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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ____________ to ____________
COMMISSION FILE NUMBER: 0-29255
FASTNET CORPORATION
-------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-2767197
------------ ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3864 COURTNEY STREET
TWO COURTNEY PLACE, SUITE 130
BETHLEHEM, PA 18017
------------- -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(610) 266-6700
--------------
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
---
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes |X| No | |
The number of shares of the registrant's Common stock outstanding as of
November 14, 2001 was 20,390,947.
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FASTNET CORPORATION
FORM 10-Q
SEPTEMBER 30, 2001
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets - September 30, 2001 and
December 31, 2000 ....................................................3
Consolidated Statements of Operations - Three and Nine Months Ended
September 30, 2001 and 2000 ..........................................4
Consolidated Statements of Cash Flows - Nine months Ended
September 30, 2001 and 2000 .........................................5
Notes to Unaudited Consolidated Financial Statements .................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ...............................................13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..........18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................................19
Item 2. Changes in Securities and Use of Proceeds ...........................19
Item 3. Defaults Upon Senior Securities .....................................19
Item 4. Submission of Matters to a Vote of Security Holders .................19
Item 5. Other Information ...................................................20
Item 6. Exhibits and Reports on Form 8-K ....................................26
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2001 2000
--------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................................... $ 6,487,815 $ 5,051,901
Marketable securities.............................................................. 4,892,467 18,455,543
Accounts receivable, net of allowance of $834,988 and $776,977..................... 2,544,901 2,570,154
Other current assets............................................................... 595,075 521,781
--------------- --------------
Total current assets.................................................. 14,520,258 26,599,379
PROPERTY AND EQUIPMENT, net............................................................. 17,693,875 19,631,011
INTANGIBLES, net........................................................................ 2,213,069 2,350,274
OTHER ASSETS............................................................................ 607,269 396,710
--------------- --------------
$ 35,034,471 $ 48,977,374
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt.................................................. $ 11,369 $ 17,541
Current portion of capital lease obligations....................................... 2,614,489 4,681,781
Accounts payable................................................................... 2,923,040 2,576,087
Accrued expenses................................................................... 2,155,854 3,804,893
Deferred revenues.................................................................. 3,417,955 3,113,321
Accrued restructuring.............................................................. 1,135,585 4,045,643
-------------- --------------
Total current liabilities............................................. 12,258,292 18,239,266
--------------- --------------
LONG-TERM DEBT.......................................................................... 23,899 29,746
CAPITAL LEASE OBLIGATIONS............................................................... 3,979,002 7,105,678
OTHER LIABILITIES....................................................................... 114,645 78,107
SHAREHOLDERS' EQUITY:
Series A Convertible Preferred stock (5,494,505 shares authorized, 2,506,421 and zero
shares outstanding at September 30, 2001 and December 31, 2000)................ 751,986 --
Common stock (50,000,000 shares authorized, 23,778,557 and 21,778,557 shares issued
and 17,990,947 and 15,990,947 shares outstanding at September 30, 2001
and December 31, 2000, respectively)............................................ 67,778,511 64,414,205
Deferred compensation.............................................................. (390,582) (797,354)
Note receivable.................................................................... (437,500) (437,500)
Accumulated other comprehensive income............................................. 15,145 17,763
Accumulated deficit................................................................ (48,058,927) (38,672,537)
Less - Treasury stock, at cost..................................................... (1,000,000) (1,000,000)
--------------- --------------
Total shareholders' equity............................................ 18,658,633 23,524,577
--------------- --------------
$ 35,034,471 $ 48,977,374
============== ==============
The accompanying notes are an integral part of these
consolidated statements.
3
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
REVENUES ............................................... $ 3,629,943 $ 3,225,325 $ 11,333,543 $ 9,424,451
OPERATING EXPENSES:
Cost of revenues .................................... 2,063,758 3,860,150 8,144,164 9,502,160
Selling, general and administrative ................. 2,503,062 6,214,916 8,251,830 14,944,414
Depreciation and amortization ....................... 2,109,175 1,389,469 5,828,767 3,504,710
------------- ------------- ------------- -------------
6,675,995 11,464,535 22,224,761 27,951,284
------------- ------------- ------------- -------------
Operating loss ...................................... (3,046,052) (8,239,210) (10,891,218) (18,526,833)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest income ..................................... 98,135 632,556 576,759 1,647,308
Interest expense .................................... (105,741) (270,593) (605,403) (793,708)
Other ............................................... (3,217) (7,290) (7,043) (12,040)
------------- ------------- ------------- -------------
(10,823) 354,673 (35,687) 841,560
------------- ------------- ------------- -------------
LOSS BEFORE EXTRAORDINARY ITEM ......................... (3,056,875) (7,884,537) (10,926,905) (17,685,273)
EXTRAORDINARY GAIN ON EARLY EXTINGUISHMENT
OF DEBT ................................................ 1,630,328 -- 1,630,328 --
------------- ------------- ------------- -------------
NET LOSS ............................................... (1,426,547) (7,884,537) (9,296,577) (17,685,273)
DEEMED DIVIDEND - BENEFICIAL CONVERSION FEATURE ........ (89,813) -- (89,813) --
------------- ------------- ------------- -------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS ............. $ (1,516,360) $ (7,884,537) $ (9,386,390) $(17,685,273)
============= ============= ============= =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE:
Loss before extraordinary item after deemed divided -
beneficial conversion feature ..................... $ (0.18) $ (0.53) $ (0.66) $ (1.27)
Extraordinary item .................................. 0.09 -- 0.10 --
------------- ------------- ------------- -------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS ............. $ (0.09) $ (0.53) $ (0.56) $ (1.27)
============= ============= ============= =============
SHARES USED IN COMPUTING BASIC AND
DILUTED NET LOSS PER COMMON SHARE ...................... 17,428,218 14,990,947 16,831,528 13,894,302
============= ============= ============= =============
The accompanying notes are an integral part of these
consolidated statements.
4
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
------------- -------------
OPERATING ACTIVITIES:
Net loss ................................................................. $ (9,296,577) $(17,685,273)
Adjustments to reconcile net loss to net cash
used in operating activities-
Extraordinary item ................................................... (1,630,328) --
Depreciation and amortization ........................................ 5,828,767 3,504,710
Issuance of stock options for services rendered ...................... 37,932 --
Amortization of debt discount ........................................ -- 255,802
Amortization of deferred compensation ................................ 114,536 275,858
Changes in operating assets and liabilities-
Decrease (increase) in assets-
Accounts receivable ............................................. 107,655 (458,678)
Other assets .................................................... (89,219) (834,971)
Increase (decrease) in liabilities-
Accounts payable and accrued expenses ........................... (2,776,188) 1,844,849
Deferred revenues ............................................... 123,551 646,995
Payments relating to restructuring costs......................... (2,910,058) --
Other liabilities ............................................... 35,538 (765,863)
------------- -------------
Net cash used in operating activities ............. (10,454,391) (13,216,571)
------------- -------------
INVESTING ACTIVITIES:
Purchases of property and equipment ...................................... (666,388) (7,627,087)
Cash acquired in business acquisition .................................... 208,821 --
Sales (purchase) of marketable securities, net ........................... 13,560,458 (26,382,541)
------------- -------------
Net cash provided by (used) in investing activities ......................... 13,102,891 (34,009,628)
------------- -------------
FINANCING ACTIVITIES:
Proceeds from long-term debt ............................................. -- 1,027,994
Repayments of long-term debt ............................................. (262,019) (1,026,981)
Payment of capital lease settlement ...................................... (2,000,000) --
Repayments of capital lease obligations .................................. (1,155,681) (1,417,427)
Proceeds from issuance of Series A Convertible Preferred stock, net ...... 2,205,114 --
Proceeds from issuance of Common stock, net .............................. -- 49,646,878
------------- -------------
Net cash provided by (used in) financing activities (1,212,586) 48,230,464
------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS ................................... 1,435,914 1,004,265
CASH AND CASH EQUIVALENTS, beginning of period .............................. 5,051,901 953,840
------------- -------------
CASH AND CASH EQUIVALENTS, end of period .................................... $ 6,487,815 $ 1,958,105
============= =============
The accompanying notes are an integral part of these
consolidated statements.
5
FASTNET CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BACKGROUND
FASTNET Corporation and its subsidiaries ("FASTNET" or the "Company"),
a Pennsylvania corporation, has been providing Internet access services to its
customers since 1994. The Company is a growing business Internet communications,
web hosting and colocation provider targeting small and medium sized enterprises
in selected high growth secondary markets in the Northeastern area of the United
States. The Company complements its Internet access services by delivering a
wide range of enhanced products and services that are designed to meet the needs
of its target customer base.
QUARTERLY FINANCIAL INFORMATION AND RESULTS OF OPERATIONS
The accompanying unaudited financial information as of September 30,
2001 and for the nine months ended September 30, 2001 and 2000 has been prepared
in accordance with accounting principles generally accepted in the United
States. In the opinion of management, all significant adjustments, consisting of
only normal and recurring adjustments, have been included in the accompanying
unaudited financial statements. Operating results for the nine months ended
September 30, 2001 are not necessarily indicative of the results that may be
expected for the full year. While the Company believes that the disclosures
presented are adequate to make the information not misleading, these
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and the notes included in the Company's latest
annual report on Form 10-K.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts
of FASTNET and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
MANAGEMENT'S USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States require management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
LIQUIDITY
The Company's business plan has required substantial capital to fund
operations, capital expenditures, expansion of sales and marketing capabilities,
and acquisitions. The Company modified its business strategy in October 2000, to
allow it to maintain operations without any additional funding in the
foreseeable future. Simultaneous with the modification of its strategic plan,
the Company recorded a charge primarily related to network and telecommunication
optimization and cost reduction, facility exit costs, realigned marketing
strategy, and involuntary employee terminations. The Company expects these
actions will reduce its cash consumption rate in the future, but may result in
early termination payments for certain contractual obligations that exist.
6
The Company has incurred losses since inception and expects to continue
to incur losses in 2001. As of September 30, 2001, the Company's accumulated
deficit was $48,058,927. As of September 30, 2001, cash and cash equivalents and
marketable securities were $11,380,282. The Company believes that it's existing
cash and cash equivalents and marketable securities will be sufficient to meet
its working capital and capital expenditure requirements into 2003. However, the
Company may be required to seek additional sources of financing. In the third
quarter of 2001 and in November 2001, the Company issued shares of its Series A
Convertible Preferred stock, as more fully described below. If additional funds
are raised through the issuance of equity securities, existing shareholders may
experience significant dilution. Furthermore, additional financing may not be
available when needed or, if available, such financing may not be on terms
favorable to the Company. If such sources of financing are insufficient or
unavailable, or if the Company experiences shortfalls in anticipated revenue or
increases in anticipated expenses, the Company may need to idle additional
markets and make further reductions in head count. Any of these events could
harm the Company's business, financial condition or results of operations.
The Company is subject to those risks associated with companies in the
Telecommunications Industry. The Company's future results of operations involve
a number of risks and uncertainties. Factors that could affect the Company's
future operating results and cause actual results to vary materially from
expectations include, but are not limited to, risks from competition, new
products and technological change, price and margin pressures and dependence on
key personnel. See Item V of this Form 10-Q for risk factors
In August 2001, the Company signed an agreement with a lender to settle
certain capital lease obligations. Pursuant to the agreement, the Company made a
$2,000,000 payment in August 2001 to the lender to settle the entire principal
balance of certain of its capital lease obligations. Additionally, the lender
transferred title of the equipment leased under the capital lease obligations to
the Company. A gain on the extinguishment of debt, net of related costs, in the
amount of $1,630,328 was recorded in the third quarter of 2001.
On September 5, 2001, the Company sold 2,506,421 shares of Series A
Convertible Preferred stock ("Series A Preferred"), no par value, at a purchase
price of $0.91 per share to several investors for gross proceeds of $2,287,109.
On November 12, 2001, the Company sold an additional 790,283 shares of Series A
Preferred at a purchase price of $0.91 per share for gross proceeds of $712,891
to the same investors (see Note 3).
On November 11, 2001, the Company entered into a settlement agreement
with an Internet bandwidth provider. The settlement agreement requires a payment
of $1,000,000 to settle all outstanding obligations for services provided by the
vendor. The $1,000,000 is included in accounts payable and accrued restructuring
on the accompanying consolidated balance sheet as of September 30, 2001.
COMPREHENSIVE INCOME
The Company follows Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income". SFAS No. 130 requires
companies to classify items of other comprehensive income by their nature in a
financial statement and display the accumulated balance of other comprehensive
income separately from in the shareholders' equity section of the balance sheet.
For the three and nine months ended September 30, 2001 and 2000, comprehensive
loss was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
---------------- ---------------- ---------------- ----------------
Net loss $ (1,426,547) $ (7,884,537) $ (9,296,577) $ (17,685,273)
Unrealized gain (loss) on
marketable securities 13,633 8,563 (2,618) 10,459
---------------- ---------------- ---------------- ----------------
Comprehensive loss $ (1,412,914) $ (7,875,974) $ (9,299,195) $ (17,674,814)
================ ================ ================ ================
REVENUE RECOGNITION
Revenues include one-time and recurring charges to customers for
providing Internet services. One-time charges primarily relate to the initial
connection fees and are recognized as revenue over the life of the customer
contract. The Company recognizes recurring access revenue over the period the
services are provided. The Company offers contracts for Internet access that are
generally paid for in advance by customers. The Company has deferred revenue
recognition on these advance payments and recognizes this revenue ratably over
the service period.
7
Revenues are also derived from the resale of products, including
hardware and software, and web hosting services. The Company sells its web
hosting and related services for contractual periods ranging from one to twelve
months. These contracts generally are cancelable by either party without
penalty. Revenues from these contracts are recognized ratably over the
contractual period as services are provided. Incremental fees for excess
bandwidth usage and data storage are billed and recognized as revenues in the
period in which customers utilize such services.
MAJOR CUSTOMERS
The Company derived revenues of approximately 5%, 20%, 11% and 23% for
the three months ended September 30, 2001 and 2000 and the nine months ended
September 30, 2001 and 2000 respectively, from WebTV. FASTNET discontinued all
services to WebTV in September, 2001. As of September 30, 2001, the Company had
an outstanding accounts receivable balance of $11,522 due from this customer. No
other customer accounted for more than 10% of revenues for the periods
presented.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period to conform
to the current period presentation.
(2) INITIAL PUBLIC OFFERING
On February 7, 2000, the Company completed its initial public offering
of 4,000,000 shares of Common stock at a price of $12.00 per share. An
additional 600,000 shares of Common stock were issued pursuant to the exercise
of the underwriters' over-allotment option. The Company received net proceeds of
$49,605,981 from the initial public offering and the exercise of the
over-allotment option.
(3) PREFERRED STOCK
The Company is authorized to issue 10,000,000 shares of Preferred
stock, no par value per share, of which 5,494,505 have been designated as Series
A Preferred.
On September 5, 2001, the Company sold 2,506,421 shares of Series A
Preferred, no par value, at a purchase price of $0.91 per share to several
investors for gross proceeds of $2,287,109 ("First Closing"). In conjunction
with the sale of the Series A Preferred at the First Closing, the Company issued
warrants to purchase 626,605 shares of Common stock at an exercise price of
$1.27 per share. The warrants expire in five years. Additionally, a founder of
the Company sold 456,169 shares of Common stock to one of the Series A Preferred
investors for $0.50 per share for proceeds to the founder of $228,085.
On November 12, 2001, the Company sold an additional 790,283 shares of
Series A Preferred at a purchase price of $0.91 per share for gross proceeds of
$712,891 and issued additional warrants to purchase 197,571 shares of Common
stock at an exercise price of $1.27 per share to the same investors involved in
the First Closing ("Second Closing").
Each share of Series A Preferred is convertible into the Company's
Common stock any time after the earlier of August 30, 2002 or a mandatory
conversion event, as defined. In the event a mandatory conversion does not
occur, the Series A Preferred is convertible at the option of the holder any
time on or after September 5, 2002. The holders of the Series A Preferred are
entitled to receive dividends at the same rate as dividends are paid with
respect to shares of Common stock. In the event of any liquidation, dissolution
or winding-up of the Company, the holders of Series A Preferred are entitled, in
preference to the holders of Common stock, to the greater of (i) $0.91 per share
plus all dividends declared but unpaid or (ii) such amount per share as would
have been payable had each share been converted to Common stock immediately
prior to such event.
The Series A Preferred stockholders generally vote together with all
other classes and series of stock as a single class. The Series A Preferred
stockholders are entitled to the number of votes equal to the number of whole
shares of Common stock into which the shares of Series A Preferred are
convertible. The Series A Preferred stockholders, as a separate series, are
entitled to elect two directors of the Company.
8
The Company allocated the proceeds from the First Closing to the Series
A Preferred, warrants to purchase Common stock, and Common stock sold by a
founder based on the relative fair values of each instrument. The fair value of
the warrants issued in the First Closing was determined based on the
Black-Scholes option pricing model using an expected life of five years, a
volatility of 100% and a risk-free interest rate of 4.529%. Accordingly,
approximately $1,804,000 of the Series A Preferred proceeds was allocated to the
Series A Preferred, $340,000 was allocated to the warrants and $143,000 was
allocated to the shares of Common stock sold by the founder. The fair values of
the warrants and the Common stock have been recorded as Common stock on the
accompanying consolidated balance sheet as of September 30, 2001. After
considering the allocation of the proceeds based on the relative fair values, it
was determined that the Series A Preferred has a beneficial conversion feature
("BCF") in accordance with Emerging Issues Task Force ("EITF") Issue No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios." The Company recorded the BCF related
to the First Closing of approximately $1,100,000 as a discount to the Series A
Preferred in the quarter ended September 30, 2001. The value of the BCF will be
recorded in a manner similar to a deemed dividend over the period from the date
of issuance to the earliest known date of conversion, August 30, 2002. The
Company recorded a deemed dividend - BCF of $89,813 for the quarter ended
September 30, 2001. The BCF related to the Second Closing will be recorded in
the quarter ended December 31, 2001 and will be accounted for in the same manner
as the BCF associated with the First Closing.
(4) ACQUISITIONS
CYBERTECH WIRELESS, INC.
On March 14, 2001, the Company acquired all the assets and
substantially all the liabilities of Cybertech Wireless, Inc., ("Cybertech") a
provider of fixed wireless Internet services headquartered in Rochester, NY, for
2,000,000 shares of common stock valued at $1,875,000. The results of operations
from the acquired business have been included in the consolidated financial
statements from the date of acquisition. The Company recorded the acquisition
using the purchase method of accounting pursuant to Accounting Principles Board
("APB") No. 16, "Accounting for Business Combinations." The excess of the
purchase price over the fair value of net assets acquired was preliminarily
determined to be $1,200,397. This entire amount was preliminarily allocated to
acquired technology and is being amortized on a straight-line basis over 3
years. Amortization expense for the nine months ended September 30, 2001, was
$216,738. The pro forma information is not presented, as information for
Cybertech is immaterial to the consolidated company.
The following table lists noncash assets that were acquired and
liabilities that were assumed as a result of the acquisition:
Noncash assets:
Accounts receivable ......................... $ 82,402
Other current assets ........................ 660,183
Property and equipment ...................... 1,395,137
Intangibles.................................. 1,200,397
--------------
$ 3,338,119
==============
Assumed liabilities:
Accounts payable ............................ $ 1,013,626
Accrued expenses ............................ 226,231
Deferred revenues ........................... 181,083
Debt ........................................ 250,000
Other liabilities ........................... 1,000
--------------
1,671,940
--------------
Net noncash assets acquired ................. 1,666,179
Purchase price paid in stock ..................... (1,875,000)
--------------
Cash acquired .................................... $ (208,821)
==============
NETREACH, INC.
On November 1, the Company acquired all of the outstanding capital
stock of NetReach, Inc., ("NetReach") a web hosting, web design and web
application development company headquartered in Ambler, Pennsylvania for
2,400,000 shares of Common stock and a contingent earnout for the next five
consecutive quarters for up to an additional 690,900 additional shares of Common
stock. The Company will record the acquisition in the fourth quarter of 2001
using the purchase method of accounting pursuant to APB No. 16, "Accounting for
Business Combinations."
9
(5) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
FASTNET considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.
Management determines the appropriate classification of its investments
in debt and equity securities at the time of purchase and reevaluates such
determinations at each balance sheet date. As of September 30, 2001, all of the
Company's investments are classified as available for sale and are included in
marketable securities in the accompanying consolidated balance sheets.
The amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization and accretion
as well as interest are included in interest income. Realized gains and losses
are included in other income in the accompanying consolidated statements of
operations. The cost of securities sold is based on the specific identification
method.
The Company's investments in debt and equity securities are diversified
among high-credit quality securities in accordance with the Company's investment
policy.
(6) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
SEPTEMBER 30, 2001 DECEMBER 31, 2000
------------------ -----------------
Equipment .............................. $ 19,698,653 $ 17,811,184
Computer equipment...................... 2,103,175 1,815,519
Computer software....................... 1,711,408 1,584,685
Furniture and fixtures.................. 650,980 609,661
Leasehold improvements.................. 3,172,079 2,961,217
---------------- ----------------
27,336,295 24,782,266
Less-Accumulated depreciation
and amortization...................... (9,642,420) (5,151,255)
---------------- ----------------
$ 17,693,875 $ 19,631,011
================ ================
Depreciation and amortization expense for the three months ended
September 30, 2001 and 2000 and the nine months ended September 30, 2001 and
2000 was $1,635,451, $1,017,592, $4,491,165 and $2,389,081, respectively. The
net carrying value of property and equipment under capital leases was $4,474,339
and $11,604,918 at September 30, 2001 and December 31, 2000, respectively.
(7) INTANGIBLE ASSETS
Intangible assets represent the purchase price of an acquired business
over the fair value of the net tangible assets at the date of acquisition.
Goodwill and intangible assets are being amortized on the straight-line basis
over 3 years. The carrying value of goodwill and other intangibles are evaluated
periodically based on fair values or undiscounted operating cash flow whenever
significant events or changes occur which might impair recovery of recorded
costs. The Company believes that no impairment of goodwill or other intangible
exists at September 30, 2001. Amortization of goodwill and other intangible
assets was approximately $473,724, $371,877, $1,337,602, and $1,115,629 for the
three months ended September 30, 2001 and 2000 and the nine months ended
September 30, 2001 and 2000, respectively, and is included in depreciation and
amortization expense.
(8) RESTRUCTURING CHARGE
On October 10, 2000, the Company announced a restructuring to its
business operations and this restructuring plan provided for the suspension of
selling and marketing efforts in 12 of the 20 markets that were operational as
of September 30, 2000 (the "Restructuring Plan"). Selling and marketing efforts
have been focused on core markets located in Pennsylvania, New Jersey and New
York. The Restructuring Plan included redesigning the network architecture
intended to achieve an overall reduction in telecommunication expenses. In
conjunction with the Restructuring Plan, the Company terminated 44 employees.
10
The Company has ceased all sales and marketing activities in the 12
closed markets and is negotiating the exit of the facilities, where practicable.
Telecommunication exit and termination costs relate to contractual obligations
the Company is unable to cancel for network and related costs in the markets
being closed. These costs consist of both Internet backbone connectivity cost,
as well as network and access costs. These services are no longer required in
the closed markets. Leasehold termination payments includes carrying costs and
rent expense for leased facilities located in non-operational markets. The
Company is actively pursuing both sublease opportunities as well as full lease
terminations.
During the fourth quarter of 2000, the Company recorded a charge for
$5,159,503. Of this restructuring charge, $1,135,585 has not been paid as of
September 30, 2001 and is, accordingly, classified as accrued restructuring. The
restructuring charges were determined based on formal plans approved by the
Company's management and Board of Directors using the information available at
the time. Management of the Company believes this provision will be adequate to
cover any future costs incurred relating to the restructuring. In addition in
2000, the Company recorded a $3,233,753 asset impairment charge as a result of
the Restructuring Plan.
The activity in the restructuring charge accrual during the nine months
ended September 30, 2001 is summarized in the table below:
ACCRUED CASH PAYMENTS ACCRUED
RESTRUCTURING DURING THE RESTRUCTURING
CHARGE NINE MONTHS CHARGE
AS OF ENDED AS OF
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2001
--------------- --------------- ---------------
Telecommunications exit and termination fees...... $ 2,552,472 $ 1,827,047 $ 725,425
Leasehold termination costs....................... 708,818 473,947 234,871
Sales and marketing contract terminations......... 522,520 434,405 88,115
Facility exit costs............................... 261,833 174,659 87,174
--------------- --------------- ---------------
$ 4,045,643 $ 2,910,058 $ 1,135,585
=============== =============== ===============
(9) DEBT
On January 19, 2000, the Company sold a $1,000,000 bridge financing
note to an investor with a warrant to purchase 30,000 shares of Common stock.
The note bore interest at 7% per annum and matured upon the completion of the
initial public offering. The warrant is exercisable at $12 per share and expires
on January 18, 2007. The warrant was valued at $255,802 using the Black Scholes
pricing model and recorded as a debt discount, which was amortized to interest
expense over the term of the note. The note was repaid with the proceeds from
the initial public offering.
(10) DEFERRED COMPENSATION
As a result of the termination or departure of employees, $292,236 of
the unamortized balance of deferred compensation was reversed in the nine months
ended September 30, 2001.
(11) LEASE ARRANGEMENT
During the first quarter of 2000, the Company received a credit line of
$3,000,000 from a vendor to purchase equipment. In April 2000, the same vendor
added a second credit facility of $5,000,000 to the original credit facility.
These credit facilities are used to secure computer-related equipment under
three-year capital leases.
In June 1999, the Company entered into a $20,000,000 master equipment
lease agreement with an equipment vendor. Leases under the agreement are payable
in three monthly installments of 0.83% of the value of the equipment leased and
33 monthly installments of 0.0345% of the value of the equipment leased. Capital
lease obligations related to the credit facilities as of June 30, 2001 totaled
$4.1 million. In August 2001, the Company signed an agreement with the lender to
11
settle certain capital lease obligations. Pursuant to the agreement, the Company
made a $2,000,000 payment in August 2001 to the vendor to settle the entire
principal balance of the capital lease obligations under the credit facilities.
Additionally, the vendor transferred title of the equipment leased under the
capital lease obligations to the Company. An extraordinary gain on the
extinguishment of debt, net of related costs, in the amount of $1,630,328 was
recorded in the third quarter of 2001.
(12) RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other
Intangible Assets." SFAS No. 141 requires business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting, and
broadens the criteria for recording intangible assets separate from goodwill.
Recorded goodwill and intangibles will be evaluated against this new criteria
and may result in certain intangibles being subsumed into goodwill, or
alternatively, amounts initially recorded as goodwill may be separately
identified and recognized apart from goodwill. SFAS No. 142 requires the use of
a nonamortization approach to account for purchased goodwill and certain
intangibles. Under a nonamortization approach, goodwill and certain intangibles
will not be amortized into results of operations, but instead would be reviewed
for impairment and written down and charged to results of operations only in the
periods in which the recorded value of goodwill and certain intangibles is more
than its fair value. The provisions of each statement which apply to goodwill
and intangible assets acquired prior to June 30, 2001 will be adopted by the
Company on January 1, 2002. We expect the adoption of these accounting standards
will result in certain of our intangibles being subsumed into goodwill and will
have the impact of reducing our amortization of goodwill and intangibles
commencing January 1, 2002; however, impairment reviews may result in future
periodic write-downs.
(13) NET LOSS PER COMMON SHARE
The Company has presented net loss per share pursuant to SFAS No. 128,
"Earnings per Share." Basic net loss per Common share was computed by dividing
net loss by the weighted average number of shares of Common stock outstanding
during the period. Diluted net loss per Common share reflects the potential
dilution from the exercise or conversion of securities into Common stock, such
as stock options. Outstanding Common stock options and warrants are excluded
from the diluted net loss per Common share calculations as the impact on the net
loss per Common share using the treasury stock method is antidilutive due to the
Company's losses.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH OUR FINANCIAL STATEMENTS AND THE RELATED NOTES TO THE FINANCIAL STATEMENTS
APPEARING ELSEWHERE IN THIS FORM 10-Q. THE FOLLOWING INCLUDES A NUMBER OF
FORWARD-LOOKING STATEMENTS THAT REFLECT OUR CURRENT VIEWS WITH RESPECT TO FUTURE
EVENTS AND FINANCIAL PERFORMANCE. WE USE WORDS SUCH AS "ANTICIPATES",
"BELIEVES", "EXPECTS", "FUTURE", AND "INTENDS", AND SIMILAR EXPRESSIONS TO
IDENTIFY FORWARD-LOOKING STATEMENTS. YOU SHOULD NOT PLACE UNDUE RELIANCE ON
THESE FORWARD- LOOKING STATEMENTS, WHICH APPLY ONLY AS OF THE DATE OF THIS
QUARTERLY REPORT ON FORM 10-Q. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM HISTORICAL RESULTS OR OUR PREDICTIONS, INCLUDING, WITHOUT LIMITATION, THOSE
FACTORS SET FORTH IN ITEM 5 PART II. THE FORWARD-LOOKING STATEMENTS ARE SUBJECT
TO A NUMBER OF RISKS AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO, OUR
ABILITY TO: ITEGRATE ACQUISITIONS; OFFER OUR CUSTOMERS IN THE NEW YORK REGION
THE FULL SUITE OF PRODUCTS AND SERVICES THAT WE OFFER OUR OTHER CUSTOMERS;
INCREASE OUR ACCESS AND ENHANCED REVENUES AS A PERCENTAGE OF OUR TOTAL REVENUES;
EXPAND OUR CUSTOMER BASE: MIGRATE CUSTOMERS FROM OUR COMPETITORS IF THE INDUSTRY
CONTINUES TO CONSOLIDATE; GROW OUR REVENUES; DECREASE SOHO REVENUES AS A
PERCENTAGE OF TOTAL REVENUES; REDUCE OUR COST OF REVENUES; CHANGE OUR INTEREST
INCOME AND INTEREST EXPENSE THROUGH REVISED OPERATIONS; REACH EBITDA POSITIVE
RESULTS BY THE END OF 2001 ALLOWING US TO MAINTAIN OPERATIONS WITHOUT ANY
ADDITIONAL FUNDING IN 2002. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THE INFORMATION CONTAINED
HEREIN IS CURRENT ONLY AS OF THE DATE OF THIS FILING AND WE UNDERTAKE NO
OBLIGATION TO UPDATE THE INFORMATION IN THIS FORM 10-Q IN THE FUTURE.
OVERVIEW
We are an Internet solutions provider offering broadband data
communication services and enhanced products and services to businesses in
selected high growth second tier markets in the Northeastern United States. Our
services included high-speed data and Internet services, data center services,
including managed and unmanaged web hosting and colocation services, small
office home office (SOHO) Internet access, wholesale ISP services, and various
professional services including web design and development. We focus our sales
and marketing efforts on businesses in the markets we serve using the value
proposition of leveraging our technical expertise with world-class customer
care. We approach our customers from an access independent position, providing
connectivity over a variety of available technologies. These include classic
Telco provided point-to-point, frame relay, ISDN, SMDS, ATM, and DSL. We also
offer FASTNET controlled last mile Internet access utilizing wireless transport.
On February 7, 2000, we completed an initial public offering of
4,000,000 shares of Common stock at a price of $12.00 per share. On March 7,
2000, we sold 600,000 shares of Common stock at a price of $12.00 per share
pursuant to the exercise of the underwriter's over-allotment option. We received
aggregate net cash proceeds of $49,605,981 million from the initial public
offering and exercise of the over-allotment option.
On March 14, 2001, we acquired all the assets and substantially all the
liabilities of Cybertech Wireless, Inc. ("Cybertech"), a provider of wireless
high speed Internet access, web hosting and SOHO access located in New York
State. Cybertech has deployed wireless networks in Rochester, Syracuse, Albany
and Buffalo. We are able to offer our customers in the New York region the full
suite of products and services offered to customers in our Pennsylvania and New
Jersey markets. We will also utilize Cybertech's employees network deployment
knowledge to build out wireless networks in selected existing FASTNET markets.
On November 1, the Company acquired all of the outstanding capital
stock of NetReach, Inc., ("NetReach") a web hosting, web design and web
application development company headquartered in Ambler, Pennsylvania for
2,400,000 shares of Common stock and a contingent earnout for up to 690,900
additional shares over the next five consecutive quarters. NetReach will become
the eSolutions division of FASTNET upon the completion of the integration.
As of September 30, 2001, we provided Internet access and enhanced
services to approximately 1,100 enterprise customers, 20,900 SOHO customers, and
8,400 customers using our web hosting, and colocation services.
13
RECENT DEVELOPMENTS
On September 5, 2001, the Company sold 2,506,421 shares of Series A
Convertible Preferred stock, no par value, at a purchase price of $0.91 per
share to several investors for gross proceeds of $2,287,109. On November 12,
2001, the Company sold an additional 790,283 shares of Series A Convertible
Preferred stock at a purchase price of $0.91 per share, for gross proceeds of
$712,891, to the same investors.
On November 11, 2001, the Company entered into a settlement agreement
with an Internet bandwidth provider. The settlement agreement requires a payment
of $1,000,000 to settle all outstanding vendor obligations. The $1,000,000 is
included in accounts payable and accrued restructuring on the accompanying
consolidated balance sheet as of September 30, 2001.
OUR HISTORY OF NET LOSSES
We have incurred net losses in each year since our inception and expect
our net losses to continue through December 31, 2001 as we seek to execute our
revised business plan. Our net losses were $1,274,290, $5,601,071 and
$31,140,920 for the years ended December 31, 1998, 1999, 2000 respectively, and
$9,296,577 for the nine months ended September 30, 2001.
MODIFICATION OF OUR STRATEGIC PLAN
On October 10, 2000, we modified our strategic plan. This modified plan
called for the suspension of selling and marketing efforts in 12 of the 20
markets that were operational as of September 30, 2000. Our selling and
marketing strategy is now focused on markets located in Pennsylvania, New Jersey
and New York.
Simultaneous with the modification of our strategic plan, we recorded a
restructuring charge of $5,159,503 primarily related to network and
telecommunication optimization and cost reduction, facility exit costs,
realigned marketing strategy, and involuntary employee terminations
The activity in the restructuring charge accrual during the nine months
ended September 30, 2001 is summarized in the table below:
ACCRUED CASH PAYMENTS ACCRUED
RESTRUCTURING DURING THE RESTRUCTURING
CHARGE NINE MONTHS CHARGE
AS OF ENDED AS OF
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2001
--------------- --------------- ---------------
Telecommunications exit and termination fees...... $ 2,552,472 $ 1,827,047 $ 725,425
Leasehold termination costs....................... 708,818 473,947 234,871
Sales and marketing contract terminations......... 522,520 434,405 88,115
Facility exit costs............................... 261,833 174,659 87,174
--------------- --------------- ---------------
$ 4,045,643 $ 2,910,058 $ 1,135,585
=============== =============== ===============
RESULTS OF OPERATIONS
REVENUES
We provide services to our customers, which we classify in three
general types: Internet access and enhanced services, SOHO Internet access, and
eSolutions web development. We target our Internet access and enhanced services
to businesses located within our active markets. FASTNET offers a broad range of
dedicated access solutions including T-1, T-3, Frame Relay, SMDS, enterprise
class Digital Subscriber Line (DSL) services and fixed broadband wireless. Our
enhanced services are complementary to dedicated Internet access and include
Total Managed Security and the sale of third party hardware and software. We
also classify our dedicated and shared web hosting and colocation services as
part of our enhanced services. Our business plan focuses on the core service
offering of Internet access coupled with add on sales of enhanced products and
services as our customers' Internet needs expand. Access and enhanced revenues
are recognized as services are provided. We expect our access and enhanced
revenues to increase as a percentage of our total revenues as we continue to
focus additional resources on marketing and promoting these services.
14
The market for data and related services is becoming increasingly
competitive. We seek to continue to expand our customer base by both increasing
market penetration in our existing markets and by increasing average revenue per
customer by selling additional enhanced products and services. We have had a
historically low churn rate with our dedicated Internet customers. We believe as
the industry consolidates that we will have opportunities to migrate customers
from our competitors as their customers become dissatisfied with the level of
service provided by the consolidated organizations. In addition, the recent
economic challenges have caused other providers to either cease operations or
terminate certain product offerings. We seek to grow our revenues by capturing
market share from other providers.
Our SOHO revenues consist of dial-up Internet access to both
residential and small office business customers, SOHO DSL Internet access, and
Integrated Services Digital Network (ISDN) Internet access. We typically bill
these services in advance of providing services. As a result, revenues are
deferred until such time as services are rendered. In the future as we execute
our business plan, we expect SOHO revenues to decrease as a percentage of total
revenues. We have reduced selling and marketing efforts targeted to this
customer base in response to increased competition from both free Internet
service providers and other providers.
We also offer our customers virtual private network (VPN) solutions.
VPN's allow business customers secure, remote access to their internal networks
through a connection to FASTNET's network. The cost of these services varies
with the scope of the services provided.
COST OF REVENUES
Our cost of revenues primarily consists of our Internet connectivity
charges and network charges. These are our costs of directly connecting to
multiple Internet backbones and maintaining our network. Cost of revenues also
includes engineering payroll, creative and programming staff payrolls for web
design and development, the cost of third party hardware and software that we
sell to our customers, facility rental expense for in market network
infrastructure, and rental expense on network equipment financed under operating
leases.
THE THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2000
REVENUES. Revenues increased by $405,000, or 13%, to $3.6 million for
the three months ended September 30, 2001 from $3.2 million for the three months
ended September 30, 2000. This increase in revenues is primarily a result of an
increase in the number of business customers using our dedicated Internet access
and enhanced products and services. Our dedicated Internet access customer base
grew by 50% from 734 as of September 30, 2000, to 1,099 as of September 30,
2001. Additionally, revenues increased due to the acquisition of Cybertech in
March 2001. Our revenue growth from our business and enterprise customers for
the three months ended September 30, 2001 was offset by the loss of Microsoft
WebTV and another user of wholesale access services. The revenues from Microsoft
WebTV declined by $453,000 or 71% from $640,000 for the three months ended
September 30, 2000 to $187,000 for the three months ended September 30, 2001.
All services to Microsoft WebTV were discontinued by September 2001. Our
decision to discontinue service is based on our commitment to improve gross
margins as well as to remain focused on our core markets
COST OF REVENUES. Cost of revenues decreased by $1.8 million, or 47%,
from $3.9 million for the three months ended September 30, 2000 to $2.1 million
for the three months ended September 30, 2001. Gross margin increased from (20)%
for the three months ended September 30, 2000 to 43% for the three months ended
September 30, 2001. The decrease in cost of revenues and the improvement in
gross margin was primarily due to the reduction in the size and improvement in
the efficiency of our network, along with reduced pricing on network elements.
The decision to discontinue service to Microsoft WebTV also contributed to the
reduction in cost of revenues and the increase in the gross margin. Offsetting
the decrease in cost of revenues was the additional cost of revenues associated
with Cybertech. Additionally, the Company reflected credits resulting from
telecommunication providers billing errors of $252,000 during the three months
ended September 30, 2001. If these credits had not been included, gross margin
would have been 36%.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general and
administrative expenses decreased by $3.7 million, or 60%, from $6.2 million for
the three months ended September 30, 2000 to $2.5 million for the three months
ended September 30, 2001. Selling, general and administrative personnel
decreased by 53 employees from 135 employees at September 30, 2000 to 82
employees at September 30, 2001. The September 30, 2001 employee count includes
ten employees that were retained as part of the Cybertech acquisition.
Advertising and promotional expenses decreased by $1.4 million from $1.6 million
15
for the three months ended September 30, 2000 to $196,000 for the three months
ended September 30, 2001. This decrease resulted from the elimination or
reduction of advertising expenses in markets where we discontinued our direct
field sales efforts. The remaining decline in selling, general, and
administrative expenses relates to the Company's continued general cost
containment efforts as well as internal systems optimizations during the three
months ended September 30, 2001.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
by $720,000, or 52%, from $1.4 million for the three months ended September 30,
2000 to $2.1 million for the three months ended September 30, 2001. This
increase is due to additional depreciation relating to networking equipment
acquired during 2000 and the nine months ended September 30, 2001 and the
depreciation on the assets acquired from the Cybertech transaction. Amortization
expense related to Cybertech was $100,000 for the three months ended September
30, 2001.
OTHER INCOME/EXPENSE. Interest income decreased by $534,000 from
$633,000 for the three months ended September 30, 2000 to $98,000 for the three
months ended September 30, 2001. This decrease in interest income resulted from
the increased use of our marketable securities to fund operations coupled with a
decrease in the related investment returns. Interest expense decreased by
$165,000 from $271,000 for the three months ended September 30, 2000 to $106,000
for the three months ended September 30, 2001. The decrease in interest expense
is the result of the early extinguishment of $4.0 million of capital lease
obligations in August 2001. We expect interest income to decrease as we use our
cash and marketable securities to fund operations. Interest expense is expected
to continue to decrease as we repay the remainder of our debt and capital lease
obligations.
EXTRAORDINARY GAIN. A gain on the early extinguishment of debt in the
amount of $1.6 million was recorded in the three months ended September 30, 2001
as a result of the settlement of $4.0 million of certain capital lease
obligations with an equipment vendor.
THE NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2000
REVENUES. Revenues increased by $1.9 million, or 20%, to $11.3 million
for the nine months ended September 30, 2001 from $9.4 million for the nine
months ended September 30, 2000. This increase in revenues is primarily a result
of an increase in the number of business customers using our dedicated Internet
access and enhanced products and services. Our dedicated Internet access
customer base grew by 50% from 734 as of September 30, 2000 to 1,099 as of
September 30, 2001. Additionally, revenues increased due to the acquisition of
Cybertech in March 2001. Our revenue growth from our business and enterprise
customers for the first nine months of 2001 was partially offset by the
following factors. We lost 33 directly connected business customers using our
DSL services due to the business failure of Northpoint Communications, Inc. We
experienced a decline in revenues from Microsoft WebTV, our largest customer and
user of our wholesale dial-up service. The revenues from this customer declined
by $905,000 from $2.2 million for the nine months ended September 30, 2000, to
$1.3 million for the nine months ended September 30, 2001. All services to
Microsoft WebTV were discontinued by September 2001. Our decision to discontinue
service is based on our commitment to improve gross margins as well as to remain
focused on our core markets.
COST OF REVENUES. Cost of revenues decreased by $1.3 million, or 14%,
from $9.4 million for the nine months ended September 30, 2000 to $8.1 million
for the nine months ended September 30, 2001. Gross margin improved from
breakeven for the nine months ended September 30, 2000 to 28% for the nine
months ended September 30, 2001. The decrease in cost of revenues and the
improvement in gross margin were primarily due to the reduction in the size and
improvement in the efficiency of our network, along with reduced pricing on
network elements. The decision to discontinue service to Microsoft WebTV also
contributed to the reduction in cost of revenues and the increase in the gross
margin. Offsetting the decrease in cost of revenues and the increase in gross
margin is the cost of revenues of Cybertech which were not included in our
operating results prior to March 15, 2001. Additionally, the Company reflected
credits resulting from telecommunication providers billing errors of $505,000
during the nine months ended September 30, 2001. If these credits had not been
included, gross margin would have been 24%.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general and
administrative expenses decreased by $6.7 million, or 45%, from $14.9 million
for the nine months ended September 30, 2000 to $8.3 million for the nine months
ended September 30, 2001. Selling, general and administrative personnel
decreased by 53 employees from 135 employees at September 30, 2000 to 82
16
employees at September 30, 2001. The September 30, 2001 employee count includes
ten employees that were retained as part of the Cybertech acquisition.
Advertising and promotional expenses decreased by $2.3 million from $2.8 million
for the nine months ended September 30, 2000, to $459,000 for the nine months
ended September 30, 2001. This decrease resulted from the elimination or
reduction of these expenses in markets where we had discontinued our direct
field sales efforts. The decrease is also due to $705,000 of non-recurring
charges that were included in the nine months ended September 30, 2000 relating
to non-cash compensation charges. The remaining decline in selling, general, and
administrative expenses relates to general cost containment efforts the Company
continued during the first nine months of 2001.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
by $2.3 million, or 66%, from $3.5 million for the nine months ended September
30, 2000 to $5.8 million for the nine months ended September 30, 2001. This
increase is comprised of additional depreciation related to networking equipment
acquired during the fourth quarter of 2000 and the nine months ended September
30, 2001 and the depreciation on the assets acquired from the Cybertech
transaction. In addition, there was an increase in amortization of $217,000 for
the nine months ended September 30, 2001 related to the Cybertech acquisition.
OTHER INCOME/EXPENSE. Interest income decreased by $1.1 million from
$1.6 million for the nine months ended September 30, 2000 to $577,000 for the
nine months ended September 30, 2001. This decrease in interest income resulted
from the use of marketable securities to fund operations coupled with a decrease
in the related investment returns. Interest expense decreased by $188,000 from
$794,000 for the nine months ended September 30, 2000 to $605,000 for the nine
months ended September 30, 2001. The decrease in interest expense is the result
of a one-time charge for the amortization of debt discount of $255,802 related
to the warrant issued in connection with the January 19, 2000 bridge financing
recorded in the first nine months of 2000 and the early extinguishment of $4.0
million of certain capital lease obligations in August 2001. We expect interest
income to decrease as we use our cash and marketable securities to fund our
operations. Interest expense is expected to decrease as we continue to repay the
remainder of our debt and capital lease obligations.
EXTRAORDINARY GAIN. A gain on the early extinguishment of debt in the
amount of $1.6 million was recorded in the nine months ended September 30, 2001
as a result of the settlement of $4.0 million of certain capital lease
obligations with an equipment vendor.
CASH FLOWS ANALYSIS
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
--------------- ---------------
Other Financial Data:
Cash flows used in operating activities....................... $ (10,454,000) $ (13,217,000)
Cash flows provided by (used in) investing activities......... 13,103,000 (34,010,000)
Cash flows provided by (used in) financing activities ........ (1,213,000) 48,231,000
--------------- ---------------
Net increase in cash and cash equivalents .................... $ 1,436,000 $ 1,004,000
=============== ===============
Cash flows from operating activities increased by $2.8 million from
cash used of $13.2 million for the nine months ended September 30, 2000 to cash
used of $10.5 million for the nine months ended September 30, 2001. This
decrease in cash used in operations is primarily the result of the reduction in
the net loss for the nine months ended September 30, 2001, offset by
restructuring payments made in the nine months ended September 30, 2001.
Cash flows from investing activities increased by $47.1 million from
cash used of $34.0 million for the nine months ended September 30, 2000 to cash
provided of $13.1 million for the nine months ended September 30, 2001. This
increase in cash flows is primarily attributable to the Company's sales rather
than purchases of marketable securities and a decrease in purchases of property
and equipment.
Cash flows from financing activities decreased by $49.4 million from
cash provided of $48.2 million for the nine months ended September 30, 2000 to
cash used of $1.2 million during the nine months ended September 30, 2001. The
decrease in cash flows from financing activities is primarily the result of the
cash inflows from the Company's Initial Public Offering and exercise of the
underwriters' over allotment partially offset by an increase in payment for
capital lease obligations. The increase in payment for capital lease obligations
and a $2.0 million payment to settle certain capital lease obligations partially
offset by the proceeds from the issuance of Preferred stock.
17
LIQUIDITY AND CAPITAL RESOURCES
The business plan we executed at the time of our IPO required
substantial capital to fund operations, capital expenditures, expansion of sales
and marketing capabilities, and acquisitions. We modified our business strategy
in October 2000 to allow us to maintain operations without any required
additional funding. Simultaneous with the modification of our strategic plan, we
recorded a non-recurring charge primarily related to network and
telecommunication optimization and cost reduction, facility exit costs,
realigned marketing strategy, and involuntary employee terminations. We expect
these actions will reduce our cash consumption rate in the future, but may
result in early termination payments for certain contractual obligations that
exist. As of September 30, 2001, we had $11.4 million in cash and marketable
securities. While we may pursue additional sources of funding, we believe that
the cash and investments we have available will be sufficient to fund operations
into 2003.
During the fourth quarter of 2000, the Company recorded a charge for
$5,160,000. Of this restructuring charge, $1,136,000 has not been paid as of
September 30, 2001 and is, accordingly, classified as accrued restructuring. The
restructuring charges were determined based on formal plans approved by the
Company's management and Board of Directors using the information available at
the time. Management of the Company believes this provision will be adequate to
cover any future costs incurred relating to the restructuring.
In August 2001, the Company signed an agreement with a vendor to settle
certain capital lease obligations. Pursuant to the agreement, the Company made a
$2,000,000 payment in August 2001 to the vendor to settle the entire principal
balance of capital lease obligations under the credit facilities. Additionally,
the vendor transferred title of the equipment leased under the capital lease
obligations to the Company. An extraordinary gain on the extinguishment of debt,
net of related costs, in the amount of $1,630,000 was recorded in the third
quarter of 2001.
On September 5, 2001, the Company sold 2,506,421 shares of Series A
Preferred, no par value, at a purchase price of $0.91 per share to several
Investors, for gross proceeds of $2,287,000. On November 12, 2001, the Company
sold an additional 790,283 shares of Series A Preferred at a purchase price of
$0.91 per share, for gross proceeds of $713,000, to the same investors.
On November 11, 2001, the Company entered into a settlement agreement
with an Internet bandwidth provider. The settlement agreement requires a payment
of $1,000,000 to settle all outstanding vendor obligations. The $1,000,000 is
included in accounts payable and accrued restructuring on the accompanying
consolidated balance sheet as of September 30, 2001.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
SFAF No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other
Intangible Assets." SFAS No. 141 required business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting, and
broadens the criteria for recording intangible assets separate from goodwill.
Recorded goodwill and intangibles will be evaluated against this new criteria
and may result in certain intangibles being subsumed into goodwill, or
alternatively, amounts initially recorded as goodwill may be separately
identified and recognized apart from goodwill. SFAS No. 142 requires the use of
a nonamortization approach to account for purchased goodwill and certain
intangibles. Under a nonamortization approach, goodwill and certain intangibles
will not be amortized into results of operations, but instead would be reviewed
for impairment and written down and charged to results of operations only in the
periods in which the recorded value of goodwill and certain intangibles is more
than its fair value. The provisions of each statement which apply to goodwill
and intangible assets acquired prior to June 30, 2001 will be adopted by the
Company on January 1, 2002. We expect the adoption of these accounting standards
will result in certain of our intangibles being subsumed into goodwill and will
have the impact of reducing our amortization of goodwill and intangibles
commencing January 1, 2002; however, impairment reviews may result in future
periodic write-downs.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK.
Our financial instruments primarily consist of debt. All of our debt
instruments bear interest at fixed rates. Therefore, a change in interest rates
would not affect the interest incurred or cash flows related to our debt. A
change in interest rates would, however, affect the fair value of the debt. The
following sensitivity analysis assumes an instantaneous 100 basis point move in
interest rates from levels at September 30, 2001 with all other factors held
18
constant. A 100 basis point increase or decrease in market interest rates would
result in a change in the value of our debt of less than $50,000 at September
30, 2001. Because our debt is neither publicly traded nor redeemable at our
option, it is unlikely that such a change would impact our financial statements
or results of operations.
All of our transactions are conducted using the United States dollar.
Therefore, we are not exposed to any significant market risk relating to
currency rates
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not involved currently in any legal proceedings that either
individually or taken as a whole, are likely to have a material adverse effect
on our business, financial condition and results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None.
(b) None.
(c) On September 5, 2001 we issued 2,506,421 shares of no par
Series A Convertible Preferred stock at a purchase price of
$0.91 to Edison Ventures Fund and Strattech Partners I, L.P.
for $2,287,109. Each share of Series A Convertible Preferred
stock is convertible into one share of Common stock at the
earlier of September 4, 2002 or a mandatory conversion date,
as defined. This sale was made under the exemption from
registration provided under Section 4(2) of the Securities
Act.
On November 1, 2001 the Company acquired all the outstanding
capital Stock of NetReach, Inc., for 2,400,000 shares of
Common stock valued at $2,232,000 and a contingent earnout for
the next five consecutive quarters for up to 690,900
additional shares of Common stock. This sale was made under
the exemption from registration provided under Section 4(2) of
the Securities Act.
(d) Use of Proceeds of the Initial Public Offering
Our initial public offering, or IPO, was completed in February 2000.
The proceeds received net of underwriting discounts and commissions, and other
transaction costs were approximately $49,606,000.
From the effective date of the Registration Statement through September
30, 2001, we utilized the proceeds from the initial public offering and
underwriters' over-allotment as follows:
Net IPO Proceeds ........................ $ 49,606,000
----------------
Repayment of debt ....................... 6,592,000
Payment of other obligations ............ 794,000
Capital Expenditures .................... 10,320,000
Working Capital Requirements ............ 25,496,000
----------------
43,202,000
Total remaining ......................... $ 6,404,000
================
Unused proceeds of the initial public offering are currently invested
in debt and equity securities diversified among high-credit quality securities
in accordance with our investment policy.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
19
ITEM 5. OTHER INFORMATION
FACTORS AFFECTING FUTURE OPERATING RESULTS
WE ONLY BEGAN TO IMPLEMENT OUR REVISED STRATEGIC BUSINESS PLAN IN OCTOBER 2000.
AS A RESULT, YOU MAY NOT BE ABLE TO EVALUATE OUR BUSINESS PROSPECTS BASED ON OUR
HISTORICAL RESULTS.
In October 2000, we announced our revised business plan and strategy in
response to changes in market conditions, the low probability of obtaining
additional financing for the existing business plan, and competitive factors.
Consequently, the evaluation of our future business prospects is difficult
because our historical results for the time that we were implementing our
revised strategy is limited. Our success will depend upon:
o our ability to attract and sell additional products and
services to our target customers;
o our ability to enter into selected product or service
partnerships; and
o our ability to open new markets through acquisitions of
financially sound ISPs within these new markets.
Our ability to successfully implement our business strategy, and the
expected benefits to be obtained from our strategy, may be adversely affected by
a number of factors, such as unforeseen costs and expenses, technological
change, economic downturns, changes in capital markets, competitive factors or
other events beyond our control.
ON OCTOBER 10, 2000, WE INITIATED OUR REVISED STRATEGIC PLAN. IF WE ARE UNABLE
TO ACHIEVE THE EXPECTED COST SAVINGS AND REDUCTION IN CASH CONSUMPTION UNDER
THIS PLAN, WE MAY HAVE TO FURTHER MODIFY OUR BUSINESS PLAN AND OUR BUSINESS
COULD BE HARMED.
If we do not achieve the expected cost savings and reduction in cash
consumption under this plan, then we will need to seek additional capital from
public or private equity or debt sources to fund our business plan. Given the
existing capital market conditions, it may be difficult or impossible to raise
additional capital in the public market in the future. In addition, we cannot be
certain that we will be able to raise additional capital through debt or private
financing at all or on terms acceptable to us. Raising additional equity capital
and issuing shares of Common stock for acquisitions likely will dilute current
shareholders. If alternative sources of financing are insufficient or
unavailable, we may be required to further modify our growth and operating plans
in accordance with the extent of available financing.
IF WE ARE UNABLE TO INTEGRATE CYBERTECH WIRELESS INC. AND NETREACH, INC. WITH
FASTNET, WE MAY NOT REALIZE OUR PLANNED COST SAVINGS.
We must be able to integrate the networks of FASTNET, Cybertech and
NetReach to gain the efficiencies we hope to achieve. We also must be able to
retain and manage key personnel, integrate the back-office operations of these
acquired companies into the back-office operations of FASTNET, and expand their
product portfolio to include wire line connectivity services and enhanced
products and services or we may not be able to achieve the operating
efficiencies we anticipate.
FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999, AND THE NINE MONTHS ENDED
SEPTEMBER 30, 2001 OUR LARGEST CUSTOMER ACCOUNTED FOR 20%, 21%, AND 11% OF OUR
TOTAL REVENUES. WE TERMINATED SERVICE TO THIS CUSTOMER IN SEPTEMBER 2001.
While the termination of our relationship with WebTV, effective
September 2001, will reduce our quarter over quarter revenue growth rate and has
produced a negative quarter over quarter growth rate for the fourth quarter of
2001, we believe that we have proactively planned to eliminate the expenses
associated with this low margin revenue stream thereby preventing any material
adverse effect on our margins. If we are unable to completely eliminate all of
the expense related to this revenue stream, then our continued expected
improvements in gross margin, which is the focus of our revised business model,
could be adversely effected.
20
WE HAVE A HISTORY OF LOSSES AND ARE UNABLE AT THIS TIME TO PREDICT IF AND WHEN
WE WILL BE ABLE TO TURN PROFITABLE.
We have incurred net losses since our inception. For the years ended
December 31, 1998, 1999, 2000, and the nine months ended September 30, 2001 we
had losses of $1.3 million, $5.6 million $31.1 million, and $9.3 million,
respectively.
In order to achieve profitability, we must develop and market products
and services that gain broad commercial acceptance by our target customers in
our target markets. We cannot give any assurances that our products and services
will ever achieve broad commercial acceptance among our customers. Although our
revenues have increased each year since we began operations, we cannot give any
assurances that this growth in annual revenues will continue or lead to our
profitability in the future. Moreover, our revised business plan may not enable
us to reduce expenses or increase revenues sufficiently to permit us to turn
profitable. Therefore, we cannot predict with certainty whether we will be able
to obtain or sustain profitability or even positive operating cash flow or that
our revised business plan will allow us to generate profitability or positive
cash flow into the future.
IT IS UNLIKELY THAT INVESTORS WILL RECEIVE A RETURN ON OUR COMMON STOCK THROUGH
THE PAYMENT OF CASH DIVIDENDS.
We have never declared or paid cash dividends on our Common stock and
have no intention of doing so in the foreseeable future. We have had a history
of losses and expect to operate at a net loss for the next several years. These
net losses will reduce our stockholders' equity. For the nine months ended
September 30, 2001, we had a net loss of $9.3 million. We cannot predict what
the value of our assets or the amount of our liabilities will be in the future.
OUR OPERATING RESULTS FLUCTUATE DUE TO A VARIETY OF FACTORS AND ARE NOT A
MEANINGFUL INDICATOR OF FUTURE PERFORMANCE.
Our operating results have fluctuated in the past and may fluctuate
significantly in the future, depending upon a variety of factors, including:
o the timing of costs including those relating to construction
of infrastructure and acquisitions to enter a new market;
o the timing of the introduction of new products and services;
o changes in pricing policies and product offerings by us or our
competitors;
o fluctuations in demand for Internet access and enhanced
products and services; and
o potential customers perception of the financial soundness of
the Company.
Therefore, we believe that period-to-period comparisons of our
operating results are not necessarily meaningful and cannot be relied upon as
indicators of future performance. If our operating results in any future period
fall below the expectations of analysts and investors, the market price of our
Common stock would likely decline.
THE MARKET PRICE AND TRADING VOLUME OF OUR COMMON STOCK ARE VOLATILE.
The market price of our Common stock has fluctuated significantly in
the past, and is likely to continue to be highly volatile. In addition, the
trading volume in our Common stock has fluctuated, and significant price
variations can occur as a result. We cannot assure you that the market price of
our Common stock will not fluctuate or decline significantly in the future. In
addition, the U.S. equity markets have from time to time experienced significant
price and volume fluctuations that have particularly affected the market prices
for the stocks of small capitalization, technology and telecommunications
companies. These broad market fluctuations may materially adversely affect the
market price of our Common stock in the future. Such variations may be the
result of changes in our business, operations or prospects, announcements of
technological innovations and new products by competitors, new contractual
relationships with strategic partners by us or our competitors, proposed
acquisitions by us or our competitors, financial results that fail to meet
public market analyst expectations, regulatory considerations and domestic and
international market and economic conditions.
WE MAY BE UNABLE TO MAINTAIN THE STANDARDS FOR LISTING ON THE NASDAQ NATIONAL
MARKET, WHICH COULD MAKE IT MORE DIFFICULT FOR INVESTORS TO DISPOSE OF OUR
COMMON STOCK AND COULD SUBJECT OUR COMMON STOCK TO THE "PENNY STOCK" RULES.
Our Common stock is listed on the Nasdaq National Market. While the
Nasdaq Has temporarily suspended the application of certain of its listing
requirements, Nasdaq generally requires listed companies to maintain standards
for continued listing, Including either a minimum bid price for shares of a
company's stock or a minimum tangible net worth. For example, Nasdaq requires
listed companies to maintain a minimum bid price of at least $1.00. If a
company's stock does not close with a minimum bid price of at least $1.00 for 30
21
consecutive trading days, then the registrant will be out of compliance with one
aspect of the Nasdaq continued listing standards. In this event, the Nasdaq's
rules allow the registrant 90 days in which to regain compliance with the
Nasdaq's listing standard by having its stock close with a minimum bid price of
$1.00 or more for ten consecutive trading days. If a registrant is unable to
cure the non-compliance within 90 days, then the company will be subject to
delisting, pending an opportunity to appeal. Maintaining compliance with each
aspect of the Nasdaq's listing standards is an on-going process for each listed
company. If we were to be delisted from the Nasdaq National Market then trading
in our stock would then be conducted on the Nasdaq SmallCap Market unless we are
unable to meet the requirements for inclusion. If we were unable to meet the
requirements for inclusion in the SmallCap Market, our Common stock would be
traded on an electronic bulletin board established for securities that do not
meet the Nasdaq listing requirements or in quotations published by the National
Quotation Bureau, Inc. that are commonly referred to as the "pink sheets". As a
result, it could be more difficult to sell, or obtain an accurate quotation as
to the price of our Common stock and certain institutional investors might not
be able to hold our Common stock.
In addition, if our Common stock were delisted, it would be subject to
the so-called penny stock rules. The SEC has adopted regulations that define a
"penny stock" to be any equity security that has a market price of less than
$5.00 per share, subject to certain exceptions. For any transaction involving a
penny stock, unless exempt, the rules impose additional sales practice
requirements on broker-dealers subject to certain exceptions.
For transactions covered by the penny stock rules, a broker-dealer must
make a special suitability determination for the purchaser and must have
received the purchaser's written consent to the transaction prior to the sale.
The penny stock rules also require broker-dealers to deliver monthly statements
to penny stock investors disclosing recent price information for the penny stock
held in the account and information on the limited market in penny stocks. Prior
to the transaction, a broker-dealer must provide a disclosure schedule relating
to the penny stock market. In addition, the broker-dealer must disclose the
following:
o commissions payable to the broker-dealer and the registered
representative; and
o current quotations for the security as mandated by the
applicable regulations.
If our Common stock were delisted and determined to be a "penny stock,"
a broker-dealer may find it to be more difficult to trade our Common stock, and
an investor may find it more difficult to acquire or dispose of our Common stock
in the secondary market.
FUTURE SALES OF OUR COMMON STOCK COULD REDUCE THE PRICE OF OUR STOCK AND OUR
ABILITY TO RAISE CASH IN FUTURE EQUITY OFFERINGS.
No prediction can be made as to the effect, if any, that future sales
of shares of Common stock or the availability for future sale of shares of
Common stock or securities convertible into or exercisable for our Common stock
will have on the market price of our Common stock. Sale, or the availability for
sale, of substantial amounts of Common stock by existing stockholders under Rule
144, through the exercise of registration rights or the issuance of shares of
Common stock upon the exercise of stock options or warrants, or the perception
that such sales or issuances could occur, could adversely affect prevailing
market prices for our Common stock and could materially impair our future
ability to raise capital through an offering of equity securities.
IN THE FUTURE, WE MAY BE UNABLE TO EXPAND OUR SALES, TECHNICAL SUPPORT AND
CUSTOMER SUPPORT INFRASTRUCTURE, WHICH MAY HINDER OUR ABILITY TO GROW AND MEET
CUSTOMER DEMANDS.
On October 10, 2000, we terminated 44 employees across all departments
of the Company. This involuntary termination may make it more difficult to
attract and retain employees. If, in the future, we are unable to expand our
sales force and our technical support and customer support staff, our business
would be harmed because this would limit our ability to obtain new customers,
sell products and services and provide existing customers with a high level of
technical support.
WE COULD FACE SIGNIFICANT AND INCREASING COMPETITION IN OUR INDUSTRY, WHICH
COULD CAUSE US TO LOWER PRICES RESULTING IN REDUCED REVENUES.
The growth of the Internet access and related services market and the
absence of substantial barriers to entry have attracted many start-ups as well
as existing businesses from the telecommunications, cable, and technology
industries. As a result, the market for Internet access and related services is
very competitive. We anticipate that competition will continue to intensify as
the use of the Internet grows. Current and prospective competitors include:
22
o national Internet service providers and regional and local
Internet service providers, including providers of free
dial-up Internet access;
o national and regional long distance and local
telecommunications carriers;
o cable operators and their affiliates;
o providers of Web hosting, colocation and other Internet-based
business services;
o computer hardware and other technology companies that bundle
Internet connections with their products; and
o terrestrial wireless and satellite Internet service providers.
We believe that the number of competitors we face is significant and is
constantly changing. As a result, it is extremely difficult for us to accurately
identify and quantify our competitors. In addition, because of the constantly
evolving competitive environment, it is extremely difficult for us to determine
our relative competitive position at any given time.
As a result of vertical and horizontal integration in the industry, we
currently face and expect to continue to face significant pricing pressure and
other competition in the future. Advances in technology and changes in the
marketplace and the regulatory environment will continue, and we cannot predict
the effect that ongoing or future developments may have on us or the pricing of
our products and services.
Many of our competitors have significantly greater market presence,
brand-name recognition, and financial resources than we do. In addition, all of
the major long distance telephone companies, also known as interexchange
carriers, offer Internet access services. The recent reforms in the federal
regulation of the telecommunications industry have created greater opportunities
for local exchange carriers, including incumbent local exchange carriers and
competitive local exchange carriers, to enter the Internet access market. In
order to address the Internet access requirements of the current business
customers of long distance and local carriers, many carriers are integrating
horizontally through acquisitions of or joint ventures with Internet service
providers, or by wholesale purchase of Internet access from Internet service
providers. In addition, many of the major cable companies and other alternative
service providers, such as those companies utilizing wireless and satellite
based service technologies, have announced their plans to offer Internet access
and related services. Accordingly, we may experience increased competition from
traditional and emerging telecommunications providers. Many of these companies,
in addition to their substantially greater network coverage, market presence,
and financial, technical and personnel resources, also already provide
telecommunications and other services to many of our target customers.
Furthermore, they may have the ability to bundle Internet access with basic
local and long distance telecommunications services, which we do not currently
offer. This bundling of services may harm our ability to compete effectively
with them and may result in pricing pressure on us that would reduce our
earnings.
OUR GROWTH DEPENDS ON THE CONTINUED ACCEPTANCE BY SMALL AND MEDIUM SIZED
ENTERPRISES OF THE INTERNET FOR COMMERCE AND COMMUNICATION.
If the use of the Internet by small and medium sized enterprises for
commerce and communication does not continue to grow, our business and results
of operations will be harmed. Our products and services are designed primarily
for the rapidly growing number of business users of the Internet. Commercial use
of the Internet by small and medium sized enterprises is still in its early
stages. Despite growing interest in the commercial uses of the Internet, many
businesses have not purchased Internet access and related services for several
reasons, including:
o lack of inexpensive, high-speed connection options;
o a limited number of reliable local access points for business
users;
o lack of affordable electronic commerce solutions;
o limited internal resources and technical expertise;
o inconsistent quality of service; and
o difficulty in integrating hardware and software related to
Internet based business applications.
23
In addition, we believe that many Internet users lack confidence in the
security of transmitting their data over the Internet, which has hindered
commercial use of the Internet. Technologies that adequately address these
security concerns may not be developed.
The adoption of the Internet for commerce and communication
applications, particularly by those enterprises that have historically relied
upon alternative means, generally requires the understanding and acceptance of a
new way of conducting business and exchanging information. In particular,
enterprises that have already invested substantial resources in other means of
conducting commerce and exchanging information may be reluctant or slow to adopt
a new strategy that may make their existing personnel and infrastructure
obsolete.
OUR SUCCESS DEPENDS ON THE CONTINUED DEVELOPMENT OF INTERNET INFRASTRUCTURE.
The recent growth in the use of the Internet has caused periods of
performance degradation, requiring the upgrade by providers and other
organizations with links to the Internet of routers and switches,
telecommunications links and other components forming the infrastructure of the
Internet. We believe that capacity constraints caused by rapid growth in the use
of the Internet may impede further development of the Internet to the extent
that users experience increased delays in transmission or reception of data or
transmission errors that may corrupt data. Any degradation in the performance of
the Internet as a whole could impair the quality of our products and services.
As a consequence, our future success will be dependent upon the reliability and
continued expansion of the Internet.
WE RELY ON A LIMITED NUMBER OF VENDORS AND SERVICE PROVIDERS, SOME OF WHICH ARE
OUR COMPETITORS. THIS MAY ADVERSELY AFFECT THE FUTURE TERMS OF OUR
RELATIONSHIPS.
We rely on other companies to supply key components of our network
infrastructure, which are available only from limited sources. For example, we
currently rely on routers, switches and remote access devices from Lucent
Technologies, Inc., Cisco Systems, Inc. and Nortel Networks Corporation. We
could be adversely affected if any of these products were no longer available on
commercially reasonable terms, or at all. From time to time, we experience
delays in the delivery and installation of these products and services, which
can lead to the loss of existing or potential customers. We do not know that we
will be able to obtain such products in the future cost-effectively and in a
timely manner. Moreover, we depend upon telecommunication companies as our
backbone providers. These companies also sell products and services that compete
with ours. Our agreements with our primary backbone providers are fixed price
contracts with terms ranging from one to three years. Our backbone providers
operate national or international networks that provide data and Internet
connectivity and enable our customers to transmit and receive data over the
Internet. Our relationship with these backbone providers could be adversely
affected as a result of our direct competition with them. Failure to renew these
relationships when they expire or enter into new relationships for such services
on commercially reasonable terms or at all could harm our business, financial
condition and results of operations.
WE NEED TO RECRUIT AND RETAIN QUALIFIED PERSONNEL OR OUR BUSINESS COULD BE
HARMED.
Competition for highly qualified employees in the Internet service
industry is intense because there are a limited number of people with an
adequate knowledge of and significant experience in our industry. Our success
depends largely upon our ability to attract, train and retain highly skilled
management, technical, marketing and sales personnel and upon the continued
contributions of such people. Since it is difficult and time consuming to
identify and hire highly qualified employees, we cannot assure you of our
ability to do so. Our failure to attract additional highly qualified personnel
could impair our ability to grow our operations and services to our customers.
WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH COULD RESULT
IN THE LOSS OF OUR CUSTOMERS OR LIABILITY TO OUR CUSTOMERS.
The continued operation of our network infrastructure depends upon our
ability to protect against:
o downtime due to malfunction or failure of hardware or
software;
o overload conditions;
o power loss or telecommunications failures;
o human error;
24
o natural disasters; and
o sabotage or other intentional acts of vandalism.
Any of these occurrences could result in interruptions in the services
we provide to our customers and require us to spend substantial amounts of money
repairing and replacing equipment. In addition, we have finite capacity to
provide service to our customers under our current infrastructure. Because
utilization of our network is constantly changing depending upon customer use at
any given time, we maintain a level of capacity that we believe to be adequate
to support our current customer base. If we obtain additional customers in the
future, we will need to increase our capacity to maintain the quality of service
that we currently provide our customers. If customer usage exceeds our capacity
and we are unable to increase our capacity in a timely manner, our customers may
experience interruptions in or decreases in quality of the services we provide.
As a result, we may lose current customers or incur significant liability to our
customers for any damages they suffer due to any system downtime as well as the
possible loss of customers.
OUR NETWORK MAY EXPERIENCE SECURITY BREACHES, WHICH COULD DISRUPT OUR SERVICES.
Our network infrastructure may be vulnerable to computer viruses,
break-ins and similar disruptive problems caused by our customers or other
Internet users. Computer viruses, break-ins or other problems caused by third
parties could lead to interruptions, delays or cessation in service to our
customers. There currently is no existing technology that provides absolute
security, and the cost of minimizing these security breaches could be
prohibitively expensive. We may face liability to customers for such security
breaches. Furthermore, such incidents could deter potential customers and
adversely affect existing customer relationships.
WE COULD FACE POTENTIAL LIABILITY FOR INFORMATION DISSEMINATED THROUGH OUR
NETWORK.
It is possible that claims could be made against Internet service
providers in connection with the nature and content of the materials
disseminated through their networks. The law relating to the liability of
Internet service providers due to information carried or disseminated through
their networks are not completely settled. While the U.S. Supreme Court has held
that content transmitted over the Internet is entitled to the highest level of
protection under the U.S. Constitution, there are federal and state laws
regarding the distribution of obscene, indecent, or otherwise illegal material,
as well as material that violates intellectual property rights which may subject
us to liability. Several private lawsuits have been brought in the past and are
currently pending against other entities which seek to impose liability upon
Internet service providers as a result of the nature and content of materials
disseminated over the Internet. If any of these actions succeed, we might be
required to respond by investing substantial resources or discontinuing some of
our service or product offerings, which could harm our business.
NEW LAWS AND REGULATIONS GOVERNING OUR INDUSTRY COULD HARM OUR BUSINESS.
We are subject to a variety of risks that could materially affect our
business due to the rapidly changing legal and regulatory landscape governing
Internet access providers. For example, the Federal Communications Commission
currently exempts Internet access providers from having to pay per-minute access
charges that long-distance telecommunications providers pay local telephone
companies for the use of the local telephone network. In addition, Internet
access providers are currently exempt from having to pay a percentage of their
gross revenues as a contribution to the federal universal service fund. Should
the Federal Communications Commission eliminate these exemptions and impose such
charges on Internet access providers, this would increase our costs of providing
dial-up Internet access service and could have a material adverse effect on our
business, financial condition and results of operations.
We face risks due to possible changes in the way our suppliers are
regulated which could have an adverse effect on our business. For example, most
states require local exchange carriers to pay reciprocal compensation to
competing local exchange carriers for the transport and termination of Internet
traffic. However, in February 1999, the Federal Communications Commission
concluded that at least a substantial portion of dial-up Internet traffic is
jurisdictionally interstate, which could ultimately eliminate the reciprocal
compensation payment requirement for Internet traffic. Should this occur our
telephone carriers might no longer be entitled to receive payment from the
originating carrier to terminate traffic delivered to us. The Federal
Communications Commission has launched an inquiry to determine a mechanism for
covering the costs of terminating calls to Internet service providers, but in
the interim state commissions will determine whether carriers will receive
compensation for such calls. If the new compensation mechanism that may be
adopted by the Federal Communications Commission increases the costs to our
telephone carriers for terminating traffic to us, or if states eliminate
reciprocal compensation payments, our telephone carriers may increase the price
of service to us in order to recover such costs. This could have a material
adverse effect on our business, financial condition and results of operations.
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None.
(b) On October 5, 2001, the Company filed a report on Form 8-K
relating to the Series A Preferred Stock Purchase Agreement
entered into by the Company with several investors.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FASTNET Corporation:
Date: November 14, 2001 /s/ Stephen A. Hurly
------------------------------------
Stephen A. Hurly
Chief Executive Officer
Date: November 14, 2001 /s/ Stanley F. Bielicki
------------------------------------
Stanley F. Bielicki
Chief Financial Officer
26