 31,
2001 compared to interest income of $224,000 for the three months ended March
31, 2000. The decrease in interest income during the March 31, 2001 quarter
resulted from increased interest expense related to capital lease obligations
and notes payable and lower interest income as a result of lower cash balances.
Equity in Losses of Affiliates. Equity in loss of affiliates was $1.9 million
during the three months ended March 31, 2001 compared to $2.3 million in the
prior year period. We anticipate that our strategic investments accounted for
under the equity method will continue to invest in the development of their
products and services, and will continue to recognize operating losses, which
will result in future charges to earnings as we record our proportionate share
of such losses. For those investments in affiliates which have been impaired
completely, we will cease recording our share of losses incurred by the
investee.
Imputed Preferred Dividend. During the three months ended March 31, 2000, the
Company recorded an imputed preferred dividend of $9.3 million as a result of
the difference between the closing prices for our common stock on the dates on
which we issued convertible preferred stock and the price per share at which
such preferred stock is convertible into common shares.
NINE MONTHS ENDED MARCH 31, 2001 COMPARED TO NINE MONTHS ENDED MARCH 31, 2000
Revenues. Revenues increased to $58.9 million during the nine months ended March
31, 2001 from $39.0 million during the same prior year period, an increase of
51%. Revenues for the nine months ended March 31, 2001 were generated through
the sale of (i) 95% voice services, (ii) 3% broadband services and (iii) 2%
Internet services. Sales during the nine months ended March 31, 2000 were
comprised of 98% voice services and 2% broadband services.
The increase in revenues during the nine months ended March 31, 2001 is
primarily a result of both (i) revenues generated from AxisTel, which was
acquired as part of the Initial Transaction, being included for the full nine
months during the current year period verses six months in the prior year period
and (ii) increased minutes transmitted, principally wholesale minutes. During
the nine months ended March 31, 2001, we transmitted 594.4 million minutes
versus 371.9 million minutes during the nine months ended March 31, 2000, an
increase of 60%.
14
15
Although revenues increased as a result of increased traffic volumes, the
average price per minute decreased 6% to $0.0991 during the nine months ended
March 31, 2001 from $0.1049 during the comparable period in fiscal 2000.
Direct Costs. Direct costs increased to $57.3 million during the nine months
ended March 31, 2001 from $37.2 million during the nine months ended March 31,
2000, an increase of 54%. The increase in direct costs is principally a result
of the increased traffic volume during the current year, partially offset by a
nominal decrease in the average cost per minute to terminate calls.
Selling, General and Administrative. Selling, general and administrative
expenses increased to $22.3 million during the nine months ended March 31, 2001
from $13.1 million in the prior year period. The increase in selling, general
and administrative expenses during the nine months ended March 31, 2001 resulted
primarily from (i) expenses incurred by companies acquired during fiscal 2000
being included for a full nine-month period, (ii) increases related to our
global network build-out and the associated expansion of staffing and facilities
and (iii) increased reserves for uncollectable accounts. The increase was offset
in part by decreases in (i) professional fees and consulting expense of $3.2
million, (ii) stock-based compensation of $0.9 million and (iii) vendor
settlement costs included in the prior year period of $0.3 million. We
anticipate that our selling, general and administrative expense will decrease in
the near term as a result of the recent measures implemented to reduce costs.
Reorganization and Restructuring Charge. In October 2000, we began execution of
a plan to consolidate the assets, network and management of our wholly owned
operating subsidiaries into a single broadband network and communication
services company. Additionally, the plan had a renewed focus on providing
broadband and voice services to other service providers, which resulted in the
discontinuation of retail Internet access services offered, principally, digital
subscriber line access and dial-up access. We recorded reorganization and
restructuring expense totaling $4.3 million during the nine months ended March
31, 2001. The reorganization and restructuring resulted in the elimination of 19
positions, which occurred over approximately a three-month period. The
reorganization and restructuring charge of $4.3 million includes cash
expenditures totaling $2.0 million related to (i) personnel severance of $0.6
million (ii) lease abandonment of $1.0 million, and (iii) other costs of $0.4
million and $2.4 million of non-cash charges, primarily for the write-down of
impaired assets and the expense associated with intrinsic value of stock options
issued to a former employee.
Impairment Loss. During the nine months ended March 31, 2001, we recorded an
impairment loss totaling $111.9 million related to (i) our investment in
iGlobal, (ii) goodwill relating to the Initial Transaction, (iii) investments in
affiliates and (iv) property and equipment. As previously discussed, as of March
31, 2001, we had made the decision to discontinue all iGlobal product offerings,
services and operations which resulted in recording an impairment loss of $64.5
million, comprised primarily of the write-off of non-cash goodwill. Further, in
assessing the recoverability of the remaining goodwill related to the Initial
Transaction, we recorded an impairment loss of $24.2 million. We recorded an
impairment loss of $11.2 million related to our investments in affiliates as a
result of the declining market conditions and the uncertainties surrounding the
recoverability of our investments. Additionally, in assessing the recoverability
of the Company's IRU fiber optic circuit, which had an estimated useful life of
20 years, we recorded an impairment charge of $11.9 million, which included the
write-off of $1.6 million in prepaid IRU maintenance fees.
Depreciation and Amortization. As a result of the reorganization transactions in
September 1999 and October 1999 and the acquisition of iGlobal in March 2000, we
recorded approximately $116.0 million in goodwill. The current year period
includes amortization of goodwill associated with both the reorganization
transactions and the iGlobal acquisition for the full nine months totaling $15.4
million compared to goodwill amortization of $2.7 million in the prior year
period related to the reorganization representing approximately six months of
amortization for the nine months ended March 31, 2000. To the extent there are
no future acquisitions, we do not anticipate incurring any additional
amortization expense due to the goodwill impairment charges recorded during the
March 2001 period. Depreciation recorded on fixed assets during the current year
period totaled $4.1 million compared to $1.5 million for the prior year period.
Interest (Income) Expense, Net. We recorded interest income, net of expense, of
$0.4 million for the nine months ended March 31, 2001 compared to net interest
expense of $0.4 million for the nine months ended March 31, 2000. The interest
income, net during the nine months ended March 31, 2001 resulted from interest
income on greater average cash balances maintained from the proceeds of private
placements completed in fiscal 2000 and 2001 together with lower interest
expense. The reduction in interest expense was primarily due to the elimination
of $8.0 million of e.Volve's debentures as a result of the reorganization
transaction on September 22, 2000.
15
16
Equity in Losses of Affiliates. Equity in loss of affiliates for the nine months
ended March 31, 2001 totaled $7.3 million and resulted primarily from our 22%
equity interest in PhoneFree.
Write Off Of Unamortized Debt Discount. The $0.9 million write off of
unamortized debt discount in fiscal 2000 resulted from the elimination of
e.Volve's outstanding debentures as a result of the reorganization transaction.
Imputed Preferred Dividend. During the nine months ended March 31, 2001, the
Company recorded an imputed preferred dividend of $2.3 million related to a $7.0
million private placement of preferred and common stock as a result of the
difference between the fair value of the securities issued and the net proceeds
received. The imputed preferred dividend recorded during the prior year period
represents the differences between the closing prices for our common stock on
the dates on which we issued convertible preferred stock during the nine months
ended March 31, 2000 and the price per share at which such preferred stock is
convertible into common shares.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2001, we had current assets of $31.7 million, including cash and
cash equivalents of $21.5 million. The working capital surplus at March 31, 2001
was $13.3 million. The Company's cash balance is expected to provide sufficient
liquidity to meet our operating and capital requirements until our third fiscal
quarter of 2002.
Although we were able to raise $7.0 million of equity capital during fiscal
2001, we did not raise all of the capital required to complete the build-out of
our global network. As a result, during the three months ended March 31, 2001,
we have taken the following measures in an effort to reduce costs and streamline
operations: (i) delayed capital expenditures relating to the expansion of our
global network, (ii) downsized our workforce by approximately 40% and (iii)
discontinued the operations of iGlobal.
In evaluating strategic alternatives, our board of directors engaged JP Morgan
on March 23, 2001 to assist in the sale or merger of our voice business.
Alternatives currently being pursued may include a merger with another company,
potential strategic acquisitions, or the sale of company assets or one or more
of our business units, further measures to significantly reduce the Company's
operating expenses, or other potential measures.
We hope that these measures, plus others that may be implemented in the future,
will position us to meet the challenges now posed by the changing
telecommunications marketplace. Nevertheless, we continue to face a challenging
liquidity situation. Since we did not raise sufficient capital to fund our
global network expansion and staffing needs, we continue to rely on revenues
from the provision of voice services, which typically generate low gross
margins. While we hope to be able to increase the volume of our voice traffic,
and therefore increase the absolute amount of gross profit from the sale of
voice services, we have historically not been able to fund our operations from
the voice line of services. As a result, in the quarter ended March 31, 2001, we
recorded write-downs of communication assets, goodwill and other strategic
investments, which cannot reasonably be expected to be recovered from positive,
future cash flows. Additionally, without access to additional capital, we might
not be able to add enough capacity to our network to accommodate the volume of
voice traffic required to generate sufficient gross profit to meet our
operational and capital expenditure requirements. Therefore, it is likely that
we will have to raise additional capital and further reduce costs. If we have to
reduce our costs further, we might also have to enact further reductions in
sales, management and engineering staff, which could have an adverse impact on
our ability to increase the volume of our voice revenues.
To the extent these matters remain unresolved prior to the issuance of our
audited financial statements for the period ended June 30, 2001, our independent
auditors have stated that it is likely their audit report on the June 30, 2001
consolidated financial statements will include a going concern explanatory
paragraph.
An additional hurdle that we face is the deteriorating credit quality of some of
our customers. Our largest customer, Qwest Communications, accounts for
approximately 40% of our revenues and we have not experienced any problems in
collecting amounts owed to us by Qwest. However, while we make every effort to
ensure that our receivables are collectible, and engage in continuous monitoring
of credit exposure with each of our customers, we have experienced a general
increase in the amount of uncollectable accounts, and have increased our
reserves accordingly. More significantly, in recent weeks two of our larger
customers, representing approximately 6% of our total revenues, have filed for
bankruptcy protection. If the deterioration in credit quality of our customers
continues, or if one or both of our bankrupt customers fails to reorganize or
generate sufficient proceeds from liquidation, we could be forced to write off a
significant amount of receivables as uncollectable. Either of these scenarios
would have an adverse effect on our ability to fund our operations.
16
17
Historically, we have funded our operations primarily through cash flow from
operations, private placements of common and preferred stock and borrowings
under loan and capital lease agreements. Our principal uses of cash have been to
fund (i) the expansion of our operations; (ii) working capital requirements;
(iii) capital expenditures, primarily for our network; (iv) operating losses;
and (v) acquisitions and strategic investments. Due to the lack of stability in
the capital markets, the economy's recent downturn and our existing lines of
business, our only source of funding, in the near term, is cash on hand. There
can be no assurance that additional financing will be available or, if
available, that financing can be obtained on a timely basis and on acceptable
terms. The failure to obtain such financing on acceptable terms could
significantly reduce our ability to fund our development and operations.
Cash flows from operating activities. Cash used in operating activities for the
nine months ended March 31, 2001 totaled $19.4 million compared to $5.0 million
for the nine months ended March 31, 2000. The increased use of cash in our
operating activities is primarily attributable to increased costs associated
with expanding our overall operations, which encompasses (i) networks, (ii)
facilities, and (iii) employee costs. During the nine months ended March 31,
2001 cash flow used by operating activities primarily resulted from operating
losses, net of non-cash charges. At March 31, 2000, cash flows used in operating
activities resulted from operating losses, net of non-cash charges, totaling
$10.4 million and increases in accounts receivable and restricted cash,
partially offset by increases in current liabilities.
Cash flows from investing activities. Net cash used in investing activities was
$4.6 million for the nine months ended March 31, 2001 compared to $9.0 million
for the same period in the prior fiscal year. Investing activities in the
current fiscal year period consisted primarily of purchases of network equipment
$2.7 million and investments in affiliated companies of $1.1 million. Investing
activities for the prior year period consisted principally of investments in
affiliates of $7.2 million and fixed asset purchases of $1.8 million
Cash flows from financing activities. Cash flows provided by financing
activities during the nine months ended March 31, 2001 totaled $4.8 million and
consisted principally of (i) net proceeds from the issuance of 7,000 shares of
Series D Preferred Stock and 450,001 shares of our common stock totaling $6.5
million, and (ii) borrowings under a credit agreement for equipment purchases of
$0.4 million, offset partially by capital lease payments of $2.1 million. Cash
flows provided from financing activities during the prior year period totaled
$26.7 million and was attributable to proceeds from the issuance of common and
preferred stock of $28.5 million, reduced partially by the repayment of a bridge
loan and capital lease payments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of political instability, foreign currency,
interest rate and other risks.
Political Instability Risks. We have relationships with foreign suppliers in
Mexico, India and other countries. We have not experienced any negative economic
consequences as a result of relationships with foreign suppliers in these
countries, but may be negatively affected should political instability in any of
these countries develop.
Foreign Currency Risks. Since the agreements we have entered into with foreign
suppliers in India and other countries are denominated in U.S. dollars, we are
not exposed to risks associated with fluctuations in these foreign currencies.
However, because our agreements with certain Mexican suppliers are denominated
in Mexican pesos, we may be exposed to fluctuations in the Mexican peso, as well
as to downturns in the Mexican economy, all of which may affect profitability.
During the nine months ended March 31, 2001, $16.4 million of our direct costs
were denominated in Mexican pesos. Our foreign currency loss during the nine
months ended March 31, 2001 totaled $62,702.
Interest Rate Risks. We have investments in money market funds of approximately
$20.5 million at March 31, 2001. Due to the short-term nature of our
investments, we believe that the effects of changes in interest rates are
limited and would not materially impact our profitability.
Other Market Risks. We are also exposed to potential risks in dealing with
foreign suppliers in foreign countries associated with potentially weaker
protection of intellectual property rights, unexpected changes in regulations
and tariffs, and varying tax consequences.
17
18
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 2, 2001, e.Volve paid Uni-Tel $250,000 in settlement of all claims
brought by Uni-Tel against e.Volve. This settlement included mutual releases and
resulted in the dismissal of all pending proceedings between the parties.
On April 10, 2001, the district judge for the United States District Court for
the District of Nevada adopted the recommendation of the magistrate judge and
entered a judgment against Orix Systems (a company controlled by Kerry Rogers)
and e.Volve for purported failures to respond to discovery requests from Eltrax,
all of which occurred prior to the reorganization transactions that resulted in
e.Volve becoming a wholly-owned subsidiary of the Company. We are currently
preparing a motion for reconsideration and are considering whether or not to
appeal the judgment. If the motion for reconsideration is denied, Orix Systems
and e.Volve will be jointly and severally liable to Eltrax in an amount equal to
$381,802, plus interest at the rate of 10.5%, from February 19, 1998, to the
date of judgment, and post-judgment interest thereafter, pending any appeal.
We are involved in other legal proceedings from time to time, none of which, if
decided adversely to us, would, in our opinion, have a material adverse effect
on our business, financial condition or results of operations.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 2001 Equity Incentive Plan
(b) Reports on Form 8-K
On March 12, 2001, we filed a Report on Form 8-K detailing a planned
reduction in staff and announcing the engagement of JP Morgan to assist
in the sale or merger of the Company's voice business.
On March 13, 2001, we filed a Report on Form 8-K announcing that we had
received a notice from Infinity Investors Limited, Infinity Emerging
Subsidiary Limited and IEO Investments Limited (the "Requesting
Holders") to the effect that the Requesting Holders were exercising
their collective right to remove certain resale restrictions under the
Registration Rights Agreement, dated September 22, 1999, by and among
Novo Networks, Inc., the Requesting Holders and certain other
stockholders of the Company (the "Registration Rights Agreement").
18
19
On April 17, 2001, we filed a Report on Form 8-K announcing that on
April 2, 2001, Internet Global Services Inc., a 100% owned subsidiary,
filed a voluntary petition for bankruptcy under Chapter 7 of the United
States Bankruptcy Code.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NOVO NETWORKS, INC.
Date: May 14, 2001 By: /s/ Jeffrey A. Marcus
Jeffrey A. Marcus
(Authorized Signatory and Chief Executive Officer)
Date: May 14, 2001 By: /s/ Daniel J. Wilson
Daniel J. Wilson
(Principal Financial and Accounting Officer)
19
20
INDEX TO EXHIBITS
Exhibit
No. Description
- --- -----------
10.1 2001 Equity Incentive Plan
20