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 June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------------- -----------------
Commission File No. 333-91469
Pathnet Telecommunications, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-2201331
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11720 Sunrise Valley Drive
Reston, VA 20191
(Address of principal executive offices) (Zip Code)
(703) 390-1000
(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 August 10, 2000, there were 3,533,769 shares of the Registrant's common
stock, par value $.01 per share, outstanding.
PATHNET TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Consolidated Balance Sheets as of June 30, 2000 (unaudited) and
December 31, 1999 3
Unaudited Consolidated Statements of Operations for the three and six
months June 30, 2000 and 1999 4
Unaudited Consolidated Statements of Comprehensive Loss for the three
and six months ended June 30, 2000 and 1999 5
Unaudited Consolidated Statements of Cash Flows for the six months
ended June 30, 2000 and 1999 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Exhibits Index 23
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PATHNET TELECOMMUNICATIONS, INC. AND SUBSIDIARIES AND PREDECESSOR COMPANY
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
------------- -------------
(UNAUDITED)
ASSETS
Cash and cash equivalents $ 80,285,059 $ 90,661,837
Accounts receivable, net of allowance for doubtful accounts
of $42,000 and $0, respectively 8,243,779 254,894
Interest receivable 434,483 1,048,417
Marketable securities available for sale 6,216,139 42,651,836
Prepaid expenses and other current assets 1,086,627 1,182,570
------------- -------------
Total current assets 96,266,087 135,799,554
Property and equipment, net 208,810,839 131,928,365
Intangible assets - rights of way 185,982,756 -
Deferred financing costs, net 15,670,986 9,649,680
Restricted cash 18,352,230 16,921,559
Marketable securities available for sale - 5,088,458
Pledged marketable securities held to maturity 20,872,635 20,796,563
Other assets 1,773,230 351,808
------------- -------------
Total assets $ 547,728,763 $ 320,535,987
============= =============
LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Accounts payable $ 47,934,665 $ 18,543,195
Accrued interest 8,932,295 8,932,293
Deferred revenue 1,292,250 -
Accrued expenses and other current liabilities 4,262,883 3,113,181
------------- -------------
Total current liabilities 62,422,093 30,588,669
12 1/4% Senior Notes, net of unamortized bond discount of $3,173,625
and $3,378,375 respectively 346,826,375 346,621,625
Deferred revenue 6,434,785 -
Other noncurrent liabilities 4,522,172 3,092,779
------------- -------------
Total liabilities 420,205,425 380,303,073
------------- -------------
Commitments and contingences Mandatorily redeemable preferred stock:
Series A convertible preferred stock, $0.01 par value, 0 and 1,000,000 shares
authorized, issued and outstanding at June 30, 2000 and December 31, 1999,
respectively (liquidation preference $1,000,000) - 1,000,000
Series B convertible preferred stock, $0.01 par value, 0 and 1,651,046 shares
authorized, issued and outstanding at June 30, 2000 and December 31, 1999,
respectively (liquidation preference $5,033,367) - 5,008,367
Series C convertible preferred stock, $0.01 par value, 0 and 2,819,549 shares
authorized, issued and outstanding at June 30, 2000 and December 31, 1999,
respectively (liquidation preference $30,000,052) - 29,961,272
Series E convertible preferred stock, $0.01 par value, 4,506,145 and 0 shares
authorized, 1,729,631 and 0 issued and outstanding and June 30, 2000 and
December 31, 1999, respectively (liquidation preference $38,000,000)
37,892,182 -
------------- -------------
Total mandatorily redeemable preferred stock 37,892,182 35,969,639
------------- -------------
Stockholders' equity (deficit):
Series A convertible preferred stock, $0.01 par value, 2,899,999 and 0 shares
authorized, issued and outstanding at June 30, 2000 and December 31, 1999,
respectively 29,000 -
Series B convertible preferred stock, $0.01 par value, 4,788,030 and 0 shares
authorized, issued and outstanding at June 30, 2000 and December 31, 1999,
respectively 47,880 -
Series C convertible preferred stock, $0.01 par value, 8,176,686 and 0 shares
authorized, issued and outstanding at June 30, 2000 and December 31, 1999,
respectively 81,767 -
Series D convertible preferred stock, $0.01 par value, 9,250,000 and 0 shares
authorized, 8,511,607 and 0 shares issued and outstanding at June 30, 2000
and December 31, 1999, respectively 85,116 -
Undesignated preferred stock, par value $0.01 per share, 10,000,000 and 0 shares
authorized, 0 shares issued and outstanding - -
Common stock, $0.01 par value, 60,000,000 shares authorized, 3,533,769 and
3,068,218 shares issued and outstanding at June 30, 2000 and December 31,
1999, respectively 35,338 30,682
Deferred compensation (8,210,274) (441,760)
Additional paid-in capital 240,645,183 6,264,362
Accumulated other comprehensive loss (38,963) (90,240)
Accumulated deficit (143,043,891) (101,499,769)
------------- -------------
Total stockholders' equity (deficit) 89,631,156 (95,736,725)
------------- -------------
Total liabilities, mandatorily redeemable preferred stock and
stockholders' equity (deficit) $ 547,728,763 $ 320,535,987
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
3
PATHNET TELECOMMUNICATIONS, INC. AND SUBSIDIARIES AND PREDECESSOR COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
Telecommunications $ 1,123,681 $ 574,115 $ 2,045,530 $ 1,150,619
Construction 11,499,944 290,700 12,504,649 540,300
------------ ------------ ------------ ------------
Total Revenue 12,623,625 864,815 14,550,179 1,690,919
------------ ------------ ------------ ------------
Operating expenses:
Cost of revenue (exclusive of depreciation shown separately below):
Telecommunications 2,996,612 1,825,079 4,739,698 3,560,334
Construction 11,418,599 844,176 12,418,196 1,760,121
Selling, general and administrative 9,154,922 3,507,704 16,924,726 6,303,071
Reorganization expenses 341,761 - 1,750,229 -
Depreciation expense 2,792,252 1,033,300 5,350,236 1,570,932
------------ ------------ ------------ ------------
Total operating expenses 26,704,146 7,210,259 41,183,085 13,194,458
------------ ------------ ------------ ------------
Net operating loss (14,080,520) (6,345,444) (26,632,906) (11,503,539)
Interest expense (9,291,580) (10,060,626) (19,033,373) (20,330,837)
Interest income 2,202,681 3,378,137 4,437,738 7,192,745
Other income (expense), net (143,216) 71,631 (315,581) 159,727
------------ ------------ ------------ ------------
Net loss (21,312,635) (12,956,302) (41,544,122) (24,481,904)
------------ ------------ ------------ ------------
Preferred stock accretion (20,216) - (20,216) -
------------ ------------ ------------ ------------
Net loss applicable to common stockholders $(21,332,851) $(12,956,302) $(41,564,338) $(24,481,904)
============ ============ ============ ============
Basic and diluted loss per common share:
Net loss $ (6.49) $ (4.46) $ (13.08) $ (8.43)
Preferred stock accretion (0.01) - (0.01) -
------------ ------------ ------------ ------------
Net loss applicable to common stockholders $ (6.50) $ (4.46) $ (13.09) $ (8.43)
============ ============ ============ ============
Weighted average number of common shares outstanding 3,282,575 2,902,358 3,175,397 2,904,166
============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
4
PATHNET TELECOMMUNICATIONS, INC. AND SUBSIDIARIES AND PREDECESSOR COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(unaudited)
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
Net loss $(21,312,635) $(12,956,302) $(41,544,122) $(24,481,904)
Other comprehensive income (loss):
Net unrealized gain (loss) on marketable
securities available for sale (24,094) (195,544) 51,277 (329,435)
------------ ------------ ------------ ------------
Comprehensive loss $(21,336,728) $(13,151,846) $(41,492,845) $(24,811,339)
============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
5
PATHNET TELECOMMUNICATIONS, INC. AND SUBSIDIARIES AND PREDECESSOR COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
----------------------------
2000 1999
------------- -------------
Cash flows from operating activities:
Net loss $ (41,544,122) $ (24,481,904)
Adjustment to reconcile net loss to net cash used in operating activities:
Depreciation expense 5,350,236 1,570,939
Amortization of deferred financing costs 570,319 568,403
Provision for write down of spare parts 240,000 -
Bad debt expense 42,000 -
Loss on sale of equipment 79,241 -
Interest expense resulting from amortization of discount on the
bonds payable 204,750 204,750
Amortization of premium on pledged securities (21,801) 315,738
Amortization of deferred compensation 2,835,261 268,152
Changes in assets and liabilities:
Accounts receivable (8,030,885) -
Interest receivable 613,934 2,321,805
Prepaid expenses and other current assets 95,943 (831,114)
Accounts payable 3,738,996 (549,190)
Deferred revenue 7,727,035 -
Accrued expenses and other liabilities (455,091) 348,887
Other and intangible assets (129,172) -
------------- -------------
Net cash used in operating activities (28,683,356) (20,263,534)
------------- -------------
Cash flows from investing activities:
Expenditures for network in progress (50,167,134) (27,294,121)
Expenditures for property and equipment (4,016,795) (355,655)
Proceeds on sale of equipment 43,639 -
Sale and maturity of marketable securites available for sale 100,130,493 98,718,634
Purchase of marketable securities available for sale (58,555,060) -
Purchase of pledged marketable securities held to maturity (20,779,272) -
Sale and maturity of pledged marketable securities held to maturity 20,725,001 19,733,615
Restricted cash (1,430,671) 2,841,283
Repayment of note receivable - 3,206,841
------------- -------------
Net cash provided by (used in) investing activities (14,049,799) 96,850,597
------------- -------------
Cash flows from financing activities:
Issuance of series E convertible preferred stock 38,000,000 -
Proceeds from option to purchase series E convertible preferred stock 1,000,000 -
Exercise of employee common stock options 428,128 5,088
Payment of deferred financing costs (7,071,751) (40,735)
------------- -------------
Net cash provided by (used in) financing activities 32,356,377 (35,647)
------------- -------------
Net (decrease) increase in cash and cash equivalents (10,376,778) 76,551,416
Cash and cash equivalents at the beginning of period 90,661,837 57,321,887
------------- -------------
Cash and cash equivalents at the end of period $ 80,285,059 $ 133,873,303
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
6
PATHNET TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
AND PREDECESSOR COMPANY
CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
Pathnet, Inc. (Pathnet), is a wholesale telecommunications provider
building a nationwide network designed to provide other wholesale and retail
telecommunications service providers with access to underserved and second and
third tier markets throughout the United States.
Pathnet Telecommunications, Inc. (Pathnet Telecommunications) was
formed on November 1, 1999, by the former shareholders of Pathnet in order to
facilitate the reorganization transaction, which became effective on March 30,
2000 (see Note 14), and to continue the activity of Pathnet. Upon finalization
of the reorganization transaction, Pathnet became a wholly-owned subsidiary of
Pathnet Telecommunications. Hereafter, Pathnet Telecommunications, Pathnet
Operating Inc. and Pathnet together with their subsidiaries are referred to as
the Company.
The Company's telecommunications network will enable its customers
including existing local telephone companies, long distance companies, internet
service providers, competitive telecommunications companies, cellular operators
and other telecommunications providers to offer additional services to new and
existing customers in the markets the Company serves without having to expend
their own resources to build, expand or upgrade their own networks.
As of June 30, 2000, the Company's network consisted of over 6,300
wireless route miles providing wholesale transport services to 57 cities and
1,100 miles of installed fiber. The Company is constructing an additional 900
route miles of network under construction, which is scheduled for completion by
the end of the year. During 2000, the Company intends to deploy additional
products and services including bundled wholesale transport and local access
services.
The Company's business is funded primarily through preferred and common
stock investments by the Company's stockholders and by proceeds from Pathnet's
$350.0 million aggregate principal amount of units consisting of 12 1/4% Senior
Notes due 2008 (Senior Notes), which have been registered under the Securities
Act of 1933, as amended (Securities Act), and warrants to purchase Common Stock
issued by Pathnet on April 8, 1998 (Debt Offering).
2. BASIS OF PRESENTATION
Pathnet was formed to build a nationwide network designed to provide
other wholesale and retail telecommunications service providers with access to
underserved and second and third tier markets throughout the United States.
Pathnet Telecommunications was formed to continue the activity of Pathnet with
strategic investments from Colonial Pipeline Company, Burlington Northern and
Santa Fe Corporation and CSX Corporation received in connection with the
reorganization transaction. Since inception, Pathnet and Pathnet
Telecommunications' activities have consisted principally of constructing and
deploying digital networks utilizing both wireless and fiber-optic technologies.
Pathnet and Pathnet Telecommunications are considered companies under common
control. Consequently, for purposes of the accompanying consolidated financial
statements, Pathnet has been treated as a "predecessor" entity. Therefore, the
consolidated financial statements as of December 31, 1999 and for the three and
six months ended June 30, 1999 represent the historical financial information of
Pathnet, the predecessor entity. The accompanying consolidated financial
statements incorporate the combined business activities of Pathnet and Pathnet
Telecommunications.
7
The Company recently commenced providing telecommunications services to
customers and recognizing the revenue from the sale of such telecommunication
services. The Company's principal activities to date have been securing
contractual alliances with its co-development partners, designing and
constructing network path segments, obtaining capital and planning its proposed
service.
In the opinion of management, the accompanying unaudited consolidated
financial statements of the Company contain all adjustments (consisting only of
normal recurring accruals) necessary to present fairly the Company's
consolidated financial position, 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 for Pathnet, Inc. included in the
Company's Registration Statement on Form S-1 filed with the Securities and
Exchange Commission and declared effective on March 14, 2000. The results of
operations for the three and six months ended June 30, 2000, are not necessarily
indicative of the operating results to be expected for the full year.
3. CONSOLIDATION
These consolidated financial statements include the accounts of Pathnet
Telecommunications and its wholly owned subsidiaries, Pathnet, Pathnet
Operating, Inc. and Pathnet/Idaho Power License, LLC (a wholly owned subsidiary
of Pathnet). All material intercompany accounts and transactions have been
eliminated in consolidation.
4. RECENT ACCOUNTING STANDARDS
In December 1999, the Securities and Exchange Commission released staff
accounting bulletin No. 101, "Revenue Recognition in Financial Statements," (SAB
101) which clarifies the Securities and Exchange Commission's view on revenue
recognition. The Company believes its existing revenue recognition policies and
procedures are generally in compliance with SAB 101 and therefore, SAB 101's
adoption will have no material impact on the Company's financial condition,
results of operations or cash flows.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation, and Interpretation of APB
Opinion No. 25" (FIN 44). The Interpretation is intended to clarify certain
problems that have arisen since the issuance of APB No. 25 "Accounting for Stock
Issued to Employees." The effective date of the Interpretation is July 1, 2000.
The provisions of the Interpretation will apply prospectively, but it will also
cover certain events occurring after December 15, 1998 or after January 12,
2000. The Company believes the adoption of FIN 44 will not have a material
effect on the current or historical consolidated financial statements, but may
impact its future accounting regarding stock option transactions.
8
5. RECLASSIFICATION
Certain amounts in the financial statements and notes thereto have been
reclassified to conform to the June 30, 2000 classifications.
6. NON CASH STOCK COMPENSATION
During the three and six months ended June 30, 2000 and 1999, the
Company incurred non cash stock compensation of:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------- --------------------------------
2000 1999 2000 1999
---------------- --------------- ----------------- ------------
Telecommunications $ 72,670 $ -- $ 111,969 $ --
================ =============== ================= ==============
Construction $ -- $ 20,583 $ -- $ 41,165
================ =============== ================= ==============
Selling, general and administrative $ 1,331,222 $ 113,493 $ 2,723,293 $ 226,987
================ =============== ================= ==============
7. LOSS PER SHARE
Basic loss per share is computed by dividing net loss by the weighted
average number of shares of common stock outstanding during the applicable
period. Diluted loss per share is computed by dividing net 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 3,073,148 employee common
stock options, the exercise of warrants to purchase 1,116,500 shares of common
stock, and the conversion of 26,105,953 shares of Series A, B, C, D and E
convertible preferred stock into shares of common stock as of June 30, 2000,
which could potentially dilute basic loss 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.
8. SEGMENT REPORTING
The Company identifies its segments based on management responsibility.
The Company measures segment loss as net operating loss. The service revenue
from the telecommunications division includes all revenues generated from the
sale of telecommunications products, including high capacity, digital transport
and competitive local access services. The construction division includes the
operating activity and the assets relating to the network build out. The
revenues for the construction division primarily relate to the management of
construction projects and the sale of dark fiber through indefeasible rights of
use agreements ("IRUs"). Other includes certain of the Company's general and
administrative functions and operating expenses. All of the Company's revenue
are attributable to customers in the United States, and all of its assets are
located in the United States.
The following tables reflect the financial information for the
reportable segments:
9
THREE MONTHS ENDED JUNE 30, 2000
TELECOMMUNICATIONS CONSTRUCTION OTHER CONSOLIDATED
Revenue $ 1,123,681 $ 11,499,944 $ -- $ 12,623,625
Operating expenses 2,996,612 11,418,599 12,288,935 26,704,146
---------------------- ------------------ --------------- ---------------
Operating loss $ (1,872,931) $ 81,345 $ (12,288,935) $ (14,080,520)
====================== ================== =============== ===============
THREE MONTHS ENDED JUNE 30, 1999
TELECOMMUNICATIONS CONSTRUCTION OTHER CONSOLIDATED
Revenue $ 574,115 $ 290,700 $ -- $ 864,815
Operating expenses 1,825,079 844,176 4,541,004 7,210,259
---------------------- ----------------- -------------- --------------
Operating loss $ (1,250,964) $ (553,476) $ (4,541,004) $ (6,345,444)
====================== ================== ============== ==============
SIX MONTHS ENDED JUNE 30, 2000
TELECOMMUNICATIONS CONSTRUCTION OTHER CONSOLIDATED
Revenue $ 2,045,530 $ 12,504,649 $ -- $ 14,550,179
Operating expenses 4,739,698 12,418,196 24,025,191 41,183,085
---------------------- ----------------- -------------- --------------
Operating loss $ (2,694,168) $ 86,453 $ (24,025,191) $ (26,632,906)
====================== ================= ============== ==============
SIX MONTHS ENDED JUNE 30, 1999
TELECOMMUNICATIONS CONSTRUCTION OTHER CONSOLIDATED
Revenue $ 1,150,619 $ 540,300 $ -- $ 1,690,919
Operating expenses 3,560,334 1,760,121 7,874,003 13,194,458
---------------------- ----------------- -------------- ---------------
Operating loss $ (2,409,715) $ (1,219,821) $ (7,874,003) $ (11,503,539)
======================= ================= ============== ===============
The majority of revenues for the three and six months ended June 30,
2000, are comprised of construction services, approximately 91.0% and 85.9%,
respectively, arising mainly from its co-development agreements with Tri-State
Generation and Transmission Association, Inc. (Tri-State). The remainder of the
Company's revenues for the three and six months ended June 30, 2000,
approximately 9.0% and 14.1%, respectively, has been derived from the sale of
bandwidth along the Company's digital network, including approximately $989,000
from one customer. 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.
9. AVAILABLE FOR SALE MARKETABLE SECURITIES
The Company's marketable securities are considered "available for
sale," and, as such, are stated at market value. Marketable securities include
restricted marketable securities of approximately $1.1 million at June 30, 2000.
The net unrealized gains and losses on marketable securities are reported as
part of accumulated other comprehensive income (loss). Realized gains or losses
from the sale of marketable securities are based on the specific identification
method.
10
The following is a summary of the investments in marketable securities
at June 30, 2000:
GROSS UNREALIZED
----------------
COST GAINS LOSSES MARKET VALUE
---- ----- ------ ------------
Available for sale securities:
U.S. Treasury securities and debt securities
of U.S. Government agencies $ 1,155,779 $ -- $ 13,323 $ 1,142,456
Corporate debt securities 5,099,323 1,402 27,042 5,073,683
------------- ----------- ------------ -------------
$ 6,255,102 $ 1,402 $ 40,365 $ 6,216,139
============= =========== ============ =============
Net proceeds from the sales and maturity of available for sale
securities were approximately $100.1 million during the six months ended June
30, 2000.
The amortized cost and market value of available for sale marketable
securities by contractual maturity, regardless of their balance sheet
classification, at June 30, 2000 is as follows:
COST MARKET VALUE
Due in one year or less $ 6,255,102 $ 6,216,139
Due after one year through two years -- --
--------------- -------------
$ 6,255,102 $ 6,216,139
=============== =============
Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to prepay obligations without
prepayment penalties.
10. PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, is comprised of the following
at June 30, 2000 and December 31, 1999:
JUNE 30, DECEMBER 31,
2000 1999
------------- -------------
Network in progress $ 132,619,441 $ 63,123,322
Communications network 79,990,290 71,604,029
Office and computer equipment 6,514,742 2,262,934
Furniture and fixtures 1,377,975 1,555,771
Leasehold improvements 474,681 337,181
------------- -------------
220,977,129 138,883,237
Less: accumulated depreciation (12,166,290) (6,954,872)
------------- -------------
Property and equipment, net $ 208,810,839 $ 131,928,365
============= =============
11
Network in progress includes (i) all direct material and labor costs
together with related allocable interest costs, necessary to construct
components of a high capacity digital wireless and fiber optic network, and (ii)
network related inventory parts and equipment. The network in progress balance
as June 30, 2000 includes approximately $82.1 million for costs incurred to
construct digital fiber optic networks and $2.8 million for a right of use under
an agreement with Northern Border Pipeline Company for microwave access. When a
portion of the network has been completed and made available for its intended
use by the Company, the accumulated costs are transferred from network in
progress to communications network and depreciated.
11. DEFERRED FINANCING COSTS
The Company has incurred costs related to the Debt Offering and the
amendment to the Senior Notes in connection with the reorganization transaction.
Such costs are amortized over the term of the debt or financing arrangement.
12. RESTRICTED CASH
Restricted cash comprises amounts held in escrow to collateralize the
Company's obligations under certain of its development agreements. The funds in
each escrow account are available only to fund the projects to which the escrow
is related. Generally, funds are released from escrow to pay project costs as
incurred. During the six months ended June 30, 2000, the Company deposited
approximately $10.9 million in escrow and invested approximately $1.1 million in
restricted marketable securities and approximately $7.7 million was released
from escrow.
13. COMMITMENTS AND CONTINGENCIES
As of June 30, 2000, the Company had capital commitments of up to
approximately $50.3 million relating to telecommunication and transmission
equipment and its agreement with its co-development partners.
On April 19, 2000, the Company was sued by several plaintiffs purporting
to represent a class of landowners damaged by the Company in connection with the
development of the Company's fiber optic network. Specifically, the complaint
alleges the Company installed or will install fiber optic facilities on the
property of the landowners in the class without obtaining the necessary legal
rights from the landowners. Based on the information currently available, in the
vast majority of the jurisdictions in which plaintiff alleges violations, the
Company is unaware of any facts that would support plaintiff's claims. In the
jurisdictions in which there is uncertainty as to the factual basis for
plaintiff's claims, the Company believes it has valid defenses to plaintiff's
claims. The Company also believes that it would be indemnified against
plaintiff's claims by the co-development partner on that project. Accordingly,
based upon the Company's current understanding of the factual basis for
plaintiff's claims and the likelihood of success, it does not believe that
plaintiff's claims will have a material adverse effect on the operations, cash
flows or financial position of the Company and believes that the likelihood of a
material loss is remote.
12
On May 17, 2000, MagTen Partners, L.P. ("Magten"), one of the Company's
bondholders, filed suit against the Company and the investors involved in the
Company's reorganization (see note 14). On July 14, 2000, the Company served the
plaintiffs with its response. Magten's claims stem from their contention that
the Company was not permitted to consummate the reorganization without unanimous
consent of the holders of the Senior Notes, and that the Company's failure to
obtain Magten's consent triggered a provision in the Indenture governing the
Senior Notes (the "Indenture"), requiring the Company to repurchase the Senior
Notes at 101% of their face value. The Company does not agree with MagTen's
interpretation of the Indenture and intends to defend the claim vigorously.
Accordingly, based upon the Company's current understanding of the factual basis
for plaintiff's claims and the likelihood of success, it does not believe that
plaintiff's claims will have a material adverse effect on the operations, cash
flows or financial position of the Company and believes that the likelihood of a
material loss is remote.
14. REORGANIZATION
On March 30, 2000, the Company completed a strategic investment
transaction with Colonial Pipeline Company, The Burlington Northern and Santa Fe
Corporation and CSX Corporation. As part of the transaction, the Company
received a contribution of over 12,000 miles of rights of way with an estimated
value of approximately $187.0 million. Generally, the Company does not begin
amortizing rights of way used in its network until the network is completed and
available for use.
In return for the rights of way, the Company issued 8,511,607 shares of
the Company's Series D convertible preferred stock. In addition to providing a
portion of the rights of way access, Colonial Pipeline paid $43.0 million in
cash to the Company, comprised of $38.0 million at the initial closing for
1,729,631 shares of the Company's Series E redeemable preferred stock, $1.0
million for the issuance of an option to purchase 1,593,082 shares of the
Company's Series E redeemable preferred stock for $21.97 per share in connection
with an initial public offering and $4.0 million for rights in 2,200 conduit
miles of our future network. Colonial Pipeline paid an additional $25.0 million
for 1,137,915 shares of the Company's Series E redeemable preferred stock upon
the completion of a fiber-optic network segment that the Company completed
during the third quarter of 2000. The option to purchase 1,593,082 shares of the
Company's Series E preferred stock expired in July 2000. The new investors
collectively received an approximate one-third equity stake in the Company, as
well as representation on the Company's Board of Directors.
Upon the closing of the transaction, all of the Pathnet's common stock
was exchanged for common stock of Pathnet Telecommunications resulting in
Pathnet becoming a wholly-owned subsidiary of Pathnet Telecommunications and all
of the Pathnet's 5,470,595 shares of mandatorily redeemable preferred stock
being converted into 15,864,715 of Pathnet Telecommunications convertible
preferred stock.
The Company obtained consents to the waiver and the amendment of
certain provisions of the indenture from the holders of a majority of Pathnet's
Senior Notes. In return for such consents, (i) Pathnet made consent fee payments
to consenting noteholders of approximately $6.6 million in the aggregate and
purchased and pledged to the trustee under the indenture for the benefit of the
noteholders, additional U.S. Treasury Securities as security covering the
October 16, 2000 interest payment on the Senior Notes and (ii) Pathnet
13
Telecommunications issued its senior guarantees of the Senior Notes. The $6.6
million consent payment to the bondholders increased deferred financing costs
and is being amortized over the remaining term of the Senior Notes. In addition,
for the six months ended June 30, 2000, the Company had expensed approximately
$1.8 million of fees for printing, legal, solicitation and other transaction
fees.
15. NONMONETARY TRANSACTIONS
In March 2000, the Company entered into an agreement with a third party
to swap 24 fibers along a 395 mile segment between Des Moines, Iowa and Chicago,
Illinois, in return for six fibers along a 1,302 mile segment from Charlotte,
North Carolina, through Savannah, Georgia, Jacksonville, Miami, and Orlando,
Florida. The Company anticipates completing the swap in the first quarter of
2001. This transaction will be treated as an exchange of similar productive
assets.
16. SUBSEQUENT EVENTS
On August 10, 2000, the Company announced the signing of a
multi-million dollar credit facility with Nortel Networks. The credit facility
consists of $210.0 million over six years to be used for the purchase of goods
and services from Nortel Networks. The Company intends to use the credit
facility to fund its continued fiber optic network build-out.
On August 10, 2000, the Company received an additional $25,.0 million
from Colonial Pipeline Company, in return for 1,137,915 shares of the Company's
Series E redeemable preferred stock. This was part of the March strategic
investment transaction, which was due upon the completion of a fiber optic
segment that the Company completed during the third quarter, 2000.
14
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. IN THIS REPORT, WE REFER TO
PATHNET TELECOMMUNICATIONS, INC., AS THE "COMPANY," "WE," "US," AND "OUR." WHERE
APPLICABLE, SUCH REFERENCES REFER TO PATHNET, INC.,OR "PATHNET", THE PREDECESSOR
REPORTING COMPANY PRIOR TO THE REORGANIZATION TRANSACTION COMPLETED ON MARCH 30,
2000.
OVERVIEW
We were formed on November 1, 1999 in order to facilitate a reorganization
transaction with Pathnet, Inc. which is now our wholly owned subsidiary. Our
reorganization was completed on March 30, 2000. Together with Pathnet, we are a
wholesale telecommunications provider building a nationwide network designed to
provide other wholesale and retail telecommunications service providers with
access to underserved and second and third tier markets throughout the United
States.
Our network will enable our customers, including existing local telephone
companies, long distance companies, internet service providers, competitive
telecommunications companies, cellular operators and other telecommunications
providers, to offer additional services to new and existing customers in these
markets without having to expend their own resources to build, expand or upgrade
their own networks.
Since Pathnet's inception in November 1995, our business has focused on:
o Entering into strategic relationships with owners of
telecommunications assets and co-development partners;
o Developing and constructing our digital backbone network;
o Negotiating collocation and interconnection agreements and installing
collocations and interconnections off our backbone network;
o Designing and developing our network architecture and operations
support systems, including the buildout and launch of our 24-hour
network operations center;
o Raising capital and hiring management and other key personnel;
o Developing "leading edge" products and services; and
o Procuring governmental authorizations.
On March 30, 2000, we completed a strategic investment transaction with
Colonial Pipeline Company, The Burlington Northern and Santa Fe Corporation and
CSX Transportation, Inc. We received the right to develop over 12,000 miles of
these investors' rights of way holdings, 8,000 of which have some form of
exclusivity. In addition to providing a portion of the rights of way access,
Colonial also made a contribution of $43.0 million in cash (consisting of $38.0
million as a first tranche cash investment, $1.0 million for options to purchase
additional shares of our stock and $4.0 million for rights in a single fiber
15
optic conduit) and agreed to make a second cash investment of $25.0 million in
our business upon the completion of our Chicago to Aurora (a suburb of Denver)
fiber optic network build. Our new investors hold approximately one-third of our
equity and have representation on our Board of Directors.
In March 2000, we entered into an agreement with a third party to swap 24
fibers along a 395 mile segment between Des Moines, Iowa and Chicago, Illinois,
in return for six fibers along a 1,302 mile segment from Charlotte, North
Carolina, through Savannah, Georgia, Jacksonville, Miami, and Orlando, Florida.
We anticipate completing the transation in the first quarter of 2001.
As of June 30, 2000, our network consisted of over 6,300 wireless route
miles, providing wholesale transport services to 57 cities, and 1,100 miles of
installed fiber. We are constructing an additional 900 route miles of network
under construction, which is scheduled for completion by the end of this year.
During 2000, we intend to deploy additional products and services including
bundled wholesale transport and local access services.
In June, we announced the first implementation of our VPOP (Virtual Point
of Presence) Plus Service, which is a packet-based local access service that
combines high-capacity transport with dial, PRI, digital subscriber line (DSL),
Voice over Internet Protocol (VoIP) and dedicated private line technologies. The
product allows ISPs to increase their service footprint while reducing their
cost in reaching underserved markets.
We have experienced operating losses since our inception, and we expect
these operating losses to continue as we expand our operations. Implementing our
business plan will require significant capital expenditures. Our financial
performance will vary from market to market, and the time when we will achieve
positive earnings before interest, taxes, depreciation and amortization, if at
all, will depend on the:
o Size of our target markets;
o Timely completion of backbone routes, collocations and
interconnections;
o Cost of the necessary infrastructure;
o Timing of and barriers to market entry; and
o Commercial acceptance of our services.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE AND SIX MONTHS ENDED JUNE 30, 2000 WITH THE THREE AND
SIX MONTHS ENDED JUNE 30, 1999
During the six months ended June 30, 2000, we completed our reorganization,
which included our acquisition of rights of way and cash from our investors. We
also continued to focus on:
o expanding the number of cities and collocations in our network,
o building out our fiber network,
o obtaining the regulatory approval and entering into interconnection
agreements in each of our target markets to enable us to obtain
16
unbundled network elements and central office space from existing
local telephone companies,
o expanding our product line, and
o developing our infrastructure including the hiring of key management
personnel.
REVENUE. For the three months ended June 30, 2000 and 1999, we generated
revenue of approximately $12.6 million and $865,000, respectively, comprised of
revenue from telecommunications services of approximately $1.1 million and
$574,000, respectively, together with revenue from construction services of
approximately $11.5 million and $291,000, respectively. For the six months ended
June 30, 2000 and 1999, we generated revenue of approximately $14.6 million and
$1.7 million, respectively, comprised of revenue from telecommunications
services of approximately $2.0 million and $1.2 million, respectively, together
with revenue from construction services of approximately $12.5 million and
$540,000, respectively. The increase in telecommunications services revenue is a
result of our ability to provide services to more cities as our network is
completed. The increase in revenue from construction services arises mainly from
our co-development agreement with Tri-State Generation and Transmission
Association, Inc. ("Tri-State") entered into during the third quarter of 1999.
We expect that a substantial portion of our future revenue will be generated
from our sale of local access services, backbone infrastructure services and
construction services.
COST OF REVENUE. Expenses for telecommunications services primarily consist
of the cost of operating the Company's network, local exchange carrier access
charges and the cost of leased capacity. For the three months ended June 30,
2000 and 1999, we incurred telecommunications services costs of approximately
$3.0 million and $1.8 million, respectively. For the six months ended June 30,
2000 and 1999, we incurred telecommunications services costs of approximately
$4.7 million and $3.6 million, respectively. The increase is related to
operating expenses as we put more of our network into service.
Expenses for construction services consist primarily of costs of sale on
network construction contracts, including conduit, fiber, cable, construction
crews and rights of way. Costs attributable to the construction of the network
for the Company's own use are capitalized. For the three months ended June 30,
2000 and 1999, the Company incurred construction services costs of approximately
$11.4 million and $0.8 million, respectively. For the six months ended June 30,
2000 and 1999, the Company incurred construction services costs of approximately
$12.4 million and $1.8 million, respectively. The increase arises from the
co-development of our route with Tri-State.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expense includes the cost of salaries, benefits, occupancy costs,
commissions, sales and marketing expenses and administrative expenses. For the
three months ended June 30, 2000 and 1999, SG&A expenses were $9.2 million and
$3.5 million, respectively. For the six months ended June 30, 2000 and 1999,
SG&A expenses were $16.9 million and $6.3 million, respectively. The increase is
attributable to additional staff costs incurred as we continued to develop our
infrastructure, along with administrative costs related to obtaining regulatory
status and deferred expense for compensatory stock options. We expect selling,
general and administrative expenses to continue to increase in the remainder of
2000 as we continue to develop or infrastructure and increase our staff level.
17
REORGANIZATION EXPENSES. Reorganization expenses are those expenses
associated with the strategic investment transaction we completed in March 2000.
Expenses for the transaction were $0.3 million and $1.8 million for the three
and six months ended June 30, 2000, respectively. There were no comparable
transaction costs for the similar periods in 1999.
DEPRECIATION EXPENSES. For the three months ended June 30, 2000 and 1999,
depreciation expenses were $2.8 million and $1.0 million, respectively. For the
six months ended June 30, 2000 and 1999, Depreciation expenses were $5.4 million
and $1.6 million, respectively. The increase is associated with more of our
network coming on line.
INTEREST EXPENSE. Interest expense for the three months ended June 30, 2000
and 1999 was approximately $9.3 million and $10.0 million, respectively.
Interest expense for the six months ended June 30, 2000 and 1999 was
approximately $19.0 million and $20.3 million, respectively. Interest expense
primarily represents interest on Pathnet's 12 1/4% Senior Notes due 2008 issued
in April 1998 together with the amortization expense related to bond issuance
costs in respect to those notes and the amortization expense related to deferred
financing costs.
INTEREST INCOME. Interest income for the three months ended June 30, 2000
and 1999 was approximately $2.2 million and $3.4 million, respectively. Interest
income for the six months ended June 30, 2000 and 1999 was approximately $4.4
million and $7.2 million, respectively. The decrease in interest income reflects
a decrease in cash and cash equivalents and marketable securities as those funds
were used in building our network, funding operations, and making interest
payments on the senior notes.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000, we had approximately $86.5 million of cash, cash
equivalents and marketable securities to fund future operations. In addition, we
had $18.3 million in restricted cash for use in building our network, as well as
$20.9 million in escrow for the bond interest payment due in October, 2000. We
received an additional $25.0 million equity investment from Colonial Pipeline
Company during the third calendar quarter of 2000.
In addition, we expect to finance the cost of some of our equipment through
vendor financing arrangements. We negotiated a credit facility with Nortel
Networks, which will, subject to certain conditions, provide us with financing
for optronic equipment that we purchase.
We estimate that our current available resources, together with those
received in our reorganization, will be sufficient to fund the implementation of
our long term business plan, as currently contemplated, including the capital
commitments described above, operating losses in new markets and working capital
needs through the fourth quarter of 2000. After such time, we expect we will
require additional financing, which may include commercial bank borrowings,
additional vendor financing or the sale or issuance of equity or debt
securities.
Our expectations of our future capital requirements and cash flows from
operations are based on current estimates. If our plans or assumptions change or
prove to be inaccurate, we may require additional sources of capital or
additional capital sooner than anticipated.
18
FORWARD-LOOKING STATEMENTS
The matters discussed in this quarterly report may include 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. Although we believe that the expectations
reflected in such forward-looking statements are reasonable, we cannot assure
you 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 quarterly report, as well as the amount of capital needed to
deploy our network; our substantial leverage and need to service our
indebtedness; the restrictions imposed by our current and possible future
financing arrangements; our ability to successfully manage the cost-effective
and timely completion of our network and our ability to attract and retain
customers for our products and services; our ability to implement our newly
expanded business plan; our ability to retain and attract relationships with the
incumbent owners of the telecommunications assets with which we expect to build
our network; our ability to obtain and maintain rights of way for the deployment
of our network; our ability to retain and attract key management and other
personnel as well as our ability to manage the rapid expansion of our business
and operations; our ability to compete in the highly competitive
telecommunications industry in terms of price, service, reliability and
technology; our dependence on the reliability of our network equipment, our
reliance on key suppliers of network equipment and the risk that our technology
will become obsolete or otherwise not economically viable; and our ability to
conduct our business in a regulated environment. We do not intend to update
these forward-looking statements. These and other risks and uncertainties
affecting us are contained from time to time in our filings with the Securities
and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to minimal market risks. We manage sensitivity of our
results of operations to market risks by maintaining a conservative investment
portfolio, (which primarily consists of debt securities, that typically mature
within one year), and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other financial instruments for trading purposes. Financial instruments held for
other than trading purposes do not impose a material market risk on us.
We are exposed to interest rate risk. We periodically need additional debt
financing due to our large operating losses, and capital expenditures associated
with establishing and expanding our network coverage increase our financing
needs. The interest rate that we will be able to obtain on debt financing will
depend on market conditions at that time, and may differ from the rates we have
obtained on our current debt.
Although all of our long-term debt bears fixed interest rates, the fair
market value of our fixed rate long-term debt is sensitive to changes in
interest rates. We have no cash flow or earnings exposure due to market interest
rate changes for our fixed long-term debt obligations. As of June 30, 2000, the
fair value of our debt was approximately $196.0 million.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 19, 2000, Pathnet, Inc. was sued by several plaintiffs
purporting to represent a class of landowners damaged by Pathnet in connection
with the development of Pathnet's fiber optic network. Specifically, the
complaint alleges that Pathnet installed or will install fiber optic facilities
on the property of the landowners in the class without obtaining the necessary
legal rights from the landowners.
On May 17, 2000, MagTen Partners, L.P. ("Magten"), one of our
bondholders, filed suit against the Company and the investors involved in the
Company's reorganization transaction (the "Reorganization"). The Reorganization,
completed on March 30, 2000, was among the Company, Colonial Pipeline Company,
The Burlington Northern and Santa Fe Corporation and CSX Corporation. On July
14, 2000, the Company served the plaintiffs with its response. Magten's claims
stem from their contention that the Company was not permitted to consummate the
Reorganization without unanimous consent of the holders of the Senior Notes, and
that the Company's failure to obtain Magten's consent triggered a provision in
the Indenture governing the Senior Notes (the "Indenture"), requiring the
Company to repurchase the Senior Notes at 101% of their face value. The Company
does not agree with MagTen's interpretation of the Indenture and intends to
defend the claim vigorously.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
EMPLOYEE STOCK OPTIONS.
As of June 30, 2000, pursuant to the exercise of stock options, we
issued 198,514 shares of common stock to certain former employees at exercise
prices ranging from $1.13 to $5.20 per share. All of these stock options were
granted under Pathnet's 1997 Stock Incentive Plan, which we assumed at the
closing of the reorganization transaction.
There were no underwriters involved in the sale of any of these
securities. Our equity securities were issued in private placement transactions
exempt from registration in accordance with Section 4(2) of the Securities Act
of 1933, as amended, and where applicable, Rule 506 under Regulation D, and were
issued without general solicitation or advertising.
USE OF PROCEEDS
We did not receive any proceeds from the issue of our guarantees.
The aggregate amount of expenses incurred for our account in connection
with the issuance and distribution of the guarantees is estimated at $9,846,278,
consisting of the following:
20
Securities and Exchange Commission registration fee........... $ 60,326
Blue Sky fees and expenses.................................... 1,300
Accounting fees and expenses.................................. 50,000*
Legal fees and expenses....................................... 1,892,364*
Printing and engraving fees................................... 345,000*
Solicitation Agent fees and expenses.......................... 768,163*
Bondholder consent fee........................................ 6,591,625*
Miscellaneous................................................. 25,000*
Trustee/Depositary/Warrant Agent fees and expenses............ 112,500*
------------
Total.................................................... $ 9,846,278
============
* Also attributable to the overall reorganization transaction.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Exhibit Index
(B) REPORTS ON FORM 8-K
None
21
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.
PATHNET TELECOMMUNICATIONS, INC.,
a Delaware corporation
(Registrant)
Date: August 10, 2000 By: /S/ RICHARD A. JALKUT
----------------------
Richard A. Jalkut
President and Chief Executive Officer
Date: August 10, 2000 By: /S/ JAMES M. CRAIG
-------------------
James M. Craig
Executive Vice-President, Chief
Financial Officer and Treasurer
(Principal Financial Officer)
22
EXHIBIT INDEX
Pursuant to Item 601 of Regulation S-K
EXHIBIT NO. DESCRIPTION OF EXHIBIT
27.1 Financial Data Schedule for the six months ended June 30,
2000.
99.1 Press release dated August 10, 2000 announcing the Company's
results for the second quarter of 2000.
23