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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 March 31, 2003
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 __
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes __ No X
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As of May 12, 2003 the registrant had 64,938,732 shares of Common Stock
outstanding.
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DSL.NET, INC.
INDEX
Page
Number
------
Part I - Financial Information
Item 1. Consolidated Financial Statements ....................................2
Consolidated Balance Sheets (unaudited) at December 31, 2002 and
March 31, 2003..................................................2
Consolidated Statements of Operations (unaudited) for the three
months ended March 31, 2002 and 2003............................3
Consolidated Statements of Cash Flows (unaudited) for the three
months ended March 31, 2002 and 2003............................4
Notes to Consolidated Financial Statements..........................5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................18
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........33
Item 4. Controls and Procedures..............................................33
Part II - Other Information
Item 2 Changes in Securities and Use of Proceeds............................33
Item 4. Submission of Matters to a Vote of Security Holders..................34
Item 6. Exhibits and Reports on Form 8-K.....................................34
Signature....................................................................36
Certifications...............................................................37
Exhibit Index................................................................39
1
Part I - Financial Information
Item 1. Consolidated Financial Statements
DSL.net, Inc.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
(unaudited)
December 31, March 31,
2002 2003
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 11,318 $ 4,478
Restricted cash (Note 2) 1 4
Accounts receivable (net of allowances of $606 and $718
at December 31, 2002 and March 31, 2003, respectively) 4,358 8,330
Inventory 707 706
Deferred costs 615 762
Prepaid expenses and other current assets 726 1,318
---------- ----------
Total current assets 17,725 15,598
Fixed assets, net 23,066 32,968
Goodwill and other intangible assets 10,656 10,951
Other assets 2,049 7,194
---------- ----------
Total assets $ 53,496 $ 66,711
========== ==========
LIABILITIES, MANDATORILY REDEEMABLE, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,621 $ 3,773
Accrued salaries 1,225 1,176
Accrued liabilities 4,621 8,371
Deferred revenue 3,591 5,855
Current portion of capital leases payable 2,676 2,643
---------- ----------
Total current liabilities 16,734 21,818
Capital leases payable 1,889 1,226
Notes payable (Note 7) -- 5,000
Credit facility (Note 7) -- 6,100
---------- ----------
Total liabilities 18,623 34,144
---------- ----------
Commitments and contingencies (Note 8)
Preferred stock: 20,000,000 preferred shares authorized (Note 9)
20,000 shares designated as Series X, mandatorily redeemable, convertible
preferred stock, $.001 par value; 20,000 and 20,000 shares issued and outstanding
as of December 31, 2002 and March 31, 2003, respectively (liquidation preference
$22,315 and $22,915 as of December 31, 2002 and March 31, 2003, respectively) 8,741 11,014
15,000 shares designated as Series Y, mandatorily redeemable, convertible
preferred stock, $.001 par value; 15,000 and 15,000 shares issued and outstanding
as of December 31, 2002 and March 31, 2003, respectively (liquidation preference
$16,380 and $16,830 as of December 31, 2002 and March 31, 2003, respectively) 5,381 7,168
Stockholders' equity (Note 9)
Common stock, $.0005 par value; 400,000,000 and 400,000,000 shares authorized;
64,929,899 and 64,937,899 shares issued and outstanding 32 32
Additional paid-in capital 305,647 308,246
Deferred compensation (437) (159)
Accumulated deficit (284,491) (293,734)
---------- ----------
Total stockholders' equity 20,751 14,385
---------- ----------
Total liabilities, preferred stock and stockholders' equity $ 53,496 $ 66,711
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
2
DSL.net, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(unaudited)
Three Months Ended
March 31,
--------------------------
2002 2003
---------- ----------
Revenue $ 11,381 $ 16,765
---------- ----------
Operating expenses:
Network (excluding $7 and $7
of stock compensation, respectively) 8,712 12,238
Operations (excluding $15 and $9
of stock compensation, respectively) 1,991 2,756
General and administrative (excluding $111 and $52
of stock compensation, respectively) 3,402 3,056
Sales and marketing (excluding $214 and $210
of stock compensation, respectively) 1,197 2,233
Stock compensation 347 278
Depreciation and amortization 5,114 4,837
---------- ----------
Total operating expenses $ 20,763 $ 25,398
---------- ----------
Operating loss $ (9,382) $ (8,633)
Interest (expense) income, net (245) (564)
Other income (expense), net 172 (46)
---------- ----------
Net loss $ (9,455) $ (9,243)
========== ==========
Net loss applicable to common stockholders:
Net loss (9,455) (9,243)
Dividends on preferred stock (594) (1,050)
Accretion of preferred stock, net of issuance costs (1,597) (3,010)
---------- ----------
Net loss applicable to common stockholders $ (11,646) $ (13,303)
========== ==========
Net loss per share, basic and diluted $ (0.18) $ (0.20)
========== ==========
Shares used in computing net loss per share, basic and diluted 64,743,155 64,931,588
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
3
DSL.net, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, except per share data)
(unaudited)
Three Months ended
March 31,
--------------------------
2002 2003
---------- ----------
Cash flows from operating activities:
Net loss $ (9,455) $ (9,243)
Reconciliation of net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 5,114 4,837
Bad debt expense 561 500
Sales credits and allowances 253 98
Amortization of deferred debt issuance costs 9 315
Stock compensation expense 347 278
Loss on sale/write-off of fixed assets 53 94
Net changes in assets and liabilities:
(Increase) in accounts receivable (1,505) (4,570)
Decrease / (increase) in prepaid and other current assets 213 (737)
(Increase) / decrease in other assets (219) 1,196
(Decrease) in accounts payable (378) (847)
Increase / (decrease) in accrued salaries 55 (49)
(Decrease) / increase in accrued expenses (1,945) 2,999
Increase in deferred revenue 185 1,180
---------- ----------
Net cash used in operating activities (6,712) (3,949)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (605) (378)
Proceeds from sales of property and equipment 73 --
Acquisitions of businesses and customer lines (650) (7,917)
(Increase) / decrease in restricted cash 18 (3)
---------- ----------
Net cash used in investing activities (1,164) (8,298)
---------- ----------
Cash flows from financing activities:
Proceeds from credit facility -- 6,100
Proceeds from common stock issuance 2 2
Proceeds from preferred stock issuance and bridge note 10,000 --
Principal payments under notes and capital lease obligations (795) (695)
---------- ----------
Net cash provided by financing activities 9,207 5,407
---------- ----------
Net increase / (decrease) in cash and cash equivalents 1,331 (6,840)
Cash and cash equivalents at beginning of period 19,285 11,318
---------- ----------
Cash and cash equivalents at end of period $ 20,616 $ 4,478
========== ==========
Supplemental disclosure of non-cash investing activities:
On January 10, 2003, the Company purchased the network assets and associated subscriber lines of
Network Access Solutions Corporation (Note 5)
The fair value of the assets acquired was $14,750
The accompanying notes are an integral part of these consolidated financial statements.
4
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 2003 presentation. The consolidated financial
statements ("financial statements") at March 31, 2003 and for the three months
ended March 31, 2002 and 2003 are unaudited, but in the opinion of management,
include all adjustments (consisting only of normal recurring adjustments) that
DSL.net, Inc ("DSL.net" or the "Company") considers necessary for a fair
presentation of its financial position and operating results. Operating results
for the three months ended March 31, 2003 are not necessarily indicative of
results that may be expected for any future periods.
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, 2002. Accordingly, footnote disclosures that would substantially
duplicate the disclosures contained in the Company's December 31, 2002 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 ("SEC"). 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, 2002, which has been filed with the
SEC.
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 (loss) 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.
5
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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, 2002, the Company incurred operating losses of approximately
$35,821 and negative operating cash flows of approximately $17,706 during the
year ended December 31, 2002. During the three months ended March 31, 2003, the
Company incurred operating losses of approximately $8,633 and negative operating
cash flows of approximately $3,949. These operating losses and negative
operating cash flows have been financed primarily by proceeds from equity
issuances. The Company had accumulated deficits of approximately $284,491 at
December 31, 2002 and approximately $293,734 at March 31, 2003.
The Company expects its operating losses, net operating cash outflows and
capital expenditures to continue through 2003. The Company successfully
completed rounds of private equity and bridge loan financings totaling
approximately $35,000 as follows: approximately $20,000 in the fourth quarter of
2001, $10,000 in March 2002, and $8,531 in May 2002 (which, after cancellation
of the bridge loans, yielded net proceeds of approximately $5,000) (Note 9). The
Company's independent accountants have noted in their report on the Company's
audited financial statements and accompanying notes included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002 that the
Company's sustained operating losses raise substantial doubt about its ability
to continue as a going concern. The Company believes that its existing cash and
cash equivalents, cash expected to be generated from operations, and funds
available under its bank credit agreement, will be sufficient to fund its
operating losses, capital expenditures, lease payments and working capital
requirements through the end of the second quarter of 2003, based on its current
business plans and projections. 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, subscriber lines or other assets, including
the proposed acquisition of network assets and associated subscriber lines from
TalkingNets (Note 13). 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, planned capital expenditures, cash
generated from operations, improvements in operating productivity, the extent
and timing of entry into new markets, and availability and prices paid for
acquisitions.
Additional financing will be required by the end of the second quarter of
2003. The Company does not believe that its operations will generate sufficient
cash to finance its 2003 operating requirements. As a result, the Company will
need to raise additional financing through some combination of borrowings
(including borrowings under the bank credit facility described in Note 7),
leasing, vendor financing and the sale of equity or debt securities. These
capital requirements may vary based upon the timing and the success of
implementation of the Company's business plan or if:
o demand for the Company's services or its cash flow from operations is
less than or more than expected;
6
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
o plans or projections change or prove to be inaccurate;
o the Company makes acquisitions;
o the Company alters the schedule or targets of its business plan
implementation; or
o the Company curtails, reorganizes, discontinues, or shuts down its
operations
There can be no assurance that the Company will be able to raise sufficient
additional debt, equity or other capital on acceptable terms, if at all. If the
Company is unable to obtain adequate funds, the Company may not be able to
continue to operate its network, respond to competitive pressures or fund its
operations. As a result, the Company may be required to significantly reduce,
reorganize, discontinue or shut down its operations. These financial statements
do not include any adjustments that might result from this uncertainty.
3. Stockholders' Equity
The Company's remaining unamortized deferred compensation balance of
approximately $159 at March 31, 2003, relating to stock options and restricted
stock held by employees and directors, is being amortized over the respective
remaining vesting periods.
4. Restructuring
The Company's restructuring reserve balance at March 31, 2003, of
approximately $911, which related to various restructuring charges recorded in
2000 and 2001, was included in the Company's accrued liabilities and represented
approximately $596 for anticipated costs pertaining to its vacated facilities
and approximately $315 for anticipated costs pertaining to its closed central
offices.
5. Acquisitions
During the quarter ended March 31, 2002, the Company entered into an Asset
Purchase Agreement, dated as of January 1, 2002, 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. The initial purchase price of $800 was subject to certain
adjustments which resulted in a $50 reduction in the purchase price. The
Broadslate customer line acquisitions were accounted for under the purchase
method of accounting and, accordingly, the adjusted purchase price of
approximately $750 was allocated to the assets acquired based on their estimated
fair values at the date of acquisition as follows: approximately $28 to net
accounts receivable acquired and approximately $722 to approximately 520
subscriber lines acquired, which amount is being amortized on a straight-line
basis over two years from the date of purchase.
In December of 2002, the U.S. Bankruptcy Court for the District of
Delaware approved the Company's bid to purchase network assets and associated
subscriber lines of Network Access Solutions Corporation ("NAS") for $14,000,
consisting of $9,000 in cash and $5,000 in a note payable to NAS. The Company
closed the transaction on January 10, 2003, whereby it acquired NAS's operations
and network assets, associated equipment in approximately 300 central offices
and approximately 11,500 associated subscriber lines. Additionally, on January
10, 2003, the Company hired approximately 78 employees formerly employed by NAS.
No pre-closing liabilities
7
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
were assumed in connection with the NAS transaction. The cash portion of the
consideration was paid from the Company's existing cash. In accordance with the
Asset Purchase Agreement, DSL.net negotiated a $1,083 reduction in the cash paid
at the closing, representing DSL.net's portion of January revenue which was
billed and collected by NAS, bringing the net cash paid for the NAS network
assets and associated subscriber lines to $7,917. The NAS note has a term of 5
years, bears interest at 12% and is collateralized by the network equipment
acquired from NAS. Interest is payable monthly in arrears on the unpaid
principal balance. The note requires interest-only payments for the first 21
months after which principal payments will commence monthly and be paid in 39
equal monthly installments together with interest on the unpaid principal
balance.
NAS provided high-speed Internet and Virtual Private Network services to
business customers using Digital Subscriber Line, frame relay and T-1 technology
via its own network facilities in the Northeast and Mid-Atlantic markets. The
NAS acquisition significantly increased the Company's subscriber base and its
facilities-based footprint in one of the largest business markets in the United
States, providing it with increased opportunities to sell more higher-margin
facilities-based services.
The acquisition has been accounted for under the purchase method of
accounting in accordance with SFAS No. 141. The results of NAS's operations have
been included in the consolidated financial statements since January 10, 2003
(the acquisition date). The allocated estimated fair values of the acquired
assets at the date of acquisition exceeded the purchase price and, accordingly,
have been written down on a pro-rata basis by asset group to the purchase price
of approximately $14,750 ($14,000 plus associated direct acquisition costs of
approximately $750) as follows: (i) intangible assets pertaining to
approximately 11,500 acquired subscriber lines of $5,406, and (ii) property and
equipment of $9,344. The Company is still in the process of obtaining third
party estimates of certain property and equipment and, thus, the allocation of
the purchase price is subject to further adjustment.
In connection with the integration of the NAS business, on January 17,
2003, the Company had a reduction in force of approximately 35 employees at its
headquarters facility in New Haven, Connecticut. The Company paid approximately
$62 in severance to the terminated employees. Subsequent to this reduction in
force, the Company's headcount approximated 230 employees.
With the acquisition of the NAS assets on January 10, 2003, the Company
acquired a number of subscribers, some of whom it services indirectly through
various Internet service providers ("ISP's"). The Company sells its services to
such ISP's who then resell such services to the end user subscriber. The Company
expects to have some increased exposure and concentration of credit risk
pertaining to such ISP's during 2003, however, no individual customer accounted
for more than 5% of first quarter 2003 revenue.
8
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth the unaudited pro forma consolidated
financial information of the Company, giving effect to the acquisition of the
Broadslate customers and the acquisition of network assets and associated
subscriber lines of NAS, as if the transactions occurred at the beginning of the
periods presented.
PRO FORMA
THREE MONTHS ENDED MARCH 31,
------------------------------
2002 2003
------------ ------------
Pro forma revenue $ 17,255 $ 17,523
Pro forma operating loss $ (10,454) $ (8,606)
Pro forma net loss $ (10,994) $ (9,261)
Pro forma net loss applicable to common stockholders $ (13,185) $ (13,321)
Pro forma net loss per share, basic and diluted $ (.20) $ (.21)
Shares used in computing pro forma net loss per share 64,743,155 64,931,588
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 customer lines acquired during the
period was approximately $382 and $5,116 for the three months ended March 31,
2002 and 2003, respectively.
6. Goodwill and Other Intangible Assets
In accordance with SFAS No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS",
which became effective January 1, 2002, the Company has ceased to amortize
approximately $8,482 of goodwill. In lieu of amortization, the Company made an
initial impairment review of its goodwill in January of 2002 and another
impairment review in December of 2002. The Company did not record any goodwill
impairment adjustments resulting from its impairment reviews. The Company will
continue to perform annual impairment reviews, unless a change in circumstances
requires a review in the interim.
Amortization expense of other intangible assets for the three months ended
March 31, 2002 and 2003 was approximately $1,342 and $1,181, 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 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 Preferred Stock
Purchase Agreement, the Company sold an additional 8,531 shares of Series Y
Preferred Stock for $5,000 in cash and delivery of the
9
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Promissory Notes for cancellation. All accrued interest on the Promissory Notes,
of approximately $145, was forgiven (Note 9).
The Company entered into a Revolving Credit and Term Loan Agreement, dated
as of December 13, 2002 (the "Credit Agreement"), with a commercial bank
providing for a revolving line of credit of up to $15,000 (the "Commitment").
Borrowings under the Credit Agreement may be made in minimum $500 increments
from time to time up to the Commitment and repayments may be made in minimum
$100 increments, in each case until the revolving credit maturity date of
December 12, 2004, at which time all amounts outstanding will convert into a
term loan payable in 12 quarterly installments commencing on December 31, 2004
(the "Term Loan"). The Company may pre-pay amounts due under the Term Loan in
increments of $1,000 without penalty. Interest is payable on all amounts
outstanding under the Credit Agreement in arrears at the end of each calendar
quarter at a variable interest rate equal to the higher of the bank's prime rate
equivalent or 0.5% percent above the Federal Funds Effective rate. As of March
31, 2003, amounts outstanding under this Credit Agreement bore interest at an
annual rate of 4.25%. The amount not drawn upon under the Commitment (subject to
certain adjustments) is subject to a commitment fee, payable in arrears at the
end of each calendar quarter, equal to an annualized rate of 0.25%. The Credit
Agreement also requires the Company and its subsidiaries, except for Vector
Internet Services, Inc., to maintain all of its bank deposit and investment
accounts with the bank. The Company's ability to borrow amounts available under
the Credit Agreement is subject to the bank's receipt of a like amount of
guarantees from certain of the Company's investors and/or other guarantors
acceptable to the bank and to certain other conditions set forth in the Credit
Agreement. As of March 31, 2003, the Company's investors had guaranteed $9,100
under the Credit Agreement. On February 3, 2003, the Company borrowed $6,100
under the Credit Agreement. As of March 31, 2003, the Company's outstanding
balance under the Credit Agreement was approximately $6,100.
The Company entered into a Reimbursement Agreement, dated as of December
27, 2002, with several private investment funds affiliated with VantagePoint
Venture Partners ("VantagePoint"), Columbia Capital Equity Partners
("Columbia"), The Lafayette Investment Fund, L.P. and Charles River Partnership,
L.P. (collectively the "Guarantors") and VantagePoint Venture Partners III (Q),
L.P., as administrative agent (the "Agent"). The Guarantors are all holders of
or affiliates of holders of the Company's Series X and Series Y Preferred Stock.
Pursuant to the terms of the Reimbursement Agreement, on December 27, 2002,
VantagePoint and Columbia issued guarantees in an aggregate amount of $6,100 to
support certain obligations of the Company under the Credit Agreement. The
Reimbursement Agreement obligates the Company to reimburse the Guarantors for
any payments they may be required to make in accordance with their guarantees.
The Company's obligations under the Reimbursement Agreement are guaranteed by
certain of the Company's wholly-owned subsidiaries and collateralized by a
Security Agreement signed by the Company and certain of its wholly-owned
subsidiaries which pledges a significant portion of the Company's consolidated
assets as collateral.
Pursuant to the terms of the Reimbursement Agreement, on December 27,
2002, the Company issued warrants to purchase 12,013,893 shares of its common
stock to VantagePoint and to Columbia, in consideration for their guarantees
aggregating $6,100. All such warrants have a ten year life and an exercise price
of $0.50 per share. On March 26, 2003, the Company, issued additional warrants,
exercisable for ten years, to purchase a total of 936,107 shares its common
stock at $0.50 per share to VantagePoint and Columbia, bringing the total number
of warrants issued in connection with the Reimbursement Agreement to 12,950,000.
Pursuant to the terms of the Reimbursement Agreement, in the event that the
Company did not borrow any loans under the
10
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Credit Agreement on or before March 31, 2003, then the Credit Agreement and all
Guarantees issued under the Reimbursement Agreement shall have been terminated
and any warrants issued to Guarantors in connection with the transactions
contemplated shall have been deemed terminated. Since the Company initiated a
loan on its bank Credit Agreement on February 3, 2003, the Guarantors'
guarantees of the subject loan became effective on February 3, 2003 and the
contingency related to the validation of the warrants was eliminated.
On February 3, 2003, the Company valued the 12,950,000 warrants at $0.514
each with a total value of approximately $6,656. The valuation was performed
using a Black Scholes valuation model with the following assumptions: (i) a risk
free interest rate of 4.01% (ten-year Treasury rate), (ii) a zero dividend
yield, (iii) a ten year expected life, (iv) an expected volatility of 153%, (v)
an option exercise price of $0.50 and (vi) a current market price of $0.52 (the
closing price of the Company's common stock on February 3, 2003). Since the
warrants were issued in consideration for loan guarantees, which enabled the
Company to secure financing at below market interest rates, the Company recorded
their value as a deferred debt financing cost which will be amortized to
interest expense over the term of the loan (approximately 57 months) using the
"Interest Method" of amortization. For the three months ended March 31, 2003,
interest expense relating to amortized deferred financing costs approximated
$315. The Company's remaining unamortized deferred financing costs was
approximately $6,341 as of March 31, 2003.
On March 3, 2003, the Company and certain of the Guarantors entered into
Amendment No. 1 to the Reimbursement Agreement, pursuant to which VantagePoint
increased its guarantee by $3,000, bringing the aggregate guarantees by all
Guarantors under the Reimbursement Agreement, as amended, to $9,100. As
consideration for VantagePoint's increased guarantee, if the Company closes an
equity financing on or before December 3, 2003, it is authorized to issue
VantagePoint additional warrants to purchase the type of equity securities
issued by it in such equity financing. The number of such additional warrants
would be determined by dividing $1,000 by the per share price of such equity
securities.
8. Commitments and Contingencies
In certain markets where the Company has not deployed its own local
broadband equipment, the Company utilizes local facilities of wholesale
providers, including Covad Communications, Inc. ("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. 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 (formerly known as
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. MCI has filed a voluntary petition to
reorganize under Chapter 11 of the U.S. Bankruptcy Code. While MCI 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 MCI to
alternative suppliers in thirty to sixty days, should MCI announce
discontinuance of such services. However, if MCI was to discontinue such
services without providing sufficient advance notice (at least sixty days), the
Company might not be able to transition
11
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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 MCI 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 the Company or its customers, if at all.
In February 2002, the Company negotiated a termination of its obligations
under its lease for vacated office space located in Milford, Connecticut. The
Company had recorded anticipated losses related to these vacated premises as
part of its restructuring charges during the year ended December 31, 2001.
Under the Company's facility operating leases, minimum office facility
operating lease payments are approximately $1,800 in 2003, $2,000 in 2004, $766
in 2005, $233 in 2006, $169 in 2007 and $28 in 2008. The Company also has
long-term purchase commitments with MCI, AT&T, Sprint and other vendors for data
transport and other services with minimum payments due even if its usage does
not reach the minimum amounts. Minimum payments under our long-term purchase
commitments are approximately $3,668 in 2003, $2,396 in 2004 and $57 in 2005.
9. 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, 2002, 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 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"), 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, before direct issuance costs of
approximately $189. 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.
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, before direct issuance
costs of approximately $300, which costs pertain to all funding transactions
under the Series Y Purchase Agreement.
In addition, in December 2001, the Company issued the Promissory Notes to
the Series Y Investors in the aggregate principal amount of $3,531 in exchange
for proceeds of $3,531. 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
12
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Preferred Stock for $5,000 in cash and delivery of the Promissory Notes for
cancellation. All accrued interest on the Promissory Notes, of approximately
$145, was forgiven (Note 7).
The Series X and Series Y Preferred Stock activity during the three months
ended March 31, 2002 is summarized as follows:
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
Discount on Series X and Y Preferred Stock resulting
from a beneficial conversion feature (10,000)
Accrued dividends on Series X and Y Preferred Stock 400 194
Accretion of beneficial conversion feature of Series X
and Y Preferred Stock 1,085 512
---------- ---------- ---------- ----------
Balance March 31, 2002 20,000 $ 1,921 6,469 $ 740
========== ========== ========== ==========
The Series X and Series Y Preferred Stock activity during the three months
ended March 31, 2003 is summarized as follows:
MANDATORILY
REDEEMABLE CONVERTIBLE PREFERRED STOCK
--------------------------------------------------------
SERIES X SERIES Y
-------------------------- -------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ---------- ---------- ----------
Balance December 31, 2002 20,000 $ 8,741 15,000 $ 5,381
Accrued dividends on Series X and Y Preferred Stock 600 450
Accretion of beneficial conversion feature of Series X
and Y Preferred Stock 1,673 1,337
---------- ---------- ---------- ----------
Balance March 31, 2003 20,000 $ 11,014 15,000 $ 7,168
========== ========== ========== ==========
10. 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 (Note 5). Certain
of the Company's stockholders, including investment funds affiliated with
Columbia, in the aggregate owned in excess of 10% of the capital stock of
13
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Broadslate. An affiliate of Columbia and a member of our Board of Directors was
a director of Broadslate until February 2002.
In accordance with the Series X Purchase Agreement, a group of private
investment funds affiliated with 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 9). Prior to the sale of the additional 10,000 shares of Series X
Preferred Stock, VantagePoint beneficially 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 beneficially owns
the equivalent of 133,067,174 shares of common stock. Two affiliates of
VantagePoint are members of the Company's Board of Directors.
In accordance with the Series Y Purchase Agreement (Note 9), in December
2001, the Company sold to the Series Y Investors 6,469 shares of its Series Y
Preferred Stock for an aggregate purchase price of $6,469. In addition, in
December 2001, the Company issued the Promissory Notes to the Series Y Investors
in the aggregate principal amount of $3,531 in exchange for proceeds of $3,531
(Note 7). 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, which resulted in net
proceeds of approximately $5,000, after the cancellation of the Promissory Notes
issued to the Series Y Investors in December 2001. An affiliate of Columbia is a
member of the Company's Board of Directors.
The Company entered into a Reimbursement Agreement, dated as of December
27, 2002, with the Guarantors and the Agent. The Guarantors are all holders of
or affiliates of holders of the Company's Series X and Series Y Preferred Stock.
Pursuant to the terms of the Reimbursement Agreement, on December 27, 2002, the
Company issued warrants to purchase 10,379,420 shares of its common stock to
VantagePoint and warrants to purchase 1,634,473 shares of its common stock to
Columbia, in consideration for their guarantees aggregating $6,100. The Company
issued additional warrants to purchase 767,301 shares of its common stock to
VantagePoint and 168,806 shares of its common stock to Columbia during the first
quarter of 2003, bringing the total number of warrants issued to 12,950,000. All
such warrants are exercisable for ten years at an exercise price of $0.50 per
share (Note 7). On March 3, 2003, the Company and certain of the Guarantors
entered into Amendment No. 1 to the Reimbursement Agreement, pursuant to which
VantagePoint increased its guarantee by $3,000, bringing the aggregate
guarantees by all Guarantors under the Reimbursement Agreement, as amended, to
$9,100. As consideration for VantagePoint's increased guarantee, if the Company
closes an equity financing on or before December 3, 2003, it is authorized to
issue VantagePoint additional warrants to purchase the type of equity securities
issued by it in such equity financing. The number of such additional warrants
would be determined by dividing $1,000 by the per share price of such equity
securities. Prior to the execution of the Reimbursement Agreement, VantagePoint
beneficially owned 21,956,063 shares of the Company's common stock and 20,000
shares of the Company's mandatorily redeemable, convertible Series X Preferred
Stock, which are convertible into 111,111,111 shares of the Company's common
stock, and Columbia owned 15,000 shares of the Company's Series Y Preferred
Stock, which are convertible into 30,000,000 shares of the Company's common
stock. Two affiliates of VantagePoint and one affiliate of Columbia are members
of the Company's Board of Directors.
14
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11. Incentive Stock Award Plans
At March 31, 2003, the Company has four stock-based employee compensation
plans, which are described more fully 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, 2002. The Company accounts for Stock-based
compensation under the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"). Accordingly, compensation expense is not recognized when options are
granted at the fair market value on the date of grant.
The Company has elected to continue following APB 25 to account for its
stock-based compensation plans. The following table presents the effect on the
Company's net loss and net loss per share as if the Company had applied the fair
value method of accounting for stock-based compensation in accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"):
Three Months Ended March 31,
----------------------
2002 2003
-------- --------
Net loss, as reported $ (9,455) $ (9,243)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (1,302) (1,515)
-------- --------
Pro forma under FAS 123 $(10,757) $(10,758)
Net loss applicable to common stockholders:
As reported $(11,646) $(13,303)
Pro forma under FAS 123 $(12,948) $(14,818)
Basic and diluted net loss per common share:
As reported $ (0.18) $ (0.20)
Pro forma under FAS 123 $ (0.20) $ (0.23)
The estimated fair value at date of grant for options granted during the
three months ended March 31, 2002 ranged from $0.80 to $1.15 per share, and for
the three months ended March 31, 2003 ranged from $0.50 to $0.53 per share. The
minimum value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
March 31,
----------------------
2002 2003
---- ----
Risk free interest rate 3.73%-4.00% 2.29%-2.70%
Expected dividend yield None None
Expected life of option 4 years 4 years
Expected volatility 165% 152%
15
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
As additional options are expected to be granted in future periods, and
the options vest over several years, the above pro forma results are not
necessarily indicative of future pro forma results.
12. 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, the
Company has discontinued amortizing approximately $8,482 of goodwill associated
with acquired businesses.
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.
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 the Company's
financial position and results of operations.
In June 2002, SFAS No. 146, "ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES"
was issued. SFAS 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.
In December 2002, SFAS No. 148 "ACCOUNTING FOR STOCK-BASED COMPENSATION -
TRANSITION AND DISCLOSURE - AN AMENDMENT OF SFAS NO. 123" was issued. SFAS No.
148 amends SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee
16
DSL.NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results (Note 11).
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS OF OTHERS," ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees.
FIN 45 requires an entity to recognize an initial liability for the fair value
of an obligation assumed by issuing a guarantee. The disclosure requirements of
FIN 45 are effective for all financial statements issued after December 15,
2002. The provision for initial recognition and measurement of the liability
will be applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 is not expected to have a material
adverse impact on the Company's financial position, results of operations or
cash flows.
13. Subsequent Events
On April 8, 2003, the Company entered into an asset purchase agreement
with TalkingNets, Inc. and TalkingNets Holdings, LLC, (collectively,
"TalkingNets") pursuant to which the Company agreed to acquire assets and
subscribers of TalkingNets for $726 in cash (the "TalkingNets Asset Purchase
Agreement"). As TalkingNets filed a voluntary petition for Chapter 11
reorganization in February 2003, the TalkingNets Asset Purchase Agreement was
subject to the approval of the U.S. Bankruptcy Court for the Eastern District of
Virginia. On April 9, 2003, the TalkingNets Asset Purchase Agreement and the
transactions contemplated thereby were approved by the Bankruptcy Court. If all
closing conditions are satisfied, the Company expects that this transaction will
be completed during the second or third quarter of 2003. On April 11, 2003, the
Company paid the full purchase price of $726 into escrow. In accordance with the
terms of the TalkingNets Asset Purchase Agreement, the Company will have a
transition period of up to 150 days to integrate TalkingNets' operations into
its own operations and obtain all requisite approvals prior to final closing of
the transaction. During the transition period, the Company will be entitled to
the revenue from the acquired customers and be obligated to pay for certain of
the related operating costs of TalkingNets' operations.
Effective May 1, 2003, the Company entered into a 35 month lease for
office space in Herndon, Virginia, with minimum lease payments of approximately
$164 in 2003, $256 in 2004, $268 in 2005 and $68 in 2006.
17
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------
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, 2002,
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 throughout the United States,
primarily using digital subscriber line, or DSL, technology. We have primarily
targeted select second and third tier cities, as well as some first tier cities,
for the deployment of our own local communications equipment. In certain markets
where we have not deployed our own equipment, we utilize the local facilities of
other carriers to provide service.
In December of 2002, the U.S. Bankruptcy Court for the District of
Delaware approved our bid to purchase network assets and associated subscriber
lines of Network Access Solutions Corporation ("NAS") for $14,000, consisting of
$9,000 in cash and $5,000 in a note payable to NAS. We closed the transaction on
January 10, 2003, whereby we acquired the majority of NAS's operations and
network assets, associated equipment in approximately 300 central offices and
approximately 11,500 associated subscriber lines. The cash portion of the
purchase price was paid from our existing cash. In accordance with the Asset
Purchase Agreement, we negotiated a $1,083 reduction in the cash paid at the
closing, representing our portion of January revenue which was billed and
collected by NAS, bringing the net cash paid for the NAS network assets and
associated subscriber lines to $7,917. In connection with the closing of the NAS
transaction, on January 10, 2003, we hired approximately 78 former NAS
employees. No pre-closing liabilities were assumed in connection with the NAS
transaction.
NAS provided high-speed Internet and Virtual Private Network services to
business customers using Digital Subscriber Line, frame relay and T-1 technology
via its own network facilities in the Northeast and Mid-Atlantic markets. The
acquisition significantly increased our subscriber base and our facilities-based
footprint in one of the largest business markets in the United States, providing
us with increased opportunities to sell more higher-margin facilities-based
services.
The acquisition has been accounted for under the purchase method of
accounting in accordance with SFAS No. 141. The results of NAS's operations have
been included in our consolidated financial statements since January 10, 2003
(the acquisition date). The allocated estimated fair values of the acquired
assets at the date of acquisition exceeded the purchase price and, accordingly,
have been written down on a pro-rata basis by asset group to the purchase price
of approximately $14,750 ($14,000 plus associated direct acquisition costs of
approximately $750) as follows: (i) intangible assets pertaining to
approximately 11,500 acquired subscriber lines of $5,406, and (ii) property and
equipment of $9,344. We are still in the process of obtaining third party
estimates of certain property and equipment and, thus, the allocation of the
purchase price is subject to further adjustment.
In connection with the integration of the NAS business, on January 17,
2003, we had a reduction in force of approximately 35 employees at our
headquarters facility in New Haven, CT.
18
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------
We paid approximately $62 in severance to the terminated employees. Subsequent
to the reduction in force, our headcount approximated 230 employees.
On February 3, 2003, we borrowed $6,100 under our Revolving Credit and
Term Loan Agreement (discussed below). The loan bears interest, payable monthly
in arrears at the bank's "base rate" and any unpaid principal balance will
automatically convert to a term loan on December 12, 2004, after which principal
payments (together with accrued interest on the unpaid principal balance) will
be made in 12 equal installments payable at the end of each calendar quarter
commencing on December 31, 2004. Amounts borrowed under the bank credit line are
guaranteed by the principal holders of our Series X and Series Y Preferred
Stock, with whom we have signed a Reimbursement Agreement (discussed below).
On April 8, 2003, we entered into an asset purchase agreement with
TalkingNets, Inc. and TalkingNets Holdings, LLC, (collectively, "TalkingNets")
pursuant to which we agreed to acquire assets and subscribers of TalkingNets for
$726 in cash (the "TalkingNets Asset Purchase Agreement"). As TalkingNets filed
a voluntary petition for Chapter 11 reorganization in February 2003, the
TalkingNets Asset Purchase Agreement was subject to the approval of the U.S.
Bankruptcy Court for the Eastern District of Virginia. On April 9, 2003, the
TalkingNets Asset Purchase Agreement and the transactions contemplated thereby
were approved by the Bankruptcy Court. If all closing conditions are satisfied,
we expect that this transaction will be completed during the second or third
quarter of 2003. On April 11, 2003, we paid the full purchase price of $726 into
escrow. In accordance with the terms of the TalkingNets Asset Purchase
Agreement, we will have a transition period of up to 150 days to integrate
TalkingNets' operations into our own operations and obtain all requisite
approvals prior to final closing of the transaction. During the transition
period, we will be entitled to the revenue from the acquired customers and be
obligated to pay for certain of the related operating costs of TalkingNets'
operations.
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, 2002,
we incurred operating losses of approximately $35,821 and negative operating
cash flows of approximately $17,706 during the year ended December 31, 2002.
During the three months ended March 31, 2003, we incurred operating losses of
approximately $8,633 and negative operating cash flows of approximately $3,949.
These operating losses and negative operating cash flows have been financed
primarily by proceeds from equity issuances. We had accumulated deficits of
approximately $284,491 at December 31, 2002 and $293,734 at March 31, 2003.
We expect our operating losses, net operating cash outflows and capital
expenditures to continue through 2003. We successfully completed rounds of
private equity and bridge loan financings totaling approximately $35,000 as
follows: approximately $20,000 in the fourth quarter of 2001, $10,000 in March
2002, and $8,531 in May 2002 (which, after cancellation of the bridge loans,
yielded net proceeds of approximately $5,000). Our independent accountants have
noted in their report that our sustained operating losses raise substantial
doubt about our ability to continue as a going concern. We believe that our
existing cash and cash equivalents, cash expected to be generated from
operations, and funds available under our bank credit agreement, will be
sufficient to fund our operating losses, capital expenditures, lease payments
and working capital requirements through the end of the second quarter of 2003,
based on our current business plans and projections. We intend to use these cash
resources to finance our capital expenditures and for our working capital and
other general corporate purposes. We may also use a portion of these cash
resources to acquire complementary businesses, subscriber lines and other
assets, including our proposed acquisition of network assets and associated
subscriber lines from TalkingNets. The amounts actually expended for these
purposes will vary significantly depending on a number of factors, including
market acceptance of our services, revenue growth, planned capital expenditures,
cash generated from operations, improvements in operating productivity, the
extent and timing of entry into new markets, and availability and prices paid
for acquisitions.
Additional financing will be required by the end of the second quarter of
2003. We do not believe that our operations will generate sufficient cash to
finance our 2003 operating requirements. As a result, we will need to raise
additional financing through some combination of borrowings (including
borrowings under our bank credit facility), leasing, vendor financing and the
sale of equity or debt securities. These capital requirements may vary based
upon the timing and the success of implementation of our business plan or if:
o demand for our services or our cash flow from operations is less than
or more than expected;
o plans or projections change or prove to be inaccurate;
o we make acquisitions;
19
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------
o we alter the schedule or targets of our business plan implementation;
or
o we curtail, reorganize, discontinue or shut down our operations.
There can be no assurance that we will be able to raise sufficient additional
debt, equity or other capital on acceptable terms, if at all. If we are unable
to obtain adequate funds, we may not be able to continue to operate our network,
respond to competitive pressures or fund our operations. As a result, we may be
required to significantly reduce, reorganize, discontinue or shut down our
operations. Our financial statements do not include any adjustments that might
result from this uncertainty.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
Financial Reporting Release No. 60, which was released in December 2001 by
the Securities and Exchange Commission (the "SEC"), 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, 2002, which has been filed with the SEC, 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 generally accepted accounting principles. The
preparation of financial statements in accordance with generally accepted
accounting principles 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:
20
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------
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 varies 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. 144, "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 and last quarters of 2002 and will be performed
annually hereafter (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 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 reviews during 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
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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
generally 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.
With the acquisition of the NAS assets on January 10, 2003, we acquired a
number of subscribers, some of whom we service indirectly through various
Internet service providers ("ISP's"). We sell our services to such ISP's who
then resell such services to the end user subscriber. We expect to have some
increased exposure and concentration of credit risk pertaining to such ISP's
during 2003, however, no individual customer accounted for more than 5% of first
quarter 2003 revenue.
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
analyses 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.
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RESULTS OF OPERATIONS
REVENUE. Revenue is recognized pursuant to the terms of each contract on a
monthly service fee basis, which varies based on the speed of the customer's
connection and the services ordered by the customer. The monthly fee includes
all 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 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.
Revenue for the three months ended March 31, 2003 increased by 47% to
approximately $16,765, from approximately $11,381 for the three months ended
March 31, 2002. The increase in revenue in the first quarter of 2003 was
primarily due to an increase in subscriber lines resulting from our acquisition
of the NAS assets. The actual revenue contributed from acquired customer lines
was approximately $382 and $5,116 for the three months ended March 31, 2002 and
2003, respectively. We expect revenue to continue to increase in 2003 as
compared to 2002 as a result of our acquisition of the NAS assets and associated
subscriber lines, and as we continue our sales and marketing efforts in our
expanded service areas, introduce additional services and, possibly, acquire
additional businesses and/or subscriber lines.
NETWORK EXPENSES. Our network 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. We lease high-speed lines and other
network capacity to connect our central office equipment and our network. 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 March 31, 2003 increased
approximately 40%, to approximately $12,238, compared to approximately $8,712
for the three months ended March 31, 2002. This increase of approximately $3,526
was primarily attributable to increased telecommunications expenses of
approximately $3,429 and increased network engineering and field operations
personnel expenses of approximately $308 resulting from our acquisition of the
NAS assets, which was partially offset by net decreases in miscellaneous other
expenses of $211. We expect our network expenses, including costs for subscriber
lines, to increase in 2003 as compared to 2002 as a result of our acquisition of
the NAS assets and associated subscriber lines, and as we add customers.
OPERATIONS EXPENSES. Our 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 March 31, 2003 were
approximately $2,756, compared to operations expenses for the three months ended
March 31, 2002 of approximately $1,991. This 38% increase of approximately $765
was primarily due to increases in operations personnel expenses of approximately
$595, equipment maintenance and small tool expense of
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------------------------------------------------
approximately $78, licensing fees of approximately $55 and other outside
services of approximately $113, partially offset by decreases in other
miscellaneous expenses of approximately $76.
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 $3,056 for the
three months ended March 31, 2003, compared to general and administrative
expenses for the three months ended March 31, 2002 of approximately $3,402. This
10% reduction of approximately $346 was primarily due to decreases in executive
bonus expense of approximately $265, decreases in insurance expense of
approximately $154, decreases in bad debt related expenses of approximately
$134, decreases in property and corporate related taxes of approximately $115
and decreases in office facilities expense of approximately $45. Partially
offsetting these decreases were increases in professional and consulting
services of approximately $319 ($120 of which related to the acquired NAS
operations) and $48 in other miscellaneous expenses.
SALES AND MARKETING. Our sales and marketing expenses consist primarily of
expenses for 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 March 31, 2003
were approximately $2,233, compared to sales and marketing expenses for the
three months ended March 31, 2002 of approximately $1,197, representing an 87%
increase of approximately $1,036. The increase in sales and marketing expenses
was primarily attributable to increased salaries, benefits and commissions
approximating $672 (of which approximately $315 resulted from the NAS
acquisition), increased advertising and direct mail marketing of approximately
$320, and increased miscellaneous expenses of approximately $44. We expect our
sales and marketing expenses to increase in future periods, as compared to 2002,
primarily as a result of the NAS acquisition.
STOCK COMPENSATION. We incurred non-cash stock compensation expenses as a
result of the granting of stock and stock options to employees, directors and
members of our former board of advisors 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 is 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 $278 and $347 for
the three months ended March 31, 2003 and 2002, 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, 2002 and March 31, 2003 of approximately $437 and $159,
respectively, are being amortized over the remaining vesting period of each
grant and are expected to be fully amortized by June 30, 2003.
As of December 31, 2002 and March 31, 2003, options to purchase 23,877,004
and 24,176,361 shares of common stock, respectively, were outstanding, which
were exercisable at weighted average exercise prices of $0.98 and $0.96 per
share, respectively.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization is primarily
attributable to the following: (i) depreciation of network and operations
equipment and Company-owned modems
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------------------------------------------------
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. Although
depreciation and amortization expense decreased in the first quarter of 2003 as
compared to the first quarter of 2002, we expect that our depreciation and
amortization expenses may increase in 2003 as compared to 2002, as a result of
our acquisition of the NAS network assets and associated subscriber lines.
Depreciation and amortization expenses were approximately $4,837 for the
three months ended March 31, 2003, compared to depreciation and amortization
expenses of approximately $5,114 for the three months ended March 31, 2002. The
decrease in depreciation and amortization expenses of approximately $277 is
primarily attributable to certain intangible and fixed assets becoming fully
depreciated during 2002, resulting in a net decline in depreciation and
amortization expense of approximately $1,070 which was partially offset by
increased depreciation and amortization expenses relating to the acquisition of
NAS assets and associated subscriber lines of approximately $793.
Depreciation expenses pertaining to assets related to network expenses and
operations expenses were approximately $3,328 and $3,416 for the three months
ended March 31, 2003 and 2002, respectively. Depreciation and amortization
expenses pertaining to assets related to general and administrative expenses
were approximately $1,509 and $1,698 for the three months ended March 31, 2003
and 2002, respectively.
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 impairment review during the first
and last quarters of 2002. We did not record any impairment adjustments
resulting from these impairment reviews and will continue to make annual
reviews, unless a change in circumstances requires a review in the interim.
INTEREST EXPENSE (INCOME) NET. Net interest expense of approximately $564
for the three months ended March 31, 2003 included approximately $589 of
interest expense which was partially offset by approximately $25 in interest
income. Net interest expense of approximately $245 for the three months ended
March 31, 2002 included approximately $332 of interest expense which was
partially offset by approximately $87 of interest income. The increase in net
interest expense of approximately $319 was primarily attributed to the
amortization of deferred non-cash financing costs of approximately $315 which
related to the warrants issued in consideration for loan guarantees under our
Reimbursement Agreement (discussed below), increased interest expense of
approximately $140 pertaining to the note payable to NAS and borrowings under
the Credit Agreement (discussed below) and decreased interest income of
approximately $61 due to lower cash balances. These net increases were partially
offset by lower interest expense in the first quarter of 2003 as compared to the
first quarter of 2002, of approximately $106 pertaining to promissory notes
cancelled in May 2002 (discussed below) and approximately $91 resulting from
lower capital lease obligations.
NET LOSS. Net loss was approximately $9,243 for the three months ended
March 31, 2003, compared to net loss for the three months ended March 31, 2002
of approximately $9,455.
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 March 31, 2003, we
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------------------------------------------------
had cash and cash equivalents of approximately $4,478 and negative working
capital of approximately $6,220.
Net cash provided by financing activities for the three months ended March
31, 2003 was approximately $5,407. This cash primarily resulted from borrowings
from our bank credit facility. Net cash provided by financing activities for the
three months ended March 31, 2002 of approximately $9,207 resulted from the sale
of our preferred stock. 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 or assets,
including the proposed acquisition of network assets and associated subscriber
lines from TalkingNets discussed above.
In March 1999, we entered into a 36-month lease facility to finance the
purchase of up to an aggregate of $2,000 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 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 $4,565 and approximately $3,869, outstanding under
capital leases at December 31, 2002 and March 31, 2003, respectively.
In November and December of 2001 and March of 2002, we received proceeds
of $6,000, $4,000 and $10,000, respectively, from the sale of 6,000, 4,000 and
10,000 shares, respectively, of Series X Preferred Stock, before direct issuance
costs of approximately $189.
In December 2001, in conjunction with our sale of shares of mandatorily
redeemable convertible Series Y Preferred Stock (the "Series Y Preferred
Stock"), we issued short-term promissory notes (the "Promissory Notes") for
proceeds of $3,531 to the Series Y Preferred Stockholders. The Promissory Notes
provided for an annual interest rate of 12%. On March 1, 2002, we sold 10,000
shares of Series X Preferred Stock for an aggregate of $10,000 pursuant to the
Series X Purchase Agreement. In May 2002, in accordance with the terms of the
Series Y Purchase Agreement, we sold an additional 8,531 shares of Series Y
Preferred Stock for $5,000 in cash and delivery of the Promissory Notes for
cancellation. All accrued interest on the Promissory Notes, of approximately
$145, was forgiven.
We entered into a Revolving Credit and Term Loan Agreement, dated as of
December 13, 2002 (the "Credit Agreement"), with a commercial bank providing for
a revolving line of credit of up to $15,000 (the "Commitment"). Borrowings under
the Credit Agreement may be made in minimum increments of $500 from time to time
up to the Commitment and repayments may be made in minimum increments of $100,
in each case until the revolving credit maturity date of December 12, 2004, at
which time all amounts outstanding will convert into a term loan payable in 12
quarterly installments commencing on December 31, 2004 (the "Term Loan"). We may
pre-pay amounts due under the Term Loan in increments of $1,000 without penalty.
Interest is payable on all amounts outstanding under the Credit Agreement in
arrears at the end of each calendar quarter at a variable interest rate equal to
the higher of the bank's prime rate equivalent or 0.5% percent above the Federal
Funds Effective Rate. As of March 31, 2003, amounts outstanding under this
Credit Agreement bore interest at an annual rate of 4.25%. The amount not drawn
upon under the Commitment (subject to certain adjustments) is subject to a
commitment fee, payable in arrears at the end of each calendar quarter, equal to
an annualized rate of 0.25%. The Credit Agreement also
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requires us and our subsidiaries, except for Vector Internet Services, Inc., to
maintain all of our bank deposit and investment accounts with the bank. Our
ability to borrow amounts available under the Credit Agreement is subject to the
bank's receipt of a like amount of guarantees from certain of our investors
and/or other guarantors acceptable to the bank and to certain other conditions
set forth in the Credit Agreement. As of March 31, 2003, our investors had
provided guarantees of $9,100 under the Credit Agreement. On February 3, 2003,
we borrowed $6,100 under the Credit Agreement. As of March 31, 2003, our
outstanding balance was $6,100.
We entered into a Reimbursement Agreement, dated as of December 27, 2002,
with several private investment funds affiliated with VantagePoint Venture
Partners ("VantagePoint"), Columbia Capital Equity Partners ("Columbia"), The
Lafayette Investment Fund, L.P. and Charles River Partnership, L.P.
(collectively the "Guarantors") and VantagePoint Venture Partners III (Q), L.P.,
as administrative agent (the "Agent"). The Guarantors are all holders of or
affiliates of holders of our Series X and Series Y Preferred stock. Pursuant to
the terms of the Reimbursement Agreement, on December 27, 2002, VantagePoint and
Columbia issued guarantees in an aggregate amount of $6,100 to support certain
of our obligations under the Credit Agreement. The Reimbursement Agreement
obligates the Company to reimburse the Guarantors for any payments they may be
required to make in accordance with their guarantees. Our obligations under the
Reimbursement Agreement are also guaranteed by certain of our wholly-owned
subsidiaries and collateralized by a Security Agreement signed by us and certain
of our wholly-owned subsidiaries which pledges a significant portion of our
consolidated assets as collateral. The Reimbursement Agreement also obligates
us, when our unrestricted cash balance equals or exceeds $11,000 to either, at
the Agent's request, (i) repay outstanding loans under the Credit Agreement in
minimum increments of $1,000 (provided that if there is less than $1,000 of
outstanding loans due under the Credit Agreement, then we shall pay such lesser
amount) to the extent that we retain unrestricted cash balances in an amount
greater than or equal to $10,000 after giving effect to such payment or (ii)
cause each Guarantor's guarantee requirement under the Credit Agreement to be
eliminated ratably in an aggregate amount equal to the outstanding loans that
would otherwise be required to be repaid pursuant to (i) above.
Pursuant to the terms of the Reimbursement Agreement, on December 27,
2002, we issued warrants to purchase 12,013,893 shares of our common stock to
VantagePoint and Columbia, in consideration for their guarantees aggregating
$6,100. All such warrants have a ten year life and an exercise price of $0.50
per share. On March 26, 2003, we, issued additional warrants, exercisable for
ten years, to purchase a total of 936,107 shares of our common stock at $0.50
per share, to VantagePoint and Columbia, bringing the total number of warrants
issued in connection with the Reimbursement Agreement to 12,950,000. Pursuant to
the terms of the Reimbursement Agreement, in the event that we did not borrow
any loans under the Credit Agreement on or before March 31, 2003, then the
Credit Agreement and all Guarantees issued under the Reimbursement Agreement
would have terminated and any warrants issued to Guarantors in connection with
the transactions contemplated would have been terminated. Since we initiated a
loan under the Credit Agreement on February 3, 2003, the Guarantors' guarantees
of the subject loan became effective on February 3, 2003 and the contingency
related to the validation of the warrants was eliminated.
On February 3, 2003, we valued the 12,950,000 warrants at $0.514 each with
a total value of $6,656. The valuation was performed using a Black Scholes
valuation model with the following assumptions: (i) a risk free interest rate of
4.01% (ten-year Treasury rate), (ii) a zero dividend yield, (iii) a ten year
expected life, (iv) an expected volatility of 153%, (v) an option exercise price
of $0.50 and (vi) a current market price of $0.52 (the closing price of our
common stock on February 3, 2003). Since the warrants were issued in
consideration for loan guarantees, which enabled us to secure financing at below
market interest rates, we recorded their value as a deferred financing cost
(guarantee fee) which will be amortized to interest expense over the term of the
loan (approximately 57 months) using the "Interest Method" of amortization. For
the three months ended March 31, 2003, amortized interest expense relating to
deferred financing costs approximated $315. Our
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remaining unamortized deferred financing cost balance was approximately $6,341
as of March 31, 2003.
On March 3, 2003, we and certain of our Guarantors entered into Amendment
No. 1 to the Reimbursement Agreement, pursuant to which VantagePoint increased
its guarantee by $3,000, bringing the aggregate guarantees by all Guarantors
under the Reimbursement Agreement, as amended, to $9,100. As consideration for
VantagePoint's increased guarantee, if we close an equity financing on or before
December 3, 2003, we are authorized to issue VantagePoint additional warrants to
purchase the type of equity securities issued by us in such equity financing.
The number of such additional warrants would be determined by dividing $1,000 by
the per share price of such equity securities.
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 $1,800 in 2003, $2,000 in 2004, $766
in 2005, $233 in 2006, $169 in 2007 and $28 in 2008. We also have long-term
purchase commitments with MCI (formerly known as WorldCom), AT&T, Sprint and
other vendors for data transport and other services with minimum payments due
even if our usage does not reach the minimum amounts. Minimum payments under our
long-term purchase commitments are approximately $3,668 in 2003, $2,396 in 2004
and $57 in 2005.
We transmit data across our network via transmission facilities that are
leased from certain carriers, including AT&T and MCI (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. MCI has
filed a voluntary petition to reorganize under Chapter 11 of the U.S. Bankruptcy
Code. While MCI has continued with its current operations since filing its
voluntary petition to reorganize in June of 2001, and 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 MCI to alternative suppliers in
thirty to sixty days, should MCI announce discontinuance of such services.
However, were MCI 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 MCI 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 us.
In February 2002, we were successful in terminating our obligations under
the lease for office space in Milford, Connecticut.
For the three months ended March 31, 2003, the net cash used in our
operating activities was approximately $3,949. 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 three months ended March 31,
2003 was approximately $8,298. Of this amount, approximately $7,917 was used for
the acquisition of NAS assets and associated subscriber lines and approximately
$378 was used for the purchase of equipment.
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The development and expansion of our business has required significant
capital expenditures. Capital expenditures, including collocation fees but
excluding acquisitions, were approximately $378 and $605 for the three months
ended March 31, 2003 and 2002, respectively, and customer assets and line
acquisitions were approximately $7,917 and $650 for the three months ended March
31, 2003 and 2002, 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 2003 are currently expected to be primarily for operational
support systems. We currently anticipate spending approximately $1,200 to $1,500
for capital expenditures, excluding acquisitions, during the year ending
December 31, 2003. The actual amounts and timing of our capital expenditures
could differ materially both in amount and timing from our current plans.
Our independent accountants have noted in their report that our sustained
operating losses raise substantial doubt about our ability to continue as a
going concern. We believe that our existing cash and cash equivalents, cash
expected to be generated from operations and funds available under the Credit
Agreement, will be sufficient to fund our operating losses, capital
expenditures, lease payments and working capital requirements through the end of
the second quarter of 2003. 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, subscriber lines or other assets, including our
proposed acquisition of network assets and associated subscriber lines from
TalkingNets discussed above. The amounts actually expended for these purposes
will vary significantly depending on a number of factors, including market
acceptance of our services, revenue growth, planned capital expenditures, cash
generated from operations, improvements in operating productivity, the extent
and timing of entry into new markets and availability and prices paid for
acquisitions.
Additional financing will be required by the end of the second quarter of
2003. We do not believe that our operations will generate sufficient cash to
finance our 2003 requirements. As a result, we will need to raise additional
financing through some combination of borrowings, leasing, vendor financing and
the sale of equity or debt securities. These capital requirements may vary based
upon the timing and the success of implementation of our business plan or if:
o demand for our services or our cash flow from operations is less than
or more than expected;
o our plans or projections change or prove to be inaccurate;
o we make acquisitions;
o we alter the schedule or targets of our business plan implementation;
or
o we curtail, reorganize, discontinue or shut down our operations.
There can be no assurance that we will be able to raise sufficient
additional debt, equity or other capital on acceptable terms, if at all. If we
are unable to obtain adequate funds, we may not be able to continue to operate
our network, respond to competitive pressures or fund our operations. As a
result, we may be required to significantly reduce, reorganize, discontinue or
shut down our operations. Our financial statements do not include any
adjustments that might result from this uncertainty.
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
29
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------
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 per share 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. On October 16, 2002, Nasdaq notified us that, while we had not regained
compliance by October 15, 2002 with the $1.00 bid price per share requirement
generally required for continued listing on the Nasdaq SmallCap Market, we did
continue to meet the initial listing requirements for the Nasdaq SmallCap Market
under Rule 4310(c)(2)(A). As a result, we had an additional 180 calendar days,
or until April 14, 2003, to comply with the minimum bid price of $1.00 per share
for 10 consecutive trading days, or such greater number of trading days as
Nasdaq may determine, in order to remain listed on the Nasdaq SmallCap Market.
On March 11, 2003, Nasdaq amended its rules to provide that a company that
satisfies the initial listing requirements for the Nasdaq SmallCap Market under
Rule 4310(c)(2)(A) would have an additional 90 days (over the 180 days already
contemplated by the Nasdaq SmallCap Market rules) to comply with the minimum bid
price of $1.00 per share. On April 15, 2003, Nasdaq notified us that, while we
had not regained compliance by April 14, 2003 with the $1.00 bid price per share
requirement generally required for continued listing on the Nasdaq SmallCap
Market, we did continue to meet the initial listing requirements for the Nasdaq
SmallCap Market under Rule 4310(c)(2)(A). As a result, we had an additional 90
calendar days, or until July 14, 2003, to comply with the minimum bid price of
$1.00 per share for 10 consecutive trading days, or such greater number of
trading days as Nasdaq may determine, in order to remain listed on the Nasdaq
SmallCap Market. If we cannot comply with the minimum bid price requirements by
July 14, 2003, Nasdaq will provide us notice that our common stock will be
de-listed from the Nasdaq SmallCap Market. We would then have the opportunity to
appeal such determination to a Listings Qualifications Panel. There can be no
assurance that we will be able to comply with the minimum bid price requirement
by July 14, 2003, if at all, or that we will continue to satisfy the other
listing requirements of the Nasdaq SmallCap Market.
Nasdaq has submitted proposed rules changes to the SEC which would, among
other things, further extend the number of days during which a company that
satisfies the initial listing requirements of the Nasdaq SmallCap Market may
continue to be listed on such market without complying with the $1.00 minimum
bid price requirement. There can be no assurance that the SEC will approve this
proposed rule change, if at all, in time to delay the possible delisting of our
common stock from the Nasdaq SmallCap Market. In addition, there can be no
assurance that we will continue to satisfy the initial listing requirements of
the Nasdaq SmallCap 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 $8,482 of goodwill associated with
acquired businesses.
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
30
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------------------------------------
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, SFAS No. 146, "ACCOUNTING FOR EXIT OR DISPOSAL ACTIVITIES"
was issued. SFAS 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.
In December 2002, SFAS No. 148 "ACCOUNTING FOR STOCK-BASED COMPENSATION -
TRANSITION AND DISCLOSURE - AN AMENDMENT OF SFAS NO. 123" was issued. SFAS No.
148 amends SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION", to provide
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We have adopted these amended
disclosure requirements in Note 11 to our financial statements included in this
Form 10-Q under the heading "Incentive Stock Award Plans".
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES, INCLUDING INDIRECT
GUARANTEES OF INDEBTEDNESS OF OTHERS," ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees.
FIN 45 requires an entity to recognize an initial liability for the fair value
of an obligation assumed by issuing a guarantee. The disclosure requirements of
FIN 45 are effective for all financial statements issued after December 15,
2002. The provision for initial recognition and measurement of the liability
will be applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN 45 is not expected to have a material
adverse impact on our financial position, results of operations or cash flows.
31
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,
among other things, those described under "Risk Factors" in our Annual Report on
Form 10-K for the year ended December 31, 2002, which has been filed with the
SEC, and (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) our need for additional funds by
the end of the second quarter of 2003, which may not be available on acceptable
terms or at all, which could adversely impact our ability to implement our
business plan and continue as a going concern, and which has resulted in our
independent accountants including a "going concern" discussion in their report
on our 2002 financial statements; (v) failure to generate sufficient revenue,
contain certain discretionary spending, obtain any additional required debt or
equity financing or achieve certain other business plan objectives could have a
material adverse affect on our results of operations and financial position, or
cause us to pursue strategic alternatives or to dispose of or discontinue some,
a significant portion or all of our operations; (vi) risks associated with the
possible removal of our common stock from the Nasdaq SmallCap Market, which
removal could adversely impact the pricing and trading of our common stock;
(vii) 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;
(viii) risks associated with the completion of the acquisition of assets and
subscriber lines from TalkingNets, (ix) risks associated with our ability to
draw amounts under our bank credit facility; (x) regulatory, legislative, and
judicial developments, which could adversely affect the way we operate our
business, (xi) risks associated with our reliance on certain carriers, including
MCI, to transmit data across our network; (xii) 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; (xiii) our dependence on wholesale providers to provide us with
local broadband facilities in areas where we have not deployed our own
equipment; (xiv) the need for us to achieve sustained market acceptance of our
services at desired pricing levels; (xv) competition; (xvi) our limited
operating history, which makes it difficult to evaluate our business and
prospects; (xvii) the difficulty of predicting the new and rapidly evolving
high-speed data communications industry; (xviii) our ability to negotiate, enter
into and renew interconnection and collocation agreements with traditional
telephone companies; and (xix) our ability to recruit and retain qualified
personnel, establish the necessary infrastructure to support our business, and
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.
32
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.
ITEM 4. CONTROLS AND PROCEDURES
a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the disclosure controls and procedures (as defined in the
Securities Exchange Act of 1934, as amended (the "Exchange Act") Rules 13a-14(c)
and 15d-14(c)) as of a date within 90 days before the filing date of this
quarterly report. Based on this evaluation, the principal executive officer and
principal financial officer concluded that our disclosure controls and
procedures effectively ensure that material information required to be disclosed
in our filings and submissions under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.
b) CHANGES IN INTERNAL CONTROLS
There have been no significant changes in our internal controls or, to our
knowledge, in other factors that could significantly affect these controls
subsequent to the date of evaluation of our disclosure controls and procedures
referred to above.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (dollars in thousands, except
per share amounts)
We entered into a Reimbursement Agreement, dated as of December 27, 2002,
with several private investment funds affiliated with VantagePoint Venture
Partners ("VantagePoint"), Columbia Capital Equity Partners ("Columbia"), The
Lafayette Investment Fund, L.P. and Charles River Partnership, L.P.
(collectively the "Guarantors") and VantagePoint Venture Partners III (Q), L.P.,
as administrative agent. The Guarantors are all holders or affiliates of the
holders of our Series X and Series Y Preferred stock. Pursuant to the terms of
the Reimbursement Agreement, VantagePoint and Columbia issued guarantees in an
aggregate amount up to $6,100 to support certain of our obligations under a
Credit Agreement we entered into in 2002 with a commercial bank. Pursuant to the
terms of the Reimbursement Agreement, on December 27, 2002, we issued warrants
to purchase 10,379,420 shares of our common stock to VantagePoint and 1,634,473
shares of our common stock to Columbia, in consideration for their guarantees
aggregating $6,100. On March 26, 2003, we issued additional warrants to purchase
767,301 shares of our common stock to VantagePoint and 168,806 shares of our
common stock to Columbia as further consideration for such guarantees. All such
warrants are exercisable for ten years at an exercise price of $0.50 per share.
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.
33
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 7, 2003, the holders of our Series X Preferred Stock acted by
unanimous written consent in lieu of a special meeting to elect Michael L.
Yagemann, an affiliate of VantagePoint, as a Class III director of the Company
to serve until the annual meeting of stockholders to be held in 2003 or until
his successor has been duly elected and qualified or until his earlier death,
resignation or removal. Messrs. David F. Struwas, Robert G. Gilbertson, Robert
B. Hartnett, Jr., Harry F. Hopper, Paul J. Keeler, William J. Marshall and James
D. Marver each continued their respective terms of office as members of our
Board of Directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
- --------------------------------------------------------------------------------
Exhibit No. Exhibit
- --------------------------------------------------------------------------------
2.01 Amended and Restated Asset Purchase Agreement, dated as of
December 11, 2002, By and among DSL.net, Inc., Network
Access Solutions Corporation, Network Access Solutions LLC,
NASOP, Inc. and Adelman Lavine Gold and Levin, A
Professional Corporation, as deposit escrow agent
(incorporated by reference to Exhibit 2.1 filed with our
Form 8-K dated as of January 10, 2003).
- --------------------------------------------------------------------------------
4.01 Form of Stock Purchase Warrant dated as of March 26, 2003
between DSL.net, Inc. and certain guarantors (incorporated
by reference to Exhibit 4.07 filed with our Annual on Form
10-K for the year ended December 31, 2002).
- --------------------------------------------------------------------------------
10.01 Amendment No. 1 to Reimbursement Agreement dated March 5,
2003 by and among DSL.net, Inc., the Guarantors party
thereto and VantagePoint Venture Partners III (Q), L.P., as
administrative Agent (incorporated by reference to Exhibit
10.28 filed with our Annual on Form 10-K for the year ended
December 31, 2002).
- --------------------------------------------------------------------------------
10.02 First Amendment to Guaranty dated March 5, 2003 by and
between VantagePoint Venture Partners III (Q), L.P. and
Fleet National Bank (incorporated by reference to Exhibit
10.29 filed with our Annual on Form 10-K for the year ended
December 31, 2002).
- --------------------------------------------------------------------------------
10.03 Letter Agreement dated March 5, 2003 by and between DSL.net,
Inc. and VantagePoint Venture Partners III (Q), L.P.
(incorporated by reference to Exhibit 10.30 filed with our
Annual on Form 10-K for the year ended December 31, 2002).
- --------------------------------------------------------------------------------
11.01* Statements of Computation of Basic and Diluted Net Loss Per
Share.
- --------------------------------------------------------------------------------
*Filed herewith
34
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on January 24, 2003,
reporting on Items 2 and 7, relating to the acquisition of network assets and
associated subscriber lines pursuant to the Amended and Restated Asset Purchase
Agreement dated as of December 11, 2002 by and among the Company and Network
Access Solutions Corporation, Network Access Solutions LLC, NASOP, Inc. and
Adelman Lavine Gold and Levin, a professional corporation, as deposit escrow
agent.
The Company filed a Current Report Amendment on Form 8-K/A on March 25,
2003, reporting on Items 2 and 7, relating to the acquisition of network assets
and associated subscriber lines pursuant to the Amended and Restated Asset
Purchase Agreement dated as of December 11, 2002 by and among the Company and
Network Access Solutions Corporation, Network Access Solutions LLC, NASOP, Inc.
and Adelman Lavine Gold and Levin, a professional corporation, as deposit escrow
agent.
The Company filed a Current Report on Form 8-K on March 31, 2003,
reporting on Item 9, relating to the certifications of its Chief Executive
Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, in connection
with the Company's annual report on Form 10-K for the year ended December 31,
2002. The certifications were submitted to the Securities and Exchange
Commission on March 31, 2003.
35
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: May 14, 2003
36
CERTIFICATIONS
I, David F. Struwas, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DSL.net, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
By: /s/ David F. Struwas
-----------------------------------
Chairman of the Board and
Chief Executive Officer
37
I, Robert J. DeSantis, certify that:
1. I have reviewed this quarterly report on Form 10-Q of DSL.net, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
By: /s/ Robert J. DeSantis
-----------------------------------
Chief Financial Officer
38
EXHIBIT INDEX
- --------------------------------------------------------------------------------
Exhibit No. Exhibit
- --------------------------------------------------------------------------------
2.01 Amended and Restated Asset Purchase Agreement, dated as of
December 11, 2002, By and among DSL.net, Inc., Network
Access Solutions Corporation, Network Access Solutions LLC,
NASOP, Inc. and Adelman Lavine Gold and Levin, A
Professional Corporation, as deposit escrow agent
(incorporated by reference to Exhibit 2.1 filed with our
Form 8-K dated as of January 10, 2003).
- --------------------------------------------------------------------------------
4.01 Form of Stock Purchase Warrant dated as of March 26, 2003
between DSL.net, Inc. and certain guarantors (incorporated
by reference to Exhibit 4.07 filed with our Annual on Form
10-K for the year ended December 31, 2002).
- --------------------------------------------------------------------------------
10.01 Amendment No. 1 to Reimbursement Agreement dated March 5,
2003 by and among DSL.net, Inc., the Guarantors party
thereto and VantagePoint Venture Partners III (Q), L.P., as
administrative Agent (incorporated by reference to Exhibit
10.28 filed with our Annual on Form 10-K for the year ended
December 31, 2002).
- --------------------------------------------------------------------------------
10.02 First Amendment to Guaranty dated March 5, 2003 by and
between VantagePoint Venture Partners III (Q), L.P. and
Fleet National Bank (incorporated by reference to Exhibit
10.29 filed with our Annual on Form 10-K for the year ended
December 31, 2002).
- --------------------------------------------------------------------------------
10.03 Letter Agreement dated March 5, 2003 by and between DSL.net,
Inc. and VantagePoint Venture Partners III (Q), L.P.
(incorporated by reference to Exhibit 10.30 filed with our
Annual on Form 10-K for the year ended December 31, 2002).
- --------------------------------------------------------------------------------
11.01* Statements of Computation of Basic and Diluted Net Loss Per
Share.
- --------------------------------------------------------------------------------
*Filed herewith
39