UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2002
[ ] 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
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
PENNSYLVANIA 23-2767197
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(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
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(610) 266-6700
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
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(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 [ ] No |X|
The number of shares of the registrant's Common stock outstanding as of
November 13, 2002 was 25,571,323.
FASTNET CORPORATION
FORM 10-Q
SEPTEMBER 30, 2002
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets - September 30, 2002 and December 31, 2001.............3
Consolidated Statements of Operations - Three and Nine Months Ended
September 30, 2002 and 2001 ......................................................4
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 2002 and 2001 ......................................................5
Notes to Unaudited Consolidated Financial Statements ..............................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................................18
Item 3. Qualitative and Quantitative Disclosures About Market Risk .......................25
Item 4. Controls and Procedures...........................................................25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................................25
Item 2. Changes in Securities and Use of Proceeds ........................................25
Item 3. Defaults Upon Senior Securities ..................................................25
Item 4. Submission of Matters to a Vote of Security Holders ..............................25
Item 5. Other Information ................................................................26
Item 6. Exhibits and Reports on Form 8-K .................................................35
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
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ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents .......................................... $ 3,677,120 $ 10,271,755
Marketable securities .............................................. 1,057,848 --
Accounts receivable, net of allowance of $1,808,189 and
$1,135,398 ....................................................... 8,061,231 2,663,800
Receivables due to bankruptcy estate of acquiree (Note 2) .......... 1,532,130 --
Other current assets ............................................... 707,969 500,795
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Total current assets .................................. 15,036,298 13,436,350
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RESTRICTED MARKETABLE SECURITIES ........................................ 4,800,000 2,300,100
PROPERTY AND EQUIPMENT, net ............................................. 17,727,887 16,397,900
INTANGIBLES, net of accumulated amortization of $2,850,030 and $1,723,947 5,049,970 1,376,053
GOODWILL ................................................................ 14,936,934 5,389,991
OTHER ASSETS ............................................................ 520,355 295,451
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$ 58,071,444 $ 39,195,845
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt .................................. $ 173,664 $ 1,160,205
Current portion of capital lease obligations (Note 8) .............. 3,686,392 366,741
Capital lease buyout ............................................... -- 1,600,000
Payable due to bankruptcy estate of acquiree (Note 2) .............. 2,500,000 --
Accounts payable ................................................... 8,891,891 2,819,073
Accrued expenses ................................................... 4,837,457 2,696,348
Deferred revenues .................................................. 7,344,942 3,446,854
Accrued restructuring .............................................. 1,215,375 1,772,117
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Total current liabilities ............................. 28,649,721 13,861,338
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LONG-TERM DEBT .......................................................... 7,287,569 2,123,923
CAPITAL LEASE OBLIGATIONS ............................................... 85,814 32,520
OTHER LIABILITIES ....................................................... 208,649 141,213
SHAREHOLDERS' EQUITY:
Preferred stock (10,000,000 shares authorized, 3,406,293 shares
issued and outstanding) .......................................... 2,253,871 1,266,247
Common stock (50,000,000 shares authorized, 25,571,323 and
20,390,947 shares outstanding) ................................... 76,130,619 71,194,396
Deferred compensation .............................................. (50,885) (357,937)
Note receivable .................................................... (483,441) (463,750)
Accumulated other comprehensive loss ............................... (1,026) --
Accumulated deficit ................................................ (55,009,447) (47,602,105)
Less - Treasury stock, 5,787,610 shares, at cost ................... (1,000,000) (1,000,000)
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Total shareholders' equity ............................ 21,839,691 23,036,851
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$ 58,071,444 $ 39,195,845
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
3
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
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REVENUES .......................................... $ 10,493,454 $ 3,629,943 $ 22,784,113 $ 11,333,543
OPERATING EXPENSES:
Cost of revenues ............................... 6,502,442 2,063,758 12,784,672 8,144,164
Selling, general and administrative (excluding
depreciation) ................................ 3,614,532 2,503,062 9,473,105 8,251,830
Depreciation and amortization .................. 2,346,245 2,109,175 6,730,409 5,828,767
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Total operating expenses ...................... 12,463,219 6,675,995 28,988,186 22,224,761
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Operating loss ................................. (1,969,765) (3,046,052) (6,204,073) (10,891,218)
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OTHER INCOME (EXPENSE):
Gain on early extinguishment of debt ........... -- 1,630,328 -- 1,630,328
Interest income ................................ 59,332 98,135 181,879 576,759
Interest expense ............................... (147,816) (105,741) (372,019) (605,403)
Other .......................................... (14,824) (3,217) (25,505) (7,043)
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Other expense, net ............................ (103,308) 1,619,505 (215,645) 1,594,641
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NET LOSS .......................................... (2,073,073) (1,426,547) (6,419,718) (9,296,577)
Deemed Dividend - Beneficial Conversion Feature ... (246,906) (89,813) (987,624) (89,813)
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NET LOSS APPLICABLE TO COMMON SHAREHOLDERS ........ $ (2,319,979) $ (1,516,360) $ (7,407,342) $ (9,386,390)
============= ============= ============= =============
BASIC AND DILUTED NET LOSS PER COMMON SHARE ....... $ (0.09) $ (0.09) $ (0.31) $ (0.56)
============= ============= ============= =============
SHARES USED IN COMPUTING BASIC AND DILUTED NET LOSS
PER COMMON SHARE .................................. 25,215,308 17,428,218 23,888,774 16,831,528
============= ============= ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
4
FASTNET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
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OPERATING ACTIVITIES:
Net loss ................................................. $ (6,419,718) $ (9,296,577)
Adjustments to reconcile net loss to net cash
used in operating activities:
Gain on Extinguishment of debt .................... -- (1,630,328)
Depreciation and amortization ..................... 6,730,409 5,828,767
Amortization of debt discount ..................... 8,363 --
Amortization of deferred compensation ............. 18,891 114,536
Stock-based compensation expense .................. 39,315 37,932
Provision for doubtful accounts ................... 497,183 33,644
Interest income from note ......................... (19,691) --
Changes in operating assets and liabilities,
net of acquisition changes:
(Increase)decrease in assets:
Accounts receivable ........................ (4,832,889) 74,011
Other assets ............................... (211,723) (89,219)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses ...... 1,943,480 (2,776,188)
Deferred revenues .......................... 815,699 123,551
Accrued restructuring ...................... (556,742) (2,910,058)
Other liabilities .......................... 10,730 35,538
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Net cash used in operating activities .. (1,976,693) (10,454,391)
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INVESTING ACTIVITIES:
Purchases of property and equipment ...................... (465,954) (666,388)
Cash acquired (paid for) acquisitions, net ............... (1,177,982) 208,821
(Purchases) sales of marketable securities, net .......... (3,558,774) 13,560,458
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Net cash provided by (used in) investing activities (5,202,710) 13,102,891
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FINANCING ACTIVITIES:
Proceeds from long-term debt ............................. 3,075,000 --
Payment of capital lease settlement ...................... (1,600,000) (2,000,000)
Repayments of long-term debt ............................. (657,880) (262,019)
Proceeds from issuance of series A preferred stock, net .. -- 2,205,114
Repayments of capital lease obligations .................. (232,352) (1,155,681)
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Net cash provided by (used in) financing activities 584,768 (1,212,586)
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......... (6,594,635) 1,435,914
CASH AND CASH EQUIVALENTS, beginning of period ................ 10,271,755 5,051,901
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CASH AND CASH EQUIVALENTS, end of period ...................... $ 3,677,120 $ 6,487,815
============= =============
The accompanying notes are an integral part of these consolidated
financial 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")
have been providing Internet access and enhanced products and services to its
customers since 1994. The Company is an Internet services provider to businesses
and residential customers located in the Northeast United States primarily
providing services in the following states: New York, Pennsylvania,
Massachusetts, Connecticut, New Jersey, Virginia, Maryland, Delaware and
Washington, DC. 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.
LIQUIDITY AND GOING CONCERN
The Company's business plan has required substantial capital to fund
operations, capital expenditures, and acquisitions. The Company modified its
business strategy in October 2000. 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. These
actions reduced the Company's cash consumption. In December 2001, the Company
recorded an additional charge related to excess data center facilities and
office space that are non-cancelable commitments of the Company. The Company
periodically re-evaluates the adequacy of this reserve and may adjust the
reserve as required (see Note 7).
The Company has incurred losses since inception and expects to continue
to incur losses in 2002. As of September 30, 2002, the Company's accumulated
deficit was $55,009,447. As of September 30, 2002, cash and cash equivalents and
marketable securities were $4,734,968. The Company's working capital deficit is
$13,613,423 as of September 30, 2002. In October 2002, the Company liquidated
restricted certificates of deposit of $4,800,000 in order to repay a bank note
(see Note 8). The Company believes that its existing cash and cash equivalents,
marketable securities, cash flows from operations, anticipated debt and lease
financing will be sufficient to meet its working capital and capital expenditure
requirements to the end of 2003 assuming satisfactory negotiation of capital
lease obligations which are included in current liabilities (see Note 8) and
repayment of the receivables collected on behalf of the Company due to the
estate of AppliedTheory. In order to finance the Company's strategic acquisition
plan and other operating strategies, the Company is actively seeking additional
debt and equity financing (see Note 2). 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 make operational changes to
decrease cash consumption. These changes may include closing certain markets and
making further reductions in head count, among other things. Any of these events
could harm the Company's business, financial condition, cash flows 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, capital
availability and dependence on key personnel. See Part II, Item 5 of this Form
10-Q for a description of additional factors that may affect the Company's
future operating results.
QUARTERLY FINANCIAL INFORMATION AND RESULTS OF OPERATIONS
The accompanying unaudited financial information as of September 30,
2002 and for the three and nine months ended September 30, 2002 and 2001 has
been prepared in accordance with accounting principles generally accepted in the
United States of America. 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 three and nine months ended September 30, 2002 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.
6
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 of America 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.
COMPREHENSIVE LOSS
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 (loss) by their nature
in a financial statement and display the accumulated balance of other
comprehensive income (loss) separately in the shareholders' equity section of
the consolidated balance sheets. For the three and nine months ended September
30, 2002 and 2001, comprehensive loss was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
-------------- ------------- ------------- -------------
Net loss before deemed dividend...................... $ (2,073,073) $ (1,426,547) $ (6,419,718) $ (9,296,577)
Unrealized gain (loss) on marketable securities...... -- 13,633 (1,026) (2,618)
-------------- ------------- ------------- -------------
Comprehensive loss................................... $ (2,073,073) $ (1,412,914) $ (6,420,744) $ (9,299,195)
============== ============= ============= =============
REVENUE RECOGNITION
Revenues include one-time and ongoing charges to customers for
accessing the Internet. One-time charges primarily relate to the initial
connection fees and telecommunication equipment sales and are recognized as
revenue over the term of the customer contract. The Company recognizes ongoing
access revenue over the period the services are provided. The Company offers
contracts for Internet access that are generally billed in advance of providing
service. These advance billings are recorded as deferred revenues and recognized
to revenue ratably over the service period as they are earned.
Revenues are also derived from web hosting services. The Company sells
its web hosting and related services for contractual periods ranging from one to
twelve months. These contacts 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 revenue in the
period in which customers utilize such services.
Revenues also include professional services and web design and
development related projects. Revenues from professional services and web design
and development related projects are generally recognized as the services are
provided. The Company generally recognizes project revenue using the
percentage-of-completion method. The percentage-of-completion method is used
over a period of time that commences with an execution of the project agreement
and ends when the project is complete. Any anticipated losses on contracts are
recorded to earnings when identified. Amounts received or billed in excess of
revenues recognized to date are classified as deferred revenues, whereas
revenues recognized in excess of amounts billed are classified as unbilled
accounts receivable and are included in accounts receivable in the accompanying
consolidated balance sheets.
MAJOR CUSTOMERS
The Company derived approximately 17% and 10% of total revenues for the
three and nine months ended September 30, 2002, respectively, from one customer.
As of September 30, 2002, the Company had outstanding accounts receivable from
this customer of $628,434. The Company derived approximately 7% and 7% of total
revenues for the three and nine months ended September 30, 2002, respectively,
from a different customer. As of September 30, 2002, the Company had outstanding
accounts receivable from this customer of $409,725. This customer is also a
shareholder of the Company (see Note 13).
7
In the three and nine months ended September 30, 2001, the Company
derived approximately 5% and 11% of total revenues, respectively, from another
customer. The Company discontinued providing services to this customer in
September 2001.
GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets". SFAS No. 142 no longer permits the amortization of
goodwill and indefinite-live intangible assets. Instead, these assets must be
reviewed annually for impairment in accordance with this statement. Accordingly,
the Company has ceased amortization of all goodwill and indefinite-live
intangible assets as of January 1, 2002. During the second quarter of 2002, the
Company completed the transitional impairment test of goodwill and other
intangible assets, which indicated that the goodwill and other intangible assets
were not impaired. Other intangible assets that meet the new criteria continue
to be amortized (see Note 5).
Amortization of goodwill was $277,056 and $752,598 for the three and
nine months ended September 30, 2001, respectively. Amortization of other
intangibles was $394,089, $196,668, $1,126,083 and $585,004 for the three months
ended September 30, 2002 and 2001 and the nine months ended September 30, 2002
and 2001, respectively.
The following table presents the impact of SFAS No. 142 relating to the
goodwill amortization on operating loss and net loss as if SFAS No. 142 was in
effect for the three and nine months ended September 30, 2001.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------------------- ------------------------------
AS REPORTED AS ADJUSTED AS REPORTED AS ADJUSTED
-------------- ------------- ------------- -------------
Loss from operations................................. $ (3,046,052) $ (2,768,996) $(10,891,218) $(10,138,620)
Net loss............................................. (1,426,547) (1,149,491) (9,296,577) (8,543,979)
-------------- ------------- ------------- -------------
Basic and diluted net loss per common share.......... $ (0.09) $ (0.07) $ (0.56) $ (0.51)
============== ============= ============= =============
ROLLFORWARD OF GOODWILL
The changes in the carrying amount of goodwill for the nine months
ended September 30, 2002 are as follows (see Note 2):
Balance, December 31, 2001 $ 5,389,991
Add: Acquisition of SuperNet 1,290,945
Add: Acquisition of NetAxs 7,640,600
Add: Assets acquired from AppliedTheory 1,227,000
Less: Adjustment to Cybertech goodwill (126,355)
Add: Adjustment to NetReach goodwill 40,550
Add: Adjustment to SuperNet 216,912
Less: Adjustment of NetAxs (879,098)
Add: Adjustment to AppliedTheory 136,389
-------------
Balance, September 30, 2002 $ 14,936,934
=============
Adjustments above were made to reflect changes to estimated fair values
of the assets and liabilities acquired. AppliedTheory and SuperNet adjustments
primarily consist of adjustments to properly reflect acquired deferred revenue
and fixed assets. NetAxs adjustment is primarily attributable to the reduction
of the balance of notes payable to former owners to offset unpaid payroll tax
liability (see Note 9).
IMPAIRMENT ANALYSIS
The Company is in the process of completing the first step of the
annual goodwill impairment test under SFAS 142. With the assistance of an
independent valuation firm, the Company will be performing a fair market value
analysis on our reporting unit in the fourth quarter of 2002. In conjunction
with the impairment tests under SFAS 142, we are also in the process of testing
its identified intangible assets for impairment under SFAS 144. The Company is
8
required to perform a fair market value analysis of its identified intangible
assets under SFAS 144 and record an impairment charge and writedown of such
assets, if any, prior to recording an impairment charge for goodwill. The SFAS
142 and SFAS 144 impairment tests may require the Company to record a non-cash
charge in the fourth quarter of 2002 to write-down a significant portion of its
goodwill and identified intangible assets.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations", which addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The standard applies to legal obligations associated with the retirement
of long-lived assets that result from the acquisition, construction, development
and (or) normal use of the asset. SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
fair value of the liability is added to the carrying amount of the associated
asset and this additional carrying amount is depreciated over the life of the
asset. The liability is accreted at the end of each period through charges to
operating expense. If the obligation is settled for other than the carrying
amount of the liability, a gain or loss on settlement would be recognized. The
Company is required and plans to adopt the provisions of SFAS No. 143 in 2003.
To accomplish this, the Company must identify all legal obligations for asset
retirement obligations, if any, and determine the fair value of these
obligations on the date of adoption. The adoption of SFAS No. 143 is not
expected to have a significant impact on the Company's results of operations,
financial position or cash flows.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of", it retains many
of the fundamental provisions of that Statement. SFAS No. 144 also supersedes
the accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business. However, SFAS No.
144 retains the requirement in Opinion No. 30 to report separately discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. The Company adopted the provisions of SFAS No.
144 effective January 1, 2002. The adoption of SFAS No. 144 did not have any
impact on results of operations, financial position or cash flows.
On April 30, 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, And 64, Amendment Of FASB Statement No. 13, And Technical
Corrections". The Statement updates, clarifies and simplifies existing
accounting pronouncements. SFAS No. 145 rescinds Statement No. 4, "Reporting
Gains and Losses from Extinguishment of Debt", which required all gains and
losses from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of related income tax effect. As a result, the
criteria in APB Opinion 30 will now be used to classify those gains and losses.
SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements", amended SFAS No. 4, and is no longer necessary because SFAS No. 4
has been rescinded. SFAS No. 145 amends SFAS No. 13, "Accounting for Leases", to
require that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. Certain provisions of SFAS No. 145 are effective
for fiscal years beginning after May 15, 2002, while other provisions are
effective for transactions occurring after May 15, 2002. The Company recorded an
extraordinary gain on the extinguishment of debt in the third and fourth
quarters of 2001 in the amounts of $1,630,328 and $4,006,049, respectively. As a
result of SFAS No. 145 which the Company has adopted, these amounts have been
reclassified from extraordinary to other income.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which requires that a liability
for a cost associated with an exit or disposal activity be recognized when the
liability is incurred and nullifies EITF 94-3. The Company plans to adopt SFAS
No. 146 in January 2003. Management believes that the adoption of this statement
will not have a material effect on the Company's future results of operations.
In September 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on EITF Issue No. 02-13, "Deferred Income Tax Considerations in
Applying the Goodwill Impairment Test in FASB Statement No. 142, Goodwill and
Other Intangible Assets". The EITF consensus requires that deferred income
taxes, if any, be included in the carrying amount of a reporting unit for the
purposes of the first step of the SFAS No. 142 goodwill impairment test. It also
provides guidance for determining whether to estimate the fair value of a
reporting unit by assuming that the unit could be bought or sold in a
non-taxable transaction versus a taxable transaction and the income tax bases to
use based on this determination. EITF No. 02-13 is effective for goodwill
impairment tests performed after September 12, 2002. The Company is currently
analyzing the impact EITF No. 02-13 will have on its consolidated financial
statements.
9
RECLASSIFICATIONS
Certain reclassifications have been made to the prior period to conform
to the current period presentation.
(2) 2001 AND 2002 ACQUISITIONS
All acquisitions have been accounted for using the purchase method of
accounting pursuant to Accounting Principles Board ("APB") No. 16, and SFAS No.
141, "Business Combinations."
CYBERTECH WIRELESS, INC.
On March 14, 2001, the Company acquired all the assets and assumed
substantially all the liabilities of Cybertech Wireless, Inc., ("Cybertech") a
provider of fixed wireless Internet services headquartered in Rochester, New
York, for 2,000,000 shares of unregistered Common stock valued at $1,875,000, or
$0.94 per share, the fair market value at the date of acquisition. The results
of operations from Cybertech have been included in the consolidated financial
statements from the date of acquisition. The excess of the purchase price over
the fair value of net assets acquired was determined to be $1,298,690. Based on
an independent valuation, $600,000 of the excess purchase price was allocated to
developed technology and the remaining $698,690 was allocated to goodwill, which
is expected to be deductible for tax purposes. The developed technology is being
amortized on a straight-line basis over a five-year period. The goodwill was
being amortized over a five-year period in 2001, however, in accordance with
SFAS No. 142, the goodwill is no longer amortized beginning January 1, 2002.
NETREACH, INC.
On November 1, 2001, the Company acquired all the outstanding capital
stock of NetReach, Inc., ("NetReach") an Internet service provider, web hosting,
web design and web application development company headquartered in Ambler,
Pennsylvania for 2,400,000 shares of unregistered Common stock valued at
$2,232,000, or $0.93 per share, the fair market value at the date of
acquisition. The excess of the purchase price over the fair value of net assets
acquired was determined to be $4,808,784. Based on an independent valuation,
$500,000 of the excess purchase price was allocated to customer relationships
and the remaining $4,308,784 was allocated to goodwill. The customer
relationships are being amortized on a straight-line basis over a five-year
period. In accordance with SFAS No. 142, the goodwill is not being amortized.
The former NetReach shareholders are entitled to receive up to an additional
690,900 shares of unregistered Common stock of the Company contingent upon the
achievement of certain revenues and margin targets, as defined, for each of the
five consecutive calendar quarters beginning October 1, 2001. The targets
related to the contingent consideration were not met in the quarters ended
December 31, 2001, March 31, 2002, June 30, 2002 and September 30, 2002.
SUPERNET, INC.
On January 31, 2002, the Company acquired all the outstanding capital
stock of SuperNet, Inc. ("SuperNet"), an Internet service provider headquartered
in East Brunswick, New Jersey. SuperNet provides Internet access to businesses
and residential customers, as well as web hosting and colocation services to
customers located in the central New Jersey region. The total purchase price was
$1,593,000, including transaction costs. The purchase price consisted of
1,096,907 unregistered shares of the Company's Common stock valued at
$1,064,000, or $0.97 per share, the fair market value at the date of
acquisition. The excess of the purchase price over the fair value of net assets
acquired was determined to be $1,790,945. Based on an independent valuation,
$500,000 of the excess purchase price was allocated to customer relationships
and the remaining $1,290,945 was allocated to goodwill, none of which is
deductible for tax purposes. The customer relationships are being amortized on a
straight-line basis over a five-year period. In accordance with SFAS No. 142,
the goodwill is not being amortized.
NETAXS, INC.
On April 4, 2002, the Company acquired all the outstanding capital
stock of NetAxs, Inc. ("NetAxs"), an Internet access, web hosting and colocation
provider located in the Philadelphia, Pennsylvania area. The aggregate
consideration paid was $984,690 in cash, the issuance of promissory notes to
certain shareholders of NetAxs having an aggregate principal amount of
$2,514,898, and 4,040,187 shares of unregistered Common stock valued at
$4,080,589, or $1.01 per share, the fair value of the Company's Common stock at
the date of acquisition. The principal due under the notes will accrue interest
at a rate of 7.09% per annum, and the notes are payable in monthly installments
through October 2005. The excess of purchase price over the fair value of net
assets acquired is estimated to be $8,140,600. Based on a preliminary
independent valuation, $400,000 was allocated to customer relationships,
$100,000 to trade names and the remaining $7,640,600 was allocated to goodwill.
The customer relationships and trade names are being amortized on a
straight-line basis over a three-year period. In accordance with SFAS No. 142,
10
the goodwill is not being amortized. Management expects that there could be
additional adjustments relating to the fair value of the acquired fixed assets
and unresolved telecommunication contracts as of the opening balance sheet,
which will adjust goodwill within the next twelve months.
APPLIEDTHEORY CORPORATION
On May 31, 2002, the Company, through a wholly-owned subsidiary
acquired selected assets of AppliedTheory Corporation and its subsidiaries
("AppliedTheory"). AppliedTheory was an Internet services business headquartered
in Syracuse, New York. The terms of the Asset Purchase Agreement were approved
by the United States Bankruptcy Court for the Southern District of New York, by
an order dated May 25, 2002, as a result of the voluntary petition for
bankruptcy filed by AppliedTheory under Chapter 11 of the U.S. Bankruptcy Code.
Under the terms of the Asset Purchase Agreement, the Company paid $4,000,000 in
cash for certain customers and fixed assets and assumed capital lease
obligations and other liabilities. The Company agreed to use its good faith
efforts to collect the accounts receivable of the acquired customer base in
existence on the Closing Date (the "Closing Receivables") on behalf of
AppliedTheory, and to remit to the Bankruptcy Court on or prior to December 31,
2002, no less than an aggregate of $2,500,000 of the Closing Receivables. The
Company has guaranteed this payment to the Bankruptcy Court. If the Company has
not collected and remitted an aggregate of $2,500,000 of the Closing Receivables
to the Bankruptcy Court on or prior to December 31, 2002, then the Company must
pay an amount equal to the difference to the Bankruptcy Court. Accordingly, the
Company has recorded the $2,500,000 as a liability on the accompanying
consolidated balance sheets.
Based upon collection information provided to the Company to date,
ClearBlue Technologies, Inc., an unrelated acquirer (ClearBlue Technologies,
Inc.) of a substantial portion of the AppliedTheory business, has collected
approximately $1,320,000 of the Closing Receivables and the Estate of
AppliedTheory (the "Estate") has collected approximately $210,000. The Company
has directly collected approximately $800,000 of the AppliedTheory Closing
Receivables purchased. The Company has requested ClearBlue Technologies, Inc. to
forward the amounts it has collected on FASTNET's behalf directly to the Estate.
The Company has requested, but not yet received, confirmation of the amounts
collected directly by the Estate. As a result, the receivables related to the
ClearBlue Technologies, Inc. and Estate collections have not been offset against
the amount due to the Estate as of September 30, 2002. The Company expects to
collect these amounts. However, if ClearBlue Technologies, Inc. does not remit
these payments to the Estate, the Company will be required to remit any
shortfalls.
The excess of the purchase price over the fair value of net assets
acquired is estimated to be $5,027,000. Based on a preliminary independent
valuation, approximately $3,800,000 was allocated to customer relationships, and
approximately $1,227,000 was allocated to goodwill. The customer relationships
are being amortized on a straight-line basis over a three-year period. In
accordance with SFAS No. 142, the goodwill is not being amortized.
The fixed assets acquired from AppliedTheory have been recorded at carryover net
book value. Management expects that there could be additional adjustments
relating to the fair value of the acquired fixed assets as a result of a
valuation of these assets to be performed subsequent to September 30, 2002. Any
adjustment in the fair value of the fixed assets will adjust goodwill.
The following table lists noncash assets that were acquired and
liabilities that were assumed as part of the above acquisitions:
Applied
Cybertech NetReach SuperNet NetAxs Theory
------------- -------------- ------------- ------------- -------------
(March 2001) (October 2001) (January 2002) (April 2002) (May 2002)
Noncash assets (liabilities) acquired:
Accounts receivable $ 76,827 $ 432,633 $ 50,978 $ 524,574 $ 2,300,000
Other assets 101,638 28,624 4,380 225,971 --
Property and equipment 1,953,682 232,630 64,124 2,537,037 4,112,752
Intangibles 1,298,690 4,808,784 1,790,945 8,140,600 5,027,062
Accounts payable (1,013,626) (1,375,713) (207,569) (1,762,499) (250,000)
Accrued expenses (306,135) (748,094) (181,586) (2,448,237) (619,384)
Deferred revenues (181,083) (252,082) (77,003) (679,069) (2,379,939)
Debt and capital lease obligations (250,000) (877,701) -- (2,175,320) (1,690,491)
Other liabilities (13,814) -- -- (969,857) (2,500,000)
------------- -------------- ------------- ------------- -------------
Acquired net assets 1,666,179 2,249,081 1,444,269 3,393,200 4,000,000
Less--Common stock issued (1,875,000) (2,232,000) (1,064,000) (4,080,589) --
Less--Notes issued -- -- -- (2,514,898) --
------------- -------------- ------------- ------------- -------------
Cash paid (acquired), net $ (208,821) $ 17,081 $ 380,269 $ (3,202,287) $ 4,000,000
============= ============== ============= ============= =============
11
The pro forma information for the 2001 and 2002 acquisitions has not
been presented as the Company is in the process of analyzing the historical
financial results of NetAxs. Once the NetAxs historical information is fully
analyzed, the pro forma data will be presented incorporating the results of
NetAxs and NetReach. The pro forma information for Cybertech and SuperNet is and
will not be presented since the information is not material. Pro forma
information for AppliedTheory is not presented, as historical financial
information for the assets acquired from AppliedTheory is not available.
(3) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid debt investments purchased with
an original maturity of ninety days or less to be cash equivalents. The
restricted marketable securities on the accompanying consolidated balance sheets
represents a certificate of deposit that was required to be maintained with the
bank that held the Company's bank note (see Note 9). In October 2002, the
Company liquidated the certificate of deposit in order to pay off the principal
balance due for this bank note.
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, 2002, 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.
(4) PROPERTY AND EQUIPMENT
As of September 30, 2002 and December 31, 2001, property and equipment
consists of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -------------
Equipment ................... $ 25,159,106 $ 19,837,983
Computer equipment .......... 2,783,912 2,182,562
Computer software ........... 1,994,235 1,761,833
Furniture and fixtures ...... 775,822 670,620
Leasehold improvements ...... 3,879,768 3,205,532
------------- -------------
34,592,843 27,658,530
Less-Accumulated depreciation
and amortization .......... (16,864,956) (11,260,630)
------------- -------------
$ 17,727,887 $ 16,397,900
============= =============
Depreciation expense for the three months ended September 30, 2002 and
2001 and the nine months ended September 30, 2002 and 2001 was $1,952,156,
$1,635,451, $5,604,326 and $4,491,165, respectively. The net carrying value of
property and equipment under capital leases was $3,131,218 and $1,035,501 at
September 30, 2002 and December 31, 2001, respectively.
12
(5) INTANGIBLE ASSETS
Intangible assets, other than goodwill, consist of the following:
SEPTEMBER 30, 2002
-----------------------------------------------------
GROSS DECEMBER 31,
USEFUL CARRYING ACCUMULATED 2001
LIFE AMOUNT AMORTIZATION NET NET
--------- -------------- ---------------- --------------- ---------------
Customer relationships......... 3-5 years $ 7,200,000 $ (2,648,017) $ 4,551,983 $ 872,212
Developed technology........... 5 years 600,000 (185,344) 414,656 503,841
Trade names.................... 3 years 100,000 (16,669) 83,331 --
-------------- ---------------- --------------- ---------------
Total.......................... $ 7,900,000 $ (2,850,030) $ 5,049,970 $ 1,376,053
============== ================ =============== ===============
Amortization expense is estimated as follows: $438,000 for the three
months ended December 31, 2002; $1,753,000 for the year ended December 31, 2003;
$1,753,000 for the year ended December 31, 2004; $889,000 for the year ended
December 31, 2005; $208,000 for the year ended December 31, 2006 and $9,000 for
the year ended December 31, 2007.
(6) ACCRUED EXPENSES
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Vendor settlement .............. $ -- $ 200,000
Professional fees .............. 228,292 96,000
Accrued compensation and related
payroll taxes .............. 1,394,813 475,810
Customer deposits .............. 581,388 --
Other .......................... 2,632,964 1,924,538
----------- -----------
$4,837,457 $2,696,348
=========== ===========
Approximately $1,000,000 of the accrued compensation and related
payroll taxes as of September 30, 2002 relates to payroll taxes that were unpaid
upon the acquisition of NetAxs. Effective September 30, 2002, the Company
reached a settlement agreement with the note holders to reduce the balance of
the notes issued to certain former shareholders of NetAxs by the amount of the
initial liability recorded. (see Note 9)
(7) RESTRUCTURING CHARGES
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 "2000 Restructuring Plan"). Selling and marketing
efforts are now focused on targeted markets. The 2000 Restructuring Plan
included redesigning the network architecture intended to achieve an overall
reduction in telecommunication expenses. In conjunction with the 2000
Restructuring Plan, the Company terminated 44 employees.
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 cost in the markets
being closed. These costs consist of Internet backbone connectivity cost, as
well as network and access costs, for services that are no longer required in
the closed markets. Leasehold termination payments include 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 (see discussion below regarding 2001 Restructuring Charge which was
recorded in December 2001).
During the fourth quarter of 2000, the Company recorded a charge for
$5,159,503. 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. In addition in the fourth quarter of 2000,
the Company recorded a $3,233,753 asset impairment charge as a result of the
Restructuring Plan.
13
Throughout 2001, the Company continually reviewed the reserves that
were established in October 2000 as part of its 2000 Restructuring Plan. In the
fourth quarter of 2001, the Company recorded an additional charge of $1,335,790
related to its excess and idle data centers and administrative offices (the
"2001 Restructuring Charge"). The amount of the charge was determined using
assumptions regarding the Company's ability to sublet or dispose of these
facilities. This decision was made in the fourth quarter of 2001 as the Company
experienced significant difficulties in attempting to dispose of or sublet these
facilities due to an overall slowdown in the economy and, in particular, the
commercial real estate market. The Company is continuing its efforts to dispose
of or sublet these facilities. As of September 30, 2002, the total amount of
lease payments relating to these excess or idle facilities is approximately $4.1
million through 2010. However, the Company continually re-evalutes the adequacy
of this reserve and may adjust the reserve as required. Actual results could
differ materially from these estimates. As of September 30, 2002, Management
believes this provision will be adequate to cover any future costs incurred
relating to the restructuring.
The activity in the restructuring charge accrual during the nine months ended
September 30, 2002 is summarized in the table below:
CASH PAYMENTS
ACCRUED DURING THE ACCRUED
RESTRUCTURING NINE MONTHS RESTRUCTURING
AS OF ENDED AS OF
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
2001 2002 2002
-------------- ------------- -------------
Telecommunications exit and termination fees......... $ 233,980 $ -- $ 233,980
Leasehold termination costs.......................... 115,543 115,543 --
Sales and marketing contract terminations............ 52,321 -- 52,321
Facility exit costs.................................. 1,370,273 441,199 929,074
-------------- ------------- -------------
$ 1,772,117 $ 556,742 $ 1,215,375
============== ============= =============
(8) CAPITAL LEASE OBLIGATIONS
The Company is currently engaged in discussions with certain vendors
for the renegotiation of capital leases of approximately $3,529,000.
Accordingly, all outstanding amounts related to these leases have been
classified as current. The Company is actively pursuing measures to resolve this
liability. The Company is not currently making any payments on these obligations
and as a result may be considered to be in default of the capital lease
obligations.
(9) DEBT
As of September 30, 2002 and December 31, 2001, debt consisted of the
following:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
Bank Note............................ $ 4,800,000 $ 2,300,000
NetReach Notes....................... 737,854 732,273
NetAxs Notes......................... 1,394,813 --
Other................................ 528,566 251,855
-------------- -------------
7,461,233 3,284,128
Less--Current portion....... (173,664) (1,160,205)
-------------- -------------
$ 7,287,569 $ 2,123,923
============== =============
BANK NOTE
In December 2001, the Company entered into a loan agreement with a bank
and issued a $2,300,000 promissory note to the bank (the "Bank Note"). From
December 2001 through June 28, 2002, the Bank Note bore interest at the annual
rate of LIBOR plus 1.5%. The Bank Note was payable in consecutive monthly
payments of $95,833 principal and interest with all principal and interest due
in December 2003. On June 28, 2002, the Company amended its loan agreement with
the Bank. In accordance with the amendment, the then current principal balance
of $1,725,000 increased to $4,800,000. The Bank Note's interest rate was
adjusted to the annual rate of LIBOR plus 1.4%. In October 2002, the Company
repaid the balance of the Bank Note of $4,800,000 by utilizing proceeds from the
restricted marketable securities with the same bank (see Note 3). Interest
expense related to the Bank Note for the three and nine months ended September
30, 2002 was $40,316 and $75,194 respectively.
14
NOTES PAYABLE
NetReach Notes
--------------
In conjunction with the NetReach acquisition, the Company issued
various notes payable in the aggregate of $760,000 (the "NetReach Notes"). Of
the $760,000 total notes payable, $525,000 are convertible notes that convert
into the Company's Common stock at a conversion price of $2.00 per share.
Additionally, if the closing price of the Company's Common stock is at least
$3.00 per share for any consecutive 30 calendar days, the Company shall have the
right to convert all of the outstanding principal and interest due under the
convertible notes into unregistered shares of the Company's Common stock at a
conversion price equal to $2.00 per share. Convertible notes in the amount of
$95,000 bear interest at 8.0% and $431,000 of the convertible notes bear
interest at prime plus 4.0%. The convertible notes mature at various dates in
2003 and 2004. Additionally, several of the convertible notes were issued with
warrants to purchase a total of 52,140 shares of the Company's Common stock at
exercise prices ranging from $1.89 to $7.57 per share. The warrants expire at
various dates from February 9, 2008 through October 17, 2008. The Company valued
the warrants using the Black-Scholes option pricing model and recorded a debt
discount of $29,581 related to the warrants. The discount is being expensed over
the terms of the convertible notes.
The remaining balance of $235,000 of the NetReach Notes are term notes.
The term notes bear interest at 8.0% and mature in 2004. Interest expense
related to the NetReach Notes for the three and nine months ended September 30,
2002 was $16,005 and $48,015, respectively. Future maturities on the NetReach
Notes as of September 30, 2002 are $235,000 through September 30, 2003, $430,000
through September 30, 2004 and $115,000 through September 30, 2005.
NetAxs Notes
------------
In conjunction with the NetAxs acquisition in April 2002, the Company
issued promissory notes to certain shareholders of NetAxs having an aggregate
principal amount of $2,514,898 ("NetAxs Notes"). The principal due under these
notes accrue interest at a rate of 7.09% per annum and are payable in monthly
principal installments through October 2005. Subsequent to the Company's
acquisition of NetAxs, it was determined that NetAxs owed certain federal and
state payroll related liabilities of approximately $767,000, exclusive of
Penalty and interest charges. The Company determined that it has a right of
offset of this liability against the promissory notes and the escrowed indemnity
property of the former shareholders of NetAxs. The Company and the former
principal shareholders of NetAxs have reached agreement to offset payments of
these liabilities against the notes. Effective October 2002, the Company began
making payments under a repayment plan proposed by the Company to the taxing
authorities. In October 2002 the Company remitted an initial payment of $309,000
to taxing authorities and will remit $45,000 per month beginning November 2002
through August 2003, exclusive of penalties and interest. Accordingly, the notes
balances are net of approximately $1,060,000 due to the tax authorities.
Interest expense related to the NetAxs notes was $43,513 and $74,036 in the
three and nine months ended September 30, 2002. Future maturities on the notes
as of September 30, 2002 are $765,000 through September 30, 2004, $551,000
through September 30, 2005 and $80,000 through September 30, 2006.
In conjunction with the NetAxs acquisition, the Company acquired
certain notes payable due to a shareholder of the Company and a company owned by
a shareholder of the Company. The notes bear interest at 10% per annum. The
balance of these notes is $261,322 as of September 30, 2002. Interest expense
related to the notes was $6,598 and $20,080 for the three and nine months ended
September 30, 2002, respectively. Future maturities on the notes as of September
30, 2002 are $16,618 through September 30, 2003, $18,358 through September 30,
2004, $15,376 through September 30, 2005, $14,409 through September 30, 2006,
$15,918 through September 30, 2007 and $180,646 thereafter.
Other Convertible Note
----------------------
On October 25, 2000, the Company entered into an agreement with an
investor to provide the Company with financial advisory services. The agreement
was amended on February 12, 2001 and expired on June 30, 2001. In exchange for
these services, the Company issued a convertible note for $250,000. This note is
due on October 24, 2003 and is convertible into 221,239 shares of Common stock.
No interest or dividends are payable on this note. Accordingly, a discount was
recorded on the note and is being amortized over the term of the note. As of
September 30, 2002, the recorded balance of the note was $221,774.
15
(10) SHAREHOLDERS' EQUITY
As a result of the termination or departure of employees from the
Company, $288,161 of the unamortized balance of deferred compensation was
reversed during the nine months ended September 30, 2002.
In the three and nine months ended September 30, 2002, the Company
recorded compensation expense of $0 and $27,730 respectively, for the
modification of the terms of certain stock options.
During the nine months ended September 30, 2002 the Company issued
40,347 shares of Common stock valued at $40,750 for the purchase of fixed
assets.
(11) PREFERRED STOCK
As of September 30, 2002 and December 31, 2001, the Company had
authorized 10,000,000 shares of no par value Preferred stock. In August 1999,
the Company designated and issued 808,629 shares as Series A Convertible
Preferred stock ("1999 Series A Preferred"). The 1999 Series A Preferred was
convertible at any time into Common stock of the Company at a one-for-one
conversion ratio. The holders of the 1999 Series A Preferred had a liquidation
preference of $7.13 per share. In August 1999, the Company sold 666,198 shares
of 1999 Series A Preferred to certain investors at $7.13 per share. The net
proceeds from the sale of the 1999 Series A Preferred were $4,445,108. The 1999
Series A Preferred converted into Common stock immediately prior to the
consummation of the Company's initial public offering.
In August 2001, the Company authorized the issuance of up to 5,494,505
shares of a newly designated Series A Convertible Preferred stock ("2001 Series
A Preferred").
On September 5, 2001, the Company sold 2,506,421 shares of 2001 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 2001 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 2001 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
2001 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"). The same founder noted above
sold an additional 143,831 shares of Common stock to the same 2001 Series A
Preferred investors for $0.50 per share for proceeds to the founder of $71,916.
Additionally, the Company issued 109,589 shares of 2001 Series A Preferred to a
law firm utilized by the Company in exchange for $100,000 of professional
services rendered, the fair value of the equity issued.
Each share of 2001 Series A Preferred is convertible, currently on a
one-for-one basis, into the Company's Common stock upon or a mandatory
conversion event, as defined under the terms of the 2001 Series A Preferred. The
holders of the 2001 Series A Preferred are entitled to receive dividends at the
same rate as dividends are paid with respect to Common stock shares. In the
event of any liquidation, dissolution or winding-up of the Company, the holders
of 2001 Series A Preferred are entitled to the greater of (i) $0.91 per share
(subject to adjustment for stock splits, stock dividends, recapitalizations and
similar events) 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 the event.
The Company allocated the proceeds from the First Closing to the 2001
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 a life of five years, a volatility of
100% and a risk-free interest rate of 4.529%. Accordingly, approximately
$1,802,000 of the 2001 Series A Preferred proceeds was allocated to the 2001
Series A Preferred, $338,000 was allocated to the warrants and $148,000 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 sheets. After considering the allocation of
the proceeds based on the relative fair values, it was determined that the 2001
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" and EITF Issue No. 00-27, "Application of Issue
No. 98-5 to Certain Convertible Instruments." The Company recorded the BCF
related to the First Closing of approximately $980,000 as a discount to the 2001
Series A Preferred in the year ended December 31, 2001. The value of the BCF is
16
being recorded in a manner similar to a deemed dividend over the period from the
date of issuance to the earliest known date of conversion, which is September 4,
2002. The Company allocated the proceeds from the Second Closing in the same
manner as discussed above. The fair value of the warrants issued in the Second
Closing was determined based on the Black-Scholes option pricing model using a
life of five years, a volatility of 100% and a risk free interest rate of
3.957%. Approximately, $517,000 of the 2001 Series A Preferred proceeds from the
Second Closing was allocated to the 2001 Series A Preferred, $264,000 was
allocated to the warrants and $41,000 was allocated to the shares of Common
stock sold by the founder. The Company recorded a BCF related to the Second
Closing of approximately $397,000 as a discount to the 2001 Series A Preferred
in the year ended December 31, 2001. The value of the BCF is being recorded in a
manner similar to a deemed dividend over the period from the date of issuance to
the earliest date of conversion, which is September 4, 2002. The Company
recorded a deemed dividend - BCF of $246,906, $89,813, $987,625 and $89,813 in
the three months ended September 30, 2002 and 2001and nine months ended
September 30, 2002 and 2001, respectively.
In addition, the terms and agreements relating to the sale of our
Series A Convertible Preferred stock contain customary covenants limiting our
flexibility, including covenants limiting our ability to incur additional debt,
create or issue any shares of capital stock with rights senior to the holders of
the Series A Convertible Preferred stock, make distributions or declare
dividends, consolidate, merge or acquire other businesses and sell assets, pay
dividends and other distributions, effect stock splits, and issue additional
equity securities.
(12) NET LOSS PER COMMON SHARE
The Company has presented net loss per common 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 net loss. The number of shares excluded from this
calculation was approximately 2,300,000 for the three months and 2,040,000 for
the nine months ended September 30, 2002.
(13) RELATED PARTY TRANSACTIONS
In June 1999, the Company entered into a financial arrangement, as
amended, with a financial advisor, who is an affiliate of a significant
shareholder of the Company ("Financial Advisor"). This agreement provided for a
payment of $320,000 due to the Financial Advisor on February 1, 2001 related to
the private placement of securities, and a $500,000 payment due upon the earlier
of the consummation of an initial public offering or February 1, 2001. This
$500,000 payment was related to general strategic and advisory services rendered
during the three months ended September 30, 1999. The $500,000 was repaid in
March 2000. Approximately $310,000 remains unpaid as of September 30, 2002 and
is included in accrued expenses on the accompanying consolidated balance sheets
as of September 30, 2002.
In October 2000, the Company issued a $250,000 convertible note and a
warrant to purchase 120,000 shares of Common stock to the Financial Advisor for
professional services rendered (see Note 9).
In November 2001, the Company issued 109,589 shares of 2001 Series A
Preferred and 27,397 warrants to purchase Common stock to a legal firm used by
the Company in exchange for $100,000 of professional services rendered. The
Company paid this firm approximately $399,000, $508,000, $0, and $212,000 in the
three and nine months ended September 30, 2002, respectively.
A property owner of one of the Company's facilities is also a holder of
a note acquired in connection with the NetReach acquisition. The Company paid
the landlord $21,000 and $48,000 in the three and nine months ended September
30, 2002, respectively.
In the year ended December 31, 2001, the Company advanced $202,000 to
several executives of the Company. The executives repaid $58,000 of the
promissory notes in the year ended December 31, 2001. All of the executives
signed promissory notes bearing interest at 3.75 percent per annum. An
additional $50,000 was advanced to an executive in the three months ended March
31, 2002. Payments have not been made on the notes in the nine months ended
September 30, 2002. The Company amended the terms of the notes in June 2002. The
promissory notes, which were to be repaid in full or through 18 monthly payments
to begin in April 2002, have been amended to be payable on demand.
A significant customer of the Company is a shareholder. A member of the
Company's Board of Directors is also an officer of this customer.
17
On May 8, 2002 the Company entered into a management consulting
agreement with a management consulting firm controlled by a compensated member
of the FASTNET Board of Directors with a minimum fee due under the contract of
$2,500 per month. The agreement provides for various business financial
planning, and acquisition consulting services to be provided as requested by the
Company on a monthly basis. The Company granted non-qualified stock options to
acquire a total of 12,000 shares of FASTNET Common Stock to the firm at the
closing price on May 8, 2002 of $1.20 per share. The Company paid this firm
$60,491 and $70,491 for the three and nine months ended September 30, 2002.
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, AND SUCH FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE
NOT LIMITED TO THE FOLLOWING: ESTIMATES OF ADEQUATE PROVISION FOR CHARGES IN
CONNECTION WITH OUR REVISED BUSINESS PLAN; FUTURE EXPANSION OF OUR CUSTOMER
BASE, INCLUDING THE MIGRATION OF CUSTOMERS FROM OUR COMPETITORS; DECREASES IN
SMALL OFFICE AND HOME OFFICE (SOHO) REVENUES AS A PERCENTAGE OF TOTAL REVENUES;
EXPECTATIONS OF FURTHER BENEFITS FROM SYNERGIES GAINED BY INTERCONNECTION OF
NETWORKS OF ACQUIRED COMPANIES, INCLUDING CERTAIN ASSETS OF APPLIEDTHEORY AND
NETAXS; PLANS TO INCREASE COLLECTION ACTIVITY AND REDUCE THE NUMBER OF SERVICES
FOR WHICH ON-ACCOUNT BILLING IS PROVIDED; EXPECTATIONS THAT COST OF REVENUES AS
A PERCENTAGE OF REVENUES WILL REMAIN STABLE IN FUTURE QUARTERS AND SUFFICIENCY
OF CURRENT PROPERTY AND EQUIPMENT TO SUPPORT OPERATIONS FOR THE FORESEEABLE
FUTURE. 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 OF PART II OF THIS FORM 10-Q.
THE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO A NUMBER OF RISKS AND
UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO, THE IMPACT OF SFAS 142 AND SFAS 144
IMPAIRMENT TESTS AND THE AMOUNTS OF RESULTANT WRITEDOWNS FOR OUR GOODWILL,
POSSIBLE WRITEDOWN OF FIXED ASSETS RESULTING FROM A VALUATION OF THE COMPANY'S
FIXED ASSETS AND IDENTIFIED INTANGIBLE ASSETS, OUR ABILITY TO: SUCCESSFULLY
RENEGOTIATE CERTAIN OBLIGATIONS AND CAPITAL LEASES THAT WE HAVE CLASSIFIED AS
CURRENT LIABILITIES; IMPROVE TURNOVER OR OUR ACCOUNTS RECEIVABLE AND OBTAIN MORE
FAVORABLE PRICING FROM OUR VENDORS; OBTAIN DEBT AND/OR EQUITY FINANCING, AS
NEEDED; SUCCESSFULLY ADJUST OUR OPERATIONS UNDER OUR MODIFIED BUSINESS PLAN;
OFFER OUR CUSTOMERS IN THE REGIONS SERVED BY COMPANIES THAT WE HAVE RECENTLY
ACQUIRED A 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
AND GROW OUR REVENUES; DECREASE SOHO REVENUES AS A PERCENTAGE OF TOTAL REVENUES;
REDUCE OUR COST OF REVENUES; AND EFFECTIVELY INTEGRATE OPERATIONS OF COMPANIES
THAT WE HAVE RECENTLY ACQUIRED. 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
FASTNET is an Internet solutions provider offering broadband data
communication services and enhanced products and services to businesses
primarily in the Northeastern United States. Our services included high-speed
data and Internet services, data center services, including managed and
unmanaged Collocation services, web hosting, small office home office (SOHO)
Internet access, wholesale ISP services, and various professional services
including e-Solutions, 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 dedicated 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, ISDN, SMDS, ATM, and DSL. We also offer FASTNET
controlled last mile Internet access utilizing wireless transport.
18
OUR HISTORY OF OPERATING LOSSES
We have incurred operating losses in each year since our inception and
expect our losses to continue through December 31, 2002 as we seek to execute
our revised business plan. Our operating losses were $14,135,388, $32,044,023,
and $5,242,373 for the years ended December 31, 2001, 2000 and 1999,
respectively, and $6,204,073 for the nine months ended September 30, 2002.
MODIFICATION OF OUR STRATEGIC PLAN
On October 10, 2000, we modified our business 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 business plan, we recorded a
restructuring charge of $5,160,000 primarily related to network and
telecommunication optimization and cost reduction, facility exit costs,
realigned marketing strategy, and involuntary employee terminations.
Throughout 2001, the Company continually reviewed the reserves that
were established in October 2000 as part of its 2000 restructuring plan. In the
fourth quarter of 2001, the Company recorded approximately an additional
$1,300,000 restructuring charge related to its excess and idle data centers and
administrative offices. This charge makes certain assumptions regarding the
Company's ability to sublet or dispose of these facilities. This decision was
made in the fourth quarter of 2001 as we experienced significant difficulties in
attempting to dispose of or sublet these facilities due to an overall slowdown
in the economy and, in particular, the commercial real estate market. We are
continuing our efforts to dispose of or sublet these facilities. As of September
30, 2002, the total amount of lease payments relating to these excess or idle
facilities is approximately $4.3 million through 2010. Accordingly, the Company
continually re-evaluates the adequacy of this reserve and may adjust the reserve
as necessary.
The activity in the restructuring charge accrual during the nine months
ended September 30, 2002 is summarized in the table below:
CASH PAYMENTS
ACCRUED DURING THE ACCRUED
RESTRUCTURING NINE MONTHS RESTRUCTURING
AS OF ENDED AS OF
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
2001 2002 2002
-------------- ------------- -------------
Telecommunications exit and termination fees......... $ 233,980 $ -- $ 233,980
Leasehold termination costs.......................... 115,543 115,543 --
Sales and marketing contract terminations............ 52,321 -- 52,321
Facility exit costs.................................. 1,370,273 441,199 929,074
-------------- ------------- -------------
$ 1,772,117 $ 556,742 $ 1,215,375
============== ============= =============
RESULTS OF OPERATIONS
REVENUES
We classify our revenue into the following major categories: revenues
from the sale of enterprise level Internet access and enhanced products and
services, SOHO Internet access which includes revenues from the sale of Internet
access to SOHOs and includes revenue from the sale of wholesale dial-up access
to customers that use our Dialplex Virtual Private Network (VPN or wholesale
Internet access services) to provide service to their subscribers, revenue from
hosting services which includes shared web hosting services, dedicated hosting
services and colocation services and revenues from e-Solutions, web design and
development services. We target our Internet access and enhanced services toward
businesses located within our active markets. FASTNET offers a broad range of
dedicated access solutions including T-1, T-3, OC-3, OC-12, Frame Relay, ATM,
SMDS, enterprise class DSL services and fixed broadband wireless. Our enhanced
services are complementary to dedicated Internet access and include Total
Managed Security. Our business plan focuses on the core service offering of
Internet access coupled with add-on sales of enhanced products and services as
our customer's Internet needs expand. Internet access and enhanced product
revenues are recognized as services are provided.
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
19
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, and revenue from the sale of
wholesale dial-up access to customers that use VPN to provide service to their
subscribers, SOHO DSL Internet access, and ISDN Internet access. Customers using
our SOHO services generally sign service contracts for one to two years. 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 and downward
pricing pressures.
We also offer our customers 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 and 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, 2002 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2001
REVENUES. Revenues for the quarter ended September 30, 2002 increased
approximately $6,864,000 or 189% over the amount for the quarter ended September
30, 2001 due to an increase in the number of customers resulting from the
Company's recent acquisitions, which are as follows:
Acquisition Date of Acquisition
----------- -------------------
NetReach, Inc. November 1, 2001
SuperNet, Inc. January 31, 2002
NetAxs, Inc. April 4, 2002
Dedicated Customers of AppliedTheory Corporation May 31, 2002
Accordingly, the increase in revenues for the quarter ended September
30, 2002 as compared to the quarter ended September 30, 2001, was largely
attributable to the NetAxs and AppliedTheory acquisitions. Due to the type of
customer base and size of these recent acquisitions, the Company experienced
substantial growth in its revenue derived from dedicated access customers. The
percentage of revenues generated from dedicated access customers increased from
approximately 56% for the quarter ended September 30, 2001 to approximately 79%
for the quarter ended September 30, 2002. Revenue from dedicated customers
increased approximately $6,169,000 or approximately 303% from the quarter ended
September 30, 2001.
COST OF REVENUES. Cost of revenues increased by approximately
$4,439,000 or approximately 215% for the quarter ended September 30, 2002 as
compared to the quarter ended September 30, 2001. This increase was primarily
due to the cost of the network acquired in the NetAxs and AppliedTheory
acquisitions.
Cost of revenues as a percentage of revenues increased from
approximately 55% for the quarter ended June 30, 2002 to approximately 62% for
the quarter ended September 30, 2002 primarily due to the higher network cost
associated with high bandwidth dedicated access customers acquired from
AppliedTheory and the cost of providing services to these additional customers.
In addition, due to its recent acquisitions, the Company believes that has not
yet fully recognized the total network cost synergies from integrating its
network to the NetAxs and AppliedTheory networks. The Company expects to benefit
from the synergies to be gained from combining and streamlining the acquired
networks; however, the Company cannot yet predict the amount and timing of these
synergies.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, General and
Administrative expenses for the quarter ended September 30, 2002 increased
approximately $1,111,000, or 44%, over the amount for the quarter ended
September 30, 2001. The increase was equally attributable to a) additional
20
personnel related expenses relating to the addition of the NetAxs and
AppliedTheory personnel; and b) increases in the Company's existing sales force
and c) increases to the allowance for uncollectible accounts that the Company
attributes to negative changes in the economy.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
by approximately $237,000, or 11%, from approximately $2,109,000 for the quarter
ended September 30, 2001 to $2,346,000 for the quarter ended September 30, 2002.
The change is a result of an increase in deprecation expense related to the
additional assets acquired from NetReach, SuperNet, NetAxs and AppliedTheory
offset by a decrease in amortization expense of goodwill. The decrease in
goodwill amortization expense is in accordance with SFAS No. 142, which states
that goodwill is no longer amortized as of January 1, 2002. Goodwill
amortization was $277,000 for the three months ended September 30, 2001.
GAIN ON EXTINGUISHMENT OF DEBT. A gain on the early extinguishment of
debt in the amount of $1,630,000 was recorded in the three months ended
September 30, 2001 as a result of the settlement of $4,000,000 of certain
capital lease obligations with an equipment vendor.
OTHER INCOME/EXPENSE. Interest income decreased from $98,000 for the
quarter ended September 30, 2001 to $59,000 for the quarter ended September 30,
2002. This decrease in interest income resulted from the liquidation of certain
marketable securities to fund operations, coupled with a decrease in the related
investment returns. Interest expense increased from approximately $106,000 for
the quarter ended September 30, 2001 to $148,000 for the quarter ended September
30, 2002. The increase in interest expense relates to assumed debt from the
NetReach and NetAxs acquisitions and the issuance of notes to NetAxs
shareholders as consideration for the acquisition.
THE NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2001
REVENUES. Revenues increased approximately $11,451,000, or 101%, to
approximately $22,784,000 for the nine months ended September 30, 2002 from
$11,334,000 for the nine months ended September 30, 2001. The acquisitions of
NetAxs, AppliedTheory and NetReach customers have accounted for the increase in
customer revenues.
COST OF REVENUES. Cost of revenues increased by approximately
$4,641,000, or 57%, from approximately $8,144,000 for the nine months ended
September 30, 2001 to $12,785,000 for the nine months ended September 30, 2002.
Gross margin improved from 28% for the nine months ended September 30, 2001 to
44% for the nine months ended September 30, 2002. The increase in cost of
revenues is due to the NetAxs, NetReach, and AppliedTheory acquisitions. Cost of
service is traditionally higher on high bandwidth customers than low bandwidth
customers. Additionally, the Company expects to realize network cost synergies
as it continues to integrate the acquired networks and satisfies the network
commitments of its recent acquired operations.
SELLING, GENERAL, AND ADMINISTRATIVE. Selling, general and
administrative expenses increased by approximately $1,221,000, or 15%, from
approximately $8,252,000 for the nine months ended September 30, 2001 to
approximately $9,473,000 for the nine months ended September 30, 2002. The
increase is primarily due to increased salary costs due to the expansion of the
Company and increases to the allowance for uncollectible accounts receivable
that the Company attributes to the negative changes in the economy. Selling,
general and administrative expenses as a percentage of revenues declined from
73% for the nine months ended September 30, 2001 of 42% for the nine months
ended September 30, 2002 primarily due to the increased revenues gained from the
acquisition of NetReach, NetAxs and AppliedTheory customers, and reduced
headcount and advertising and marketing expenses.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
by approximately $902,000, or 15%, from approximately $5,829,000 for the nine
months ended September 30, 2001 to $6,730,000 for the nine months ended
September 30, 2002. This increase is comprised of additional depreciation
related to networking equipment acquired in connection with the NetReach,
NetAxs, and AppliedTheory acquisitions and an increase in amortization expense
from intangibles recorded for the 2001 and 2002 acquisitions, offset by a
decrease in goodwill amortization as a result of SFAS No. 142. Goodwill
amortization was $753,000 for the nine months ended September 30, 2001.
GAIN ON EXTINGUISHMENT OF DEBT. A gain on the early extinguishment of
debt in the amount of $1,630,000 was recorded in the nine months ended September
30, 2001 as a result of the settlement of $4,000,000 of certain capital lease
obligations with an equipment vendor.
OTHER INCOME/EXPENSE. Interest income decreased by approximately
$395,000 from approximately $577,000 for the nine months ended September 30,
2001 to approximately $182,000 for the nine months ended September 30, 2002.
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 approximately $233,000 from approximately $605,000
for the nine months ended September 30, 2001 to approximately $372,000 for the
nine months ended September 30, 2002. The decrease in interest expense is
primarily the result of the settlement of capital lease obligations during 2001
offset by interest.
21
CASH FLOWS ANALYSIS
The following table set forth cash flows data for the periods indicated:
NINE MONTHS ENDED
SEPTEMBER 30, 2002
-------------------------------
2002 2001
-------------- --------------
Other Financial Data:
Cash flows used in operating activities.......................... $ (1,977,000) $ (10,454,000)
Cash flows provided by (used in) investing activities............ (5,203,000) 13,103,000
Cash flows provided by (used in) financing activities ........... 585,000 (1,213,000)
-------------- --------------
Net increase (decrease) in cash and cash equivalents ............ $ (6,595,000) $ 1,436,000
============== ==============
Cash used in operating activities decreased by approximately $8,477,000
from cash used of approximately $10,454,000 for the nine months ended September
30, 2001 to cash used of approximately $1,977,000 for the nine months ended
September 30, 2002. This decrease in cash used in operations is primarily the
result of improved gross margin resulting in a lower operating loss, and
non-recurring payments made in 2001.
We have a working capital deficit of approximately $13,613,000 as of
September 30, 2002, primarily attributable to the increase in accounts payable
and accrued expenses, increase in deferred revenue reflective of Company growth
and increase in number of customers, and capital lease obligations that are
currently being renegotiated.
Cash flows from investing activities decreased by approximately
$18,306,000 from cash provided of approximately $13,103,000 for the nine months
ended September 30, 2001 to cash used of approximately $5,203,000 for the nine
months ended September 30, 2002. This decrease resulted from the sale of
marketable securities required to fund our operating losses in 2001 and 2002 and
from cash paid to fund acquisitions during 2002.
Cash flows from financing activities increased by approximately
$1,798,000 from cash used of approximately $1,213,000 for the nine months ended
September 30, 2001 to cash provided by of approximately $585,000 for the nine
months ended September 30, 2002. The increase in cash provided by financing
activities is primarily the result of the proceeds of $3,100,000 from our bank
note partially offset by a $1,600,000 payment made to settle a capital lease
obligation in the first quarter of 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and marketable securities balances (exclusive of
restricted marketable securities) declined approximately $5,537,000 from the
amount at December 31, 2001 to approximately $4,735,000 at September 30, 2002.
This reduction was primarily due to the use of $1,178,000, net to acquire the
AppliedTheory customer base, NetAxs and SuperNet as well as the satisfaction of
liabilities related to the NetReach, SuperNet, and NetAxs acquisitions.
Additionally, the Company had capital lease and debt repayments of approximately
$1,832,000 during this period. The remainder of the decline in cash was due to
amounts utilized to fund operating losses.
On June 28, 2002, the Company amended its Bank Note from $2,300,000 to
$4,800,000. This amount has been classified as restricted marketable securities
since the Loan Agreement for this Bank Note requires the Company to retain the
proceeds of the loan in a certificate of deposits with the Bank. Subsequent to
the third quarter of 2002, the Company liquidated the certificate of deposit and
repaid the note in full.
In connection with the acquisition of the AppliedTheory customer base,
the Company guaranteed to the Bankruptcy Court the collection of at least
$2,500,000 from the accounts receivable attributable to the customers purchased
by the Company. These receivables have been recorded at their estimated net
realizable value of $1,532,000 as of September 30, 2002. The Company is required
to satisfy the guarantee of $2,500,000 no later than December 31, 2002. Based
upon collection information provided to the Company to date, ClearBlue
Technologies, Inc., an unrelated acquirer of a substantial portion of the
AppliedTheory business, has Collected approximately $1,320,000 of this amount
and the Estate of AppliedTheory has collected approximately $210,000. The
Company has directly Collected approximately $800,000 of the AppliedTheory
receivables purchased. The Company has requested ClearBlue Technologies, Inc. to
forward the amounts it has collected on FASTNET's behalf directly to the Estate
of AppliedTheory. The Company has requested but not yet received confirmation of
the amounts collected directly by the Estate or ClearBlue Technologies, Inc. As
a result, the receivables applicable to the ClearBlue Technologies, Inc. and
Estate collections have not been offset against the amount due the Estate as of
September 30, 2002. The Company expects to collect these amounts. However, if
ClearBlue Technologies, Inc. does not remit these payments to the Estate, the
Company will be required to remit any shortfalls.
22
The Company believes that its property and equipment are sufficient for
the operation of its existing business for the next twelve months and does not
anticipate the need to make material capital expenditures related to any
expansion of our business.
During the fourth quarter of 2000, we recorded an initial charge of
$5,160,000 in connection with our modified business plan, and during the fourth
quarter of 2001, we recorded an additional charge for $1,336,000. Of these
restructuring charges, $1,215,000 has not been paid as of September 30, 2002 and
is, accordingly, classified as accrued restructuring. The Company anticipates
that the entire amount accrued will be paid in 2002 and 2003. 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 is currently reviewing this provision in light of its
existing and future operating needs, status of facility exit and sublease
activities and the overall economy.
Subsequent to the Company's acquisition of NetAxs, it was determined
that NetAxs owed certain Federal and State payroll related liabilities of
approximately $767,000, exclusive of penalty and interest charges. The Company
has determined that it has a right of full offset of this liability against the
promissory notes and other amounts issued to the former shareholders of NetAxs
including amounts held in escrow. The Company and the former principal
shareholders of NetAxs have reached agreement to offset payments of these
liabilities against the notes. As a result, the Company has suspended payment of
the principal and interest due under the promissory notes pending satisfaction
of the related liabilities. Subsequent to September 30, 2002, the Company began
making payments under a payment plan proposed to the taxing authorities in a
manner consistent with the principal and interest due under the NetAxs
promissory notes. As a result, the Company does not anticipate that this
arrangement will have a material impact on the Company's working capital needs.
The Company is currently evaluating the timing and amount of capital
that its operations will require. We may require financing sooner than
anticipated if capital requirements vary materially from those currently
planned, if revenues do not increase as anticipated, or if the Company is not
successful in reducing its network and operating costs as planned. We have no
commitments for any additional financing and have no lines of credit or similar
sources of financing, and we cannot be sure that we can obtain additional
commitments on favorable terms, if at all. If we are unable to obtain additional
financing, we may be required to reduce our scope of operations or anticipated
growth plans, which could materially affect our results of operations and
financial condition.
If we do not continue to achieve the cost savings and reduction in cash
consumption under this plan, then we may 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.
The Company is aggressively seeking to improve the turnover of its
accounts receivable through increased customer contact, stricter enforcement of
its payment terms and increased integration of its payment and service delivery
systems. Concurrent with this strategy, the Company is reducing its accounts
payable balances in order to obtain more favorable pricing from its vendors and
in response to increased liquidity concerns throughout the industry. The
Company's available working capital and operating efficiency will be dependent
on the success and outcome of these events and strategies.
The Company's working capital deficit increased from approximately
$425,000 at December 31, 2001 to a deficit of approximately $13,613,000 at
September 30, 2002 primarily due to the acquisition of capital leases related to
the NetAxs and AppliedTheory acquisitions and increased amounts payable due to
the pre-acquisition liabilities of NetAxs. The Company is currently negotiating
settlement of the obligations and the leases have been accordingly classified as
current liabilities. The Company is currently negotiating alternative capital
lease terms including options for early retirement of the debt as well as an
extension of the payment schedule. The Company has suspended payments of these
capital lease obligations and as a result may be considered to be in default of
the terms of the obligations. The Company cannot give assurance as to the
satisfactory outcome or timing of the negotiations. The Company is also
exploring certain equity capital alternatives and has entered into discussions
with various lenders to provide the Company with additional sources of working
capital (including an asset based line of credit) to fund its ongoing operations
and future acquisition plans. The Company cannot give assurance as to the
potential success of these efforts or the potential dilution to existing
shareholders that may occur if the Company should raise equity or debt capital.
The Company believes that its working capital will be sufficient to fund the
Company's operations to the end of 2003 assuming satisfactory negotiations of
capital lease obligations which are included in current liabilities (see Note 8)
and repayment of the receivables collected on behalf of the Company due to the
Estate of AppliedTheory.
23
The Company is continuing to seek and evaluate candidates for
acquisition that meet its selection criteria despite its currently reduced
working capital level. As a result, in the short term, the Company may choose to
issue higher levels of stock as consideration in such contemplated transactions.
This course of action may lead to additional shareholder dilution. The Company
cannot at this time assess the likelihood of such transactions but expects to be
actively seeking growth through acquisitions.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations", which addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The standard applies to legal obligations associated with the retirement
of long-lived assets that result from the acquisition, construction, development
and (or) normal use of the asset. SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
fair value of the liability is added to the carrying amount of the associated
asset and this additional carrying amount is depreciated over the life of the
asset. The liability is accreted at the end of each period through charges to
operating expense. If the obligation is settled for other than the carrying
amount of the liability, a gain or loss on settlement would be recognized. The
Company is required and plans to adopt the provisions of SFAS No. 143 in 2003.
To accomplish this, the Company must identify all legal obligations for asset
retirement obligations, if any, and determine the fair value of these
obligations on the date of adoption. The adoption of SFAS No. 143 is not
expected to have a significant impact on the Company's results of operations,
financial position or cash flows.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
While SFAS No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of", it retains many
of the fundamental provisions of that Statement. SFAS No. 144 also supersedes
the accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business. However, SFAS No.
144 retains the requirement in Opinion No. 30 to report separately discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. The Company adopted the provisions of SFAS No.
144 effective January 1, 2002. The adoption of SFAS No. 144 did not have any
impact on results of operations, financial position or cash flows.
On April 30, 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, And 64, Amendment Of FASB Statement No. 13, And Technical
Corrections". The Statement updates, clarifies and simplifies existing
accounting pronouncements. SFAS No. 145 rescinds Statement No. 4, "Reporting
Gains and Losses from Extinguishment of Debt", which required all gains and
losses from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of related income tax effect. As a result, the
criteria in APB Opinion 30 will now be used to classify those gains and losses.
SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements", amended SFAS No. 4, and is no longer necessary because SFAS No. 4
has been rescinded. SFAS No. 145 amends SFAS No. 13, "Accounting for Leases", to
require that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. Certain provisions of SFAS No. 145 are effective
for fiscal years beginning after May 15, 2002, while other provisions are
effective for transactions occurring after May 15, 2002. The Company recorded an
extraordinary gain on the extinguishment of debt in the third and fourth
quarters of 2001 in the amounts of $1,630,328 and $4,006,049, respectively. As a
result of SFAS No. 145, which the Company has adopted, these amounts have been
reclassified from extraordinary to other income.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which requires that a liability
for a cost associated with an exit or disposal activity be recognized when the
liability is incurred and nullifies EITF 94-3. The Company plans to adopt SFAS
No. 146 in January 2003. Management believes that the adoption of this statement
will not have a material effect on the Company's future results of operations.
In September 2002 the Emerging Issues Task Force ("EITF") reached a
consensus in EITF Issue No. 02-13, "Deferred Income Tax Considerations in
Applying the Goodwill Impairment Test in FASB Statement No. 142, Goodwill and
Other Intangible Assets" ("EITF 02-13"). The EITF consensus requires that
deferred income taxes, if any, be included in the carrying amount of a reporting
unit for the purposes of the first step of the SFAS 142 goodwill impairment
test. It also provides guidance for determining whether to estimate the fair
value of a reporting unit by assuming that the unit could be bought or sold in a
non-taxable transaction versus a taxable transaction and the income tax bases to
use based on this determination. EITF 02-13 is effective for goodwill impairment
tests performed after September 12, 2002. We are currently analyzing the impact
EITF 02-13 will have on our consolidated financial statements.
24
IMPAIRMENT ANALYSIS
We are in the process of completing the first step of the annual
goodwill impairment test under SFAS 142. With the assistance of an independent
valuation firm, we will be performing a fair market value analysis on our
reporting unit in the fourth quarter of 2002. In conjunction with the impairment
tests under SFAS 142, we are also in the process of testing our identified
intangible assets for impairment under SFAS 144. We are required to perform a
fair market value analysis of our identified intangible assets under SFAS 144
and record an impairment charge and writedown of such assets, if any, prior to
recording an impairment charge for goodwill.
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, 2002 with all other factors held
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, 2002. 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.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures as of November 19, 2002 was conducted under
the supervision and with the participation of our management, including our
chief executive officer and chief financial officer. Based on that evaluation,
our management, including our chief executive officer and chief financial
officer, concluded that our disclosure controls and procedures were effective as
of November 19, 2002. There have been no significant changes in our internal
controls or in other factors that could significantly affect these controls
subsequent to November 19, 2002.
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) None.
(d) None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
25
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.
o our continued ability to attract and sell additional products
and services to our target customers;
o our continued ability to enter into selected product or
service partnerships; and
o our continued ability to open new markets through the
acquisition of 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.
IF WE ARE UNABLE TO SUSTAIN THE COST SAVINGS AND REDUCTION IN CASH CONSUMPTION
UNDER OUR REVISED BUSINESS PLAN, WE MAY HAVE TO FURTHER MODIFY OUR BUSINESS PLAN
AND OUR BUSINESS COULD BE HARMED.
If we do not continue to achieve the cost savings and reduction in cash
consumption under this plan, then we may 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 THE OPERATIONS WE HAVE ACQUIRED WITH FASTNET, WE
MAY NOT REALIZE OUR PLANNED COST SAVINGS.
A key element of our business strategy is to grow through acquisitions,
and we must be able to integrate the networks of FASTNET and these acquired
operations 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 operations into the back-office operations of FASTNET, and expand our
consolidated company product portfolio across our increased customer base from
these acquired operations or we may not be able to achieve the operating
efficiencies we anticipate.
To integrate our newly acquired operations successfully, we must:
o install and standardize adequate operational and control
systems;
o deploy standard equipment and telecommunications facilities;
o employ qualified personnel to provide technical and marketing
support in new as well as existing locations;
o eliminate redundancies in overlapping network systems and
personnel;
o incorporate acquired technology and products into our existing
service offerings;
o implement and maintain uniform standards, procedures and
policies;
o standardize marketing and sales efforts under the common
FASTNET brand, and, where applicable, maintain the brand name
integrity of products and services that continue to be
marketed and sold under the brand names utilized by the
acquired operations; and
o continue the expansion of our managerial, operational,
technical and financial resources.
26
The process of consolidating and integrating acquired operations takes
a significant period of time, places a significant strain on our managerial,
operating and financial resources, and could prove to be even more expensive and
time-consuming than we have predicted. We may increase expenditures in order to
accelerate the integration and consolidation process with the goal of achieving
longer-term cost savings and improved profitability.
The key integration challenges we face in connection with our acquisitions
include:
o acquired operations, facilities, equipment, service offerings,
networks, technologies, brand names and sales, marketing and
service development efforts may not be effectively integrated
with our existing operations;
o anticipated cost savings and operational benefits may not be
realized;
o in the course of integrating an acquired operation, we may
discover facts or circumstances that we did not know at the
time of the acquisition that adversely impact our business or
operations, or make the integration more difficult or
expensive;
o integration efforts may divert our resources from our existing
business;
o standards, controls, procedures and policies may not be
maintained;
o employees who are key to the acquired operations may choose to
leave; and we may experience unforeseen delays and expenses.
WE FACE RISKS ASSOCIATED WITH ACQUISITIONS.
We expect to continue our targeted acquisition and expansion strategy.
Future acquisitions could materially adversely affect our operating results as a
result of dilutive issuances of equity securities and the incurrence of
additional debt. In addition to the equity securities that we have issued to
date in connection with our completed acquisitions, we may also be obligated to
issue additional equity securities based on earn-out provisions set forth in the
acquisition agreements. In addition, the purchase price for many of these
acquired businesses likely will significantly exceed the current fair value of
the net identifiable assets of the acquired businesses. As a result, material
goodwill and other intangible assets would be required to be recorded which
would result in significant charges in future periods. These charges, in
addition to the financial impact of such acquisitions, could have a material
adverse effect on our business, financial condition and results of operations.
We recorded all business acquisitions under the purchase method of accounting.
Effective January 1, 2002, the Company no longer amortizes goodwill and certain
intangibles pursuant to Statement of Financial Accounting Standards No. 142
"Goodwill and Other Intangible Assets". We cannot assure you of the number,
timing or size of future acquisitions, or the effect that any such acquisitions
might have on our operating or financial results.
IF WE ARE UNABLE TO SUCCESSFULLY RENEGOTIATE THE PAYMENT TERMS OF CERTAIN OF OUR
CAPITAL LEASES, WE MAY BE CONSIDERED TO BE IN DEFAULT OF A SIGNIFICANT AMOUNT OF
OUR CAPITAL LEASE OBLIGATIONS.
We are currently attempting to renegotiate certain of our capital leases
totaling approximately $3.5 million, which we acquired in connection with our
acquisitions of NetAxs and of certain assets of AppliedTheory. While we have
been actively engaged in discussions with the vendors of these capital leases to
obtain modified payment terms, we have continued to not make any payments on
these obligations. As a result, we may be considered to be in default of these
capital lease obligations and we have classified all outstanding amounts related
to these leases as current on our balance sheet for the quarter ended September
30, 2002. We cannot assure you that we will be able to successfully renegotiate
these capital leases, and if not, that we will be able to cure any default or
that the lessors will not seek repayment or the other remedies that are
available to them. Potential lender remedies could include, among other things,
accelerating our obligations under affected leases and repossessing the
equipment and otherwise seeking to enforce their security interests in such
equipment and other secured assets, which may be crucial to the operations of
the business. Any such events could have a material adverse effect upon us and,
to the extent that payments of all outstanding amounts related to the capital
leases are accelerated, could have a significant adverse impact on our available
cash for operations.
OUR OPERATING RESULTS AND FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED BY
FINANCIAL ACCOUNTING OF OUR ACQUISITIONS, INCLUDING DILUTIVE ISSUANCES OF
SECURITIES, INCURRENCE OF DEBT, AND THE RECORDING OF SIGNIFICANT IMPAIRMENT
CHARGES FOR INTANGIBLE ASSETS AND GOODWILL.
We expect to continue our targeted acquisition and expansion strategy. Future
acquisitions could materially adversely affect our operating results as a result
of dilutive issuances of equity securities and the incurrence of additional
debt. In addition to the equity securities that we have issued to date in
connection with our completed acquisitions, we may also be obligated to issue
additional equity securities based on earn-out provisions set forth in the
acquisition agreements. In addition, the purchase price for many of these
acquired businesses likely will significantly exceed the current fair value of
the net identifiable assets of the acquired businesses. As a result, material
goodwill and other intangible assets could be required to be recorded which
would result in significant charges in future periods. These charges, in
addition to the financial impact of such acquisitions, could have a material
adverse effect on our business, financial condition and results of operations.
We cannot assure you of the number, timing or size of future acquisitions, or
the effect that any such acquisitions might have on our operating or financial
results.
In Intangible Assets". SFAS No. 142 no longer permits the amortization of
goodwill and indefinite-live intangible assets. Instead, these assets must be
reviewed annually for impairment in accordance with this statement. Accordingly,
the Company has ceased amortization of all goodwill and indefinite-live
intangible assets as of January 1, 2002. During the second quarter of 2002 we
completed the transitional impairment test of goodwill and other intangibles
assets, which indicated that the goodwill and other intangible assets were not
impaired. We are in the process of completing the first step of the annual
goodwill impairment test under SFAS 142. With the assistance of an independent
valuation firm, we will be performing a fair market value analysis on our
reporting unit in the fourth quarter of 2002. In conjunction with the impairment
tests under SFAS 142, we are also in the process of testing our identified
intangible assets for impairment under SFAS 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." We are required to perform a fair market
value analysis of our identified intangible assets under SFAS 144 and record an
impairment charge and writedown of such assets, if any, prior to recording an
impairment charge for goodwill. The SFAS 142 and SFAS 144 impairment tests may
require us to record a non-cash charge in the fourth quarter of 2002 to
writedown a significant portion of our goodwill and identified intangible
assets. The recording of such charges may have a adverse effect on our results
of operations and financial condition.
WE ARE SUBJECT TO RESTRICTIVE COVENANTS THAT LIMIT OUR FLEXIBILITY.
Our loan agreement with Wachovia Bank contains customary covenants
limiting our flexibility, including covenants limiting our ability to incur
additional debt, make liens, make investments, consolidate, merge or acquire
other businesses and sell assets, pay dividends and other distributions, make
capital expenditures and enter into transactions with affiliates. Failure to
comply with the terms of the loan would entitle the bank to foreclose on certain
of our assets, including the capital stock of our subsidiaries. The bank would
be repaid from the proceeds of the liquidation of those assets before the assets
would be available for distribution to other creditors and, lastly, to the
holders of FASTNET's capital stock. In addition, the terms and agreements
relating to the sale of our Series A Convertible Preferred stock contain
customary covenants limiting our flexibility, including covenants limiting our
ability to incur additional debt, create or issue any shares of capital stock
with rights senior to the holders of the Series A Convertible Preferred stock,
make distributions or declare dividends, consolidate, merge or acquire other
businesses and sell assets, pay dividends and other distributions, effect stock
splits, and issue additional equity securities. Such covenants may make it
difficult for us to pursue our business strategies. Such restrictive covenants
may make it difficult for us to pursue our business strategies without the
consent of parties to these agreements, which we may not be able to obtain. Our
ability to satisfy the financial and other restrictive covenants may be affected
by events beyond our control.
27
WE HAVE A HISTORY OF LOSSES AND ARE UNABLE AT THIS TIME TO PREDICT WHEN WE WILL
BE ABLE TO TURN PROFITABLE.
We have incurred net losses since our inception. For the nine months
ended September 30, 2002 and for the years ended December 31, 2001, 2000 and
1999, we had net losses applicable to common shareholders of approximately $7.4
million, $8.9 million, $31.1 million, and $5.6 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 positive operating cash flow or that our revised business
plan will allow us to generate 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 shareholders' equity. For the nine months September
30, 2002, we had a net loss applicable to common shareholders of approximately
$7.4 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 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 continue to 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 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.
28
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. Nasdaq
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. We received a letter dated October 14, 2002, from
the staff of the NASDAQ Stock Market, or NASDAQ, which notified us that the bid
price for our common stock had been below $1.00 per share for a period of thirty
consecutive days. NASDAQ advised us that we would be given a period of ninety
days within which to comply with the minimum bid price requirement in order to
maintain the listing of our common stock on the NASDAQ National Market. If we
are unable to demonstrate compliance with the minimum bid requirement for ten
consecutive days on or before January 13, 2003, NASDAQ will provide us with
written notification that our common stock will be delisted. At that time we may
appeal the staff's decision to a NASDAQ Listing Qualification Panel. In the
alternative, we may apply to transfer our securities to the NASDAQ SmallCap
Market. If we submit a transfer application and pay the applicable listing fees
by January 13, 2003, initiation of de-listing proceedings will be stayed pending
NASDAQ's review of our transfer application. If the transfer application is
approved, we will have a 180 day grace period ending on April 14, 2003 from
meeting the NASDAQ SmallCap listing requirements and will be eligible for an
additional 180 day grace period if we meet the initial listing requirements for
the NASDAQ SmallCap Market. We intend to pursue all available options to meet
the NASDAQ listing requirements. If our common stock is delisted from the NASDAQ
National Market, sales of our common stock would likely be conducted on the
SmallCap Market or in the over-the-counter market. This may have a negative
impact on the liquidity and price of our common stock and investors may find it
more difficult to purchase or dispose of, or to obtain accurate quotations as to
the market value of, our common stock.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.
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 shareholders 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.
29
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY CHANGES IN SUPPLIERS OF OUR
LEASED-LINE CONNECTIONS, OUR INABILITY TO RENEGOTIATE TERM COMMITMENTS WITH SUCH
SUPPLIERS OR DELAYS IN DELIVERY OF SERVICES FROM SUCH SUPPLIERS.
From time to time, we are dependent on third party suppliers for our
leased-line connections or bandwidth. The term of these contracts are of varying
lengths and may in certain instances exceed the term of the contract with the
customer. As a result, from time to time during the terms of our customer
contracts, we may be required to extend the terms of our current leased-line
connection contracts, enter into new contracts with third-suppliers in order to
maintain adequate levels of bandwidth or seek to terminate contracts with
vendors based upon network utilization and customer related cancellations. To
the extent that these suppliers increase prices, are unwilling to renegotiate
terms or have difficulty in delivering their services, we may incur a loss and
or be required to develop alternative sources for such services. If we are
unable to negotiate extended terms with our current third-party suppliers, or we
are unable to enter into new contracts with other third-party suppliers, in a
timely manner or under terms that are acceptable to us, our ability to fulfill
our obligations under our customer contracts may be hindered and could have an
adverse effect on our business.
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
could be harmed since this more limited staff could limit our ability to obtain
new customers, sell products and services and provide existing customers with a
high level of technical support.
WE 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:
o national Internet service providers and regional and local
Internet service providers, including any remaining viable
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
30
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 OUR TARGET CUSTOMERS OF THE
INTERNET FOR COMMERCE AND COMMUNICATION.
If the use of the Internet by businesses and 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.
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.
31
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 a limited number of companies as our
primary 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;
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.
32
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 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 is 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, the Federal Communications Commission has concluded that at
least a substantial portion of dial-up Internet traffic is jurisdictionally
interstate, and has adopted plans for gradually eliminating the reciprocal
compensation payment requirement for Internet traffic. If the FCC completes its
planned elimination of reciprocal compensation payments, 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 an alternative mechanism for covering the costs
of terminating calls to Internet service providers. In the interim, state
commissions will determine whether carriers will receive compensation for such
calls. If the new compensation mechanism 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.
Although 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, a recently-adopted Pennsylvania statute subjects Internet service
providers to fines and potential imprisonment and felony charges for failing to
disable access to child pornography within five days of notification by the
state Attorney General's office. We could be subject to this law after it goes
into effect on April 20, 2002. Although it is not possible for us to predict the
outcome, it is possible that this law could be ruled unconstitutional.
OUR PRIOR USE OF ARTHUR ANDERSEN LLP AS OUR INDEPENDENT PUBLIC ACCOUNTANT COULD
IMPACT OUR ABILITY TO ACCESS THE CAPITAL MARKETS.
Our consolidated financial statements as of and for each of the three
years in the period ended December 31, 2001 were audited by Arthur Andersen LLP.
On March 14, 2002, Andersen was indicted on federal obstruction of justice
33
charges arising from the government's investigation of Enron Corporation.
Following this event, our Audit Committee directed management to consider the
need to appoint new independent public accountants. On July 31, 2002, at the
direction of the Board of Directors, acting upon the recommendation of the Audit
Committee, we dismissed Andersen and appointed KPMG LLP as our new independent
public accountants for fiscal year 2002. On June 15, 2002, a jury found Andersen
guilty on the government's charges.
SEC rules require us to present our audited financial statements in
various SEC filings, along with Andersen's consent to our inclusion of its audit
report in those filings. However, Andersen is unable to provide a consent to us
for inclusion in our future SEC filings relating to its report on our
consolidated financial statements as of and for each of the three years in the
period ended December 31, 2001. Additionally, Andersen is unable to provide us
with assurance services, such as advice customarily given to underwriters of our
securities offerings and other similar market participants. The SEC recently has
provided regulatory relief designed to allow companies that file reports with
the SEC to dispense with the requirement to file a consent of Andersen in
certain circumstances. Notwithstanding this relief, the inability of Andersen to
provide its consent or to provide assurance services to us in the future could
negatively affect our ability to, among other things, access the public capital
markets. Any delay or inability to access the public markets as a result of this
situation could have a material adverse impact on our business. Also, an
investor's ability to seek potential recoveries from Andersen related to any
claims that an investor may assert as a result of the audit performed by
Andersen may be limited significantly both as a result of an absence of a
consent and the diminished amount of assets of Andersen that are or may in the
future be available to satisfy claims.
AS A RESULT OF OUR LATE FILING OF A CURRENT REPORT ON FORM 8-K, IT MAY BE MORE
TIME CONSUMING AND COSTLY FOR US TO CONSUMMATE ADDITIONAL OFFERS AND SALES OF
EQUITY AND DEBT SECURITIES IN ACCORDANCE WITH APPLICABLE SECURITIES LAWS. AS A
RESULT, OUR ABILITY TO RAISE CAPITAL THROUGH THE PUBLIC CAPITAL MARKETS MAY BE
HINDERED.
In the event that the Company determines it is necessary to raise
additional capital to fund its activities, we may explore the possibility of
accessing the public capital markets. Because of the Company's inability to
timely file a Current Report on Form 8-K in connection with the NetAxs
acquisition, under the SEC's rules relating to public offerings of securities,
the Company is not currently eligible to issue securities under a Form S-3 and
will not be eligible to use Form S-3 to register additional securities in
connection with a public offering until it has made timely filings of periodic
reports with the SEC for at least twelve calendar months after August 2003.
Under the SEC's rules relating to the registration of securities to be sold in a
public offering, a registration statement on Form S-3, as opposed to a Form S-1,
permits issuers to provide more streamlined disclosure by incorporating by
reference previously filed information with the SEC. As a result of the
Company's inability to use Form S-3 in connection with the registration of
securities, the process of registering debt or equity securities of the Company
before August 2003 will be more costly and require significantly more time to
consummate. In the event that our ability to access the public capital markets
is limited in time, or becomes too costly for us to complete, we may be unable
to raise additional capital in this manner.
34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Form of Demand Note relating to certain officers of
the Registrant.
99.1 Certification of Chief Executive Officer of the
Company pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification of Chief Financial Officer of the
Company pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K
On July 30, 2002, the Company filed a Current Report on Form
8-K relating to the Company's change in its independent public
accountant.
On August 14, 2002, the Company filed a Current Report on Form
8-K relating to the Company's acquisition of certain assets of
AppliedTheory.
35
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 19, 2002 /s/ Stephen A. Hurly
-----------------------------------
Stephen A. Hurly
Chief Executive Officer
Date: November 19, 2002 /s/ Ward Schultz
-----------------------------------
Ward Schultz
Chief Financial Officer (Principal
Financial & Accounting Officer)
36
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen A. Hurly, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FASTNET Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002
/s/ Stephen A. Hurly
-----------------------
Stephen A. Hurly
Chief Executive Officer
37
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Ward Schultz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FASTNET Corporation.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002
/s/ Ward Schultz
----------------------------------
Ward Schultz
Chief Financial Officer (Principal
Financial & Accounting Officer)
38
EXHIBIT INDEX
-------------
10.1 Form of Demand Note relating to certain officers of the
Registrant.
99.1 Certification of Chief Executive Officer of the Company
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer of the Company
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
39