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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-27525
DSL.NET, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1510312
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
545 Long Wharf Drive
New Haven, Connecticut 06511
(Address of principal executive offices) (Zip Code)
(203) 772-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
As of August 13, 2002 the registrant had 64,878,966 shares of Common Stock
outstanding.
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DSL.NET, INC.
INDEX
Page
Number
------
Part I - Financial Information
Item 1. Consolidated Financial Statements .............................3
Consolidated Balance Sheets (unaudited) at December 31,
2001 and June 30, 2002...................................3
Consolidated Statements of Operations (unaudited) for
the three and six months ended June 30, 2001 and 2002....4
Consolidated Statements of Cash Flows (unaudited) for
the six months ended June 30, 2001 and 2002..............5
Notes to Consolidated Financial Statements..................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................15
Item 3. Quantitative and Qualitative Disclosures about Market Risk....25
Part II - Other Information
Item 2. Changes in Securities and Use of Proceeds.....................26
Item 4. Submission of Matters to a Vote of Security Holders...........27
Item 6. Exhibits and Reports on Form 8-K..............................29
Signature ..........................................................30
Exhibit Index ..........................................................31
2
Part I - Financial Information
Item 1. Consolidated Financial Statements
DSL.net, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(unaudited)
ASSETS December 31, June 30,
2001 2002
------------ ------------
Current assets:
Cash and cash equivalents $ 19,285 $ 20,492
Restricted cash 346 305
Accounts receivable (net of allowances of $3,844 and $4,255 at
December 31, 2001 and June 30, 2002, respectively) 5,856 6,109
Deferred costs 1,131 1,030
Prepaid expenses and other current assets 2,235 2,023
------------ ------------
Total current assets 28,853 29,959
Fixed assets, net 36,861 29,910
Goodwill and other intangible assets 14,741 12,769
Other assets 569 954
------------ ------------
Total assets $ 81,024 $ 73,592
============ ============
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,327 $ 3,999
Accrued salaries 907 932
Accrued liabilities 9,636 6,893
Deferred revenue 3,966 4,251
Current portion of capital leases payable 2,902 2,803
Current portion of bridge loan payable 3,531 --
------------ ------------
Total current liabilities 25,269 18,878
Capital leases payable 4,560 3,185
------------ ------------
Total liabilities 29,829 22,063
------------ ------------
Commitments and contingencies (Note 8)
Preferred stock, 20,000,000 preferred shares authorized:
20,000 shares designated as Series X, mandatorily
redeemable convertible preferred stock, $.001 par
value, 10,000 and 20,000 shares ($10,115 and $21,115
liquidation preference) issued and outstanding as of
December 31, 2001 and June 30, 2002, respectively 436 4,194
15,000 shares designated as Series Y, mandatorily
redeemable convertible preferred stock, $.001 par
value, 6,469 and 15,000 shares ($6,475 and $15,480
liquidation preference) issued and outstanding as of
December 31, 2001 and June 30, 2002, respectively 34 1,806
Stockholders' equity:
Common stock, $.0005 par value; 200,000,000 and
400,000,000 shares authorized;
64,851,462 and 64,878,966 shares issued and outstanding
as of December 31, 2001 and June 30, 2002, respectively 32 32
Additional paid-in capital 300,757 313,767
Deferred compensation (1,667) (1,025)
Accumulated deficit (248,397) (267,245)
------------ ------------
Total stockholders' equity 50,725 45,529
------------ ------------
Total liabilities, mandatorily redeemable convertible
preferred stock and stockholders' equity $ 81,024 $ 73,592
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
3
DSL.net, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Revenue $ 10,348 $ 11,596 $ 19,170 $ 22,977
------------ ------------ ------------ ------------
Operating expenses:
Network (excluding $8, $8, $15 and $15
of stock compensation, respectively) 11,872 8,625 23,719 17,337
Operations (excluding $59, $14, $119 and $29
of stock compensation, respectively) 32,078 1,856 37,193 3,847
General and administrative (excluding $136, $57, $228 and $168
of stock compensation, respectively) 10,367 3,373 15,830 6,776
Sales and marketing (excluding $219, $217, $435 and $430
of stock compensation, respectively) 4,074 1,577 9,039 2,774
Stock compensation 422 296 797 642
Depreciation and amortization 7,805 5,274 16,016 10,388
------------ ------------ ------------ ------------
Total operating expenses 66,618 21,001 102,594 41,764
------------ ------------ ------------ ------------
Operating loss (56,270) (9,405) (83,424) (18,787)
Interest income (expense), net 101 8 630 (236)
Other (expense) income, net -- 3 (2) 175
------------ ------------ ------------ ------------
Net loss $ (56,169) $ (9,394) $ (82,796) $ (18,848)
============ ============ ============ ============
Net loss applicable to common stockholders:
Net loss $ (56,169) $ (9,394) $ (82,796) $ (18,848)
Dividends on preferred stock -- (879) -- (1,473)
Accretion of preferred stock, net of issuance costs -- (2,461) -- (4,057)
------------ ------------ ------------ ------------
Net loss applicable to common stockholders $ (56,169) $ (12,734) $ (82,796) $ (24,378)
============ ============ ============ ============
Net loss per share, basic and diluted $ (0.88) $ (0.20) $ (1.30) $ (0.38)
============ ============ ============ ============
Shares used in computing net loss per share, basic and diluted 63,735,232 64,868,362 63,561,430 64,806,104
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements.
4
DSL.net, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
June 30,
----------------------------
2001 2002
------------ ------------
Cash flows from operating activities:
Net loss $ (82,796) $ (18,848)
Reconciliation of net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 16,016 10,388
Amortization of deferred debt issuance costs 29 9
Stock compensation expense 797 642
Restructuring charges for write-down of fixed assets 25,330 --
Impairment charges for write-down of goodwill 3,155 --
Loss on sale/write-off of fixed assets -- 52
Decrease / (increase) in other assets 48 (385)
Net changes in current assets and liabilities:
(Increase) in accounts receivable, net (636) (228)
Decrease in prepaid and other current assets 435 313
(Decrease) in accounts payable (4,681) (328)
(Decrease) / increase in accrued salaries (65) 24
Increase / (decrease) in accrued liabilities 3,789 (2,738)
Increase in deferred revenue 1,068 285
------------ ------------
Net cash (used in) operating activities (37,511) (10,814)
------------ ------------
Cash flows provided by (used in) investing activities:
Purchases of property and equipment (3,421) (880)
Proceeds from sales of property and equipment -- 85
Acquisitions of businesses and customer lines (2,690) (750)
Decrease in restricted cash 178 40
------------ ------------
Net cash (used in) investing activities (5,933) (1,505)
------------ ------------
Cash flows provided by (used in) financing activities:
Proceeds from issuance of common stock for stock option
exercises and employee stock purchase plan 36 10
Proceeds from preferred stock issuance, net -- 15,000
Principal payments under notes and capital lease obligations (3,196) (1,484)
------------ ------------
Net cash (used in) provided by financing activities (3,160) 13,526
------------ ------------
Net (decrease) / increase in cash and cash equivalents (46,604) 1,207
Cash and cash equivalents at beginning of period 72,324 19,285
------------ ------------
Cash and cash equivalents at end of period $ 25,720 $ 20,492
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
5
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Summary of Significant Accounting Policies
A. Basis of Presentation
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements. Actual
results may differ from those estimates. Certain prior period amounts have been
reclassified to conform to the 2002 presentation. The consolidated financial
statements ("financial statements") at June 30, 2002 and for the three and six
months ended June 30, 2001 and 2002 are unaudited, but in the opinion of
management, include all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation of
financial position and operating results. Operating results for the three months
and six months ended June 30, 2002 are not necessarily indicative of results
that may be expected for any future periods.
Network and operations expenses, which were previously reported as a
combined amount on the consolidated statements of operations, have been
separated into two components: (1) network expenses and (2) operations expenses.
Network expenses include costs related to network engineering and network
operations personnel, costs for telecommunications lines between customers,
central offices, network service providers and the Company's network, costs for
rent and power at the Company's central offices, costs to connect to the
Internet, costs of customer line installations and the costs of customer premise
equipment when sold to customers. Operations expenses include costs related to
customer care, customer provisioning, customer billing, customer technical
assistance, purchasing, headquarters facilities operations, operating systems
maintenance and support and other related overhead expenses.
The accompanying unaudited interim financial statements have been prepared
with the assumption that users of the interim financial information have either
read or have access to the Company's financial statements for the year ended
December 31, 2001. Accordingly, footnote disclosures which would substantially
duplicate the disclosures contained in the Company's December 31, 2001 audited
financial statements have been omitted from these unaudited interim financial
statements. These financial statements have been prepared in accordance with the
instructions to Form 10-Q and the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
instructions, rules and regulations. While management believes the disclosures
presented are adequate to make these financial statements not misleading, these
financial statements should be read in conjunction with the Company's audited
financial statements and related notes included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2001, which has been filed with the
Securities and Exchange Commission.
B. Revenue Recognition
The Company recognizes revenue in accordance with SEC Staff Accounting
Bulletin ("SAB") No. 101, "REVENUE RECOGNITION IN FINANCIAL STATEMENTS", which
requires that four basic criteria be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured. Determination of criteria (3) and (4) are based on
management's judgments regarding the fixed nature of the fee charged for
services rendered and products delivered and the collectibility of those fees.
C. Earnings (Loss) Per Share
Basic earnings per share is computed by dividing income or loss applicable
to common shareholders by the weighted average number of shares of the Company's
common stock outstanding during the period, after giving consideration to shares
subject to repurchase.
6
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Diluted earnings per share is determined in the same manner as basic
earnings per share except that the number of shares is increased assuming
exercise of dilutive stock options and warrants using the treasury stock method
and dilutive conversion of the Company's outstanding preferred stock. The
diluted earnings per share amount is the same as the basic earnings per share
amount because the Company had a net loss during each period presented and the
impact of the assumed exercise of the stock options and warrants and the assumed
conversion of preferred stock would have been anti-dilutive.
2. Liquidity
As reflected in the Company's audited financial statements and related
notes included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2001, the Company incurred operating losses of approximately
$115,895,000 and negative operating cash flows of approximately $62,990,000
during the year ended December 31, 2001. During the six months ended June 30,
2002, the Company incurred operating losses of approximately $18,787,000 and
negative operating cash flows of approximately $10,814,000. These operating
losses and negative operating cash flows have been financed primarily by
proceeds from equity issuances. The Company had accumulated deficits of
approximately $248,397,000 at December 31, 2001 and of approximately
$267,245,000 at June 30, 2002.
The Company expects its operating losses, net operating cash outflows and
capital expenditures to continue during 2002. The Company recently completed
rounds of private equity and bridge loan financings totaling approximately $35
million as follows: approximately $20 million in the fourth quarter of 2001, $10
million in March 2002, and $8.5 million in May 2002 (which, after cancellation
of the bridge loans, yielded net proceeds of approximately $5 million) (Note
10). The Company believes that its existing cash and cash equivalents, and cash
expected to be generated from operations, will be sufficient to fund its
operating losses, capital expenditures, lease payments and working capital
requirements through the second quarter 2003 and beyond, until it achieves cash
flow positive status, based on its current business plans and projections, as
approved by the Company's board of directors. The Company intends to use these
cash resources to finance its capital expenditures and for working capital and
other general corporate purposes. The Company may also use a portion of these
cash resources to acquire complementary businesses, customers and other assets.
However, the Company may need to obtain additional financing in order to
complete certain acquisitions or operate its business after certain
acquisitions. The amounts actually expended for these purposes will vary
significantly depending on a number of factors, including market acceptance of
the Company's services, revenue growth, cash generated from operations,
improvements in operating productivity, the extent and timing of entry into new
markets, and availability and prices paid for acquisitions. Failure to generate
sufficient revenue, contain certain discretionary spending or achieve certain
other business plan objectives could have a material adverse affect on the
Company's results of operations and financial position.
3. Stockholders' Equity
In January 2001, the Company exercised its repurchase right for 1,288,566
shares of common stock at $.001875 per share, representing the remaining
unvested shares from one of the Company's founding shareholders who had
terminated his employment. The shares were subsequently cancelled and $323,832,
or $0.2513 per share, was reclassified from deferred compensation to additional
paid-in capital and common stock.
The Company's remaining unamortized deferred compensation balance of
approximately $1,025,000 at June 30, 2002, relating to stock options and
restricted stock held by employees and directors, is being amortized over the
respective remaining vesting periods.
7
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. Restructuring
In December 2000, the Company initiated a new business plan strategy
designed to conserve its capital, reduce its losses and extend its cash
resources. This strategy included the following actions: 1) further network
expansion was curtailed; 2) network connections to certain central offices were
suspended; 3) certain facilities were vacated and consolidated; 4) operating
expenses were reduced; and 5) headcount was reduced by approximately 140
employees. These actions resulted in a restructuring charge of approximately
$3,542,000.
In March 2001, the Company re-evaluated its restructuring reserve related
to the corporate restructuring announced in December of 2000 and recorded an
increase in the reserve of approximately $831,000, which was primarily related
to delays in subleasing its vacated facilities and additional costs pertaining
to its suspended central offices. Of that amount, approximately $440,000 was
included in network expenses and operations expenses and approximately $391,000
was included in general and administrative expenses.
In June 2001, due to the lack of liquidity in the financial markets, the
Company further re-evaluated its business plans and determined that additional
actions were necessary to further reduce its losses, further extend its cash
resources and reduce its total funding requirements. These actions included: 1)
further reductions in operating expenses; 2) closure of approximately 100
non-active and 250 active central offices; and 3) an additional
reduction-in-force of approximately 90 employees. These actions resulted in
additional restructuring charges approximating $32,503,000, which included
$3,155,000 for impairments of goodwill relating to the Company's acquisition of
Tycho Networks, Inc. and certain assets of Trusted Net Media Holdings, LLC. The
goodwill impairment analysis was accomplished by comparing the carrying value of
the assets with the expected future net cash flows generated over the remaining
useful life of the assets. Since the carrying value was more than the expected
future net cash flows, the goodwill was reduced to the net present value of the
expected future net cash flows. Of the approximately $32,503,000 in additional
restructuring charges, approximately $27,561,000 was included in network
expenses and operations expenses; approximately $35,000 was included in sales
and marketing expenses and approximately $4,907,000 was included in general and
administrative expenses.
The Company's restructuring reserve balance at June 30, 2002, of
approximately $973,000, which related to various restructuring charges recorded
in 2000 and 2001, was included in the Company's accrued liabilities and
represented approximately $658,000 for anticipated costs pertaining to its
vacated facilities and approximately $315,000 for anticipated costs pertaining
to its closed central offices.
5. Acquisitions
During the first half of 2001, the Company acquired approximately 1,100
customer lines referred by Covad Communications, Inc. ("Covad") under the Covad
Safety Net program, for aggregate fees of approximately $696,000. These customer
line acquisitions were accounted for under the purchase method of accounting
and, accordingly, the purchase price has been allocated to the customer lines
acquired based on their estimated fair values at the date of acquisition. This
amount is being amortized on a straight-line basis over two years from the date
of purchase.
During the quarter ended June 30, 2001, the Company entered into agreements
with Covad and Zyan Communications, Inc. ("Zyan"), a California-based ISP which
had filed for bankruptcy protection; affording the Company the right to acquire
up to 4,800 Zyan customer lines whose wholesale circuit connections were being
supported by Covad. In accordance with the Covad agreement, the anticipated
purchase price of $1,467,000 for these Zyan lines was escrowed at closing and
restricted as of June 30, 2001. Ultimately, the Company was able to contract for
service with and acquire approximately 2,800 former Zyan customers, for a
purchase price of approximately $1,075,000 and as of December 31, 2001 the
remaining escrow balance of approximately $392,000 had been returned to the
Company. The Zyan customer line acquisitions were accounted for under the
purchase method of accounting and, accordingly, the purchase price was allocated
to customer lines acquired based on their estimated fair values at the date of
acquisition. This amount is being amortized on a straight-line basis over two
years.
8
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The Company entered into an Asset Purchase Agreement, dated as of
January 1, 2002 (the "Asset Purchase Agreement"), with Broadslate Networks, Inc.
("Broadslate") for the purchase of business broadband customer accounts and
certain other assets, including certain accounts receivable related to the
customer accounts, for $800,000, subject to certain adjustments. The Asset
Purchase Agreement provided for an initial cash payment of $650,000, with
$150,000 retained by the Company (the "Holdback Amount"), to be paid to
Broadslate after a transition period, subject to certain adjustments, as
provided for in the Asset Purchase Agreement. On March 26, 2002, the Company
gave notice to Broadslate of its intent to pursue an indemnity claim against the
Holdback Amount for the full amount in accordance with the provisions of the
Asset Purchase Agreement. The claim and final settlement amount of $150,000 was
applied to the Holdback Amount as follows: (i) approximately $50,000 pertained
to the Company's request for reimbursement of a ratable portion of the purchase
price paid for certain customer lines which were not available for migration to
the Company's network, as a result of various breaches by Broadslate under the
Asset Purchase Agreement and (ii) approximately $100,000 was for amounts due to
the Company from revenue collected by Broadslate, net of related costs, during
the customer transition period as provided for in the Asset Purchase Agreement.
The Broadslate customer line acquisitions were accounted for under the purchase
method of accounting and, accordingly, the adjusted purchase price of
approximately $750,000 was allocated to the assets acquired based on their
estimated fair values at the date of acquisition as follows: approximately
$28,000 to net accounts receivable acquired and approximately $722,000 to the
customer lines acquired which amount is being amortized on a straight-line basis
over two years from the date of purchase.
The following table sets forth the unaudited pro forma consolidated
financial information of the Company, giving effect to the acquisition of end
users under the Covad Safety Net program and the acquisition of Zyan customers
and Broadslate customers, as if the transactions occurred at the beginning of
the periods presented.
(dollars in thousands, except share
and per share amounts)
PRO FORMA
SIX MONTHS ENDED JUNE 30,
--------------------------------------
2001 2002
------------------- -----------------
Pro forma revenue $ 23,808 $ 22,977
Pro forma operating loss $(80,984) $ (18,787)
Pro forma net loss $(80,979) $ (18,848)
Pro forma net loss applicable to common stockholders $(80,979) $ (24,378)
Pro forma net loss per share, basic and diluted $ (1.27) $ (0.38)
Shares used in computing pro forma net loss per share 63,561,430 64,806,104
The pro forma results are not necessarily indicative of the actual results
of operations that would have been obtained had the acquisitions taken place at
the beginning of the respective periods or the results that may occur in the
future.
The actual revenue attributable to acquired customer lines was
approximately $1,374,000 and $784,000 for the six months ended June 30, 2001 and
2002, respectively.
9
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
6. Goodwill and Other Intangible Assets
In accordance with SFAS No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS",
which became effective in 2002, the Company has ceased to amortize approximately
$8,482,400 of goodwill. The Company recorded approximately $2,484,000 of
amortization during 2001 relating to this goodwill, and would have recorded an
equal amount in 2002. In lieu of amortization, the Company made an initial
impairment review of its goodwill during the first quarter of 2002, and will
perform annual impairment reviews thereafter, unless a change in circumstances
requires a review in the interim. The Company did not record any goodwill
impairment adjustments resulting from its initial impairment review. The
following shows the pro forma results had SFAS 142 been implemented as of
January 1, 2001:
(dollars in thousands,
except per share amounts)
THREE MONTHS ENDED
JUNE 30,
-------------------------------------
2001 2002
----------------- ----------------
Net loss applicable to common stockholders - as reported $ (56,169) $ (12,734)
Add back amortization of goodwill 621 -
----------------- ----------------
Adjusted net loss applicable to common stockholders $ (55,548) $ (12,734)
================= ================
Net loss per share, basic and diluted - as reported $ (0.88) $ (0.20)
Add back amortization of goodwill 0.01 -
----------------- ----------------
Adjusted net loss per share, basic and diluted $ (0.87) $ (0.20)
================= ================
(dollars in thousands,
except per share amounts)
SIX MONTHS ENDED
JUNE 30,
-------------------------------------
2001 2002
----------------- ----------------
Net loss applicable to common stockholders - as reported $ (82,796) $ (24,378)
Add back amortization of goodwill 1,242 -
----------------- ----------------
Adjusted net loss applicable to common stockholders $ (81,554) $ (24,378)
================= ================
Net loss per share, basic and diluted - as reported $ (1.30) $ (0.38)
Add back amortization of goodwill 0.02 -
----------------- ----------------
Adjusted net loss per share, basic and diluted $ (1.28) $ (0.38)
================= ================
Amortization expense of other intangible assets for the three and six
months ended June 30, 2001 was approximately $1,288,000 and $2,930,000,
respectively. For the three and six months ended June 30, 2002, amortization
expense was approximately $1,352,000 and $2,694,000, respectively.
7. Debt
In December 2001, in conjunction with the Company's sale of shares of
mandatorily redeemable convertible Series Y Preferred Stock (the "Series Y
Preferred Stock"), the Company issued short-term promissory notes (the
"Promissory Notes") for proceeds of $3,531,000 to the Series Y Preferred
Stockholders. The Promissory Notes provided for an annual interest rate of 12%.
In May 2002, in accordance with the terms of the Series Y Purchase Agreement,
the Company sold an additional 8,531 shares of Series Y Preferred Stock for
$5,000,000 in cash and delivery of the Promissory Notes for cancellation. All
accrued interest on the Promissory Notes, of approximately $145,000, was
forgiven (Note 10).
10
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
8. Commitments and Contingencies
In certain markets where the Company has not deployed its own DSL
equipment, the Company utilizes local DSL facilities from wholesale providers,
including Covad, in order to provide service to its end-user customers. These
wholesale providers may terminate their service with little or no notice. The
failure of Covad or any of the Company's other wholesale providers to provide
acceptable service on acceptable terms could have a material adverse effect on
the Company's operations. Covad emerged from bankruptcy in December 2001.
However, there can be no assurance that Covad or other wholesale providers will
be successful in managing their operations and business plans.
The Company transmits data across its network via transmission facilities
that are leased from certain carriers, including AT&T and MCI WorldCom
Communications, Inc. ("WorldCom"). The failure of any of the Company's data
transport carriers to provide acceptable service on acceptable terms could have
a material adverse effect on the Company's operations. WorldCom, has filed a
voluntary petition to reorganize under Chapter 11 of the U.S. Bankruptcy Code.
While WorldCom has announced that it expects to continue with its current
operations without adverse impact on its customers, it may not be able to do so.
The Company believes that it could transition the data transport services
currently supplied by WorldCom to alternative suppliers in thirty to sixty days,
should WorldCom announce discontinuance of such services. However, if WorldCom
was to discontinue such services without providing sufficient advance notice (at
least sixty days), the Company might not be able to transition such services in
a timely manner, which could disrupt service provided by the Company to certain
of its customers. This could result in the loss of revenue, loss of customers,
claims brought against the Company by its customers, or could otherwise have a
material adverse effect on the Company. Even if WorldCom was to provide adequate
notice of any such discontinuation of service, there can be no assurance that
the Company would be able to transition such service without a material adverse
impact on DSL.net or its customers, if at all.
On January 23, 2002, the Company amended its long-term purchase commitment
with AT&T for data transport services. The amendment reduced the Company's
minimum purchase commitment to $1,100,000 for the contract year ending in
November 2002 and $987,000 for the contract period ending in October 2003. The
Company also has a commitment to purchase $17,600 per month of certain
additional network capacity from AT&T throughout the commitment period.
In February 2002, the Company negotiated a termination of its obligations
under its lease for vacated office space located in Milford, CT. The Company had
recorded anticipated losses related to these vacated premises as part of its
restructuring charges during the year ended December 31, 2001. Consequently, no
additional costs related to this lease will be incurred during the year ended
December 31, 2002.
9. Related Party Transactions
In January 2002, the Company entered into an Asset Purchase Agreement with
Broadslate for the purchase of business broadband customer accounts and certain
other assets, including accounts receivables related to the acquired customer
accounts, for an adjusted purchase price of approximately $750,000 (Note 5).
Certain of the Company's stockholders, including investment funds affiliated
with Columbia Capital, in the aggregate own in excess of 10% of the capital
stock of Broadslate. An affiliate of Columbia Capital and a member of our Board
of Directors was a director of Broadslate until February 2002.
In accordance with the Series X Purchase Agreement (Note 10), a group of
private investment funds affiliated with VantagePoint Venture Partners
("VantagePoint") purchased an additional 10,000 shares of the Company's
mandatorily redeemable convertible Series X Preferred Stock ("the Series X
Preferred Stock") in a closing that occurred on March 1, 2002 (Note 10). Prior
to the sale of the additional 10,000 shares of Series X Preferred Stock,
VantagePoint owned approximately 21,956,063 shares, or approximately 34%, of the
Company's total outstanding common stock and 10,000 shares of Series X Preferred
Stock. The 20,000 shares of Series X Preferred Stock owned by VantagePoint are
convertible into approximately 111,111,111 shares of common stock. As a result,
VantagePoint owns the equivalent of 133,067,174 shares of common stock. Two
affiliates of VantagePoint are members of the Company's Board of Directors.
11
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In accordance with the Series Y Purchase Agreement (Note 10), in December
2001, the Company sold to Columbia Capital Equity Partners III, L.P., Columbia
Capital Equity Partners II, L.P., The Lafayette Investment Fund, L.P., Charles
River Partnership X, A Limited Partnership and N.I.G. Broadslate (collectively
with their assigns, the "Series Y Investors") 6,469 shares of Series Y Preferred
Stock for an aggregate purchase price of $6,469,000. In addition, during
December 2001, the Company issued Promissory Notes to the Series Y Investors in
the aggregate principal amount of $3,531,000 in exchange for proceeds of
$3,531,000. In May 2002, the Company sold to the Series Y Investors 8,531 shares
of Series Y Preferred Stock for total proceeds of $8,531,000, which resulted in
net proceeds of approximately $5,000,000, after the cancellation of the
Promissory Notes issued to the Series Y Investors in December 2001. An affiliate
of the Columbia Capital entities is a member of the Company's Board of
Directors.
10. Mandatorily Redeemable Convertible Preferred Stock
As more fully described in the Company's audited financial statements and
related notes included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001, which was filed with the Securities and Exchange
Commission, the Company entered into a Series X Preferred Stock Purchase
Agreement (the "Series X Purchase Agreement") with VantagePoint on November 14,
2001, relating to the sale and purchase of up to an aggregate of 20,000 shares
of Series X Preferred Stock at a purchase price of $1,000 per share. On December
24, 2001, the Company entered into a Series Y Preferred Stock Purchase Agreement
(the "Series Y Purchase Agreement") with the Series Y Investors relating to the
sale and purchase of up to an aggregate of 15,000 shares of Series Y Preferred
Stock at a purchase price of $1,000 per share.
Pursuant to the Series X Purchase Agreement, in November and December 2001,
the Company sold an aggregate of 10,000 shares of Series X Preferred Stock to
VantagePoint for total proceeds of $10,000,000, before direct issuance costs of
$189,128. Pursuant to the Series X Purchase Agreement, on March 1, 2002, the
Company sold an additional 10,000 shares of Series X Preferred Stock to
VantagePoint for total proceeds of $10,000,000.
Pursuant to the Series Y Purchase Agreement, in December 2001, the Company
sold an aggregate of 6,469 shares of Series Y Preferred Stock to the Series Y
Investors for an aggregate purchase price of $6,469,000, before direct issuance
costs of approximately $300,000, which costs pertain to all funding transactions
under the Series Y Purchase Agreement.
In addition, during December 2001, the Company issued the Promissory Notes
to the Series Y Investors in the aggregate principal amount of $3,531,000 in
exchange for proceeds of $3,531,000. The Promissory Notes provided for an annual
interest rate of 12%. In May 2002, in accordance with the terms of the Series Y
Purchase Agreement, the Company sold 8,531 additional shares of Series Y
Preferred Stock for $5,000,000 in cash and delivery of the Promissory Notes for
cancellation. All accrued interest on the Promissory Notes, of approximately
$145,000, was forgiven (Note 7).
12
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The Series X and Series Y preferred stock activity during the six months
ended June 30, 2002 is summarized as follows:
(dollars in thousands)
MANDATORILY
REDEEMABLE CONVERTIBLE PREFERRED STOCK
-------------------------------------------------
SERIES X SERIES Y
---------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT
-------- -------- -------- --------
Balance December 31, 2001 10,000 $ 436 6,469 $ 34
Issuance of shares 10,000 10,000 8,531 8,531
Issuance costs -- --
Discount on Series X and Y preferred stock resulting
from a beneficial conversion feature (10,000) (8,531)
Accrued dividends on Series X and Y preferred stock 1,000 473
Accretion of beneficial conversion feature of Series X
and Y Preferred Stock 2,758 1,299
-------- -------- -------- --------
Balance June 30, 2002 20,000 $ 4,914 15,000 $ 1,806
======== ======== ======== ========
11. Recently Issued Accounting Pronouncements
In July 2001, Statement of Financial Accounting Standards ("SFAS") No. 142
"GOODWILL AND OTHER INTANGIBLE ASSETS" was issued. SFAS No. 142 requires that
goodwill and intangible assets with indefinite lives no longer be amortized but
instead be measured for impairment at least annually, or when events indicate
that there may be an impairment. SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001. With the implementation of SFAS No. 142, we
have discontinued amortizing approximately $8,482,000 of goodwill associated
with acquired businesses. The Company recorded approximately $2,484,000 of
amortization related to this goodwill in 2001 and would have recorded an equal
amount in 2002.
In June 2001, SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS"
was issued. SFAS No. 143 addresses financial accounting and reporting for legal
obligations associated with the retirement of tangible long-lived assets and the
associated retirement costs that result from the acquisition, construction, or
development and normal operation of a long-lived asset. Upon initial recognition
of a liability for an asset retirement obligation, SFAS No. 143 requires an
increase in the carrying amount of the related long-lived asset. The asset
retirement cost is subsequently allocated to expense using a systematic and
rational method over the asset's useful life. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. The adoption of this statement is
not expected to have a material affect on the Company's financial position or
results of operations.
13
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In August 2001, SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF
LONG-LIVED ASSETS" was issued. SFAS 144 supersedes SFAS No. 121, "ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF" and supercedes and amends
certain other accounting pronouncements. SFAS No. 144 retains the fundamental
provisions of SFAS No. 121 for recognizing and measuring impairment losses on
long-lived assets held for use and long-lived assets to be disposed of by sale,
while resolving significant implementation issues associated with SFAS No. 121.
Among other things, SFAS No. 144 provides guidance on how long-lived assets used
as part of a group should be evaluated for impairment, establishes criteria for
when long-lived assets are held for sale, and prescribes the accounting for
long-lived assets that will be disposed of other than by sale. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The adoption of
SFAS No. 144 has not had a material impact on our financial position and results
of operations.
In June 2002, Statement of Financial Accounting Standards No.
146,"ACCOUNTING FOR EXIT OR DISPOSAL Activities" ("FAS NO. 146") was issued. FAS
No. 146 addresses the accounting for costs to terminate a contract that is not a
capital lease, costs to consolidate facilities and relocate employees, and
involuntary termination benefits under one-time benefit arrangements that are
not an ongoing benefit program or an individual deferred compensation contract.
The provisions of the statement will be effective for disposal activities
initiated after December 31, 2002. The Company is currently evaluating the
financial impact of adoption of SFAS No. 146.
12. Subsequent Events
On August 6, 2002, the Company closed on an Asset Purchase Agreement dated
as of July 30, 2002 (the "Abacus Agreement") with Abacus America, Inc. for the
purchase of broadband customer lines. The Abacus Agreement provided for a cash
payment for each successfully migrated broadband customer line, with a maximum
potential payment of approximately $844,000 if all the customer lines are
successfully migrated, and required a purchase price deposit of approximately
$211,000.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion of the financial condition and results of
operations of DSL.net should be read in conjunction with the financial
statements and the related notes thereto included elsewhere in this Form 10-Q
and the audited financial statements and notes thereto and Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in our Annual Report on Form 10-K for the year ended December 31, 2001,
which has been filed with the Securities and Exchange Commission.
OVERVIEW
We provide high-speed data communications, Internet access, and related
services to small and medium-sized businesses, primarily using digital
subscriber line, or DSL, technology. We have primarily targeted select second
and third tier cities for the deployment of our own local communications
equipment. In first tier cities, and certain other markets where we have not
deployed our own equipment, we utilize the local facilities of other carriers to
provide service.
As reflected in our audited financial statements and related notes included
in our Annual Report on Form 10-K for the year ended December 31, 2001, we
incurred operating losses of approximately $115,895,000 and negative operating
cash flows of approximately $62,990,000 during the year ended December 31, 2001.
During the six months ended June 30, 2002, we incurred operating losses of
approximately $18,787,000 and negative operating cash flows of approximately
$10,814,000. These operating losses and negative operating cash flows have been
financed primarily by proceeds from equity issuances. We had accumulated
deficits of approximately $248,397,000 at December 31, 2001 and $267,245,000 at
June 30, 2002.
We expect our operating losses, net operating cash outflows and capital
expenditures to continue during 2002. We recently completed rounds of private
equity and bridge loan financings totaling approximately $35 million as follows:
$20 million in the fourth quarter of 2001, $10 million in March 2002 and $8.5
million in May 2002 (which, after cancellation of the bridge loans, yielded net
proceeds of approximately $5 million). We believe that our existing cash and
short-term investments and cash expected to be generated from operations will be
sufficient to fund our operating losses, capital expenditures, lease payments
and working capital requirements through the second quarter 2003 and beyond,
until we achieve cash flow positive status, based on our current business plans
and projections, as approved by our board of directors. We intend to use these
cash resources to finance our capital expenditures and for working capital and
other general corporate purposes. We may also use a portion of these cash
resources to acquire complementary businesses, customers and other assets.
However, we may need to obtain additional financing in order to complete certain
acquisitions or operate our business after certain acquisitions. The amounts
actually expended for these purposes will vary significantly depending on a
number of factors, including market acceptance of our services, revenue growth,
cash generated from operations, improvements in operating productivity, the
extent and timing of entry into new markets, and availability and prices paid
for acquisitions. Failure to generate sufficient revenue, contain certain
discretionary spending or achieve certain other business plan objectives could
have a material adverse affect on our results of operations and financial
position.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
Financial Reporting Release No. 60, which was released in December 2001 by
the Securities and Exchange Commission, requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. We have identified the accounting principles critical to
our business and results of operations. Note 2 to our audited financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2001, which has been filed with the Securities and Exchange
Commission, includes a complete summary of the significant accounting policies
and methods used in the preparation of our financial statements. The following
is a brief discussion of the more significant accounting policies and methods
used by us.
In addition, Financial Reporting Release No. 61, which was released in
December 2001 by the SEC, requires all companies to include a discussion to
address, among other things, liquidity, off-balance sheet arrangements,
contractual obligations and commercial commitments.
Management's discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles
15
generally accepted in the United States of America. The preparation of financial
statements in accordance with generally accepted accounting principles in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, including the
recoverability of tangible and intangible assets, disclosure of contingent
assets and liabilities as of the date of the financial statements, and the
reported amounts of revenues and expenses during the reported period. The
markets for our services are characterized by intense competition, rapid
technological development, regulatory and legislative changes, and frequent new
product introductions, all of which could impact the future value of our assets
and liabilities.
We evaluate our estimates on an on-going basis. The most significant
estimates relate to revenue recognition, goodwill and other long-lived assets,
the allowance for doubtful accounts, income taxes, contingencies and litigation.
We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ materially from those estimates.
Management believes the following critical accounting policies affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements:
REVENUE RECOGNITION:
We recognize revenue in accordance with SEC Staff Accounting Bulletin No.
101 (SAB N0. 101), "REVENUE RECOGNITION IN FINANCIAL STATEMENTS", which requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured. Determination of criteria (3) and (4) are based on
management's judgments regarding the fixed nature of the fee charged for
services rendered and products delivered and the collectibility of those fees.
Revenue is recognized pursuant to the terms of each contract on a monthly
service fee basis which vary based on the speed of the customer's Internet
connection and the services ordered by the customer. The monthly fee includes
phone line charges, Internet access charges, the cost of the equipment installed
at the customer's site and the other services we provide, as applicable. Revenue
that is billed in advance of the services provided is deferred until the
services are rendered. Revenue related to installation charges is also deferred
and amortized to revenue over 18 months. Related direct costs incurred (up to
the amount of deferred revenue) are also deferred and amortized to expense over
18 months. Any excess direct costs over installation charges are charged to
expense as incurred. In certain instances, we negotiate credits and allowances
for service related matters. We establish a reserve for such credits based on
historical experience.
We seek to price our services competitively. The market for high-speed data
communications services and Internet access is rapidly evolving and intensely
competitive. While many of our competitors and potential competitors enjoy
competitive advantages over us, we are pursuing a significant market that, we
believe, is currently under-served. Although pricing is an important part of our
strategy, we believe that direct relationships with our customers and
consistent, high quality service and customer support will be key to generating
customer loyalty. During the past several years, market prices for many
telecommunications services and equipment have been declining, a trend that
might continue.
GOODWILL AND OTHER LONG-LIVED ASSETS:
We account for our long-lived assets in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 121, "ACCOUNTING FOR THE IMPAIRMENT
OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF," which
requires that long-lived assets and certain intangible assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. If undiscounted expected future cash
flows are less than the carrying value of the assets, an impairment loss is to
be recognized based on the fair value of the assets.
Effective January 1, 2002, we adopted SFAS No. 142, "GOODWILL AND OTHER
INTANGIBLE ASSETS". This statement requires that the amortization of goodwill be
discontinued and instead an impairment approach be applied. The impairment tests
were performed during the first quarter of 2002 and will be performed annually
thereafter (or more often if adverse events occur) and are based upon a fair
value approach rather than an evaluation of the undiscounted cash flows. If
impairment exists, under SFAS No. 142, the resulting charge is
16
determined by the recalculation of goodwill through a hypothetical purchase
price allocation of the fair value and reducing the current carrying value to
the extent it exceeds the recalculated goodwill. We did not record any goodwill
impairment adjustments resulting from our impairment review during the first
quarter of 2002.
Other long-lived assets, such as identifiable intangible assets and fixed
assets, are amortized or depreciated over their estimated useful lives. These
assets are reviewed for impairment whenever events or circumstances provide
evidence that suggests that the carrying amount of the assets may not be
recoverable, with impairment being based upon an evaluation of the identifiable
undiscounted cash flow. If impaired, the resulting charge reflects the excess of
the asset's carrying cost over its fair value.
If market conditions become less favorable, future cash flows (the key
variable in assessing the impairment of these assets) may decrease and as a
result we may be required to recognize impairment charges.
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. We sell
our services directly to end users mainly consisting of small to medium sized
businesses, as opposed to selling to Internet service providers who then resell
such services. We believe that we do not have significant exposure or
concentrations of credit risk with respect to any given customer. However, if
the country or any region we service experiences an economic downturn, the
financial condition of our customers could be adversely affected, which could
result in their inability to make payments to us. This could require additional
provisions for allowances. In addition, a negative impact on revenue related to
those customers may occur.
INCOME TAX:
We use the liability method of accounting for income taxes, as set forth in
Statement of Financial Accounting Standards No. 109, "ACCOUNTING FOR INCOME
TAXES". Under this method, deferred tax assets and liabilities are recognized
for the expected future tax consequences of temporary differences between the
carrying amounts and the tax basis of assets and liabilities and net operating
loss carryforwards, all calculated using presently enacted tax rates.
We have not generated any taxable income to date and, therefore, have not
paid any federal income taxes since inception. Our state and federal net
operating loss carryforwards begin to expire in 2004 and 2019, respectively. Use
of our net operating loss carryforwards may be subject to significant annual
limitations resulting from a change in control due to our recent sales of series
X and series Y preferred stock. We are currently assessing the potential impact
resulting from these transactions. We have provided a valuation allowance for
the full amount of the net deferred tax asset since management has not
determined that these future benefits will more likely than not be realized.
LITIGATION:
From time to time, we may be involved in litigation concerning claims
arising in the ordinary course of our business, including claims brought by
former employees and claims related to acquisitions. We record liabilities when
a loss is probable and can be reasonably estimated. These estimates are based on
an analysis made by internal and external legal counsel who consider information
known at the time. We believe we have made reasonable estimates in the past;
however, court decisions could cause liabilities to be incurred in excess of
estimates.
RESULTS OF OPERATIONS
REVENUE. Revenue is recognized pursuant to the terms of each contract on a
monthly service fee basis. The monthly service fees vary based on the speed of
the connection and the services ordered. The monthly fee includes all phone line
charges, Internet access charges, the cost of the modem installed at the
customer's site and the other services we provide, as applicable.
Revenue increased by 12% for the three months ended June 30, 2002 to
approximately $11,596,000, compared to approximately $10,348,000 for the three
months ended June 30, 2001. Revenue increased by 20% to approximately
$22,977,000 for the six months ended June 30, 2002, from approximately
$19,170,000 for the six months ended June 30, 2001. These increases for both
periods were primarily due to the increased
17
number of customers subscribing for our services and contributions from
acquisitions. Actual revenue attributable to newly acquired customer lines was
approximately $382,000 and $1,234,000 for the three months ended June 30, 2002
and 2001, respectively. Actual revenue attributable to newly acquired customer
lines was approximately $784,000 and $1,374,000, for the six months ended June
30, 2002 and 2001, respectively. We currently expect revenue to increase in
future periods as we continue our sales and marketing efforts in our existing
service areas and introduce additional services. Revenue may also increase in
future periods as a result of acquisitions.
NETWORK EXPENSES. Our network expenses (which were previously included
under the heading "network and operations expenses") include costs related to
network engineering and network operations personnel, costs for
telecommunications lines between customers, central offices, network service
providers and our network, costs for rent and power at our central offices,
costs to connect to the Internet, costs of customer line installations and the
costs of customer premise equipment when sold to our customers. Our costs for
customer lines will increase as we add customers. We lease high-speed lines and
other network capacity to connect our central office equipment and our network.
In addition, costs incurred to connect to the Internet are expected to increase
as the volume of data communications traffic generated by our customers
increases.
Network expenses for the three months ended June 30, 2002 decreased 27% to
approximately $8,625,000, compared to approximately $11,872,000 for the three
months ended June 30, 2001. For the six months ended June 30, 2002, network
expenses decreased 27% to approximately $17,337,000, from approximately
$23,719,000 for the six months ended June 30, 2001. These decreases for both
periods were primarily attributable to decreased telecommunications expenses
resulting from our restructuring and cost containment efforts during 2001.
OPERATIONS EXPENSES. Our operations expenses (which were previously
included under the heading "network and operations expenses") include costs
related to customer care, customer provisioning, customer billing, customer
technical assistance, purchasing, headquarters facilities operations, operating
systems maintenance and support and other related overhead expenses.
Operations expenses for the three months ended June 30, 2002 were
approximately $1,856,000, compared to operations expenses for the three months
ended June 30, 2001 of approximately $32,078,000. This 94% reduction was
primarily due to decreases resulting from our restructuring and cost containment
efforts during 2001 and included reductions in: restructuring charges of
approximately $27,561,000, salaries and benefits of approximately $1,448,000,
equipment maintenance and support of approximately $434,000, consulting and
outsourcing services of approximately $546,000, and miscellaneous other expenses
of approximately $233,000. Operations expenses for the six months ended June 30,
2002 were approximately $3,847,000, compared to operations expenses for the six
months ended June 30, 2001 of $37,193,000. This 90% reduction was primarily due
to decreases resulting from our restructuring and cost containment efforts
during 2001 and included reductions in: restructuring charges of approximately
$28,000,000, salaries and benefits of approximately $2,964,000, equipment
maintenance and support of approximately $769,000, consulting and outsourcing
services of approximately $1,076,000, and miscellaneous other expenses of
approximately $537,000.
GENERAL AND ADMINISTRATIVE. Our general and administrative expenses consist
primarily of costs relating to human resources, finance, executive,
administrative services, recruiting, insurance, legal and auditing services,
leased office facilities rent and bad debt expenses.
General and administrative expenses were approximately $3,373,000 for the
three months ended June 30, 2002, compared to general and administrative
expenses for the three months ended June 30, 2001 of approximately $10,367,000.
This 67% reduction was primarily due to decreases resulting from our
restructuring and cost containment efforts during 2001 and included reductions
in: restructuring and impairment charges of approximately $4,907,000,
professional fees of approximately $660,000, salaries and benefits of
approximately $863,000, sales, use, property and other taxes of approximately
$156,000, bad debt expense of approximately $325,000 and other expenses of
approximately $190,000. These reductions were partially offset by increased
insurance costs of approximately $107,000. General and administrative expenses
for the six months ended June 30, 2002 were approximately $6,776,00,0 compared
to general and administrative expenses for the six months ended June 30, 2001 of
approximately $15,830,000. This 57% reduction was primarily due to decreases
resulting from our restructuring and cost containment efforts during 2001 and
included reductions in: restructuring and impairment charges of approximately
$5,298,000, professional fees of approximately $1,540,000, salaries and benefits
of approximately $1,472,000, sales, use,
18
property and other taxes of approximately $512,000, bad debt expense of
approximately $258,000, office facilities expense of approximately $164,000 and
other expenses of approximately $174,000. These reductions were partially offset
by increased insurance costs of approximately $364,000.
SALES AND MARKETING. Our sales and marketing expenses consist primarily of
expenses for sales and marketing personnel, the development of our brand name,
promotional materials, direct mail advertising and sales commissions and
incentives.
Sales and marketing expenses for the three months ended June 30, 2002 were
approximately $1,577,000, compared to sales and marketing expenses for the three
months ended June 30, 2001 of approximately $4,074,000, a 61% decrease. The
decrease in sales and marketing expenses was primarily attributable to decreased
costs that resulted from our restructuring and cost containment efforts during
2001, including reductions in: advertising and direct mail marketing expenses of
approximately $906,000, salaries and benefits of approximately $875,000,
professional and consulting services of approximately $622,000 and other
expenses of approximately $94,000. For the six months ended June 30, 2002, sales
and marketing expenses were approximately $2,774,000, compared to marketing
expenses for the six months ended June 30, 2001 of approximately $9,039,000, a
69% decrease. The decrease in sales and marketing expenses was primarily due to
decreased costs that resulted from our restructuring and cost containment
efforts during 2001, including reductions in: advertising and direct mail
marketing expenses of approximately $2,711,000, salaries and benefits of
approximately $1,929,000, professional and consulting services of approximately
$1,332,000 and other expenses of approximately $293,000.
STOCK COMPENSATION. We incurred non-cash stock compensation expenses as a
result of the granting of stock and stock options to employees and directors
with exercise prices per share subsequently determined to be below the fair
values per share of our common stock for financial reporting purposes at the
dates of grant. The stock compensation, if vested, was charged immediately to
expense, while non-vested compensation is being amortized over the vesting
period of the applicable options or stock, which was generally 48 months.
Unvested options for terminated employees are cancelled and the value of such
options are recorded as a reduction of deferred compensation with an offset to
additional paid-in-capital.
Non-cash stock compensation expense was approximately $296,000 and $422,000
for the three months ended June 30, 2002 and 2001, respectively. For the six
months ended June 30, 2002 and 2001, non-cash stock compensation expense was
approximately $642,000 and $797,000, respectively. These expenses consisted of
charges and amortization related to stock options and restricted stock granted
to our employees and directors. The unamortized balances as of December 31, 2001
and June 30, 2002 of approximately $1,667,000 and $1,025,000, respectively, are
being amortized over the remaining vesting period of each grant and are expected
to be fully amortized by June 30, 2003.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization is primarily
attributable to the following assets: (i) depreciation of network and operations
equipment and Company-owned DSL modems and routers installed at customer sites,
(ii) depreciation of information systems and computer hardware and software,
(iii) amortization and depreciation of the costs of obtaining, designing and
building our collocation space and corporate facilities and (iv) amortization of
intangible capitalized costs pertaining to acquired businesses and customer line
acquisitions.
Depreciation and amortization expenses were approximately $5,274,000 for
the three months ended June 30, 2002, compared to depreciation and amortization
expenses of approximately $7,805,000 for the three months ended June 30, 2001.
This 32% decrease in depreciation and amortization expenses for the three months
ended June 30, 2002 primarily resulted from restructuring write-offs of central
office equipment and impairment write-offs of intangible assets taken during
2001. For the six months ended June 30, 2002, depreciation and amortization
expenses were approximately $10,388,000, compared to depreciation and
amortization expenses of approximately $16,016,000 for the six months ended June
30, 2001. This 35% decrease in depreciation and amortization expenses for the
six months ended June 30, 2002 primarily resulted from restructuring write-offs
of central office equipment and impairment write-offs of intangible assets taken
during 2001.
Also, in accordance with SFAS No. 142 (see recently issued accounting
pronouncements, discussed below), we discontinued amortization of goodwill
beginning January 1, 2002, and completed an initial impairment review during the
first quarter of 2002. We did not record any impairment adjustments resulting
from this initial impairment review. Consequently, amortization expense related
to our goodwill was
19
approximately $622,000 higher for the three months ended June 30, 2001 than for
the three months ended June 30, 2002. For the six months ended June 30, 2001,
amortization expense related to our goodwill was approximately $1,242,000 higher
than for the six months ended June 30, 2002.
Depreciation expenses pertaining to assets related to network expenses and
operations expenses were approximately $3,713,000 and $5,295,000 for the three
months ended June 30, 2002 and 2001, respectively. For the six months ended June
30, 2002 and 2001, depreciation expenses pertaining to assets related to network
expenses and operations expenses were approximately $7,130,000 and $10,665,000,
respectively. Depreciation and amortization expenses pertaining to assets
related to general and administrative expenses were approximately $208,000 and
$600,000 for the three months ended June 30, 2002 and 2001, respectively. For
the six months ended June 30, 2002 and 2001, depreciation expenses pertaining to
assets related to general and administrative expenses were approximately
$564,000 and $1,180,000, respectively.
INTEREST EXPENSE (INCOME) NET. Net interest income of approximately $8,000
for the three months ended June 30, 2002 included approximately $83,000 of
interest income, which was partially offset by approximately $75,000 of net
interest expense. The $75,000 of net interest expense included $220,000 of
interest expense, partially offset by the reversal of $145,000 of previously
accrued interest expense pertaining to interest forgiven on $3,531,000 of
short-term promissory notes, which were cancelled in May 2002 upon the issuance
of additional Series Y Preferred Stock, in accordance with the terms of the
Series Y Preferred Stock Purchase Agreement. For the three months ended June 30,
2001, net interest income of approximately $101,000 included approximately
$475,000 of interest income, which was partially offset by approximately
$374,000 of interest expense. The decrease in net interest income for the three
months ended June 30, 2002 as compared to the three months ended June 30, 2001
was primarily due to lower cash and investment balances in the more recent
period. The decrease in interest expense for the three months ended June 30,
2002 compared to the three months ended June 30, 2001 primarily related to lower
capital lease obligations in the current period.
Net interest expense of approximately $236,000 for the six months ended
June 30, 2002 included approximately $170,000 of interest income, which was
offset by approximately $406,000 of net interest expense. For the six months
ended June 30, 2001, net interest income of approximately $630,000 included
approximately $1,435,000 of interest income, which was partially offset by
approximately $805,000 of interest expense. The decrease in net interest income
for the six months ended June 30, 2002 as compared to the six months ended June
30, 2001 was primarily due to lower cash and investment balances in the more
recent period. The decrease in interest expense for the three months ended June
30, 2002 compared to the three months ended June 30, 2001 primarily related to
lower capital lease obligations in the more recent period.
RESTRUCTURING CHARGES. In December 2000, we initiated a new business plan
strategy designed to conserve capital, reduce our losses and extend our cash
resources. This strategy included the following actions: 1) further network
expansion was curtailed; 2) network connections to certain central offices were
suspended; 3) certain facilities were vacated and consolidated; 4) operating
expenses were reduced; and 5) headcount was reduced by approximately 140
employees. These actions resulted in restructuring charges of approximately
$3,542,000.
In March 2001, we re-evaluated its restructuring reserve related to the
corporate restructuring announced in December of 2000 and recorded an increase
in the reserve of approximately $831,000, which was primarily related to delays
in subleasing its vacated facilities and additional costs pertaining to its
suspended central offices. Of that amount, approximately $440,000 was included
in network and operations expenses and approximately $391,000 was included in
general and administrative expenses.
In June 2001, due to the lack of liquidity in the financial markets, we
further re-evaluated our business plans and determined that additional actions
were necessary to further reduce our losses, further extend our cash resources
and reduce our total funding requirements. These actions included: 1) further
reductions in operating expenses; 2) closure of approximately 100 non-active and
250 active central offices; and 3) an additional reduction-in-force of
approximately 90 employees. These actions resulted in additional restructuring
and impairment charges approximating $32,503,000, which included $3,155,000 for
impairments of goodwill relating to our acquisition of Tycho Networks, Inc. and
certain assets of Trusted Net Media Holdings, LLC. The goodwill impairment
analysis was accomplished by comparing the carrying value of the assets with the
expected future net cash flows generated over the remaining useful life of the
assets. Since the carrying value was more than the expected future net cash
flows, the goodwill was reduced to the net present value of the expected future
net cash flows. Of the approximately $32,503,000 in additional restructuring
charges, approximately $27,561,000 was included in network and operations
expenses; approximately $35,000
20
was included in sales and marketing expenses and approximately $4,907,000 was
included in general and administrative expenses.
The restructuring reserve balance at June 30, 2002, of approximately
$973,000, which related to various restructuring charges recorded in 2000 and
2001, is included in the our accrued liabilities and represents approximately
$658,000 for anticipated costs pertaining to our vacated facilities and
approximately $315,000 for anticipated costs pertaining to our closed central
offices.
NET LOSS. Net loss was approximately $9,394,000 for the three months ended
June 30, 2002, compared to net loss for the three months ended June 30, 2001 of
approximately $56,169,000. For the six months ended June 30, 2002, net loss was
approximately $18,848,000, compared to net loss for the six months ended June
30, 2001 of approximately $82,796,000.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our capital expenditures and operations primarily with the
proceeds from the sale of stock and from borrowings, including equipment lease
financings. As of June 30, 2002, we had cash, cash equivalents and restricted
cash of approximately $20,797,000 and working capital of approximately
$11,081,000.
Net cash provided by financing activities for the six months ended June 30,
2002, was approximately $13,526,000. This cash primarily resulted from the sale
of our preferred stock. Net cash used by financing activities for the six months
ended June 30, 2001 of approximately $3,160,000 was mainly used for principal
payments under the Company's then outstanding term loan and capital lease
obligations. We have used, and intend to continue using, proceeds from our
financings primarily to implement our business plan and for working capital and
general corporate purposes. We have also used, and may in the future use, a
portion of such proceeds to acquire complementary businesses, customers and
other assets.
In March 1999, we entered into a 36-month lease facility to finance the
purchase of up to an aggregate of $2,000,000 of equipment. Amounts financed
under this lease facility bear an interest rate of 8% or 9%, depending on the
type of equipment, and are secured by the financed equipment. In July 2000, we
entered into a 48-month lease agreement with an equipment vendor to finance the
purchase of network equipment. We have leased approximately $8,900,000 under
this agreement. Amounts financed under this agreement bear an interest rate of
12% and are secured by the financed equipment. In addition, during 1999 and
2000, we purchased and assumed through acquisition certain equipment and
computer software under other capital leases, which are being repaid over
periods ranging from 24 months to 60 months at rates ranging from 7.5% to 15%.
In the aggregate, there was approximately $7,462,000 and approximately
$5,988,000, outstanding under capital leases at December 31, 2001 and June 30,
2002, respectively.
In May 1999, we entered into a collateralized credit facility (the "Credit
Facility") with a bank to provide up to $5,000,000 for the purchase of
telecommunications equipment, office equipment and vehicles. The Credit Facility
expired in May 2000 and converted to a term loan payable over 36 months. The
term loan bore interest on outstanding borrowings at 1% over the higher of the
bank's prime rate or the federal funds rate plus 0.5%. As of June 30, 2001,
amounts outstanding under this term loan bore interest at 8.0% per annum. The
term loan was secured by a lien on certain equipment and vehicles owned by us
and located at our principal office in New Haven, CT, and imposed certain
financial and other covenants requiring us to maintain certain financial ratios
and limited new indebtedness, the creation of liens, types of investments,
mergers, consolidations and the transfer of all or substantially all of our
assets. The term loan was paid off during the third quarter of 2001.
In December 2001, in conjunction with our sale of Series Y Preferred Stock,
we issued short-term promissory notes for proceeds of $3,531,000 to the Series Y
Investors. The promissory notes provided for an annual interest rate of 12%. The
promissory notes were cancelled in May 2002 in connection with the sale of an
additional 8,531 shares of Series Y Preferred Stock to the Series Y Investors
(discussed below) and all accrued interest, approximating $145,000, was
forgiven.
On March 1, 2002, we sold 10,000 shares of Series X Preferred Stock for an
aggregate of $10,000,000 pursuant to the Series X Purchase Agreement. In May
2002, pursuant to the Series Y Purchase Agreement, we sold an aggregate of 8,531
shares of Series Y Preferred Stock to the Series Y Investors for total proceeds
of $8,531,000. In accordance with the Series Y Purchase Agreement, the
above-mentioned promissory notes
21
were cancelled as partial payment for the Series Y preferred stock, resulting in
net proceeds of approximately $5,000,000.
As a result of the development of our operating infrastructure and
acquisitions, we have entered into certain long-term agreements providing for
fixed payments. Under our facility operating leases, minimum office facility
operating lease payments are approximately $2,294,000 in 2002, $1,707,000 in
2003, $1,609,000 in 2004 and $577,000 in 2005. We also have long-term purchase
commitments with WorldCom and AT&T for data transport services with minimum
payments due even if our usage does not reach the minimum amounts. The WorldCom
commitment began in May 2000 and requires minimum purchases of $4,800,000 per
contract year. The WorldCom contract ends in November 2004. The AT&T commitment
was renegotiated on January 23, 2002, and requires minimum purchases of
$1,100,000 for the contract year ending in November 2002 and $987,000 for the
contract year ending in October 2003. We also have a commitment to purchase
$17,600 per month of certain additional network capacity from AT&T throughout
the commitment period.
We transmit data across our network via transmission facilities that are
leased from certain carriers, including AT&T and WorldCom (as described above).
The failure of any of our data transport carriers to provide acceptable service
on acceptable terms could have a material adverse effect on our operations.
WorldCom, has filed a voluntary petition to reorganize under Chapter 11 of the
U.S. Bankruptcy Code. While WorldCom has announced that it expects to continue
with its current operations without adverse impact on its customers, it may not
be able to do so. We believe that we could transition the data transport
services currently supplied by WorldCom to alternative suppliers in thirty to
sixty days, should WorldCom announce discontinuance of such services. However,
were WorldCom to discontinue such services without providing sufficient advance
notice (at least sixty days), we might not be able to transition such services
in a timely manner, which could disrupt service provided by us to certain of our
customers. This could result in the loss of revenue, loss of customers, claims
brought against us by our customers, or could otherwise have a material adverse
effect on us. Even were WorldCom to provide adequate notice of any such
discontinuation of service, there can be no assurance that we would be able to
transition such service without a material adverse impact on us or our
customers, if at all, or that such discontinuation of service would not
otherwise have a material adverse effect on the Company.
As part of our restructuring in December 2000, we vacated certain office
space in Milford, Connecticut and Chantilly, Virginia and did not occupy certain
space in Santa Cruz, California. During the second and third quarters of 2001,
we vacated our office space located in Atlanta, Georgia and Santa Cruz,
California. As of December 31, 2001, we had been successful in terminating our
lease for office space in Chantilly, Virginia and in assigning our lease in
Atlanta, Georgia. We have entered into a 14-month sublease agreement on our
office space in Santa Cruz, California with a one-year renewal option. In
February 2002, we were successful in terminating our obligations under the lease
for office space in Milford, CT.
For the six months ended June 30, 2002, the net cash used in our operating
activities was approximately $10,814,000. This cash was used for a variety of
operating expenses, including salaries, network operations, sales, marketing and
promotional activities, consulting and legal expenses, and overhead expenses.
Net cash used in investing activities for the six months ended June 30,
2002 was approximately $1,505,000. Of this amount, approximately $880,000 was
used for the purchase of equipment, and approximately $750,000 was used to
acquire customer lines. These expenditures were partially offset by
approximately $85,000 in proceeds from the sale of excess equipment, and
approximately $40,000 in a decrease in restricted cash.
The development and expansion of our business has required significant
capital expenditures. Capital expenditures, including collocation fees but
excluding acquisitions, were approximately $880,000 and $3,421,000 for the six
months ended June 30, 2002 and 2001, respectively, and customer line
acquisitions were approximately $750,000 and $2,690,000 for the six months ended
June 30, 2002 and 2001, respectively. The actual amounts and timing of our
future capital expenditures will vary depending on the speed at which we expand
and implement our network and implement service for our customers. As a result
of our decision to suspend further deployment of our network, our planned
capital expenditures for 2002, exclusive of acquisitions, are currently expected
to be primarily for the purchase and installation at our customers' sites of the
equipment necessary for us to provide our services, as well as for the continued
development of our network and operational support systems. We currently
anticipate spending a total of approximately $200,000 to $400,000 for capital
expenditures, excluding acquisitions, during the remainder of the year ending
December
22
31, 2002. The actual amounts and timing of our capital expenditures could differ
materially both in amount and timing from our current plans.
We expect our operating losses, net operating cash outflows and capital
expenditures to continue during 2002. We believe that our existing cash and
short-term investments, and cash generated from operations will be sufficient to
fund our operating losses, capital expenditures, lease payments and working
capital requirements through the second quarter of 2003 and beyond, until we
attain cash flow positive status, based on our current business plans and
projections, as approved by our board of directors. We intend to use our cash
resources to finance our capital expenditures and for working capital and other
general corporate purposes. We may also use a portion of these cash resources to
acquire complementary businesses, customers and other assets. However, we may
need to obtain additional financing in order to complete certain acquisitions or
operate our business after certain acquisitions. The amounts actually expended
for these purposes will vary significantly depending on a number of factors,
including the rate of market acceptance of our services, revenue growth, cash
generated from operations, improvements in operating productivity, the
availability of attractive acquisition opportunities and the extent and timing
of our entry into new markets.
Our capital requirements may vary based upon the timing and the success of
implementation of our business plan and as a result of regulatory, technological
and competitive developments or if:
o demand for our services or our cash flow from operations is less than
or more than expected;
o our development plans or projections change or prove to be inaccurate;
o we make acquisitions; or
o we accelerate additional deployment of our network or otherwise alter
the schedule or targets of our business plan implementation.
Our financial statements included herein do not include any adjustments that
might result from these uncertainties.
On July 22, 2002, the Nasdaq Stock Market, Inc. ("Nasdaq") transferred the
listing of our common stock from the Nasdaq National Market to the Nasdaq
SmallCap Market. We applied for such transfer as a result of our non-compliance
with Nasdaq's Marketplace Rule 4450(a)(5), which required us to maintain a bid
price of $1.00 for at least 10 consecutive trading days during the last ninety
day period prior to July 17, 2002 in order to remain qualified for listing on
the Nasdaq National Market. As a result of the transfer of the listing of our
common stock to the Nasdaq SmallCap Market, we have until October 15, 2002 to
comply with the minimum bid price of $1.00 for 10 consecutive trading days, or
such greater number of trading days as Nasdaq may determine. If we are unable
to comply with this minimum bid price requirement, Nasdaq will determine whether
we meet the other initial listing criteria for the Nasdaq SmallCap Market set
forth in Rule 4310(c)(2)(A). If we are unable to satisfy the other initial
listing criteria at that time, Nasdaq will provide us notice that our common
stock will be delisted from the Nasdaq SmallCap Market. If Nasdaq determines
that we satisfy the other initial listing criteria, we will have an additional
180 calendar days to comply with the minimum bid price of $1.00 for 10
consecutive trading days, or such greater number of trading days as Nasdaq may
determine. If we are unable to satisfy all the initial listing requirements at
that time, Nasdaq will provide us notice that our common stock will be de-listed
from the Nasdaq SmallCap Market. There can be no assurances that we will be able
to comply with the minimum bid price requirement by October 15, 2002, if at all,
or that we will continue to satisfy the other initial listing requirements of
the Nasdaq SmallCap Market.
In addition, in the event our common stock trades for a minimum of $1.00
per share on the Nasdaq SmallCap Market for 30 consecutive trading days by April
13, 2002 and we, at all times, have maintained compliance with all of the other
maintenance requirements for listing on the Nasdaq National Market, the Nasdaq
has indicated that we may qualify to have our common stock transferred back to
the Nasdaq National Market.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, Statement of Financial Accounting Standards ("SFAS") No. 142
"GOODWILL AND OTHER INTANGIBLE ASSETS" was issued. SFAS No. 142 requires that
goodwill and intangible assets with indefinite lives no longer be amortized but
instead be measured for impairment at least annually, or when events indicate
that there may be an impairment. SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001. With the implementation of SFAS No. 142, we
have discontinued amortizing approximately $8.5 million of goodwill associated
with acquired businesses. We recorded approximately $2.5 million of amortization
related to this goodwill in 2001 and would have recorded an equal amount in
2002.
23
In June 2001, SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS"
was issued. SFAS No. 143 addresses financial accounting and reporting for legal
obligations associated with the retirement of tangible long-lived assets and the
associated retirement costs that result from the acquisition, construction, or
development and normal operation of a long-lived asset. Upon initial recognition
of a liability for an asset retirement obligation, SFAS No. 143 requires an
increase in the carrying amount of the related long-lived asset. The asset
retirement cost is subsequently allocated to expense using a systematic and
rational method over the asset's useful life. SFAS No. 143 is effective for
fiscal years beginning after June 15, 2002. The adoption of this statement is
not expected to have a material affect on our financial position or results of
operations.
In August 2001, SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF
LONG-LIVED ASSETS" was issued. SFAS 144 supersedes SFAS No. 121, "ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF" and supercedes and amends
certain other accounting pronouncements. SFAS No. 144 retains the fundamental
provisions of SFAS No. 121 for recognizing and measuring impairment losses on
long-lived assets held for use and long-lived assets to be disposed of by sale,
while resolving significant implementation issues associated with SFAS No. 121.
Among other things, SFAS No. 144 provides guidance on how long-lived assets used
as part of a group should be evaluated for impairment, establishes criteria for
when long-lived assets are held for sale, and prescribes the accounting for
long-lived assets that will be disposed of other than by sale. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The adoption of
SFAS No. 144 has not had a material impact on our financial position and results
of operations.
In June 2002, Statement of Financial Accounting Standards No. 146,
"ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES" ("FAS NO. 146") was issued. FAS No.
146 addresses the accounting for costs to terminate a contract that is not a
capital lease, costs to consolidate facilities and relocate employees, and
involuntary termination benefits under one-time benefit arrangements that are
not an ongoing benefit program or an individual deferred compensation contract.
The provisions of the statement will be effective for disposal activities
initiated after December 31, 2002. We are currently evaluating the financial
impact of adoption of SFAS No. 146.
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The statements contained in this
report, which are not historical facts, may be deemed to contain forward-looking
statements. These statements relate to future events or our future financial or
business performance, and are identified by terminology such as "may," "might,"
"will," "should," "expect," "scheduled," "plan," "intend," "anticipate,"
"believe," "estimate," "potential," or "continue" or the negative of such terms
or other comparable terminology. These statements are subject to a variety of
risks and uncertainties, many of which are beyond our control, which could cause
actual results to differ materially from those contemplated in these
forward-looking statements. In particular, the risks and uncertainties include
those described under "Risk Factors" in our Annual Report on Form 10-K for the
year ended December 31, 2001, which has been filed with the Securities and
Exchange Commission. The risks and uncertainties include, among other things,
(i) fluctuations in our quarterly operating results, which could adversely
effect the price of our common stock; (ii) our unproven business model, which
may not be successful; (iii) our ability to execute our business plan in a
timely manner to generate the forecasted financial and operating results, which
may not be achieved if our sales force is not able to generate sufficient sales
to customers or if we are not able to install and commence service for customers
in a timely manner; (iv) risks associated with the possible removal of DSL.net's
common stock from the Nasdaq SmallCap Market, which removal could adversely
impact the pricing and trading of DSL.net's common stock; (v) risks associated
with acquisitions, including difficulties in identifying and completing
acquisitions, integrating acquired businesses or assets and realizing the
revenue, earnings or synergies anticipated from any acquisitions; (vi) risks
associated with our reliance on two carriers, including WorldCom, to transmit
data across our network; (vii) the challenges relating to the timely
installation of service for customers, including our dependence on traditional
telephone companies to provide acceptable telephone lines in a timely manner;
(viii) our dependence on wholesale DSL providers to provide us with local DSL
facilities in areas where we have not deployed our own DSL equipment; (ix) the
need for us to achieve sustained market acceptance of our services at desired
pricing levels; (x) competition; (xi) our limited operating history, which makes
it difficult to evaluate our business and prospects; (xii) the difficulty of
predicting the new and rapidly evolving high-speed data communications industry;
(xiii) our ability to negotiate, enter into and renew interconnection and
collocation agreements with traditional telephone companies; (xiv) regulatory,
legislative, and judicial developments, which could adversely affect the way we
operate our business; and (xv) our ability to recruit and retain qualified
personnel, establish the necessary infrastructure to support our business, and
24
manage the growth of our operations. Existing and prospective investors are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. We undertake no obligation, and disclaim any
obligation, to update or revise the information contained in this report,
whether as a result of new information, future events or circumstances or
otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have no derivative financial instruments in our cash and cash
equivalents. We invest our cash and cash equivalents in investment-grade, highly
liquid investments, consisting of commercial paper, bank money markets and
certificates of deposit and corporate bonds.
25
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
DSL.net's Annual Meeting of Stockholders was held on May 29, 2002. At such
meeting, DSL.net's stockholders approved amendments to DSL.net's certificate of
incorporation to:
o increase the number of authorized shares of DSL.net common stock from
200,000,000 shares to 400,000,000 shares and the total number of authorized
shares of DSL.net capital stock from 220,000,000 shares to 420,000,000
shares;
o allow holders of a class or series of DSL.net preferred stock (including
the Series X preferred stock and the Series Y preferred stock), when voting
or acting as a separate class or series, to act by written consent;
o provide that the Series X preferred stock shall rank on parity with the
Series Y preferred stock upon redemption or a liquidation, dissolution or
winding up of DSL.net;
o increase from $2.00 per share to $2.50 per share the closing sale price of
DSL.net common stock on the Nasdaq Stock Market required during a period of
45 consecutive trading days, commencing after May 13, 2002, to cause the
then outstanding Series X preferred stock to automatically convert into
DSL.net common stock; and
o limit to the period ending June 28, 2002 the requirement that DSL.net
obtain the consent of the holders of at least a majority of the then
outstanding Series X preferred stock to authorize or issue, or to obligate
itself to issue, equity related securities having rights, preferences or
privileges pari passu with the Series X preferred stock.
The increase in the authorized shares of DSL.net common stock provides
DSL.net with the flexibility to issue shares of common stock to meet corporate
purposes, including financings, acquisitions and equity-based compensation
plans. In addition, DSL.net's Series Y preferred stock was not convertible into
shares of common stock until the authorized shares of DSL.net common stock was
increased to at least 250,000,000 shares. Upon the increase in the authorized
shares of DSL.net common stock, each share of Series Y preferred stock became
convertible into 2,000 shares of common stock. The amendment to allow the Series
X preferred stock and the Series Y preferred stock to approve by written consent
actions that trigger the special voting rights of the Series X preferred stock
and the Series Y preferred stock will enable DSL.net to obtain such consent
without the delay and expense of a stockholders meeting. The remaining
amendments modify the terms of the Series X preferred stock to be consistent
with the comparable terms of the Series Y preferred stock.
These amendments were implemented on May 29, 2002, by the filing of a
Certificate of Amendment of Amended and Restated Certificate of Incorporation,
as amended, of the Company.
On May 30, 2002, DSL.net sold an aggregate of 8,531 shares of Series Y
preferred stock for an aggregate purchase price of $8,531,000. Pursuant to the
Certificate of Designation of the Series Y preferred stock, the following
rights, preferences and privileges of the Series Y preferred stock materially
limit or qualify the rights of holders of DSL.net's common stock:
o The right to cumulative dividends of 12% per year ($120.00 per share per
annum) when and as declared by DSL.net's board of directors or upon the
liquidation, dissolution, winding up or change of control of DSL.net, or
the conversion or redemption of the Series Y preferred stock;
o In connection with the liquidation, dissolution, winding up or a change of
control of DSL.net, the right to preferential liquidation payments, as well
as the right to thereafter share along with holders of DSL.net's common
stock and Series X preferred stock with respect to the remaining assets of
DSL.net;
o The right to convert each share of Series Y preferred stock into 2,000
shares of common stock, subject to adjustment for certain subsequent
dilutive issuances and stock splits. The Series Y preferred stock
automatically converts into common stock upon the close of business on the
date on which the closing sale price of the common stock on the Nasdaq
Stock Market has exceeded $2.50 per share (as adjusted for any stock
splits, stock dividends, recapitalizations or the like) for a period of 45
consecutive days commencing on or after June 26, 2002;
o The right to require DSL.net to redeem all outstanding shares of Series Y
preferred stock, at the option of the holders of a majority of the
then-outstanding shares of Series Y preferred stock at any time on or after
26
January 1, 2005, at a price equal to $1,000.00 per share plus all unpaid
accrued dividends (whether or not declared); and
o Voting rights similar to those of the holders of common stock, with each
share of Series Y preferred stock having 978.5 votes, as well as the right
to vote, as a separate class, to approve the (i) issuance of any security
with rights senior to the Series Y preferred stock or (ii) any alteration
of the rights or reclassification of the Series Y preferred stock.
In addition, a stockholders agreement between DSL.net, the Series X
preferred stockholders and the Series Y preferred stockholders enables the
directors elected by the Series X preferred stockholders (including one director
nominated by the Series Y preferred stockholders) to have majority control of
the Board of Directors.
Finally, the dividend, liquidation preference and redemption rights of the
Series X preferred stock and the Series Y preferred stock may decrease the cash
available (i) to DSL.net to carry out its business plan or (ii) for distribution
to holders of DSL.net's common stock.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act of 1933, as amended, set forth in Section 4(2) thereof
relative to sales by an issuer not involving any public offering or the rules
and regulations thereunder.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
DSL.net's Annual Meeting of Stockholders was held on May 29, 2002. Holders
of an aggregate of 64,858,966 shares of DSL.net common stock, 20,000 shares of
DSL.net Series X preferred stock, and 6,469 shares of DSL.net Series Y preferred
stock at the close of business on April 16, 2002 were entitled to vote at the
meeting. Each share of Series X preferred stock has the right to approximately
5,555.56 votes, each share of Series Y preferred stock has the right to 978.5
votes and each share of common stock has the right to one vote. At such meeting,
the DSL.net's stockholders voted as follows:
PROPOSAL 1. To elect three members of the board of directors to serve for
three-year terms as Class II directors, each director to serve for such term or
until his respective successor has been duly elected and qualified, or until his
earlier death, resignation or removal.
- ----------------- --------------------------------- ----------------------------- ---------------------------------
Series X Series Y Common
- ----------------- ----------------- --------------- -------------- -------------- ------------------ --------------
Director Name Total Series X Total Series Total Series Total Series Total Common Total Common
Votes for Each X Votes Y Votes for Y Votes Votes for Each Votes
Nominee Withheld from Each Nominee Withheld Nominee Withheld
Each Nominee from Each from Each
Nominee Nominee
- ----------------- ----------------- --------------- -------------- -------------- ------------------ --------------
Robert G. 111,111,111 0 N/A N/A N/A N/A
Gilbertson
- ----------------- ----------------- --------------- -------------- -------------- ------------------ --------------
Paul J. Keeler 111,111,111 0 5,485,471 0 56,661,949 450,583
- ----------------- ----------------- --------------- -------------- -------------- ------------------ --------------
William J. 111,111,111 0 N/A N/A N/A N/A
Marshall
- ----------------- ----------------- --------------- -------------- -------------- ------------------ --------------
No other persons were nominated, or received votes, for election as directors of
DSL.net at the 2002 Annual Meeting of Stockholders. Messrs. David F. Struwas,
Harry F. Hopper, and James D. Marver each continued their respective terms of
office after the 2002 Annual Meeting of Stockholders.
27
PROPOSAL 2. To consider and act upon a proposal to approve the issuance of up to
an additional 8,531 shares of Series Y preferred stock, in connection with the
Series Y preferred stock purchase agreement dated as of December 24, 2001, and
the shares of DSL.net common stock to be issued upon conversion of such shares
of Series Y preferred stock.
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total Votes for Total Votes Abstentions from Broker Non-Votes
Proposal 2 Against Proposal 2 Proposal 2
- ----------------------- --------------------- -------------------- --------------------- --------------------
Common stock 30,384,147 1,078,569 219,400 25,430,416
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series X preferred 111,111,111 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series Y preferred 5,485,471 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
PROPOSAL 3. To consider and act upon a proposed amendment to paragraph A of
Article IV of DSL.net's certificate of incorporation to increase the number of
authorized shares of DSL.net common stock from 200,000,000 shares to 400,000,000
shares and the total number of authorized shares of DSL.net capital stock from
220,000,000 shares to 420,000,000 shares.
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total Votes for Total Votes Abstentions from Broker Non-Votes
Proposal 3 Against Proposal 3 Proposal 3
- ----------------------- --------------------- -------------------- --------------------- --------------------
Common stock 55,794,792 1,220,482 97,258 0
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series X preferred 111,111,111 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series Y preferred 5,485,471 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
PROPOSAL 4. To consider and act upon a proposed amendment to Article VII of
DSL.net's certificate of incorporation to provide that, except as otherwise set
forth in the certificate of designation for any class or series of preferred
stock, holders of a class or series of DSL.net preferred stock (including the
Series X and Series Y preferred stock), when voting or acting as a separate
class or series, may act by written consent.
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total Votes for Total Votes Abstentions from Broker Non-Votes
Proposal 4 Against Proposal 4 Proposal 4
- ----------------------- --------------------- -------------------- --------------------- --------------------
Common stock 30,837,907 607,802 236,407 25,430,416
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series X preferred 111,111,111 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series Y preferred 5,485,471 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
PROPOSAL 5. To consider and act upon proposed amendments to DSL.net's
certificate of incorporation to amend the terms of DSL.net's Series X preferred
stock to (i) provide that the Series X preferred stock shall rank on parity with
the Series Y preferred stock upon redemption or a liquidation, dissolution or
winding up of DSL.net; (ii) increase from $2.00 per share to $2.50 per share the
closing sale price of the common stock on the Nasdaq Stock Market required
during a period of 45 consecutive trading days, commencing after May 13, 2002,
to cause the then outstanding Series X preferred stock to automatically convert
into common stock; and (iii) limit to the period ending June 28, 2002 the
requirement that DSL.net obtain the consent of the holders of at least a
majority of the then outstanding Series X preferred stock to authorize or issue,
or to obligate itself to issue, equity-related securities having rights,
preferences or privileges pari passu with the Series X preferred stock.
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total Votes for Total Votes Abstentions from Broker Non-Votes
Proposal 5 Against Proposal 5 Proposal 5
- ----------------------- --------------------- -------------------- --------------------- --------------------
Common stock 30,932,273 577,693 172,150 25,430,416
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series X preferred 111,111,111 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series Y preferred 5,485,471 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
28
PROPOSAL 6. To consider and act upon a proposal to approve DSL.net's Amended and
Restated 2001 Stock Option and Incentive Plan.
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total Votes for Total Votes Abstentions from Broker Non-Votes
Proposal 6 Against Proposal 6 Proposal 6
- ----------------------- --------------------- -------------------- --------------------- --------------------
Common stock 55,574,580 1,426,099 111,853 0
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series X preferred 111,111,111 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series Y preferred 5,485,471 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
PROPOSAL 7. To ratify the selection of the firm of PricewaterhouseCoopers LLP as
auditors for the fiscal year ending December 31, 2002.
- ----------------------- --------------------- -------------------- --------------------- --------------------
Total Votes for Total Votes Abstentions from Broker Non-Votes
Proposal 7 Against Proposal 7 Proposal 7
- ----------------------- --------------------- -------------------- --------------------- --------------------
Common stock 56,875,921 180,892 55,719 0
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series X preferred 111,111,111 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
Series Y preferred 5,485,471 0 0 0
stock
- ----------------------- --------------------- -------------------- --------------------- --------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS.
- --------------- ---------------------------------------------------------------
Exhibit No. Exhibit
- --------------- ---------------------------------------------------------------
3.01 Amended and Restated Certificate of Incorporation of DSL.net,
as amended (incorporated by reference to Exhibit 4.01 filed
with our Form S-8 dated as of June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
3.02 Amended and Restated By-Laws of DSL.net, as amended
(incorporated by reference to Exhibit 4.02 filed with our
Form S-8 dated as of June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
4.01 Description of capital stock (contained in the Certificate of
Incorporation incorporated by reference to Exhibit 4.01 filed
with our Form S-8 on June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
10.1 Amended and Restated 2001 Stock Option and Incentive Plan
(incorporated by reference to Exhibit 4.03 filed with our
Form S-8 on June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
10.2 Amendment No. 6 to Lease, dated as of April 22, 2002, by and
between DSL.net, Inc. and Long Wharf Drive, LLC (filed
herewith).
- --------------- ---------------------------------------------------------------
11.01 Statement of Computation of Basic and Diluted Net Loss Per
Share (filed herewith).
- --------------- ---------------------------------------------------------------
(b) Reports on Form 8-K.
None.
29
SIGNATURE
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.
DSL.NET, INC.
By:/s/ Robert J. DeSantis
-----------------------------
Robert J. DeSantis
Chief Financial Officer
Date: August 13, 2002
30
EXHIBIT INDEX
- --------------- ---------------------------------------------------------------
Exhibit No. Exhibit
- --------------- ---------------------------------------------------------------
3.01 Amended and Restated Certificate of Incorporation of DSL.net,
as amended (incorporated by reference to Exhibit 4.01 filed
with our Form S-8 dated as of June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
3.02 Amended and Restated By-Laws of DSL.net, as amended
(incorporated by reference to Exhibit 4.02 filed with our
Form S-8 dated as of June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
4.01 Description of capital stock (contained in the Certificate of
Incorporation incorporated by reference to Exhibit 4.01 filed
with our Form S-8 on June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
10.1 Amended and Restated 2001 Stock Option and Incentive Plan
(incorporated by reference to Exhibit 4.03 filed with our
Form S-8 on June 6, 2002 (No. 333-89886)).
- --------------- ---------------------------------------------------------------
10.2 Amendment No. 6 to Lease, dated as of April 22, 2002, by and
between DSL.net, Inc. and Long Wharf Drive, LLC (filed
herewith).
- --------------- ---------------------------------------------------------------
11.01 Statement of Computation of Basic and Diluted Net Loss Per
Share (filed herewith).
- --------------- ---------------------------------------------------------------
31