FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission file No. 333-52247
Pathnet, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-1941838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1015 31st Street, N.W.
Washington, DC 20007
(Address of principal executive offices)
(Zip Code)
(202) 625-7284
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
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 [ ] No [X]
As of May 1, 1998, there were 1,000,813 shares of the Issuer's common stock, par
value $.01 per share, outstanding.
PATHNET, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 1998
INDEX
Page
----
Part I. Financial Information
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 1998 (unaudited)
and December 31, 1997 1
Consolidated Statements of Operations for the three months ended
March 31, 1998 (unaudited) and 1997 (unaudited) and for the period
August 25, 1995 (date of inception) to March 31, 1998 (unaudited) 2
Consolidated Statements of Cash Flows for the three months ended
March 31, 1998 (unaudited) and 1997 (unaudited) and for the period
August 25, 1995 (date of inception) to March 31, 1998 (unaudited) 3
Notes to Consolidated Financial Statements (unaudited) 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk 11
Part II. Other Information
Item 1. Legal Proceedings 11
Item 2. Changes in Securities and Use of Proceeds 11
Item 3. Defaults Upon Senior Securities 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Item 5. Other Information 12
Item 6. Exhibits and Reports on Form 8-K 13
Signatures 14
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PATHNET, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED BALANCE SHEETS
ASSETS
March 31, 1998 December 31,
(unaudited) 1997
---------------- ----------------
Current assets:
Cash and cash equivalents $ 4,856,610 $ 7,831,384
Prepaid expenses and other current assets 156,716 48,571
---------------- ----------------
Total current assets 5,013,326 7,879,955
Property and equipment, net 9,964,580 7,207,094
Deferred financing costs -- 250,428
Restricted cash 288,736 760,211
---------------- ----------------
Total assets $ 15,266,642 $ 16,097,688
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 7,280,298 $ 5,592,918
Accrued expenses 257,334 --
Deferred revenue 200,000 300,000
---------------- ----------------
Total current liabilities 7,737,632 5,892,918
---------------- ----------------
Series A convertible preferred stock, $0.01 par value, 1,000,000 shares
authorized, issued and outstanding at March 31, 1998 and December 31, 1997,
respectively (liquidation preference $1,000,000) 1,000,000 1,000,000
Series B convertible preferred stock, $0.01 par value, 1,651,046 shares
authorized, issued and outstanding at March 31, 1998 and December 31, 1997,
respectively (liquidation preference $5,033,367) 5,008,367 5,008,367
Series C convertible preferred stock, $0.01 par value, 2,819,549 shares
authorized; 939,850 shares issued and outstanding at March 31, 1998 and
December 31, 1997, respectively (liquidation preference $10,000,367) 9,961,274 9,961,274
---------------- ----------------
Total convertible preferred stock $ 15,969,641 $ 15,969,641
================ ================
Commitments and contingencies
Stockholders' equity (deficit):
Voting common stock, $0.01 par value, 10,200,000 and 7,500,000 shares
authorized at March 31, 1998 and December 31, 1997, respectively; 1,000,813
and 1,000,000 shares issued and outstanding at March 31, 1998
and December 31, 1997, respectively 10,008 10,000
Note receivable from stockholder -- (9,000)
Additional paid-in capital 382,063 381,990
Deficit accumulated during the development stage (8,832,702) (6,147,861)
---------------- ----------------
Total stockholders' equity (deficit) (8,440,631) (5,764,871)
---------------- ----------------
Total liabilities and stockholders' (deficit) $ 15,266,642 $ 16,097,688
================ ================
The accompanying notes are an integral
part of these financial statements
1
PATHNET, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the period
For the three months For the three August 25, 1995
ended March 31, months ended (date of inception)
1998 March 31, 1997 to March 31, 1998
(unaudited) (unaudited) (unaudited)
------------------ ------------------ ------------------
Revenue $ 100,000 $ 10,000 $ 263,500
------------------ ------------------ ------------------
Expenses:
Cost of revenue 714,740 -- 714,740
General and administrative 1,922,217 486,630 6,664,107
Research and development -- -- 245,059
Legal and consulting 225,813 71,324 1,304,364
------------------ ------------------ ----------------
2,862,770 557,954 8,928,270
------------------ ------------------ ----------------
Net operating loss (2,762,770) (547,954) (8,664,770)
Interest expense -- -- (415,357)
Interest and other income 77,929 17,107 247,425
------------------ ------------------ ------------------
Net loss $ (2,684,841)$ (530,847)$ (8,832,702)
================== ================== ==================
Basic and diluted loss per share $ (2.68)$ (0.53)$ (8.83)
================== ================== ==================
Weighted average number of common shares outstanding 1,000,352 1,000,000 1,000,033
================== ================== ==================
The accompanying notes are an integral part
of these financial statements.
2
PATHNET, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months For the three August 25, 1995
ended March 31, months ended (date of inception)
1998 March 31, 1997 to March 31, 1998
(unaudited) (unaudited) (unaudited)
------------------ ------------------ ------------------
Cash flows from operating activities:
Net loss $ (3,384,192)$ (530,847)$ (8,832,702)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation expense 37,223 6,112 93,241
Loss on disposal of asset -- -- 5,500
Write-off of deferred financing costs 337,910 -- 337,910
Interest expense for beneficial conversion feature of bridge loan -- -- 381,990
Accrued interest satisfied by conversion of bridge loan to Series B
preferred stock -- -- 33,367
Changes in assets and liabilities:
Prepaid expenses and other current assets (108,145) -- (156,716)
Deferred revenue (100,000) -- 200,000
Accounts payable 1,687,380 (63,259) 2,188,285
Accrued expenses 257,334 (4,125) 257,334
------------------ ------------------ ------------------
(573,139) (519,119) (5,491,791)
Net cash used in operating activities ------------------ ------------------ ------------------
Cash flows from investing activities:
Expenditures for property and equipment (710,337) (37,385) (904,478)
Expenditures for network construction in progress (2,084,372) -- (4,066,830)
Restricted cash 471,475 -- (288,736)
Repayment of note receivable 9,000 -- 9,000
------------------ ------------------ ------------------
Net cash used in investing activities (2,314,234) (37,385) (5,251,044)
------------------ ------------------ ------------------
Cash flows from financing activities:
Issuance of voting and non-voting common stock -- -- 1,000
Proceeds from sale of Series A preferred stock -- -- 1,000,000
Proceeds from sale of Series B preferred stock -- -- 4,000,000
Proceeds from sale of Series preferred stock representing the
conversion of committed but undrawn portion of bridge
loan to Series B preferred stock -- -- 300,000
Proceeds from sale of Series C preferred stock -- -- 10,000,054
Proceeds from bridge loan -- -- 700,000
Exercise of stock options 81 -- 81
Issuance costs -- -- (63,780)
Financing costs (87,482) -- (337,910)
------------------ ------------------ ------------------
Net cash (used in) provided by financing activities (87,401) -- 15,599,445
------------------ ------------------ ------------------
Net (decrease) increase in cash and cash equivalents (2,974,774) (629,504) 4,856,610
Cash and cash equivalents at the beginning of period 7,831,384 2,318,037 --
------------------ ------------------ ------------------
Cash and cash equivalents at the end of period $ 4,856,610 $ 1,688,533 $ 4,856,610
================== ================== ==================
The accompanying notes are an integral
part of these financial statements.
3
PATHNET, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BUSINESS and FINANCING
Pathnet, Inc. (the Company) was incorporated in the State of Delaware
on August 25, 1995. On August 28, 1995, Path Tel, Inc. (Path Tel), a
shell company with no operations, was merged with and into the Company,
with the Company being the surviving corporation. The sole owner of
Path Tel was the founder (Founder) of the Company. The Company intends
to offer high quality, low cost, long haul telecommunications capacity
to telecom service providers as a "carrier's carrier."
The Company plans to deploy its digital network by upgrading,
integrating and leveraging existing telecommunications assets, sites
and rights of way, including those utilized by railroads, utilities,
state and local governments and pipelines. By integrating the existing
networks of Incumbents, the Company expects to obtain the equivalent of
a nationwide spectrum license at minimal licensing costs. In return for
providing equipment, designing systems and managing the construction of
Incumbent networks, the Company will receive the exclusive contractual
right to market excess capacity created and aggregated on Incumbent
networks. The revenue generated from this activity may be shared with
the Incumbents. In addition to deploying its network by forming
long-term relationships with Incumbents, the Company may enter into
alternative markets or acquire or deploy complementary
telecommunications assets or technologies.
The Company has in place several contracts requiring it to upgrade
existing telecommunication systems. In addition, the Company is
currently in the process of negotiating with several national long
distance carriers who will likely be purchasers of the excess capacity
created. Management believes the first network upgrade has been
completed and capacity is available for commercial sale. The Company is
dependent upon the network upgrades to achieve its objective.
Management's plans to fund operations and the transitioning services
will potentially include public and private sources and strategic
corporate alliances.
The Company has incurred an accumulated deficit of $8,832,702 for the
period August 25, 1995 (date of inception) to March 31, 1998.
Management believes that the Company has adequate liquidity and capital
to fund operations through the second quarter of 2000.
2. BASIS OF ACCOUNTING
The Company's activities to date principally have been securing
contractual alliances with Incumbents, designing and constructing
network segments, obtaining capital and planning its proposed service.
Accordingly, the Company's financial statements are presented as a
development stage enterprise, as prescribed by Statement of Financial
Accounting Standards No. 7, "Accounting and Reporting by Development
Stage Enterprises." As a development stage enterprise, the Company has
been relying on the issuance of preferred stock rather than recurring
revenues for its primary sources of cash since inception.
In the opinion of management, the accompanying unaudited consolidated
financial statements of Pathnet, Inc. and its subsidiary contain all
adjustments
4
(consisting only of normal recurring accruals) necessary to present
fairly the Company's consolidated financial position as of March 31,
1998, and the results of operations and cash flows for the periods
indicated. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. It is
suggested that these condensed consolidated financial statements be
read in conjunction with the financial statements and notes thereto
included in the Company's Registration Statement on Form S-1
(Registration No. 333-52247). The results of operations for the three
months ended March 31, 1998 are not necessarily indicative of the
operating results to be expected for the full year.
3. NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued two new standards
that became effective for reporting periods beginning after December
15, 1997, Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (SFAS 130), and Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131). Effective March 31,
1998, the Company adopted SFAS 130 and SFAS 131. The adoption of these
standards has no material affect on the Company's consolidated
financial statements.
4. LOSS PER SHARE
The Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share" (SFAS 128) effective December 31, 1997. Basic
earnings (loss) per share is computed by dividing net income (loss) by
the weighted average number of shares of common stock outstanding.
Diluted earnings (loss) per share is computed by dividing net income
(loss) by the weighted average common and potentially dilutive common
equivalent shares outstanding. The computation of diluted loss per
share was antidilutive in each of the years presented; therefore, basic
and diluted loss per share are the same.
5
5. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, is comprised of the following
at March 31, 1998 and December 31, 1997:
March 31, 1998 December 31,
(unaudited) 1997
---------------- ----------------
Network construction in progress $8,916,167 $6,831,795
Office and computer equipment 732,748 248,880
Furniture and fixtures 309,074 120,093
Leasehold improvements 99,832 62,344
---------------- ----------------
10,057,821 7,263,112
Less accumulated depreciation (93,241) (56,018)
---------------- ----------------
Property and equipment net $9,964,580 $7,207,094
================ ================
6. SUBSEQUENT EVENTS
On April 8, 1998, the Company completed the issuance and sale of
350,000 units, each consisting of a $1,000 principal amount of 12 1/4%
Senior Notes due 2008 (the Notes) and a warrant to purchase 1.1 shares
of common stock or 385,000 shares in total (the Warrants) at an
exercise price of $0.01 per share for total gross proceeds of
$350,000,000. Issuance costs of approximately $10,500,000 have been
paid. Approximately $345,900,000 of the proceeds have been allocated to
the Notes and approximately $4,100,000 have been allocated to the
Warrants based upon estimated fair values. Interest on the Notes will
accrue at an annual rate of 12 1/4% payable semiannually, in arrears,
beginning October 15, 1998, with principal due in full on April 15,
2008. The Company used $81,128,751 of proceeds to purchase U.S.
Government debt securities which are pledged as collateral for
repayment of all interest due on the Notes through April 15, 2000 with
the balance deposited in cash accounts. The Notes are redeemable, in
whole or part, at any time on or after April 15, 2003 at the option of
the Company, at the following redemption prices plus accrued and unpaid
interest (i) April 15, 2003; 106% of the principal amount, (ii) April
15, 2004; 104% of the principal amount, (iii) April 15, 2005; 102% of
the principal amount and (iv) April 15, 2006; 100% of the principal
amount. In addition, at any time prior to April 15, 2001, the Company
may redeem within sixty days, with the net cash proceeds of one or more
public equity offerings, up to 35% of the aggregate principal at a
redemption price equal to 112.25% of the principal amount plus accrued
and unpaid interest provided that at least 65% of the original
principal amount of the Notes remain outstanding. Upon a change in
control, as defined, each holder of the Notes may require the Company
to repurchase all or a portion of such holder's Notes at a
6
purchase price of cash equal to 101% of the principal amount plus
accrued and unpaid interest and liquidated damages if any.
The Notes contain certain covenants which restrict the activities of
the Company including limitations of indebtedness, restricted payments,
issuances and sales of capital stock, affiliate transactions, liens,
guarantees, sale of assets and dividends.
The Warrants expire on April 15, 2008 and are not separately
transferrable until the earlier of (i) October 15, 1998, (ii) a
registered exchange offer for the Notes, (iii) the occurrence of an
exercise event, as defined, (iv) an event of default, as defined, and
(v) a date determined by the lead initial purchaser of the units.
On April 8, 1998, the Company completed the sale of 1,879,699 shares of
Series C convertible preferred stock for an aggregate purchase price of
approximately $20,000,000. There were no issuance costs associated with
the sale.
On May 8, 1998, the Company filed a Registration Statement with the
Securities and Exchange Commission for an initial public offering (the
Offering). On May 4, 1998, the Company's Board of Directors approved a
5-for-1 stock split, subject to stockholder approval. The stock split
will occur upon the effective date of the aforementioned Registration
Statement. The timing and size of the Offering are dependent on market
conditions and there can be no assurance that the Offering or the stock
split will occur. The pro forma effects on loss per share information
of the stock split are as follows:
For the three months ended
March 31,
----------------------------
1998 1997
--------- ---------
Basic and diluted loss per share,
as reported $(2.68) $(0.53)
Pro forma basic and diluted loss
per share $(0.54) $(0.11)
Weighted average number of
common shares outstanding, as 1,000,352 1,000,000
reported
Pro forma weighted average number
of common shares outstanding 5,001,762 5,000,000
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this item constitute forward-looking
statements. See Part II. Other Information, Item 5(a) "Forward-Looking
Statements."
OVERVIEW
The Company intends to offer high quality, low cost, long haul
telecommunications capacity to telecom service providers as a "carrier's
carrier." The Company plans to deploy its digital network by upgrading,
integrating and leveraging existing telecommunications assets, sites and rights
of way, including those utilized by railroads, utilities, state and local
governments and pipelines ("Incumbents"). The Company's business commenced on
August 25, 1995 and has been funded primarily through equity investments by the
Company's stockholders and a private placement of units consisting of senior
notes and warrants to purchase common stock (the "Debt Offering") in April 1998.
A substantial portion of the Company's activities to date has involved
developing strategic relationships with Incumbents. Due to Pathnet's focus on
developing strategic relationships with Incumbents, its historical revenues only
reflect certain consulting services in connection with the design, development
and construction of digital microwave infrastructure. The Company has also been
engaged in the acquisition of equipment, the development of operating systems,
the design and construction of a Network Operations Center (the "NOC"), capital
raising and the hiring of management and other key personnel. The Company has
experienced significant operating and net losses and negative operating cash
flow to date and expects to continue to experience operating and net losses and
negative operating cash flow until such time as it is able to generate revenue
sufficient to cover its operating expenses. In addition to deploying its network
by forming long-term relationships with Incumbents, the Company may enter into
alternative markets or acquire or deploy complementary telecommunications assets
or technologies.
BUSINESS DEVELOPMENT, CAPITAL EXPENDITURES AND ACQUISITIONS
From inception (August 25, 1995) through March 31, 1998, expenditures
for property, plant and equipment, including construction in progress, totaled
$10.1 million. In addition, the Company incurred significant other costs and
expenses in the development of its business and has recorded cumulative losses
from inception through March 31, 1998 of $8.9 million.
RESULTS OF OPERATIONS
The Company's principal activity from inception through the third
quarter of 1996 involved introducing its business plan to over 300 Incumbents
with significant private networks through face to face meetings. As the Company
began to enter into formal relationships with Incumbents in 1996, additional
engineering, legal, and financial personnel were recruited to support the
increased workflow and to negotiate Incumbent contracts. By the first quarter of
1997, the Company initiated construction on the first segment of the network,
and additional engineering and management personnel were recruited, including
Mr. Richard A. Jalkut, the Company's President and Chief Executive Officer. The
Company has also begun marketing and sales efforts, and hired Mr. Kevin J.
Bennis to develop and execute its sales and marketing plan.
REVENUE
In establishing relationships with Incumbents, the Company has acted as
a provider of services for transitioning the Incumbents from their old network
system onto the Company's network. The services provided by the Company to
Incumbents, including analysis of existing facilities and system performance,
advisory services relating to PCS relocation matters, and turnkey network
construction management, provided substantially all of the Company's historical
revenues.
8
The Company expects substantially all future revenue to be generated from the
sale of telecommunications services. For the three months ended March 31, 1998
and 1997, the Company generated revenues of $100,000 and $10,000, respectively,
from construction management services. The increase is attributable to the
continued performance of these services. For the year ended December 31, 1997,
the Company generated revenues of $162,500, of which $100,000 was derived from
construction management services and $62,500 from PCS relocation advisory
services compared with revenues of $1,000 from PCS relocation advisory services
for the year ended December 31, 1996. The Company generated no revenue during
the period from inception (August 25, 1995) to December 31, 1995.
COSTS AND EXPENSES
For the three months ended March 31, 1998 and 1997, the Company
incurred operating expenses of approximately $2.9 million and $558,000,
respectively. For the year ended December 31, 1997, the Company incurred
operating expenses of approximately $4.3 million compared to operating expenses
of $1.3 million for the year ended December 31, 1996 and $429,000 for the period
from inception through December 31, 1995. Cost of revenue reflects direct costs
associated with performance of construction management services and costs
incurred for telecommunications services for which no corresponding revenue
exists. The increase in expense was directly related to an increase in selling,
general and administrative expenses ("SG&A") as the Company expanded its
engineering, technical, legal, finance, and general management personnel in
connection with the continued signing of new Incumbent agreements and the
ongoing construction of the Company's network. The Company expects SG&A to
continue to increase in the remainder of 1998 as additional staff is added in
all functional areas, particularly in sales and marketing.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to generate cash primarily from external financing
and, as its network matures, from operating activities. The Company's primary
uses of cash will be to fund capital expenditures, working capital and operating
losses. Deployment of the Company's digital network and expansion of the
Company's operations and services will require significant capital expenditures.
Capital expenditures will be used primarily for continued development and
construction of its network, implementing the Company's sales and marketing
strategy and constructing and improving the Company's NOC.
On April 8, 1998, the Company completed the issuance and sale of the
350,000 units (collectively, the "Units"), consisting of 12 1/4% Senior Notes
due 2008 (the "Notes") and warrants (the "Warrants") to purchase shares of
common stock, par value $.01 per share ("Common Stock") resulting in net
proceeds to the Company of $339.5 million, after reduction for offering costs of
approximately $10.5 million. The Company used $81.1 million of the net proceeds
of the Debt Offering to purchase securities (the "Pledged Securities") in an
amount sufficient to provide for payment in full of the interest due on the
Notes through April 15, 2000 and which have been pledged as security for
repayment of the Notes. The indenture relating to the Notes (the "Indenture")
contains provisions restricting, among other things, the incurrence of
additional indebtedness, the payment of dividends and the making of restricted
payments, the sale of assets and the creation of liens.
Concurrently with the Debt Offering, the Company completed the issuance
and sale of 1,879,699 shares of Series C Convertible Preferred Stock at an
aggregate price of $20.0 million (the "1998 Private Equity Investment"),
bringing the total investment by the Company's private equity investors to $36.0
million.
On May 8, 1998, the Company filed a registration statement under the
Securities Act of 1933, as amended, with the Securities and Exchange Commission,
relating to an initial public offering of the Company's Common Stock (the
"Offering"). The timing and size of the Offering are dependent on market
conditions and there can be no assurance that the Offering will be completed.
9
In addition, the Company is currently exploring several vendor
financing alternatives. Although the Company has received commitments (subject
to definitive documentation) from certain of its vendors and prospective lenders
in connection with two such proposed vendor financing facilities, the Company
has not decided to pursue any one particular proposed facility.
The Company currently forecasts that it will require approximately $380
million to fund the Company's operating losses, working capital and capital
expenditures for the next 24 months, at which time the Company expects to have
completed a 29,000 route mile network. Proceeds from the Debt Offering, the
Initial Public Offering and the 1998 Private Equity Investment, together with
other cash on hand, are expected to provide the Company with adequate resources
to meet these projected capital requirements. The Company intends to use any
additional available funds to accelerate its development plans.
The Company expects that a majority of future capital expenditures will
result from customer orders for additional capacity. The Company believes that
the modular design of its network will enable the Company to rely on traditional
sources of financing. In addition, the Company expects to rely on other sources,
including public and private debt and equity financings and operating cash flow
to fund future growth. The Company has not finalized commitments for any
additional financing and there can be no assurance that the Company will be able
to secure financing from these sources on terms that are favorable to the
Company. In addition, the Company may require additional capital in the future
to fund operating deficits and net losses and for potential strategic alliances,
joint ventures and acquisitions. Although there can be no assurance, if the
network roll out were delayed from the schedule currently anticipated by the
Company or if demand for the Company's services were lower than expected, the
Company expects that it would be able to defer or reduce portions of its capital
expenditures.
Because the Company's cost of rolling out its network and operating its
business, as well as its revenues, will depend on a variety of factors
(including, among other things, the ability of the Company to meet its roll-out
schedules, its ability to negotiate favorable prices for purchases of network
equipment, the number of customers and the services they purchase, regulatory
changes and changes in technology), actual costs and revenues will vary from
expected amounts, possibly to a material degree, and such variations are likely
to affect the Company's future capital requirements. Accordingly, there can be
no assurance that the Company's actual capital requirements will not exceed the
anticipated amounts described above. Further, the exact amount of the Company's
future capital requirements will depend upon many factors, including the cost of
the development of its network, the extent of competition and pricing of
telecommunication services in its markets, the acceptance of the Company's
services and the development of new products.
INFLATION
Management does not believe that the Company's business is affected by
inflation to a significantly different extent than the general economy.
YEAR 2000
The Company has established processes for evaluating and managing the
risks and costs associated with Year 2000 software failures. Management is in
the process of taking steps to ensure a smooth Year 2000 transition, including
working with its software vendors to assure that by the end of the first quarter
of 1999, the Company is fully prepared for the Year 2000. The Company has
identified and analyzed both internally developed and acquired software that
utilizes date embedded codes that may experience operational problems when the
Year 2000 is reached. The Company is making and intends to complete necessary
modifications to the identified software by the end of the
10
first quarter of 1999. The Company is also communicating with Incumbents,
suppliers, financial institutions and others with which it does business to
coordinate Year 2000 compliance. Management does not anticipate that the Company
will incur significant operating expenses or be required to invest heavily in
computer systems improvements to be Year 2000 compliant, and does not anticipate
that business operations will be disrupted or that its customers will experience
any interruption of service as a result of the millennium change.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued two new standards
that became effective for reporting periods beginning after December 15, 1997:
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (SFAS 130), and Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" (SFAS
131). Effective March 31, 1998, the Company adopted SFAS 130 and SFAS 131. The
adoption of these standards has no material affect on the Company's financial
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On March 19, 1998, the Company solicited written consents from holders
of its Common Stock, Series A Convertible Preferred Stock, Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock to approve (i) an
amendment to the Company's Restated Certificate of Incorporation; (ii) an
amendment to the Company's Bylaws; (iii) the issuance of Units, consisting of
the Notes and the Warrants, in the Debt Offering; (iv) the incurrence of
indebtedness under a vendor credit facility; (v) the election of certain
individuals as officers of the Company; and (vi) an amendment to the Company's
1997 Stock Incentive Plan (the "1997 Plan") and an increase in the authorized
shares of Common Stock reserved under the 1997 Plan to an aggregate of 1,153,667
shares. Effective March 24, 1998, the Company received written consents
approving the proposals listed in the previous sentence from holders
representing an aggregate of 4,590,896
11
shares of Common Stock, Series A Convertible Preferred Stock, Series B
Convertible Preferred Stock and Series C Convertible Preferred Stock. The
remaining holder representing 813 shares of Common Stock did not respond. In
connection with such written consents, the Company also solicited and received
from the same holders certain amendments and waivers to (i) the Investment and
Stockholders' Agreement, dated as of August 28, 1995, as amended, by and among
the Company and certain of its stockholders signatories thereto; (ii) the
Investment and Stockholders' Agreement, dated as of December 23, 1996, as
amended, by and among the Company and certain of its stockholders signatories
thereto; and (iii) the Investment and Stockholders' Agreement, dated as of
October 31, 1997, by and among the Company and certain of its stockholders
signatories thereto.
In connection with the 1998 Private Equity Financing, the Company
solicited written consents from holders of its Series A Convertible Preferred
Stock, Series B Convertible Preferred Stock and Series C Convertible Preferred
Stock to approve a proposal to issue an additional 1,879,699 shares of Series C
Convertible Preferred Stock. Effective March 27, 1998, such proposal was
approved by the holders of Series A Convertible Preferred Stock, Series B
Convertible Preferred Stock and Series C Convertible Preferred Stock, as the
Company received written consents from holders representing an aggregate of
2,891,479 shares of Series A Convertible Preferred Stock, Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock. Holders representing
an aggregate of 711,124 shares of Series A Convertible Preferred Stock, Series B
Convertible Preferred Stock and Series C Convertible Preferred Stock did not
respond.
On April 1, 1998, the Company solicited written consents from holders
of its Common Stock, Series A Convertible Preferred Stock, Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock to approve a proposal
to increase the size of the Debt Offering to an aggregate amount of $350.0
million. Effective April 1, 1998, the Company received written consents
approving such proposal from holders representing an aggregate of 4,590,896
shares of Common Stock, Series A Convertible Preferred Stock, Series B
Convertible Preferred Stock and Series C Convertible Preferred Stock. The
remaining holder representing 813 shares of Common Stock did not respond.
ITEM 5. OTHER INFORMATION
(A) FORWARD-LOOKING STATEMENTS
Certain statements in this Report, in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and in oral
statements made by or with the approval of an authorized executive officer of
the Company constitute forward-looking statements, including statements which
can be identified by the use of forward-looking terminology such as "believes,"
"anticipates," "expects," "may," "will," or "should" or the negative of such
terminology or other variations on such terminology or comparable terminology,
or by discussions of strategies that involve risks and uncertainties. All
statements other than statements of historical facts in this Report, including,
without limitation, such statements under the caption "Management's Discussion
and Analysis of Financial Condition and Results of Operations," regarding the
Company or any of the transactions described in this Report or the timing,
financing, strategies and effects of such transaction, are forward- looking
statements. Although the Company believes that the expectations reflected in
such forward- looking statements are reasonable, it can give no assurance that
such expectations will prove to have been correct. Important factors that could
cause actual results to differ materially from expectations include, without
limitation, the amount of capital needed to deploy the Company's network; the
Company's substantial leverage and its need to service its indebtedness; the
restrictions imposed by the Company's current and possible future financing
arrangements; the ability of the Company to
12
successfully manage the cost effective and timely completion of its network and
its ability to attract and retain customers for its services; the ability of the
Company to retain and attract relationships with the incumbent owners of the
telecommunications assets with which the Company expects to build its network;
the Company's ability to retain and attract key management and other personnel
as well as the Company's ability to manage the rapid expansion of its business
and operations; the Company's ability to compete in the highly competitive
telecommunications industry in terms of price, service, reliability and
technology; the Company's dependence on the reliability of its network
equipment, its reliance on key suppliers of network equipment and the risk that
its technology will become obsolete or otherwise not economically viable; the
Company's ability to conduct its business in a regulated environment; and the
other factors described in conjunction with the forward-looking statements in
this Report. The Company does not intend to update these forward-looking
statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
27.1 Financial Data Schedule.
(B) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the quarter
ended March 31, 1998.
13
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PATHNET, INC.,
a Delaware corporation
Date: May 22, 1998 By: /s/ Richard A. Jalkut
-------------------------
Richard A. Jalkut
President and Chief Executive Officer
Date: May 22, 1998 By: /s/ William R. Smedberg, V
------------------------------
William R. Smedberg, V
Vice President, Finance
(principal accounting and
financial officer)
14