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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 2001.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to .
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COMMISSION FILE NUMBER 000-26153
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HIGH SPEED ACCESS CORP.
(Exact name of Registrant as specified in its charter)
DELAWARE 61-1324009
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10901 WEST TOLLER DRIVE
LITTLETON, COLORADO 80127
(Address of principal executive offices, including zip code)
720/922-2500
(Registrant's telephone number, including area code)
FORMER NAME, FORMER ADDRESS, AND FORMER YEAR, IF CHANGED SINCE LAST REPORT:
NOT APPLICABLE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Number of shares of Common Stock outstanding as of October 31, 2001...60,394,835
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INDEX
<Table>
PAGE
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2001 (Unaudited) and
December 31, 2000 3
Condensed Consolidated Statements of Operations for the three and nine
months ended September 30, 2001 and 2000 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 2001 and 2000 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 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 26
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 26
Item 2 - Changes in Securities and Use of Proceeds 27
Item 3 - Defaults upon Senior Securities 27
Item 4 - Submission of Matters to a Vote of Security Holders 27
Item 5 - Other Information 27
Item 6 - Exhibits and Reports on Form 8-K 27
Signatures 29
</Table>
2
Part I. Financial Information
Item 1. Financial Statements
HIGH SPEED ACCESS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 12,132 $ 114,847
Short-term investments 22,419 13,229
Restricted cash 2,404 2,469
Accounts receivable, net of allowance for doubtful accounts of $595
and $296, respectively 5,131 2,087
Prepaid expenses and other current assets 6,528 3,818
--------- ---------
Total current assets 48,614 136,450
Property, equipment and improvements, net 29,472 63,008
Intangible assets, net -- 4,197
Deferred distribution agreement costs, net 9,082 11,783
Other non-current assets 5,424 4,269
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Total assets $ 92,592 $ 219,707
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,467 $ 15,395
Accrued compensation and related expenses 7,939 6,757
Other current liabilities 13,048 9,073
Long-term debt, current portion 2,359 2,633
Capital lease obligations, current portion 8,261 7,790
--------- ---------
Total current liabilities 37,074 41,648
Long-term debt 516 2,313
Capital lease obligations 5,311 11,380
Other liabilities 551 --
--------- ---------
Total liabilities 43,452 55,341
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Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value (aggregate liquidation
preference of $75.0 million), 10,000,000 shares authorized,
75,000 shares issued and outstanding at September 30, 2001 and
December 31, 2000 1 1
Common stock, $.01 par value, 400,000,000 shares authorized,
60,394,835 and 58,684,052 shares issued and outstanding at
September 30, 2001 and December 31, 2000, respectively 604 587
Class A common stock, 100,000,000 shares authorized, none issued
and outstanding -- --
Additional paid-in-capital 742,144 737,215
Deferred compensation (2,056) (713)
Accumulated deficit (691,907) (573,217)
Accumulated other comprehensive income 354 493
--------- ---------
Total stockholders' equity 49,140 164,366
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Total liabilities and stockholders' equity $ 92,592 $ 219,707
========= =========
</Table>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
3
HIGH SPEED ACCESS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- ------------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Net revenue $ 11,396 $ 4,282 $ 27,700 $ 9,033
Costs and expenses:
Operating 17,839 18,133 62,319 48,923
Engineering 4,626 6,048 17,466 16,439
Sales and marketing 1,163 5,928 8,603 18,393
General and administrative:
Non-cash compensation expense from stock options, warrants
and restricted stock 240 95 510 143
Amortization of distribution agreement costs 643 796 5,322 1,912
Asset impairment charges 27,480 -- 29,147 --
Other general and administrative expenses 10,681 6,520 24,080 15,660
------------ ------------ ------------ ------------
Total general and administrative 39,044 7,411 59,059 17,715
------------ ------------ ------------ ------------
Total costs and expenses 62,672 37,520 147,447 101,470
------------ ------------ ------------ ------------
Loss from operations (51,276) (33,238) (119,747) (92,437)
Investment income 536 1,544 2,835 5,535
Interest expense (551) (544) (1,778) (1,564)
------------ ------------ ------------ ------------
Net loss available to common stockholders $ (51,291) $ (32,238) $ (118,690) $ (88,466)
============ ============ ============ ============
Basic and diluted net loss available to common stockholders per share $ (0.87) $ (0.56) $ (2.02) $ (1.59)
============ ============ ============ ============
Weighted average shares used in computation of basic and diluted net
loss available to common stockholders per share 58,811,036 57,112,159 58,755,437 55,563,508
</Table>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
HIGH SPEED ACCESS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(IN THOUSANDS)
(UNAUDITED)
<Table>
<Caption>
2001 2000
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OPERATING ACTIVITIES
Net loss $(118,690) $ (88,466)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 25,863 14,549
Asset impairment charges 29,147 --
Non-cash compensation expense from stock options, warrants and restricted stock 510 143
Amortization of distribution agreement costs 5,322 1,912
Changes in operating assets and liabilities:
Restricted cash 65 (2,439)
Accounts receivable (3,044) (1,125)
Prepaid expenses and other current assets (3,419) (6)
Other non-current assets (1,155) (195)
Accounts payable (12,824) 4,101
Accrued compensation and related expenses 1,279 1,948
Other current liabilities 3,649 4,715
Other liabilities 551 --
--------- ---------
Net cash used in operating activities (72,746) (64,863)
--------- ---------
INVESTING ACTIVITIES
Purchases of short-term investments (40,740) (95,890)
Sales and maturities of short-term investments 31,411 180,781
Purchases of property, equipment and improvements, net of leases (12,870) (27,088)
Net cash paid in connection with the purchase of Digital Chainsaw -- (3,573)
--------- ---------
Net cash (used in) provided by investing activities (22,199) 54,230
--------- ---------
FINANCING ACTIVITIES
Net proceeds from issuance of common stock -- 10,000
Payments on capital lease obligations (5,949) (3,940)
Proceeds from long-term debt 1,900 1,213
Payments on long-term debt (3,721) (814)
Proceeds from exercise of stock options -- 672
--------- ---------
Net cash (used in) provided by financing activities (7,770) 7,131
--------- ---------
Net change in cash and cash equivalents (102,715) (3,502)
Cash and cash equivalents, beginning of period 114,847 53,310
--------- ---------
Cash and cash equivalents, end of period $ 12,132 $ 49,808
========= =========
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Equipment acquired under capital leases $ 351 $ 11,346
Property and equipment purchases payable $ 1,401 $ 1,460
Warrants earned in connection with distribution agreements $ 2,621 $ 8,846
Issuance of common stock and employee stock options in connection with the
purchase of Digital Chainsaw -- $ 21,611
Issuance of common stock in connection with distribution agreement $ 375 --
Issuance of common stock in connection with restricted stock grants $ 1,853 --
Issuance of common stock in connection with employer match for 401(k) Plan $ 97 --
</Table>
The accompanying notes are an integral part of these
condensed consolidated financial statements.
5
ITEM 1 - NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION
THE COMPANY
High Speed Access Corp. and its subsidiaries (hereinafter referred to as
the Company, we, us, or our) provides high speed Internet access to residential
and commercial end users primarily using cable modem technology. The Company
enters into long-term exclusive contracts with cable system operators to provide
a suite of services on a comprehensive "turnkey" basis, as well as on an
unbundled or "network services" basis. These services enable a cable system's
customers to receive high speed Internet access.
In exchange for providing the Company with access to its customers in the
turnkey solution, we pay the cable operator a portion of the monthly fees
received from an end user that subscribes to our services. In an unbundled or
Network Services solution, we deliver fewer services and incur lower costs than
a turnkey solution, but also earn a smaller percentage of the subscription
revenue or a fixed fee on a per subscriber basis. Under the Network Services
solution, our cable partners will typically bill the end user and will remit to
us our percentage of the revenue or the fixed fee. Network Services solutions
have become a significant part of our business mix.
On September 28, 2001, we entered into an asset purchase agreement with
Charter Communications Holding Company, LLC, an affiliate of Charter
Communications, Inc. ("Charter"), pursuant to which we will sell to Charter
substantially all of the assets and operations associated with our provision of
high speed Internet access to residential and commercial customers of Charter
and its affiliates via cable modems. This sale is subject to approval by a
majority of the holders of our common stock other than Charter, Vulcan Ventures,
Incorporated ("Vulcan"), their affiliates and our executive officers. We have
also agreed to continue these operations until the closing of the asset sale.
We are presently winding down our operations other than those subject to
the asset purchase agreement. We intend to either fulfill or negotiate an early
termination to our existing contractual obligations to Kabel Nordrhein-Westfalen
GMBH & Co. ("KNRW") in Germany. At this time, we cannot predict whether our KNRW
contract, pursuant to which we provide ISP infrastructure services, will
terminate upon fulfillment in August 2002, or be mutually terminated on some
earlier date.
If the closing of the asset purchase agreement does not occur, we will
likely file for bankruptcy.
BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements included herein
reflect all adjustments, consisting only of normal recurring adjustments, except
for the asset impairment and restructuring charges taken during the period ended
September 30, 2001, which in the opinion of management are necessary to present
fairly the Company's financial position, results of operations and cash flows
for the periods presented. Certain information and footnote disclosures normally
included in audited financial information prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to the
Securities and Exchange Commission's rules and regulations.
The results of operations for the period ended September 30, 2001 are not
necessarily indicative of the results to be expected for any subsequent quarter
or for the entire fiscal year ending December 31, 2001. These financial
statements should be read in conjunction with the financial statements and notes
thereto included in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2000.
ABILITY TO CONTINUE AS A GOING CONCERN
As of September 30, 2001, we had $36.9 million in cash and cash
equivalents, short-term investments and restricted cash. In order to preserve
cash, the Company has implemented a series of significant cost reduction
measures. Among the actions being taken by the Company are:
o the completion of its previously announced exit from certain
non-Charter one-way cable TV markets;
o substantially completed the exit of its turnkey contracts with cable
operators other than Charter (covering approximately 23,000
subscribers);
6
o the scaling back of the operations of Digital Chainsaw, Inc.
("Digital"), including reducing its workforce and eliminating all
service offerings other than web site hosting and the subsequent sale
of substantially all of the operating assets, including hosted
customer websites, on October 31, 2001;
o ceasing entry into the Digital Subscriber Line ("DSL") market and
ceasing development of any other new service and product offerings
other than those that are expected to be cash flow positive in the
short term;
o material reductions in workforce; and
o entering into a management agreement with Charter, pursuant to which
Charter is responsible for the purchase and installation of cable
modems and related equipment while sharing responsibility for product
marketing. In addition, Charter has the option to undertake additional
management responsibilities with respect to the business related to
the assets it seeks to acquire.
After these changes are completed, the Company's operations will consist of
its cable Internet access business with Charter and our existing international
ISP infrastructure services business. The Company expects these reductions in
its operations to result in future operating cost reductions, the amounts of
which cannot yet be determined. However, even with these changes, the Company
will continue to experience substantial negative cash flow from its remaining
operations. Although the Company will continue to monitor the size of its
workforce and the levels of its other operating costs and cash commitments with
a view to conserving cash, the Company will not be able to reduce costs
significantly enough to continue as a going concern without additional
financing.
The Company believes that it will not be able to secure additional
financing in the current economic environment being faced by the
telecommunications industry before its cash reserves are depleted in early 2002.
In light of the difficult current financing environment, the Company has entered
into the asset purchase agreement with Charter. If the asset sale to Charter is
not consummated, the Company will likely file for bankruptcy.
Consequently, there is substantial doubt as to the Company's ability to
continue as a going concern unless it completes the sale of assets to Charter.
The accompanying condensed consolidated financial statements have been prepared
on a going concern basis and include no adjustments that may result from the
outcome of this uncertainty.
See Note 7, "Business Developments."
RECLASSIFICATION
Certain prior period amounts in the condensed consolidated financial
statements have been reclassified to conform to the current period presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain 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 results of operations during the reporting period.
These estimates are based on knowledge of current events and anticipated future
events. Actual results could differ from those estimates.
NOTE 2 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141, "Business Combinations"
("SFAS 141"), which provides that all business combinations should be accounted
for using the purchase method of accounting and establishes criteria for the
initial recognition and measurement of goodwill and other intangible assets
recorded in connection with a business combination. The provisions of SFAS 141
apply to all business combinations initiated after June 30, 2001 and to all
business combinations accounted for by the purchase method that are completed
after June 30, 2001, or later. The Company will apply the provisions of SFAS 141
to any future business combinations.
In addition, the FASB issued Statements of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which establishes
the accounting for goodwill and other intangible assets following their
recognition. SFAS 142 applies to all goodwill and other intangible assets
whether acquired singly, as part of a group, or in a business combination. SFAS
142
7
provides that goodwill should not be amortized but should be tested for
impairment annually using a fair-value based approach. In addition, SFAS 142
provides that other intangible assets other than goodwill should be amortized
over their useful lives and reviewed for impairment in accordance with
Statements of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS 121"). SFAS 142 is effective for the Company beginning on January 1,
2002. The Company has no intangible assets or goodwill at September 30, 2001,
and therefore expects that the adoption of SFAS 142 on January 1, 2002 will have
no impact on the financial condition or results of operations of the Company.
In October 2001, the FASB issued Statements of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121. SFAS 144 applies to all
long-lived assets and consequently amends Accounting Principles Board Opinion
No. 30, "Reporting Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business" ("APB 30"). SFAS 144 develops one accounting model
(based on the model in SFAS 121) for long-lived assets that are to be disposed
of by sale, as well as addresses the principal implementation issues. SFAS 144
requires that long-lived assets that are to be disposed of by sale be measured
at the lower of book value or fair value, less cost to sell. That requirement
eliminates APB 30's requirement that discontinued operations be measured at net
realizable value or that entities include under "discontinued operations" in the
financial statements amounts for operating losses that have not yet occurred.
Additionally, SFAS 144 expands the scope of discontinued operations to include
all components of an entity with operations that (1) can be distinguished from
the rest of the entity and (2) will be eliminated from the ongoing operations of
the entity in a disposal transaction. SFAS 144 is effective for the Company
beginning on January 1, 2002.
NOTE 3 - LOSS PER SHARE
The Company computes net loss available to common stockholders per share
under the provisions of Statements of Financial Accounting Standards No. 128,
"Earnings per Share," ("SFAS 128"). Under the provisions of SFAS 128, basic net
loss available to common stockholders per share is computed by dividing the net
loss available to common stockholders for the period by the weighted average
number of shares of common stock outstanding during the period.
Diluted earnings per share is determined in the same manner as basic
earnings per share, except that the number of shares is increased assuming
exercise of dilutive stock options and warrants using the treasury stock method
and assuming conversion of preferred stock. In addition, income or loss is
adjusted for dividends and other transactions relating to preferred stock for
which conversion is assumed. The calculation of diluted net loss available to
common stockholders per share excludes potential common shares if the effect is
dilutive.
Basic and diluted net loss available to common stockholders per share for
the three months ended September 30, 2001 and 2000, were $0.87 and $0.56 based
on weighted average shares outstanding of 58,811,036 and 57,112,159,
respectively. For the nine months ended September 30, 2001 and 2000, basic and
diluted net loss available to common stockholders were $2.02 and $1.59 based on
weighted average shares outstanding of 58,755,437 and 55,563,508, respectively.
Diluted loss available to common stockholders per share equals basic loss
available to common stockholders per share because the assumed exercise of the
Company's stock options and warrants and the assumed conversion of preferred
stock are dilutive.
Options and warrants to purchase 10,874,224 shares and 7,857,519 shares of
common stock at September 30, 2001 and 2000, respectively, were excluded from
the calculation of net loss available to common stockholders per share. There is
a potential to issue additional warrants pursuant to the agreements set forth in
Note 5. These potential warrants have been excluded from the calculation above
because they are not currently measurable and would be dilutive. Also excluded
from the calculation were 75,000 shares of preferred stock that are convertible
into 14,952,906 shares of common stock at September 30, 2001 and 1,495,000
shares of un-vested, restricted stock issued during the quarter.
NOTE 4 - COMPREHENSIVE LOSS
Comprehensive loss, comprised of net loss available to common stockholders
and net unrealized holding gains and losses on investments, totaled $51.3
million and $32.2 million for the three months ended September 30, 2001 and
2000, respectively, and $118.8 million and $87.7 million for the nine months
ended September 30, 2001 and 2000, respectively.
8
NOTE 5 - DISTRIBUTION AGREEMENTS
As an inducement to certain cable partners to commit systems, the Company
issued warrants to purchase its common stock in connection with Network Service
agreements and other agreements, collectively referred to as distribution
agreements. The Company values warrants to purchase its common stock using an
accepted options pricing model based on the value of the stock when the warrants
are earned. The Company recognizes an addition to equity for the fair value of
any warrants issued, and recognizes the related expense over the term of the
agreement with the respective cable system, generally four to five years, in
accordance with Emerging Issues Task Force Issue No. 96-18, "Accounting for
Equity Instruments that are Issued to Other than Employees for Acquiring or in
Conjunction with Selling, Goods or Services."
In May 2000, the Company entered into a distribution agreement with
Charter, a related party. Under this agreement, Charter committed to provide the
Company exclusive right to provide Network Services related to the delivery of
Internet access to homes passed in certain cable systems. We provide Network
Services, including system monitoring and security, as well as call center
support. Charter receives the warrants described in the following paragraph as
an incentive to provide the Company additional homes passed, although it is not
obligated to do so. Charter can terminate these exclusivity rights, on a
system-by-system basis, if the Company fails to meet performance specifications
or otherwise breaches the agreement. The agreement has an initial term of five
years and may be renewed at Charter's option for additional successive five-year
terms.
In connection with this distribution agreement, the Company and Charter
entered into an amended and restated warrant to purchase up to 12,000,000 shares
of common stock at an exercise price of $3.23 per share and terminated two
warrants that had been issued to Charter in November 1998. The new warrant
becomes exercisable at the rate of 1.55 shares for each home passed committed to
us by Charter under the distribution agreement entered into by Charter and us in
November 1998. The warrant also becomes exercisable at the rate of .775 shares
for each home passed committed to us by Charter under the distribution agreement
entered into in May 2000 up to 5,000,000 homes passed, and at a rate of 1.55
shares for each home passed in excess of 5,000,000. Charter also has the
opportunity to earn additional warrants to purchase shares of common stock upon
any renewal of the May 2000 agreement. If the asset sale to Charter is
consummated, the warrant and the May 2000 agreement will terminate. Such a
renewal warrant will have an exercise price of $10 per share and will be
exercisable to purchase 0.5 shares for each home passed in the systems for which
the May 2000 agreement is renewed. With respect to each home passed, launched or
intended to be launched on or before the second anniversary date of the second
distribution agreement, the Company will pay Charter, at Charter's option, a
launch fee of $3.00 per home passed committed. As of September 30, 2001, the
Company has paid Charter approximately $6.7 million of launch fees related to
launched systems or systems to be deployed in the near future. In these systems
where the Company paid a launch fee to Charter, the Company receives additional
revenue in years two through five of the distribution agreement. The launch fees
paid are amortized against the additional revenue received from Charter. The
Company recently received a non-binding proposal from Charter to acquire the
Company's cable modem business with Charter. See Note 7, "Business Developments"
and "Item 2 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Recent Developments" for a description of such
proposal.
For the three and nine months ended September 30, 2001, the Company
recognized $6.7 million and $16.4 million of revenue, respectively, under these
Charter distribution agreements. At September 30, 2001 the Company had
receivables from Charter of $4.4 million.
As of September 30, 2001, various cable partners, including Charter, had
earned 2,826,714 warrants under distribution agreements. No additional warrants
were earned during the three months ended September 30, 2001. Deferred
distribution agreement costs of $9.1 million, net of accumulated amortization of
$8.2 million, were recorded in conjunction with these warrants at September 30,
2001. Amortization of distribution agreement costs of $0.6 million and $5.3
million were recognized in the statement of operations for the three and nine
months ended September 30, 2001, respectively. Included in the nine month amount
are deferred distribution agreement costs of $2.8 million related to warrants in
terminated systems. The remaining distribution agreement costs which relate
solely to Charter systems, will be written off in connection with the asset sale
to Charter.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
The Company, our directors, our former directors, as well as Charter and
Paul Allen have been named as defendants in three class action lawsuits filed in
the Court of Chancery of the State of Delaware (Denault, et. al. v. O'Brien, et.
al., Civil Action No. 19045NC, Tesche, et. al. v. O'Brien, et al., Civil Action
No. 19046NC and Johnson, et. al. v. O'Brien, et. al., Civil Action No. 19053NC).
All three lawsuits, which subsequently have been consolidated, allege, among
other things, that the initially proposed cash purchase price of $73 million is
grossly inadequate and that "[t]he purpose of the proposed acquisition is to
enable CCI [Charter] and Allen to acquire [the company's] valuable assets for
their own benefit at the expense of [the company's] public shareholders."
The suits allege that the defendants breached their fiduciary duties owed
to the Company in connection with the making and
9
consideration of Charter's proposal. The plaintiffs ask to represent the
interests of all common stockholders of the Company and seek injunctive relief
preventing the Company from going forward with the transaction, to rescind the
transaction in the event it is consummated and unspecified monetary damages. We
believe these lawsuits are without merit and intend to vigorously defend against
the claims made therein.
Also, on November 5, 2001, the Company, our Chief Financial Officer and our
former President, together with Lehman Brothers, Inc., J.P. Morgan Securities,
Inc., CIBC World Markets Corp., and Banc of America Securities, Inc., were named
as defendants in a class action lawsuit filed in the United States District
Court for the Southern District of New York. The lawsuit alleges that the
Company's Registration Statement dated June 3, 1999 and Prospectus dated June 4,
1999 (together "offering materials") for the issuance and initial public
offering of 13,000,000 shares of the Company's common stock to investors
contained material misrepresentations and/or omissions, alleging that the
Company's four underwriters engaged in a pattern of conduct to surreptitiously
extract inflated commissions greater than those disclosed in the offering
materials, among other acts of misconduct. The plaintiff asks to represent the
interest of all common shareholders of the Company and seeks unspecified
monetary damages. We believe this lawsuit is without merit and intend to
vigorously defend against the claims made therein.
Other than the matters above, the Company is not a party to any material
legal proceedings. In the opinion of management, the amount of ultimate
liability with respect to any actions known as of September 30, 2001 will not
materially affect the financial position, results of operations or cash flows of
the Company.
NOTE 7 - BUSINESS DEVELOPMENTS
On September 28, 2001, we entered into an asset purchase agreement with
Charter pursuant to which we will sell to Charter substantially all of the
assets and operations associated with our provision of high speed Internet
access to residential and commercial customers of Charter and its affiliates via
cable modems. We have also agreed to continue these operations until the closing
of the asset sale. The agreed-upon purchase price for the contracts and
associated assets is $81.1 million, consisting of cash and the assumption of
certain liabilities, subject to certain adjustments. In addition, as part of the
proposed transaction consideration, all 37,000 and 38,000 shares of the
Company's convertible preferred stock held by Charter and Vulcan, respectively,
would be cancelled. Additionally, all warrants held by Charter to purchase
shares of our common stock would be cancelled.
In September 2001, our agreement with Time Warner Cable, a unit of AOL/Time
Warner, covering the provision of high speed Internet access services over
AOL/Time Warner's cable systems terminated in accordance with its terms. We had
entered into this agreement in May 2001.
On October 31, 2001 we sold substantially all of the operating assets of
Digital, including its hosted customer websites.
In addition to the asset sale to Charter described above, on November 1,
2001 we entered into an agreement with Vulcan to purchase 20,222,139 shares of
our common stock from Vulcan for an aggregate purchase price of $4.4 million or
$0.22 per share. This purchase price represents a discount of 26% to our common
stock's 20-day trailing average closing price as of October 26, 2001. This
purchase is conditioned on, and will close concurrently with, the consummation
of the asset sale. The shares of common stock subject to this agreement
represent all of the shares of our common stock held by Vulcan.
During the third quarter of 2001, the Company recorded an asset impairment
charge of $27.5 million for the write-down of non-Charter fixed assets. These
assets include equipment used in two-way markets in which we ceased operations
and other excess inventory used in the cable modem and DSL businesses,
furniture, fixtures and equipment located in our Denver corporate headquarters
and call center, regional offices and Digital facility, information systems not
being purchased by Charter, and the goodwill related to the purchase of
CATV.net, Inc. ("CATV"), High Speed Access Network, Inc. ("HSAN") and Digital.
Additionally, the Company recorded in general and administrative expenses an
estimate for lease termination charges of $3.9 million relating to office space
which we currently intend to vacate.
Also during the third quarter of 2001, the Company recorded in general and
administrative expenses $3.2 million of severance and related costs relating to
workforce reductions of approximately 250 employees. Approximately $0.9 million
of these costs were paid during the quarter ended September 30, 2001. The
balance of the severance benefits will be paid through the first quarter of
2002.
10
NOTE 8 - SEGMENT INFORMATION
Segment information has been prepared in accordance with Statements of
Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information." The Company has two reportable segments:
International ISP Infrastructure Services and High Speed Internet Access and
Related Services. The segments were determined based upon the types of services
offered.
In February 2001, the Company began providing Internet infrastructure
services to KNRW in Germany. Revenues from the service agreement are recognized
as services are provided. Prior to 2001, the International ISP Infrastructure
Services segment expenses related to business development activities.
The High Speed Internet Access and Related Services segment includes all
operations of the cable modem business, Digital, and all corporate departments
including accounting, marketing, engineering, human resources and legal and
regulatory functions.
Results of each segment are measured based upon income (loss) from
operations before investment income, interest expense and taxes. In addition,
income (loss) from operations for the International ISP Infrastructure Services
segment excludes allocations of corporate overhead expenses.
The following table sets forth certain financial information by segment (in
thousands):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------ ------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Net revenue:
International ISP Infrastructure Services $ 2,615 $ -- $ 4,692 $ --
High Speed Internet Access and Related Services 8,781 4,282 23,008 9,033
--------- --------- --------- ---------
Total net revenue $ 11,396 $ 4,282 $ 27,700 $ 9,033
========= ========= ========= =========
Income (loss) from operations:
International ISP Infrastructure Services $ 1,445 $ (335) $ 1,891 $ (749)
High Speed Internet Access and Related Services (52,721) (32,903) (121,638) (91,688)
--------- --------- --------- ---------
Total income (loss) from operations $ (51,276) $ (33,238) $(119,747) $ (92,437)
========= ========= ========= =========
</Table>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains certain statements of a
forward-looking nature relating to future events or the future financial
performance of the Company. Such statements are only predictions, involve risks
and uncertainties, and actual events or results may differ materially from the
results discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include those discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risk Factors" as well as those discussed in other filings with the
Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2000. The Company is not
soliciting the vote of any of its stockholders with respect to the approval of
the proposed sale of substantially all of its assets to Charter pursuant to this
Quarterly Report on Form 10-Q. The Company intends to provide to stockholders,
as soon as reasonably practicable, a definitive proxy statement relating to a
special meeting of stockholders at which, among other things, the sale of
substantially all of the Company's assets to Charter will be considered.
OVERVIEW
We provide high speed Internet access to residential and commercial
customers primarily via cable modems. As of September 30, 2001, we had deployed
our services in systems covering approximately 3,850,000 homes passed and had
approximately 200,000 high speed residential end users. Approximately 3,675,000
of our 3,850,000 homes passed are deployed to business and residential customers
of Charter. Subsequent to September 30, 2001, we have successfully negotiated
out of all non-Charter distribution agreements.
On September 28, 2001, we entered into an asset purchase agreement with
Charter, pursuant to which we will sell to Charter substantially all of the
assets and operations associated with our provision of high speed Internet
access to residential and commercial customers of Charter and its affiliates via
cable modems. We have also agreed to continue these operations until the closing
of the asset sale.
11
We are presently winding down our operations other than those subject to
the asset purchase agreement. We intend to either fulfill or negotiate an early
termination to our existing contractual obligations to KNRW in Germany. At this
time, we cannot predict whether our KNRW contract, pursuant to which we provide
ISP infrastructure services, will terminate upon fulfillment in August 2002, or
be mutually terminated on some earlier date.
If the closing of the asset purchase agreement does not occur, we will
likely file for bankruptcy.
OUR BUSINESS PRIOR TO THE CLOSING
Until the closing of the asset purchase agreement, we will provide high
speed Internet access via cable modems to residential and commercial customers
of Charter. At the closing, we will transfer to Charter essentially all of the
assets related to these operations in accordance with the terms of the asset
purchase agreement. In the event that the closing does not occur, we will likely
file for bankruptcy.
We provide services to residential and commercial customers of Charter,
primarily in exurban markets. Pursuant to our existing operating agreements with
Charter, we provide a suite of services on a comprehensive "turnkey" basis as
well as on an unbundled or "network services" basis. These services enable
Charter's customers to receive high speed Internet access. Previously, we had
similar relationships with cable system operators other than Charter. However,
we have exited from these relationships.
In our turnkey solution, we generate revenue primarily from the monthly
fees we receive from end users for our cable modem-based Internet access
services. In our turnkey solution, we generally bill the end user directly and
pay our cable partners a portion of the monthly fee we receive. In these
instances, we report our revenues net of the percentage split we pay to our
cable partners. For promotional purposes, we often provide new end users with 30
days of free Internet access when they subscribe to our services. As a result,
our revenue does not reflect new end users until the end of the promotional
period. We also receive revenues from renting cable modems to end users.
In a Network Services solution, we deliver fewer services and incur lower
costs than in a turnkey solution but will also earn a smaller percentage of the
subscription revenue or a fixed fee on a per subscriber basis. Charter bills the
end user and remits to us our percentage of the revenue or the fixed fee.
Network Services solutions have become a significant part of our business mix.
In connection with the asset purchase agreement, we have entered into a
management agreement with Charter relating to the management of these operations
prior to the closing. Under the management agreement, Charter will assume
responsibility for the purchase and installation of cable modems and will share
marketing responsibilities with us.
Our revenue also includes international ISP infrastructure services to KNRW
in Germany. During 2001, international revenue has become an increasingly
significant part of our business mix.
OUR BUSINESS AFTER THE CLOSING
We have not yet determined what our strategic direction will be following
the consummation of the asset sale and are considering at least three possible
alternatives. Currently, we anticipate pursuing one of the following three
options.
o Option 1 - Make No Distribution; Retain the Proceeds and Reinvent the
Business. We may elect to:
(i) make no distribution to stockholders:
(ii) proceed, as expeditiously and prudently as possible, with the sale of all
of our remaining assets except those required to fulfill our existing
contractual obligations with respect to our international
operations or new strategic initiatives; and
(iii) use all of the proceeds from the asset sale to pursue select domestic
business opportunities as they arise, including the possible acquisition
of an existing business or the development of one or more new businesses.
o Option 2 -- Make a Partial Distribution; Retain Part of the Proceeds and
Reinvent the Business. We may elect to:
12
(i) make a portion of the proceeds from the asset sale available to our
stockholders through a direct distribution, a stock redemption or stock
repurchase program;
(ii) proceed, as expeditiously and prudently as possible, with the sale of all
of our remaining assets except those required to fulfill our existing
contractual obligations with respect to our international operations or
new strategic initiatives; and
(iii) use the remaining proceeds from the asset sale to pursue select domestic
business opportunities as they arise, including the possible acquisition
of an existing business or the development of one or more new businesses.
o Option 3 -- Distribute All of the Proceeds: Wind Down the Business and
Dissolve. We may decide to cease all of our operations and seek stockholder
approval of a plan of liquidation and dissolution so that we may liquidate
all of our remaining assets, pay our known liabilities, distribute our
remaining cash on hand (subject to the set aside of adequate reserves to
cover known, unknown and contingent liabilities that we reasonably expect
to be incurred) and dissolve.
At this time, we cannot predict which option we will pursue. We currently
do not know whether we will make any distributions, or, if we do, the number,
amount or timing of such distributions. Additionally, we may not be successful
in identifying, developing and executing a new business strategy and could
eventually use all, or a substantial portion, of our remaining cash on hand in
connection with any such new business efforts.
In the event we decide to pursue option 1 or option 2, we anticipate that
our operations would consist of the businesses described below. There may be
additional risks that we do not currently know of or that we currently deem
immaterial because of the information available to us. All of these risks may
impair our business operations and could decrease the value of your investment.
INTERNATIONAL BUSINESS
We provide professional services relating to the design, testing and
implementation of broadband Internet access infrastructure services to KNRW in
Germany. Revenues from the service agreement are recognized as services are
provided. For the three and nine months ended September 30, 2001, we recognized
revenues from the service agreement of $2.6 million and $4.7 million,
respectively. Although we believe our international business will be profitable
in the current year and beyond, we cannot assure you that it will be profitable.
Although the term of our current master contract with KNRW expires in
February 2004, our present engagement is scheduled to terminate in August 2002.
We are discussing with KNRW the possibility of mutually terminating our
engagement prior to that, but we cannot predict exactly when that might occur,
if it occurs at all. In any event, KNRW has the right to terminate our contract
with them after the 18-month anniversary of the execution of the contract
(August 2002) or in the event we engage in a transaction constituting a "change
of control" of High Speed Access International, the subsidiary through which we
operate our international business. Even if we do not negotiate an early
termination to the contract, we cannot assure you that KNRW will not terminate
our contract in August 2002 or attempt to do so following the consummation of
the asset sale.
OTHER BUSINESS OPPORTUNITIES; POSSIBLE DISSOLUTION
We also may decide to explore opportunities to acquire, invest in or
develop new lines of business. To date, the board has not proposed a new
strategic direction for the Company. Accordingly, we cannot predict what
businesses we may enter or strategies we may adopt; and thus can offer no
indication of what risks and opportunities might arise in the context of such a
new direction.
RECENT DEVELOPMENTS
Since July 2001, we have taken the following actions to reduce our
operating costs:
o Exit from One-Way Cable TV Markets. We have completed our previously
announced exit from one-way cable TV markets. In the second quarter of
2001, we recorded a $1.7 million asset impairment charge for the
write-down of equipment used in one-way markets and a $1.1 million
charge for other operating costs, primarily non-cancelable lease
obligations.
13
o Exit from Most Two-Way Cable TV Markets. We have exited all of our
two-way cable system agreements except for those with Charter. As of
September 30, 2001, we were in the process of terminating service in
40 systems covering approximately 500,000 homes passed and serving
23,000 high speed residential customers. We will not recognize any
revenue from these subscribers subsequent to October 1, 2001, although
we may continue to provide certain services, including e-mail,
personal web pages and assistance in transitioning services to new
providers, through November 30, 2001. During the quarter ended
September 30, 2001 we recorded an asset impairment charge of $17.5
million for the write-down of the equipment used in these markets,
additional excess inventory used in the cable modem business,
furniture and fixtures and equipment located in our Denver corporate
headquarters and call center and other regional offices, and the write
off of the remaining goodwill associated with the acquisition of CATV
and HSAN.
o Wind Down of Digital, No Earnout Payment. During the quarter ended
September 30, 2001, we recorded an asset impairment charge of $2.2
million for the write-down of the Digital assets, including the
write-off of the remaining goodwill associated with the acquisition of
Digital.
In June 2000, we entered into an agreement to acquire Digital, a
Florida-based web hosting and systems integration company. In August
2000, we issued 3,000,000 shares of common stock in connection with
this transaction in exchange for all for the outstanding shares of
Digital. The purchase agreement requires us to issue up to $25.0
million of our common stock to Digital's former shareholders if
Digital met certain revenue performance targets during 2000 and 2001.
On September 29, 2001, we issued to the Digital former shareholders'
representative a report indicating that Digital had not met the
revenue performance targets established for 2000 and 2001. On October
31, 2001 we sold substantially all of the operating assets of Digital,
including its hosted customer websites.
o Abandon DSL Effort. We have discontinued our efforts to enter the DSL
market and are attempting to sell our DSL equipment. For the quarter
ended September 30, 2001, we recorded an asset impairment charge
relating to the DSL assets of $3.2 million. In connection with the
purchase of certain DSL assets, we entered into a $1.9 million debt
financing agreement with Lucent Technologies Inc. ("Lucent") in July
2001. The debt obligation was paid in full on September 28, 2001 at a
discount of $250,000. This transaction, along with prior purchases,
has fulfilled our $5.0 million purchase obligation with Lucent.
o Write Off Unnecessary Information Systems. We recorded an asset
impairment charge of $4.6 million during the quarter ended September
30, 2001 for information systems which are not being acquired by
Charter and are not required for our continued operations.
o Exit Unnecessary Leased Space. We recorded a charge of $3.9 million
during the quarter ended September 30, 2001 for non-cancelable lease
obligations for office space which we currently intend to vacate.
o Prepay Certain Obligations. We expect to pay certain debt and lease
obligations immediately prior to the closing of the asset sale. We
expect to pay approximately $9.5 million related to these obligations
and record a charge of approximately $1.1 million related to the early
termination of these obligations assuming closing of the asset sale
occurs on or prior to December 31, 2001.
o Terminate AOL/TimeWarner Agreement. In September 2001, our agreement
with Time Warner Cable, a unit of AOL/Time Warner, covering the
provision of high speed Internet access services over AOL/Time
Warner's cable systems terminated in accordance with its terms. We had
entered into this agreement in May 2001.
o Reduce Workforce. We have reduced our workforce to include only those
employees that Charter has agreed to hire on the closing date, those
necessary to operate any assets to be operated as a going concern
after the closing and those necessary to effect the orderly wind-down
and/or restructuring of our remaining assets. Excluding our
international operating personnel (21 employees as of October 15,
2001), we expect to reduce our staff to 12 to 15 full time employees
on or about January 1, 2002, after the consummation of the asset sale.
During the quarter ended September 30, 2001, we incurred approximately
$3.2 million in severance and related costs relating to these
workforce reductions. We do not expect that we will incur additional
costs related to workforce reductions or severance in the fourth
quarter of 2001.
14
At the present time, with the exception of the continuing Charter
operations and the wind-down of our non-Charter turnkey business, the
only assets we are operating are those directly related to the
fulfillment of our KNRW contract in Germany.
We will continue to monitor the size of our workforce and the levels of our
other operating costs and cash commitments with a view to conserving cash,
thereby enhancing our ability to pursue alternative business strategies and/or
maximize a potential distribution to our stockholders.
Our expenses consist of the following:
o Operating costs, which consist primarily of salaries and related
personnel expenses for customer care, field technical support, network
operations center, international, and content and web hosting
employees; telecommunications expenses, including charges for Internet
backbone and telecommunications circuitry; allocated cost of
facilities; costs of installing cable modems for our end users; and
depreciation and maintenance of equipment. Many of our operating costs
are relatively fixed in the short term.
o Engineering expenses, which consist primarily of salaries and related
personnel expenses for the development and support of our information
systems; network design and installation of the telecommunications and
data network hardware and software; system testing and project
management expenses; allocated cost of facilities; and depreciation
and maintenance on the equipment used in our engineering processes.
o Sales and marketing expenses, which consist primarily of salaries and
related personnel expenses, commissions, costs associated with the
development and distribution of sales and marketing materials, the
preparation of database market analytics, and direct mail and
telemarketing expenses.
o Non-cash compensation expense from stock options, warrants and
restricted stock consists of the fair market value of our stock at the
time of grant over the exercise price of the stock options granted to
employees and directors amortized over the vesting period and the fair
market value of non-distribution agreement warrants and restricted
stock issued to employees amortized over the vesting period.
o Amortization of distribution agreement costs, which relates to
warrants issued to cable and strategic partners in connection with
distribution agreements. We measure the cost of warrants issued to
cable and strategic partners based on the fair values of the warrants
when earned by those partners. Because the fair value of the warrant
is dependent to a large extent on the price of our common stock, the
cost of warrants earned in the future may vary significantly. Costs of
warrants granted in connection with distribution agreements are
amortized over the term of the underlying agreement. For markets in
which service was terminated during the second quarter of 2001, the
remaining value of the associated warrants was fully amortized.
o Asset impairment charges, which consists of the write-down of
non-Charter fixed assets. These assets include equipment used in
exited two-way markets and other excess inventory used in the cable
modem and DSL businesses, furniture, fixtures and equipment located in
our Denver corporate headquarters and call center, regional offices
and Digital facility, information systems not being purchased by
Charter, and the goodwill related to the purchase of CATV, HSAN and
Digital.
o Other general and administrative expenses, which consist primarily of
salaries for our executive, administrative and finance personnel;
allocated cost of facilities; severance and related costs;
amortization of goodwill; and fees for professional services.
Our operating results have varied on a quarterly basis during our short
operating history and may fluctuate significantly in the future due to a variety
of factors, many of which are outside our control. In addition, the results of
any quarter do not indicate the results to be expected for a full fiscal year.
The factors that may contribute to fluctuations in our operations are set forth
generally under the caption "Management's Discussion and Analysis of Financial
Conditions and Results of Operations - Risk Factors" and particularly in that
section under the heading "Our Quarterly Operating Results Are Likely To
Fluctuate Significantly And May Not Meet Our Expectations Or The Expectations Of
Analysts And Investors". As a result of such factors, our annual or quarterly
results of operations may be below the expectations of public market analysts or
investors, in which case the market price of the common stock could be
materially and adversely affected.
15
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001
COMPARED WITH THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
REVENUES
Net revenue consists of net monthly subscription fees for cable modem-based
and traditional dial-up Internet services, cable modem rental income,
international infrastructure services, monthly fees for web hosting services and
overall strategic consulting. Total net revenue for the three months ended
September 30, 2001 and 2000 was $11.4 million and $4.3 million, respectively, an
increase of $7.1 million. Total net revenue for the nine months ended September
30, 2001 and 2000 was $27.7 million and $9.0 million, respectively, an increase
of $18.7 million.
In February 2001, the Company began providing internet infrastructure
services to KNRW in Germany. Revenues from the service agreement are recognized
as services are provided. For the three and nine months ended September 30,
2001, the Company recognized revenues of $2.6 million and $4.7 million,
respectively. This agreement is terminable by KNRW in the event of a change of
control of the Company.
Revenue by product offering as a percentage of total net revenue is as follows:
<Table>
<Caption>
% OF REVENUE
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------------------- ------------------------------
2001 2000 2001 2000
---- ---- ---- ----
Cable modem-based subscription fees - Turnkey 28% 37% 31% 42%
Cable modem-based subscription fees - Network Services 30% 11% 27% 8%
Traditional dial-up service fees 2% 10% 4% 14%
Cable modem rental fees 14% 19% 16% 21%
International infrastructure services 23% -- 17% --
Web hosting 2% 3% 3% 1%
Other revenue 1% 20% 2% 14%
--- --- --- ---
100% 100% 100% 100%
=== === === ===
</Table>
COSTS AND EXPENSES
OPERATING. Operating costs for the three months ended September 30, 2001
and 2000 were $17.8 million and $18.1 million, respectively, a decrease of $0.3
million. The decrease in operating costs for the quarter resulted primarily from
cost savings associated with exiting certain non-Charter one-way cable TV
markets, scaling back operations of Digital and cost reduction efforts for the
remaining cable modem business. These cost reductions were partially offset by
increases in personnel and personnel related costs for additional staff in our
customer care and international operations. Operating costs for the nine months
ended September 30, 2001 and 2000 were $62.3 million and $48.9 million,
respectively, an increase of $13.4 million. The increase in operating costs
during 2001 resulted primarily from an increase in personnel and personnel
related costs for additional staff in our customer care and network operation
centers, international operations and additional personnel costs associated with
the purchase of Digital, our larger subscriber base, additional depreciation of
capital equipment from the expansion of our network during the first half of the
year and the installation of cable modems for additional subscribers. In
addition, operating costs for the nine months ended September 30, 2001 include
lease termination and other one-way system charges of $1.1 million.
ENGINEERING. Engineering expenses for the three months ended September 30,
2001 and 2000 were $4.6 million and $6.0 million, respectively, a decrease of
$1.4 million. The decrease in engineering expenses for the quarter resulted
primarily from a reduction in expenses for the development of our information
systems and the curtailment of developing new service and product offerings.
Engineering expenses for the nine months ended September 30, 2001 and 2000 were
$17.5 million and $16.4 million, respectively, an increase of $1.1 million. The
increase in engineering expenses for the nine month period resulted from the
development and support of information systems, an increase in personnel and
personnel-related costs for additional technical staff to support cable modem
services during the first half of the year, continued network design and system
testing during the first half of the year and additional depreciation on capital
equipment. These increases were partially offset by a reduction in expenses for
the development of our billing system.
SALES AND MARKETING. Sales and marketing expenses for the three months
ended September 30, 2001 and 2000 were $1.2 million and $5.9 million,
respectively, a decrease of $4.7 million. Sales and marketing expenses for the
nine months ended September 30, 2001 and 2000 were $8.6 million and $18.4
million, respectively, a decrease of $9.8 million. The decrease in sales and
marketing expenses resulted primarily from lower direct advertising costs, and
reduced sales and marketing efforts due to exiting certain non-Charter markets.
16
NON-CASH COMPENSATION EXPENSE FROM STOCK OPTIONS, WARRANTS AND RESTRICTED
STOCK. Non-cash compensation expense from stock options, warrants and restricted
stock for the three months ended September 30, 2001 and 2000 was $0.2 million
and $0.1 million, respectively, an increase of $0.1 million. Non-cash
compensation expense from stock options, warrants and restricted stock for the
nine months ended September 30, 2001 and 2000 was $0.5 million and $0.1 million,
respectively, an increase of $0.4 million. These expenses represent the excess
of the fair market value of our common stock over the exercise price of the
stock options granted to employees and directors amortized over the vesting
period, the amortization of common stock purchase warrants issued to contractors
and the fair value of restricted stock amortized over the restriction period.
The increase in 2001 resulted from the issuance of 1.5 million shares of
restricted stock to key members of management.
AMORTIZATION OF DISTRIBUTION AGREEMENT COSTS. Amortization of distribution
agreement costs for the three months ended September 30, 2001 and 2000 was $0.6
million and $0.8 million, respectively, a decrease of $0.2 million. Amortization
of distribution agreement costs for the nine months ended September 30, 2001 and
2000 was $5.3 million and $1.9 million, respectively, an increase of $3.4
million. The costs consist of the amortization of the value of warrants earned
under distribution agreements for commitments of homes passed. During the second
quarter of 2001, amortization of distribution agreements costs included $2.8
million for the amortization of warrants issued in one-way markets where service
was terminated during this period. The Company had issued 2,826,714 and
1,658,464 warrants in connection with distribution agreements at September 30,
2001 and 2000, respectively.
In May 2000, the Company and Charter entered into an amended and restated
warrant to purchase up to 12,000,000 shares of our common stock at an exercise
price of $3.23 per share. The restated warrant becomes exercisable at the rate
of 1.55 shares for each home passed committed to us by Charter under the
distribution agreement entered into by Charter and us in November 1998. The
warrant also becomes exercisable at the rate of .775 shares for each home passed
committed to us by Charter under the second distribution agreement entered into
in May 2000 up to 5,000,000 homes passed and at a rate of 1.55 shares for each
home passed in excess of 5,000,000. Charter also has the opportunity to earn
additional warrants to purchase shares of our common stock upon any renewal of
the May 2000 agreement. Such a renewal warrant will have an exercise price of
$10 per share and will be exercisable to purchase one-half of a share for each
home passed in the systems for which the May 2000 agreement is renewed. If the
asset sale is consummated, these warrants and the May 2000 agreement will
terminate.
ASSET IMPAIRMENT CHARGES. Asset impairment charges for the three and nine
months ended September 30, 2001 were $27.5 million and $29.1 million,
respectively. During the third quarter of 2001, the Company recorded an asset
impairment charge of $27.5 million for the write-down of non-Charter fixed
assets. These assets include equipment used in two-way markets in which we
ceased operations and other excess inventory used in the cable modem and DSL
businesses, furniture, fixtures and equipment located in our Denver corporate
headquarters and call center, regional offices and Digital facility, information
systems not being purchased by Charter, and the goodwill related to the purchase
of CATV, HSAN and Digital. During the second quarter of 2001, the Company
recorded an asset impairment charge of $1.6 million related to the assets
located in terminated non-Charter one-way systems.
OTHER GENERAL AND ADMINISTRATIVE. Other general and administrative expenses
for the three months ended September 30, 2001 and 2000 were $10.7 million and
$6.5 million, respectively, an increase of $4.2 million. Other general and
administrative expenses for the nine months ended September 30, 2001 and 2000
were $24.1 million and $15.7 million, respectively, an increase of $8.4 million.
The increase in other general and administrative expenses resulted from
severance costs associated with the termination of certain employees, additional
personnel and personnel related costs to administer the procurement, accounting
and finance functions during the first half of the year, lease termination
costs, additional depreciation on capital equipment and the amortization of
intangible assets associated with the purchase of Digital.
NET INVESTMENT EXPENSE / INCOME. Net investment expense for the three
months ended September 30, 2001 was $15,000 compared to net investment income of
$1.0 million for the three months ended September 30, 2000. Net investment
income for the nine months ended September 30, 2001 and 2000 was $1.1 million
and $4.0 million, respectively. The decrease in net investment income for the
three and nine months ended September 30, 2001, is the result of lower
investment balances. Net investment income represents interest earned on cash,
cash equivalents, short-term investments and restricted cash.
INCOME TAXES. At December 31, 2000, we accumulated net operating loss
carryforwards for federal and state tax purposes of approximately $182.1
million, which will expire beginning in 2018. At December 31, 2000, we had net
deferred tax assets of $77.6 million relating principally to our accumulated net
operating losses. Our ability to realize the value of our deferred tax assets
depends on our future earnings, if any, the timing and amount of which are
uncertain. We have recorded a valuation allowance for the entire
17
net deferred tax asset as a result of those uncertainties. Accordingly, we did
not record any income tax benefit for net losses incurred for the three and nine
months ended September 30, 2001 and 2000.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2001, we had approximately $36.9 million in cash and
cash equivalents, short-term investments and restricted cash. To preserve cash,
the Company has implemented a series of significant cost reduction measures.
Among the actions being taken by the Company are:
o the completion of its previously announced exit from certain one-way
cable TV markets;
o the commencement of negotiations to exit all of its turnkey contracts
with cable operators other than Charter (covering approximately 23,000
subscribers);
o the scaling back of the operations of Digital, including reducing its
workforce and eliminating all service offerings other than web site
hosting and the subsequent sale of certain operating assets, including
hosted customer websites, on October 31, 2001;
o ceasing entry into the DSL market and ceasing development of any other
new service and product offerings other than those that are expected
to be cash flow positive in the short term;
o material reductions in workforce; and
o entering into a management agreement with Charter, pursuant to which
Charter is responsible for the purchase and installation of cable
modems and related equipment while sharing responsibility for product
marketing. In addition, Charter has the option to undertake additional
management responsibilities with respect to the business related to
the assets it seeks to acquire.
After these changes are completed, the Company's operations will consist of
its Internet access cable business with Charter and our existing international
ISP infrastructure services business. The Company expects these reductions in
its operations to result in future operating cost reductions, the amounts of
which cannot yet be determined. However, even with these changes, the Company
will continue to experience substantial negative cash flow from its remaining
operations. Although the Company will continue to monitor the size of its
workforce and the levels of its other operating costs and cash commitments with
a view to conserving cash, the Company will not be able to reduce costs
significantly enough to continue as a going concern without additional
financing.
The Company believes that it will not be able to secure additional
financing in the current economic environment being faced by the
telecommunications industry before its cash reserves are depleted in early 2002.
In light of the difficult current financing environment, the Company has entered
into the asset purchase agreement with Charter. If the asset sale to Charter is
not consummated, the Company will likely file for bankruptcy.
At September 30, 2001, we had cash and cash equivalents of $12.1 million
and short-term investments of $22.4 million, compared with $114.8 million of
cash and cash equivalents and $13.2 million of short-term investments at
December 31, 2000. We had significant negative cash flow from operating
activities for the nine months ended September 30, 2001. Cash used in operating
activities for the nine months ended September 30, 2001 was $72.7 million,
caused primarily by a net loss of $118.7 million, an increase in current and
non-current assets of $7.5 million, a net decrease in accounts payable, accrued
expenses and other current liabilities of $7.3 million, offset by non-cash
expenses of $60.8 million.
Cash used in investing activities for the nine months ended September 30,
2001 was $22.2 million, due to the purchase of short-term investments totaling
$40.7 million and capital expenditures of $12.9 million, partially offset by
sales and maturities of short-term investments of $31.4 million. The principal
capital expenditures incurred during this period were for the purchase of cable
modems, data center equipment, and DSL equipment.
Cash used by financing activities for the nine months ended September 30,
2001 was $7.8 million, comprised of net payments on capital lease obligations
and long-term debt.
If the asset sale is not consummated, we expect to experience substantial
negative cash flow from operating activities and negative cash flow from
investing activities and would likely be unable to attract the funding we need
to continue as a going concern. Under
18
such circumstances, our future cash requirements will depend on a number of
factors, including the success of our cost reduction measures and changes in our
operating expenses, such as our personnel expense.
We expect to incur $15.0 million of capital expenditures in 2001
principally related to the purchase of cable modems, the upgrade of our data
center infrastructure and the purchase of $3.4 million of DSL assets. For the
nine month period ended September 30, 2001, we have incurred $12.9 million of
capital expenditures.
INVESTMENT PORTFOLIO. Cash equivalents are highly-liquid investments with
insignificant interest rate risk and original maturities of 90 days or less and
are stated at amounts that approximate fair value based on quoted market prices.
Cash equivalents consist principally of investments in interest-bearing money
market accounts with financial institutions and highly-liquid investment-grade
debt securities of the U.S. Government.
Short-term investments are classified as available-for-sale and, as a
result, are stated at fair value. Short-term investments are principally
comprised of highly-liquid debt securities of corporations and the U.S.
Government. We record changes in the fair market value of securities held for
short-term investment as an equal adjustment to the carrying value of the
security and stockholders' equity.
Restricted cash is comprised of certificates of deposit collateralizing
letters of credit backing certain leases.
LOAN FACILITIES. The Company has $2.9 million outstanding under various
loan facilities at September 30, 2001 with interest rates on draws on the
facilities ranging from 14.63% to 15.52%. No draws were made on loan facilities
for the nine months ended September 30, 2001.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141, "Business Combinations"
("SFAS 141"), which provides that all business combinations should be accounted
for using the purchase method of accounting and establishes criteria for the
initial recognition and measurement of goodwill and other intangible assets
recorded in connection with a business combination. The provisions of SFAS 141
apply to all business combinations initiated after June 30, 2001 and to all
business combinations accounted for by the purchase method that are completed
after June 30, 2001, or later. The Company will apply the provisions of SFAS 141
to any future business combinations.
In addition, the FASB issued Statements of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which establishes
the accounting for goodwill and other intangible assets following their
recognition. SFAS 142 applies to all goodwill and other intangible assets
whether acquired singly, as part of a group, or in a business combination. SFAS
142 provides that goodwill should not be amortized but should be tested for
impairment annually using a fair-value based approach. In addition, SFAS 142
provides that other intangible assets other than goodwill should be amortized
over their useful lives and reviewed for impairment in accordance with Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 142 is
effective for the Company beginning on January 1, 2002. The Company has no
intangible assets or goodwill at September 30, 2001, and therefore expects that
the adoption of SFAS 142 on January 1, 2002 will have no impact on the financial
condition or results of operations of the Company.
In October 2001, the FASB issued Statements of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"). SFAS 144 supercedes SFAS 121. SFAS 144 applies to all
long-lived assets and consequently amends Accounting Principles Board Opinion
No. 30, "Reporting Results of Operations - Reporting the Effects of Disposal of
a Segment of a Business" ("APB 30"). SFAS 144 develops one accounting model
(based on the model in SFAS 121) for long-lived assets that are to be disposed
of by sale, as well as addresses the principal implementation issues. SFAS 144
requires that long-lived assets that are to be disposed of by sale be measured
at the lower of book value or fair value, less cost to sell. That requirement
eliminates APB 30's requirement that discontinued operations be measured at net
realizable value or that entities include under "discontinued operations" in the
financial statements amounts for operating losses that have not yet occurred.
Additionally, SFAS 144 expands the scope of discontinued operations to include
all components of an entity with operations that (1) can be distinguished from
the rest of the entity and (2) will be eliminated from the ongoing operations of
the entity in a disposal transaction. SFAS 144 is effective for the Company
beginning on January 1, 2002.
19
RISK FACTORS
You should carefully consider the following factors and other information
in this Form 10-Q and other filings we make with the Securities and Exchange
Commission before trading in our common stock. If any of the following risks
actually occur, our business and financial results could be materially and
adversely affected. In that case, the trading price of our common stock could
decline and you could lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS PRIOR TO THE CHARTER ASSET PURCHASE AND OUR
CONTINUING BUSINESS IF THE ASSET PURCHASE FAILS TO CLOSE
WE NEED SUBSTANTIAL ADDITIONAL CAPITAL IF WE ARE TO CONTINUE OUR OPERATIONS
BEYOND EARLY 2002.
The Company believes that it will not be able to secure additional
financing in the current economic environment being faced by the
telecommunications industry before its cash reserves are depleted in early 2002.
In light of the difficult current financing environment, the Company has entered
into the asset purchase agreement with Charter. If the asset sale to Charter is
not consummated, the Company will likely file for bankruptcy. Consequently,
there is substantial doubt as to the Company's ability to continue as a going
concern unless it completes the sale of assets to Charter.
WE HAVE NOT BEEN PROFITABLE AND EXPECT FUTURE LOSSES.
We have a limited operating history and have recognized only limited
revenues since our inception, April 3, 1998. Our senior management team and
other employees have worked together at our Company for only a relatively short
period of time. Since our founding, we have not been profitable, and have
incurred substantial losses to create and introduce our broadband Internet
access services, to operate these services, and to grow our business. Our
limited operating history, the dynamic and immature nature of our industry, and
changes in our business model make predicting our operating results, including
operating expenses, difficult. We also expect to continue to incur substantial
losses and experience substantial negative cash flow from operations for the
foreseeable future.
OUR QUARTERLY OPERATING RESULTS FLUCTUATE SIGNIFICANTLY AND MAY NOT MEET OUR
EXPECTATIONS OR THE EXPECTATIONS OF ANALYSTS AND INVESTORS.
Our revenues and expenses, and in particular our quarterly revenues and
operating results have varied in the past and may fluctuate significantly in the
future due to a variety of factors, many of which are outside of our control.
These factors include:
o Our ability to close the Charter asset purchase in a timely manner;
o Changes in our operating expenses including, in particular, personnel
expenses;
o The success of our cost control measures; and
o Economic conditions specific to the Internet and cable industries, as
well as general economic and market conditions.
In addition, our operating expenses are based on our expectations of the
future demand for our services and are relatively fixed in the short term. We
may be unable to adjust spending quickly enough to offset any unexpected demand
surge or shortfall in demand. A shortfall in revenues in relation to our
expenses could have a material and adverse effect on our business and financial
results.
The quarter-to-quarter comparisons of our results of operations should not
be relied upon as an indication of future performance. It is possible that in
some future periods our results of operations may be below our expectations and
the expectations of public market analysts and investors. In that event, the
price of our common stock is likely to fall.
OUR LARGEST CABLE PARTNER CAN TERMINATE ITS CONTRACT WITH US.
Our only remaining cable partner is Charter, to whom we have agreed to sell
the majority of our assets and operations. Charter is an affiliate of Vulcan, an
affiliate of Microsoft co-founder Paul Allen, who may be deemed to beneficially
own 48.5% of our
20
outstanding common stock as of September 30, 2001, assuming 100% conversion of
the Company's convertible preferred stock and the exercise of 2,650,659 warrants
owned by Charter.
We have entered into several agreements with Charter, including several
distribution agreements. The first distribution agreement was entered into in
November 1998 and the second in May 2000. Under both agreements, we provide
various Network Services related to the delivery of Internet access to homes
passed in some of Charter's cable systems. Under the May 2000 agreement, we will
provide Network Services, including call center support for cable modem
customers as well as network monitoring, troubleshooting and security services.
The agreement has an initial term of five years and may be renewed at Charter's
option for additional successive five-year terms. In a Network Services
solution, we deliver fewer services and incur lower costs than in turnkey
solutions, but will also earn a smaller percentage of the subscription revenue
based on a fixed fee per subscriber. Under the November 1998 agreement, we
provide comprehensive turnkey services.
Charter may, for various reasons or no reason as set forth in the
distribution agreements, terminate our rights. If Charter were to terminate
either agreement, in whole or for any material system, regardless of any
termination fee we may receive, we would lose end users and thus revenue.
BECAUSE OF OUR RELATIONSHIP WITH VULCAN VENTURES, NEW INVESTORS WILL HAVE LITTLE
INFLUENCE OVER MANAGEMENT DECISIONS.
Vulcan and Charter currently own 35.6% and 12.9%, respectively, of our
outstanding stock assuming 100% conversion of the Company's convertible
preferred stock and the exercise of 2,650,659 warrants owned by Charter. Charter
also has warrants to purchase up to 12,000,000 shares of our common stock at an
exercise price of $3.23 per share. Paul Allen is the controlling stockholder of
Charter and Vulcan and as a result Mr. Allen's beneficial ownership of our
outstanding stock is 48.5%. Accordingly, Mr. Allen will be able to significantly
influence and possibly exercise control over most matters requiring approval by
our stockholders, including the election of directors and approval of
significant corporate transactions. This concentration of ownership may also
have the effect of delaying or preventing a change in control. In addition,
conflicts of interest may arise as a consequence of Mr. Allen's control
relationship with us, including:
o Conflicts between Vulcan, Charter and other affiliates of Mr. Allen
and our other stockholders, whose interests may differ with respect
to, among other things, our strategic direction or significant
corporate transactions;
o Conflicts related to corporate opportunities that could be pursued by
us, on the one hand, or by Vulcan, Charter or other affiliates of Mr.
Allen, on the other hand; or
o Conflicts related to existing or new contractual relationships between
us, on the one hand, and Mr. Allen and his affiliates, such as Vulcan
and Charter, on the other hand.
If the asset purchase transaction with Charter and the stock repurchase
transaction with Vulcan are consummated, all shares of preferred stock held by
Charter and Vulcan would be cancelled. See Note 7, "Business Developments" and
Item 2 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Recent Developments" for a description of the
transactions.
WE DEPEND ON THIRD PARTIES AND OUR BUSINESS IS SUBJECT TO DISRUPTION BY EVENTS
OUTSIDE OUR CONTROL.
Our operations depend upon the capacity, reliability and security of the
infrastructure used to carry data between our end users and the Internet. A
significant portion of that infrastructure, including the cable infrastructure,
is owned by third parties. Accordingly, we have no control over its quality and
maintenance. We also rely on other third parties to provide a connection from
the cable infrastructure to the Internet and to provide fulfillment services to
us. Currently, we have transit agreements with MCI WorldCom and its affiliate,
UUNet, and others to support the exchange of traffic between our data servers,
the cable infrastructure and the Internet. We also have agreements with various
vendors to manage and oversee our customer installation process, including
installation, customer education, dispatch service, quality control, recruitment
and training. The failure of these third parties to maintain this infrastructure
and otherwise fulfill their obligations under these agreements could have a
material adverse effect on our business and financial results.
21
Our operations also depend on our ability to avoid damages from fires,
earthquakes, floods, power losses, telecommunications failures, network software
flaws, transmission cable cuts, and similar events. The occurrence of any of
these events could interrupt our services. The failure of the Internet backbone,
our servers, or any other link in the delivery chain, whether from operational
disruption, natural disaster or otherwise, resulting in an interruption in our
operations could have a material adverse effect on our business and financial
results.
WE ARE SUBJECT TO RISKS OF INTERNATIONAL OPERATIONS.
We provide ISP infrastructure consulting services to KNRW in Germany. We
believe that our existing contractual obligations to KNRW will be fulfilled by
mid-2002. Consequently, we are subject to the risks of conducting business
internationally, including:
o Foreign currency fluctuations, which could result in increased
operating expenses;
o The burdens of complying with a variety of foreign laws and trade
standards;
o Tariffs and trade barriers;
o Difficulty in accounts receivable collection;
o Foreign taxes;
o Unexpected changes in regulatory requirements, including the
regulation of Internet access; and
o Uncertainty regarding liability for information retrieved and
replicated in foreign countries.
We are not actively seeking other international expansion opportunities. In
the unlikely event that we do expand internationally, in addition to those risks
listed above, we will also be subject to general geopolitical risks, such as
political and economic instability and changes in diplomatic and trade
relationships. Our international operations could harm our revenues and ability
to achieve profitability.
OUR CONVERTIBLE PREFERRED STOCK CONTAINS ANTI-DILUTION PROVISIONS AND OTHER
RESTRICTIONS ON OUR FUTURE ACTIVITIES.
Vulcan and Charter own 38,000 and 37,000 convertible preferred shares,
respectively. Paul Allen controls Vulcan and Charter. The shares of convertible
preferred stock were initially convertible at a conversion price of $5.01875 per
share into 14,943,960 shares of common stock. The conversion price is subject to
an anti-dilution adjustment which increases the number of shares that will be
issued to Vulcan and Charter upon conversion of the convertible preferred stock
if we issue common stock (or are deemed to issue common stock) at below the
conversion price. The conversion price at September 30, 2001 was $5.01575.
The terms of the convertible preferred stock also place significant
restrictions on our activities in the future. Among other things, these
constraints will require us to:
o Obtain the approval of Vulcan and Charter before declaring a dividend,
entering into a merger, acquisition, consolidation, business
combination, or other similar transaction, or issuing any debt or
equity securities;
o Provide Vulcan and Charter with a right of first refusal to purchase
shares of stock, common or otherwise, that we may offer in the future;
and
o Offer and make available to Vulcan, Charter and their affiliates,
licensing and business arrangements relating to our technologies,
products and services, of any combination thereof, on terms and
conditions at least as favorable as those agreed to with any third
party at substantially the same level of purchase or other financial
commitment.
Because the convertible preferred stock has voting rights, its issuance has
a dilutive effect on the relative voting power of our common stockholders. You
should also be aware that conversion of the convertible preferred stock into
shares of common stock will
22
have a dilutive effect on earnings per share of our common stockholders. In
addition, you should note that we may issue additional shares of common stock in
connection with the payment of dividends or conversion price adjustments on the
convertible preferred stock, which may increase the number of shares of common
stock issued in connection with the transaction.
RISKS RELATED TO THE CHARTER ASSET PURCHASE AND OUR BUSINESS AFTER THE CLOSING
OF THE CHARTER ASSET PURCHASE
WE MIGHT FAIL TO SATISFY A CLOSING CONDITION OR OTHERWISE FAIL TO CLOSE THE
ASSET PURCHASE AGREEMENT WITH CHARTER.
The consummation of the asset purchase agreement is subject to a number of
conditions, including conditions related to:
o The representations and warranties contained in the asset purchase
agreement;
o The performance of all obligations contained in the asset purchase
agreement;
o Required consents;
o The absence of any developments having a material adverse effect; and
o The delivery of required opinions and certificates.
In addition, as a condition to the closing of the asset sale, the asset
purchase agreement requires the approval of a majority of the votes actually
cast at a Special Meeting (in person or by proxy) by holders of our common stock
other than Charter, Vulcan, their respective affiliates and certain of our
executive officers. The satisfaction of this condition does not depend on any
minimum number of votes to be present or cast at the Special Meeting and there
will not be a separate vote or ballot for the purposes of satisfying this
condition. Rather, this condition will be satisfied by the approval of a simple
majority of those votes actually cast. Accordingly, for the purposes of
satisfying this condition in the asset purchase agreement, broker non-votes and
abstentions will have no effect, whereas votes actually cast for or against the
asset sale will have an effect.
If we violate any of these provisions and fail to cure or obtain a waiver
of such conditions, the Company will continue to exist as a publicly owned
entity, however we will not have sufficient capital to fund our operations and
it is likely that we will file for bankruptcy. If the asset sale is not
consummated, our preferred stock will remain outstanding. Therefore, if we
subsequently liquidate and dissolve, Charter Communications Ventures, LLC and
Vulcan, as the holders of our preferred stock, will have a liquidation
preference over holders of our common stock with respect to any liquidating
distribution of our assets. Accordingly, if the asset sale is not approved or
otherwise not consummated, your stock would likely be rendered worthless.
Additionally, if Charter Communications Ventures, LLC and Vulcan were to
continue to hold our preferred stock, we would be unable to sell substantially
all of our assets or merge into or otherwise be acquired by another company
without the consent of Charter Communications Ventures, LLC and Vulcan.
WE ARE SUBJECT TO RISKS INHERENT IN PURSUING OTHER BUSINESS OPPORTUNITIES SHOULD
WE ELECT TO REMAIN IN BUSINESS.
The Company may decide to explore opportunities to acquire, invest in or
develop new lines of business. To date, our board has not proposed a new
strategic direction for the Company. Accordingly, we cannot predict what
businesses we may enter or strategies we may adopt; and thus can offer no
indication of what risks and opportunities might arise in the context of such a
new direction.
Similarly, any new strategic direction we choose could likely involve the
acquisition or development of other businesses. Any
23
decision we make with respect to any new strategic direction will likely involve
risks, including the following:
o We have no specific plan as to what businesses or products we may seek
to acquire or develop, and therefore may have no operating history or
experience in such businesses upon which you may base an evaluation of
any strategic business plan and determine our prospects. Any business
we might develop will likely involve all of the risks, uncertainties,
expenses and difficulties frequently encountered by development stage
companies.
o Our future success depends, in significant part, on our ability to
attract, hire and retain directors, management and other personnel
with the managerial, marketing and technical skills that may be
required by any business or businesses that we acquire in the future.
As part of our recent cost-cutting measures, we have substantially
reduced the Company's workforce (except for those employees who will
be hired by Charter). Competition for personnel is intense, and there
may be a limited number of persons with knowledge of, and experience
in, any industry we might seek to enter. If we fail to timely
identify, recruit and hire qualified personnel, we may be unable to
compete effectively.
o To be successful in any planned acquisition, we will need to identify
applications, technologies and businesses that are complementary, and
we may need to integrate disparate technologies and corporate cultures
and potentially manage a geographically dispersed company. Each
subsequent acquisition may divert our attention from our existing
business concerns and expose us to unforeseen liabilities or risks
associated with entering new markets. Integrating newly acquired
organizations and technologies into our company could be expensive,
time consuming and may strain our resources. We anticipate that we
will face intense competition for acquisitions, and that many of these
competitors will be larger, better-funded organizations. If we fail to
execute our acquisition strategy successfully for any reason, our
business may be adversely affected. We do not have a tested business
model and we cannot be sure that any business model we develop will
yield positive results.
o We may pay for some of our acquisitions by issuing additional common
stock and this could dilute our stockholders. We may also use cash to
buy companies or technologies in the future. If we do use cash, we may
need to incur debt to pay for these acquisitions as well as to fund
any operating losses. Acquisition financing may not be available on
favorable terms or at all. In addition, we may be required to amortize
significant amounts of goodwill and other intangible assets in
connection with future acquisitions, which would have an adverse
affect on our results of operations.
We intend to identify potential acquisition candidates through contacts
with persons and entities including investment banks, accountants, consultants,
and other professionals. Affiliates of ours, including their officers and
directors who are instrumental in identifying or closing future acquisitions,
may be compensated by payment of fees or in amounts which are in addition to the
amount of salary, bonus or directors fees which we customarily pay such
individuals. Any such additional compensation will be determined on a case by
case basis by the board of directors prior to or at the time of the acquisition.
As of this date we are not a party to any agreement regarding the provision of
such services or payments of such fees or amounts.
We may not be successful in identifying, developing and executing a new
business strategy and could eventually use all, or a substantial portion, of our
remaining cash on hand in connection with any such new business efforts.
WE MAY CONTINUE TO BE SUBJECT TO RISKS IN OUR INTERNATIONAL BUSINESS.
As discussed above, we intend to either fulfill or negotiate an early
termination to our existing contractual obligations to provide professional
services relating to the design testing and implementation of broadband Internet
access infrastructure services to KNRW in Germany.
Although the term of our current master contract with KNRW expires in
February 2004, our present engagement is scheduled to terminate in August 2002.
We are discussing with KNRW the possibility of mutually terminating our
engagement prior to that, but we cannot predict exactly when that might occur,
if it occurs at all. In any event, KNRW has the right to terminate our contract
with them after the 18-month anniversary of the execution of the contract
(August 2002) or in the event we engage in a transaction constituting a "change
of control" of High Speed Access International, the subsidiary through which we
operate our international business. Even if we do not negotiate an early
termination to the contract, we cannot assure you that KNRW will not terminate
our contract with them in
24
August 2002 or attempt to do so following the consummation of the asset sale.
MISCELLANEOUS RISKS
OUR STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE.
The stock market has experienced extreme price and volume fluctuations. In
particular, the market prices of the securities of Internet-related companies
have been especially volatile. In the past, companies that have experienced
volatility in the market price of their stock have been the object of securities
class action litigation. If we were the object of securities class action
litigation, it could result in substantial costs and a diversion of our
management's attention and resources.
WE MAY BE DELISTED BY NASDAQ.
On September 10, 2001, we received formal notice from the Nasdaq Stock Market
that we were not in compliance with the continuing listing requirements because
the market price of our common stock was below $1.00 per share. However, on
September 27, 2001, in response to the extraordinary market conditions following
the terrorist attacks on September 11, Nasdaq announced that it had implemented
an across-the-board moratorium on the minimum bid and public float requirements
for continued listing until January 2, 2002. On October 9, 2001, we received
notification from Nasdaq that the previously announced moratorium would apply to
us. Nevertheless, we currently believe that we will not be in compliance with
these requirements after the moratorium is lifted. We anticipate that the market
price of our common stock will remain below $1.00 per share and may decline
further if, among other things, we make distributions to our stockholders. We
also expect that our market capitalization will fall below the minimum required
for continued listing by Nasdaq. Accordingly, we do not expect our common stock
to remain eligible for listing and we expect that it will be de-listed in 2002.
If our common stock is de-listed, trading of our common stock would be conducted
in the over-the-counter market on an electronic bulletin board established for
unlisted securities in what are commonly referred to as the "pink sheets."
WE MAY BECOME SUBJECT TO BURDENSOME GOVERNMENT REGULATION.
Our business has two main components. First, we supply information and
entertainment to customers primarily over the cable systems of our cable system
partners. This information and entertainment includes materials that we obtain
from third parties (including Vulcan and its affiliates) as well as information
generally available on the Internet that our customers will reach by means of
our service. Second, we install and maintain the equipment needed to transmit
that information to customers over the cable systems of our cable partners in a
form that can be understood by customers' personal computers. There are certain
risks associated with both aspects of this business.
With regard to supplying information, we are subject to the same types of
risks that apply to all businesses that publish, broadcast or distribute
information. These include potential liability for defamation, libel, invasion
of privacy and similar claims, as well as potential liability for copyright or
trademark infringement and similar claims. In addition, the law relating to the
liability of Internet and online service providers for information carried on or
disseminated through their networks is unsettled. There are also some specific
federal laws regarding the distribution of obscene or indecent content by means
of communications facilities (including distribution of such content to minors)
under which we are subject to potential liability. These risks are mitigated to
some extent by a federal law passed in 1996 that immunizes Internet service
providers from legal liability for defamation and similar claims in connection
with information that the Internet service provider did not itself create. The
law regarding these issues is controversial, and could be changed in ways that
would expose us to greater liability. Also, the Digital Millennium Copyright
Act, passed in 1998, creates a "safe harbor" from copyright infringement
liability for Internet service providers who meet its requirements, which we
intend to do. Finally, if we expand our operations to other countries with less
extensive legal protections for publishers and speakers, our potential liability
for our activities in those countries could be much greater than in the United
States.
The other main aspect of our business -- installing and maintaining the
equipment needed to permit cable systems to transmit information in a
computer-accessible format -- is not currently regulated by state or federal
governments. Even so, the business of our cable partners is subject to
regulation by the federal government and by local governments (which issue
franchises to cable systems) in accordance with federal law. There are four main
ways that these regulations could change that might severally and negatively
affect our business.
First, our service is generally classified by cable operators as a "cable
service." This means that our cable partners may offer our service over their
cable systems under their present franchise rights. If our service is not a
cable service, then some franchising authorities (usually cities or countries)
might claim that our cable partners need separate authorization to offer it.
This separate
25
authorization may not be obtainable on reasonable terms, or at all. In the
alternative, even if the service is treated as cable service, local franchising
authorities may seek to impose "non-discrimination" or "open access" obligations
on our cable partners as a condition of franchise transfer or renewal.
Second, if our service is not a "cable service," it could be reclassified
as a "telecommunications service." This could subject our cable partners (and
possibly us) to regulation as "telecommunications carriers" at the state and
federal level. For example, if we or our cable partners were either classified
as telecommunications common carriers, or otherwise subject to common
carrier-like access and non-discrimination requirements in the provision of our
Internet over cable service, we or they could potentially be subject to
government-regulated terms, conditions and prices for Internet connection
services, as well as become obligated to make contributions to the universal
service support fund. We may also provide Internet telephony services over cable
plant, and this service may be regulated in the future as a common carrier
telecommunications service. It is not clear what impact compliance with those
regulations would have on our business, but the impact could be severe.
Moreover, we or our cable partners might then have to get a "telecommunications
franchise" from some localities. This franchise might not be available on
reasonable terms, or at all. The regulatory climate affecting our existing
business is uncertain. Historically, the Company and its cable partners believed
that for regulatory purposes our services would be considered a form of cable
service, or an unregulated information service. Some federal courts have reached
decisions consistent with these views. However, in June 2000, the federal
appeals court for the 9th Circuit concluded that a cable operator's provision of
transmission facilities in some instances is a telecommunications service under
the Communications Act. This classification could subject our cable partners,
and possibly us, to federal and state regulation as "telecommunications
carriers." If we or our cable partners were classified as telecommunications
common carriers, or otherwise subject to common carrier-like access and
non-discrimination requirements in the provision of our Internet over cable
service, the Company or Charter could be subject to burdensome governmental
regulations. In particular, the government might seek to regulate us and our
cable partners with respect to the terms, conditions and prices for Internet
connection services and interconnections with the public switched telephone
network, and require that we make contributions to the universal service support
fund. The law in this area thus remains unsettled. Moreover, some local
franchising authorities might claim that our cable partners need a separate
franchise to offer our service. This franchise may not be obtainable on
reasonable terms, or at all.
THE FUTURE SALE OF SHARES MAY HURT OUR MARKET PRICE.
A substantial number of shares of our common stock are available for
resale. If our stockholders sell substantial amounts of our common stock in the
public market, the market price of our common stock could fall. These sales also
might make it more difficult for us to sell equity securities in the future at
times and prices that we deem appropriate. If we are successful in closing the
Charter asset purchase and Vulcan stock repurchase, the number our outstanding
common shares will decrease from approximately 60 million to 40 million.
WE HAVE ANTI-TAKEOVER PROVISIONS.
Certain provisions of our certificate of incorporation, our bylaws and
Delaware law, in addition to the concentration of ownership by Mr. Paul Allen,
makes it difficult for a third party to acquire us, even if doing so might be
beneficial to our other stockholders.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is limited to interest rate sensitivity, which
is affected by changes in the general level of U.S. interest rates, and foreign
currency exchange rates. Our cash equivalents are invested with high-quality
issuers and limit the amount of credit exposure to any one issuer. Due to the
short-term nature of our cash equivalents, we believe that we are not subject to
any material market risk exposure. Substantially all of our revenues are
realized in U.S. dollars and are from customers in the United States. We do not
have any foreign currency hedging instruments.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS.
The Company, our directors, our former directors, as well as Charter and
Paul Allen have been named as defendants in three class action lawsuits filed in
the Court of Chancery of the State of Delaware (Denault, et. al. v. O'Brien, et.
al., Civil Action No. 19045NC, Tesche, et. al. v. O'Brien, et al., Civil Action
No. 19046NC and Johnson, et. al. v. O'Brien, et. al., Civil Action No. 19053NC).
All three lawsuits, which subsequently have been consolidated, allege, among
other things, that the initially proposed cash purchase price of $73 million is
grossly inadequate and that "[t]he purpose of the proposed acquisition is to
enable CCI [Charter] and Allen to acquire
26
[the company's] valuable assets for their own benefit at the expense of [the
company's] public shareholders."
The suits allege that the defendants breached their fiduciary duties owed
to the Company in connection with the making and consideration of Charter's
proposal. The plaintiffs ask to represent the interests of all common
stockholders of the Company and seek injunctive relief preventing the Company
from going forward with the transaction, to rescind the transaction in the event
it is consummated and unspecified monetary damages. We believe these lawsuits
are without merit and intend to vigorously defend against the claims made
therein.
Also, on November 5, 2001, the Company, our Chief Financial Officer and our
former President, together with Lehman Brothers, Inc., J.P. Morgan Securities,
Inc., CIBC World Markets Corp., and Banc of America Securities, Inc., were named
as defendants in a class action lawsuit filed in the United States District
Court for the Southern District of New York. The lawsuit alleges that the
Company's Registration Statement dated June 3, 1999 and Prospectus dated June 4,
1999 (together "offering materials") for the issuance and initial public
offering of 13,000,000 shares of the Company's common stock to investors
contained material misrepresentations and/or omissions, to wit: that the
Company's four underwriters engaged in a pattern of conduct to surreptitiously
extract inflated commissions greater than those disclosed in the offering
materials, among other acts of misconduct. The plaintiff asks to represent the
interest of all common shareholders of the Company and seeks unspecified
monetary damages. We believe this lawsuit is without merit and intend to
vigorously defend against the claims made therein.
We are not a party to any other material legal proceedings.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) In December 2000, we issued and sold 38,000 shares and 37,000 shares of
senior convertible preferred stock to Vulcan and Charter Communications
Ventures, LLC, an affiliate of Charter, respectively. In this private placement,
we received aggregate consideration of $38,000,000 and $37,000,000 from Vulcan
and Charter, respectively. The preferred stock may convert into common stock of
the Company at a conversion price of $5.01575 per share, subject to adjustment
for future stock issuances at less than the conversion price and other customary
adjustments. The initial proceeds to the Company were $75.0 million. Through
September 30, 2001 the proceeds have been applied as follows:
Direct or indirect payment to others for:
<Table>
Offering expenses $ 1,000,000
Working capital $47,045,042
</Table>
None of these expenses were direct or indirect payments to investors or
officers or 10% stockholders of the Company. The remainder of the proceeds is
invested in interest-bearing money market accounts with financial institutions
and highly-liquid investment-grade debt securities of corporations and the U.S.
Government. This issuance of preferred stock was made in reliance on the
exemption from registration provided by section 4(2) of the Securities Act and
Rule 506 promulgated thereunder.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Corporation's Annual Meeting of Shareholders was held on August 3,
2001. Matters submitted to, and approved by, shareholders are listed below, as
is a tabulation of voting.
(1) The following persons nominated as Directors were elected:
<Table>
<Caption>
Class II For Withheld
- -------- --- --------
Michael E. Gellert 31,221,790 35,478,862
Daniel J. O'Brien 31,221,790 35,478,862
</Table>
Other Directors continuing in office are as follows: David A. Jones,
Robert S. Saunders and Irving W. Bailey, II.
Directors, Jerald L. Kent, Stephen E. Silva, and William D. Savoy tendered
their resignations prior to the meeting.
(2) Ratification of selection of PricewaterhouseCoopers LLP as independent
auditors of the Company for the fiscal year ending December 31, 2001 was
approved by the following vote.
<Table>
<Caption>
For Withheld Abstain
- --- -------- -------
59,147,878 77,865 7,474,909
</Table>
(3) Adoption of the High Speed Access Corp. 2001 Employee Stock Purchase
Plan was approved by the following vote.
<Table>
<Caption>
For Withheld Abstain Broker Nonvotes
- --- -------- ------- ---------------
37,924,438 1,407,053 7,492,831 19,876,330
</Table>
(4) Amendment to Company's 1999 Stock Option Plan to increase the number
of shares of Common Stock reserved for issuance thereunder and permit the
issuance of restricted stock and ratify an award previously made thereunder was
approved by the following vote.
<Table>
<Caption>
For Withheld Abstain Broker Nonvotes
- --- -------- ------- ---------------
37,346,163 1,968,159 7,510,900 19,875,430
</Table>
ITEM 5 - OTHER INFORMATION.
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
See Exhibit Index.
27
(b) Reports on Form 8-K
On October 1, 2001, the Company filed a report on Form 8-K which
announced that had entered into a definitive agreement with Charter
Communications Holding Company, LLC, an affiliate of Charter
Communications, Inc. (collectively, "Charter"), which provides for the
sale by the Company of substantially all of the assets used by the
Company to serve Charter's high speed data customers.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
High Speed Access Corp.
Date: November 14, 2001 By /s/ Daniel J. O'Brien
--------------------------------------
Daniel J. O'Brien
President, Chief Executive Officer and
Director
Date November 14, 2001 By /s/ George Willett
--------------------------------------
George Willett
Chief Financial Officer
29
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT TITLE
------- -------------
10.1 Asset Purchase Agreement, dated September 28, 2001, between High
Speed Access Corp. and Charter Communications Holding Company, LLC
(incorporated herein by reference to Exhibit 99.3 to the Company's
current report on Form 8-K, filed with the Securities and Exchange
Commission on October 1, 2001).
10.2 Voting Agreement, dated September 28, 2001, among High Speed Access
Corp., Charter Communications Ventures, LLC, Vulcan Ventures
Incorporated and certain other stockholders of High Speed Access
Corp. (incorporated herein by reference to Exhibit 99.4 to the
Company's current report on Form 8-K, filed with the Securities and
Exchange Commission on October 1, 2001).
10.3 Services and Management Agreement, dated September 28, 2001, between
High speed Access Corp and Charter Communications, Inc.
(incorporated herein by reference to Exhibit 99.5 to the Company's
current report on Form 8-K, filed with the Securities and Exchange
Commission on October 1, 2001).
10.4 License Agreement, dated September 28, 2001, among High Speed Access
Corp., HSA International, Inc. and Charter Communications Holding
Company, LLC (incorporated herein by reference to Exhibit 99.6 to
the Company's current report on Form 8-K, filed with the Securities
and Exchange Commission on October 1, 2001).
10.5 Stock Purchase Agreement, dated as of November 1, 2001, between High
Speed Access Corp. and Vulcan Ventures Incorporated.
</Table>