SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to _________________
Commission File No. 333-53467
Pathnet, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-1941838
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1015 31st Street, N.W.
Washington, DC 20007
(Address of principal executive offices) (Zip Code)
(202) 625-7284
(Registrant's telephone number, including area code)
Not Applicable
(Former name,former address and former fiscal year,if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of May 10, 1999, there were 2,906,860 shares of the Issuer's common stock,
par value $.01 per share, outstanding.
PATHNET, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
INDEX
Page
Part I. Financial Information
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 1999 (unaudited) and
December 31, 1998 3
Unaudited Consolidated Statements of Operations for the three months
ended March 31, 1999 and 1998 and for the period August 25, 1995
(date of inception) to March 31, 1999 4
Unaudited Consolidated Statements of Comprehensive Loss for the
three months ended March 31, 1999 and 1998 and for the period
August 25, 1995 (date of inception) to March 31, 1999 5
Unaudited Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and 1998 and for the period August 25, 1995
(date of inception) to March 31, 1999 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Part II. Other Information
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
Exhibits Index 20
2
Part I. Financial Information
Item 1. Financial Statements
PATHNET, INC. AND SUBSIDIARIES
(Development Stage Enterprises)
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1999 1998
------------- -------------
(unaudited)
ASSETS
Cash and cash equivalents $ 98,333,292 $ 57,321,887
Note receivable - 3,206,841
Interest receivable 2,511,486 3,848,753
Marketable securities available for sale, at market 61,094,006 97,895,773
Prepaid expenses and other current assets 4,374,514 205,505
------------- -------------
Total current assets 166,313,298 162,478,759
Property and equipment, net 69,038,378 47,971,336
Deferred financing costs, net 10,224,246 10,508,251
Restricted cash 10,846,191 10,731,353
Marketable securities available for sale, at market 50,074,604 71,899,757
Pledged marketable securities held to maturity 62,655,577 61,824,673
Other assets 108,565 -
------------- -------------
Total assets $ 369,260,859 $ 365,414,129
============= =============
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable $ 14,284,332 $ 10,708,263
Accrued interest 19,651,045 8,932,294
Accrued expenses and other current liabilities 1,510,532 639,688
------------- -------------
Total current liabilities 35,445,909 20,280,245
12 1/4% Senior Notes, net of unamortized bond discount of $3,685,500 and $3,787,875
respectively 346,314,500 346,212,125
Other non-current liabilities 103,017 -
------------- -------------
Total liabilities 381,863,426 366,492,370
------------- -------------
Series A convertible preferred stock, $0.01 par value, 1,000,000 shares authorized, issued
and outstanding at March 31, 1999 and December 31, 1998, respectively (liquidation
preference $1,000,000) 1,000,000 1,000,000
Series B convertible preferred stock, $0.01 par value, 1,651,046 shares authorized, issued
and outstanding at March 31, 1999 and December 31, 1998, respectively (liquidation
preference $5,033,367) 5,008,367 5,008,367
Series C convertible preferred stock, $0.01 par value, 2,819,549 shares authorized, issued
and outstanding at March 31, 1999 and December 31, 1998, respectively (liquidation
preference $30,000,052) 29,961,272 29,961,272
------------- ------------
Total mandatorily redeemable preferred stock 35,969,639 35,969,639
------------- ------------
Common stock, $0.01 par value, 60,000,000 shares authorized at March 31, 1999
and December 31, 1998, respectively; 2,903,324 and 2,902,358 shares issued and
outstanding at March 31, 1999 and December 31, 1998, respectively 29,033 29,024
Deferred compensation (843,988) (978,064)
Additional paid-in capital 6,157,488 6,156,406
Accumulated other comprehensive income 74,320 208,211
Deficit accumulated during the development stage (53,989,059) (42,463,457)
------------- -------------
Total stockholders' equity (deficit) (48,572,206) (37,047,880)
------------- -------------
Total liabilities, mandatorily redeemable preferred stock and stockholders' equity(deficit) $ 369,260,859 $ 365,414,129
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
3
PATHNET, INC. AND SUBSIDIARIES
(Development Stage Enterprises)
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
For the period
August 25, 1995
For the three months ended (date of inception
March 31, to March 31,
----------------------------------
1999 1998 1999
------------- -------------- -------------
Revenue $ 826,104 $ 100,000 $ 2,573,143
------------- -------------- -------------
Operating expenses:
Cost of revenue 2,651,200 714,740 10,198,820
Selling, general and administrative 2,795,360 2,110,807 18,420,709
Depreciation expense 537,639 37,223 1,326,470
------------- -------------- -------------
Total operating expenses 5,984,199 2,862,770 29,945,999
------------- -------------- -------------
Net operating loss (5,158,095) (2,762,770) (27,372,856)
Interest expense (10,270,211) - (43,258,022)
Interest income 3,814,608 80,740 17,929,844
Write-off of initial public offering costs - - (1,354,534)
Other income (expense), net 88,096 (2,811) 85,509
------------- -------------- -------------
Net loss $ (11,525,602) $ (2,684,841) $ (53,970,059)
============= ============== =============
Basic and diluted loss per
common share $ (3.97) $ (0.93) $ (18.61)
============= ============== =============
Weighted average number of
common shares outstanding 2,902,895 2,901,022 2,900,762
============= ============== =============
The accompanying notes are an integral part of these consolidated
financial statements.
4
PATHNET, INC. AND SUBSIDIARIES
(Development Stage Enterprises)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(unaudited)
For the period
August 25, 1995
For the three months ended (date of inception
March 31, to March 31,
----------------------------------
1999 1998 1999
------------- -------------- -------------
Net loss $ (11,525,602) $ (2,684,841) $ (53,970,059)
Other comprehensive income:
Net unrealized (loss) gain on marketable
securities available for sale (133,891) - 74,320
------------ -------------- -------------
Comprehensive loss $ (11,659,493) $ (2,684,841) $ (53,895,739)
============ ============== =============
The accompanying notes are an integral part of these consolidated financial
statements.
5
PATHNET, INC. AND SUBSIDIARIES
(Development Stage Enterprises)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the period
August 25, 1995
For the three months ended (date of inception
March 31, to March 31,
--------------------------------
1999 1998 1999
------------- -------------- --------------
Cash flows from operating activities:
Net loss $ (11,525,602) $ (2,684,841) $ (53,970,059)
Adjustment to reconcile net loss to net cash used in operating activities
Depreciation expense 537,639 37,223 1,326,470
Amortization of deferred financing costs 284,005 - 1,126,795
Loss on disposal of asset - - 5,500
Write-off of deferred financing costs - 337,910 581,334
Interest expense resulting from amortization of discount on the
bonds payable 102,375 - 409,500
Amortization of premium paid on pledged securities 167,295 - 167,295
Stock based compensation 134,076 - 835,371
Interest expense for beneficial conversion feature of bridge loan - - 381,990
Accrued interest satisfied by conversion of bridge loan to
Series B convertible preferred stock - - 33,367
Changes in assets and liabilities:
Interest receivable 339,068 - (4,507,884)
Prepaid expenses and other assets (4,277,574) (108,145) (4,483,079)
Accounts payable (1,234,100) 1,687,380 (726,486)
Accrued interest 10,718,751 - 19,651,045
Accrued expenses and other liabilities 973,861 157,334 1,613,548
------------- -------------- --------------
Net cash used in operating activities (3,780,206) (573,139) (37,555,293)
----------- -------------- --------------
Cash flows from investing activities:
Expenditures for network in progress (16,668,923) (2,084,372) (52,028,047)
Expenditures for property and equipment (125,589) (710,337) (3,331,482)
Sale (purchase) of marketable securities available for sale 58,493,029 - (111,094,290)
Purchase of marketable securities - pledged as collateral - - (83,097,655)
Sale of marketable securities - pledged as collateral - - 22,271,181
Restricted cash (114,838) 471,475 (10,846,191)
Repayment of note receivable 3,206,841 9,000 9,000
------------- -------------- --------------
Net cash provided by (used in) investing activities 44,790,520 (2,314,234) (238,117,484)
------------- -------------- --------------
Cash flows from financing activities:
Issuance of voting and non-voting common stock - - 1,000
Proceeds from sale of preferred stock - - 35,000,052
Proceeds from sale of Series B convertible preferred stock representing the
conversion of committed but undrawn portion of bridge loan to Series B
convertible preferred stock - - 300,000
Proceeds from bond offering - - 350,000,000
Proceeds from bridge loan - - 700,000
Exercise of employee common stock options 1,091 81 1,172
Payment of issuance costs for preferred stock offerings - - (63,780)
Payment of deferred financing costs - (87,482) (11,932,375)
------------- -------------- --------------
Net cash provided by (used in) financing activities 1,091 (87,401) 374,006,069
------------- -------------- --------------
Net increase in cash and cash equivalents 41,011,405 (2,974,774) 98,333,292
Cash and cash equivalents at the beginning of period 57,321,887 7,831,384 -
------------- -------------- --------------
Cash and cash equivalents at the end of period $ 98,333,292 $ 4,856,610 $ 98,333,292
============= ============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
6
PATHNET, INC. AND SUBSIDIARIES
(DEVELOPMENT STAGE ENTERPRISES)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Pathnet, Inc. (Company) is a carrier's carrier, providing high-quality,
low-cost digital fiber and wireless communications capacity to under-served and
second- and third-tier U.S. markets. During the first quarter of 1999, Pathnet
expanded its business strategy to include construction and deployment of digital
networks utilizing both wireless and fiber-optic technologies. The decision to
incorporate fiber-optic technologies into existing plans for a nationwide
network was made to satisfy demand from potential customers for high-bandwidth
facilities, which the Company's wireless network is not equipped to handle.
Pathnet offers telecommunications service to inter-exchange carriers, local
exchange carriers, internet service providers, Regional Bell Operating
Companies, cellular operators and resellers.
During the first quarter of 1999, the Company continued to focus on
developing its network. As part of its expanded strategy, the Company entered
into two agreements with Worldwide Fiber USA (WFI) (formerly known as Pacific
Fiber Link, LLC) in March 1999 to construct and market a multi-conduit
fiber-optic network between Chicago, Illinois and Denver, Colorado. (See note 9
to these Financial Statements.)
As of March 31, 1999, the Company had approximately 2,100 route miles
of completed network and approximately 4,600 route miles of network under
construction.
The Company's business is funded primarily through equity investments
by the Company's stockholders and $350.0 million aggregate principal amount of
12 1/4% Senior Notes due 2008 (Senior Notes) which have been registered under
the Securities Act of 1933, as amended (Securities Act).
A substantial portion of the Company's activities to date has involved
developing strategic relationships with railroads, pipelines, utilities and
state and local governments (Incumbents) and building its network. Accordingly,
a majority of its revenues to date reflect only certain consulting and advisory
services in connection with the design, development and construction of digital
microwave infrastructure. The remainder of its revenues to date (approximately
28.8 per cent) has been derived from the sale of bandwidth along the Company's
digital network. The Company has experienced significant operating and net
losses and negative operating cash flow to date and expects to continue to
experience operating and net losses and negative operating cash flow until such
time as it is able to generate revenue sufficient to cover its operating
expenses.
2. BASIS OF ACCOUNTING
While the Company recently commenced providing telecommunication
services to customers and recognizing the revenue from the sale of such
telecommunication services, its principal activities to date have been securing
contractual alliances with Incumbents and partners, designing and constructing
network segments, obtaining capital and planning its proposed service.
Accordingly, the Company's consolidated financial statements are presented as a
development stage enterprise, as prescribed by Statement of Financial Accounting
Standards No. 7, "Accounting and Reporting by Development Stage Enterprises." As
a development stage enterprise, the Company has been relying on
7
the issuance of equity and debt securities, rather than recurring revenues, for
its primary sources of cash since inception.
In June 1997, the Financial Accounting Standards Board issued SFAS
No.131, "Disclosures About Segments of an Enterprise and Related
Information"("SFAS No. 131"). SFAS No. 131 changes the way public companies
report segment information in annual financial statements and also requires
those companies to report selected segment information in interim financial
reports to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers. Management
believes the Company's current operations comprise only one segment, the sale of
telecommunications capacity, and as such, adoption of SFAS No. 131 does not
impact the disclosures made in the Company's financial statements.
In the opinion of management, the accompanying unaudited consolidated
financial statements of the Company and its subsidiaries contain all adjustments
(consisting only of normal recurring accruals) necessary to present fairly the
Company's consolidated financial position as of March 31, 1999, and the results
of operations and cash flows for the periods indicated. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted. These unaudited consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the period ended December 31, 1998
filed with the Securities and Exchange Commission. The results of operations for
the three months ended March 31, 1999 are not necessarily indicative of the
operating results to be expected for the full year.
3. REVENUE RECOGNITION
The Company earns revenue from the sale of telecommunication capacity
and for project management and consulting services. Revenue from the sale of
telecommunications capacity is earned when the service is provided. Revenue for
project management and consulting services is recognized based on the percentage
of the services completed. The Company defers revenue when contractual payments
are received in advance of the performance of services.
Revenue from the sale of telecommunication capacity includes revenue
earned under indefeasible right of use (IRU) agreements. The Company recognizes
revenue under such agreements on a straight-line basis over their term.
On a limited basis, the Company makes purchases of telecommunications
equipment and ancillary services on behalf of the Incumbents. During the first
quarter of 1999, the Company purchased approximately $3.6 million of
telecommunications equipment, which includes shelters and towers, and ancillary
services on behalf of two of its Incumbents. The Company makes these purchases
in an agency capacity, passing such costs onto the Incumbents at no margin.
Accordingly, the Company has not recorded the transactions in the accompanying
Consolidated Statement of Operations. As of March 31, 1999, the Company
recorded, as a component of Prepaid Expenses and Other Current Assets, $2.4
million related to these transactions.
8
4. LOSS PER SHARE
Basic earnings (loss) per share is computed by dividing net income
(loss) by the weighted average number of shares of Common Stock outstanding
during the applicable period. Diluted earnings (loss) per share is computed by
dividing net income (loss) by the weighted average common and potentially
dilutive common equivalent shares outstanding during the applicable period. For
each of the periods presented, basic and diluted loss per share are the same.
The exercise of 2,936,493 employee Common Stock options, the exercise of
warrants to purchase 1,116,500 shares of Common Stock, and the conversion of
5,470,595 shares of Series A, B and C convertible preferred stock into
15,864,715 shares of Common Stock as of March 31, 1999, which could potentially
dilute basic earnings per share in the future, were not included in the
computation of diluted loss per share for the periods presented because to do so
would have been antidilutive in each case.
5. MARKETABLE SECURITIES
The Company's marketable securities are considered "available for
sale," and, as such, are stated at market value. The net unrealized gains and
losses on marketable securities are reported as part of accumulated other
comprehensive income. Realized gains or losses from the sale of marketable
securities are based on the specific identification method.
The following is a summary of the investments in marketable securities at March
31, 1999:
Gross Unrealized
----------------
Cost Gains Losses Market Value
----------------- ------------ ----------- ------------------
Available for sale securities:
U.S. Treasury securities and debt securities
of U.S. Government agencies $ 35,735,957 $ 9,098 $ 14,562 $ 35,730,493
Certificates of deposit and money market
funds 1,999,832 1,908 -- 2,001,740
Corporate debt securities 73,358,501 79,887 2,011 73,436,377
----------------- ------------ ----------- ------------------
$ 111,094,290 $ 90,893 $ 16,573 $ 111,168,610
================= ============ =========== ==================
Net proceeds from the sales of available for sale securities were
approximately $58,493,000 and gross realized gains on sales of available for
sale securities were approximately $86,000 during the three months ended March
31, 1999.
9
The amortized cost and estimated fair value of available for sale
securities by contractual maturity at March 31, 1999 is as follows:
Cost Market Value
------------------ ----------------
Due in one year or less $ 61,048,866 $ 61,094,006
Due after one year through two years 50,045,424 50,074,604
------------------ ----------------
$ 111,094,290 $ 111,168,610
================== ================
Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to prepay obligations without
prepayment penalties.
In addition to marketable securities, the Company has investments in
pledged marketable securities that are pledged as collateral for repayment of
interest on the Company's Senior Notes through April 2000) and are classified as
non-current assets on the consolidated balance sheet. As of March 31, 1999,
pledged marketable securities consisted of U.S. Treasury securities classified
as held to maturity with an amortized cost of approximately $60.6 million,
interest receivable on the pledged marketable securities of approximately $2.0
million and cash and cash equivalents of approximately $41,000. All of the
investments contractually mature by March 31, 2000.
6. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, is comprised of the following
at March 31, 1999 and December 31, 1998:
March 31, December 31,
1999 1998
----------------- ----------------
Network in progress $ 49,662,363 $ 38,669,088
Communications network 17,335,336 6,890,686
Office and computer equipment 2,421,084 2,267,647
Furniture and fixtures 767,982 766,013
Leasehold improvements 178,083 166,733
---------------- ------------------
70,364,848 48,760,167
Less: accumulated depreciation (1,326,470) (788,831)
---------------- ------------------
Property and equipment, net $ 69,038,378 $ 47,971,336
================ ==================
Network in progress includes (i) all direct material and labor costs
incurred on the construction of the network together with related allocable
interest costs, necessary to construct components of a high capacity digital
network which is owned and maintained by the Company, and (ii) network related
10
inventory of parts and equipment. When a portion of network has been completed
and made available for use by the Company it is transferred from network in
process to communications network. As of March 31, 1999, the Company incurred
non-cash capital expenditures of approximately $15.0 million.
7. RESTRICTED CASH
Restricted cash comprises amounts held in escrow to secure the
Company's obligations under certain of its Fixed Point Microwave Services (FPM)
agreements. The funds in each escrow account are available only to fund the
project to which the escrow is related until such project has been completed, at
which time surplus funds will be returned to the Company. Generally, funds are
released from escrow to pay project costs when such costs incurred and agreed
upon under the contract. During the three months ended March 31, 1999, no funds
were released from escrow.
8. COMMITMENTS AND CONTINGENCIES
As of March 31, 1999, the Company had capital commitments of up to
approximately $93.0 million relating to telecommunication and transmission
equipment and its agreement with WFI. (see note 9 to these Financial
Statements).
9. FIBER AGREEMENT
On March 31, 1999, the Company signed two agreements with WFI to
construct and market a multi-conduit fiber-optic network between Chicago,
Illinois and Denver, Colorado. The total shared projected cost for this project
is in excess of $100 million. The 1,100-mile network between Chicago and Denver
will pass through Des Moines, Iowa; Omaha, Nebraska; and Lincoln, Nebraska. WFI
will lead-manage the project with construction to be completed in two segments.
The first segment, Chicago to Omaha, is expected to be complete in late 1999
with the second segment, Omaha to Denver, scheduled to come on line in 2000.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
CERTAIN STATEMENTS CONTAINED IN THIS ITEM CONSTITUTE FORWARD-LOOKING
STATEMENTS. SEE "FORWARD-LOOKING STATEMENTS" BELOW.
Overview
During the first quarter of 1999, Pathnet expanded its business
strategy to include construction and deployment of digital networks utilizing
both wireless and fiber-optic technologies. The decision to incorporate
fiber-optic technologies into existing plans for a nationwide network was made
to satisfy demand from potential customers for high-bandwidth facilities.
Due to Pathnet's focus to date on developing its network, the majority
of its revenues to date reflect certain consulting and project management
services in connection with the design, development and construction of digital
microwave infrastructure. The remaining portion of its revenues has resulted
from the sale of bandwidth services along its network. The Company has
experienced significant operating and net losses and negative operating cash
flow to date and expects to continue to experience operating and net losses and
negative operating cash flow until such time as it is able to generate revenue
sufficient to cover its operating expenses.
Worldwide Fiber Agreement
The Company continued to focus on developing its network in the first
quarter of 1999. As part of its expanded strategy, the Company entered into
agreements with Worldwide Fiber USA (WFI) (formerly known as Pacific Fiber Link,
LLC) in March 1999 to construct and market a multi-conduit fiber-optic network
between Chicago, Illinois and Denver, Colorado. The 1,100-mile network will pass
through Des Moines, Iowa; Omaha, Nebraska; and Lincoln, Nebraska.
Results of Operations
Three Months Ended March 31, 1999 Compared with the Three Months Ended March 31,
1998
During the three months ended March 31, 1999, the Company continued to
focus on developing relationships with railroads, pipelines, utilities and state
and local governments (collectively, "Incumbents") and partners, the buildout of
its network and the development of its infrastructure including the hiring of
key management personnel.
Revenue
For the three months ended March 31, 1999 and 1998, the Company
generated revenues of approximately $826,000 and $100,000, respectively. For the
three months ended March 31, 1999, the Company generated revenues from the sale
of telecommunications services of approximately $576,000, together with revenue
from consulting and advisory services in connection with the design, development
and construction of digital microwave infrastructure of approximately $250,000.
For the three months ended March 31, 1998, the Company's revenues consisted
primarily of revenue from consulting and
12
advisory services. The Company expects that a majority of future revenue to be
generated from the sale of telecommunications services.
Operating Expenses
For the three months ended March 31, 1999 and 1998, the Company
incurred operating expenses of approximately $6.0 million and $2.9 million,
respectively. The increase is primarily as a result of the continued increased
activity in the buildout of the Company's network and additional staff costs
incurred as part the development of the Company's infrastructure. The Company
expects selling, general and administrative expenses to continue to increase in
the remainder of 1999 as additional staff is added. Cost of revenue reflects
direct costs associated with performance of construction, management services
and costs incurred in connection with the provision of telecommunications
services.
Interest Expense
Interest expense for the three months ended March 31, 1999 was
approximately $10.3 million. There was no interest expense for the three months
ended March 31, 1998. Interest expense primarily represents interest on the
Company's 12 1/4% Senior Notes due 2008 issued in April 1998 (the "Senior
Notes") together with the amortization expense related to bond issuance costs in
respect of the Senior Notes.
Interest Income
Interest income for the three months ended March 31, 1999 and 1998 was
approximately $3.8 million and $81,000, respectively. This increase is primarily
a result of additional cash arising from the Senior Notes issued in April 1998.
Liquidity and Capital Resources
The Company expects to continue to generate cash primarily from
external financing and, as its network matures, from operating activities. The
Company's primary uses of cash will be to fund capital expenditures, working
capital and operating losses. Deployment of the Company's digital network and
expansion of the Company's operations and services will require significant
capital expenditures. Capital expenditures will be used primarily for continued
development and construction of its network, implementation of the Company's
sales and marketing strategy and constructing and improvement of the Company's
Network Operating Center (the "NOC").
As of March 31, 1999, the Company had capital commitments of up to
approximately $93.0 million relating to telecommunications and transmission
equipment and its agreement with WFI. It is anticipated that these will be met
with current resources of the Company and with the sale of dark and lit fiber
capacity.
As of March 31, 1999, the Company had approximately $209.4 million of
cash, cash equivalents and marketable securities available for the funding of
future operations. The Company expects these resources will be sufficient to
fund the implementation of the Company's business plan into 2000. After such
time, the Company expects to be required to procure additional financing which
may include
13
commercial bank borrowings, additional vendor financing or the sale or issuance
of equity or debt securities. There can be no assurance the Company will be
successful in raising sufficient capital or in obtaining such financing on terms
acceptable to the Company.
Pursuant to a Commitment Letter between Lucent and the Company that was
executed in connection with the supply agreement between Lucent and the
Company (the "Commitment Letter"), Lucent may provide financing of up to
approximately $400 million for fiber purchases for the construction of the
Company's network and may provide or arrange financing for future phases of such
network. Under the terms of the Commitment Letter, the total amount of financing
provided by Lucent will not exceed $1.8 billion of the $2.1 billion potential
value of the supply agreement. Certain material terms of the Company's
agreements with Lucent, including the terms of the Commitment Letter, are
currently under review by Lucent and the Company. There can be no assurance that
the transactions, including the financing contemplated by Commitment Letter,
will be consummated at all or consummated on the terms described above. In
addition, the Company may require additional capital in the future to fund
operating deficits and net losses and for potential strategic alliances, joint
ventures and acquisitions.
Because the Company's cost of designing and building its network and
operating its business, as well as its revenues, will depend on a variety of
factors (including, among other things, the ability of the Company to meet its
roll-out schedules, its ability to negotiate favorable prices for purchases of
network equipment, the number of customers and the services and products they
purchase, regulatory changes and changes in technology), actual costs and
revenues will vary from expected amounts, possibly to a material degree, and
such variations are likely to affect the Company's future capital requirements.
Accordingly, there can be no assurance that the Company's actual capital
requirements will not exceed the anticipated amounts described above.
Year 2000
The Year 2000 issue exists because many computer systems and software
applications use two digits rather than four digits to designate an applicable
year. As a result, the systems and applications may not properly recognize the
Year 2000, or process data that includes that date, potentially causing data
miscalculations or inaccuracies or operational malfunctions or failures.
In the fourth quarter of 1998, the Company began a corporate-wide
program to ready its technology systems and non-technology systems and software
applications for the Year 2000. The Company's objective is to target Year 2000
compliance for all of its systems, including network and customer interfacing
systems, and has grouped these systems into one of six compliance areas: Network
Architecture, Internal Infrastructure, Software Applications, Financial
Relationships, Supply-Chain Relationships and Customer Relationships. Because
the Company has operated for only a few years, few legacy systems or
applications exist. However, the Company has identified all systems and
applications that may need to be modified or reprogrammed in order to achieve
Year 2000 compliance and is working towards implementing any necessary changes
and expects to complete this process by the end of the third quarter of 1999.
As part of its Year 2000 plan, the Company has requested confirmation
from its communications equipment vendors and other key suppliers, financial
institutions and customers that their systems will
14
be Year 2000 compliant. Responses received to-date indicate a high level of Year
2000 compliance at these companies, however, there can be no assurance that the
systems of companies with which the Company does business will be Year 2000
compliant.. The Company expects to receive additional responses in the next
quarter. If the vendors important to the Company fail to provide needed products
and services, the Company's network buildout and operations could be affected
and thereby have a material adverse effect on the Company's results of
operations, liquidity and financial condition. Moreover, to the extent that
significant customers are not Year 2000 compliant and that affects their network
needs, the Company's sales could be lower than otherwise anticipated.
The Company's expenditures to implement its Year 2000 plan have not
been material to date and it does not believe its future expenditures on this
matter will be material. Because its existing systems are relatively new, it
does not expect that it will have to replace any of its systems. To the extent
it would have to replace a significant portion of its technology systems, its
expenditures could have material adverse effect on the Company. The Company has
hired an outside consultant to assist it with its Year 2000 compliance, but the
Company has relied primarily on its existing employees to develop and implement
its Year 2000 compliance strategy. As a result, its expenditures to ensure Year
2000 compliance have not been material to date. The Company expects to continue
to use existing employees for the significant part of its Year 2000 compliance
efforts in the future.
The Company is currently formulating a contingency plan in the event
that certain of its suppliers or service providers may not be Year 2000
compliant. This plan will continue to be developed throughout 1999. The Company
expects to have such plan in operation by the end of the fourth quarter of 1999.
Forward-Looking Statements
Certain statements in this Report, in future filings by the Company
with the Securities and Exchange Commission, in the Company's press releases and
in oral statements made by or with the approval of an authorized executive
officer of the Company constitute forward-looking statements, including
statements which can be identified by the use of forward-looking terminology
such as "believes," "anticipates," "expects," "may," "will," or "should" or the
negative of such terminology or other variations on such terminology or
comparable terminology, or by discussions of strategies that involve risks and
uncertainties. All statements other than statements of historical fact in this
Report, including, without limitation, such statements under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," regarding the Company or any of the transactions described in this
Report or the timing, financing, strategies and effects of such transaction, are
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to be correct. Important factors
that could cause actual results to differ materially from expectations include,
without limitation, those described in conjunction with the forward-looking
statements in this Report, as well as the amount of capital needed to deploy the
Company's network; the Company's substantial leverage and its need to service
its indebtedness; the restrictions imposed by the Company's current and possible
future financing arrangements; the ability of the Company to successfully manage
the cost-effective and timely completion of its network and its ability to
attract and retain customers for its products and services; the ability of the
Company to implement its newly expanded business plan; the
15
ability of the Company to retain and attract relationships with the incumbent
owners of the telecommunications assets with which the Company expects to build
its network; the ability of the Company to obtain and maintain rights-of-way for
the deployment of its network; the Company's ability to retain and attract key
management and other personnel as well as the Company's ability to manage the
rapid expansion of its business and operations; the Company's ability to compete
in the highly competitive telecommunications industry in terms of price,
service, reliability and technology; the Company's dependence on the reliability
of its network equipment, its reliance on key suppliers of network equipment and
the risk that its technology will become obsolete or otherwise not economically
viable; and the Company's ability to conduct its business in a regulated
environment. The Company does not intend to update these forward-looking
statements. These and other risks and uncertainties affecting the Company are
discussed in greater detail in the Company's 1998 Annual Report on Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to the impact of interest rate changes and
changes in the market value of its investments. As of March 31, 1999, the
Company's investments include certificates of deposit, money market funds, U.S.
Government obligations (primarily fixed income securities) and high-quality debt
securities. The Company employs established policies and procedures to manage
its exposure to changes in the market risk of its marketable securities, which
are classified as available for sale as of March 31, 1999. The Company's Senior
Notes have fixed interest rates and the fair value of these instruments is
affected by changes in market interest rates. The Company has not used
derivative financial instruments in its investment portfolio.
Investments in fixed rate interest earning instruments carry a degree
of interest rate risk. The fair market value of these securities may be
adversely impact due to a rise in interest rates. Investments in certificates of
deposit and money market funds may adversely impact future earnings due to a
decrease in interest rates. Due in part to these factors, the Company's future
investment income may all short of expectations due to changes in interest rates
or the Company may suffer losses in principal if forced to sell securities that
have declined in market value due to changes in interest rates. As of March 31,
1999, a 10% increase or decline in interest rates would not have a material
impact on the Company's future earnings, fair values, or cash flows related to
investments in certificates of deposit or interest earning marketable
securities. In addition, as of March 31, 1999, a 10% decrease in market values
would not have a material impact on the Company's future earnings, fair values,
financial position or cash flows related to investments in marketable
securities.
16
Part II. Other Information
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
During the first quarter, the Company solicited written consents from
its stockholders to approve (i) the removal of David Schaeffer as the Chairman
of the Board and Treasurer of the Company, (ii) the appointment of William
Smedberg as Treasurer of the Company and (iii) the offer by the Company to David
Schaeffer of a consultancy role with the Company on such terms and conditions to
be determined by a subcommittee of the Board of Directors. Effective February
12, 1999, the Company received written consents approving such proposals from
stockholders representing 14,413,661 votes, with stockholders representing
1,454,378 votes abstaining and stockholders representing 2,900,000 votes
objecting.
On February 12, 1999 the Company solicited written consents from the
holders of its Series A Convertible Preferred Stock, Series B Convertible
Preferred Stock and Series C Convertible Preferred Stock (collectively, the
"Preferred Stockholders") to approve (i) the removal of David Schaeffer as the
Chairman of the Board and Treasurer of the Company, (ii) the appointment of
William Smedberg as Treasurer of the Company and (iii) the offer by the Company
to David Schaeffer of a consultancy role with the Company on such terms and
conditions to be determined by a subcommittee of the Board of Directors.
Effective February 12, 1999, the Company received written consents approving
such proposals from Preferred Stockholders representing 14,411,303 votes with
Preferred Stockholders representing 1,453,412 votes abstaining.
On March 3, 1999, the Company solicited written consents from the Preferred
Stockholders to approve (i) the removal of William Smedberg as Vice President of
the Company and the appointment of Mr. Smedberg as Executive Vice President,
Corporate Development, (ii) increases and changes to the compensation of certain
employees of the Company, (iii) changes to the authorized signatories for
transfers and withdrawals of the Company's funds, (iv) an increase in the
Company's directors and officers insurance coverage, (v) certain interconnection
arrangements relating to the Company's network and (vi) the payment of an
invoice for outside counsel services. Effective March 3, 1999, the Company
received written consents approving such proposals from Preferred Stockholders
representing 14,255,167 votes with preferred stockholders representing 1,609,548
votes abstaining.
17
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Index
(b) Reports on Form 8-K
On February 3, 1999, the Company filed a report on Form 8-K
providing information under Items 5 and 7. The report announced the
Company's expansion of its integrated network strategy to incorporate
fiber in response to growing demand on selected and the Company's
selection of Lucent Technologies to be the exclusive supplier of
fiber-optic cable for its nationwide, voice and data network.
On February 12, 1999, the Company filed a report on Form 8-K
providing information under Items 5 and 7. The report announced that
David Schaeffer would no longer serve as Chairman of the Board or
Treasurer of the Company. The Company also announced that William R.
Smedberg, currently the Vice President, Finance and Corporate
Development, will replace Mr. Schaeffer as Treasurer.
On April 29, 1999, the Company filed a report on Form 8-K
providing information under Items 5 and 7. The report announced
strategic agreements with Worldwide Fiber USA (formerly known as
Pacific Fiber Link, LLC) to construct and market a multi-conduit
fiber-optic network between Chicago, Illinois and Denver, Colorado with
a total projected cost for the project in excess of $100 million.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PATHNET, INC.,
a Delaware corporation
(Registrant)
Date: May 14, 1999 By: /s/ Richard A. Jalkut
-----------------------------------------
Richard A. Jalkut
President and Chief Executive Officer
Date: May 14, 1999 By: /s/ James M. Craig
-----------------------------------------
James M. Craig
Executive Vice-President, Chief
Financial Officer (Principal Accounting
& Financial Officer)
19
EXHIBIT INDEX
Pursuant to Item 601 of Regulation S-K
Exhibit No. Description of Exhibit
----------- ----------------------
27.1 Financial Data Schedule for the three months ended March 31,
1999.
99.1 Press release dated May 14, 1999 announcing the Company's
results for the first quarter of 1999.
20